Chris LeCates

Risky Business: Uncertain Outcomes for Application of Bankruptcy Code 365

Bankruptcy

Variations in How States Treat Oil & Gas Leases Make Dispositions Complicated

Ability of a debtor to assume, assign, or reject oil and gas “leases” under section 365 of the Bankruptcy Code

Section 365(a) of the Bankruptcy Code (11 U.S.C. § 365) provides that “the trustee, subject to the court’s approval, may assume or reject any executory contract or unexpired lease of the debtor.” On the face of the statute, it would appear an oil and gas lease may be rejected in bankruptcy as an “unexpired lease.” However, as one court has held, “[t]he term ‘oil and gas lease’ is a misnomer because the interest created by an oil and gas lease is not the same as an interest created by a lease governed by landlord and tenant law.” In re Topco, Inc., 894 F.2d 727, 740, n.17 (5th Cir. 1990).1 This “misnomer” used by the industry for oil and gas leases, along with inconsistent interpretation by the various states, has created issues regarding whether section 365 is applicable. And, even if the oil and gas lease is not considered a “lease” for purposes of section 365, it might in the alternative be considered an executory contract, and still subject to section 365. As discussed below, these questions are usually decided based on the property laws of the relevant state, with the answer oftentimes hinging on whether oil and gas leasehold interests are considered a vested fee interest in real property. If state law treats oil and gas leases as conveying a vested fee interest (also referred to as a “freehold interest”), it is unlikely they will be deemed an “executory contract or unexpired lease” subject to section 365. See Topco, Inc., 894 F.2d at 740.

Whether an agreement is an “executory contract” is a question of federal law. (see Cameron v. Pfaff Plumbing and Heating, Inc., 966 F.2d 414 (8th Cir.1992)), but is informed to a considerable extent by state law principles the bankruptcy court is bound to respect. In re Aurora Oil & Gas Corp., 439 B.R. 674 (Bankr. W.D. Mich. 2010). Specifically, state law governs the extent of a debtor’s interest in property. See Butner v. U.S., 440 U.S. 48 (1979). This includes the classification of oil and gas leases as freehold or leasehold, which is important in determining whether it may be set aside as an unexpired lease under section 365. See In re Topco, Inc., 894 F.2d at n.17 (stating that, in Texas, oil and gas leases do not constitute unexpired leases subject to section 365).

Are Oil and Gas Leases Unexpired Lease?

Oil and gas leases are usually entitled “Oil and Gas Lease” and the parties are referred to as “lessor” and “lessee,” with a reversionary interest in favor of the grantor. These factors support an argument that section 365 allows rejection of the “lease.” Nevertheless, the majority of state? courts that have addressed whether oil and gas leases are unexpired leases subject to section 365 have determined that they are not. For example, a bankruptcy court indicated that, with respect to oil and gas leases in Texas, they do not constitute unexpired leases subject to section 365 because they convey interests in real property. Matter of Topco, Inc., 894 F.2d 727, n.17 (5th Cir. 1990). An Illinois bankruptcy court likewise concluded the oil and gas lease in question did not constitute an “unexpired lease” within the meaning of section 365(d)(4), where an oil and gas lease grants a freehold estate under Illinois law, rather than leasehold. In re Hanson Oil Co., Inc., 97 B.R. 468, 472 (Bankr. S.D. Ill. 1989).

Interestingly, an Oklahoma bankruptcy court held that oil and gas leases are not unexpired leases subject to section 365 under the real property laws of Oklahoma, although based on slightly different reasoning. See In re Clark Res., Inc., 68 B.R. 358, 359 (Bankr. N.D. Okla. 1986). The court reasoned that an Oklahoma oil and gas agreement grants a profit à ‘prendre rather than a leasehold estate, and thus the unexpired lease portion of 11 U.S.C. section 365, does not apply to the Oklahoma oil and gas lease. “The interest created by an oil and gas lease in Oklahoma is not ‘real estate’ and conveys no interest in land itself, it is a chattel real, an incorporeal hereditament and a profit à ‘prendre which is in the nature of a license to explore by drilling and permits the lessee to capture oil and gas which is then treated as personalty.” Id.

A federal district court in Ohio also found the oil and gas leases in that case were not leases of nonresidential real property within the meaning of sections 365(d)(4) and 365(m), but nevertheless concluded that the bankruptcy court’s holding that the leases were forfeited under section 365(d)(4) was erroneous. In re Frederick Petroleum Corp., 98 B.R. 762, 767 (S.D. Ohio 1989). The court believed that “the Ohio courts, if given the opportunity to do so, would characterize the property interest involved as being like or similar to the interest recognized under Oklahoma law.” Id. at 766.

Conversely, the court in Aurora Oil & Gas Corp. considered oil and gas leases rental agreements to use real property and therefore “leases” within the meaning of section 365. The court emphasized the differences, citing state law:

Michigan treats a lessee’s interest as a leasehold or profit á prendre, but not a freehold estate. In this significant respect, Michigan departs from the law of Texas and several other oil and gas states that apparently regard a lessee’s interest under an oil and gas lease as a freehold or fee.

In re Aurora Oil & Gas Corp., 439 B.R. at 678.

Are Oil and Gas Leases Real Property Interests?

State laws characterizing the nature of oil and gas leases can be analyzed to speculate whether a lease in any given state might be rejected in bankruptcy, but the answer is not clear in most instances. Many courts have addressed whether oil and gas leases are “real property” interests,2 and the Fifth Circuit in Matter of Topco, Inc., 894 F.2d 727, n.17 (5th Cir. 1990), indicated this classification would be determinative of whether the lease can be rejected in bankruptcy; however, the other bankruptcy courts cited above analyzed whether oil and gas leases are freehold real property interests (as opposed to leasehold interests which may also be considered a type of real property) – not simply whether or not an oil and gas lease is real property. While potentially helpful in guessing what a court might hold, we do not think classification as “real property” is necessarily determinative of whether a lease will be rejected under section 365; and, unfortunately, there is not a lot of caselaw addressing the freehold – leasehold dichotomy in the context of oil and gas leases.3 We note that in those states that have determined oil and gas leases are personal property, we believe there is an increased likelihood such leases would be rejected in bankruptcy under section 365.

Are Oil and Gas Leases Executory Contracts?

Those seeking to apply section 365 to an oil and gas leasehold interest may alternatively argue that the documents underlying the interest are executory contracts.4 “Though neither the Bankruptcy Code nor the predecessor Bankruptcy Act defines the term ‘executory contract,’ many courts have adopted the Countryman definition [being that an executory contract is one under which the obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete perform would constitute a material breach excusing the performance of the other],5 or some variation of it.”6 Id. “However, because [the oil and gas lessor] often has nothing more to do than ‘sit back and collect royalty payments’ or wait for the reversion to occur by operation of law, the Countryman definition typically prevents finding conveying documents to be executory contracts.” See id. (citations omitted).

Courts in some jurisdictions have concluded that oil and gas leases are executory contracts,7 while other courts have determined they are not.8 Interestingly, in interpreting Louisiana law which classifies an oil and gas lease as real property, the bankruptcy court in Texaco Inc. v. Louisiana Land and Exploration Co., 136 B.R. 658, 668 (M.D. La. 1992), states that while a mineral lease constitutes “real rights,” this court concludes that the Louisiana mineral lease is an “executory contract” within the meaning of section 365(a). Other courts have been critical of this decision. For example, another Louisiana bankruptcy court declined to follow Judge Parker’s interpretation of executory contracts in Texaco, holding that “the mineral leases at issue in the present case do not constitute ‘executory contracts’ within the Countryman definition as adopted by the 5th Circuit.” In re WRT Energy Corp., 202 B.R. 579, 584 (Bankr. W.D. La. 1996). The court in WRT Energy also concluded that oil, gas, and mineral leases vest the lessee with real rights, which “clearly supports a finding that the [oil, gas, and mineral lease] is not an unexpired lease within the meaning of section 365 of the Bankruptcy Code. Id.

Does Classification of an Oil and Gas Lease Hinge on Production?

A Pennsylvania bankruptcy court has concluded oil and gas leases are initially an executory contract, but that the classification changes once production is obtained. In re Powell, 482 B.R. 873 (Bankr. M.D. Pa. 2012), order vacated on other grounds in part, 2015 WL 6964549 (M.D. Pa. 2015).9 The court reasoned that if gas had been produced prior to the bankruptcy filing, then section 365 would not apply because at that point, the gas company would have been vested with a fee simple determinable interest (apparently, akin to a vested fee or freehold interest) in the oil and gas – so effectively the gas company would have been producing its own gas. Id. 10 Under this reasoning, the interest is characterized as a lease or an executory contract under section 365 is moot. Id. 11

The question about whether oil and gas leases are “executory contracts” has been decided, at least by one court, based on the moment in which the oil and gas lessee’s freehold estate vested, which is not necessarily the moment the lease is executed. This rationale presents a risk that courts may initially consider an oil and gas lease to be an executory contract. The Pennsylvania bankruptcy court’s decision is based on the characterization of oil and gas leases under Pennsylvania law. In this respect, the law in most states and cases we have reviewed do not indicate that vesting of oil and gas leasehold rights might be delayed. However, in Pennsylvania and West Virginia, which are the states that appear to have made such a determination, the oil and gas freehold estate vests at the time production begins, or at the time oil and gas is found.12

Conclusion

The risk that an oil and gas lease will be rejected in the event of a filing under section 365 of the Bankruptcy Code depends primarily on the relevant state’s property laws, so there is no certainty of outcome.. Debtors or potential purchasers of an oil and gas lease should thoroughly examine the property laws of the governing state and, if available, any relevant bankruptcy court decisions applying those respective state laws in the context of section 365 to properly assess the risk of rejection.

1But see Texaco Inc. v. Louisiana Land & Expl. Co., 136 B.R. 658, 665 (M.D. La. 1992), stating that the reasoning in Topco was dicta.

2Within the Tenth Circuit, the majority of courts have concluded that oil and gas leases are real property rights. See, e.g., Gaddis v. McDonald, 633 P.2d 1102 (Colo. App. 1981) (overriding royalty interest in respect to oil and gas leases is real property interest); Terry v. Humphreys, 1922-NMSC-013, 27 N.M. 564, 203 P. 539 (an oil and gas lease for a period of five years, or as long thereafter as oil and gas, or either of them, is produced from said land by the lessee, conveys “real property”); Dame v. Mileski, 80 Wyo. 156, 340 P.2d 205 (1959) (overriding royalty interest reserved by assignor of oil and gas lease was real property); Chase v. Morgan, 9 Utah 2d 125, 339 P.2d 1019, 1021 (1959) (oil and gas leases are real estate); c.f. First Nat. Bank v. Dunlap, 1927 OK 67, 122 Okla. 288, 254 P. 729 (interest of lessee under oil and gas lease is not “real estate”); High Plains Oil, Ltd. v. High Plains Drilling Program-1981, Ltd., 263 Kan. 1, 946 P.2d 1382 (1997) (Oil and gas leases are personal property).

Within the Fifth Circuit, courts have generally concluded that oil and gas leases convey real property rights. See, e.g., In re WRT Energy Corp., 202 B.R. 579, 137 O.G.R. 315 (Bankr. W.D. La. 1996) (holding that oil and gas interests in Louisiana grant “real rights,” rather than “personal rights,” thereby preventing their characterization as unexpired leases); Rogers v. Ricane Enterprises, Inc., 772 S.W.2d 76 (Tex. 1989) (an oil and gas lease conveys an interest in real property as does an assignment of all or a portion thereof); Nygaard v. Getty Oil Co., 918 So. 2d 1237, 1241 (Miss. 2005) (indicating that Mississippi would follow Texas law in interpreting the nature of oil and gas leasehold rights).

States within the Eighth Circuit have likewise have generally determined that oil and gas leases are interests in real property. See Coral Prod. Corp. v. Cent. Res., Inc., 273 Neb. 379, 730 N.W.2d 357 (2007) (an interest in an oil and gas lease is an interest in real property to the extent that it grants the lessee the right to remove minerals from the land); ANR W. Coal Dev. Co. v. Basin Elec. Power Co-op., 276 F.3d 957, 965 (8th Cir. 2002) (overriding royalty holders have an interest that is a form of real property under North Dakota law); Greene Cty. v. Smith, 148 Ark. 33, 228 S.W. 738 (1921) (indicating oil and gas leases are real property, which is defined as including not only the land itself but also buildings and all rights and privileges appertaining thereto). We note that we are not aware of any state cases in South Dakota, Iowa, Minnesota, or Missouri that clearly address this question.

3We are aware of the following cases addressing this issue: Cravens v. Hubble, 375 Ill. 51, 52, 30 N.E.2d 622, 623 (1940) (“An oil and gas lease which remains in force as long as oil and gas are produced, involves a freehold”); Alphonzo E. Bell Corp. v. Listle, 74 Cal. App. 2d 638, 646, 169 P.2d 462, 467 (1946) (referring to an oil and gas lease, the court stated “She was thereby immediately vested with a present interest in the land, an estate tantamount to a freehold”); In re Clark Res., Inc., 68 B.R. 358, 359 (Bankr. N.D. Okla. 1986) (Oklahoma oil and gas agreement grants a profit à ‘prendre rather than a leasehold estate); In re Aurora Oil & Gas Corp., 439 B.R. at 678 (Michigan treats a lessee’s interest as a leasehold or profit á prendre). Ralston v. Thacker, 932 S.W.2d 384, 387 (Ky. Ct. App. 1996) (“An oil and gas lease is an interest in real estate generally termed a ‘chattel real’ and is an estate less than freehold or fee-simple interest. “); Pearson v. Black, 120 S.W.2d 1075 (Tex. Civ. App. 1938) (title to all gas, coal and other minerals granted by oil and gas lease constituted a “freehold estate” in lands being a “determinable fee estate”); Somont Oil Co. v. A & G Drilling, Inc., 2002 MT 141, 310 Mont. 221, 49 P.3d 598 (appearing to treat the lessee as acquiring a fee simple determinable estate) (overruled on other grounds). See also infra note 12, indicating oil and gas leases include a freehold estate under Pennsylvania law, but that the vesting of this estate is delayed until production is obtained. However, if oil or gas is produced, a fee simple determinable is created in the lessee. See Sabella v. Appalachian Dev. Corp., 2014 PA Super 237, 103 A.3d 83, 101 (2014).

4See Oil and Gas Interests, Commercial Bankruptcy Litigation § 8:45.

5See, e.g., In re Kemeta, LLC, 470 B.R. 304 (Bankr. D. Del. 2012); In re Midwest Portland Cement Co., 174 Fed. Appx. 34, 46 Bankr. Ct. Dec. (CRR) 45 (3d Cir. 2006); In re Grand Chevrolet, Inc., 26 F.3d 130 (9th Cir. 1994); In re Sunterra Corp., 361 F.3d 257, 42 Bankr. Ct. Dec. (CRR) 222, 51 Collier Bankr. Cas. 2d (MB) 1276, Bankr. L. Rep. (CCH) P 80068 (4th Cir. 2004); Matter of Chicago, R. I. & P. R. Co., 604 F.2d 1002, 1004, 5 Bankr. Ct. Dec. (CRR) 618, 21 C.B.C. 305, Bankr. L. Rep. (CCH) P 67225 (7th Cir. 1979) (Bankruptcy Act case); Jenson v. Continental Financial Corp., 591 F.2d 477, 481, Bankr. L. Rep. (CCH) P 67051 (8th Cir. 1979) (Bankruptcy Act case). See also, In re Ravenswood Apartments, Ltd., 338 B.R. 307, 46 Bankr. Ct. Dec. (CRR) 16, Bankr. L. Rep. (CCH) P 80455, 2006 FED App. 0002P (B.A.P. 6th Cir. 2006); Dollar Development I, LLC v. Village Green Properties, Ltd., 2006 WL 572709 (W.D. Mich. 2006); In re Helm, 335 B.R. 528, 45 Bankr. Ct. Dec. (CRR) 281, 55 Collier Bankr. Cas. 2d (MB) 817 (Bankr. S.D. N.Y. 2006); In re FV Steel and Wire Co., 331 B.R. 385, 45 Bankr. Ct. Dec. (CRR) 119, 61 Env’t. Rep. Cas. (BNA) 1566, 35 Envtl. L. Rep. 20196 (Bankr. E.D. Wis. 2005); In re Nickels Midway Pier, LLC, 332 B.R. 262, 45 Bankr. Ct. Dec. (CRR) 163, 55 Collier Bankr. Cas. 2d (MB) 236 (Bankr. D. N.J. 2005), aff’d in part, rev’d on other grounds in part and remanded, 341 B.R. 486, 46 Bankr. Ct. Dec. (CRR) 126, 55 Collier Bankr. Cas. 2d (MB) 1854 (D.N.J. 2006), order aff’d, 255 Fed. Appx. 633, 49 Bankr. Ct. Dec. (CRR) 35 (3d Cir. 2007).

6See Matter of C & S Grain Co., Inc., 47 F.3d 233, 26 Bankr. Ct. Dec. (CRR) 939, Bankr. L. Rep. (CCH) P 76395 (7th Cir. 1995) (“For purposes of the Bankruptcy Code, an executory contract is one in which the obligations of each party remain substantially unperformed.”); In re Mirant Corp., 440 F.3d 238, 46 Bankr. Ct. Dec. (CRR) 13, 55 Collier Bankr. Cas. 2d (MB) 1050, Bankr. L. Rep. (CCH) P 80453 (5th Cir. 2006) (holding that Congress intended the term “executory contract” in the Bankruptcy Code to refer to a contract on which performance remains due to some extent on both sides); Cameron v. Pfaff Plumbing and Heating, Inc., 966 F.2d 414 (8th Cir. 1992) (holding that “performance remains due to some extent,” as a definition of an “executory contract,” is equivalent to the Countryman definition); Turner v. Avery, 947 F.2d 772, 22 Bankr. Ct. Dec. (CRR) 495, Bankr. L. Rep. (CCH) P 74349 (5th Cir. 1991) (holding that an attorney’s contingent fee contract is executory if further legal services must be performed by the attorney before the matter may be brought to a conclusion); Gibson v. Resolution Trust Corp., 51 F.3d 1016, 26 U.C.C. Rep. Serv. 2d 547 (11th Cir. 1995) (recognizing that courts have characterized executory contracts as those with “remaining reciprocal obligations”); cf. In re Becknell & Crace Coal Co., Inc., 761 F.2d 319, 322 (6th Cir. 1985) (“[E]xecutory contracts involve obligations which continue into the future…. They include leases, employment contracts and agreements to buy or sell in the future.”) (quoting source omitted); In re General Development Corp., 84 F.3d 1364 (11th Cir. 1996) (approving the use of the “functional approach,” under which “the question of whether a contract is executory is determined by the benefits that assumption or rejection would produce for the estate”).

7See Texaco Inc. v. Louisiana Land and Exploration Co., 136 B.R. 658, 668 (M.D. La. 1992).

8See Laugharn v. Bank of America Nat. Trust & Savings Ass’n, 88 F.2d 551 (9th Cir.1937).

An Oklahoma bankruptcy court, held that oil and gas leases are not executory contracts subject to section 365, based on Oklahoma property law related to oil and gas leases. See supra In re Clark Resources, Inc., 68 B.R. 358 (Bkrtcy. N.D. Okl. 1986). Where the lessee’s only remaining obligation was payment of money and the lessor’s only remaining obligation is to defend their title and not interfere with lessee’s operations, the court apparently concluded this would not satisfy the Countryman definition pertaining to executory contracts, as neither party is “saddled with complex obligations to perform” and “[b]reach of these duties by the lessor or lessee would not excuse performance by the party not in breach, but would merely abate the obligation of the non-breaching party for as long as the breaching party was in breach.” See id. at 359-360.

9The Court apparently rejected the Bankruptcy Court’s determination that an oil and gas lease conveys as a matter of law, up until the point of production, an inchoate right that is subject to rejection under section 365– instead, one must look to the terms of the instrument to determine what interest has been conveyed.

10The court references the Pennsylvania Supreme Court’s decision in T.W. Phillips Gas and Oil Co. v. Jedlicka, 615 Pa. 199, 42 A.3d 261 (2012), which constructed a special interpretation of an oil and gas lease as conveying a title that is inchoate and allowing exploration only until oil or gas is found, regardless of the linguistics used in the lease. “If development during the agreed upon primary term is unsuccessful, no estate vests in the lessee. If, however, oil or gas is produced, a fee simple determinable is created in the lessee, and the lessee’s right to extract the oil or gas becomes vested.” Id. at 267.

11But oil and gas had not been produced at the time of the bankruptcy filing. Instead of analyzing whether the oil and gas lease was an executory contract, the In re Powell court concluded that the lease was an “unexpired lease” agreement “to use real property” and was subject to section 365(m) of the Bankruptcy Code. See also In re Tayfur, 505 B.R. 673, 682–83 (Bankr. W.D. Pa.), aff’d, 513 B.R. 282 (W.D. Pa. 2014), aff’d, 599 F. App’x 44 (3d Cir. 2015).

12E.g., In re Powell, 482 B.R. 873, 175 O.G.R. 187 (Bankr. M.D. Pa. 2012), order vacated on other grounds in part, 2015 WL 6964549 (M.D. Pa. 2015) (“Until oil or gas is produced, no freehold estate vests in the lessee.”); Hutchinson v. McCue, 101 F.2d 111 (C.C.A. 4th Cir. 1939)(under West Virginia law, lessee under oil and gas lease for fixed term and as long thereafter as oil shall be produced and rentals paid acquires in the first instance a mere license or inchoate right to go on the land and explore for oil and gas, but after oil or gas is found, the lessee acquires a vested interest therein); Headley v. Hoopengarner, 60 W. Va. 626, 55 S.E. 744 (1906) (the lessee has no vested estate therein until it is discovered).

NDIC To Hold Special Hearing on Potential Output Restrictions

Oil and Gas Regulations

Last month, North Dakota adopted a waiver program that allowed O&G producers to keep wells in non-completed or inactive status longer than regulations typically permitted. The policy was designed to prevent producers from either bringing more unwanted crude to market or being forced to abandon wells.

Now, North Dakota is looking into requiring oil and natural gas production cuts. The North Dakota Industrial Commission (“NDIC”) has announced the Oil and Gas Division of the Department of Mineral Resources has scheduled a special hearing for May 20 on whether or not the current production of oil and natural gas at low prices is a waste of energy pursuant to North Dakota Century Code § 38-08-02(19); the consequences of determining that waste is occurring, and what relief may be appropriate and necessary to prevent the waste of North Dakota crude oil production.

Under N.D.C.C. § 38-08-03, waste of oil and gas is prohibited. Section § 38-08-04, N.D.C.C., provides that the commission has authority to determine whether waste exists or is imminent, and to limit and allocate production of oil and gas from any field, pool, or area and to establish and define as separate marketing districts those contiguous areas within the state which supply oil and gas to different markets, and to limit and allocate the production of oil and gas for each separate marketing district. Section § 38-08-06 provides further guidelines for determining market demand and regulate the amount of production in marketing districts:

The commission shall determine market demand for each marketing district and regulate the amount of production as follows:

1. The commission shall limit the production of oil and gas within each marketing district to that amount which can be produced without waste, and which does not exceed the reasonable market demand.

2. Whenever the commission limits the total amount of oil or gas which may be produced in the state or a marketing district, the commission shall allocate or distribute the allowable production among the pools therein on a reasonable basis, giving, where reasonable under the circumstances to each pool with small wells of settled production, an allowable production which prevents the general premature abandonment of such wells in the pool.

. . . .

5. . . . The commission shall allocate the total allowable for the state in such manner as prevents undue discrimination between marketing districts, fields, pools, or portions thereof resulting from selective buying or nomination by purchasers.

In the past, the above statutes have rarely been utilized by the NDIC; however, the May 20 special hearing by the NDIC could potentially lead to output restrictions. Lynn Helms, director of the Oil and Gas Division of the state’s Department of Mineral Resources, previously advised against a decision to order output pro-rationing. The commission has asked oil and natural gas producers to weigh in on a wide array of oil market issues and the challenges of cutting or shutting in production. Written comments are due to the commission by May 15.

North Dakota will join Oklahoma in considering a similar proposal. Oklahoma regulators have enabled producers to voluntarily shut in their wells, but will revisit that decision and consider issuing an additional order in May that could force operators to limit oil production rates to prevent waste. A similar order was proposed in Texas that would have required oil companies operating in Texas to cut production by 20 percent, but after a month-long debate, Texas energy regulators on Tuesday said they will not wade into global oil politics to mandate oil production cuts for the first time in 50 years, despite crude oil’s plummet to historic lows.

EPA Issues Temporary Policy for Violations Caused By COVID-19

Oil and Gas Regulations, , , ,

On March 26, 2020 EPA issued a temporary policy for enforcement of environmental legal obligations during the COVID-19 pandemic. The policy provides the framework for the agency’s use of its enforcement discretion where COVID-19 related worker shortages and governmental restrictions affect facility operations and impede the ability of regulated entities to comply with EPA requirements. The policy does not extend to Superfund or Resource Conservation and Recovery Act (“RCRA”) corrective actions, which will be subject to forthcoming guidance, or pesticide imports under the Federal Insecticide, Fungicide, and Rodenticide Act (“FIFRA”).

Broadly speaking, the policy states that EPA will forego enforcement of certain civil violations where compliance is not reasonably practicable due to the COVID-19 pandemic, subject to compliance with specified reporting and documentation requirements. The application of enforcement discretion does not apply to criminal violations of environmental statutes and EPA indicates it will distinguish between unavoidable violations that result from COVID-19 restrictions and violations resulting from intentional disregard of legal requirements.

EPA’s policy applies different standards based on the category of potential noncompliance. If compliance with routine monitoring and reporting—such as stack testing, water and effluent sampling, inspections or training—is not reasonably practicable due to COVID-19, entities should report noncompliance using existing procedures as set forth in permit or statute. If such procedures do not exist, facilities must develop documentation and maintain noncompliance information internally. Ultimately, the better a facility’s documentation of how COVID-19 exigencies made compliance reasonably impracticable, the more likely EPA will be to forego enforcement.

The policy likewise provides guidelines for the following situations:

  • settlement agreement and consent decree reporting obligations and milestones;
  • facility operations impacted by COVID-19 that create an acute risk or imminent threat to human health or the environment;
  • facilities suffering from failure of air emission control, wastewater or waste treatment systems, or other equipment that may result in exceedances;
  • hazardous waste generators;
  • animal feeding operations;
  • public water systems regulated under the Safe Drinking Water Act; and
  • critical infrastructure.

Regardless of the situation, entities must first make every effort to comply with environmental compliance obligations. If compliance is not reasonably practicable because of circumstances caused by COVID-19, entities must do the following to be covered by the policy:

  1. Minimize effects and duration of any noncompliance caused by COVID-19;
  2. Identify the specific nature and dates of noncompliance;
  3. Identify how COVID-19 was the cause of noncompliance and decisions and actions taken in response;
  4. Return to compliance ASAP;
  5. Document the information and actions in 1–4.

Compliance with steps 1–5 is a condition of coverage under the policy.

Effective Period Starting March 13. The policy is retroactive—it applies to noncompliance events occurring from March 13 until the policy is terminated. During the effective period, the policy applies in lieu of otherwise applicable EPA policies. Even after the policy is revoked, noncompliance events that occurred during the effective period will be covered by the policy.

Caution! State Enforcement. The policy applies only to EPA enforcement actions—authorized states and tribes may take a different approach. It is likely that state agencies will issue their own parallel guidance in the coming days and weeks, and permittees should look to those policies in states that have delegated authority to administer environmental programs.

What Is Excluded? The policy does not apply to:

  • activities carried out under Superfund and RCRA Corrective Action enforcement instruments, although EPA indicated that separate guidance will be issued to address these programs;
  • pesticides and related imports;
  • requirements for preventing, responding to, and reporting accidental releases of oil and hazardous substances;
  • on-going enforcement matters.

This article was authored by Emily Schilling, Ashley Peck, Chris LeCates, and Hayley Siltanen.

We encourage you to visit Holland & Hart’s Coronavirus Resource Site, a consolidated informational resource offering practical guidelines and proactive solutions to help companies protect their business interests and their workforce. The dynamic Resource Site is regularly refreshed with new topics and updates as the COVID-19 outbreak and the legal and regulatory responses continue to evolve. Sign up to receive updates and for upcoming webinars.

Idaho Court Voids 845 Federal Leases

Federal Lands, News Blasts, Oil and Gas Cases

United States District Court in Idaho voids numerous federal oil and gas leases in sage-grouse habitat areas within Nevada, Utah, and Wyoming, and sets aside corresponding Trump administration leasing procedures, while reinstating more stringent standards implemented during the Obama administration.[1]

In a win for environmentalists, a federal district court judge in Idaho voided 845 federal oil and gas leases in greater sage-grouse habitat areas issued in 2018 in Nevada, Utah, and Wyoming, finding Trump administration leasing policies are invalid.  These leases and leasing policies, which were aimed at streamlining and simplifying the federal leasing process, were challenged as part of a broader effort to block drilling in habitat for the greater sage-grouse-an area that spans 67 million acres across 11 Western states.

In 2018, under the Trump administration, Bureau of Land Management (“BLM”)[2] leasing procedures changed with the implementation of the BLM’s Instruction Memorandum (“IM”) 2018-034.  Western Watersheds Project and Center for Biological Diversity (collectively “WWP”), sued the BLM and the Secretary of the Interior in the federal district court in Idaho, asking the court to (1) vacate IM 2018-034 and, correspondingly, (2) vacate the leases issued under IM 2018-034.  The State of Wyoming and oil and gas industry association Western Energy Alliance intervened in the action (collectively, with the BLM and Secretary of the Interior, referred to herein as “Defendants”). 

Initially, the court entered a preliminary injunction requiring that, for oil and gas leases scheduled for the fourth quarter of 2018 and thereafter, the BLM must use procedures in the Obama-era instruction memorandum, IM 2010-117, and discontinue the use of conflicting procedures in IM 2018-034.[3]  Thereafter, the court conducted a hearing to consider WWP claims that the Trump-era policy, IM 2018-034 (which affects environmental analysis of oil and gas leases), violates environmental law and revised previously existing BLM leasing processes without any public procedures (notice and comment) or environmental review.[4] The court issued its order as discussed below.

INVALIDATION OF IM 2018-034

Initially, the court concluded that IM 2018-034 is final agency action and thus subject to judicial review under the Administrative Procedures Act (“APA”). The court found that IM 2018-034 unequivocally replaces IM 2010-117, is effective immediately, and compliance therewith is mandatory,[5]being a final agency action, made up of both policy and rule.[6] Because it is subject to judicial review, the court next addressed whether it is procedurally and substantively valid.

To be procedurally valid, i.e. validly implemented, the court analyzed whether IM 2018-034 is a statement of policy that is exempt from requisite APA/FLPMA[7] notice-and-comment procedures.  The court concluded IM 2018-034 is not a general statement of policy and, thus, is a substantive rule that should have been issued through notice-and-comment procedures, but was not. Therefore, IM 2018-034 was invalidly implemented.[8]

To be substantively valid, the terms of IM 2018-034 must be valid. The court concluded its terms improperly constrain public participation in BLM oil and gas leasing decisions.  The court stated, “Public involvement in oil and gas leasing is required under FLPMA and NEPA,” and whether IM 2018-034 sufficiently allows for such public involvement “must be a complete ‘yes.’”[9] However, the court held IM 2018-034 does “not quite” allow sufficient public involvement under FLPMA and NEPA.[10]

Finally, apparently as an additional reason for invalidating IM 2018-034 for procedural deficiencies, the court stated, “[u]nder the APA, agency action may be set aside if it is arbitrary and capricious,”[11] and “[t]he agency’s administrative record reveals no analysis that would explain or justify the transition from IM 2010-117 to 2018-034 and the resulting curtailment of the public’s involvement in oil and gas leasing decisions on public land.”[12]  Thus, the court concluded IM 2018-034’s issuance was arbitrary and capricious.[13] “Faster and easier lease sales, at the expense of public participation, is not enough.”[14]

Based on the foregoing, the court set aside IM 2018-034’s at-issue provisions and IM 2010-117’s corresponding provisions were reinstated until the BLM completes a prior notice-and-comment rulemaking to govern its lease review process.[15]

INVALIDATION OF LEASE SALES IN SAGE-GROUSE HABITAT MANAGEMENT AREAS

The parties do not dispute that the BLM applied IM 2018-034 in approving the “Phase One Lease Sales,” more particularly described as the following lease sales:

  • June 2018 Wyoming
  • June 2018 Nevada
  • September 2018 Wyoming
  • September 2018 Nevada
  • September 2018 Utah

Defendants essentially argue “no harm no foul,” claiming that, despite application of IM 2018-034 to the Phase One Lease Sales, WWP was not prevented from submitting substantive comments on the sales and WWP, in fact, did so.[16] The court was unconvinced, stating that, “with more time to comment on the Phase One Lease Sales, WWP and other organizations would have more meaningfully participated in the process and, relatedly, put BLM on notice.”[17]  “Yet, not being allowed to participate at the leasing stage, or in having to hurriedly clamber to do so because of IM 2018-034’s condensed comment and protest periods, oil and gas leases have been issued without the full benefit of public input.”[18]

Although the court rejected Defendants’ “no harm no foul” argument, the court did limit the impact of its decision to those oil and gas leases that affect greater sage-grouse habitats.[19]  The court concluded, “a nationwide directive to all oil and gas lease sales throughout the United States, without regard to whether such lease sales implicate sage-grouse habitat, is not justified.”[20]  “Therefore, the remedy here – setting aside certain of IM 2018-034’s provisions in favor of IM 2010-117’s – applies to oil and gas lease sales contained in whole or in part within the Sage-Grouse Plan Amendments’ recognized ‘Planning Area Boundaries’ encompassing ‘Greater Sage-Grouse Habitat Management Areas,’ as indicated in the following BLM Map: ”[21]

IM 2010-117 was thus reinstated by the court, but its application was limited to areas within the Planning Area Boundaries identified in the foregoing map.

PHASE ONE LEASE SALES SET ASIDE AND PRELIMINARY INJUCTION APPLYING TO SUBSEQUENT LEASE SALES CONFIRMED

Based on the foregoing, the court set aside the Phase One Lease Sales, stating that “setting aside the Phase One Lease Sales will not be so disruptive as to merit an exception from the standard remedy of vacatur.”[22]  Based on the court’s holding, each of the Phase One Leases presumably is contained in whole or in part within the Planning Area Boundaries, but we have not separately confirmed this fact. The WWP identified in its complaint the specific leases issued under these sales, which list we have attached hereto.

The court also addressed the previously entered preliminary injunction, which applied the Obama standards to sales scheduled for the fourth quarter of 2018 and thereafter, determining that the rationale behind issuing the preliminary injunction remains solid. As such, the court likewise entered partial summary judgment in WWP’s favor in that respect.[23]

CONCLUSIONS

The Western Energy Alliance indicated that it plans to appeal and the State of Wyoming will be doing so as well.  They are coordinating with the BLM and Department of Justice to determine their response.  Among the criticisms of the order are that the Obama standards, IM 2010-117, likewise failed to undergo any notice-and-comment rulemaking, as is the nature of Instruction Memorandums, and that the judge in this case simply preferred one to the other.

The following pages contain a list of leases relevant to this order, as identified in WWP’s Second Amended Complaint.  This list includes the following categories of leases:

1.         Phase One Lease Sales (sales from the June and September 2018 lease sales in Nevada, Utah, and Wyoming) which, as discussed above, were specifically set aside by the court’s order.  It is not clear whether there were other lease sales during these June and September 2018 periods that might implicate sage-grouse habitat.

2.         Lease sales for the fourth quarter of 2018 and the first quarter of 2019.  The court indicates that, in accordance with its preliminary injunction, the BLM postponed upcoming December 2018 lease sales in sage-grouse habitats to follow the Obama procedures contained in IM 2010-117.  Accordingly, the court did not specifically set aside these “post-Phase One Leases” (as we have identified them in the following list).  Presumably, if such leases have been issued, they were issued in accordance with IM 2010-117.  However, we have not confirmed this information, and it will need to be separately investigated. We also have not confirmed that the attached list, which was obtained from WWP’s complaint, includes all federal oil and gas leases in sage-grouse habitats issued in the last quarter of 2018 and thereafter.

3.         Various lease sales in 2017 and 2018 prior to the second quarter of 2018.  These “pre-Phase One Leases” (as we have identified them in the following list) were outside the scope of the court’s order (which addressed pending motions pertaining to IM 2018-034 under WWP’s Fourth and Fifth Claims for Relief).  Nevertheless, the validity of these pre-Phase One leases is still at issue in the action and yet to be decided. Because these “pre-Phase One Leases” were not addressed in the court’s order, we have not investigated the nature of the claims surrounding these leases, nor have we confirmed that it is an exhaustive list of leases that might be implicated by WWP’s remaining claims.

For your convenience, we have separately identified/categorized the pre-Phase One Leases, Phase One Leases, and post-Phase One Leases.

[1] Western Watersheds Project, & Center for Biological Diversity v. Ryan K. Zinke, Sec’y of Interior; David Bernhardt, Deputy Sec’y of Interior; & United States Bureau of Land Management, & State of Wyoming; Western Energy Alliance, No. 1:18-CV-00187-REB, 2020 WL 959242, at *1 (D. Idaho Feb. 27, 2020).

[2] The BLM being the federal agency handling leasing of federal oil and gas interests.

[3] Id. at *2.

[4] Id. at *3. The court did not address arguments as to another instruction memorandum, IM 2018-026, apparently because this applied to other Claims for Relief and the pending “partial” summary judgment motions pertained specifically to IM 2018-034. See id.

[5] Id. at **3, 10, 11.

[6] Id. at *27.

[7] Federal Land Policy and Management Act of 1976.

[8] Id. at *15.

[9] Id.

[10] National Environmental Policy Act.

[11] Id. at *18 (citing 5 U.S.C. § 706(2)(A)).

[12] Id. at *20.

[13] Id.

[14] Id.

[15] Specifically: for all succeeding oil and gas lease sales, (1) use of IM 2018-034, Section III.A – “Parcel Review Timeframes” is enjoined and replaced with IM 2010-117, Section III.A – “Parcel Review Timeframes;” (2) use of IM 2018-034, Section III.B.5 – “Public Participation” is enjoined and replaced with IM 2010-117, Section III.C.7 – “Public Participation;” (3) use of 2018-034, Section III.D. – “NEPA Compliance Documentation” is enjoined and replaced with IM 2010-117, Section III.E – “NEPA Compliance Documentation;” and (4) use of IM 2018-034, Section IV.B – “Lease Sale Parcel Protests” is enjoined and replaced with IM 2010-117, Section III.H – “Lease Sale Parcel Protests.”

[16] Id. at **20-21.

[17] Id. at *25.

[18] Id.

[19] Western Watersheds Project, 2020 WL 959242 at *27.

[20] Id.

[21] Id. at *28.

[22] Id. at *30 (“Instead, because of the violations already welded into the Phase One Lease Sale process, vacatur here will avoid harm to the environment and further the purposes of NEPA and FLPMA.”)

[23] Id. at *2.

How Are Federal Oil and Gas Leases Pooled and Unitized?

FAQs of Federal Oil and Gas Leases, Federal Lands, Oil and Gas Agreements, Oil and Gas Regulations, Uncategorized, , , , , , ,

In the context of federal oil and gas leases, the terms “communitization” and “unitization” are distinct concepts which are subject to different statutes, regulations, and procedures. As such, the method to “communitize” a federal oil and gas lease is different than the process used to “unitize” such leases. These respective differences are highlighted herein.

Communitization of Federal Oil and Gas Leases

Virtually all oil and gas producing states have promulgated minimum acreage requirements for the drilling of oil or gas wells.[1]  The United States recognized the importance of state conservation statutes, and accordingly passed an amendment to the Mineral Leasing Act which allowed federal lessees to conform to state well spacing orders through a communitization agreement.[2]  Communitization is the agreement to combine small tracts, of which one or more is federal or Indian lands, for the purpose of committing enough acreage to form the spacing/proration unit necessary to comply with the applicable state conservation requirement and to provide for the development of these separate tracts which cannot be independently developed in conformity with said conservation requirements.[3] In essence, communitization is the federal equivalent of pooling the lands in a spacing/proration unit under state law.  The common thread of all federal communitization agreements is that at least one federal or Indian lease or tract must be involved.[4]  That federal or Indian lease is communitized with other leases that may be federal, Indian, state, or fee.[5]

Although there is no prescribed form for a federal communitization agreement in the regulations, the regulations do require that certain information be included within the communitization agreement.  There are relatively few requirements for communitization agreements, but the applicant must usually provide sufficient information so the authorized officer can make a determination that it would be in the best interests of conservation and of the United States for the federal leasehold to be communitized.[6]  Specifically, the agreement must describe the separate tracts comprising the drilling or spacing unit, describe the apportionment of production or royalties to the parties, name the operator, contain adequate provisions for the protection of the interests of the United States, be filed prior to the expiration of the federal leases involved, and be signed by or on behalf of all necessary parties.[7]  The BLM Manual 3160-9-Communitization includes a standard or model communitization agreement form, one for federal leases and one for Indian leases, which should be used whenever possible.[8]

The necessary parties include all working interest owners and lessees of record. A communitization agreement may be approved without joinder by the royalty, overriding royalty, and production payment interest owners, but this will result in different payment scenarios depending upon the location of a successfully completed well.[9]

 If a state has them, the state’s compulsory pooling statutes may be utilized to commit a nonconsenting party’s interest to the communitization agreement; although, without the consent of the Secretary of the Interior, the state commission does not have jurisdiction to force pool unleased interests of the United States.[10]  Copies of any compulsory/force pooling order should be furnished with and be part of the communitization agreement if such interest owner does not execute the agreement.[11]  The authorized officer in the appropriate BLM office must approve, on behalf of the Secretary, the communitization agreement with respect to any included federal leases.[12]

Although not mandatory, the filing of a Preliminary Application for Approval to Communitize is recommended, particularly in instances where the model form of communitization agreement is not followed precisely.[13]  The BLM Manual provides that a request for preliminary approval to communitize may be filed at any time with the authorized officer. It is also recommended that preliminary approval be requested if there is some doubt as to whether the proposed tracts are logically subject to communitization, or if there is any doubt as to whether a communitization of multiple zones will be approved. The preliminary approval procedure will expedite final approval and may avoid the necessity of extensive revisions and re-execution of a finalized communitization agreement.[14]

The BLM will not approve an agreement that purports to communitize all horizons from the surface down to the center of the earth.[15] However, if it is anticipated that the well will be completed in multiple formations, it is important to include all formations and horizons that are producing or may produce hydrocarbons intended to be allocated pursuant to the terms of the communitization agreement.[16]  All communitized formations must be subject to the same spacing requirements and, where multiple and clearly distinct formations are covered by the same communitization agreement, the BLM Manual provides that Section 1 be amended to clearly state that the agreement shall apply separately to each formation as though a separate communitization agreement for each formation had been executed.[17]  In the event a proposed well is projected to test multiple formations that are subject to different spacing requirements, separate communitization agreements should be submitted to BLM for each formation or set of formations with the same spacing requirements.[18]

The communitization agreement must be filed prior to the expiration of the federal leases to be communitized.[19]  The regulations require that the communitization agreement be filed in triplicate with the proper BLM office.[20]  If state lands are involved one additional counterpart must be submitted.

An executed counterpart of the approved communitization agreement, duly acknowledged, should be filed of record in the county in which the land is located. When fee leases are involved, the operator should record either the communitization agreement or otherwise comply with the terms of the pooling provision of any fee lease.[21]

In order to approve a communitization agreement, the Mineral Leasing Act requires that the Secretary determine communitization is “in the public interest”[22]:

The public interest requirement for an approved communitization agreement shall be satisfied only if the well dedicated thereto has been completed for production in the communitized formation at the time the agreement is approved or, if not, that the operator thereafter commences and/or diligently continues drilling operations to a depth sufficient to test the communitized formation or establish to the satisfaction of the authorized officer that further drilling of the well would be unwarranted or impracticable.”[23]

Communitization agreements usually provide for a term of two years and so long thereafter as communitized substances are, or can be, produced from the communitized area in paying quantities.[24]  Assuming the public interest requirement is satisfied, any federal lease eliminated from an approved communitization agreement, or any federal lease in effect at the termination of the agreement, shall continue in effect for the original term of the federal lease or for two years after its elimination from the plan or termination of the agreement, whichever is longer, and for so long thereafter as oil or gas is produced in paying quantities.[25]  No lease shall be extended if the public interest requirement has not been satisfied.[26]

Unitization of Federal Oil and Gas Leases

Unitization is the agreement to jointly operate an entire producing reservoir or a prospectively productive area of oil and/or gas. The entire unit area is operated as a single entity, without regard to lease boundaries, and allows for the maximum recovery of production from the reservoir. Costs are reduced because the reservoir can be produced by utilizing the most efficient spacing pattern, separate tank batteries are not necessary, and there is no requirement to drill unnecessary offset wells. The objective of unitization is to provide for the unified development and operation of an entire geologic prospect or producing reservoir so that exploration, drilling, and production can proceed in the most efficient and economical manner by one operator.[27]

The Bureau of Land Management is the administering agency for federal onshore units and has established procedures that must be followed to unitize federal lands.[28] Although not required by the regulations, the BLM strongly encourages an informal discussion with the authorized officer of BLM office having jurisdiction over the area where the lands are located concerning the proposed area of the unit, the depth of the test well and formation to be tested, and the form of agreement.[29]  This should be done prior to filing of an application.[30] It is recommended that this is done in order to ensure the unit approval process moves smoothly.

BLM regulations provide that,  to initiate the formation of a federal unit, an application for designation of a proposed unit area be filed in duplicate.[31] The application must be accompanied by a map or diagram outlining the area sought to be designated and indicating the federal, state, privately owned, or Indian lands by symbols or colors.[32]  The plat must indicate the separate leasehold interests involved and identify them by serial number in the case of federal and Indian oil and gas leases.[33]  It is advisable to show the ownership and expiration dates of each lease involved. The application must also be accompanied by a geologic report and it must indicate the zones that are to be unitized (if all zones or formations are not to be included).[34]

The owners of any interest in the oil and gas deposits to be unitized are proper parties to the unit agreement. All such parties must be invited to join the agreement.[35] This includes royalty owners and holders of overriding royalty interests and any other non-cost bearing interests in production, as well as working interest owners. Prior to approval, notice of the proposed agreement must be given to all parties with a request to join the agreement.[36]  When state lands are to be unitized with federal lands, the unit agreement must be approved by the state prior to submission to the BLM for final approval.[37]

After the unit area has been designated and the unit agreement has been fully executed by the parties desiring to commit their interests to the unit, a minimum of four signed counterparts must be filed for approval with the proper BLM office.[38]  These instruments should be accompanied by a request from the proponent for final approval of the unit, setting forth the acreage interests fully committed, effectively committed, partially committed, and not committed and show the percentage in each category.[39]  A showing must also be made that all parties owning not committed interests within the unit area have been extended an invitation to join in the unit agreement and that a reasonable effort has been made to obtain the joinder of all such parties.[40]  The request for final approval must include a list of the overriding royalty interest owners who have executed or ratified the unit agreement.[41] A tract will be considered “fully committed” if all interest owners have joined the unit and all working interest owners have also executed the applicable operating agreement.[42] A tract will be considered “effectively committed” to the unit without joinder by overriding royalty interest owners and will be treated identically as a “fully committed” tract, but, will result in different payment scenarios depending upon the location of the successfully completed unit well.[43] A tract will be considered “partially committed” if less than all of the lessors/royalty interest owners have joined, or all operating rights owners of a federal lease have joined but the record title holder has not.[44]  Such partially committed tracts may be considered to be under the effective control of the unit operator, however, no unit benefits will accrue to the tract in the absence of actual operations on the partially committed tract or an allocation of production to that tract either from a well on the tract or from another location.[45] Finally, if any working interest owner in a tract does not commit its interest, that tract is deemed “not committed.”[46]  BLM regulations provide that a unit agreement will not be approved “unless the parties signatory to the agreement hold sufficient interests in the unit area to provide reasonably effective control of operations.”[47] Generally, 85% of the tracts in the unit must be fully, effectively or partially committed to meet this “effective control” requirement.[48]

After four signed counterparts of the executed agreement are submitted, the authorized officer approves the unit agreement upon a determination that the agreement is necessary or advisable in the public interest and is for the purpose of more properly conserving natural resources.[49] A model federal onshore unit agreement for unproven areas (hereinafter “Model Form”) is included in the BLM regulations and promulgated to help implement these provisions.[50] Section 9 of the Model Form specifically provides for the commencement of an initial test well within six months after the effective date of the unit.[51] If a discovery is not made in the initial test well, provision is made for continuous drilling on unitized lands until a discovery is made provided that not more than six months elapse between the completion of one well and the commencement of the next.[52]  Paying quantities for purposes of meeting the drilling obligations in section 9 is defined as quantities of unitized substances sufficient to repay the costs of drilling, completing, and producing operations, with a reasonable profit.[53]

Upon approval, the unit agreement becomes effective.[54]  However, the public interest requirement is satisfied only if the unit operator commences actual drilling operations and diligently prosecutes such operations in accordance with the terms of the agreement.[55]  If this requirement is not satisfied, the approval of the agreement and lease segregations and extensions shall be invalid.[56]  Evidence of the approved unit should be recorded in the county records to impart notice.

Finally, it is important to understand the interplay between the unit agreement and the unit operating agreement because both agreements, taken together, constitute the unit arrangement and establish the contractual rights and obligations of the parties.

In addition to setting forth the terms and conditions for the unit, the unit agreement prescribes the method of allocating production for purposes of determining royalties, overriding royalties, production payments, and other non-cost bearing burdens, but does not dictate the working interest owners’ respective shares of production or the allocation of costs/royalty burdens associated therewith.[57] These, and other duties and obligations among the working interest owners, are matters covered by the unit operating agreement.[58]

The BLM does not prescribe any particular form of unit operating agreement and the working interest owners are generally free to use whatever form of unit operating agreement they prefer.[59] The unit operating agreement is entered into by the working interest owners who are committing their interests to the unit in conjunction with the execution of the unit agreement.[60] The interests of the royalty owners are not affected by the form of unit operating agreement chosen by the working interest owners.[61] Two copies of the unit operating agreement are required to be filed in the proper BLM office before the unit agreement will be approved.[62]

[1] Angela L. Franklin, Communitization Agreements in the 21st Century, Federal Onshore Oil and Gas Pooling and Communitization, Paper 3-4 (Rocky Mt. Min. L. Fdn. 2006) [hereinafter Communitization Agreements].

[2] See Mineral Leasing Act, Pub. L. No. 696, § 17(b), 60 Stat. 952 (1946).

[3] See 2 Lewis C. Cox, Jr., Law of Federal Oil and Gas Leases § 18.01 (2017).

[4] Communitization Agreements, supra note 2, at 3-5.

[5] Id.

[6] 1 Bruce M. Kramer & Patrick H. Martin, The Law of Pooling and Unitization § 16.04 (3rd ed. 2017).

[7] 43 C.F.R. § 3105.2-3(a) (2018).

[8] Communitization Agreements, supra note 2, at 3-5.

[9] Id.

[10] Id. at 3-6.

[11] Id.

[12] 43 C.F.R. § 3105.2-3 (2018).

[13] Communitization Agreements, supra note 2, at 3-7.

[14] See id.

[15] Id. at 3-8.

[16] Id.

[17] Bureau of Land Management, BLM Manual 3160-9-Communitization .11M (1988) [herein after BLM Manual].

[18] Communitization Agreements, supra note 2, at 3-8.

[19] 43 C.F.R. § 3105.2-3(a) (2018).

[20] Id. § 3105.2-1.

[21] Communitization Agreements, supra note 2, at 3-10.

[22] 30 U.S.C. § 226(m) (2018).

[23] 43 C.F.R. § 3105.2-3(c) (2018).

[24] See Section 10 of Model Form of a Federal Communitization Agreement in BLM Manual app.

[25] 43 C.F.R. § 3107.4 (2018). But see, R. E. Hibbert, 8 IBLA 379 (1972), GFS (O&G) 6 (1973).

[26] 43 C.F.R. § 3107.4 (2018).

[27] Kramer & Martin, supra, § 18.01[2].

[28] Id. § 18.04[1].

[29] Kramer & Martin, supra, § 18.04[2].

[30] See id.

[31] 43 C.F.R. § 3183.2 (2018)

[32] Kramer & Martin, supra, § 18.04[3] (citing 43 C.F.R. §§ 3181.2, 3183.2).

[33] See id. § 18.04[3].

[34] See 43 C.F.R. § 3181.2 (2018).

[35] 43 C.F.R. § 3181.3 (2018).

[36] See Kramer & Martin, supra, § 18.04[4].

[37] 43 C.F.R. § 3181.4(a) (2018).

[38] 43 C.F.R. § 3183.3 (2018).

[39] See Kramer & Martin, supra, § 18.04[6].

[40] Id. (citing 43 C.F.R. § 3181.3).

[41] See Kramer & Martin, supra, § 18.04[6].

[42] See Frederick M. MacDonald, Preparing and Finalizing the Unit Agreement: Making Sure Your Exploratory Ducks are in a Row, Federal Onshore Oil and Gas Pooling and Communitization, Paper 8-23 (Rocky Mt. Min. L. Fdn. 2006).

[43] Id. at 8-24.

[44] Id.

[45] Id.

[46] Id. at 8-25.

[47] 43 C.F.R. § 3183.4(a) (2018)

[48] MacDonald, supra, at 8-16.

[49] See Kramer & Martin, supra, § 18.04[6]. (citing 43 C.F.R. § 3183.4).

[50] See Thomas W. Clawson, Paying Well Determinations, Federal Onshore Oil and Gas Pooling and Communitization, Paper 11-3 (Rocky Mt. Min. L. Fdn. 2006).

[51] See Model Form, § 9, 43 C.F.R. § 3186.1.

[52] See Kramer & Martin, supra, § 18.03[2][b][iii].

[53] Model Form, § 9, 43 C.F.R. § 3186.1.

[54] Kramer & Martin, supra, § 18.04[6] (citing Lario Oil & Gas Co., 92 IBLA 46, GFS(O&G) 54 (1986)).

[55] Kramer & Martin, supra, § 18.04[7].

[56] 43 C.F.R. § 3183.4(b) (2018).

[57] See Steven B. Richardson and Lynn P. Hendrix, The Unit Operating Agreement for Federal Exploratory Units, Oil and Gas Agreements: Joint Operations, Paper 13-3 (Rocky Mt. Min. L. Fdn. 2008).

[58] Id.

[59] Id. at 13-1.

[60] Id. at 13-3.

[61] Id.

[62] Id.