William Ward

Practical Advice Regarding Pooling Clauses

Pooling is a fundamental concept within oil and gas law, but one that is often misunderstood. Pooling is most commonly defined as “the combining of two or more tracts of land into one unit for drilling purposes … accomplished voluntarily, or through compulsion.”¹ In other words, it is how a lessee is able to extend a lease without physically drilling on the lease. For private (fee) oil and gas leases, the ability of the lessee to pool the lease is typically addressed in the lease provisions. These provisions are known as the pooling clause. This article provides some practical tips in dealing with the issues that arise from pooling clauses.

The first question that should be asked is if there is an existing spacing order in place for the lands and formation(s) involved. Many pooling clauses provide that the lease can only be pooled in conformity with a spacing order from the applicable state regulatory agency. If you encounter such a clause, you will need to check for a state spacing order, and if an order is not already in place, you will need to initiate the required steps to obtain an order. There may also be an order in place that does not match your proposed operation. If so, a new order would need to be obtained modifying the existing order. If spacing is governed by statewide spacing, you will want to double check the language in the pooling clause to confirm that statewide spacing is sufficient.

If the proposed well will be a horizontal well, there are special considerations that need to be addressed. Some lease provisions specifically address horizontal spacing. Many states have special statewide rules that are in place for horizontal wells. Particular attention should be paid to any total acreage limitation included in the pooling clause of the lease, for example, the lease cannot be included in a pooled unit for oil greater than 160 acres. If the lease has this limitation, an amendment to the lease may be the best option to eliminate this conflict.

The next question when reading a pooling clause is what role, if any, the lessor will have in the pooling process. The most common oil and gas lease terms allow the lessee to pool the lease without obtaining any additional consent from the lessor. In some cases, if the lessor desires to retain this right, they will strike out the pooling provision in the entirety, or add a specific lease provision requiring their consent. If the lease does not have a pooling clause, or if the pooling clause is stricken, the lease can only be pooled with the express consent of the lessor. This consent would be expressed by having the lessor execute a pooling agreement. The pooling agreement should be recorded to provide third parties with notice of the terms of the agreement. If obtaining consent is not an option, compulsory pooling by the governing state agency would be the alternative.

Some leases require that notice of the pooling be provided to the lessor in order for the pooling to be effective. If the pooling clause requires that notice be mailed to the lessor, an effort should be made to locate both the last address of record and a current address, utilizing online resources. If a more recent address is discovered, the notice should be mailed to both the address of record and the new address that was located. More commonly, the lease requires that for it to be properly pooled, a proper declaration of pooling needs to be executed and recorded by the lessee in the applicable county. Care should be taken in drafting the declaration of pooling. It should be signed by all parties owning a working interest in the lease. In order to be recorded, the signatures will need to be originals and it will need to be notarized. It should describe the specific lease(s) being pooled, including the recording information (Book/Page, Entry No.) for each lease. It should cite the authority to pool contained in the lease, for example: “Pursuant to Paragraph 10 of the lease.” It should define the pool, the total lands included and the formation(s) covered. If the lease covers more lands than what is being pooled, the declaration should describe all of the lands covered by the lease. This is particularly important in states that utilize a tract index recording system. If the pooling is in conformity with a state spacing order, it should be noted. If the party executing the declaration was not the original lessee, a statement as to the succession (Book/Page, Entry No. of the document transferring the interest in the lease) should be included. If the operator is drilling the well to earn an interest in the lease from another party, for example under a farmout agreement, it is recommended that the declaration be executed by both the record title owner and the party that is to earn the interest. Doing this would avoid any dispute as to the correct party to execute the declaration. Once executed, confirmation should be made that the declaration of pooling is properly recorded and, if it is a tract index state, that it is has been properly indexed against the lands.

Confirmation should be made that the effective date of the pooling is either the date of, or prior to the date, of first production. The effective date should also be prior to the termination date of the lease. Most lease provisions provide that the declaration of pooling must be prior to lease expiration. In the event the well was drilled prior to lease expiration, but the declaration of pooling was not timely recorded in order to avoid any issue, the lessor should execute a pooling declaration which includes a statement that the lease was properly pooled prior to the expiration date of the lease.

Finally, after reading the specific pooling provisions in the leases to be pooled, a broader examination of some additional issues raised by pooling the lease should be conducted. Confirmation should be made that all of the leases to be pooled are private leases. If the pool includes either federal, Indian, or state leases, additional steps will be needed to pool these leases. As to state leases, various state agencies have adopted different rules and procedures regarding private pooling agreements. As to federal and Indian leases, there are two ways to pool them: a federally approved unit or communitization agreement. The nuances of federal unitization and communitization will be further explored in a subsequent article in this series.

¹ Patrick H. Martin and Bruce M. Kramer, Williams & Meyers, Oil and Gas Law § P Terms. (LexisNexis Matthew Bender 2016).

Proceeds from Production: You Have to Know When to Hold ‘Em

Once an oil or gas well has been drilled and begins producing, one of the critical title decisions that a landman or division order analyst must make is when to hold proceeds in suspense. Most oil and gas producing states have a statute requiring that proceeds be paid to owners within a set amount of time after the date of first production or a penalty is imposed on the operator.¹ If it is determined by a court or administrative agency that proceeds were not timely paid and were instead held in suspense improperly, the penalty on the operator can be imposed retroactively and can be substantial.²

As an initial matter, it is important to distinguish between proceeds that are not paid because they are suspended and proceeds that are not paid because the owner cannot be located to receive the payment. In the event an owner entitled to proceeds cannot be located, the proceeds are technically deemed unclaimed, not suspended. If the last address of record for the payee is no longer current, the operator is required to conduct an inquiry reasonably calculated to locate the owner. This should include a review of both traditional and online databases. Evidence of this search should be maintained in case there is a future challenge. If the owner remains unlocatable after completing a diligent search, the proceeds should be treated as unclaimed and the ultimate disposition of the funds will be governed by the unclaimed property statutes within the state of the last known address. Suspended funds, on the other hand, are not subject to the unclaimed property statute and it is not uncommon for suspense accounts to continue to accrue proceeds for many years. It is also possible to have proceeds attributable to an owner who are both in suspense and are unclaimed. This is often the case for unlocatable heirs or devisees of a decedent when there is no completed probate proceeding. In this case, because the proceeds are subject to potential multiple claims, they are suspended until the probate action is concluded and then, if the interest is vested but the owner is unlocatable, the proceeds become unclaimed property. We note that it is also possible for an owner to change from unlocatable to suspended. For example, if further research discloses that a payee is deceased, the proceeds should then be held in suspense until the necessary curative is recorded to properly vest title in the decedent’s heirs or devisees.

An operator may choose to obtain a division order title opinion to assist it in confirming the title of the owners, locating the last address of record for the owners, and making the decision for which owners, if any, to hold proceeds in suspense. Several oil and gas producing states provide a measure of legal protection to an operator if it acts in accordance with a title opinion when deciding to suspend proceeds.³

One recent decision from North Dakota highlights the potential danger in making the decision to suspend proceeds. In the unreported decision of Tank v. Burlington Res. Oil and Gas Co., LP,⁴ the U.S. District Court ruled that an operator unjustifiably held in suspense the proceeds payable to a royalty owner whose mineral interest was subject to an existing mortgage that predated the oil and gas lease. First, the title attorney indicated that that there was a risk in having the lease invalidated upon a foreclosure and required a subordination of the mortgage to the lease. Second, because the mortgage contained what appeared to be an absolute assignment of production proceeds, the title attorney indicated that confirmation should be made as to who should receive the proceeds. Both of the requirements appear to be reasonably necessary to protect the operator from potential liability. The court, however, determined that neither issue qualified as an “existing” dispute that justified holding the proceeds in suspense. As to the presence of the existing mortgage, the court said that until there was an actual foreclosure there was no title dispute. As to the uncertainty of which party was entitled to receive proceeds, the court said that a determination should have been made based on the records and a check cut to someone.

The standard set forth in this case reaffirms the need to have a division order title opinion that clearly articulates the owners whose proceeds should be suspended and sets forth the nature of the dispute which authorizes the suspension. The dispute should be one that is not easily resolved and contains the potential for the operator to be exposed to multiple liability. Operators should insist that their title examiners provide clear instructions as to the nature and scope of the title defect, the exact portion of the owner’s interest that should be held in suspense, and include detailed guidance as to the curative required to be completed before the proceeds should be paid. By law in some states (or, as a matter of good practice, in those states without a statutory requirement), a copy of the title opinion requirement (but only that requirement) outlining the issue causing the suspension should be provided to the owner. This information should be provided to the owner prior to the statutory deadline to make the first payment.

Finally, whether to suspend proceeds for any owner is ultimately the decision of the operator, and not the title attorney. The business risk of a potential challenge can always be assumed and payments made even though a title examiner instructed that proceeds should be suspended. As a practical matter, there may be situations where there is a legal defect in title that authorizes suspension, but the real risk of a challenge is remote and the operator may elect to assume the risk and not hold the interest in suspense, particularly where the operator’s interest is derived from the potentially disputed interest. If the division order title opinion does not provide sufficient facts to enable an operator to make this decision, the operator should inquire of the title examiner to fully understand and analyze the risk that would be assumed if the payments were made with the title defect outstanding.

¹See Colo. Rev. Stat. Ann. §§ 34-60-118 and -118.5; Mont. Code. Ann. § 82-10-110; Nev. Rev. Stat. Ann. § 522.024; N.M. Stat. Ann. § 48-9-6; N.D. Cent. Code Ann. § 47-16-39.3; Tex. Bus. & Com. Code Ann. § 9.319; Tex. Nat. Res. Code Ann. §§ 91.401, 91.402, and 91.403; Utah Code Ann. §§ 40-6-8 and -9; Wyo. Stat. Ann. § 30-5-305.
²The possibility of a retroactive penalty adds to the risk for a new operator that assumes responsibility for distributing proceeds already held in suspense when it acquires a prior operator’s property.
³In New Mexico and Utah the protection is limited to the opinion of an attorney licensed in the state. See N.M. Stat. Ann. § 70-10-5; Utah Code Ann. § 40-6-9(8).
⁴No. 4:10-CV-088, 2013 WL 3766526 (D.N.D. July 16, 2013).