title owner

What Are the Types of Interests in Federal Oil and Gas Leases and How Are They Assigned?

FAQs of Federal Oil and Gas Leases, Federal Lands, , , , , ,

Federal oil and gas leases are administered by the Bureau of Land Management (“BLM”) pursuant to the Mineral Leasing Act of 1920, as amended (“MLA”), and the implementing federal regulations. Federal leases have a slightly different ownership scheme than fee oil and gas leases. As to fee leases, the lessee owns a leasehold interest that includes the right to drill for and produce the leased substances, subject to royalty payments to the lessor. The term “working interest” is commonly used and is generally considered synonymous with the lessee’s interest and the term “leasehold interest.” As to federal leases, the lessee’s leasehold interest includes both record title and operating rights. Initially, these two types of interests are merged together as  the record title interest, but the operating rights interest can be severed from the record title interest by assignment.  The record title interest includes the obligation to pay rent and the rights to assign and relinquish the lease.[1] The operating rights interest authorizes the holder to drill for and conduct operations and produce the leased substances.[2] When all or a portion of the operating rights have been severed from the record title, the operating rights interest owner is primarily liable for its pro rata share of payment obligations under the lease while the record title interest owner is secondarily liable.[3] At the extreme, if all of the operating rights as to all depths are severed by assignment from the record title interest, the lessee owns “bare” record title interest and has no rights to drill for and produce the leased substances. The term “working interest” is generically associated with the operating rights interest unless said operating rights interest has not been severed from the record title interest, then it is associated with the record title interest. Otherwise, the range of interests that may be created out of federal leases is nearly the same as fee leases.

The interests in federal leases are generally conveyed by a “transfer,” being defined in the federal regulations as “any conveyance of an interest in a lease by assignment, sublease or otherwise.”[4] Set forth below is a discussion of the different types of interests that may be transferred in federal leases and whether the instrument transferring the interest must be filed with and approved by the BLM.[5]

Record Title Interests

The MLA and federal regulations use the term “assignment” for a transfer of all or a portion of the lessee’s record title interest in a lease.[6] All assignments of record title interests must be on the currently approved BLM form Assignment of Record Title Interest in a Lease for Oil and Gas or Geothermal Resources, Form 3000-003.[7] Record title interests may be transferred as to all or part of the acreage in the lease or as to either a divided or undivided interest therein.[8] Record title interests may not be transferred as to limited depths or horizons, separately as to either oil or gas, less than part of a legal subdivision,[9] or less than 640 acres (outside of Alaska).[10]

Upon receipt of the assignment, the BLM will engage in an “adjudication” process whereby the BLM will determine and identify the owners of interests and their percentage interest in the lease as a consequence of the assignment and approve the assignment if it meets all statutory and regulatory requirements. The rights of the assignee will not be recognized by the BLM until the assignment has been approved.[11]

Operating Rights Interests

The MLA and federal regulations use the term “sublease” for a transfer of a non-record title interest in a lease, including a transfer of operating rights. All transfers of operating rights interests must be on the currently approved BLM form Transfer of Operating Rights (Sublease) in a Lease for Oil and Gas or Geothermal Resources, Form 3000-3a.[12] For transfers of operating rights interests, the MLA and federal regulations do not contain any limitations on such transfers other than it must be as to “all or part of the acreage in the lease.”[13]

Upon receipt of the transfer, the BLM will engage in the adjudication process to determine and identify the owners of interests and their percentage interest in the lease as a consequence of the transfer and approve the assignment if it meets all statutory and regulatory requirements. The rights of the transferee will not be recognized by the BLM until the transfer has been approved.[14]  However there was a period of time where most state offices of the BLM did not adjudicate transfers of operating rights.

Beginning in 1985, the BLM issued internal guidance, Washington Office Instruction Memorandum No. 1986-175 (Dec. 30, 1985) (“IM 1986-175”), stating that it was not necessary for the BLM to “adjudicate” operating rights assignments[15] on the grounds that they are third-party contracts. The BLM adjudicators were instructed to stop adjudicating operating rights transfers, and to instead “rubber stamp” them within 30 days of their submission when there was no “evidence to the contrary regarding qualifications and proper bonding.”[16] Accordingly, most BLM offices began accepting transfers of operating rights and “approved” the transfers without confirming and determining the ownership of the operating rights interests. In 2013, the BLM issued Instruction Memorandum No. 2013-105 (April 4, 2013) (“IM 2013-105”), directing all BLM offices to immediately begin again adjudicate transfers of operating rights interests.[17]  Understanding that there would be a backlog to carry this out this directive, IM 2013-105 provides a priority schedule for adjudicating existing and future transfers of operating rights as follows: if first production occurs on or after October 1, 2012, adjudicate all transfers of operating rights immediately; if first production occurred prior to October 1, 2012, adjudicate as necessary to enable the Office of Natural Resources Revenue (“ONRR”) to issue appropriate orders to the owners; and adjudicate all remaining unadjudicated operating rights transfers when time and staffing allows.

Obviously, the BLM offices are faced with trying to adjudicate and determine the current operating rights interest owners based on over thirty years of potentially incomplete and possibly erroneous transfers contained in the BLM lease files. A survey was conducted in 2017 of the following BLM State Offices to determine how they were implementing IM 2013-105 and adjudicating transfers of operating rights.[18]

Colorado

For leases occurring prior to 2012, the Colorado State Office is only conducting reviews for leases with production at the request of ONRR. When it discovers discrepancies, it considers those transfers null and void from their inception and does not provide or send out unapproved operating rights decision letters because the transfers were never adjudicated. Colorado is not willing to accept county records or other outside sources to assist in curing title deficiencies. For leases occurring after October 1, 2012, the Colorado Office will adjudicate all transfers accordingly.

Montana, North Dakota, South Dakota, and Utah[19]

The Montana and Utah State Office never stopped adjudicating transfers of operating rights; accordingly, IM 2013-105 did not change how they are adjudicating such transfers.

New Mexico, Kansas, Oklahoma, and Texas[20]

The New Mexico State Office is conducting a piecemeal review of its lease files. Initially, when the New Mexico State Office received a new assignment and could not account for the purported interest to be assigned, they retroactively denied previously approved transfers either (a) all the way back until the title examiner could account for the purported interest; or (b) through 1991. It appears that recently, the New Mexico State Office has become willing to consider outside records in examining title to fill in gaps in currently filed assignments, such as recorded assignments, evidence of corporate successions, etc.

Wyoming

The Wyoming State Office adjudicates operating rights for all new leases, as well as any adjudications requested by ONRR. It also has plans to adjudicate operating rights for all producing leases according to staff availability. The Wyoming State Office is currently using the Lease Interest Worksheet to chain title retroactively and adjudicate operating rights at the request of the ONRR. During this review, and when any new transfer is filed, if the State Office examiner cannot account for the purported interest to be assigned, they stamp the Lease Interest Worksheet “discrepancy.” Thereafter, the Wyoming State Office will not approve any subsequent transfer until the problem in the chain of title is resolved. No notice of the discrepancy is provided to the parties who received interests through transfers now marked with a discrepancy, so without review of the current BLM case file for each lease or subsequently denied transfer, parties who believed they previously owned operating rights are not aware their rights have been called into question. This requires the Wyoming State Office to deny any subsequent transfers for leases containing a discrepancy, and to disregard any assignments occurring before the discrepancy that were previously approved.

In an attempt to complete a chain of title, bring current its files, and resolve any discrepancies, the Wyoming State Office is accepting a certified copy of an assignment recorded in the county records and attached to a BLM form Transfer of Operating Rights that is completed by general references to the attached county assignment. The Wyoming State Office will issue a decision stating that its records are incomplete and in order to complete its records, it is accepting and approving the assignment.

Overriding Royalty Interests, Production Payments, and Other Interests

The federal regulations make specific reference to only two other types of interests, overriding royalty interests and production payments.[21] Transfers of these interests must be filed with the BLM and will be included in the lease file, but are not subject to BLM approval.[22] While they can be filed on either a BLM form assignment,[23] any form of assignment may be used.

While net profits interests and carried interests are not expressly mentioned in the regulations governing assignments of interests, such interests are included in the definition of “interest.”[24] The usual practice is to follow the same filing procedures prescribed from assignments of overriding royalty interests and production payments above.

Liens and Security Interests under Mortgages and Other Financing Instruments

Liens and security interests in federal leases created under mortgages and other financing instruments do not fall within the definition of “interests” under the regulations and are not required to be accepted for filing under the regulations. Most BLM offices will discourage or even reject the filing of mortgages and other financing instruments. As a result, mortgages and other financing instruments are typically only filed in the county records.

Transfers by Operation of Law

The regulations identify two types of transfers by operation of law: death and corporate reorganization. When an owner dies, his or her rights will be recognized as having been transferred to the heirs, devisees, executor, or administrator of the estate, upon the filing of a statement that all parties are qualified to hold an interest in a federal lease.[25] The BLM office will typically also require, along with the statement, supporting information concerning the demise of the owner.

In the case of corporate name change, merger, or conversion, no assignment is required unless otherwise required by state law. The regulations require that notification of the name change, merger, or conversion be furnished in the proper BLM office.[26]

_____________________

Prior to filing any transfer with the BLM, it is always to the advantage of the parties to the transfer to make inquiry of the oil and gas adjudication personnel at the applicable BLM office to confirm that the parties have prepared the transfer in compliance with the office’s policies and procedures.

[1] 43 CFR § 3100.0-5(c). Record title is the ownership in a federal lease as recognized by the BLM.  Therefore, it has no connection to the title or leasehold ownership reflected in the applicable county records.

[2] 43 CFR § 3100.0-5(d). The term “operating rights” should not be confused with the right to serve as operator on the ground. An operator is the person or entity that is responsible under the terms and conditions of the lease for operations being conducted on the leased lands; it can include, but is not limited to, the lessee record title interest owner or operating rights interest owner. See 43 CFR § 3160.0-5

[3] See 43 CFR §§ 3106.7-6(b), 3216.12.

[4] Id. § 3100.0-5(e).

[5] Not addressed herein are the qualifications to own an interest in a federal lease and the specific filing requirements.

[6] Id. § 3100.0-5(e).

[7] Most recent revision date is August 1, 2015.

[8] Id. § 3106.1(a). Note, the assignment of the entire interest in a portion of the leasehold will result in a segregation of the lease.

[9] Generally, requiring all of a governmental lot or quarter-quarter section under the Public Land Survey System.

[10] 30 USC § 1987a; 43 CFR § 3106.1. The 640 acre limitation was added to Section 30A of the MLA in 1987 pursuant to the Federal Oil and Gas Onshore Leasing Reform Act. Assignments of record title of less than 640 acres will be approved if the assignment constitutes the entire lease or is demonstrated to further the development of oil and gas.

[11] 43 CFR § 3106.1(b).

[12] Most recent revision date is August 1, 2015.

[13] 43 CFR § 3106.1. There is no written guidance defining “part of the acreage” or addressing this apparent acreage requirement. It appears that at least some minimal amount of acreage must be transferred to comply. Accordingly, although some BLM State offices will accept transfers of operating rights for less than 40 acres, they will not accept for approval, or even for filing purposes only, transfers of operating rights in a wellbore only.

[14] Id. § 3106.1(b).

[15] The term “assignment” is used generically in the IM applying to an assignment of either a record title interest or an operating rights interest.

[16] IM 1986-175.

[17] IM 2013-105 was issued in direct response to the 1996 amendment to Section 102(a) of the Federal Oil and Gas Royalty Management Act, 30 USC § 1712(a), providing that the owner of the operating rights shall be primarily liable for its pro rata share of payment obligations under the lease and the owner of the record title interest (if different from the owner of the operating rights interest) became secondarily liable. The federal regulations at 43 CFR Section 3016.7-6 and 3216.12, reflect these same principals. Furthermore, the BLM form Transfer of Operating Rights (Sublease) in a Lease for Oil and Gas or Geothermal Resources specifically provides that the transferee’s signature “constitutes acceptance of all applicable terms, conditions, stipulations, and restrictions pertaining to the lease… (Part B, paragraph 3) and “upon approval of a transfer of operating rights (sublease), the sublessee is responsible for all lease obligations under the lease rights transferred to the sublessee” (Part C, paragraph 8).

[18] See Jared A. Hembree and Uriah J. Price, Holding a Wolf by the Ears – A Look into BLM’s Policy on the Retroactive Adjudication of Operating Rights, 63 Rocky Mt. Min. L. Inst., Paper 11 (2017) (not yet published).

[19] The Montana State Office administers federal lands in Montana, North Dakota, and South Dakota. The Utah State Office administers federal lands in Utah only.

[20] The New Mexico State Office administers federal lands in New Mexico, Kansas, Oklahoma, and Texas.

[21] 43 CFR § 3106.1.

[22] 43 CFR § 3106.1(b).

[23] Both of the current BLM forms include a box that can be checked to indicate that it is for an overriding royalty interest assignment.

[24] 43 CFR § 3000.0-5(1).

[25] Id. § 3106.8-1.

[26] Id. § 3106.8-3.

Utilizing Online Resources to Save Time: A Primer for Landmen and Title Examiners

Due Diligence, Title Issues/Curative, , , , , , , ,

Advances in technology save everyone time. We all look to technology to organize and inform our daily lives in both professional and personal settings. How can technology be used to save time when dealing with common title issues? Something as simple as knowing where to obtain a patent or how to determine potential heirs can save a landman time and avoid unnecessary questions and research.

There is a vast amount of title information available online, but knowing where to find it is half the battle. This article provides a brief summary of some of the best online resources available to landmen. These websites1 provide materials ranging from oil and gas plats to well production records, which can be used to form a more complete and accurate picture of the land and title issues being examined.

Because most land ownership in the Western United States originated with the federal government, a good place to start is with the Bureau of Land Management (“BLM”) website2, regardless of the current ownership of the land. The BLM website provides land patents, surveys, master title and oil and gas plats, and historical indices for a select group of states:

  • Official BLM Patents are particularly useful to confirm federal reservations.
  • Survey plats can be used to track changes in legal descriptions.
  • Plats provide a visual representation and depict the current uses on those lands in a given township and range.
  • Historical indices provide a ledger-like record of all uses that have occurred in a given township and range.

However, land status records for a few of the Western states are maintained separately on the respective BLM state office’s website.3 See the BLM website for more information regarding the availability of these records.

In addition, geographic reports with accompanying serial register pages are available through the Bureau of Land Management Land & Mineral Legacy Rehost 2000 System (“LR-2000”) website4. These reports can be obtained by searching lands by township, range, and section. Geographic reports provide a list of all uses, including mining claims, federal leases, right-of-ways, and communitization agreements for a designated geographic area and will provide the BLM internal serial number for each use. Once you have the serial number, an accompanying serial register page which is available for both inactive and active uses provides more detailed information pertaining to each use.

The next source of valuable information is the state entity tasked with regulating oil and gas. Various oil and gas records can be found on state oil and gas commission websites:

Unfortunately, most states have unique websites that require a little patience to navigate. Also, some states do not provide older production records online. Although it is easier to search in some states than others, most states also provide spacing and pooling orders. These records are helpful to find detailed information on a well or to determine whether a lease has been properly held by production.

Individual county resources available online can vary greatly. Fortunately, more and more counties are providing online parcel viewers, often with aerial maps, which can be used to give a visual representation of the land, surface parcel boundaries, parcel acreage, roads, railroads, utilities, and bodies of water. Most county websites at least provide the status of property taxes which can help confirm surface ownership, while other counties provide additional resources through a paid subscription service.

You may also need to research corporate status or history of an entity. Every state has an entity that regulates the corporations registered in the state5 with a range of information that can be obtained regarding a business entity including (but not limited to) officers, addresses, and formation dates. One type of data that is typically available from these Secretary of State sites, but often requires a fee, is the corporate succession. However, there are other online resources that are free and easier to use. For example, the BLM Wyoming website offers the Corporate Name Change & Mergers Index6 and the National Association of Division Order Analysts maintains a mergers and acquisitions database as well.7 In the event a landman is faced with a gap in title between two entities, these resources particularly helpful to confirm whether an entity has merged or changed its name.

In addition to government sponsored websites, there are also some private sites that can be useful, especially in the area of genealogy. Genealogical research may be required for various title curative issues that may arise, including determining potential heirs, or confirming the death of a join tenant. There are many helpful resources online to troubleshoot these issues, including GenealogyBank.com8, a subscription-based service with a database of 6,500 newspapers which can aide in the search for an obituary or death notice. In addition, Ancestry.com9 can be used for a more intense, subscription-based genealogical search for census records, birth and death certificates, and other historical documents like military and marriage records.

These easy to access records can save time and money when dealing with basic title issues that arise at the outset of many, often time-sensitive, title projects.

1Many of these online resources limit their liability regarding the accuracy of the information provided.
2https://www.glorecords.blm.gov/default.aspx.
3For example, Nevada and Wyoming.
4http://www.blm.gov/lr2000.
5Colorado, Delaware, Montana, New Mexico, North Dakota, Utah, Wyoming.
6 http://www.blm.gov/wy/st/en/resources/public_room/corporate_list.html.
7http://www.nadoa.org/forms/ma/From_To_Updated_2014.pdf.
8http://www.genealogybank.com/.
9http://www.ancestry.com/.

The Granting Clause: The Gift That Keeps on Granting

Fee Lease 101 Series, Lease Provisions, Title Issues/Curative,

The granting clause of a lease contains the required words of grant that create an interest in the lessee.1 This clause is typically found at the beginning of the lease and is often overlooked when drafting a lease, to the detriment of the lessee. The granting clause generally covers three main topics: (i) the leased substances; (ii) the associated easement rights; and (iii) the property description.

Leased substances

The granting clause should include a careful description of the substances covered by the lease. Typical granting clauses include language such as “oil, gas, and other minerals,”2 “oil and all gas of whatsoever nature or kind,”3 or some variation of these simplistic descriptions. Even though this language may, at first glance, seem uncontroversial, the failure to adequately list the substances covered by the lease has led to a multitude of lawsuits.

For example, the failure to adequately define the leased substances can lead to questions whether the lease covers coalbed methane, which depending on the state, may not be included in a general grant of gas. Another problem is encountered when interpreting what is included in the “other minerals” under a lease. The parties to a lease should not rely on a court to dictate what substances are covered by that lease.

As a practical matter, the goal in drafting the leased substances portion of the granting clause is to ensure that the lease covers all substances that are necessary to produce the oil and gas from the leasehold. Any special substances that may be encountered, such as coalbed methane, helium, carbon dioxide, hydrogen, or sulfur, should be individually listed in the lease. By including a list of known or expected substances, together with catch-all language to cover substances that may not yet be known or expected in the field, the lessee can avoid unfavorable interpretations by a court that could render the lease unprofitable or unusable.

Associated Easement Rights

The second part of the granting clause is the description of the easement granted to the lessee. Historically, the grant of an easement and the right to conduct surface operations has been broadly, if not vaguely, described in the lease. The lessee has, instead, relied on the implied right of access to the surface estate arising from the mineral estate’s dominance. Reliance on this implied right of access can be problematic when the surface owner engages in activities that prevent or inhibit oil and gas development or when the surface owner disagrees with and challenges the lessee’s use of the surface estate.

As for split estate lands, the lessee should be careful to ensure that the lease does not grant and that the lessee does not rely on a right of access that was not reserved or conveyed in the deed creating the split estate. Keep in mind that the lessor can only grant the rights that the lessor owns.

To avoid these issues, I recommend that this portion of the granting clause describe the specific activities that the lessee will be conducting on the leased premises, such as construction and location of the various production facilities, powerlines, roads, pipelines, and any other activity that may foreseeably be required to produce the oil and gas. By describing the specific activities, the surface owner is put on notice of the types of activities that the lessee is planning to conduct on the surface estate. If a lawsuit ensues, it will be very difficult if not impossible for the surface owner to argue that they were unaware that the surface would be used for these activities.

I note also that, even though the lessee, through careful drafting of the lease, may be able to secure surface access for gathering facilities and other surface disturbance activities not related to production of oil and gas from the leasehold, this grant of access could be terminated upon expiration of the lease term. For such activities, I recommend that the lessor obtain a separate surface use agreement specifically granting the right to conduct these activities to ensure that they survive termination of the lease.

The Leased Premises

Finally, the granting clause should include a description of the land covered by the lease. This should, of course, include a legal description of the property together with the acreage covered by the leasehold. For small or irregular tracts of land, the lease should include a Mother Hubbard clause4 to ensure that inadequately described property that is adjacent to and contiguous with the leasehold will be covered by the lease.

In the event that the lease is limited in depth, the property description should include language that identifies the specific interval covered by the lease, making sure that the depth description is tied to a measured depth in a specific well. A carefully crafted depth description will avoid confusion as to the actual depth covered by the lease.

Other Considerations

A common, but surprising, issue is that some granting clauses fail to include present words of grant. That is, the granting clause describes the activities that can be undertaken on the leasehold but does not expressly grant the rights to the underlying oil and gas.5

Another issue that you should be aware of is that, with horizontal drilling resulting in ever increasingly long laterals, the easement in the granting clause should include language granting the lessee a subsurface easement to accommodate horizontal development. Again, if this subsurface easement will be used for the benefit of lands located outside the leasehold, the subsurface easement should be created by a separate agreement between the parties, thereby preventing the easement from terminating with the underlying lease. Also, for a lease limited by depth, the granting language should include a subsurface easement for all depths that must be traversed in order to access the leased interval.

In summary, through careful drafting of the various components of the granting clause, the lessee can protect itself from unexpected complications and ensure that it is allowed to fully develop and produce the oil and gas resource.

1Patrick H. Martin & Bruce M. Kramer, Williams & Myers, Manual of Oil and Gas Terms 497 (12th ed. 2003).
2David E. Pierce, Incorporating a Century of Oil and Gas Jurisprudence Into the “Modern” Oil and Gas Lease, 33 Washburn L. J. 786 (1994).
3Martin & Kramer.
4A clause commonly included in contemporary leases to meet the problem of adequately describing strips of land owned by a lessor contiguous to the land specifically described by the lease and intended to be covered by the lease. Id. at 246. Also known as a cover-all clause or an all-inclusive clause.
5Pierce.

Potential Pitfalls of Continuous Drilling Provisions in HBP Fee Leases

Fee Lease 101 Series, Lease Provisions,

A common but often overlooked oil and gas lease provision is the “continuous drilling” or “continuous operations” provision. Generally, a continuous drilling provision allows a temporary cessation of production without automatically resulting in the termination of an oil and gas lease that has been extended by production. In order to qualify for the temporary cessation, certain operations (as defined in the lease or by case law) must be commenced on the leased premises or lands pooled or unitized therewith within a specified time period (typically from 30 to 120 days). Two examples are as follows:

If, at the expiration of the primary term of this lease, oil or gas is not being produced on the leased premises or on acreage pooled therewith but Lessee is then engaged in drilling or reworking operations thereon, then this lease shall continue in force so long as operations are being continually prosecuted on the leased premises or on acreage pooled therewith; and operations shall be considered to be continuously prosecuted if not more than ninety (90) days shall elapse between the completion or abandonment of one well and the beginning of operations for the drilling of a subsequent well.

If, at the expiration of the primary term, oil or gas is not being produced on said land, but lessee is then engaged in drilling or reworking operations thereon, the lease shall remain in force so long as operations are prosecuted with no cessation of more than 30 consecutive days.

Continuous drilling provisions are of particular importance when analyzing older, HBP leases. Specifically, a number of situations should be considered. Has your lease produced each and every month since the expiration of the primary term? Have you or your predecessor ceased production to rework the well or recomplete in a new formation? Have severe weather conditions caused a temporary cessation of production? Each of these situations could potentially lead to a finding that your lease has expired.

Oil and gas wells generally do not have perfect production histories. Williams & Meyers states: “Since repairs, breakdowns, and reworking operations are incidental to the normal operation of a lease, the parties must have contemplated that the temporary cessation of production caused by such events would not result in automatic termination of the lease.”1 Based upon this implied understanding, if an oil and gas lease does not contain a continuous drilling provision, the lessee may extend the lease by exercising reasonable diligence in the continuance of its operations on the leased premises. In other words, courts have held that a temporary cessation of production is allowed where no specific deadline is provided.2 What is temporary? There is no hard and fast rule. An Arkansas court found a temporary cessation where a fire destroyed a producing well and production was not resumed for four years.3 However, whether a cessation of production is temporary is a question of fact that will depend on the individual circumstances.4 Although the individual facts may vary, courts typically weigh the following factors: failure of the lessor for a substantial period of time to claim forfeiture during which time the lessee was engaged in activities on the lease, absence of drainage, intent of lessee to hold the lease, and diligence of the lessee in seeking to find a market or to resume production.5 Due to the fact-intensive nature of the analysis, each circumstance must be carefully reviewed under the applicable case law in that state.

The continuous drilling provision was created in order to provide more certainty in the face of inconsistent court rulings. While providing the parties with a more reliable test, a continuous drilling provision could prove fatal to an HBP lease. According to Williams & Meyers: “Where there are express savings provisions in a lease that specify dates [i.e., 30-120 days] by which the lessee must take certain action or the lease will terminate, the temporary cessation of production doctrine will not apply so as to extend the lease beyond those specified time limits.”6 Unlike the analysis above, the specific time periods by which a lessee must recommence operations are hard and fast.7 Absent some other lease provision, mechanical issues with the well, lack of a market, or any other delay in production could cause a lease to be deemed expired in as few as 30 days without production. Therefore, careful attention should be made to the production (and operations) history on the leased premises to ensure any continuous drilling provision has been strictly observed.

Despite a constant push for greater efficiencies in acquisition due diligence and title opinions, a thorough HBP analysis should not be forgotten. Such analysis may require obtaining well records back to the date of first production, reviewing the complete well file, and investigating the cause of any delays in production.

For More Information Contact:
David B. Hatch
Phone: 801-799-5834
Email: dbhatch@hollandhart.com

1Williams & Meyers, “Oil and Gas Law” § 604.4.
2Id.
3Saulsberry v. Siegel, 252 S.W.2d 834 (Ark. 1952).
4See Watson v. Rochmill, 155 S.W.2d 783 (Tex. 1941).
5Williams & Meyers, § 604.4 at fn. 11; see, e.g., Somont Oil Co. v. A & G Drilling, Inc., 49 P.3d 598 (Mont. 2002) (finding the intent and diligence of the operator in restoring production is a factor in determining with a cessation of production is temporary).
6Williams & Meyers, § 604.4.
7See, e.g., Greer v. Salmon, 479 P.2d 294 (N.M. 1970) (finding that where the lessee didn’t strictly comply with the 90-day cessation clause the lease terminated).

The Implied Covenant to Drill and Develop in Montana

Royalty Issues, , ,

In Montana, there are many older oil and gas leases held by production, particularly in eastern Montana. These leases often times cover several tracts of land and do not contain a Pugh Clause. Although one or more of the tracts of the lease may be part of a producing unit, other tracts are not. Because there is no Pugh Clause in the lease, there is no explicit contractual right to a release of the nonproducing tracts. Given the recent development of the Bakken, the fact that a mineral owner may have nonproducing tracts of land held by an older lease with unfavorable royalty provisions is an undesirable situation for the owner. Mineral owners are, therefore, turning towards common law and unique mechanisms under Montana law to gain releases of these lands.

According to Montana Code Annotated Section 82-1-201, when an executed and recorded oil or gas lease is forfeited, cancelled, or expires, the lessee is required to have the lease released from record in the county where the leased land is situated within 60 days from the forfeiture. If the lessor sends a written notice requesting a release and the lessee fails to record the release within 30 days of the notice, then the lessee is guilty of a misdemeanor punishable by a fine of up to $250.1 Additionally, if, “by its terms,” an oil or gas lease has expired and is subject to forfeiture for nonperformance andmore than 3 years have elapsed since expiration, the mineral owner may serve written notice on the lessee pursuant to Section 82-1-202(2) demanding a release. The notice must inform the lessee that unless it files an affidavit stating that the lease is in effect within 60 days of the date of service of the notice, the lease must be terminated and is of no effect.2 After this 60-day period has expired, the mineral owner may file an affidavit of service of the notice in the county clerk’s office and from the filing of this notice the lands are released from the lien of the lease.3

Mineral rights owners have been increasingly using these statutes to demand partial releases of oil and gas leases pursuant to the implied covenant to drill and develop in Montana. Many times, the owners will send notice pursuant to Section 82-1-202(2) asserting that a lease has been expired for more than three years as to a tract or tracts of land because the lessee has failed to develop these tracts. The mineral owners cannot demand a release under an express provision of the lease because another tract in the lease is part of a producing unit and there is no Pugh Clause. Thus, the lease is technically held by production. Mineral owners, therefore, have turned to the implied covenant to drill and develop in order to gain releases of nonproducing tracts. If a lessee fails to respond to this notice because it believes the mineral owner had no right to send it, then the mineral owner proceeds to record an affidavit of service pursuant to Section 82-1-202(4) asserting that the lands are released. Whether the affidavit actually does release the lands may hinge on whether the owner had the right to demand a release as to certain tracts of land pursuant to the implied covenant to drill and develop.

Forfeitures of oil and gas leases are favored by the law and will be strictly enforced in Montana.4 In Sundheim v. Reef Oil Corp., mineral owners brought an action based partially upon a breach of an implied covenant to reasonably and prudently develop the leasehold.5 The Montana Supreme Court analyzed this covenant, but refused to consider it beyond the terms of the lease.6 The Court specifically found that pursuant to two express provisions in the lease, the operator had a duty to explore for or produce oil and gas from the leasehold.7 If the producer failed, the terms of the lease allowed the lessors to terminate the lease.8 The operator also had the option to make delay rentals, which it did.9 The acceptance of these delay rentals excused the lessee from fulfilling the duty to develop the leasehold.10 The Court specifically stated that it “will not look beyond these express provisions in order to impose a duty upon [the lessee] which is in contravention of their terms.”11

In Berthelote v. Loy Oil Co., the Court considered the implied covenant to produce and market gas and noted that “if a lease is terminated by the breach of implied covenants, it is forfeited.”12 Although neither Sundheim nor Bertheloteanalyzed whether an oil and gas lease should be partially released based upon the implied covenant to drill and develop the leasehold, both cases appear to lay the groundwork for such a claim. However, when analyzing a Pugh Clause in a lease, the Court has noted that absent a Pugh Clause “the lease would remain in effect as to the entire leased premises.”13 Given this statement by the Court and the Court’s reluctance in Sundheim to look beyond the express provisions of a lease to impose a duty which is in contravention of the lease terms, there is a good argument that a court will not impose an implied duty to develop a lease which is already held by production, even if certain tracts are not part of a producing unit. Unless there is an express provision (Pugh Clause) in the lease requiring the lessee to develop every tract or risk forfeiture, it is unlikely that a Montana court will afford a remedy based upon this implied covenant.

However, it is still important that a lessee not ignore a demand sent pursuant to Section 82-1-202. According to the statute, if a lessee fails to respond to this notice, then the mineral owner can record an affidavit of service pursuant to Section 82-1-202(4) and the lands are released. If a lessee does not timely response and the lessor files an affidavit of service, the lessee may be left trying to figure out how to make it clear in the county records that the lease has not in fact been released. Thus, it is best to consult with an attorney immediately upon receipt of such a notice if the lessee believes that the tracts are not subject to forfeiture.

1Mont. Code Ann. § 82-1-201(3). 
2Mont. Code Ann. § 82-1-202(2). 
3Mont. Code Ann. § 82-1-202(4).
4Stanolind Oil & Gas Co. v. Guertzgen, 100 F.2d 299, 300–01 (Mont. 1938). 
5Sundheim v. Reef Oil Corp., 806 P.2d 503 (1991).
6Id. at 509–10.
7Id. at 509. 
8Id. 
9Id. at 509–10. 
10Id. 
11Id. at 510.
12Berthelote v. Loy Oil Co., 28 P.2d 187, 190 (Mont. 1933).
13Fed. Land Bank of Spokane v. Texaco Inc., 820 P.2d 1269, 1272 (Mont. 1991).