On January 13 I was one of four speakers at an oil and gas seminar in Overland Park, Kansas, put on by Half Moon Seminars. It had been nearly 30 years since I was a seminar speaker. With 40+ attendees it was considered a “sellout”, which surprised me. I didn’t think there could be enough interest in the subject in the Kansas City area to garner even 10 attendees. The majority were from title companies, about a half dozen (other than the speakers) were lawyers. The rest were, interestingly, from engineering firms. Everybody was, of course, seeking CEC (Continuing Education Credit). My particular topic had to do with title examination and how to cure defects in title to minerals and leasehold interests. I had a well organized presentation sketched out, but within a minute of starting I was off it and never got back. I was originally concerned how to fill two hours on my topic, and ultimately amazed how fast the two hours flew by. If you’re interested, here’s the seminar brochure.

Mineral and leasehold title is an esoteric subcategory of real estate titles. The problem we run into these days is that the title companies no longer do title abstracts, at least not in this part of the state. In the “old” days, abstracts were common. Somebody from the title company did the actual searching of records at the courthouse, and then they typed up an “abstract” (summary) of all the material provisions of each and every instrument affecting title, and bound all these summaries together into the “abstract”. The title company was bonded for errors and omissions, so if they missed something there would be insurance money to cover the damages. We attorneys would examine the abstracts and base our title opinions on what we found there. If we missed something in the abstract, then our own malpractice insurance came into play.

And then as large areas became urbanized, everybody switched to title insurance. In urban settings, there was little concern about oil and gas leases. The title companies got used only looking back 25 years in the chain of title, since most defects older than that were “cured” by the Marketable Title Act. Unfortunately, certain critical defects in mineral title are not cured by the Marketable Title Act. To do a proper title examination and opinion regarding mineral title or an oil and gas lease based thereon, one must search clear back to the original government grant (Patent). Most title companies are not too keen at this prospect. Consequently, these days, I generally have to do a “stand up” opinion, meaning, I go to the courthouse and search the chain of title myself. I think it’s called a “stand up” because in most register of deeds offices, you hauled the title books from shelves along the walls and looked through them at a counter, standing up. At least, that’s how it was before the books started getting replaced by computers. In most of the rural counties, it’s still done the old fashioned way, poring through the old books, standing up at the counter.

I suspect the level of interest evidenced by the seminar attendance reflects the growing clash of urbanization into rural areas, where developers hoping to build housing subdivisions are encountering oil wells and wondering what that bodes for their vision of development. Or, maybe it was just a different topic from the usual seminar and attendees were motivated by curiosity. In any event, it was one of the better seminars I’ve attended in the past few years.

Back in the 80′s and 90′s (and earlier but that was before my time) we had oil and gas leases that contained mostly “boilerplate” clauses. People often referred to a standard “Producer’s 88″ lease. There were, actually, dozens of variations on the so-called “Producer’s 88″, but the variations were mostly a matter of which boilerplate clauses were or were not included in a particular lease form. These boilerplate clauses were born in the first couple of decades of the 20th century, and they remained basically unchanged for nearly 100 years. You decided which lease form you liked and bought it in tablets of 50 from your preferred forms printer. As you went around to landowners, you tore off a lease, filled in the blanks, and got it signed and notarized. Some landmen (people who go around to landowners to get them to sign leases) carried a typewriter with them, many just filled them in by hand.

These boilerplate clauses became the subject of decades of court interpretations. Consequently, we had lots of court decisions telling us what these clauses meant and how they were to be interpreted. Court cases also developed what were called “implied covenants” inherent in these boilerplate clauses. There were (and still are) covenants such as the implied covenant to develop the lease, the implied covenant to produce and market oil and/or gas, the implied covenant to operate as a reasonable and prudent operator. You couldn’t find these obligations by reading the leases; the courts declared them to exist by implication. As a rule, they benefitted the landowners (lessors).

Then along came word processors. Nobody wanted to fill in forms with a typewriter any more, so lease forms were copied to hard drives and blanks were filled in with the word processor. Over time, people with lease forms on their computers decided to start messing around with the wording. Some of these people were lawyers who generally made changes that legally made sense. Other people were non-lawyers who generally made changes because they didn’t understand the lease in the first place and thought they’d make “improvements”. Non-lawyers generally had little inkling of how their changes might conflict with a century old body of court decisions.

Lawyers, especially over the last decade or so, have been making changes that specifically emasculate the implied covenants. It’s interesting to see how they come up with wording to eliminate covenants that aren’t contained in the wording of the lease in the first place. They’re not something you can “select” and “delete” on the word processor. You have to come up with language that expressly supersedes something that was there by implication in the first place!

Landowners have always been at a disadvantage when it came to comprehending oil and gas leases. It’s worse now, as clever lawyers (dare I count myself among them?) generate new lease forms that remove implied covenants – covenants that were favorable to landowners even though they didn’t know it. The “Standard Producer’s 88″? A thing of the past, if it ever existed in the first place.

Many oil and gas drilling programs involve selling undivided fractional interests to “investors”. Who would imagine that every time they draw up an assignment of an undivided fractional interest they should think about securities law? Well, they should. A lawyer who prepares participation agreements, operating agreements, or working interest assignments for such programs is working with securities. Incredibly, many, and possibly most, oil and gas lawyers do not realize (or maybe just do not acknowledge) their practice involves securities law.

Whether the drilling program is set up for investors to receive working interest assignments, limited partnership certificates, LLC membership certificates, or some other evidence of participation, it falls within the purview of federal and state securities laws. Usually, it will be state securities commissioners taking enforcement action, often in the form of a “cease and desist” order, for starters. Most oil and gas drilling programs offered by small independent producers are eligible for exemptions from registration under securities laws. In practice, most offerors don’t bother to attend to qualifying for such exemptions. Most of the time, this causes no problem. This is called “being lucky”.

We’re now seeing drilling programs offered via the internet. For an introduction to the risks and pitfalls, see “Oil & Gas Investment Solicitations on the Internet” at Lewis Mosburg’s excellent Internet Oil & Gas Newsletter.

In a major and surprising ruling, the Kansas Corporation Commission ruled in Docket No. 07-CONS-155-CSHO that a lessee who takes a a new oil and gas lease does not, without more, thereby become responsible for plugging existing wells on the leased premises. The July 16, 2008 order In the Matter to Show Cause … with regards to responsibility under K.S.A. 55-179 for plugging abandoned wells … was a pleasant surprise to operators who, motivated by $100+ oil, have been scrambling to lease up properties with expired leases. They will be responsible for existing wells they rework, as this will fall under the “exercising control” criterion of the statute. However, this was always to be expected. However, the July 16 order represents a virtual reversal of the Commission’s long standing but unofficial policy of holding operators responsible for old wells drilled or operated under a previous lease regardless of whether they were operated under the new lease.

The case started out on a more narrow issue. The old wells on the property in question were oil wells and the new lease was for gas only. The lessee argued that since its new lease did not cover oil, it was not responsible for plugging the old oil wells. This is a logical argument that I thought likely to be persuasive. In past years, when clients got a new lease on property with old wells, we’d sometimes craft the legal description to exclude the well spacing acreage (essentially 2.5 acres in Eastern Kansas, 10 acres in Western) around each old well. If the KCC sought to assert liability, the argument would be that they were not covered under the new lease and, therefore, the client had no liability and, indeed, no right to plug the wells. I never had to test this argument, as the Commission never sought to impose plugging liability on a client with such a lease. But, drafting a lease with this sort of legal description was a pain in the rear end and, frankly, raised other interesting (in an academic way) issues. The issues in the recent case, however, expanded so that the “gas only” lease defense turned out to be unnecessary. It appears that the Commission’s public policy rationale is that the ruling will motivate operators to report old wells they “discover” on their “new” leases, so the State can get a handle on these abandoned wells and take appropriate measures to protect against pollution of groundwater and other potential problems posed by these old unplugged wells.

You can download the order as a pdf file here.

A lot of people subscribe to the myth that an oil and gas lease stays in force as long as the lessee pays the lessor some royalty at least once a year. As a result of this myth, you may see leases going on and on with eighty or so barrels sold off every December. Of course, if the lease itself has a provision that makes this good enough, then so it is. But I’ve never seen such a lease with anything like that as a standard provision, and it’s extremely rare to see it added as a special provision.

In the absence of special provisions, a lease will remain in force so long as it continues to produce in “paying quantities”. There are two facets to this term. The first is the arithmetic of comparing income to expenses to see whether it’s in the red or the black. The second is the time period over which this determination is made. Obviously, a one month period would be too short to get an accurate view, unless it’s otherwise established that it’s a typical month over the long haul. Courts have applied time periods ranging from a few months to a few years. It depends on what’s sufficient to enable the court to say that it would provide a reasonable and prudent operator sufficient data to determine whether the lease should be produced or abandoned.

There’s a standard litany of cases seen in virtually every brief on the issue of whether a lease has terminated for lack of production in paying quantities. The basic brief reads something like this:

A load of oil a year may or may not amount to paying quantities. The bigger issue is, actually, the subject of a different covenant, one that you generally won’t see actually written in the lease. We’ll talk about this implied covenant in a later article.