Special Report: Energy Law
How to Avoid Lease-Related Litigation
David Ammons is a partner in Diamond McCarthy in Dallas and is board certified in oil, gas and mineral law by the Texas Board of Legal Specialization. He handles a wide range of complex litigation and bankruptcy matters, with a special emphasis on oil and gas disputes, director and officer liability, and business fraud actions.
Copyright 2013. ALM Media Properties, LLC. All rights reserved.
March 4, 2013
Like most commercial litigation, oil and gas disputes that end up at the courthouse are expensive. They usually end in a settlement that both sides would have considered unsatisfactory at the outset of the case. Most in-house counsel despise litigation, hope to avoid it, and prefer to limit their interactions with outside litigation counsel to exchanging holiday cards.
Much of the recent oil and gas litigation filed in Texas has concerned issues relating to lease negotiation, interpretation and enforcement. By following these five suggestions, in-house counsel may be able to shrink their litigation budgets by avoiding these all-too-common disputes.
1. Train new land professionals regarding the more problematic aspects of negotiating leases with mineral interest owners. Most land professionals deal honestly with mineral interest owners and know what they can say during the process. However, in recent years, the industry has seen a large influx of new land professionals, which has coincided with mineral interest owners becoming more litigious.
Mineral interest owners unhappy with the deals they struck with oil and gas companies increasingly claim that land professionals made misrepresentations during lease negotiations. Companies should train their less experienced land professionals on how to discuss potentially problematic subjects with mineral interest owners. Those subjects include the legal effects of a proposed lease, the company’s future development plans, the company’s expectations regarding future production and royalties, and what the company is willing to pay for a particular lease.
2. When acquiring leases on acreage with prior hydrocarbon development, thoroughly investigate whether existing wells were properly cased and cemented and/or plugged. The decision by the 5th Court of Appeals in Dallas in Hunt Oil Co. v. Live Oak Energy Inc. (2009) illustrates the potential consequences of insufficient due diligence on this issue.
In that case, Live Oak acquired leasehold interests from Hunt Oil in the Pettit formation in Louisiana. Prior to that acquisition, Hunt Oil had drilled 50 wells through the Pettit formation to recover oil from formations below. Hunt Oil allegedly had failed to properly case and cement many of those wells, which damaged Live Oak’s leasehold interests.
The 5th Court held that the applicable statute of limitations barred Live Oak’s claims, rejecting the argument that the discovery rule applied to toll the limitations period. According to the court, using public records and files turned over by Hunt Oil, Live Oak reasonably could have discovered the potential for damage to the Pettit formation at the time it acquired its leasehold interests. The Hunt Oil case and others like it should encourage in-house counsel to insist on detailed due diligence.
3. Revise pooling provisions in form leases to account for horizontal drilling of oil wells. Smaller oil and gas companies often use form leases to cut down on acquisition costs. Lawyers developed many of them when horizontal drilling of oil wells was not that common in Texas. Today, many companies are investing in unconventional oil plays, where the old form leases may not be up to the job.
Problems have arisen as a result of form leases that contain pooling provisions that limit the size of pooled units for oil production to an acreage amount insufficient for drilling commercial horizontal wells. It can be difficult for a lessee to obtain a lease amendment to correct an erroneous pooling provision, and it can be very challenging for a lessee to modify a pooled unit after completion of a producing well on that unit. The better option is to revise pooling provisions in form leases to ensure that they reflect the current realities of horizontal drilling of oil wells.
4. Prepare for delays attributable to government action and/or inaction. As a result of the controversy over hydraulic fracturing, federal, state and local governments across the United States are racing to enact new and more burdensome drilling regulations. Delays in the issuance of new drilling permits have come hand-in-hand with the push for new drilling regulations.
These delays have impacted lessees who generally must begin drilling operations within the primary terms of their leases to perpetuate them. In light of these trends, lessees should expect government-related delays and plan accordingly.
Because the act of applying for a drilling permit is generally not sufficient to constitute “commencing drilling operations,” in-house counsel should ensure that the company takes that step long before the end of the primary lease term.
Lease provisions that excuse failure to commence drilling operations within the primary term because of government-related delays — which includes force majeure provisions — are a fallback option. However, some courts are reluctant to enforce these provisions, particularly where they conclude that a lessee failed to take reasonable steps to remedy the delay and/or the lessee’s own conduct contributed in some way to the delay.
5. Regularly communicate with and educate lessors and local interest groups. Good communication by oil and gas companies is critical to keeping lessors happy. Some companies have done a poor job of communicating with and educating their lessors and the interest groups in the communities where they operate. Much of the controversy over hydraulic fracturing might have been avoided with better communication, from the outset, as to the safety of the technology and its importance to U.S. energy independence.
Implementing these suggestions can help save oil and gas companies significant amounts of money in litigation. In-house counsel who do so might just find themselves only talking with their outside counsel to thank them for their holiday cards.