Oil & Gas Division Orders. Andrew Graham Steptoe & Johnson PLLC Morgantown, WV

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1 Oil & Gas Division Orders Andrew Graham Steptoe & Johnson PLLC Morgantown, WV

2 Division orders Purpose Liability Notice Conflicts Division order title opinions Risk allocation Company need

3 What is a division order? Declares the type of interest and the portion of production each interest owner (royalty owner, WI, production payment, etc.) is entitled to from a well May contain additional provisions How is the price calculated? Is there a warranty for the interest? Is interest owner required to give notice of changes of ownership? DOs for NGLs often contain technical specifics regarding the measuring and valuing of product

4 What happens if royalty is paid incorrectly? Payor can be liable for accounting for unpaid royalty, plus interest If royalty is payable in kind, payor and purchaser of production can be liable for conversion Division order helps protect against adverse claims Who seeks this protection? Lessee, purchaser of production, or well operator (OK)

5 Transfer/Declaration Distinction Some division orders transfer title If royalty oil is payable in kind and is sold by lessee without a division order, lessee and purchaser may be liable for conversion Lessor and lessee have a principal/agent relationship Most division orders just declare interests Gas lessees are usually expected to market gas for lessor and then account percentage of value as royalty Lessor and lessee have a creditor/debtor relationship

6 Binding effect of division order Parties to division orders are estopped from asserting that past payments were too small to compensate for the interest that they own But parties can ask for corrections that will affect payments in the future Some courts (MS, OK, WV) have held that division orders bind interest owners from pursuing adverse claims against each other, as well as claims against payor

7 Division order only covers what it covers The protection of a division order only extends to the interests included in the division order If some part of Blackacre is excluded from the division order, payments related to the excluded portion are not subject to the division order Same outcome if division order is limited to specific producing formation A division order that is limited to the Marcellus Shale has no effect on production from the Utica Shale

8 Notice of Change of Ownership Division orders generally contain a notice of change of ownership clause OG leases often contains such clauses too Payor isn t bound by transfer of payee s interest to third party until notice is given Can payor refuse to pay royalty until a division order has been signed? In many states, the answer is no (KS, LA, AR, OK) Tex. Nat. Res. Code requires interest owners to sign statutory division order

9 The 3 Rs: Revoke/Ratify/Revive Division orders are generally viewed as binding on the parties who sign them until they are revoked Generally viewed as terminable at will Division orders won t ratify or revive leases unless they contain ratification or revival language Courts in LA, MT, PA, and TX have reached this result But if lessor signs division order and then acquiesces to the payment of royalty over a long period of time, lease may have been ratified TX: Duval v. W.T. Carter & Brothers

10 Conflicts between DO and Lease A leases Blackacre to B. Lease provides that royalty will be percentage of market value A executes division order that provides that royalty will be percentage of actual proceeds TX: Exxon Corp. v. Middleton (1981) Unless division order is revoked, royalty should be calculated consistent with division order, not lease

11 Detrimental Reliance KS: Maddox v. Gulf Oil Corp. Division order isn t supported by consideration and it doesn t estop royalty owner s adverse claims unless payor has relied on division order to its detriment TX: Gavenda v. Strata Energy, Inc. Division order incorrectly stated that royalty owner owned ½ of usual 1/8 royalty (6.25%). Actually owned ½ royalty (50%). Division order didn t protect payor because payor benefitted from payor s mistake If payments are mis-directed as between royalty owners, division order will protect payor so long as mistakes don t affect total amount of royalty paid and improper payment doesn t benefit payor

12 Division Order Title Opinions A division order title opinion (DOTO) determines who owns what share in the products produced and marketed In order to prepare DOTO, lawyer must examine recorded title documents and other available information relating to the mineral estate Where there are title defects, payments are withheld until defects are corrected

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14 Why do you need a title opinion? Drill a well Pay a royalty owner What do you do about: Competing chains of title? Affidavits of heirship? Probate information? Do you pay or do you hold funds in suspense?

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16 Each producer can decide what the DOTO will cover Calculations only? Updated title with calculations? Complete statement of title with calculations All prior drilling opinions reviewed DOTO includes new comments and requirements State of title at the date of first sales Updated information Burden shifts from producer to mineral owner

17 How much advice do you want from your lawyer? Advisory comments Curative requirements How do you want the royalty calculated? Tract Unit Owner

18 Who are the royalty owners? Who owns a part of the leasehold? Which lands are you paying for? Survey analysis Pooling Sufficient authority to pool? Updating the chain of title

19 Each producer can determine the basis for the DOTO Unit Lease Tract Who will review the curative requirements? In-house DOTO examiner

20 Curative review and recommendations When to take legal action Quiet title actions Declaratory judgment actions Interpleader Reducing producer risk Handling outstanding issues

21 QUESTIONS? Andrew Graham Steptoe & Johnson PLLC 21