Review of the Typical California Oil & Gas Lease with a focus on Essential, Defensive and Administrative Clauses and Keeping Your Lease Alive Michael N. Mills Thomas A. Henry Michael J. Sherman Juliet H. Cho
Outline Essential Clauses Defensive Clauses (Keeping Your Lease Alive) Administrative Clauses 2
Essential Clauses Transfer rights to search for, develop, and produce minerals (the essence of the lease): Granting Clause Cover All Clause Term or Habendum Clause Drilling/Delay Rental Clause 3
Granting Clause Grants mineral rights to the Lessee and must identify: Size Substance Location Type of Interest: Non-possessory (profit a prendre) Not absolute title or exclusive right to use land ONLY the exclusive right to search for, develop, and produce oil and gas Lessee cannot interfere with Lessor s use of land unless it is adverse, injurious, or conflicting to Lessee s use 4
Granting Clause Cases Brookshire Oil Co. v. Casmalia Ranch Oil & Dev. Co. (1909) 156 Cal. 211, 217 Cassinos v. Union Oil Co. of California (1990) 14 Cal.App.4th 1770, 1780 5
Cover All Clause aka Mother Hubbard Clause Extends lease to the entire land or interest area being leased Purpose: If any portion of land or interest is inadvertently left out or the lease contains an inadequate description 6
Habendum Clause Two clauses in one: Primary term: fixed length for exploration Secondary term: hold lease by production To have and to hold the same for a term of 20 years and so long thereafter as [hydrocarbons are] produced therefrom. 7
Habendum Clause (cont.) To have and to hold the same for a term of 20 years and so long thereafter as [hydrocarbons are] produced therefrom. produced = producing in paying quantities (Lough v. Coal Oil, Inc. (1990) 217 Cal.App.3d 1518) Cessation outside primary term = *Except if temporary (Montana-Fresno Oil Co. v. Powell (1963) 219 Cal.App.2d 653) Termination* 8
Drilling/Delay Rental Clause Unless Clause If operations for drilling have not commenced within 1 year, the Lease shall terminate, unless the Lessee pays a delay rental of Automatic termination Or Clause If operations for drilling have not commenced within 1 year, Lessee shall pay an annual rental until drilling operations have commenced No automatic termination 9
Defensive Clauses Operations Shut-in Royalty Keeping Your Lease Alive Dry Hole Force Majeure Pooling 10
Operations Clause Purpose: extend primary term by operations without production Two variations: Continue with any operation, including new wells Continuous Operations Well Completion Can only complete well in process at expiration 11
Dry Hole Clause Protect primary term from expiring if a dry hole Surrender Dry Hole Pay Delay Rentals Drill new well 12
Pooling Clause Pool leases and interests covering multiple parcels Benefits: Hold leases by production Drilling obligations met by operations anywhere in the pool 13
Pooling Clause (cont.) Size and shape shall not exceed 640 acres. of any size or shape as Lessee may desire one well per 160 acres, or major fraction thereof. Overlapping pools and well-by-well pooling Pugh Clauses 14
Force Majeure Clause Protects lessee from unforeseen events by war, riots, strikes, lockouts, action of the elements, accidents, inability to obtain adequate drilling rigs and materials on the open market... or any other cause beyond the control of Lessee. May not apply to all terms in the lease (San Mateo Community College Distr. v. Half Moon Bay Ltd. Partnership (1998) 65 Cal.App.4th 401, 413) 15
Shut-In Royalty Clause Continue secondary term with payment on shut-in wells Typically only applies to gas wells During such times that a market for gas does not exist, Lessee may suspend the operation of any such well; however, Lessee shall pay $1.00 per acre, which shall be deemed the equivalent of production in paying quantities 16
Administrative Clauses Defensive clauses that help with the administration of the lease: Warranty Clause Lesser Interest Clause Surrender Clause Free Gas Clause 17
Warranty Clause Lessor guarantees title to the land is not defective Lessor promises to defend any challenges to title If clause is breached: Lessor may be liable for any and all payments Lessor received under the lease 18
Lesser Interest Clause Also known as the Proportionate Reduction Clause If it turns out Lessor has less than 100% of mineral interest in the leased land: Lease payments are reduced to actual percentage of property owned by lessor Reduces royalties, rentals, and other payments made from Lessee to Lessor 19
Lesser Interest Clause Example: X leases entirety of the mineral estate to Y Y finds out X owns only 70% of the mineral interest If a lesser interest clause exists in the lease, Y can reduce payments to X by 30% 20
Subrogation Clause If Lessor runs into financial hardship, how does Lessee protect its interest? 21
Subrogation Clause Lessee can pay the mortgage and taxes of leased property in order to protect Lessee s interest and any future ownership interests are subrogated to the Lessee s interest Lessee then recovers payments from future proceeds to Lessor under the lease 22
Surrender Clause Surrender: Lessee has the option to give up all of, or part of, the land under the lease However, Lessor cannot use Surrender Clause to compel Lessee to surrender at any time When is this used? If land becomes unproductive Why is this beneficial? Proportionately reduces Lessee s liability for delay rentals 23 and other payment obligations
Free Gas Clause Lessor s Royalty Alternative: can opt to receive royalty in form of gas produced on land vs. receiving cash royalty payment How to protect Lessee s interests: Create limits on use, type, and/or amount of gas Include acknowledgement of risk undertaken by Lessor 24
Free Gas Clause Case Vedder Petroleum Corporation, Ltd. v. Lambert Lands Company (1942) 50 Cal.App.2d 102, 110 25
Thank You Michael N. Mills mnmills@stoel.com Thomas A. Henry tahenry@stoel.com Juliet H. Cho jhcho@stoel.com Michael J. Sherman mjsherman@stoel.com 26