Interpreting Assignments of the Oil and Gas Lease
By Jereme M. Cowan
Under Oklahoma law, an oil and gas lease grants a cluster of rights in land,1 forming an estate in real property with the nature of fee.2 Like many of the sticks in the metaphorical bundle, the estate created under the oil and gas lease is freely assignable and divisible.3 As a result, oil and gas leaseholds can be transferred, in whole or in part, by the holder of the oil and gas lease, such practice being a central element to oil and gas development.4 Furthermore, the transfers of leasehold are usually executed and delivered by legal instruments ubiquitously titled “assignments,” which are filed of record in the same manner as any instrument affecting title to real property.5 Given the history of Oklahoma’s oil booms,6 not to mention Oklahoma’s current role in the U.S. shale boom, assignments inundate many of the county clerk records where oil and gas exploration is prevalent. Therefore, it is likely that an examination of oil and gas land titles in one of these counties will require the interpretation of assignments.
BASIC RULES OF CONSTRUCTION
Assignments are a contract and a conveyance.7 As such, they are to be read in accordance with the basic rules of contractual interpretation,8 which comprise not only those findings in Oklahoma’s case law but also the statutory provisions of 15 O.S. §§151-178. In a nutshell, Oklahoma’s rules on interpreting assignments begin with prioritizing the true intent of the parties, as gathered from the four corners of the instrument.9 If the assignment is unambiguous, then the written instrument will govern,10 along with all technical terms in the assignment being interpreted as commonly understood among persons in the oil and gas industry.11 However, if there is an ambiguity, then the contractual interpretation can be aided by extrinsic evidence in order to resolve the intrinsic uncertainties of the assignment.12
These rules make it imperative for an attorney conducting a title examination to understand the business and terminology of the oil and gas industry as it pertains to the transfer of leasehold, not to mention understanding general rules of land titles and the law of oil and gas. The purpose of this article is not to give a complete account of the oil and gas industry nor an account of all rules governing the transfer of oil and gas rights in the record title. Rather, the purpose is to give an introductory and cursory overview, presented on a step-by-step basis, for an attorney who may find themselves, either willingly or unwillingly, examining assignments of oil and gas leases filed in Oklahoma.
STEP 1: WHAT TYPE OF INTEREST?
First and foremost, the title examiner needs to determine the type of interest being assigned (or reserved) in the leasehold. More often than not, if the assignment is transferring an interest in a lease without overriding royalty language or net profits language, then a working interest is being assigned. When there is ambiguity, the title examiner should remember that a working interest is the right to work on the leased property — searching, developing and producing oil and gas. On the other hand, an overriding royalty interest is share in production attributable to a particular lease.
STEP 2: WHAT AMOUNT OF INTEREST?
Working interests tend to be relatively straightforward. Either the assignor is purporting to assign all of its right, title and interest under a lease, all of a lease (read 100 percent) or a fractional interest in a lease. Digressing a bit, now would be a good moment to discuss the difference between all right, title and interest of the assignor and 100 percent of a lease. All of the assignor’s right, title and interest could be 100 percent or could be some fractional interest. It depends on what the assignor owns of record. If an assignor assigns a lease without any fractional limitations or without the foregoing language limiting it to the assignor’s right, title and interest, then the assignor is purporting to assign 100 percent of the lease. The prudent examiner notes the distinction.
Overriding royalty interest can sometimes not be as straightforward. Often, the assignor decides to use a formula for the computation of the assigned or reserved overriding royalty interest. For example, a recitation in the assignment reads as follows: an overriding royalty interest equal to the difference between 20 percent and lease burdens. Here, the overriding royalty interest would be calculated by first adding up all the lease burdens, such as a one-eighth landowner’s royalty and a previously conveyed one-thirty-second overriding royalty interest, and then subtracting that number from 20 percent, which is represented mathematically as: 20% - (1/8 + 1/32) = 4.375%.
There are various business reasons for computing an assigned or reserved overriding royalty interest with the subtraction of lease burdens from a certain percentage, the most prominent being that assignments of leases typically cover a block of leases, which contain various lease net revenue interests. Showing the overriding royalty interest as a formula rather than a specific number allows the assignor to either retain or convey the leases at certain net revenue interest. In the prior example, assuming the assignor was assigning the overriding royalty interest, it was retaining an 80 percent net revenue interest in all the leases covered by the assignment except, of course, those leases which were already burdened greater than 20 percent.
STEP 3: WHAT LEASE IS COVERED?
All leasehold interests derive from a lease. Therefore, it is imperative that the examining attorney determine what lease is covered by an assignment. If the assignment covers one or just a few leases, then the lease(s) will probably be described somewhere in the body of the instrument. If the assignment covers multiple leases, then typically they will be described in an exhibit “A” attached thereto. However, it should be noted that in some cases an assignment may not describe a particular lease or leases but instead will include language that it is the intent to assign all leasehold rights in a particular tract of land, usually the unitized area. For example, an assignment may read that all of the assignor’s rights in the leasehold covering the SW/4 are transferred to the assignee without giving further explanation as to the underlying leases. In this particular example, the assignor is conveying whatever leasehold rights it may own from whatever source such rights might derive as to the SW/4.
STEP 4: WHAT ARE THE LIMITATIONS TO THE ASSIGNED INTEREST?
By far the most challenging (and often most ambiguous) aspect of an assignment is the limitations to the assigned interest. Like land itself, a lease is a bundle of sticks. A lease can be cut and carved any which way, limited only by the imagination of the oil and gas industry. If an assignor wants to assign a lease insofar as that lease covers a particular formation in the strata, then the assignor can do so. The following are standard limitations that the examining attorney should recognize.
An assignment can be limited to the wellbore of a well. A wellbore limitation means that the assignor is assigning only those rights to production from the wellbore of a certain well, arguably at the total depth it existed at the time of the assignment. All interest outside the wellbore are excluded from the assignment, entailing that a wellbore assignee can produce from shallower formations in the wellbore but cannot produce from deeper formations or lands outside the wellbore.
The central problem with wellbore only assignments is determining when in fact there is a wellbore only assignment. The title examiner should be aware that a wellbore assignment is the narrowest of assignments. Very limited rights to the lease are being assigned. It can be argued that the lease or unit and the lands covered by the lease or unit need only be described for informational purposes, as it is rights to the wellbore being assigned. Furthermore, the fact that a well or unit is mentioned in the description of the lease does not entail that the assignor intended to convey wellbore rights only. More often than not, a reference to a well or unit in Oklahoma is for informational purposes.
Some assignments are limited to certain depths or to a particular formation. For instances, an assignment may limit the assigned leases “insofar as said leases cover the Woodford Formation” or “insofar as from the surface to a depth of 8,100 feet.” Depth limitations are usually more prominent than wellbore limitations and are considerably less ambiguous. Furthermore, title examiners should always read an assignment thoroughly to determine whether a depth limitation is pertinent. Many times, such a limitation is buried in one of the numerous special provisions of the assignment or placed in one of the exhibits attached thereto.
In order to accommodate the formation of units, leases will often be assigned only as to a portion of the lands covered thereby. For example, a participant enters into a joint operating agreement with the operator that has proposed the drilling of a 40-acre unit well located in the NW/4 NW/4. If the participant owns all of a certain lease covering the N/2 NW/4, the participant may decide to assign only that portion of the lease covering the NW/4 NW/4, thereby retaining all rights in the NE/4 NW/4. Therefore, assignments may contain limitations as to the area acreage being conveyed.
The foregoing steps serve as an introduction to interpreting assignments of oil and gas leases. Most certainly, each step of analysis could be accompanied by a more detailed explanation. That said, the key point to be made here is that the interpretation of assignments in oil and gas land titles requires a familiarization of the business practices of the oil and gas industry, not just an understanding of the governing law.
1. See Hinds v. Phillips Petroleum Company, 1979 OK 22, 591 P.2d 697, 698 (1979) (stating that “[t]he cluster of rights comprised within an instrument we refer to ‘in deference to custom’ as an ‘oil and gas lease’ includes a great variety of common-law interests in land”).
2. See Shields v. Moffitt, 1984 OK 42, 683 P.2d 530, 532-33 (1984) (finding that “the holder of an oil and gas lease during the primary term or as extended by production has a base or qualified fee, i.e., an estate in real property have the nature of a fee, but not a fee simple absolute”).
3. See Hinds at 699 (concluding that leasehold interests are freely alienable “in whole or in part”); Eugene Kuntz, Kuntz, a Treatise on the Law of Oil and Gas, Volume Five, §64.1, 259 (1987) (asserting that the oil and gas lease is freely assignable “in the absence of a provision to the contrary”); see also Shields at 533 (holding that a lease clause restricting alienation was void).
4. John S. Lowe, Oil and Gas Law in a Nutshell, Sixth Edition (2014).
5. Joyce Palomar, Patton and Palomar on Land Titles, 3rd Edition, Volume One, 3 (2003).
6. Kenny A. Franks, The Oklahoma Petroleum Industry (Norman: University of Oklahoma Press, 1980).
7. See Plano Petroleum, LLC v. GHK Exploration, L.P., 2011 OK 18 (2011).
8. K & K Food Servs. v. S & H, Inc., 2000 OK 31, 3 P.3d 705, 708.
9. See Messner v. Moorehead, 1990 OK 17, ¶8, 787 P.2d 1270, 1272.
10. Messner at 1273.
11. 15 O.S. §161.
12. Crockett v. McKenzie, 1994 OK 3, ¶5, 867 P.2d 463, 465.
ABOUT THE AUTHOR
Jereme M. Cowan is a managing partner at Cowan & Fleischer PLLC. Mr. Cowan’s practice fo-cuses on oil and gas land titles. He has planned, moderated and spoken at a number of oil and gas seminars sponsored by the Oklahoma Bar Association.
Originally published in the Oklahoma Bar Journal --
OBJ 88 pg. 285 (Feb. 11, 2017)