assignment of oil and gas interest

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Oklahoma Bar Journal

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.

CONCLUSION 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.

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.

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.

Originally published in the  Oklahoma Bar Journal --  OBJ 88 pg. 285 (Feb. 11, 2017)

The Oil and Gas Report

What Are the Types of Interests in Federal Oil and Gas Leases and How Are They Assigned?

Federal oil and gas leases are administered by the Bureau of Land Management (“BLM”) pursuant to the Mineral Leasing Act of 1920, as amended (“MLA”), and the implementing federal regulations. Federal leases have a slightly different ownership scheme than fee oil and gas leases. As to fee leases, the lessee owns a leasehold interest that includes the right to drill for and produce the leased substances, subject to royalty payments to the lessor. The term “working interest” is commonly used and is generally considered synonymous with the lessee’s interest and the term “leasehold interest.” As to federal leases, the lessee’s leasehold interest includes both record title and operating rights. Initially, these two types of interests are merged together as  the record title interest, but the operating rights interest can be severed from the record title interest by assignment.  The record title interest includes the obligation to pay rent and the rights to assign and relinquish the lease. [1] The operating rights interest authorizes the holder to drill for and conduct operations and produce the leased substances. [2] When all or a portion of the operating rights have been severed from the record title, the operating rights interest owner is primarily liable for its pro rata share of payment obligations under the lease while the record title interest owner is secondarily liable. [3] At the extreme, if all of the operating rights as to all depths are severed by assignment from the record title interest, the lessee owns “bare” record title interest and has no rights to drill for and produce the leased substances. The term “working interest” is generically associated with the operating rights interest unless said operating rights interest has not been severed from the record title interest, then it is associated with the record title interest. Otherwise, the range of interests that may be created out of federal leases is nearly the same as fee leases.

The interests in federal leases are generally conveyed by a “transfer,” being defined in the federal regulations as “any conveyance of an interest in a lease by assignment, sublease or otherwise.” [4] Set forth below is a discussion of the different types of interests that may be transferred in federal leases and whether the instrument transferring the interest must be filed with and approved by the BLM. [5]

Record Title Interests

The MLA and federal regulations use the term “assignment” for a transfer of all or a portion of the lessee’s record title interest in a lease. [6] All assignments of record title interests must be on the currently approved BLM form Assignment of Record Title Interest in a Lease for Oil and Gas or Geothermal Resources, Form 3000-003. [7] Record title interests may be transferred as to all or part of the acreage in the lease or as to either a divided or undivided interest therein. [8] Record title interests may not be transferred as to limited depths or horizons, separately as to either oil or gas, less than part of a legal subdivision, [9] or less than 640 acres (outside of Alaska). [10]

Upon receipt of the assignment, the BLM will engage in an “adjudication” process whereby the BLM will determine and identify the owners of interests and their percentage interest in the lease as a consequence of the assignment and approve the assignment if it meets all statutory and regulatory requirements. The rights of the assignee will not be recognized by the BLM until the assignment has been approved. [11]

Operating Rights Interests

The MLA and federal regulations use the term “sublease” for a transfer of a non-record title interest in a lease, including a transfer of operating rights. All transfers of operating rights interests must be on the currently approved BLM form Transfer of Operating Rights (Sublease) in a Lease for Oil and Gas or Geothermal Resources, Form 3000-3a. [12] For transfers of operating rights interests, the MLA and federal regulations do not contain any limitations on such transfers other than it must be as to “all or part of the acreage in the lease.” [13]

Upon receipt of the transfer, the BLM will engage in the adjudication process to determine and identify the owners of interests and their percentage interest in the lease as a consequence of the transfer and approve the assignment if it meets all statutory and regulatory requirements. The rights of the transferee will not be recognized by the BLM until the transfer has been approved. [14]   However there was a period of time where most state offices of the BLM did not adjudicate transfers of operating rights.

Beginning in 1985, the BLM issued internal guidance, Washington Office Instruction Memorandum No. 1986-175 (Dec. 30, 1985) (“IM 1986-175”), stating that it was not necessary for the BLM to “adjudicate” operating rights assignments [15] on the grounds that they are third-party contracts. The BLM adjudicators were instructed to stop adjudicating operating rights transfers, and to instead “rubber stamp” them within 30 days of their submission when there was no “evidence to the contrary regarding qualifications and proper bonding.” [16] Accordingly, most BLM offices began accepting transfers of operating rights and “approved” the transfers without confirming and determining the ownership of the operating rights interests. In 2013, the BLM issued Instruction Memorandum No. 2013-105 (April 4, 2013) (“IM 2013-105”), directing all BLM offices to immediately begin again adjudicate transfers of operating rights interests. [17]  Understanding that there would be a backlog to carry this out this directive, IM 2013-105 provides a priority schedule for adjudicating existing and future transfers of operating rights as follows: if first production occurs on or after October 1, 2012, adjudicate all transfers of operating rights immediately; if first production occurred prior to October 1, 2012, adjudicate as necessary to enable the Office of Natural Resources Revenue (“ONRR”) to issue appropriate orders to the owners; and adjudicate all remaining unadjudicated operating rights transfers when time and staffing allows.

Obviously, the BLM offices are faced with trying to adjudicate and determine the current operating rights interest owners based on over thirty years of potentially incomplete and possibly erroneous transfers contained in the BLM lease files. A survey was conducted in 2017 of the following BLM State Offices to determine how they were implementing IM 2013-105 and adjudicating transfers of operating rights. [18]

For leases occurring prior to 2012, the Colorado State Office is only conducting reviews for leases with production at the request of ONRR. When it discovers discrepancies, it considers those transfers null and void from their inception and does not provide or send out unapproved operating rights decision letters because the transfers were never adjudicated. Colorado is not willing to accept county records or other outside sources to assist in curing title deficiencies. For leases occurring after October 1, 2012, the Colorado Office will adjudicate all transfers accordingly.

Montana, North Dakota, South Dakota, and Utah [19]

The Montana and Utah State Office never stopped adjudicating transfers of operating rights; accordingly, IM 2013-105 did not change how they are adjudicating such transfers.

New Mexico, Kansas, Oklahoma, and Texas [20]

The New Mexico State Office is conducting a piecemeal review of its lease files. Initially, when the New Mexico State Office received a new assignment and could not account for the purported interest to be assigned, they retroactively denied previously approved transfers either (a) all the way back until the title examiner could account for the purported interest; or (b) through 1991. It appears that recently, the New Mexico State Office has become willing to consider outside records in examining title to fill in gaps in currently filed assignments, such as recorded assignments, evidence of corporate successions, etc.

The Wyoming State Office adjudicates operating rights for all new leases, as well as any adjudications requested by ONRR. It also has plans to adjudicate operating rights for all producing leases according to staff availability. The Wyoming State Office is currently using the Lease Interest Worksheet to chain title retroactively and adjudicate operating rights at the request of the ONRR. During this review, and when any new transfer is filed, if the State Office examiner cannot account for the purported interest to be assigned, they stamp the Lease Interest Worksheet “discrepancy.” Thereafter, the Wyoming State Office will not approve any subsequent transfer until the problem in the chain of title is resolved. No notice of the discrepancy is provided to the parties who received interests through transfers now marked with a discrepancy, so without review of the current BLM case file for each lease or subsequently denied transfer, parties who believed they previously owned operating rights are not aware their rights have been called into question. This requires the Wyoming State Office to deny any subsequent transfers for leases containing a discrepancy, and to disregard any assignments occurring before the discrepancy that were previously approved.

In an attempt to complete a chain of title, bring current its files, and resolve any discrepancies, the Wyoming State Office is accepting a certified copy of an assignment recorded in the county records and attached to a BLM form Transfer of Operating Rights that is completed by general references to the attached county assignment. The Wyoming State Office will issue a decision stating that its records are incomplete and in order to complete its records, it is accepting and approving the assignment.

Overriding Royalty Interests, Production Payments, and Other Interests

The federal regulations make specific reference to only two other types of interests, overriding royalty interests and production payments. [21] Transfers of these interests must be filed with the BLM and will be included in the lease file, but are not subject to BLM approval. [22] While they can be filed on either a BLM form assignment, [23] any form of assignment may be used.

While net profits interests and carried interests are not expressly mentioned in the regulations governing assignments of interests, such interests are included in the definition of “interest.” [24] The usual practice is to follow the same filing procedures prescribed from assignments of overriding royalty interests and production payments above.

Liens and Security Interests under Mortgages and Other Financing Instruments

Liens and security interests in federal leases created under mortgages and other financing instruments do not fall within the definition of “interests” under the regulations and are not required to be accepted for filing under the regulations. Most BLM offices will discourage or even reject the filing of mortgages and other financing instruments. As a result, mortgages and other financing instruments are typically only filed in the county records.

Transfers by Operation of Law

The regulations identify two types of transfers by operation of law: death and corporate reorganization. When an owner dies, his or her rights will be recognized as having been transferred to the heirs, devisees, executor, or administrator of the estate, upon the filing of a statement that all parties are qualified to hold an interest in a federal lease. [25] The BLM office will typically also require, along with the statement, supporting information concerning the demise of the owner.

In the case of corporate name change, merger, or conversion, no assignment is required unless otherwise required by state law. The regulations require that notification of the name change, merger, or conversion be furnished in the proper BLM office. [26]

_____________________

Prior to filing any transfer with the BLM, it is always to the advantage of the parties to the transfer to make inquiry of the oil and gas adjudication personnel at the applicable BLM office to confirm that the parties have prepared the transfer in compliance with the office’s policies and procedures.

[1] 43 CFR § 3100.0-5(c). Record title is the ownership in a federal lease as recognized by the BLM.  Therefore, it has no connection to the title or leasehold ownership reflected in the applicable county records.

[2] 43 CFR § 3100.0-5(d). The term “operating rights” should not be confused with the right to serve as operator on the ground. An operator is the person or entity that is responsible under the terms and conditions of the lease for operations being conducted on the leased lands; it can include, but is not limited to, the lessee record title interest owner or operating rights interest owner. See 43 CFR § 3160.0-5

[3] See 43 CFR §§ 3106.7-6(b), 3216.12.

[4] Id. § 3100.0-5(e).

[5] Not addressed herein are the qualifications to own an interest in a federal lease and the specific filing requirements.

[6] Id. § 3100.0-5(e).

[7] Most recent revision date is August 1, 2015.

[8] Id. § 3106.1(a). Note, the assignment of the entire interest in a portion of the leasehold will result in a segregation of the lease.

[9] Generally, requiring all of a governmental lot or quarter-quarter section under the Public Land Survey System.

[10] 30 USC § 1987a; 43 CFR § 3106.1. The 640 acre limitation was added to Section 30A of the MLA in 1987 pursuant to the Federal Oil and Gas Onshore Leasing Reform Act. Assignments of record title of less than 640 acres will be approved if the assignment constitutes the entire lease or is demonstrated to further the development of oil and gas.

[11] 43 CFR § 3106.1(b).

[12] Most recent revision date is August 1, 2015.

[13] 43 CFR § 3106.1. There is no written guidance defining “part of the acreage” or addressing this apparent acreage requirement. It appears that at least some minimal amount of acreage must be transferred to comply. Accordingly, although some BLM State offices will accept transfers of operating rights for less than 40 acres, they will not accept for approval, or even for filing purposes only, transfers of operating rights in a wellbore only.

[14] Id. § 3106.1(b).

[15] The term “assignment” is used generically in the IM applying to an assignment of either a record title interest or an operating rights interest.

[16] IM 1986-175.

[17] IM 2013-105 was issued in direct response to the 1996 amendment to Section 102(a) of the Federal Oil and Gas Royalty Management Act, 30 USC § 1712(a), providing that the owner of the operating rights shall be primarily liable for its pro rata share of payment obligations under the lease and the owner of the record title interest (if different from the owner of the operating rights interest) became secondarily liable. The federal regulations at 43 CFR Section 3016.7-6 and 3216.12, reflect these same principals. Furthermore, the BLM form Transfer of Operating Rights (Sublease) in a Lease for Oil and Gas or Geothermal Resources specifically provides that the transferee’s signature “constitutes acceptance of all applicable terms, conditions, stipulations, and restrictions pertaining to the lease… (Part B, paragraph 3) and “upon approval of a transfer of operating rights (sublease), the sublessee is responsible for all lease obligations under the lease rights transferred to the sublessee” (Part C, paragraph 8).

[18] See Jared A. Hembree and Uriah J. Price, Holding a Wolf by the Ears – A Look into BLM’s Policy on the Retroactive Adjudication of Operating Rights, 63 Rocky Mt. Min. L. Inst., Paper 11 (2017) (not yet published).

[19] The Montana State Office administers federal lands in Montana, North Dakota, and South Dakota. The Utah State Office administers federal lands in Utah only.

[20] The New Mexico State Office administers federal lands in New Mexico, Kansas, Oklahoma, and Texas.

[21] 43 CFR § 3106.1.

[22] 43 CFR § 3106.1(b).

[23] Both of the current BLM forms include a box that can be checked to indicate that it is for an overriding royalty interest assignment.

[24] 43 CFR § 3000.0-5(1).

[25] Id. § 3106.8-1.

[26] Id. § 3106.8-3.