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THE ASSIGNMENT OF OIL & GAS LEASES: CONDITIONS, CONSTRAINTS, AND CONSEQUENCES

Mark K. Glasser Baker Botts L.L.P. Houston, Texas

Scott Humphrey Jesse R. Pierce & Associates Houston, Texas

Mark K. Glasser and Scott Humphrey, The Assignment of Oil & Gas Leases: Conditions, Constraints, and Consequences, in Center for American and International Law, Sixty-second Annual Institute on Oil and Gas Law (LexisNexis Matthew Bender 2011).
The authors wish to acknowledge the substantial contribution to this paper by Ben T. Sweet, associate lawyer at Baker Botts L.L.P.

TABLE OF CONTENTS

1.01. Introduction. ..............................................................................................2 1.02. Direct Transfer of a Lease and Consent-to-Assign Clauses. .................3 [1] Ownership-in-Place States. ...........................................................6 [a] [b] [c] [d] [2] Texas. ..................................................................................6 Pennsylvania. ...................................................................17 Oklahoma. ........................................................................18 Colorado. ..........................................................................22

States that Follow a Non-Ownership Approach for Mineral Leases............................................................................................23 [a] [b] [c] [d] [e] [f] [g] [h] Louisiana. .........................................................................23 New York..........................................................................24 Kansas...............................................................................24 Montana............................................................................26 Ohio...................................................................................28 Arkansas. ..........................................................................30 West Virginia. ..................................................................30 California..........................................................................31

[3] [4] [5]

Leases on Federal Lands.............................................................33 Restatement (Third) of Property................................................34 Conclusion. ...................................................................................37

1.03 Post-Transfer Concerns for the Lessee-Assignor. ................................38 [1] [2] [3] [4] [5] [6] Delay Rentals. ..............................................................................40 Royalties. ......................................................................................40 Restoration of Surface.................................................................41 Implied Covenants.......................................................................41 Obligations Under Joint Operating Agreements......................42 Undisclosed Agreements with Third Parties.............................44

1.01. Introduction. The assignment of a lessees rights and obligations under an oil and gas lease is a practice as old as the industry itself. With accelerated exploration and production activity in new shale plays, and the accompanying increase in leasing and conveyancing, this practice is perhaps more prevalent than ever. In these emerging prospects, speculators are abundant, new players are buying in, and legacy operators are regularly entering into agreements to share exploration opportunities and development costs. The assignment of rights and obligations under oil and gas leases is an integral part of this process. The assignment of all or some interest in an oil and gas lease may take a number of forms. A producer may directly acquire the assets of another producer, necessitating the direct assignment of the selling partys rights and obligations under its leases. A lessee may enter into a farmout agreement assigning all or a portion of its interest under a lease to another party while retaining an overriding royalty interest. The cross-assignment of rights under leases is also a common feature of Area of Mutual Interest (AMI) agreements, wherein producers agree to share in leases acquired in a specific prospect. While these are the most common instances, assignments may arise from any number of other private contracts or transactions. As landmen, lawyers, and others involved in purchasing oil and gas leases are aware, todays landowners have become increasingly sophisticated with respect to the development of their mineral rights. More often than in years past, landowners today seek legal advice regarding the negotiation and enforcement of those rights. That advice commonly includes a recommendation that lessors -2-

endeavor to prohibit or restrict the transferability of leasehold interests. It is therefore essential for industry participants to understand the basic principles surrounding the transferability of oil and gas leases. This paper will first address the permissibility of a direct transfer of an oil and gas lease in cases where the lease purports to prohibit or limit the right of transfer. The paper will then address the problems that may occur after the assignment of a lease, including any remaining obligations of the assignor, the consequences of an assignees default upon its obligations, and, finally, the problems that may arise when previously undisclosed parties are found to have an interest in an assigned lease. 1.02. Direct Transfer of a Lease and Consent-to-Assign Clauses. It is generally accepted that an oil and gas lease is freely assignable by the lessee, absent an express clause stating otherwise.1 This proposition is unquestioned in part because almost all lease forms today include either specific assignment provisions or state that the lease is binding on all heirs and assigns. This impliedly authorizes assignments.2 Texas courts have held that the rights and obligations under these agreements are assignable even in the absence of such provisions.3 But when a clause is present that requires the consent of the lessor before the lease may be assigned, the first and all subsequent lessees must know

See 3 EUGENE KUNTZ, A TREATISE ON OIL AND GAS 35.2(a) (Anderson Publishing 1989) (hereinafter KUNTZ).
2 3

Id.

Gladys Belle Oil Co. v. Turner, et al., 12 S.W.2d 847, 849 (Tex. Civ. App.Austin 1929, writ refd).

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the consequences of assigning without consent, including, of course, whether such a clause is enforceable at all. An apparent roadblock to the assignment of an oil and gas lease is the presence of a clause such as these: This lease may be assigned only with the written consent of the lessors. In the event Lessee assigns their rights under this lease without the written consent of the Lessors, this lease shall ipso facto terminate as to the interest so assigned. In the complexity and urgency that surrounds many oil and gas transactions, often with hundreds of leases at issue, clauses such as these may be overlooked or ignored. It may also be the case that a lease has been assigned several times before, with the proper consent never requested, documented, or both. In some instances, consent may have been requested but the request denied or ignored. One might expect the validity and legal effect of these clauses to have been addressed numerous times by courts. They have not been. There are surprisingly few reported decisions involving the effect of consent-to-assign clauses in oil and gas leaseseven fewer in which the issue is conclusively resolved. Moreover, the approaches taken by courts, and their conclusions, vary widely depending upon the manner in which the interest conveyed under an oil and gas lease is classified under the applicable states property law, including whether the state follows the ownership-in-place theory or the exclusive-rightto-take theory.

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Texas, Pennsylvania, and several other states in shale oil and gas producing regions follow the ownership-in-place theory, which holds that the lessee under an oil and gas lease obtains a fee simple determinable estate in the minerals in place.4 In assessing the incidents of ownership of an oil and gas lease, courts in these states therefore rely on well-established real property precedents.5 Other states, including Kansas and Louisiana, follow the exclusive-right-to-take or non-ownership theory, which holds that that an oil and gas lease conveys only a profit a prendre, that is, the exclusive right to extract the minerals but not a possessory interest in the minerals in place.6 In those states, the courts do not necessarily follow the law regarding the conveyance of fee simple estates when construing the provisions of oil and gas leases. They may instead draw upon general landlord-tenant principles and other facets of commercial contract law.7 In light of this divergence, it is not surprising that courts in these states treat consent-to-assign clauses in oil and gas leases quite differently. There follows a summary of relevant case law respecting the enforceability of a consent-to-assign-clause in an oil and gas lease in the predominant oil and gas producing states. In this examination, the states are grouped depending upon whether they follow the ownership-in-place theory or the non-ownership theory. For further guidance, an analysis of this issue under the Restatement (Third) of Property is also included. From this analysis, certain

4 5 6 7

See 2 KUNTZ 23.2. Id. Id. Id.

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conclusions may be drawn about the manner in which the courts in each of these jurisdictions may be expected to treat the validity of, and the putative breach of, a consent-to-assign clause. [1] Ownership-in-Place States. [a] Texas.

Under Texas law, an oil and gas lease conveys to the lessee a fee simple determinable in the minerals in place.8 Such an estate is conveyed regardless of the language used in the granting clause of the lease.9 When construing the rights and incidents of ownership under an oil and gas lease, Texas courts therefore look to the great wealth of law regarding conveyances of fee simple estates.10 This reliance is of particular importance here because Texas courts have long disfavored restraints upon the alienation of fee interests.11 Remarkably, there are to date no reported Texas decisions in which a court has directly ruled upon the enforceability of a consent-to-assign clause in an oil and gas lease. There is one reported decision involving such a clause in a mineral deed and another reported decision in which such a provision appeared in an oil and gas lease, but the enforceability of the provision in the latter case was non-

8 9

Texas Co. v. Daugherty, 176 S.W. 717, 722 (Tex. 1915); see also KUNTZ 23.26. Stephens County v. Mid-Kansas Oil & Gas Co., 254 S.W. 290, 294 (Tex. 1923). KUNTZ, 23.2.

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See, e.g., Diamond v. Rotan, 124 S.W. 196, 198 (Tex. Civ. App.Texarkana 1910, writ refd) (That a general restraint upon the power of alienation, when incorporated in a deed or will otherwise conveying a fee-simple right to the property, is void, is now too well settled to require discussion.) General restraints on alienation seem to be disallowed because, as the U.S. Supreme Court stated in Potter v. Couch, 141 U.S. 296, 315 (1891), [T]he right of alienation is an inherent and inseparable quality of an estate of fee simple.

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determinative of the outcome.12 Nevertheless, the courts in both of these cases addressed well-established property law precedents involving restraints on the alienation of fee simple interests. It is useful to review these precedents and principles to better understand how a Texas court might apply them in the context of a direct (and unavoidable) challenge to a consent-to-assign clause in an oil and gas lease. In Bouldin v. Miller,13 the Texas Supreme Court analyzed the enforceability of a provision in a land deed from a grandfather to his grandsons that required the land to remain unsold until the youngest of said boys shall become of age.14 Before the youngest grandchild turned twenty-one the land was sold by the grandsons guardian on their behalf.15 Two of the grandsons later brought suit to recover title to the land, arguing that the sale was void due to the restriction imposed by the original grant from their grandfather.16 At the outset of its opinion, the court concluded that [it] is clear that the language used does not amount to a condition the breach of which would defeat the estate of the grantees, or either of them, and cause same to revert to the
Outlaw v. Bowen, 285 S.W.2d 280, 283 (Tex. Civ. App.Amarillo 1955, writ refd n.r.e); Knight v. Chicago Corp., 183 S.W.2d 666 (Tex. Civ. App.San Antonio 1944, affd 188 S.W.2d 564). In a recent case, Cedyco Corp. v. Petroquest Energy, LLC, 497 F.3d 485 (5th Cir. 2007), an oil and gas lease interest was auctioned subject to the consent of the lessor because the underlying lease itself contained a consent-to-assign clause. The assignor-lessee, Petroquest, after seeking consent from the original lessor, Exxon, decided not to transfer the lease because Exxon sought, as a condition of its consent-to-assign, that Petroquest indemnify Exxon for all acts of the new assignee. Petroquest found this unacceptable and so chose to cancel the sale instead of pressing the issue of whether this would be considered an unreasonable restraint on alienation. This case therefore sheds no light on the manner in which a court might view such a provision under Texas law.
13 14 15 16 12

28 S.W. 940 (Tex. 1894). Id. at 940. Id. Id. at 941.

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grantor or his heirs.17 The court gives no rationale for this conclusion, although it is true that the language of the provision does not indicate that the grandfather intended that there be a right of re-entry or termination of the interest upon breach, which is typically required of a condition subsequent.18 The court then phrased the question to be answered as follows: [C]ould the grantor, conveying to the grantees a vested estate in fee simple, without a condition the breach of which would avoid the estate granted, impose a valid limitation or restriction upon the power of the grantees to convey the estate granted for any period of time, however reasonable?19 In answering this question, the court first noted that, at common law, if a grantor placed such a condition not to alien on a piece of property, a transfer that violated that condition could only be enforced by the original grantor exercising his right of reentry.20 The court then refused to uphold the provision upon the following basis: [T]he first grantor could not complain because there would be no condition broken, and therefore no right of reentry in him; and the second grantor could not complain because he would be estopped by his own conveyance. . . . Then, since this unlimited
17 18

Id.

See Ryan v. Porter, 61 Tex. 106 (1884) (examining numerous authorities and holding that the language of the restriction must clearly indicate an intent on the part of the grantor that a breach of the provision shall result in a forfeiture before it will be construed to be a condition subsequent); see also Howard R. Williams, Restrictions on the Use of Land: Conditions Subsequent and Determinable Fees, 27 TEX. L. REV. 158, 167 (explaining that in order for a condition subsequent to be found, there must normally be language of re-entry in the instrument of conveyance); RESTATEMENT (FIRST) OF PROPERTY, 24 cmts. b & e (1936) (illustrating language that will typically be considered to have created a condition subsequent).
19 20

Bouldin, 28 S.W. at 941. Id. at 942.

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power of alienation is a necessary incident to such estate, and since there is no person who can enforce the attempted limitation on the power to sell when there is no condition, it follows that the words of limitation in the deed above are ineffectual in law. . . .21 The court concluded that the deed must be construed as if [the words of limitation] had not been written therein.22 Importantly, the court added that it express[es] no opinion as to what would have been the effect of the deed above set out if the language used had been sufficient to express a condition in restraint of alienation until the youngest grantee arrived at the age of 21.23 While the Bouldin court found the clause in question ineffectual in law, and construed the deed as if [the words] had not been written therein,24 one later case, instead of striking similar language, held that the prohibited language served to convert the clause to a covenant, for which the only remedy under the facts of that case would be damages.25 The holding in Bouldin has been applied many times by Texas courts in similar factual settings.26 The Texas Supreme Courts holding in Bouldin was
21 22 23

Id. (emphasis added). Id.

Id. Instead of determining what the outcome would have been had the deed correctly stated the condition subsequent that the boys reach twenty-one years of age, Bouldin deferred to Laval v. Staffel, 64 Tex. 370 (1885). Laval, without deciding the question either, simply states [a]s to the validity of such restrictions the authorities differ, some upholding them and some declaring them void. Id.
24 25

Id.

See, e.g., Gips v. Red Robin Corp., 366 S.W.2d 853, 857 (Tex. Civ. App.Houston 1963, writ refd n.r.e.) (analyzing a provision similar to that in Bouldin and holding that the plaintiff could pursue damages only and not the forfeiture of the interest). See, e.g., Seay v. Cockrell, 115 S.W. 1160 (Tex. 1909) (holding that because a will granted a fee simple estate, a provision that the land not be sold during the lifetimes of the devisees was void); Frame v. Whitaker, 36 S.W.2d 149, 151(Tex. 1931) (finding void a restriction
26

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also cited in the context of a mineral deed in Outlaw v. Bowen.27 In that case, Outlaw conveyed an undivided 1/2 mineral interest to Bowen, who later conveyed the interest to her son.28 The Outlaw-Bowen deed contained a provision prohibiting the conveyance or assignment of the interest to any other party. The son to whom the interest was transferred later sought a declaratory judgment that the restraint on alienation cast a cloud upon his title and should be removed. Citing Bouldin, the court found the provision to be unenforceable, stating that [i]t seems to be the law in Texas, as well as the weight of authorities, that a restraint on alienation imposed on a fee simple title is unenforceable unless the instrument in which the restraint is imposed provides for an enforceable penalty in the event of violation.29 This statement is interesting in part because the Bouldin court never used a term as broad as enforcible penalty. What the Outlaw court seems to be saying is that the correct interpretation of Bouldin is that, absent some expressly-reserved right of reentry, or perhaps a forfeiture provision, the restraint on alienation fails.30
in a will that prevented the sale of the property bequeathed during the devisees lifetime); Sprinkle v. Leslie, 81 S.W. 1018, 1019 (Tex. Civ. App.Fort Worth 1904, writ refd) (holding that a restriction against the sale of the property during the grantees lifetime was advisory only and did not prohibit such a sale where the restriction impose[d] no penalty, nor reserve[d] right of reentry, as for condition subsequent broken); Dodson v. Dodson, 299 S.W.2d 775, 776 (Tex. Civ. App.Austin 1957, no writ) (finding void as against public policy a provision in a deed that prohibited the grantee from selling the land during the grantees lifetime).
27 28 29 30

285 S.W.2d 280 (Tex. Civ. App.Amarillo 1955, writ refd n.r.e.). Id. at 283. Id.

This conclusion is bolstered by the Kansas case to which Outlaw cites for the same proposition. In that case, Somers v. OBrien, 281 P. 888, 888 (Kan. 1929), the court held that when restrictions against alienation are properly made, they are valid, but to be effective some enforceable result of the consequences for the breach of such restrictions must be prescribed in the instrument. Id. at 890. To further clarify, the court noted that the clause at issue contained neither a right of reentry not an alternative grant or other consequences. In Wright v. Jenks, 261 P. 840 (Kan. 1927), where the restriction on alienation was found valid, the clause provided that the

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The enforceability of a consent-to-assign clause in an oil and gas lease was directly raised in Knight v. Chicago Corp.31. In Knight, the Richardson Petroleum Company purchased a lease containing a consent-to-assign clause from the plaintiffs. Later, the Richardson Petroleum Company entered into a unitization agreement with another company, in which the plaintiffs lease was included.32 The plaintiffs argued that the unitization agreement constituted an assignment of the lease, and because consent was neither sought nor given, the consent-to-assign clause in the lease was violated and the lease should be terminated.33 The clause at issue provided: In the event Lessee, its successors or assigns, should attempt to assign any undivided interests, overriding royalty or oil payments without the written consent of the Lessors, other than assignments to banks and oil field companies for the procurement of money, supplies and equipment for the operation and development of the leased premises, or should attempt to assign any tract or tracts of less than 80 acres, this lease shall ipso facto terminate as to the interest so assigned, as well as all of the remaining interest owned by the person or corporation making such assignment.34

estate would terminate in the grantee and pass to his collateral kindred in the event of assignment. Id.
31 32 33 34

183 S.W.2d 666 (Tex. Civ. App.San Antonio 1944, affd 188 S.W.2d 564). Id. at 668. Id. at 669. Id. at 668.

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The court of appeals upheld the trial courts ruling that the plaintiff should take nothing in its trespass to try title suit on the grounds that a unitization agreement was not an undivided interest under the language of this clause and the clause therefore did not apply.35 Consequently, the court did not reach the question of the enforceability of the consent-to-assign clause. The court of appeals decision was affirmed in a published decision of the Texas Supreme Court, which also avoided directly ruling on the enforceability of this provision by holding that the clause did not apply to the transaction at issue.36 Although the Knight court did not say that the clause in questionwhich certainly contained an enforcible penaltywas valid, the case is sometimes cited by commentators for the proposition that it effectively so held. This is a questionable reading of the case. Nevertheless, some of the observations made by the court in that case are instructive on the manner in which a Texas court might ultimately rule on the issue. The court noted: The law looks with disfavor upon forfeiture provisions. Hence, a construction of the provision as a covenant is to be preferred over its construction as a condition subsequent. Likewise, the interpretation as a condition subsequent is less objectionable than its construction as a special limitation . . . .37
35 36 37

Id. at 670. 188 S.W.2d 564, 567-68 (Tex. 1945).

Id. at 671 (quoting A. W. Walker, Jr., The Nature of the Property Interests Created by an Oil and Gas Lease in Texas, 8 TEX. L. REV. 483, 490 (1930)); See also 2 HERBERT THORNDYKE TIFFANY, THE LAW OF REAL PROPERTY 188 (3d ed. 1939); Howard R. Williams, Restrictions on the Use of Land: Conditions Subsequent and Determinable Fees, 27 TEX. L. REV. 158, 164-73 (providing a thorough discussion and comparison of the different language and effects of conditions subsequent and special limitations).

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The court concluded the following regarding the clause at issue: The covenant against the assignment of undivided interests places an obligation upon the lessee to refrain from doing a certain act, or prohibits the doing of a certain act. This prohibition is not absolute, however. The act may be done with the written consent of the lessors. Under [this] contract, therefore, the validity of an assignment of an undivided interest rests with the option of the lessors. The clause therefore possesses the characteristics of a condition subsequent rather than those of a limitation. In our opinion an optional restraint upon alienation of the nature here involved can not operate by way of limitation.38 The courts finding that a consent-to-assign provision that contains a forfeiture provision does not operate as a special limitation, and thus does not result in automatic forfeiture if breached, is consistent with the manner in which Texas courts have treated such provisions in deeds conveying real property interests: They are flatly disfavored and routinely held unenforceable. It is admittedly curious that the Knight court did not therefore declare the consent clause unenforceable instead of devoting so much time to an alternative basis for its decision, to-wit, that because the lessors knew of the subsequent pooling of the lease and accepted royalties after they knew this, they waived the right of forfeiture.39 The court could have more readily said that the clause was an invalid restraint on alienation and declared it ineffectual. Its failure to do so has likely
38 39

Knight, 183 S.W.2d at 671 (emphasis added). Id. at 672.

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contributed to the view that the enforceability of such clauses is still an open question in Texas. However, more recent Texas case law supports the proposition that Texas courts will not enforce such restraints on alienation at all, even when a clause contains the enforcible penalty that Outlaw seems to require. One such case is OConnor v. Thetford,40 where a Texas court of appeals analyzed a deed containing the following clause: [A]ny alienation, voluntary or otherwise or any attempt at alienation, of all or any portion of said premises on the part of said grantee herein named, shall have the force and effect to at once terminate all estate passed to said grantee under this conveyance and shall cause all estate hereby conveyed to immediately revest in the grantor . . . .41 The court observed that there are two distinct lines of authority regarding the enforceability of such a provisionone line that holds that a restraint upon the alienation of a fee simple title for a limited period, no matter how brief, is inconsistent with the nature of such an estate and thus is unenforceable, and a second line that holds a restraint upon the alienation of a fee-simple title, if for a reasonable time, is a valid restriction.42 While generally conceding that the first line of cases is more persuasive, the court held that the provision was invalid no

40 41 42

174 S.W. 680 (Tex. Civ. App.San Antonio 1915, writ refd). Id. at 680. Id. at 681.

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matter which rule applied, because a restraint on alienation that extended to the grantees entire lifetime is per se unreasonable.43 In Diamond v. Rotan,44 another court of appeals analyzed a similar provision, concluding that such restraints are unenforceable regardless of the reasonableness of the time period of the restriction. Noting that Texas courts had not previously judged the enforceability of such a provision in a deed, the Court looked to the U.S. Supreme Court decision in Potter v. Couch,45 where, under similar facts, the court stated that a restriction, whether by way of condition or of devise over, not forbidding alienation to particular persons or particular purposes only, but against any and all alienation whatever during a limited time of an estate in fee, is . . . void as repugnant to the estate of the first taker by depriving him during that time of the inherent power of alienation.46 Extending this reasoning to the facts in Diamond, the Texas court found that it did not matter whether the restriction on alienation clause in the deed contained a forfeiture penalty, and thus found the provision containing the restriction to be unenforceable: Upon principle we can see no distinction between the two classes of cases, when it appears from the whole instrument that the primary purpose of the condition, or restriction, is to prevent alienation of the property, and not merely to affix a limitation to
43 44

Id.

124 S.W. 196 (Tex. Civ. App.Texarkana 1910, writ refd). Diamond v. Rotan cites to Laval v. Staffel and Bouldin v. Miller, both previously discussed, for the proposition that a general restraint on alienation is unenforceable.
45 46

141 U.S. 296 (1891). Id. at 315.

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the estate conveyed. . . . The fact that the grantor says the first estate shall upon the happening of such contingency terminate is entitled to no more weight than should be given language from which the law would imply such an intention.47 As recently as last year, the same line of reasoning was applied to facts virtually identical to those in Griffin v. Griffin,48 indicating that Texas courts still adhere to these long-established doctrines in cases involving restrictions on alienation of fee simple estates.49 In Griffin, the court of appeals considered a provision in a deed that restricted the sale of the property during the grantees lifetimes, further stating that a grant in violation of the provision shall be ab initio null and void, and of no force and effect whatsoever.50 The court held that because it is evident that the grantor tried to prevent the grantees from having the ability to dispose of the property during their lifetime . . . [s]uch a limitation on the ability to convey what is otherwise a fee simple conveyance is void.51 As shown below, these recent cases, particularly when viewed in tandem with pertinent principles taken from the Restatement (Third) of Property, leave

47 48 49

Diamond, 124 S.W. at 199. 2010 WL 140383 (Tex. App.Waco 2010, pet. denied).

There is, however, an apparent distinction in Texas law between clauses that attempt to restrict the alienation of fees simple and clauses that only require the lessee-assignor to take steps once the lease is assigned to notify the original lessor of the assignment. Clauses such as this, requiring the lessee, upon assignment to another party, to notify the lessor promptly or face financial penalties, are valid and enforceable. See Trafalgar House Oil & Gas Inc. v. Hinojosa, 773 S.W.2d 797, 799 (Tex. App.San Antonio 1989, no writ) (holding that a $1,000.00 liquidated damages clause for failure to notify lessor within 30 days of an assignment was valid and enforceable).
50 51

Griffin, 2010 WL 140383 at *3. Id. at *4.

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little doubt that Texas courts will not enforce consent-to-assign clauses of any nature in the context of an oil and gas lease. [b] Pennsylvania.

Like Texas, Pennsylvania follows the ownership-in-place doctrine,52 and holds that an oil and gas lease conveys to the lessee a fee determinable in the minerals in place.53 At least one court has directly considered the enforceability of a consent-to-assign cause in the context of an oil and gas lease. In Hague v. Ahrens,54 the Third Circuit Court of Appeals (applying Pennsylvania law) court considered a clause in an oil and gas lease that stated [t]his lease not to be sold, assigned, or transferred without the written consent of the party of the first part.55 As with the Texas Supreme Court in Bouldin, the Third Circuit found such language to be insufficient to create a condition subsequent.56 But the Third Circuit provided a much more complete explanation of its holding: The law regards conditions with the same disfavor it does forfeitures; and for similar reasons. A clause will not therefore be treated as a condition if it can be construed a covenant without violence to its terms. If the purpose to create a condition, or conditional limitation, is not expressed in clear, unequivocal languageas the courts have frequently said in apt terms, such
See Hamilton v. Foster, 166 A. 50, 52 (Pa. 1922) (holding that oil and gas while in place are part of the land, may be sold in place separate and apart from the surface and from any minerals beneath it, and necessarily belong to the owner in fee or his grantee, so long as they remain part of the property).
53 54 55 56 52

Snyder Bros., Inc. v. Peoples Nat. Gas Co., 676 A.2d 1226, 1230 (Pa. 1996). 53 F. 58 (3rd Cir. 1892). Id. at 58. Id. at 59-60.

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as upon condition, provided nevertheless, so long as, during, etc.the clause will be treated as a covenant, simply. The provision under consideration does not contain such language.57 Although not using the term enforcible penalty, the fact that there were no stated consequences for a breach of the assignment clause is clearly what drives this courts decision. While explaining that the clause cannot operate as a condition subsequent, the court notes the words of the assignment clause that convey no suggestion even that the lease may be lost by such a transfer.58 The court also pointed to other clauses in the contract that did provide for the remedy of forfeiture as evidence that the lessor did not contemplate forfeiture as a consequence of the failure to obtain consent before assignment. [c] Oklahoma.

Oklahoma follows what has been described as a qualified ownership doctrine.59 One Oklahoma court thus describes a mineral deed as conveying ownership of the minerals in place, but states that [t]he title to the oil and gas in place by such conveyance, grant, or exception does not vest, and no ownership of the minerals in place is acquired until the grantee finds and captures the same.60 In another case, the interest is described as one that is similar to a fee interest in that it may be granted separate and apart from the surface estate, but that it is also

57 58 59

Id. at 60. Id.

1 PATRICK H. MARTIN AND BRUCE M. MILLER, WILLIAMS & MEYERS, OIL AND GAS LAW 203.2 (LexisNexis Matthew Bender 2009) (hereinafter WILLIAMS & MEYERS).
60

Cuff v. Kislosky, 25 P.2d 290, 292 (Okla. 1933).

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akin to a profit prendre.61 While not strictly adhering to the ownership-in-place doctrine, Oklahoma nevertheless classifies a lessees interest in an oil and gas lease as an interest in land: Whatever the name used, the interest represented is one in land, although the lease itself does not operate as a conveyance of any oil or gas in situ but constitutes merely a right to search for and reduce to possession such of these substances as might be found. Rather than a true lease, it is really a grant in praesenti of oil and gas to be captured in the lands described during the term demised and for so long thereafter as these substances may be produced. . . . Although, as shown, an oil and gas lease creates an interest or estate in realty, it is not deemed per se real estate. In this respect a distinction is recognized in our law between real estate and an estate in real property.62 Oklahoma courts also rely on cases involving the conveyance of a fee simple estate when treating the issue of alienability. One such case is Lohmann v. Adams,63 in which the Oklahoma Supreme Court analyzed whether a restraint on alienation clause that did not contain a specific remedy for breach was enforceable.64 The court held that such a clause constituted a disabling restraint which, under the Restatement of Property, is defined as a restraint upon

61

Rich v. Doneghey, 177 P. 86, 89-90 (Okla. 1918). Hinds v. Phillips Petroleum Co., 591 P.2d 697, 698-699 (Okla. 1979). 540 P.2d 552 (Okla. 1975). Id. at 553-554.

62
63 64

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alienation which is an attempt by otherwise effective conveyance or contract to cause a later conveyance to be void.65 The court quoted Section 405 the Restatement of Property, which states: All restraints on alienation run counter to the policy of freedom of alienation so that to be upheld they must in some way be justified. But disabling restraints have an additional objection to their validity since to be effective they must enable the person restrained to deny the validity of his own conveyance . . . .66 Adopting the position of the Restatement that all disabling restraints, other than those imposed on equitable interests under a trust, are invalid, the court then held that a restriction on alienation that does not include a forfeiture penalty is invalid.67 This holding was applied by the Oklahoma Supreme Court in the context of a consent-to-assign clause in an oil and gas lease in Shields v. Moffitt.68 In that case, the court examined a clause in an oil and gas lease that provided [t]his lease may be assigned only with the written consent of the lessors, but contained no penalty or forfeiture in the event of a breach.69 Acknowledging that an oil and gas lease conveys a qualified fee . . . that has the nature of a fee, but not a fee simple

65 66 67 68 69

Id. at 555 (quoting RESTATEMENT (FIRST) OF PROPERTY 404(1)(a)). Id. (quoting RESTATEMENT (FIRST) OF PROPERTY 405). Id. at 556. 683 P.2d 530 (Okla. 1984). Id. at 531.

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absolute, the court cited Lohmann and held that lease clause at issue was void and of no force or effect.70 Oklahoma courts have thus taken an approach similar to Texas courts when analyzing bare consent-to-assign clauses, that is, clauses that forbid the assignment of the lease but specify no remedy in the event of an assignment in breach of the provisions. In such cases, Texas and Oklahoma courts have both ruled that such clauses are void and unenforceable. A question the Oklahoma Supreme Court considered but did not answer in Lohmann is whether a consent-to-assign clause that contained a remedy, or enforcible penalty as Texas courts call it, would be valid. In Lohmann, in addition to reviewing the enforceability of a bare restriction on alienation, the court also considered the validity of a provision in a deed that provided that upon any attempt to alienate the property by the grantee, his estate would terminate and the remainder would vest immediately in his sons.71 The Court was able to avoid deciding whether such a forfeiture restraint was enforceable because under the facts of the case the result would be the same whether the provision was valid or void.72 In its discussion, however, the court described with apparent approval the case of Crookum v. Ketchum,73 where the same court held that a forfeiture clause that restricted the alienation of the property for a period of 15 years was inoperative.74 The court cautioned that its opinion in Lohmann should not be
70 71 72 73 74

Id. at 534. Lohmann, 540 P.2d at 554. Id. at 557. 50 P.2d 710 (Okla. 1935). Id.

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construed as a holding that forfeiture restrictions were necessarily a valid form of restraint, and further stated that [i]n any given case consideration would have to be given to the justifications for the restraint and the nature of the estate restrained.75 [d] Colorado.

The Colorado Supreme Court has stated that oil and gas and other

minerals may be severed from the realty and a separate estate created therein is recognized in this jurisdiction.76 With respect to oil and gas leases, the Colorado Supreme Court has stated the property interest created by an oil and gas lease is of the same quality as that created by a mineral deed,77 and that the lessee obtains the lessors rights in the mineral estate78 It is therefore apparent that Colorado would also recognize the ownership-in-place doctrine with respect to an oil and gas lease.79 There are no known decisions in which a Colorado court has considered the enforceability of a consent-to-assign clause in an oil and gas lease.

75 76 77 78

Lohmann, 540 P.2d at 557. Simson v. Langholf, 293 P.2d 302, 306 (Colo. 1956). Keller Cattle Co. v. Allison, 55 P.3d 257, 262 (Colo. 2002).

Garman v. Conoco, Inc. 886 P.2d 652, 656 (Colo. 1994) (stating that in an oil and gas lease [t]he lessor relinquishes its right to the mineral estate to the lessee). Hagood v. Heckers, 513 P.2d 208, 214 (Colo. 1973) (adopting and recognizing [t]he majority rule in western states [which] appears to favor interpretation of the lessees interest in the oil and gas lease as an interest in real estate).
79

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[2]

States that Follow a Non-Ownership Approach for Mineral Leases. [a] Louisiana.

Louisiana subscribes to the non-ownership theory. Under the Louisiana Mineral Code [s]olid minerals are insusceptible of ownership apart from the land until reduced to possession.80 Louisiana courts have therefore held that an oil and gas lease conveys a right of servitude (an incorporeal right), a real right on the land, a right to extract the oil and utilize the gas from the land81 and that a lease does not vest in the lessee title to the minerals, but only an exclusive right to produce the same ownership being completed by reducing them to possession.82 Only one known Louisiana decision treats the enforceability of a consentto-assign clause in a mineral lease.83 That case involved a clause in a sand and gravel lease that prohibited subleasing without the consent of the lessor.84 The court of appeals affirmed the trial courts decision that the lessees execution of an operating agreement with a third party constituted a sub-lease in violation of this clause, and that such a violation justified the trial courts decision that the lease was forfeited.85 The court observed that [t]he covenant in the lease against

LA. REV. STAT. ANN. 31:5; see also, Frost-Johnson Lumber Co. v. Sallings Heirs, 91 So. 207 (La. 1920) (Mineral oil and gas, while at large beneath the surface of the land, or supposed to be there, are not subject to ownership, as physical or corporeal property.).
81 82

80

Exchange Natl Bank of Shreveport v. Head, 99 So. 272, 274 (La. 1924).

ONeal v. Union Producing Co., 57 F. Supp. 440, 443 (W.D. La. 1944), affd 153 F.2d 157 (5th Cir. 1946). Phoenix Assocs. Land Syndicate, Inc. v. E.H. Mitchell & Co., L.L.C., 970 So.2d 605 (La. App. 1 Cir. 9/14/07, writ denied).
84 85 83

Id. at 612. Id. at 614-616.

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subletting is for the benefit of the landlord, because it is regarded as for his interest to determine who shall be a tenant of his property.86 [b] New York.

New York decisions indicate that the courts in that state also follow the non-ownership theory with respect to the rights granted under an oil and gas lease. In one early case, the states highest court examined the law in several other jurisdictions and concluded that under an oil and gas lease no title to the oil vested in the lessee until it had been taken from the ground and reduced to possession.87 A later decision by the court of appeals echoed that conclusion, finding that a lease of rights to occupy land for the purpose of prospecting for oil is not a grant of the oil in the land. It gives title to that oil only which is extracted from the earth and is reduced to possession by the prospector.88 There are no known decisions in which a New York court has considered the enforceability of a consent-to-assign clause in an oil and gas lease. [c] Kansas.

Like Texas and Oklahoma, Kansas subscribes to the doctrine that a mineral deed conveys a real property interest.89 However, an oil and gas lease under Kansas law is treated differently. One early case described an oil and gas lease interest as follows:
86 87 88 89

Id. at 613. Wagner v. Mallory, 169 N.Y. 501 (1902). Reeland v. Moore Oil Co., 242 A.D. 462, 466 (N.Y. App. Div. 1934).

Richards v. Schearer, 64 P.2d 56 (Kan. 1937); In re Wolfe, 181 B.R. 90 (D. Kan. 1995) (Kansas recognizes an ownership-in-place concept of oil and gas. Under this theory, ownership extends to oil and gas in the ground as part of the land, similar to the ownership of hard minerals. The owner of the surface of the land also owns the minerals in place below the ground, a corporeal estate in realty in the oil and gas.).

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Gas and oil leases are in a class by themselves. They are not strictly leases as defined and treated in the law of landlord and tenant. They are in the nature of written licenses with a conditional grant conveying the grantors interest in the gas or oil well, conditioned that gas or oil is found in paying quantities.90 Later cases clarify that a lease conveys no interest in the land, but is merely a license to explore,91 and that it should be classified as a license to explore, and is personal propertyan incorporeal hereditamenta profit a prendre.92 More recently, the Kansas Supreme Court summarized the cases classifying the oil and gas lease as follows: The Kansas courts, like those of other jurisdictions, have found some difficulty in fitting the interest of an oil and gas lessee into the traditional common-law classifications relating to ordinary surface interests in land. . . . A number of our opinions state categorically in general language that an oil and gas lease is personal property. . . . In other fields of the law our statutes and court decisions have considered oil and gas leasehold interests as realty for certain purposes. . . . It is obvious from this analysis of the Kansas statutes and decisions that in this state an oil and gas lease is a hybrid property interest. For some purposes an oil and

90 91 92

Dickey v. Coffeyfield Vitrified Brick & Tile, Co., 76 P. 398 (Kan. 1904). Burden v. Gypsy, 40 P.2d 463, 465 (Kan. 1935). Connell v. Kanwa Oil, 170 P.2d 631, 653 (Kan. 1946).

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gas leasehold interest is considered to be personal property and for other purposes it is treated as real property.93 Given the hybrid nature of an oil and gas lease under Kansas law, it would appear that Kansas courts may draw from among property law, landlord-tenant, and contract law principles when determining the enforceability of a consent-toassign clause. The only known Kansas case that has considered a consent-toassign clause in an oil and gas case ruled that a consent-to-assign clause that did not specify forfeiture as a penalty for breach should be treated as a covenant not as a condition the breach of which should result in forfeiture.94 In doing so, the court drew on earlier property and contract law cases in Kansas and other states holding that forfeitures should not be inferred from the terms of the contract, lease, or deed.95 While not ruling directly on the validity of such a clause, this decision is in line with the view of the ownership-in-place states summarized above that a bare consent-to-assign clause that contains no penalty of forfeiture cannot result in a forfeiture of the leasehold interest. [d] Montana.

Like Kansas, Montana subscribes to the ownership-in-place theory with respect to the direct ownership of mineral interests,96 and, like Kansas, holds that an oil and gas lease does not operate as a conveyance of a fee interest in the oil

93 94 95 96

Ingram v. Ingram, 521 P.2d 254, 257-258 (Kan. 1974) (citations omitted) Rose v. Lanyon Zinc Co., 74 P. 625, 627-28 (Kan. 1903). Id.

Homestake Explor. Corp. v. Shoregge, 264 P. 388, 391 (Mont. 1928). (Both petroleum and gas, as long as they remain in the ground, are a part of the realty. They belong to the owner of the land, and are a part of it as long as they are on it or in it, or subject to his control.).

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and gas in place.97 Montana law states that an oil and gas lease yields a profit a prendre, which gives to the lessor the exclusive right to search for oil and gas on the land, which become the personal property of the lessee once extracted.98 Therefore, when construing oil and gas leases, Montana courts do not rely solely on precedents involving the conveyance of fee interests, but instead utilize other contract and property law precedents as may be appropriate. In contrast to Kansas, however, a Montana court found in Stanolind Oil & Gas Co. v. Guertzgen99 that under Montana law a bare consent-to-assign clause in an oil and gas lease is enforceable. In Stanolind, the court was asked to review the effect of a rider to an oil and gas lease that prohibited the lessee from assigning the lease without the consent of the lessor.100 The court in Stanolind presumed the enforceability of such a provision, found that there was no question that the assignment constituted a breach of the provision, and instead focused its analysis solely on the appropriate remedy for a breach.101 The court turned to Montana contract law precedents regarding oil and gas leases, noting that oil and gas leases are to be construed liberally in favor of the lessor and strictly against the lessee and that Montana courts have consistently declared that in connection with such leases forfeitures are favored by the law.102 The court also noted that
97 98 99

Id. Id. 100 F.2d 299 (9th Cir. 1938). Id. at 300. Id.

100 101 102

Id. at 300-301. The reason forfeitures are favored by the law in oil and gas leases in Montana is that, according to the Stanolind court, Oil and gas leases deal with property of a highly speculative nature, and the protection of the interests of the lessor is considered of paramount importance. Id. at 301.

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under Montana law an implied right of forfeiture will be enforced with strictness equal to that respecting an express right.103 In conclusion, the court said that we understand the rule to be that an oil and gas lease will be regarded as terminable upon breach of a covenant, express or implied, and held that [w]hen an assignment, to which [the lessor] does not consent, has been effected, [the lessor] has the present right of treating the assignee as an interloper and of declaring the lease at an end.104 Because Montana courts enforce even bare consent-to-assign clauses, the question whether a consent-to-assign clause must contain an enforcible penalty to be valid does not arise. [e] Ohio.

It is not clear whether Ohio subscribes to the ownership-in place theory or the non-ownership theory. In one line of cases, it seems that Ohio follows the ownership-in-place theory, at least with respect to ownership of the mineral estate: It is well-established Ohio law that minerals, including oil and gas, are considered realty until physically severed from the land. Where the owner of a fee simple estate in realty grants title to the surface lands to another and retains ownership in one half of the

103 104

Id. at 301. Id.

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minerals beneath the surface, the grantor retains a fee simple estate in one half of all of the minerals beneath the surface.105 Another line of cases appears to follow the non-ownership theory: The character of the instrument of conveyance reveals that it is other than a grant of real property. Possession of oil and gas, having as they do a migratory character, can be acquired only by severing them from the land under which they lie, and in effect the instrument of conveyance in the instant case is no more than a license to effect such a severance.106 Further evidence that Ohio follows the non-ownership theory, at least with respect to the interests conveyed under and oil and gas lease, is found in cases where it was held that an oil and gas lease could be abandoneda concept that is obviously inconsistent with the characteristics of a real property interest.107 As with the other jurisdictions summarized herein, there is little Ohio authority regarding the enforceability of a consent-to-assign clause in an oil and gas lease. In the only identifiable decision, a trial court found that the assignment of a lease that contained a bare consent-to-assign clause was ineffectual because, among other things, it was made without the consent of the lessor.108 The court of appeals affirmed the trial courts decision on the grounds that the lease terminated before it was assigned because of the lessees failure to drill a second well within
Lighthorse v. Clinefelter, 521 N.E.2d 1146, 1148 (Ohio Ct. App. 1987) (citing Pure Oil Co. v. Kindall, 156 N.E. 119 (Ohio 1927).
106 107 108 105

Back v. Ohio Fuel Gas Co., 113 N.E.2d 865,867 (Ohio 1953). 1 WILLIAMS & MEYERS 203.1 at p. 39. Curtis v. American Energy Dev. Inc., 2002 WL 1357726 at *5 (Ohio Ct. App. 2002).

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the allotted time period, and so did not comment on the trial courts holding regarding the consent-to-assign clause.109 While this is scant authority, it is consistent with the holdings in the other non-ownership jurisdictions described above. [f] Arkansas.

Arkansas courts also hold that a mineral deed conveys a property right to the minerals in place.110 However, under Arkansas law, and oil and gas lease does not convey a fee interest; it only grants to the lessee the right to produce oil and gas from the property during the terms of the lease.111 Therefore, [i]t is not a present sale of or transfer of title to the gas, but, on account of its vagrant nature, the gas does not become actually owned until actually possessed.112 There are no known decisions in which an Arkansas court has considered the enforceability of a consent-to-assign clause in an oil and gas lease. [g] West Virginia.

West Virginia follows the ownership-in-place theory with respect to mineral interests.113 West Virginia, however, does not treat an oil and gas lease as bestowing a vested property right until oil or gas is actually discovered on the property: The title is inchoate, and for purposes of exploration only until oil is found. If it is not found, no estate vests in the lessee, and his
109 110 111 112 113

Id. Bodcaw Lumber Co. v. Goode, 254 S.W. 345, 346-47 (Ark. 1923). Davis v. Collins, 254 S.W.2d 571, 572 (Ark. 1952). Osborn v. Arkansas Territorial Oil & Gas Co., 146 S.W. 122, 124 (Ark. 1912). Bogess v. Milam, 34 S.E.2d 267, 269-70 (W. Va. 1945).

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title, whatever it is, ends when the unsuccessful search is abandoned. If oil is found, then the right to produce becomes a vested right, and the lessee will be protected in exercising it in accordance with the terms and conditions of his contract.114 There are no known decisions in which a West Virginia court has considered the enforceability of a consent-to-assign clause in an oil and gas lease. [h] California.

Although not a known shale oil and gas producing region, an examination of California law is instructive because the courts there have considered a consent-to-assign clause in an oil and gas lease. California courts hold that an oil and gas lease creates only a profit a prendre, which the California Supreme Court describes as a right to remove a part of the substance of the land and which also creates a right to the possession of the surface as is necessary for the exercise of the profit.115 Therefore, like Montana courts, in assessing the enforceability of consent-to-assign clauses California courts are not constrained to rely upon precedents involving the conveyance of fee interests. The case of Valer Oil Co. v. Souza116 illustrates the manner in which California courts have looked outside of the law of real property when considering this issue. In that case, the court analyzed the enforceability of a consent-to-assign provision in four identical oil and gas leases. Among other grounds for finding that the leases at issue had terminated, the court stated
Crawford v. Ritchey, 27 S.E. 220, 223 (W. Va. 1897); see also Arbaugh v. Raines, 184 S.E.2d 620, 623 (W. Va. 1971).
115 116 114

Callahan v. Martin, 43 P.2d 788 (Cal. 1935). 182 Cal. App. 2d 790 (Cal. 1960).

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[t]here is ample authority to sustain the trial court's conclusions that the leases terminated because of the violation of the covenant against assignments.117 The courts reliance on the Chapman case is important because Chapman was not a case involving an oil and gas lease; it involved only a standard commercial lease. In that context, the Chapman court explained the appropriate remedy in the event of the breach of a consent-to-assign clause: The assignment of a lease in violation of a covenant against assignment without the consent of the lessor is nevertheless a binding assignment which passes the leasehold estate, and with which runs all covenants touching the land. Such an assignment in violation of the covenant is, however, subject to the option in the lessor to forfeit the lease. The only remedy for the breach of such a covenant would be the exercise by the lessor of his option to forfeit the lease.118 Thus, under California law, the breach of a consent-to-assign clause creates a right in the lessor to declare the lease forfeit; it does not provide an avenue for the lessee to avoid his assignment to a third party. As with Montana, because courts in California seem willing to enforce a bare consent-to-assign clause, there seems to be no reason why a court would not be willing to enforce a similar clause that also provided for a penalty in the event of failure to procure consent.

117 118

Id. at 801 (citing to Chapman v. Great Western Gypsum Co., 14 P.2d 758 (Cal. 1932)). Chapman, 14 P.2d at 761.

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[3]

Leases on Federal Lands.

Leases on federal land merit separate consideration when analyzing the effect of a consent-to-assign clause. By statute, such leases cannot be assigned without the consent of the Secretary of the Interior.119 The purpose of this requirement is to ensure that the lessee qualifies as a proper lessee under applicable statutes. Obviously, the codification of this consent requirement in the U.S. Code renders the question of its enforceability moot. Such clauses have been found to be enforceable even in states that otherwise follow the ownership-in-place doctrine.120 Still unclear, however, is the question of remedy. Cases that have examined the effect of a breach of a consent-to-assign clause in a federal oil and gas lease hold that the such clauses are for the benefit of and protection of the government only, and cannot be raised by an individual.121 It is therefore generally held that the assignor cannot claim that the lease has been forfeited by the failure to obtain approval.122 Nor can an assignee avoid its obligations because of such a failure.123

119 120 121 122 123

30 U.S.C.A 187. See, e.g., Oasis Oil Co. v. Bell Oil & Gas Co., 106 F. Supp. 954 (W.D. Okla. 1952). Royal Recovery Oil v. Van Acker, 180 P.2d 436, 438 (Cal. App. 4th 1947). Id. (reversing the trial court decision vesting title in the assignor).

Gibbons v. Pan American Petroleum Corp. 262 F.2d 852, 853-54 (10th Cir. 1958) (holding that an assignee could not avoid liability for unpaid delay rentals on the grounds that consent to the assignment was never received). But see Oasis Oil Co. v. Bell Oil & Gas Co., 106 F. Supp. 954 (W.D. Okla. 954) (holding that the assignees title did not vest until consent was received, so that proceeds from production prior to such consent belonged to the assignor).

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[4]

Restatement (Third) of Property.

The courts of both Texas and Oklahoma have (perhaps unintentionally) left open the possibility that they might apply a reasonableness test when analyzing the enforceability of a consent-to-assign clause that includes a forfeiture provision. This approach is consistent with the Restatement (Third) of Property.124 The Restatement (Third) applies to servitudes, which are defined broadly to encompass a consent-to-assign clause in an oil and gas lease (at least in those states where such leases grant a fee simple).125 While the Restatement (Third) does not distinguish between bare restrictions on alienation and those with forfeiture clauses, it reinforces the concept that a reasonableness test should be employed when considering the validity of such clauses. Section 3.4 of the Restatement (Third) states that [a] servitude that imposes a direct restraint on the alienation of the burdened estate is invalid if the restraint is unreasonable.126 Comment b to this section defines direct restraints as including prohibitions on transfer without the consent of another.127 This section goes on to state that [r]easonableness is determined by weighing the utility of the restraint against the injurious consequences of enforcing the restraint.128 In determining reasonableness, comment c adds that the nature of the property interest is an important factor, and that greater
Restatement (Third) of Property: Servitudes (2000) (hereinafter the Third Restatement). Id. 1.1(1) (A servitude is a legal device that creates a right or an obligation that runs with the land or an interest in land, including covenants in leases.).
126 127 128 125 124

Id. 3.4 (emphasis added). Id. cmt. b. Id. 3.4.

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restraints are justified in estates of lesser duration than on estates of longer duration, and on nonpossessory interests than on possessory interests.129 Comment d provides even more specific guidance in the context of restraints on transfer without consent: A prohibition on transfer of property without the consent of another is an unreasonable restraint on alienation unless there is a strong justification for the prohibition, and, unless the consent can be withheld only for reasons directly related to the justification for the restraint. Examples of justifications strong enough to outweigh the harm caused by a consent-to-transfer requirement can be found in residential cooperative arrangements and affordable housing projects.130 Assuming that the Restatement (Third) approach were to be applied by a Texas or Oklahoma court, it is useful to examine how these considerations relate to the case of a consent-to-assign clause in an oil and gas lease that contains a forfeiture provision. Comment d emphasizes that there must be a strong justification for the prohibition on assignment without consent in order for such a restraint to be enforceable. There are of course reasons why a lessor might want to restrict the assignment of a lease only to those that it approves.131 For example, the lessor

129 130 131

Id. cmt. c. Id. cmt. d (emphasis added).

See, e.g., David E. Pierce, An Analytical Approach to Drafting Assignments, 44 SW. L.J. 943, 950 (1990) (identifying the lessors reliance on the finances, skill, and reputation of the original lessee, the lessors desire to share in any increased value of any leasehold, and the lessors

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may have relied on the reputation, skill, and financial position of the original lessee and thus would want to ensure the same qualifications in any subsequent lessees.132 Also, because an assignment of an oil and gas lease often is accompanied by the retention of an overriding royalty by the original lessee, an accumulation of such non-cost bearing interests might discourage development of the lease.133 While these are facially legitimate concerns, it is questionable whether they are strong enough to outweigh the harm caused by enforcing a forfeiture provision. Comment c outlines some of the harmful effects that might flow from restraints on alienation, including impediments to the operation of a free market in land and limiting prospects for . . . development.134 Such harmful effects might well result from a restriction on the assignability of an oil and gas lease. Especially in new prospects, leases are often accumulated by speculators who intend to re-convey the interests to parties who will actually develop the leases. Such transactions are a necessary part of the operation of the market in oil and gas interests and the development of new prospects. Restrictions on the free assignability of these leases can only impair this market. The prospects of developing the land may also be impeded by such clauses if the original lessee encounters financial difficulty and is unable to develop the minerals for several years. The free assignment of the lease to another, more financially sound lessee
desire to know the current owners of the leasehold as several reasons that the lessor may want to restrict assignment).
132 133 134

Id. Id. Restatement (Third) 3.4 cmt. c.

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would allow the original lessee to realize value from the lease and allow for the more rapid development of the lease and the payment of royalties. Thus, while there may valid financial reasons for including such clauses in a lease, there are also pronounced negative impacts that may harm the prospects for the development of the mineral interest. [5] Conclusion.

The precedents cited above reflect a split of authorities among states regarding the enforceability of consent-to-assign clausesa split that is largely dependent upon the manner in which these states view the type of interest conveyed under an oil and gas lease. Under California and Montana law, which follow the exclusive-right-to-take or non-ownership theory, such provisions are found to be enforceable whether they do or do not contain an enforceable penalty creating a right in the lessor to forfeit the lease if breached. However, in Texas, Pennsylvania, and Oklahoma, where the courts look to real property law to construe oil and gas leases, it appears that the courts will find a bare consent-toassign clause, which contains no explicit remedy for a breach, to be unenforceable. These authorities may be relevant in other states that have seen an increase in assignments related to shale gas plays, such as Arkansas,135 where the courts have not yet examined the enforceability of consent-to-assign provisions in oil and gas leases. While Texas and Oklahoma courts have not directly addressed whether a consent-to-assign clause that provides a forfeiture provision or other enforcible
Arkansas follows the ownership-in-place theory. See Bodcaw Lumber Co. v. Goode, 254 S.W. 345 346-47 (Ark. 1923) ([M]ineral rights . . . may be the subject-matter of a separate sale or reservation so as to create or reserve a right in perpetuity.).
135

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penalties in an oil and gas lease is valid, there is enough guidance to suggest that such provisions will not and probably should not be enforced. These states are generally opposed to any restrictions on the alienation of fee simple interests and look with disfavor upon forfeiture provisions in real property conveyances. There is some support in the case law for the application of a reasonableness test with respect to such provisions, consistent with the manner in which the Restatement (Third) would view such provisions. But as it appears that the common justifications for restrictions on the assignability of an oil and gas lease do not outweigh the public and private harm resulting from the enforcement of such clauses, Texas courts should decline to enforce them, whether bare, selfeffectuating, or otherwise. 1.03 Post-Transfer Concerns for the Lessee-Assignor. Another important area of concern for a lessee is whether the assignment of its rights and obligations under a lease to another party absolves it of all responsibility under the lease, or whether there are ongoing duties for which it may bear continued responsibility. It is broadly understood that when an oil and gas lease is assigned, the assignee becomes responsible for all of for the covenants in the lease (although, as seen below, this does not automatically extinguish all obligations owed to the original lessor by the original lessee).136 The responsibility for the observance of covenants in the lease passes through to an assignee under the doctrine of privity of estate because they are covenants that run

E.g., Pierce Fordyce Oil Assn v. Woodrum, 188 S.W. 245, 254 (Tex. Civ. App.Fort Worth 1916, no writ), see also WILLIAMS & MEYERS 403.3 n. 1 (listing decisions in various jurisdictions that hold as such).

136

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with the land.137 Consequently, if an assignee in turn assigns the lease to yet another party, privity of estate is destroyed as to the prior assignee and it is no longer responsible to the original lessor for those covenants.138,139 Absent an express clause that terminates its obligations, the original lessee-assignor will continue to be responsible to the lessor for covenants in the lease under the doctrine of privity of contract.140 Many oil and gas leases contain clauses eliminating contractual liability of this nature, but some do not. Where they do not, the courts are nearly universal in their finding that the original lesseeassignor retains obligations to the lessor with respect to at least some of the covenants under the lease.141 While the form that these issues may take will be too varied to predict outcomes comprehensively or with certainty, this paper will now turn to common

See, e.g., Hafeman v. Gem Oil Co., 80 N.W.2d 139, 162-64 (Neb. 1956) (summarizing the law of various jurisdictions and holding that the covenant to pay rentals ran with the land and thus was binding on assignee).
138 139

137

WILLIAMS & MEYERS 403.3.

However, such an assignee may still retain obligations to their assignor under the doctrine of privity of contract. For example, in Shore Exploration & Production Corp. v. Exxon Corp., 976 F. Supp. 514 (N.D. Tex. 1997), the lessee, Shore Exploration, assigned its interest in the lease to Texaco, who subsequently re-assigned the lease to another entity. Id. at 519 (describing the Texaco Leases among other leases not relevant here). In its assignment to Texaco, however, Shore Exploration retained an overriding royalty interest which was later lost when the ultimate assignee failed to pay delay rentals. Id. Shore Exploration then sued Texaco for failure to give notice that the delay rentals would not be paid, as was required under the ShoreTexaco assignment. Even though Texaco was no longer in privity of estate with Shore Exploration, the court found that Texaco was still in privity of contract with Shore Exploration, and found that Texaco was liable for this breach. (Id. at 521). WILLIAMS & MEYERS 403.1 & n.1 (surveying cases holding same); see also David E. Pierce, An Analytical Approach to Drafting Assignments, 44 SW. L.J. 943, 961 (1990). E.g., Whale v. Rice, 49 P.2d 737 (Okla. 1935) (holding that the assignment of the lease did not relieve the original lessee/assignor from its liability to pay rentals and royalties to the lessor); LA. Rev. Stat 31:129 (An assignor or sublessor is not relieved of his obligations or liabilities under a mineral lease unless the lessor has discharged him expressly and in writing.); see also WILLIAMS & MEYERS 403.3 n. 1 &2 (listing decisions in various jurisdictions that hold as such).
141 140

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problems that may be encountered by the original lessee upon its assignment of an oil and gas lease. [1] Delay Rentals.

In many leases there is an express covenant that the lessee either must drill a well within a specified time period or pay delay rentals to the lessor. If the lessee fails to do so the lease is not terminated but the lessee is liable to the lessor for the unpaid rentals.142 As noted above, once the lease is assigned, this duty to drill or pay rentals primarily falls on the assignee. Nevertheless, courts have held that if the assignee fails to pay rentals, the lessor may bring an action directly against the original lessee-assignor for the collection of rentals.143 Of course, the original lessee-assignor, being in privity of contract with the offending assignee, may bring a suit of its own against the assignee to recover these rentals or for other damages it may have suffered because of the failure to pay rentals.144 [2] Royalties.

There is an express covenant in oil and gas leases requiring the payment of royalties to the lessor out of production under the lease. If the assignee fails to pay such royalties the lessor may sue the original lessee for them.145

142 143 144

Id. 29.3. Benson v. Nynan, 16 P.2d 963 (Kan. 1933); Whale v. Rice 49 P.2d 737 (Okla. 1935).

WILLIAMS & MEYERS 403.3; Shore Exploration & Production Corp. v. Exxon Corp., 976 F. Supp. 514 (N.D. Tex. 1997) (finding assignee liable to assignor who held an overriding royalty interest for damages resulting from the lapse of the lease due to the failure to pay delay rentals).
145

Gillett v. Elmhurst Inv. Co., 207 P. 843 (Kan. 1922).

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[3]

Restoration of Surface.

Another obligation that may remain with the original lessee is the responsibility to restore the surface to its original condition once production activities have ceased. Many leases contain such a requirement. In these cases, as with rentals and royalties due under the lease, the lessee may be held responsible for restoration of the surface even if it did not conduct the operations at issue.146 [4] Implied Covenants.

The examples cited above all involve express covenants in the lease. But implied covenants, such as the covenant to protect against drainage or the covenant to market the gas, also may be at issue. The lessor may bring an action against the original lessee for the breach of an implied covenant even after the lease is assigned to another party. In Gillet v. Elmhurst Inv. Co.,147 plaintiffs alleged that in addition to breaching the express covenant to pay royalties the assignee of a lease failed to adequately protect against drainage, thus breaching this implied covenant. The Kansas Supreme Court allowed the case to proceed against both the lessee and the assignees on all counts, including the implied covenants, finding that [the lessee] is liable on the covenants, because he made them and [the assignees] are liable on the covenants, because they stand in [the

See Allain v. Shell Western E & P, Inc., 762 So. 2d 709 (La. Ct. App. 2000) (finding lessee-assignor liable for burial of a pipeline at a depth shallower than that allowed under the lease).
147

146

207 P. 843 (Kan. 1922).

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lessees] shoes.148 Therefore, there is a basis for enforcing both express and implied covenants against the original lessee.149 [5] Obligations Under Joint Operating Agreements.

Lessees must also be aware of possible continued obligations under agreements that are appurtenant to the lease, such as joint operating agreements (JOAs). Such obligations were addressed by the Texas Supreme Courts in Seagull Energy E&P, Inc. v. Eland Energy, Inc.150 In Seagull, Eland assigned its interest in two offshore leases to Nor-Tex Gas Corporation along with Elands rights and obligations under the two JOAs appurtenant to the two leases.151 When Nor-Tex failed to pay its share of the operating costs under one of the JOAs, Seagull, as operator, brought suit against Nor-Tex and Eland for breach of the JOA.152 Eland argued that it no longer had any obligations under the JOA, because it no longer owned a participating interest in the properties governed by the JOA.153 The Texas Supreme Court noted that the JOA did not contain an express clause stating that Elands obligations would cease if it assigned its interest to another party.154 Therefore, applying the contract principle that a party who assigns its contractual rights and duties to a third party remains liable

148 149

Id. at 844.

As the editors of one treatise observe, this is even more likely to true with respect to implied covenants that are found to be implied in fact, that is, can be implied from the intent of the original parties to the lease, than those that are implied by law. See WILLIAMS & MEYERS 403.2 & n. 1.
150 151 152 153 154

207 S.W.3d 342 (Tex. 2006). Id. at 344. Id. Id. at 346. Id. at 347.

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unless expressly or impliedly released by the other party to the contract, the court held that Eland was still liable on the contract notwithstanding the assignment of the lease to Nor-Tex.155 This holding is notable in several respects. First, and most important to the discussion here, it creates another source of potential ongoing obligations when a lease is assigned, at least under Texas law. That is, in addition to the express and implied covenants under the lease, the lessee may also be obligated for all of the responsibilities of a working interest owner under a related JOA. Second, the case is notable because Eland was not the original lessee under these leases, but a remote assignee like Nor-Tex. Normally, that would mean that Eland would only be responsible for the obligations under the lease and the JOA during the period it held the interest, and that it would bear no ongoing responsibility after it assigned them to Nor-Tex. But here, the Texas Supreme Court emphasized that Eland expressly assumed certain rights and responsibilities under the two JOAs when it acquired its interest.156 Under Texas landlord-tenant principles, when an assignee of a lease expressly assumes the lease, it is deemed to be in privity of contract with the lessor, and will remain so even if it assigns the lease to another.157

155 156 157

Id. at 346-47. Id. at 344.

See Amco Trust, Inc. v. P.C. Naylor, 317 S.W.2d 47, 50 (Tex. 1958) (There is no privity of contract between the lessor and a sublessee, and the latter is not liable to the lessor on the covenants of the lease, unless he assumes or otherwise binds himself to perform the same.).

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[6]

Undisclosed Agreements with Third Parties.

Finally, another issue to which lessees should be alert when assigning or cross-assigning oil and gas leases is the existence of undisclosed agreements with third parties regarding the leasehold interest. This issue is arising with increasing frequency in the new shale plays where companies are partnering on development. Consider the following example: Company A and Company B enter into a joint development agreement or area of mutual interest (AMI) agreement where they agree to cross-assign on a 50-50 shared basis any lease interests that they currently own or acquire within a specific target area. However, Company B has a prior agreement with Party C whereby Company B must convey to Party C a 10% interest in any lease interests it obtains in the same target area. (In this example, Party C may be an investor or perhaps a geologist who has assisted Company B in identifying prospects in this area.158) This relationship between Company B and Party C was not disclosed to Company A at the time the AMI is formed. Under this example, the competing rights of the parties under the two agreements may create problems. If Company B obtains a lease in the target area after the formation of the AMI, it faces a legal dilemma: It is contractually bound to convey 10% of the interest to Party C but it is also bound to offer to assign 50% of the lease to Company A. In order to not breach the agreements with Company A and Party C, Company Bs only possible choice is to convey 10% of the
See, e.g., Roark v. Stallworth Oil & Gas, Inc., 813 S.W.2d 492, 493-94 (Tex. 1991) (involving alleged breach of an agreement whereby oil company promised to convey to a landman a 5% interest in whatever property the company obtained within a specific prospect).
158

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interest to Party C and assign 50% of the total leasehold interest to Company A, so that the ownership in the leasehold interest would then look as follows: Company A = 50% Company B = 40% Party C = 10%

This approach would appear to solve the problem, because it makes both Company A and Party C whole under their respective agreements with Company B. But if the AMI between Company A and Company B contains a preferential purchase right, Company B will face another dilemmaCompany Bs obligation to convey 10% of its lease interest to Party C will trigger the preferential right of Company A which, if exercised, will leave Party C emptyhanded. That is, if Company A exercises its preferential right, there is no way for Company B to deliver a 10% interest into the hands of Party B. Legally, there is no escape from this dilemma, as Company B now must breach of one the agreements with either Company A or Party C. The only practical solution for Company B is to negotiate an agreement that is satisfactory to all parties, or face a legal action by Company A or Party C (or both) that it will almost certainly lose. This is but one of many possible scenarios involving cross-assignments of interests under AMIs or similar agreements that may lead to litigation if there are undisclosed agreements with third parties involving the interests in the target area. Obviously, such litigation can be avoided if all such agreements are disclosed prior to the formation of the AMI so that these issues may be dealt with in the context of the assignment. However, in order to guard against the effects of such

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undisclosed agreements, the parties to AMIs and similar agreements should be certain that their partners undertake representations and warranties that they have disclosed all such agreements. As these examples indicate, lessee/assignors must be careful to avoid ongoing obligations when assigning their interest. The best way to do this is to include an express provision in the lease stating that the lessees obligations under the lease will terminate upon the assignment. Of course, the cost of such a provision may be the inclusion of a consent-to-assign clause which, as discussed earlier, may present its own issues. In addition, the lessee should be certain that a similar provision is contained in any JOA that may be appurtenant to the lease so that obligations under the JOA do not continue even after the underlying lease is assigned. Finally, if not already expressly provided elsewhere, the assignment should include an indemnification clause whereby the assignee must indemnify the assignor against any claims that arise from a breach of the covenants of the lease, even if not the fault of the assignee.

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