Surface Use at the 5th Circuit

Originally published by Robert Woods, Yetter Coleman LLP.

Surface use agreements (SUAs) are part of the new reality of oil and gas development, especially when sophisticated lessors with large tracts of land are involved. Thus, it’s no surprise that lawsuits over the meaning of surface use agreements are heading up to the courts of appeals.

Under a classic oil and gas lease, without a surface use agreement in place, the lessee has the right to use as much of the surface as is “reasonably necessary” to exploit the mineral estate and there is no common law duty to restore the property to its prior condition. After all, in Texas, the mineral estate is the “dominant” estate.

This can be a relatively harsh state of affairs for landowners. To change it, lessors can impose some specific protections against surface damage by requiring the lessee to enter into a surface use agreement alongside their lease (or even embedded within their lease). For older leases, this is often done in conjunction with negotiations of lease extensions or the resolution of disputes on other topics. The precise terms of surface use agreements vary, but they may specify liquidated damages for specific uses of or damages to the surface (e.g., a fixed price for a well pad), require restoration,  ensure lessor input into the planning of surface development, delineate water rights or surface mining rights in greater detail, protect prized wildlife, etc.

In Fort Worth 4th St. Partners, L.P. v. Chesapeake Energy Corp., 882 F.3d 574 (5th Cir. 2018), FWP sued Chesapeake for breach of a surface use agreement. FWP had leased its minerals to another company, who eventually assigned the lease to Chesapeake. There was a surface use agreement in place that required the lessee to pay $6 per square foot of surface land used for various operations, as of a certain date. If Chesapeake drilled a set number of wells by then, however, the price dropped to $3 per square foot.

Before the payment date, Chesapeake purchased FWP’s surface rights for $34 million. There were two contracts involved in this transaction: (1) a real estate agreement conveying surface rights to Chesapeake and (2) a “Master Agreement” providing for amendments to the surface use agreement and the lease.

The real estate agreement conveyed the surface “together with all improvements and fixtures thereon and all rights, privileges, easements, benefits and agreements appurtenant thereto.” The Master Amendment contained the following provisions:

• “Elimination of Surface Use Restrictions . . . FWP shall no longer be entitled to restrict or limit where or how operations for drilling, operation and producing oil, gas or other minerals under the Lease are conducted. Therefore, any provision of the Surface Agreement which purports to limit or restrict the Working Interest Owner’s right to enter upon or use any surface of the FWP Lands are hereby deleted and terminated, including, but not limited to Paragraphs 1 through 13.”
• “The terms, provisions, covenants, and conditions [of the surface use agreement] are intended to be, and shall be deemed to be covenants running with the FWP Lands.” (the SUA itself stated that “[t]he terms, provisions and conditions hereof shall be covenants running with land and shall be binding upon and inure to the benefit of the Working Interest Owner, the Surface Owner, and each of their respective successors”)
• “The parties hereto acknowledge and agree that the terms and provisions of the Lease, the [surface use agreement], and the Joint Operating Agreement, as amended, shall remain in full force and effect.”

FWP claimed in its lawsuit that it retained the right under the surface use agreement to receive the per square foot payment on the payment date, whereas Chesapeake argued that this right was extinguished and/or transferred to Chesapeake when Chesapeake purchased the surface rights from FWP. Both sides moved for summary judgment, and FWP attached to its motion an affidavit from one of its owners claiming that the parties intended the per square foot payment to be a personal right held by FWP, not a “covenant running with the land.” In Texas, a covenant (promise) “runs with the land” when four requirements are met: (1) it touches and concerns the land; (2) it relates to a thing in existence or specifically binds the parties and their assigns; (3) it is intended by the original parties to run with the land; and (4) the successor to the burden has notice. Only (1) and (3) are relevant here.

The district court rejected FWP’s argument and the Fifth Circuit affirmed. Circuit Judge Dennis, writing for the Court, first noted that FWP apparently was arguing that the benefit of the square foot payment did not run with the land, while at the same time arguing that the duty to make that payment did run with the land. Setting this apparent contradiction aside, the Court reasoned that the right to receive payment under the surface use agreement touched and concerned the land because it did not merely compensate FWP for damage, but was structured such that Chesapeake has the incentive to use as little of the surface as necessary. As such, it was sufficiently connected to the land itself that it touched and concerned the land.

The Court then noted that the parties must have intended the payment right to run with the land, because they agreed in the Master Agreement and the surface use agreement itself that the covenants of the surface use agreement would run with the land, without exception. Because it held that the contracts were unambiguous, the Court ignored FWP’s affidavit.

In the end, Chesapeake avoided over $2 million in additional surface fee damages, but it took a decent amount of Texas real property law to get there.

 

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