Operator Runs Out the Clock on Co-Tenant

Originally published by Charles Sartain.

Co-authors Ethan Wood and Chance Decker

Less than a year ago, we discussed the “Unanswered Questions” left in the wake of Devon Energy Prod. Co., LP v. Apache Corp. (which did answer the question, “Who is a ‘Payor’ Under the Texas Natural Resources Code?”). We asked:

“But if the non-participating working interest owner is not paying royalties—what is keeping the lease alive? Absent pooling of the leases or a JOA, the non-participating working interest owner cannot rely on the operator’s actions to perpetuate its leases. A sly operator can obtain top leases from the non-participating working interest lessors and run out the clock on those leases …”

In Cimarex Energy Co. v. Anadarko Petroleum Corp., the operator did just that …

(Don’t ask us for advice on your March Madness bracket; our clairvoyance is limited to potential litigation in the oil patch.)

The facts

In 2009 Cimarex leased 1/6^th of the interest in a 440-acre tract in Ward County. Between 2007 and 2010 Anadarko leased the remaining 5/6^ths in the 440-acre tract and in 2012, drilled two wells on the 440-acre tract that reached payout within a year.

Cimarex’s lessors demanded royalty payments from Cimarex and a dispute between Cimarex and Anadarko ensued over cotenant accounting for the two wells. Those parties eventually entered into a Settlement Agreement in 2013, in which Anadarko agreed to account to Cimarex on a monthly basis for its 1/6^ths share of production less drilling, completion and operating costs for the two wells. Both parties also agreed to assume the responsibility of paying their respective lessors royalties.

Before the initial dispute between Anadarko and Cimarex, Anadarko secured top leases on the 1/6^th interest that was leased to Cimarex. After December 21, 2014 (the end of the primary term of the Cimarex lease), Anadarko ceased making payments to Cimarex based on Anadarko’s belief that the Cimarex Lease had expired for lack of production. Cimarex then sued Anadarko for breach of the 2013 Settlement Agreement. Anadarko prevailed in its summary judgment motion at the trial court. Cimarex appealed.

Keeping leases alive

Typical Texas oil and gas leases require production in paying quantities after the end of the primary term to keep the lease alive (with a few exceptions). Unfortunately for Cimarex, Texas courts have routinely imposed the production requirement on the lessee itself—i.e., production in paying quantities from a lessee’s cotenant will not keep the non-producing lessee’s lease alive. Therefore, Cimarex’s mere payment of royalties to the lessors failed to keep the Cimarex Lease alive past the primary term.

Was the Settlement Agreement a JOA?

The El Paso Court of Appeals then turned to whether the 2013 Settlement Agreement was effectively a joint operating agreement between Cimarex and Anadarko (one exception to the rule that lessees must obtain production to perpetuate their leases is where the lessee enters into a JOA with a party who does obtain production). The court concluded that the 2013 Settlement Agreement gave Cimarex the rights of a cotenant but did not include any language indicating an intent to enter into a JOA, nor did the parties post-settlement conduct confirm the existence of JOA.

What about estoppel?

Lastly, Cimarex argued that its lessors’ acceptance of royalties prior to December 2014 estopped them from asserting that Cimarex was not entitled to rely on Anadarko’s production to extend the Cimarex lease. The court of appeals rejected this argument because the lessors’ acceptance of royalties during the primary term was not inconsistent with their later assertion that the lease expired for lack of production after the primary term.

Hats off to some savvy landmen and one smooth operator.

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