SCOTX Upholds Lower Decisions in Retained Acreage Disputes (Endeavor v. Discovery; XOG v. Chesapeake)

After having waited with baited breath for a few years, oil and gas professionals dealing with land, title, and leases heard from the Supreme Court of Texas (“SCOTX”) on a few anticipated disputes pertaining to “retained acreage” provisions. These provisions enable mineral owning lessors to encourage fuller development of the leased acreage and prevent lessee operators from holding an undue amount of acreage based on the production from one or a few wells.

In Endeavor Energy Resources, L.P., et al. v. Discovery Operating, Inc., et al., (No. 15-0155), SCOTX agreed with the lower court that, given the particular language of the lease’s retained acreage provision conditioning the amount of acreage retained to the assignment of acreage to a proration unit, that Endeavor’s inadvertent assignment of fewer acres than which it may have otherwise been entitled resulted in a termination as to their interest as to the leased lands not so assigned to the unit. At the urging of Discovery – as well as the numerous amici who chose to make their thoughts known to the Court – the justices determined that the idea of “assignment” used in this context is a term of art in the oil and gas industry, and can only reasonably be understood to mean the filing of a form with the Texas Railroad Commission assigning the number of acres according to that agency’s rules. While the Court agrees that the Railroad Commission does not have the power to adjudicate and determine property rights, in this situation the parties contracted in their lease such that the acres to be retained was expressly conditioned on such an assignment of acreage made with that regulatory body. Ultimately, as Chief Justice Hecht succinctly observes in the companion XOG case discussed below, Endeavor‘s holding is that a regulatory proration unit “assigned to a well” means acreage that is actually assigned by the operator, and not automatically by consequence of the applicable field rules governing the well.

Of note to the author was the discussion regarding “obtaining the maximum producing allowable,” a concept where the size of a proration unit in a given field can sometimes vary between a standard number of acres with the inclusion of up to a defined number of additional “tolerance” acres – this increase in size is tied to breadth of production. In a regulatory sense, larger units can produce more oil. In this case, Endeavor argued that because it could have assigned all of the tolerance acres available to it with the regulatory agency, that meant they could rely on language saying that the proration units were to have the “number of acres required to comply with [Commission rules governing obtaining “the maximum producing allowable for the particular well.” This reasoning did not persuade the Court; given that they assigned a number of acres per unit that was in between the standard and maximum sizes (with tolerance acreage applied), they were determined to have retained merely the lesser amount. More interestingly, toward the end of its discussion on this topic the Court briefly addressed the concept that the use of tolerance acreage – which affords the operator the ability to produce more oil from the well on that unit – in situations where the tolerance acreage is not needed nor warranted by the low production in an effort merely to squat in bad faith on more lease acreage than one would otherwise be entitled. The Court observed that “if a well is draining a certain amount of acreage, but the operator intends to claim more than the amount, the operator may open itself up to claims that it is not acting in good faith in purporting to retain a substantially greater amount of acreage.” Obviously this was not at issue here in this case, but this author believes that the Court is providing a preview of coming attractions in the next frontier of retained acreage disputes, where an operator assigns the standard acreage and also some or all of the tolerance acreage for a total greater than what it should be entitled to given lackluster production from the well in a given proration unit and purports to retain such excess acreage.

In XOG Operating, LLC v. Chesapeake Exploration LP (No. 15-0935), the Court leaves for the Endeavor decision the discussion on regulatory frameworks and lease provisions more broadly, but suffice it to say oil and gas practitioners know after reading these cases several things:

1. “Assignment” of acreage is, in the eyes of the Court, understood to mean an operator’s assignment of acreage with the regulatory agency (here, the Texas Railroad Commission).
2. The Court will consider any retained acreage dispute on the facts and particularly on the given language of the provision at issue, not unlike how the Court handles fixed vs. floating royalty disputes.
3. Scrutinize any retained acreage provisions that you or your client will be subject to quite carefully, because courts will apply them as written regardless of novel factual circumstances or unwitting clerical errors.

This blog post is also available at my LinkedIn page.