RETAINED-ACREAGE CLAUSES IN OIL-AND-GAS CONTRACTS
State Bar of Texas, Advanced Oil, Gas & Energy Resources Law CLE, September 2016
by Ryan Clinton & Jad Davis
I. INTRODUCTION
Retained-acreage clauses have been part of the fabric of Texas oil-and-gas law for quite some time. Loosely speaking, retained-acreage clauses provide that at the end of a period of time or upon the conclusion of certain activity, the lessee or assignee’s oil-and-gas rights will terminate except as to those interests designated in the contract as being retained—or “earned”—by development. Retained-acreage clauses have been incorporated into contracts including farmout agreements, assignments, and oil-and-gas leases, among others. E.g., Eland Energy, Inc. v. Rowden Oil & Gas, Inc., 914 S.W.2d 179, 182-83 (Tex. App.—San Antonio 1995, writ denied) (farmee to retain 40 acres per well); TransTexas Gas Corp. v. Forcenergy Onshore, Inc., No. 13-02-387-CV, 2004 WL 1901717, at *1 (Tex. App.—Corpus Christi Aug. 26, 2004, pet. denied) (mem. op.) (assignee required to reassign undeveloped acreage). A typical retained-acreage clause in a lease might say:
At the end of the primary term or upon the cessation of continuous-development operations, whichever is later, the lessee’s rights and obligations shall terminate as to all lands and depths except, as to each producing well, 40 acres surrounding the well and those depths above the lowest productive zone for such well.
This paper discusses the purpose, history, and mechanics of retained-acreage clauses, analyzes a potential statute-of-frauds issue in retained-acreage litigation, and offers advice for those attempting to craft or construe retained-acreage clauses.
II. PURPOSE AND HISTORY
Many older Texas oil-and-gas leases set the duration of the conveyance—as specified in the lease’s “habendum clause”—as a fixed period (called the “primary term”) plus however long thereafter that oil or gas is produced from the leased lands. Anadarko Petroleum Corp. v. Thompson, 94 S.W.3d 550, 554 (Tex. 2002). This type of lease is sometimes referred to as a “habendum clause only” lease. Under such a lease, if the lessee fails to achieve production in paying quantities during the primary term or production ceases anytime thereafter, the mineral interests revert automatically to the lessor. Id. Because leases revert automatically upon certain conditions, they are said to create a “fee simple determinable” estate. Nat’l Gas Pipeline Co. of Am. v. Pool, 124 S.W.3d 188, 192 (Tex. 2003).
Under a traditional “habendum clause only” lease, production anywhere on the leased lands perpetuates the lease as to all of the leased lands. See Matthews v. Sun Oil Co., 425 S.W.2d 330, 333 (Tex. 1968). This is true even if the lessee achieves production on only a small portion of a large lease; the entirety of the lease may be held by production from only a single well. See id. To counteract that possibility, some leases include “retained-acreage clauses.” See Elizabeth N. “Becky” Miller, Drafting Oil and Gas Leases, State Bar of Tex. Oil & Gas Disputes Course, at 7 (2015); Katy Pier Moore and Paul P. Santoyo, Analysis of Oil and Gas Leases, Including Termination, State Bar of Tex. Oil, Gas and Mineral Title Examination Course, at 13 (2014). When parties to a lease included a retained-acreage clause, they “opt out” of the habendum-clause-only rule that production anywhere on a lease perpetuates the lease as to any and all lands. See Moore and Santoyo at 13. In its place, the parties agree that upon the expiration of the lease’s primary term (or, if applicable, the cessation of the lessee’s continuous-development operations), all leased oil-and-gas rights automatically revert to the lessor except for those rights expressly identified as being retained by the lessee. In addition to protecting the lessor (by terminating the contract as to undeveloped acreage), retained-acreage clauses may also be said to protect the lessee “from losing those portions of a lease that had productive wells located thereon if the rest of the lease terminated.” ConocoPhillips Co. v. Vaquillas Unproven Minerals, Ltd., No. 04-15-00066-CV, 2015 WL 4638272, at *1 (Tex. App.—San Antonio Aug. 5, 2015, pet. filed) (quoting Bruce M. Kramer, Oil and Gas Leases and Pooling: A Look Back and a Peek Ahead, 45 Tex. Tech. L. Rev. 877, 881 (2013)).
Retained-acreage clauses are occasionally referred to as “Pugh” clauses because the first retained-acreage-type clauses have been attributed to a Louisiana lawyer named Lawrence G. Pugh, “a distinguished attorney of Crowley, Louisiana.” Sandefer Oil & Gas, Inc. v. Duhon, 961 F.2d 1207, 1208 n.1 (5th Cir. 1992). It has been said that his intent was to “void the consequences of the holding of Louisiana mineral law … that production from a unit including a portion of a leased tract will maintain the lease in force as to all the lands covered by the lease.” Id. (quoting Fremaux v. Buie, 212 So.2d 148, 149 n.1 (La.App. 1968)). As the Montana Supreme Court put it, “[t]he Pugh clause does just what it provides; it terminates the lease as to lands not embraced in a producing oil and gas unit.” Fed. Land Bank of Spokane v. Texaco, Inc., 820 P.2d 1269, 1272 (Mont. 1991). Likewise, the North Dakota Supreme Court has said that “[t]he main purpose of a Pugh clause ‘is to protect the lessor from the anomaly of having the entire property held under a lease by production from a very small portion,’ and the clause is designed to ‘foster[] reasonable development of leased property.’” Egeland v. Cont’l Resources, Inc., 616 N.W.2d 861, 866 (N.D. 2000) (quoting, in part, Sandefer Oil & Gas, 961 F.2d at 1208). Generally, “Pugh” clauses—as differentiated from ordinary retained-acreage clauses—limit leasehold rights that may be retained by pooling. E.g., Sandefer Oil & Gas, 961 F.2d at 1208. A “Pugh” clause may also be differentiated from a standard retained-acreage clause in that it defines what acreage is lost after automatic reversion (rather than what acreage is retained). Id.
III. THE MECHANICS OF RETAINED-ACREAGE CLAUSES: WHEN, WHICH, AND HOW MUCH?
Although retained-acreage clauses are common in the oil-and-gas industry (and have been around for many decades), they are not included in any widely circulated form lease. As a result, retained-acreage clauses vary significantly. This wide variation among retained-acreage clauses is an obstacle to the desire of some to create a “one size fits all” substantive rule that would apply in all retained-acreage-clause cases. In reality, each clause is its own animal, and following Texas’s rules of contract construction, each clause should be given the meaning afforded by its own plain terms. Anadarko, 94 S.W.3d at 554.
Still, there are some basic commonalities that can inform the way retained-acreage clauses should be written and construed. Most importantly, a retained-acreage provision should provide a mechanism for determining three things:
(1) when the retained-acreage clause is triggered;
(2) which interests are excepted from reversion upon the clause’s triggering event (and thus retained); and
(3) if limited, how many acres are excepted from reversion upon the clause’s triggering event (and thus retained).
See Richard Gillman and William B. Burford, 28A West’s Legal Forms, Specialized Forms § 22:32(19) (2015). Providing a mechanism for answering these three questions in the clearest language possible may prevent disagreement and litigation between parties in the future.
While this paper discusses general retained-acreage clause language (and provides examples in previous and pending litigation), the words of any particular clause, of course, govern over legal generalities. Oil-and-gas contracts, including leases, are interpreted under Texas’s rules of contract construction. Anadarko, 94 S.W.3d at 554. The construction of an unambiguous contract is a question of law reviewed de novo. Id. An interpreting court’s “primary duty is to ascertain the parties’ intent as expressed within the lease’s four corners.” Id. Thus, courts will “give words their plain, common, or generally accepted meaning unless the contract shows that the parties used words in a technical or different sense,” and are to “‘construe contracts from a utilitarian standpoint bearing in mind the particular business activity sought to be served,’ and avoiding unreasonable constructions when possible and proper.” Plains Expl. & Prod. Co. v. Torch Energy Advisors, Inc., 473 S.W.3d 296, 305 (Tex. 2015) (quoting Reilly v. Rangers Mgmt., Inc., 727 S.W.2d 527, 530 (Tex. 1987)). “To that end, [courts] consider the entire writing, harmonizing and giving effect to all the contract provisions so that none will be rendered meaningless.” Plains, 473 S.W.3d at 305.
A. When Are Retained-Acreage Clauses Triggered?
The first question to answer when drafting or construing a retained-acreage clause is when the clause’s automatic reversion occurs. Often, a retained-acreage clause will indicate that the clause is triggered “at the end of the primary term or upon the cessation of continuous-development operations, whichever is later.” But even without the terms “whichever is later” included, courts are likely to construe these clauses to mean that the automatic reversion happens upon the latter of the end of the contract’s primary term or the cessation of the lessee’s continuous-development operations. E.g., Cmty. Bank of Raymore v. Chesapeake Exploration, L.L.C., 416 S.W.3d 750, 755-56 (Tex. App.—El Paso 2013, no pet.).
Litigants have argued over whether the retained-acreage clause is triggered just once (sometimes called a “snapshot” termination) or continuously, over and over again, whenever either production or continuous development ceases on any previously retained portion of the lease (sometimes called a “rolling” termination). This issue was most recently addressed in Chesapeake Exploration L.L.C. v. Energen Resources Corp., 445 S.W.3d 878, 879-80 (Tex. App.—El Paso 2014, no pet.). There, the lease provided that upon the expiration of continuous development, “the lease terminates as to all acreage except for” each “proration unit … upon which there exists … a well capable of producing oil and/or gas in commercial quantities.” Id. at 879.[1] Chesapeake argued that the retained-acreage clause provided “for continuous and automatic termination, i.e., ‘rolling’ termination, of [retained units] as they cease to produce” over time—even long after the initial reversion was triggered. Id. at 881. Energen countered that the clause “operated once and only once—when continuous development ended,” and thus acreage retained upon automatic reversion was not later terminated if the particular unit stopped producing. Id. The court of appeals agreed with Energen, reasoning that there was nothing in the “plain, grammatical language of the retained acreage clause” expressly providing “for rolling termination of [retained] units as they cease to” produce. Id. at 883. The court said it would not “impose[] an unnecessary limitation on the kind and character of the estate” absent “language so clear, precise, and unequivocal that no other conclusion could be reached.” Id.
The same conclusion was reached in Humphrey v. Seale, 716 S.W.2d 620 (Tex. App.—Corpus Christi 1986, no writ). There, the retained-acreage clause stated that the lessee would retain “forty (40) acres designated as a well block around [each] producing well.” Id. at 621. The lessors argued that the “40 acres was retained around the well only while the well produced, and upon the cessation of production of a particular well, the 40 acres surrounding that well reverted to the landowner and was no longer subject to the … lease.” Id. The court of appeals disagreed, reasoning that nothing in the lease “require[d] the lessee to relinquish additional acreage from the lease after the” initial termination was triggered. Id. at 622. The court concluded:
If the parties to the lease had wished to provide for a continual relinquishment of nonproducing acreage, so that a 40-acre tract would no longer be subject to the lease once production had ceased on that particular 40-acre tract, it would have been simple to include such language. However, in the absence of such a provision, the general rule that production [anywhere] on the lease premises will maintain the lease [everywhere] prevails.
Id.
B. Which Interests Are Excepted from Automatic Reversion?
A retained-acreage clause should also provide a mechanism for determining which interests are retained upon automatic reversion. While retained-acreage clauses are fairly uniform in describing when automatic reversion occurs, see supra, the same cannot be said for which interests a transferee is to retain. Retained-acreage provisions may provide for the retention of interests either horizontally (i.e., acres) or vertically (i.e., depths), or both. This paper focuses on horizontally severed interests.
Oil-and-gas contracts vary widely in how they define what acreage is retained, if any, upon reversion. A sample of Texas precedent illustrates a variety of clauses including those that define acreage retained upon reversion as:
· “forty (40) acres designated as a well block around such producing well,” Humphrey v. Seale, 716 S.W.2d 620, 621 (Tex. App.—Corpus Christi 1986, no writ);
· “such land as may be allocated to a well for production purposes,” Mayfield v. de Benavides, 693 S.W.2d 500, 503 (Tex. App.—San Antonio 1985, writ ref’d n.r.e.); and
· “that part of the acreage which is then (at the end of the primary term) pooled or unitized for drilling, reworking operations, or production of oil and/or gas from such a unit or units then formed by LESSEE,” SMK Energy Corp. v. Westchester Gas Co., 705 S.W.2d 174, 176 (Tex. App.—Eastland 1985, writ ref’d n.r.e.).
When the retained-acreage clause permits the lessee to select a specified number of acres from a larger tract, the contract should provide a mechanism for making the selection and identifying the selection made. For example, a lease might require the lessee—at the time of automatic reversion—to “execute and deliver to Lessor a written release” of the acreage or interests not retained. E.g., ConocoPhillips Co. v. Vaquillas Unproven Minerals, Ltd., No. 04-15-00066-CV, 2015 WL 4638272, at *1 (Tex. App.—San Antonio Aug. 5, 2015, pet. filed); ConocoPhillips Co. v. Ramirez, No. 04-05-00488-CV, 2006 WL 1748584, at *1 (Tex. App.—San Antonio June 28, 2006, no pet.). Similarly, a clause might command that the lessee “select or designate” the specific acreage retained for each well. Whitaker v. Formby, 469 S.W.2d 241, 242 (Tex. Civ. App.—Texarkana 1971, no pet.); see also Sutton v. SM Energy Co., 421 S.W.3d 153, 159-60 (Tex. App.—San Antonio 2013, no pet.) (lessee required to designate and record retained tract “in the office of the County Clerk in which the well tract is situated and a copy of such instrument shall be furnished to Lessor”).
Problems may arise if the lessee is required but fails to make an acreage designation. In Parten v. Cannon, for example, the retained-acreage clause required the lessee to “designate in writing and place same of record with the County Clerk in Madison County, Texas, a description of that part of the leased premises” retained for each producing well. 829 S.W.2d 327, 329 (Tex. App.—Waco 1992, writ denied). After the lessee failed to do so, the lessor claimed that the lease reverted in its entirety. Id. But the court of appeals disagreed, reasoning that the acreage was retained by development—not recording. Id. at 331. Because the lessee did not designate and record its acreage retained, the parties ultimately agreed to use the lessee’s Railroad Commission proration-unit filings in lieu of recorded designations. Id. at 329. It is not clear how the court would have resolved the question of which acres were retained had the parties not agreed to use the lessee’s Railroad Commission filings instead.
Some retained-acreage clauses define acreage retained by reference to the Texas Railroad Commission’s system of oil-and-gas regulation. But those too vary widely. For example, the oil-and-gas lease in Fisher v. Walker provided that at the end of the primary term, the lease terminates as to all lands and depths “not contained in a producing proration unit that is specified and approved by the Railroad Commission of Texas, and from which … oil, gas, or other liquid hydrocarbons are being produced in commercial quantities.” 683 S.W.2d 885, 886 (Tex. App.—El Paso 1985, writ ref’d n.r.e.). Similarly, the leases in Chesapeake v. Energen defined the acreage retained as that in a “proration unit established under … [the] rules and regulations [of the RRC …] upon which there exists … a well capable of producing oil and/or gas in commercial quantities.” 445 S.W.3d at 879.
In XOG Operating, LLC v. Chesapeake Exploration Ltd. P’ship, the contract defined the acreage retained for each producing well upon reversion of the estate as that in a “proration unit” “prescribed by field rules … of the appropriate regulatory authority” if such field rules exist. 480 S.W.2d 22, 25 (Tex. App.—Amarillo 2015, pet. filed) (emphasis original). But in the event a well was drilled within a formation without field rules, the well would retain a “proration unit … deemed to be 320 acres.” Id. For five wells drilled into a formation with field rules, the court of appeals looked to the applicable field rules—which “prescribed” proration units of 320 acres—and held that each of those wells retained the “prescribed” 320 acres. Id. at 29. And for a single well drilled into a field without field rules, the court followed the clause’s terms mandating a “deemed” retained unit of 320 acres. Id. That seems right on its face, but a dissenting justice opined that the contract set the acreage retained by however many acres the lessee assigned to its wells in its Railroad Commission filings—not however many acres were “prescribed” by the field rules. Id. at 31 (Campbell, J., dissenting).
Although not in the retained-acreage context, the Texas Supreme Court has previously addressed the interaction between Railroad Commission rules and a lease that defines leasehold rights with reference to the Commission’s rules. In Jones v. Killingsworth, the lease gave the lessee the “right and power to pool” the leased acreage in a unit that “shall not substantially exceed 40 acres,” but if the Railroad Commission “prescribe[d] or permit[ted] larger units,” then the lessee’s pooled units “may conform substantially in size with those prescribed by government regulations.” 403 S.W.2d 325, 326-27 (Tex. 1965). The lessee created a unit of 170 acres (although the parties treated it as containing 160 for purposes of the litigation), and the lessors contended that the lease terminated because the pooled unit was not authorized by the lease. Id. at 327. Because the lease authorized pooling of 40 acres or however many acres were “prescribed” by Railroad Commission rules, the Supreme Court turned to the Commission’s rules—which “prescribed” 80-acre units but “permitted” 160-acre units. Id. at 327-28. In turn, because the lease stated that pooled units may contain up to the “size” of “those prescribed by government regulations,” the Court held that the lessee had authority to pool up to 80 acres (the “prescribed” unit), not 160 (a “permitted” unit). Id.; see also Atlantic Richfield Co. v. Hilton, 437 S.W.2d 347, 349-51 (Tex. Civ. App.—Tyler 1969, writ ref’d n.r.e.) (following Jones). Like the court of appeals in XOG, therefore, the Supreme Court in Jones held that when the Commission’s rules specify a “prescribed” unit size, and the applicable lease limits rights to those “prescribed” by the Commission, the “prescribed” unit size specified by the Commission dictates the lessee’s rights. In light of Jones, the court of appeals’s conclusion in XOG seems to rest on solid ground.
In Endeavor Energy Res., L.P. v. Discovery Operating, Inc., 448 S.W.3d 169 (Tex. App.—Eastland 2014, pet. filed), the lease states, in part, that upon cessation of the lessee’s continuous-development operations, the lease will revert to the lessors except as to those lands in “a government proration unit assigned to a well.” Id. at 172 (emphasis added). In its Railroad Commission filings, the lessee had—consistent with the applicable field rules—assigned 81-acre proration units to its relevant wells at the time it ceased continuous-development operations. Id. at 173-74. Accordingly, the court of appeals held that for each producing well, the lessee retained the number of acres it had assigned to its wells’ proration units at the time the clause was triggered. Id. at 177-79. The provision at issue in Endeavor is discussed again below in the paper’s discussion of how many acres are retained by a given clause.
At the time of this paper’s writing, both XOG and Endeavor are pending on petition for review, with each petitioner claiming that its case was wrongly decided and the other case correctly decided. For purposes of full disclosure, the authors of this paper represent the respondent in each case. The similarities and differences between XOG and Endeavor are interesting. Both instruments make reference to the Railroad Commission’s rules and “proration units,” but the remainder of the clauses are different. The XOG contract defines a retained “proration unit” as that “prescribed by [the Railroad Commission’s] field rules,” if any. 480 S.W.2d at 25. The Endeavor lease defines a retained “proration unit” as a governmental unit “assigned to a well.” 448 S.W.3d at 172. The Commission’s proration system illuminates the distinction between the two definitions.
When the Commission adopts field rules for an oil-and-gas formation, it will often set a standard proration-unit size—which it refers to as a “prescribed” proration unit. See H. Phillip Whitworth and D. Davin McGinnis, Square Pegs, Round Holes: The Application and Evolution of Traditional Legal and Regulatory Concepts for Horizontal Wells, 7 Tex. J. Oil Gas & Energy L. 177, 206 n.136 (2011-12); William Royal Furgeson, Jr., Note, 44 Tex. L. Rev. 1051, 1051 (1965). After the Commission adopts field rules (including prescribing standard units) for a formation and an operator drills a successful well into the field, the operator will then “assign” leased acreage to the particular well’s proration unit in order to obtain permission to produce oil or gas from the well. See Browning Oil Co., Inc. v. Luecke, 38 S.W.3d 625, 634 (Tex. App.—Austin 2000, pet. denied) (“an operator must … designate the proration unit and the acreage assigned to it”); Dennis, supra n.1 at 227; Whitworth and McGinnis, supra at 183-86. The operator may—depending on the field rules—assign more or less acreage to the particular well’s proration unit than that “prescribed” in a standard unit. E.g., XOG Operating, 480 S.W.2d at 25 (noting field rules’ “fractional proration unit” of size less than “prescribed” unit).
That distinction—between the Railroad Commission’s adoption of a “prescribed” proration unit size and a well operator’s “assignment” of acreage to a particular well’s proration unit—explains the differing outcomes in XOG and Endeavor. The XOG court concluded that the plain terms of the contract at issue there set the number of acres retained as that in a proration unit “prescribed by … field rules,” which was undisputedly 360 acres (i.e., the standard unit size set by the Commission). 480 S.W.2d at 29. It therefore rejected the argument of one party that the number of acres retained should have been what the operator assigned to its particular proration unit. Id. On the other hand, the Endeavor court concluded that the plain terms of the lease at issue there set the number of acres retained as that in a proration unit that the operator “assigned to a well,” which was undisputedly 81 acres (i.e., the number of acres that the operator assigned to its well in its Railroad Commission filings). 448 S.W.3d at 177-79. It therefore rejected the argument of one party that the number of acres retained should have been twice what the operator assigned to its particular wells. Id.
Both cases now sit in the Texas Supreme Court. As of the time of this paper’s writing, merits briefing has been completed in Endeavor and has been requested in XOG. Each petitioner is relying on the other opinion for a “conflict,” yet they take opposite views of what the law should be. The XOG petitioner argues that acreage retained should be determined by the number of acres the operator assigned to a particular wells even when the contract does not expressly say so, and the Endeavor petitioner argues that the acreage retained should not be determined by the number of acres the operator assigned to its particular wells even when the lease does say so. They cannot both be right. But, at least in the view of the authors of this paper, both petitioners can be wrong. It is our view (as you might expect given that we represent the respondent in each) that the courts of appeals correctly construed the plain terms of the instruments before them in each case. Instead of creating a “one size fits all” substantive rule that would apply to retained-acreage cases regardless of what the individualized clauses say, each court correctly followed the most fundamental rule of contract construction: give effect to the parties’ intent as demonstrated in the plain terms of the words of their agreements. Anadarko, 94 S.W.3d at 554.
C. If Limited in Number, How Many Acres Are Excepted from Automatic Reversion?
A retained-acreage clause may also specify or restrict the quantity (as opposed to the location) of acres that each producing well will or may retain. For example, many retained-acreage provisions set a specific number of acres each well is to retain. E.g., Sutton, 421 S.W.3d at 159 (160 acres); Eland Energy, Inc. v. Rowden Oil & Gas, Inc., 914 S.W.2d 179, 182 (Tex. App.—San Antonio 1995, writ denied) (40 acres); Nafco Oil & Gas, Inc. v. Tartan Resources Corp., 522 S.W.2d 703, 705 (Tex. App.—Corpus Christi 1975, writ ref’d n.r.e.) (20 acres).
Others rely on Railroad Commission rules to calculate the number of acres retained. In Endeavor Energy, for example, the full retained-acreage clause—excerpted in part above, see supra—states that the lessor retains those acres “in a governmental proration unit assigned to a well” and that the assigned acreage is to “contain the number of acres required to comply with the applicable rules and regulations of the Railroad Commission of Texas for obtaining the maximum producing allowable for the particular well.” 448 S.W.3d at 172. The parties disagree over what that means, although both appear to agree that the number of acres that may be “assigned to a well” is affected by the Commission’s “rules and regulations.” See id. At the Texas Supreme Court, the petitioner is asserting that the words “governmental proration unit assigned to a well” are ambiguous and that the remainder of the clause simply means “greatest acreage possible in the field.” The respondent contends that nothing in the clause is ambiguous, that the acreage retained is set by the acreage that the lessee “assigned” to a particular well’s governmental proration unit, and that the number of acres permitted to be assigned is only the amount necessary to obtain the particular well’s “maximum producing allowable” (i.e., its fair share of the field’s permitted production) from the Railroad Commission. The court of appeals favored the respondent’s construction, and as indicated, merits briefing has been completed at the Texas Supreme Court.
In ConocoPhillips v. Vaquillas, the leases defined the acreage earned per well as either 40 acres for each oil well and 640 acres for each gas well or whatever the Railroad Commission’s field rules, if any, provide for the wells. 2015 WL 4638272, at *1. The parties disagreed over whether the Railroad Commission adopted field rules establishing units that were different from those in the contract. Id. The court of appeals acknowledged that no field rule “expressly set forth a number of acres per well,” but reasoned that a statewide rule’s “standard acreage for a well” applied under the circumstances. Id. at *3. The court of appeals’s judgment was appealed to the Texas Supreme Court, but at the time of the writing of this paper, the matter is abated due to anticipated settlement. As a result, we will likely never know whether the Supreme Court would have agreed.
IV. STATUTE OF FRAUDS
Another question that may arise in retained-acreage litigation is whether a “selection” or “option” clause—i.e., a retained-acreage clause that affords the assignee the right to select the acreage retained among a larger tract—violates the statute of frauds. Generally, an instrument conveying real property “must furnish within itself, or by reference to some other existing writing, the means or data by which the land to be conveyed may be identified with reasonable certainty.” Morrow v. Shotwell, 477 S.W.2d 538, 539 (Tex. 1972). It has been argued, therefore, that a contract that allows one party to select acreage conveyed (or retained)—such as a retained-acreage clause that gives the assignee the right to select acreage—could violate the statute of frauds.
In Stekoll Petroleum v. Hamilton, for example, the Texas Supreme Court held that a contract that permitted a buyer to select “1,000 acres equitably checkerboarded in a fashion similar to the checker-boarding in the first block” violated the statute of frauds because it “makes uncertain and indefinite the land on which petitioner is to acquire the lease and that on which the lease is to be left to respondents.” 152 Tex. 182, 255 S.W.2d 187, 191 (Tex. 1953). The Court explained that it could not be determined what would satisfy the “equitably checkerboarded” requirement, and that no defined pattern could be surmised from the referenced “first block” because “[t]he contract and the other instruments do not disclose a clearly defined pattern for the first block.” Id. at 191. The Court asked, “What is a checker-boarding in a fashion similar to that of the checker-boarding in the first block? How nearly similar must it be? What is an equitable checkerboarding?” Id. at 192. The contract left no way to tell.
But importantly, the Court wrote preemptively in Stekoll that it was the ambiguity of the “checkerboarding” requirement—and not the self-selection aspect of the contract—that rendered it unenforceable. The Court explained that “option” or “selection” contracts generally satisfy the statute of frauds because “the grantee does not acquire a present title, but acquires an equitable right to make the selection and thereby to become the owner of the tract selected….” Id. at 191 (citing Turner v. Hunt, 131 Tex. 492, 116 S.W.2d 688 (1938)). For example, the Court noted its own prior opinion holding that a contract for oil-and-gas leasehold interests that allowed a buyer to select “any 1500 acres” in “a block of leases covering 2500 acres” satisfied the statute of frauds. Id. (discussing Taylor v. Lester, 12 S.W.2d 10987 (Tex. Civ. App.—Austin 1928, writ ref’d)). Intermediate courts that have followed this rule include:
· the Corpus Christi Court of Appeals, see Harkins v. N. Shore Energy, L.L.C., No. 13-12-00504-CV, 2014 WL 1789572, at *9 (Tex. App.—Corpus Christi May 1, 2014, no pet.) (mem. op.) (holding that “selection agreements” do not violate the statute of frauds);
· the Fort Worth Court of Appeals, see Best Building Co. v. Sikes, 394 S.W.2d 57, 62 (Tex. Civ. App.—Fort Worth 1965, writ ref’d n.r.e.) (a contract giving one party a “right of determination or selection of an amount and location of premises (within an area certainly ascertainable) meets the requirements of the Statute of Frauds”); and
· the Texarkana Court of Appeals, see Skeeters v. Granger, 314 S.W.2d 364, 367 (Tex. Civ. App.—Texarkana 1958, writ ref’d n.r.e.) (contract giving a party the “right or power to make a selection or determination” does not violate the statute of frauds).
Eland Energy, Inc. v. Rowden Oil & Gas, Inc. addressed option contracts in the retained-acreage-clause context. 914 S.W.2d 179 (Tex. App.—San Antonio 1995, writ denied). In Eland, one party transferred to another party the right to explore for oil and gas in a large area of land. Id. at 181. The contract stated that the transferee would earn a number of acres surrounding each successful well. Id. at 182. One of the parties argued that the statute of frauds rendered the retained-acreage provision unenforceable “because the description of the land to be conveyed is too vague.” Id. at 186. The court of appeals disagreed, reasoning that the initial contract conveyed to the transferee an “equitable right to perfect his title in [earned] tracts by selecting the boundaries of the . . . tracts he had earned.” Id. at 187 (citing Stekoll, 255 S.W.2d at 191). That “right to make the designation,” said the court of appeals, “coupled with the interest in doing so, satisfies the requirements of the statute of frauds.” Id. (citing Tiller v. Fields, 301 S.W.2d 185, 190 (Tex. Civ. App.—Texarkana 1957, no writ)).
V. CRAFTING AND CONSTRUING RETAINED-ACREAGE CLAUSES
What can be learned from retained-acreage precedent given the large variance among retained-acreage clauses? As a start, perhaps no lesson is more important than this: those who craft or agree to language in retained-acreage clauses need to make sure they understand what the particular language means, what the consequences of the particular clause’s language will be under various predictable circumstances, and what language must be included in the clause to achieve the policy goals of the particular party.
For example, if a lessor wants a “rolling termination” of retained acreage—such that acreage retained upon the clause’s initial triggering event will later revert again at any time upon the cessation of production in a producing unit—the clause must expressly say so. Courts have now repeatedly rejected requests to judicially imply “rolling termination” terms.
Likewise, if the parties wish to pin the number or boundaries of acreage retained based on reference to Texas Railroad Commission rules and regulations, they should specify precisely what they mean. Under the court of appeals’s opinion in Discovery, a clause that sets acreage retained based on the acres “assigned to a well” under Railroad Commission rules will be read consistently with how oil-and-gas precedent, scholars, and practitioners have read those words thus far—i.e., the specific acreage assigned to a well by its operator in Railroad Commission filings. See supra. And under the court of appeals’s opinion in XOG, a clause that sets acreage retained based on the acreage “prescribed” by Railroad Commission field rules will be read consistently with how the Supreme Court construed the same term in Jones—i.e., the number of acres in the standard (or “prescribed”) proration unit as set by the Railroad Commission. Id.
In addition, if the parties to a retained-acreage clause wish the lessee or assignee to have the power to select the particular acreage retained by a productive well, the parties should provide a requirement for the lessee/assignee to make such a designation and a mechanism for identifying the selection made—such as Railroad Commission acreage assignments or a required recording in county records. The parties might even consider a default designation (such as the assignment of acreage in Railroad Commission filings) to determine leasehold rights in the event that the lessee fails to designate acreage as otherwise provided in the contract.
Finally, in order to comply with the statute of frauds, parties who adopt retained-acreage clauses permitting the lessee to select the acreage retained by a producing well should avoid prescribing limitations on the acreage retained that cannot be understood or with which compliance cannot be verified. Requiring acreage selected around a well in the form of a “square as nearly as possible around the well” may suffice, but stating that the acreage must form a “checkerboard pattern” (or setting limitations by making reference to instruments that do not exist) will subject the clause to statute-of-limitations concerns.
At the end of the day, parties to oil-and-gas contracts need to ensure that the words they choose mean what they intend them to mean. Be as clear and precise as possible. And don’t expect courts to imply limitations that are not expressly included. It is ultimately the words used that matter—nothing more and nothing less.
[1] A “proration unit” is a concept used by the Railroad Commission to allocate a fraction of a regulated field’s total allowed production to a particular well in the field. See Stephen Taylor Dennis, Browning Oil Co. v. Luecke: Has Texas Illuminated a Dark Distinction Between Vertical and Horizontal Drilling?, 34 St. Mary’s L.J. 215, 227 (2002); Pickens v. R.R. Comm’n, 387 S.W.2d 35, 38 (Tex. 1965).