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The following article was presented by John K. H. Akers, Jr., Attorney at Law, at the Fiftieth Annual Rocky Mountain Mineral Law Institute (July 22, 23 & 24, 2004) See 50 Rocky Mt. Min. L. Inst. 21-1 (2004)

OVERRIDING ROYALTY INTERESTS: PITFALLS, PRECEDENT, AND PROTECTION

Synopsis

§ 21.01 Introduction [1] The Definition and Nature of an Overriding Royalty Interest [2] Other Forms of Nonoperating Interests § 21.02 “Extension or Renewal” Clauses Applicable to Overrides [1] Washout Protection in the Absence of an “Extension or Renewal” Clause [2] Washout Protection Under the “Oklahoma Rule” [3] Interpretation of the “Extension or Renewal” Clause in Other Jurisdictions [4] Miscellaneous “Extension or Renewal” Clause Cases [5] Application of the Rule Against Perpetuities § 21.03 Calculation of Overriding Royalty Interests § 21.04 Enforcement of Express and Implied Covenants by the Overriding Royalty Interest Owner [1] Enforcement of Implied Covenants as “Running With the Land” [2] Enforcement of Implied Covenants Arising Out of Express Covenants in the Assignment § 21.05 Pooling and Unitization § 21.06 The Nonoperating Interest and Bankruptcy § 21.07 Matters to Be Considered in Drafting an Assignment or Reservation of an Overriding Royalty Interest

§ 21.01 Introduction that dictate whether the lease that is burdened by their interest will be drilled or abandoned. Since An adversarial relationship, the result of nonoperating interests, absent contractual protection conflicting economic interests, exists between the or special circumstances, expire or terminate at the operating and nonoperating interest owners in an oil same time as the lease that they are carved out of, and gas lease. Owners of operating interests, the there are thousands of sad stories of landmen and cost-bearing working interest, must bear, in addition geologists who assigned a lease to an operator in to the risks of geological misinterpretations, exchange for an overriding royalty interest, then mechanical failures, environmental obstructionists, watched helplessly as their lease expired, without and confiscatory taxation, the financial burden of any effort on the part of the operator to develop it, nonoperating interests. Owners of the latter, only to discover that the operator had taken a new consisting of overriding royalty interests, production lease from the same lessor, covering the same lands, payments, net profits interests, and the like, expect but free and clear of their overriding royalty interest. their allotted share of oil and gas free of the expense of exploration, development, and It doesn’t have to be that way. The courts have operation-“freeloaders” as perceived by the never hesitated to enforce written provisions in burdened operating interest owners. grants and assignments of nonoperating interests which give the owners a say in the operation of a The owners of nonoperating interests, in their lease. Even in the absence of a written agreement, simplest form, have no control over the decisions

1 the courts have been able, with some regularity, to proportionate share of production and severance recognize the difference between a shrewd operator taxes.4 and an unscrupulous one, and to construct rules and Whether a jurisdiction classifies an override as real remedies designed to protect the nonoperating or personal property will usually depend on how the interest owner from the latter. jurisdiction classifies a landowner’s royalty interest.5 This paper will highlight the advantages and In most jurisdictions an overriding royalty interest is disadvantages of the nonoperating interest, and regarded as real property.6 The notable exceptions are summarize recent court decisions that have altered Kansas and Oklahoma, where an overriding royalty the rights and liabilities traditionally associated with interest is considered personal property before and ownership of such interests. Wishing to show no after it is produced.7 It is too simplistic to state that a preference for the burden or the burdened, the author jurisdiction will only classify an overriding royalty will also discuss the protection that current laws interest as either real or personal property. In reality, afford to both the nonoperating interest owner who courts will usually characterize an override as an seeks to ensure the perpetuation of his or her interest interest in real property for purposes that affect the and the operating interest owner who seeks to limit land involved, and as a personal property interest for the influence that the nonoperating interest owner purposes of payments that arise from the interest.8 can exert over operations. Since an overriding royalty interest is a [1] The Definition and Nature of an Overriding nonpossessory right that attaches only when the oil Royalty Interest and gas is brought to the surface, it cannot be adversely possessed or partitioned,9 and the owner is An overriding royalty interest is a nonoperating not entitled to possessory remedies like trespass to interest that is carved out of the working interest of try title (an action to regain possession from a an oil and gas lease, rather than the royalty interest. trespasser).10 Conversely, a lessee cannot bring a It can be created through a conveyance, but it is partition action in an attempt to extinguish an more commonly created by a reservation in the overriding royalty interest that the lessee claims has assignment or transfer of an oil and gas lease. It is a overburdened the working interest to the extent that nonpossessory interest that attaches only when its further production, development, or sale of a lease is share of oil and gas is reduced to possession, giving impossible.11 The realty/personalty distinction that the owner no right, absent an agreement to the contrary, to participate in decisions with regard to 4 Richard W. Hemingway, The Law of Oil and Gas the development and operation of the burdened § 9.9(b), at 637 (3d ed. 1991). 1 lease. Since an overriding royalty interest is “carved 5 2 Williams & Meyers, supra note 1, § 418.1, at 354. out” of the leasehold interest, it is limited in duration 6 2 Kuntz, supra note 1, § 63.2, at 221; Page v. Fees-Krey, to the term of the burdened lease.2 Inc., 617 P.2d 1188, 1194 (Colo. 1980); Team Bank v. Meridian Oil, Inc., 879 P.2d 779, 781 (N.M. 1994); Unless the grant or reservation of the interest Meeker v. Ambassador Oil Co., 308 F.2d 875 (10th Cir. provides otherwise, the owner of an overriding 1962) (applying Oklahoma law); Tennant v. Dunn, 110 royalty interest is entitled to its specified share of oil S.W.2d 53, 57 (Tex. App. 1937); Connaghan v. Eighty- Eight Oil Co., 750 P.2d 1321, 1324 (Wyo. 1988). or gas produced under the terms of the lease free and 7 Campbell v. Nako Corp., 402 P.2d 771, 775 (Kan. 1965); 3 clear of drilling, completing, and operating costs. Connell v. Kanwa Oil, Inc., 170 P.2d 631 (Kan. 1946); However, it is almost universally accepted that the Barker v. Boyer, 794 P.2d 322, 324 (Kan. Ct. App. overriding royalty interest owners will bear their 1990). See 1 Williams & Meyers, supra note 1, § 214.2, at 175-78, for a discussion of the “inconsistent” court decisions in Oklahoma with regard to the realty- personalty classification of non-operating interests. 1 2 Howard R. Williams & Charles J. Meyers, Oil And 8 Grynberg v. Waltman, 946 P.2d 473, 476 (Colo. Ct. App. Gas Law § 418.1 (2003); 5 Eugene O. Kuntz, A Treatise 1996); Kentucky Bank & Trust Co. v. Ashland Oil & on the Law of Oil and Gas § 63.2, at 218 (1991); T- Transp. Co., 310 S.W.2d 287 (Ky. 1958). See Ferguson Vestco Litt-Vada v. Lu-Cal One Oil Co., 651 S.W.2d v. Coronado Oil Co., 884 P.2d 971 (Wyo. 1994) (where 284 (Tex. Civ. App.-Austin 1983); Garman v. Conoco, this rationale was applied to a net profits interest). Inc., 886 P.2d 652, 656 (Colo. 1994); Campbell v. Nako 9 De Mik v. Cargill, 485 P.2d 229 (Okla. 1971); T-Vestco Corp., 402 P.2d 771, 775 (Kan. 1985); Connaghan v. Litt-Vada v. Lu-Cal One Oil Co., 651 S.W.2d 284 (Tex. Eighty-Eight Oil Co., 750 P.2d 1321,1324 (Wyo. 1988). Civ. App.—Austin 1983); Connaghan, 750 P.2d at 1324. 2 2 Williams & Meyers, supra note 1, § 418.2, at 356; 10 Standard Oil Co. v. Marshall, 265 F.2d 46, 54 (5th Cir. Campbell, 402 P.2d at 775. 1959); T-Vestco Litt-Vada, 651 S.W.2d 284 (citing 2 3 5 Kuntz, supra note 1, § 63.2, at 218; De Mik v. Cargill, Williams & Meyers, supra note 1, § 418.1, at 342). 485 P.2d 229, 239 (Okla. 1971). 11 De Mik, 485 P.2d at 235.

2 applies to an override allows the owner to bring a is that an overriding royalty interest continues for quiet title action to perfect title to the owner’s the entire term of the lease, whereas a production interest in a lease (real property) but to also maintain payment terminates when the specified amount of a conversion action for revenues due as a result of production or money has been received by the owner actual production (personal property).12 of the production payment. Thus, in any state where an overriding royalty is considered to be realty, a When the circumstances dictate that the overriding production payment should also be a present interest royalty interest is real property: (1) the Statute of in land.18 Frauds will apply to any instrument creating an override, requiring at minimum a written The production payment is gaining popularity as a memorandum signed by the party who bears the way to finance oil and gas operations and purchases, override, describing the agreement in enough detail but it differs from a mortgage secured by production that parol evidence will not be necessary to prove up so long as no personal obligation exists on the part any substantive terms;13 (2) specific performance is of the burdened party to pay the stated amount.19 available as a remedy to compel an assignment or A net profits interest differs from an overriding conveyance of the interest14 assuming that the terms royalty interest to the extent that the former is to be of the contract are clear, and that there has been paid out of net production after specified costs have partial performance of the contract by the party been recovered by the burdened party.20 Under the seeking such a remedy;15 and (3) state recording usual net profits arrangement, the burdened party statutes will apply to the instrument creating the pays all costs of exploration and development, then override, and will mandate that the instrument be after recouping these costs from its share of recorded to ensure priority as against subsequent bona production distributes to the owner of the net profits fide purchasers for value without actual notice.16 interest the latter’s agreed share of the “profits.”21 [2] Other Forms of Nonoperating Interests Although some commentators have argued that the Although this chapter focuses primarily on the net profits interest should be viewed as an interest in creation and protection of overriding royalty real property,22 the nature of a net profits interest is interests, there are other forms of nonoperating such that many jurisdictions have interpreted it as an interests that are similar to overrides. With the interest in the proceeds of production and therefore exceptions noted below, the legal precedents set personal property, rather than an interest carved out forth in the cases discussed herein will apply of the working interest in a lease, like an override or interchangeably to all nonoperating interests. production payment, which is generally considered real property.23 A production payment (sometimes referred to as an “oil payment,” especially if limited to oil The only thing that can be said with any assurance production) is “a share of the oil [or gas] produced [with regard to the question whether a net profits from described premises, free of the costs of interest is real or personal property] is that a net production at the surface, terminating when a given profits interest may or may not be an interest in land volume of production has been paid over or when a and that the nature of the interest and the rights of its specified sum from the sale of such oil [or gas] had 17 been realized.” 18 Frank W.R. Huber & James A. Taylor, “Creation and Conveyance of Oil and Gas Leasehold Burdens,” 31 [T]he only significant difference between an Rocky Mt. Min L. Inst. 14-1, 14-8 (1985); see also overriding royalty interest and a production payment Walker, “Oil Payments,” 20 Tex. L. Rev. 259, 269 (1942); 2 Williams & Meyers, supra note 1, § 422.3; 12 See Ferguson v. Coronado Oil Co., 884 P.2d 971 (Wyo. Roberts v. Lone Star Producing Co., 369 S.W.2d 373 1994) pertaining to a net profits interest. (Tex. Civ. App.—Eastland 1963); McMahon v. 13 Gruss v. Cummins, 329 S.W.2d 496, 502 (Tex. Civ. Christmann, 303 S.W.2d 341 (Tex. 1957). App.—El Paso 1959); John O. Schofield, Inc. v. Nikkel, 19 Marshall, 265 F.2d at 53. But see In re Senior-G & A 731 N.E.2d 915, 925 (Ill. 2000). Operating Co. v. Aguillard, 957 F.2d 1290 (5th Cir. 14 Globe Drilling Co. v. Cramer, 562 P.2d 762, 765 (Colo. 1992), discussed in § 21.06 below, wherein a production Ct. App. 1977). payment secured by mortgage was determined to be a 15 John O. Schofield, 731 N.E.2d at 925. secured loan. 16 Page v. Fees-Krey, Inc., 617 P.2d 1188 (Colo. 1980). 20 2 Williams & Meyers, supra note 1, § 424. 17 2 Williams & Meyers, supra note 1, § 422, at 366.10. 21 Id. § 424.1, at 439. See also Standard Oil Co. v. Marshall, 265 F.2d 46, 53 22 See id. at 440. (5th Cir. 1959) (applying Texas law); 5 Kuntz, supra 23 Ferguson v. Coronado Oil Co., 884 P.2d 971, 976-77 note 1, § 63.3, at 243. (Wyo. 1994).

3 owner must be determined from the provisions of Frauds requires that a grant or reservation of an the instrument which created it.24 override be in writing. Absent circumstances supporting equitable relief such as reliance and part Overriding royalty interests, production payments, performance, an oral agreement that an override and net profits interests in an unadulterated form reserved by an assignor will attach to any extension share the following characteristics: (1) they are or renewal of the burdened lease is unenforceable.28 carved out of the lessee’s working interest in an oil and gas lease and are consequently limited to the An “extension” of an existing oil and gas lease is term of the burdened lease; (2) the burdened usually defined as an instrument that prolongs or working interest owner has no personal obligation as continues the term of an existing oil and gas lease.29 the interest is only payable out of production; Renewal and extension are concepts closely allied to (3) they are nonpossessory interests granting the one another, normally involving a continuation of owner the right to a share in the minerals when the relationship on essentially the same terms and produced, but carrying no right to participate in the conditions as the original contract.30 operation of the burdened lease; and (4) they do not bear any of the costs of developing and operating the [I]n determining whether a subsequent lease lands subject to the interest.25 constitutes an “extension or renewal” a court must consider the circumstances surrounding the § 21.02 “Extension or Renewal” Clauses Applicable execution of the leases, the relationship of the to Overrides parties, whether new consideration was given for the An “extension or renewal clause” for purposes of subsequent lease, and the significant similarities and this discussion is a provision in an assignment or differences in the terms and conditions of the reservation of an overriding royalty interest or other leases.31 nonoperating interest that protects the owner against There appear to be no hard and fast rules to a “washout.”26 A “washout” is the elimination of the distinguish an “extension or renewal” lease from a nonoperating interest as a result of the termination or “new” lease, primarily because the classification of a surrender of the burdened lease, and the subsequent lease as one or the other often has more to do with reacquisition of a lease on the same lands by the equity than fact. The Tenth Circuit, applying Kansas lessee or its agent with the intention of taking the law, held that five “replacement” leases taken by the lease free of the burden of that nonoperating lessee at a bonus cost of $130,000, covering interest.27 An example of an extension or renewal (collectively) the same lands included in the single clause is as follows: prior lease, each subject to a primary term and The overriding royalty interest reserved by Assignor landowner royalty that was different from the prior in the leases subject to this assignment (the “subject lease, were “new” leases, and not “extensions or leases”) shall apply to every extension, renewal or renewals.”32 However, the Kansas Supreme Court modification of any of the subject leases, or any has ruled that a lease that covered more land than a portion thereof, taken by Assignee or its successors, prior lease, had a one-year primary term rather than assigns, agents or employees (hereinafter referred to the three-year term of the prior lease, and was taken as the “Assignee”), and to any new lease taken by 13 months after the prior lease expired was an Assignee on the lands, or any portion of the lands, “extension or renewal” of the prior lease.33 The U.S. covered by the subject leases within one year of the District Court for the District of Wyoming recently expiration, termination or surrender of any of the ruled that leases taken two and one-half months after subject leases. 28 Thomas v. Whyte, 146 N.W.2d 721, 722 (Mich. Ct. App. 1966). Because an overriding royalty interest is usually 29 considered an interest in real property, the Statute of Sunac Petroleum Corp., 416 S.W.2d at 802 (citing Mutual Paper Co. v. Hoague-Sprague Corp., 8 N.E.2d 802 (Mass. 1937)). 24 5 Kuntz, supra note 1, § 63.5, at 254. 30 Sawyer, 215 F. Supp. 2d at 1264 (citing Williams 25 Huber & Taylor, supra note 18, at 14-4. Petroleum Co. v. Midland Cooperatives, Inc., 679 F.2d 26 8 Williams & Meyers, supra note 1, at 371; Sawyer v. 815, 817 (10th Cir. 1982)). Guthrie, 215 F. Supp. 2d 1254, 1258 n.2 (D. Wyo. 31 Lillibridge v. Mesa Petroleum Co., 907 F.2d 1031, 1033 2002); Otter Oil Co. v. Exxon Co., U.S.A., 834 F.2d 531, (10th Cir. 1990). 534 (5th Cir. 1987); Sunac Petroleum Corp. v. Parkes, 32 Lillibridge, 907 F.2d 1031; see also Sunac Petroleum 416 S.W.2d 798, 804 (Tex. 1967). Corp., 416 S.W.2d 798. 27 Sawyer, 215 F. Supp. 2d at 1258; Otter Oil Co., 834 F.2d 33 Howell v. Cooperative Refinery Ass’n, 271 P.2d 271 at 533. (Kan. 1954).

4 the prior leases had expired, which covered different overriding royalty owner and the lessee, the courts formations under less acreage, had a larger are reluctant to extend an overriding royalty beyond landowner royalty, a shorter primary term, a shorter the term of the burdened lease, even when the lessee continuous drilling clause, and more rigid pooling takes a new lease prior to expiration or surrender of requirements, among other variances with the prior the old. This is especially true when, as is often the leases, were “new” leases not “extensions, renewals case, the burdened lease contains a provision that the or substitute[s].”34 A new lease entered into one year lessee can surrender or abandon it at any time. 39 after the expiration of a prior lease, costing $27,000 Since most oil and gas leases give the lessee the in new bonus consideration, which had a different option during the primary term to drill, pay delay primary term, delay rental obligation, and continuous rentals, or surrender the lease, the foregoing rule of drilling obligation, was a “new” lease, not a renewal, law is applied with some frequency. according to the Texas Supreme Court.35 The courts will grant an assignor/overriding [1] Washout Protection in the Absence of an royalty interest owner the same rights in a new lease “Extension or Renewal” Clause taken by the assignee when the circumstances of the relationship between the parties creates a fiduciary As a general rule, an overriding royalty interest relationship that requires one to exercise a duty of carved out of the working interest in a lease will be good faith and fair dealing towards the other. Such limited in duration to the term of the burdened lease. was the situation confronting the Oklahoma Absent an “extension or renewal” clause that applies Supreme Court in the case of Rees v. Briscoe.40 Rees to the override, and absent circumstances of fraud, had assigned his leases to Briscoe in exchange for breach of a fiduciary relationship, or bad faith in the the reservation of an override and an oral promise by conduct of the lessor or lessee, the expiration, Briscoe to drill each of the leases before they surrender, or termination of an oil and gas lease expired. No other consideration was involved. burdened by an override will result in the Briscoe drilled one of the three wells promised, then extinguishment of the override without recourse by proceeded to obtain “extensions” of two of the its owner.36 The reservation of an overriding royalty leases assigned by Rees, which were executed interest in an assignment of an oil and gas lease, before the prior leases expired, and which Briscoe without more, does not create a fiduciary proceeded to drill after the prior leases expired, relationship between the assignor and the assignee.37 without giving Rees his override. The court held that Professor Kuntz writes that “as a matter of theory,” under the circumstances presented, Rees and Briscoe an overriding royalty interest burdening an oil and gas had a fiduciary relationship and that Briscoe’s lease should apply to any modifications or extensions failure to grant Rees an override in the extension of the lease that are made while the original is still in leases was a breach of the duties that flowed from full force and effect, with or without an extension or that relationship, prompting the court to declare that renewal clause.38 However, there appears to be little Rees held a constructive trust against the new leases support in the case law for Professor Kuntz’s in the amount of his original override.41 proposition. In Brannan v. Sohio Petroleum Co.,42 the Tenth In the absence of an extension or renewal clause in Circuit Court of Appeals,43having determined that the the assignment that reserves the override, or assignment from Brannan to Sohio which reserved an circumstances creating a fiduciary duty between the override was not subject to any drilling commitment, and that Brannan had received a cash bonus as well as 34 Sawyer, 215 F. Supp. 2d at 1264. 35 Sunac Petroleum Corp., 416 S.W.2d at 803. the override in exchange for the assignment, ruled 36 In re GHR Energy Corp., 972 F.2d 96, 99 (5th Cir. that Sohio owed no fiduciary duty to Brannan. 1992); Wier v. Glassell, 44 So. 2d 882, 887 (La. 1950); Consequently, Brannan was not entitled to apply his De Mik v. Cargill, 485 P.2d 229, 233 (Okla. 1971); override to a “top” lease that Sohio took prior to the Campbell v. Nako Corp., 402 P.2d 771, 775 (Kan. 1965); expiration of Brannan’s lease covering the same lands S.W. Bardill, Inc. v. Bird, 346 S.W.2d 25 (Ky. 1961); 2 Williams & Meyers, supra note 1, § 418.2, at 356; 5 Kuntz, supra note 1, § 63.2, at 227. 39 Goocey v. Hopkins, 266 S.W. 1087 (Ky. Ct. App. 1925); 37 Degenhart v. Gold King Petroleum Corp., 851 P.2d 304, Sasser v. Dantex Oil & Gas, Inc., 906 S.W. 2d 599 (Tex. 306 (Colo. Ct. App. 1993); Brannan v. Sohio Petroleum App.—San Antonio 1995). Co., 260 F.2d 621, 623 (10th Cir. 1958); Sunac 40 315 P.2d 758 (Okla. 1957). Petroleum Corp., 416 S.W.2d at 804; 5 Kuntz, supra 41 Id. note 1, § 63.2, at 232. 42 260 F.2d 621 (10th Cir. 1958). 38 5 Kuntz, supra note 1, § 63.2, at 227-28. 43 Reserved.

5 as Brannan’s lease, which Sohio successfully drilled record contained evidence sufficient to support a after the Brannan lease expired.44 determination that Hughes owed a fiduciary duty to Probst (i.e., testimony by Hughes that he believed a The Kansas Supreme Court has ruled that the deeper, potentially productive sand was located on assignor of a lease who reserved an override was the leased premises, but did not think the term of the entitled to the same override in a subsequent lease original lease allowed him enough time for further covering the same premises taken by the exploration), its ruling focused instead on the assignee/lessee when the assignee/lessee and the “renewal or extension” clause in the assignment: mineral owner/lessor colluded to fraudulently cancel the original lease in order to eliminate the override.45 [u]nder the terms of [Probst’s] assignment, defendants were under the obligation to exercise the On bona fide forfeiture or surrender of an oil and gas utmost good faith to secure a renewal or an lease, the overriding royalty created thereunder falls extension of the lease if they desired to continue to with the lease. But if such forfeiture or surrender is further prospect the property for oil or gas. . . .49 obtained by fraud or collusion between the landowner and the lessee for the purpose of avoiding Having determined that Hughes owed Probst a or cutting out the overriding royalty interest holder fiduciary duty to obtain a renewal or extension, the and the substitution of a new lease directly to the variances between the old and new lease were lessee, then a court of equity may grant relief to the deemed immaterial. overriding royalty holder against such forfeiture or The Tenth Circuit Court of Appeals followed the surrender.46 rule of Probst when it held that a “protection” lease [2] Washout Protection Under the “Oklahoma covering lands in Oklahoma, taken three months after Rule” the irreparable collapse of the casing in the only producing well holding a proof lease, was subject to Anyone who depends on the income generated by the “extension or renewal” clause in an assignment of an overriding royalty interest should rank the the original lease from Union Oil Company to “extension or renewal” clause as second only in Independent Gas & Oil Producers, Inc. wherein importance to the magnitude of one’s interest, Union reserved an override.50 Earlier testimony especially in Oklahoma. Overriding royalty owners in established that the only consideration Union received Oklahoma are the beneficiaries of a generous rule of for its assignment was the override and Independent’s law, unique to that jurisdiction, which provides that commitment to drill the failed well. It was also the existence of an “extension or renewal” clause in established that at the time Independent took the an assignment creating an overriding royalty interest, protection lease, it still believed the prior lease had by itself, gives rise to a fiduciary duty between the value. parties to the assignment and their successors. The facts of this case bring [the protection lease] The “Oklahoma rule” was first established in the squarely within the purview of the principles case of Probst v. Hughes,47 which interpreted an previously outlined [in Probst]. The parties’ lease assignment of an oil and gas lease from Probst to assignment expressly subjects renewals and Hughes that reserved an override and that provided: extensions of [the original lease] to the overriding “[t]his reservation shall likewise apply as to all royalty interest held by Union and thus triggers modifications, renewals of such lease or extensions operation of the fiduciary rule. The propriety of the that the assignee, his successor and assigns, may rule’s application here is unquestionable inasmuch secure.”48 It is unclear from the opinion whether as the reserved royalty was an important part of the Hughes allowed the Probst lease to expire before consideration received by Union for the assignment taking a new lease from the landowner, or whether and Independent believed the lease to be lucrative the new lease was taken four months after the despite temporary cessation.51 original lease terminated because of a cessation of production. It is clear that the new lease had [3] Interpretation of the “Extension or Renewal” different terms than the original lease. Although the Clause in Other Jurisdictions

44 Id. (applying Oklahoma law). See also Sunac Petroleum Corp. v. Parkes, 416 S.W. 2d 798 (Tex. 1967). 45 Campbell v. Nako Corp., 402 P.2d 771 (Kan. 1965). 49 Id. at 878 (emphasis added). 46 Id. at 779. 50 Independent Gas & Oil Producers, Inc. v. Union Oil Co., 47 286 P. 875 (Okla. 1930). 669 F.2d 624 (10th Cir. 1982). 48 Id. at 876. 51 Id. at 627.

6 Outside of Oklahoma, there are no cases to be applies to and burdens the second oil and gas lease found holding that the “extension or renewal” clause upon which production was obtained.55 in an assignment or grant of an overriding royalty The “confidential relationship” between an creates, of its own accord, a fiduciary duty between assignor/overriding royalty interest owner and an the parties. The courts in these jurisdictions will still assignee/lessee was the focus of an earlier decision impose fiduciary duties on the assignor and assignee by the Kansas Supreme Court in Howell v. if circumstances of bad faith or illicit conduct exist. Cooperative Refinery Ass’n.56 The case involved an However, absent bad acts on the part of the oil company (CRA) and an independent geologist assignee/lessee, most courts are inclined to interpret (Howell) who agreed that CRA would provide the the extension or renewal clause in an agreement “on financing for Howell to acquire four leases covering a the basis of a definitional approach which applies prospect he had generated, and that Howell would accepted legal distinctions between the terms subsequently assign the leases to CRA, reserving an extension or renewal and new leases.”52 overriding royalty interest that would apply to any Some commentators have opined that the Kansas extension or renewal of the leases. CRA drilled three Supreme Court decision in Reynolds-Rexwinkle Oil, of the four leases acquired by Howell, but refused (for Inc. v. Petex, Inc.53 adopted the Oklahoma rule with no apparent reason) to drill on the last lease, which it regard to an “extension or renewal” clause, but a released upon the expiration of its primary term. CRA close reading of the case has led the author to then proceeded to take a new lease on the undrilled conclude that the ruling in Reynolds has more to do tract, but refused to assign Howell any override. The with the applicability of the extension or renewal court held that the circumstances of the agreement clause than its existence. The issue confronted was between CRA and Howell created a confidential whether an extension or renewal clause in an relationship between the parties that entitled Howell assignment of an oil and gas lease from Reynolds to to an override in the new lease: Petex, wherein Reynolds reserved an override, While . . . “Confidential relation” may be defined applied to a “substantially similar” “top” lease as meaning a relationship between business obtained by Petex prior to the expiration of associates that would lead an ordinarily prudent Reynold’s lease. What appears to have persuaded [person] in the management of [his] business to the court to grant Reynolds an override in the new repose that degree of confidence in [another] which Petex lease was a finding that the new lease taken by results in the substitution of the [other’s] will and Petex fit the definition of “extensions or renewals” judgment for [his] in material matters involved, it as defined in the assignment and the fact that the has been defined in the law as any relation existing relationship between the parties created a duty of between the parties to a transaction wherein one “fair dealing:” party [the oil company] is bound to act with utmost [T]he fact [that] Petex took the second lease while good faith for the benefit of the other party the original lease it held was still in full force and [geologist].57 effect requires a ruling that the overriding royalty of Absent a fiduciary or confidential relationship Reynolds attaches to the later lease. But, this is between the assignor and assignee, the courts can be because of the extension and renewal language in conservative in their evaluation of a lease as an the assignment and not due to any finding of bad “extension or renewal.” In the case of Lillibridge v. faith on Petex’s part.54 Mesa Petroleum Co.58 the Tenth Circuit Court of . . . . Appeals held that in spite of an “extension or renewal” clause in Lillibridge’s assignment of a [A] duty of fair dealing exists under the facts of this lease to Mesa which reserved an override, case. This duty, coupled with the “extension or Lillibridge was not entitled to the same override in renewal” wording of the assignment, and the taking five “top” leases taken by Mesa covering the same of the subsequent lease while the first one was in full lands as the original “bottom” lease. Noting that the force and effect compels a ruling, as a matter of law, “top” lease consisted of five separate leases, rather that [Rexwinkle’s] overriding royalty interest . . . than one lease, that each of the five leases had a

52 Sawyer v. Guthrie, 215 F. Supp. 2d 1254, 1264 (D. Wyo. 55 Id. at 920-21. 2002). 56 271 P.2d 271 (Kan. 1954). 53 1 P.3d 909 (Kan. 2000). 57 Id. at 274 (citing 15 C.J.S. 821). 54 Reserved. 58 907 F.2d 1031 (10th Cir. 1990).

7 different landowner royalty rate than the original boiler plate language [i.e., an “extension or renewal” lease, and that the assignee/lessee paid an additional clause] in a document negotiated at arms’ length bonus of $130,000 for the top leases, the court ruled between virtual strangers is not such a situation. . . . that they were “new” leases rather than “extensions [T]he Court will not take pity on an experienced, or renewals.” The commentators have not been albeit partially unsuccessful oil and gas impressed: investor. . . .63 Lillibridge greatly narrows the scope of protection The Sawyer v. Guthrie case is worthy of further provided by an express extension or renewal clause, elaboration regarding Sawyer’s argument that, in at least in the Tenth Circuit. Unless the terms and spite of the fact that the farmout did not require conditions of the second lease are essentially the continuous drilling by the assignee/lessee prior to same as those of the original lease, the Tenth Circuit the end of the primary term (only the requirement Court of Appeals will not give effect to the that the lessee must release, at the end of the primary extension or renewal clause.59 term, any of the leased lands not included in a 40- acre producing unit), the duty of good faith and fair Texas has also declined to adopt the Oklahoma dealing that is implied in every Wyoming contract rule. In Sunac Petroleum Corp. v. Parkes60 the Texas (and every contract in most jurisdictions in the Supreme Court considered whether a party owning an United States) obligated Guthrie and the other override in a lease (which was thought to be in its working interest owners to establish paying secondary term) was entitled to the same override in a production, or prosecute continuous drilling and “protection” lease taken by the lessee in response to reworking operations, on Sawyer’s leases in order to the lessor’s allegation that the prior lease had expired perpetuate all of the acreage under said leases. at the end of the primary term. It was ultimately Sawyer alleged that the penalty for such malfeasance determined that the lessor was correct and that the should be the extension of his override to the new prior lease had expired more than a year prior to the leases taken by Guthrie. execution of the protection lease, as a result of an innocent mistake with regard to pooling. The court The court rejected Sawyer’s argument, stating: found no evidence that either party occupied a [Sawyer] attempts to imply that it was the duty of position of confidence or trust in relation to the other. Defendants to drill on every section of land covered Noting that the assignment creating the override by the [prior leases] so that the Leases would never granted the assignee/lessee the right to surrender the expire as long as oil or gas was available in the leased lease without the overriding royalty owner’s lands. Such a provision does not appear in the Leases permission, the court ruled that the protective lease or other contracts relating thereto, and the Court will was a “new” lease to which the override did not not imply such a provision under the duty of good extend.61 faith and fair dealing. . . .64An implied duty to not let According to the U.S. District Court for the any . . . part of the land covered by the [prior leases] District of Wyoming, interpreting Wyoming law in remain undrilled would eviscerate the actual the case of Sawyer v. Guthrie,62 the inclusion of a contractual language which only includes a duty to clause reserving an overriding royalty interest, in an drill one test well. . . . Rather than imposing an assignment made pursuant to a farmout agreement, absolute duty to drill otherwise, the Express Farmout which states that the override is subject to “any and states that Defendants “shall continue to have the all extension, renewal and substitute leases” does right to drill additional wells on the acreage.” . . . This not, by itself, create a fiduciary relationship between language uses the word “right” as opposed to creating the parties: a duty to drill ad infinitum.65 This is not to say that there would never be a time A breach of the covenant of good faith and fair where a fiduciary relationship could have been dealing occurs when a party interferes with or fails created, but in the present case, the inclusion of to cooperate in the other party’s performance.66 59 Reynolds-Rexwinkle, 1 P.3d at 919 (citing Ney, Note, The covenant of good faith and fair dealing may not, “Protecting Overriding Royalty Interests in Oil and Gas however, be construed to establish new, independent Leases: Are the Courts Moving to Washout Extension or Renewal Clauses?” 31 Washburn L.J. 544, 563 (1992). 63 Id. at 1266-67. 60 416 S.W.2d 798 (Tex. 1967). 64 Reserved. 61 See also Exploration Co. v. Vega Oil & Gas Co., 843 65 Id. at 1262-63. S.W.2d 123 (Tex. App.—Houston 1992). 66 Id. at 1262 (citing Restatement (Second) of Contracts 62 215 F. Supp. 2d 1254 (D. Wyo. 2002). §205).

8 rights or duties not agreed upon by the parties. In any extensions or renewals taken within one (1) year other words, the concept of good faith and fair of termination of the subject leases. . . .71 dealing is not a limitless one. The implied obligation Two of the six leases that Hanson assigned must arise from the language used or it must be expired prior to drilling. EOG negotiated renewal indispensable to effectuate the intention of the leases that provided for a landowner royalty (LOR) parties. In the absence of evidence of self-dealing or of 25.0% rather than the 16.67% LOR that burdened breach of community standards of decency, fairness Hanson’s leases. After the renewal leases became or reasonableness, the exercise of contractual rights productive, EOG informed Hanson that because of alone will not be considered a breach of the the 25% LOR, Hanson would not receive any covenant.67 overriding royalty interest. Hanson argued and the . . . The Court will not contradict the express court agreed that his override was to be calculated language of the Agreements by interpreting a duty of on the basis of the terms of the assignment, i.e., the good faith and fair dealing on the contracts to mean difference between a 16.67% LOR (the “burdens that Defendants are required to drill on and on, on existing on the effective date of this Assignment”) every portion of the land, until all possible minerals and 25%, and not on the difference between the new are extracted from the land covered by the [prior 25.0% LOR and 25%, i.e., 0%.72 leases].68 An extension or renewal clause which provides [4] Miscellaneous “Extension or Renewal” Clause that an assignor’s reserved overriding royalty Cases interest will apply to other oil and gas leases secured by the assignee/lessee in an area of mutual interest An assignor who reserves an overriding royalty does not apply to fee mineral interests subsequently interest in an assignment that is subject to an acquired by the assignee/lessee in such area.73 “extension or renewal” clause is not entitled to the same override in a subsequent lease taken by a third [5] Application of the Rule Against Perpetuities party who has no previous relationship with the The rule against perpetuities prohibits a grant of assignee/lessee, even if the third party assigns the an interest “unless the interest must vest, if at all, no new lease to the assignee/lessee, so long as the later than 21 years after the death of some person assignee/lessee is under no obligation to the alive when the interest was created.”74 “The rule overriding royalty interest owner to extend the prior against perpetuities is not a rule of construction, but lease.69 is a positive mandate of law, to be obeyed The problem of applying an “inclusive” overriding irrespective of question of intention.”75 royalty interest to an extension or renewal lease was The rule does not invalidate a provision that grants addressed by the Texas appellate court in the case of the owner of an overriding royalty in a lease the right EOG Resources, Inc. v. Hanson Production Co.70 to receive the same override in “renewals, extensions Hanson and EOG entered into an agreement wherein or modifications” of the lease.76 Hanson agreed to assign six oil and gas leases to EOG in exchange for an overriding royalty interest Significantly, the [rule against perpetuities] touches in each lease equal to the difference between 25% only contingent future interests; a presently vested and “existing lease burdens.” However, the actual interest is not subject to the rule. . . . assignment of the leases from Hanson to EOG, . . . Union’s property interest in any renewals or prepared in accordance with the agreement, provided extension of [the lease in which it owned an ORI] that Hanson would reserve: vested at the time of [the original assignment [a]n overriding royalty equal to the difference creating the ORI] and the rule against perpetuities is between the aggregate of the basic royalties, not operable in such a situation.77 overriding royalties and similar burdens chargeable to Assignor’s leases existing on the effective date of this Assignment and twenty five percent (25.00%). 71 Id. at 700 (emphasis added). 72 The overriding royalty reserved herein shall burden Id. at 701, 703. 73 In re GHR Energy Corp. v. Transamerican Natural Gas Corp., 972 F.2d 96 (5th Cir. 1992). 67 Reserved. 74 Black’s Law Dictionary 1331 (7th ed. 1999). 68 Sawyer, 215 F. Supp. 2d at 1262-63. 75 Melcher v. Camp, 435 P.2d 107, 108 (Okla. 1967). 69 K&E Drilling, Inc. v. Warren, 340 P.2d 919 (Kan. 1959). 76 Independent Gas & Oil Producers, Inc. v. Union Oil Co., 70 94 S.W.3d 697 (Tex. App.—San Antonio 2002). 669 F.2d 624 (10th Cir. 1982).

9 The rule does invalidate a provision that grants the interest merely by virtue of ownership of mineral owner of an overriding royalty in a lease the right, rights. It is acquired only by contract, and is payable without a time limitation, to the same override in a in the amount and to the person designated by the “new lease or leases” covering the same lands.78 In contract. . . .”83 the case of Cities Service Oil Co. v. Sohio Petroleum In the absence of ambiguity, courts and title Co.,79 Cities assigned an Oklahoma lease to a third examiners are compelled by the legal canons of party, reserving an override that was to apply to construction to determine the intention of the parties “[a]ny renewal, extension or new lease or leases to a contract from the “four corners” of the covering the lands assigned.”79.1 The lease was document. The plain meaning of the words that the eventually drilled by George Post, resulting in a dry parties have chosen to describe the nature and hole, and was left to expire at the end of its primary magnitude of their interest will control. term. Two years later, Post obtained a new lease on the same property which was eventually assigned to Reservations, if made, may be worded as the parties and drilled by Sohio. Cities sued claiming it was please. If they provide that the grantor shall have a entitled to its override in the new lease. The U.S. named fraction of the oil produced on all of the District Court for the District of Western Oklahoma described land, that is one thing; if they provide that ruled against Cities, holding that since the right to he shall have a fraction of what is produced from the apply the override to a new lease, being a future interest conveyed by the particular lease, it is interest, might not vest less than 21 years after some another thing. The courts will enforce either life in being at the creation of the reservation, the agreement as made.84 “extension or renewal” clause, as it pertained to The single biggest impediment to the title “new” leases, violated the Oklahoma rule against 80 examiner’s ability to determine the size of the perpetuities and was void. override that the parties intended is the failure of the A rule against perpetuities “savings” clause, like parties to recognize that there are two ways in which the one that follows, should ensure that any an interest can be proportionately reduced: (1) a extension or renewal clause drafted, including one reduction proportionate to the mineral interest that pertains to new leases, will not be rendered void covered by the oil and gas lease in question (as and unenforceable: illustrated in Clause A below); and (2) a reduction proportionate to the amount of working interest that is Any other provision hereof to the contrary being assigned (as illustrated in Clause B): notwithstanding, any right granted or reserved herein to receive a future interest in a [overriding royalty Clause A interest/production payment/net profits interest] The overriding royalty interest (reserved/assigned) shall, in any event, terminate one day prior to the in each lease that is the subject of this assignment expiration of 21 years after the death of the survivor shall be proportionately reduced in the ratio that the of all descendants of Joseph P. Kennedy, father of mineral interest covered by the lease bears to the full the late President of the United States, who are mineral interest in the lands covered by the lease. living on the effective date of this assignment.81 Clause B § 21.03 Calculation of Overriding Royalty Interests The overriding royalty interest (reserved/assigned) An overriding royalty interest is the creation of a in each lease that is the subject of this assignment contract between an assignor and an assignee, and shall be proportionately reduced in the ratio that the the language of the contract will determine the working interest assigned in each lease bears to the nature and quantum of the interest conveyed or 82 full working interest in the lands covered by the reserved. “[N]obody acquires . . . an overriding lease. 77 Id. at 628; see also Howell v. Cooperative Refinery If the only proportionate reduction language Ass’n, 271 P.2d 271, 276 (Kan. 1954). included in an assignment is that contained in 78 345 F. Supp. 28 (W.D. Okla. 1972). 79 Id. 7 9. 1 Id. at 29 (emphasis added). Equitable Res. Energy Co., 979 P.2d 948 (Wyo. 1999). 80 Id. at 30-31. 83 Barker v. Boyer, 794 P.2d 323, 325 (Kan. Ct. App. 1990) 81 Adapted from Hubert & Taylor, supra note 18, at 14-33. (citing Williams v. Sohio Petroleum Co., 151 N.E.2d 645 82 Downen Enterprises v. Gem Oil & Gas Co., 476 N.E.2d (Ill. App. Ct. 1958)). 42, 43 (Ill. App. Ct. 1985); Williams v. Sohio Petroleum 84 Williams, 151 N.E.2d at 648 (citing Pollock v. McAlester Co., 151 N.E.2d 645 (Ill. App. Ct. 1958); Wolter v. Fuel Co., 223 S.W.2d 813, 815 (Ark. 1949)).

10 Clause A, then an assignment conveying a 20% eighth (1/8th) of seven-eighths (7/8ths) of oil, if as federal operating rights (i.e., working interest) in a and only when produced, saved and marketed from federal oil and gas lease, covering all of the minerals said land under this lease,” in addition to a 1/8th under the leased premises, reserving a “5% overriding landowner royalty interest, reserved a $15,000 royalty interest,” cannot be reduced to the 1% of production payment payable out of an undivided 8/8ths overriding royalty interest that was probably 1/8th of 7/8ths of production, without proportionate intended. The same problem occurs if the only reduction.88 proportionate reduction language used in an The literal analysis applied in the cases cited above assignment reserving the same override is that has also been used to determine the quantum of appearing in Clause B, and the assignment conveys overriding royalty interest reserved in assignments of all of the working interest in a lease that covers only an oil and gas lease. The Illinois Supreme Court has 20% of the minerals under the leased premises. ruled that the reservation of a “[t]hree sixty-fourths The “lesser interest” clause of an oil and gas lease (3/64ths) over-riding royalty out of the Seven-eighths operates to reduce the royalty of the lessor if the (7/8ths) working interest” in an oil and gas lease that lessor owns less than all of the minerals under the covered only three-quarters of the minerals under the leased premises, but it cannot be used to reduce an leased premises results in the reservation of an overriding royalty interest that has been reserved in undivided 3/64ths of 7/8ths overriding royalty the lease unless (to restate a now familiar mantra) interest, without proportionate reduction.89 there is an express agreement to do so.85 This rule has In First National Bank v. Kinabrew,90 the Texas been applied even in situations where the lessor under Civil Court of Appeals was asked to construe an an oil and gas lease reserves an overriding royalty assignment transferring “ONE EIGHTH of EIGHT interest in the lease that is in addition to the EIGHTS [sic] (1/8 of 8/8) of All the Oil, Gas, and landowner’s royalty. In fact, some of the case law other minerals which may be produced, marketed and available to illustrate how courts have interpreted the saved from the herein described premises.” The quantum of an overriding royalty interest granted or assignment did not contain a legal description of any reserved in an instrument pertains to overrides lands, but rather seven oil and gas leases. Each of the reserved by lessors, for instance: oil and gas leases contained a legal description of the (1) The reservation, in an oil and gas lease covering same 120.3-acre production unit. These leases less than 100% of the minerals under the leased combined covered less than 100% of the minerals premises, of a “1/8th of 8/8ths Overriding Royalty underlying the unit. The court ruled that the Interest” (without reference to leases or lands) in assignment was unambiguous and that the assignee addition to a 1/8th landowner royalty interest, was entitled to a net 1/8 of 8/8ths ORI in production reserves an undivided 1/8th of 8/8ths override that is from the lands described in the leases,91 rejecting the not proportionately reduced.86 assignor’s argument that the wording of the assignment required that the court look to the leases, (2) The reservation, in an oil and gas lease covering determine the combined percentage of minerals that ¼ of the minerals under the leased premises, of an the leases covered, and reduce the 1/8th of 8/8ths ORI “[o]verriding royalty of 1/32nd of 7/8ths of all oil accordingly.92 and gas produced and saved under and by virtue of this oil and gas lease in addition to a 1/8th Lest the reader come away with the impression that landowner royalty interest, reserved an undivided ¼ there is a logical consistency to the rules construing of 1/8th of 7/8ths overriding royalty, i.e., grants and reservations of overriding royalty interests, proportionately reduced to reflect the mineral ponder the decision of the Wyoming Supreme Court interest covered by “this oil and gas lease.”87 in Wadi Petroleum, Inc. v. Ultra Resources93 (3) The reservation, in an oil and gas lease covering 88 7/12ths of the minerals under the leased premises, of R. Lacy, Inc. v. Jarrett, 214 S.W.2d 692, 693 (Tex. Civ. App.—Texarkana 1948) (emphasis added); see also a production payment of “$15,000.00 out of one- Middleton v. Broussard, 504 S.W.2d 839 (Tex. 1974). 89 Fry, 119 N.E.2d at 751; see also Barker v. Boyer, 794 85 Fry v. Farm Bureau Oil Co., 119 N.E.2d 749, 751 (Ill. P.2d 322 (Kan. Ct. App. 1990). 1954); Williams, 151 N.E.2d 645, 648; see also Pollock, 90 589 S.W.2d 137, 149 (Tex. Civ. App. 1979) (emphasis 223 S.W.2d 813. added). 86 Downen Enterprises, 476 N.E.2d at 44. 91 Id. 87 Williams, 151 N.E.2d at 646 (emphasis added); see also 92 Id. at 149. Pollock, 223 S.W.2d 813. 93 65 P.3d 703 (Wyo. 2003).

11 interpreting the reservation of a “3-1/8% of 8/8ths assignments.”101 Wadi may prove to be a classic overriding royalty” in a federal-form assignment of an example of the right decision for the wrong reasons. undivided 20% of 8/8ths working interest in a federal Although the Wadi decision may be an aberration, oil and gas lease. The court, without any mention of it is also an effective illustration of the reason why the the decisions discussed above or the legal principles use of the “8/8ths” suffix to indicate that the interest behind them, held that the reservation was ambiguous being assigned is a “net interest,” not to be “due to a lack of clarity and incompleteness of proportionately reduced is no longer sufficient. For expression”94 and allowed the admission of extrinsic example, if the desired result is that the division credit evidence, in the form of a “more-or-less” a party with a 0.03000000 overriding royalty interest, contemporaneous agreement and the expert testimony the grant or reservation should refer to a “net 3.0% of by title attorneys, to persuade it that the parties to the 8/8ths” overriding royalty reservation in the “lands assignment intended that the 3.125% override would covered by the leases which are the subject of the be reduced by a fraction of 20/100ths, i.e., a net assignment” that is “not to be proportionately reduced 0.625% of 8/8ths override. What is mystifying to in any way, regardless of the working interest in the those who can only evaluate the propriety of the leases included in this assignment, or the mineral decision from the written opinion is that the “more- interest covered by said leases.” If the intent of the or-less” contemporaneous agreement that the court parties is that the override be proportionately reduced considered specified that Wadi’s predecessor in to reflect the mineral interest covered and the working interest was to reserve (1) an “undivided 1/16th of interest assigned, the drafter should avoid any 8/8ths overriding royalty” in certain leases that were terminology relating to a “net” or “8/8ths” interest, not the subject of the suit, “[w]hich overriding should ensure that the override is reserved in the royalty shall not be proportionately reduced if El “production attributable to the leases” that are the Paso owns less than the entire leasehold interest subject of the assignment, and should include [emphasis added];” and (2) a “3-1/8th overriding proportionate reduction language that addresses both royalty” in the leases that were the subject of the suit, the mineral interest and the working interest. with no language concerning proportionate reduction.95 Seizing on the missing proportionate § 21.04 Enforcement of Express and Implied reduction language, the court held that: “at a Covenants by the Overriding Royalty Interest Owner minimum, the silence creates an ambiguity which Implied covenants between lessors and lessees of requires reference to evidence outside the four corners 96 oil and gas leases have been recognized for over a of the principal documents.” hundred years. Although there is some disagreement The court mentions that Wadi “essentially paid among the commentators as to the reasons for the nothing”97 for the leases in question, and that “Wadi evolution of these implied covenants,102 there seems did not diligently research exactly what it bought,”98 to be a consensus that they arose from the principle of but also felt compelled to mention that these matters cooperation as defined in contract law, i.e., the were not material to its determination, but simply requirement that the parties to a contract must “part of the ‘whole story.’ ”99 The outsider is left cooperate with one another in order to ensure that the with the impression that the “whole story” has much purpose of their contract is achieved. to do with the fact that before Hondo sold out to The bare bones of the [oil and gas] leasing Wadi, Hondo had executed division orders certifying transaction are the transfer to the operator of the that it owned a 0.625% ORI in the subject leases and exclusive privilege of exploring, drilling on, and accepted payments pursuant to those division 100 extracting minerals from the premises. In return for orders, a fact that the court also felt compelled to this exclusive privilege, the lessee promises to pay explain was “not used to ‘alter or amend’ the terms the lessor royalty on minerals produced and saved of the assignments but only to assist the trial court in from the land. Pecuniary return to the landowner resolving the inherent ambiguity in the depends upon diligent operation of the premises by the lessee. If he permits oil and gas to be drained 94 Id. at 710. away from the land, the lessor’s return is diminished 95 Id. at 706. 96 Id. at 707. 101Wadi Petroleum, 65 P.3d at 711. 97 Id. 102See 5 Williams & Meyers, supra note 1, at ch. 8 and 5 98 Id. Kuntz, supra note 1, ch. 55, for a comprehensive 99 Id. discussion of the origin and purpose of implied 100Reserved. covenants.

12 or destroyed. If the product is not marketed, there is and grantee, and there is no basis for concluding that no return. If the lessee fails to develop known, the parties contemplated that the grantor would owe producing formations, return is delayed indefinitely. the grantee any duties regarding development. In each of these cases, as in others, the principle of Accordingly, covenants usually implied in oil and cooperation requires that the lessee conduct gas leases should not be implied in this instance. . . . operations calculated to accomplish the purposes of In the absence of an express covenant to develop and the lease agreement, namely, the exploitation of the in the absence of special circumstances which reveal mineral resources of the land.103 that development is the object of the sale, the covenants implied in oil and gas leases should not be Generally, the implied covenants that apply to the implied in the grant of an overriding royalty interest. contemporary oil and gas lease are: Where an overriding royalty is reserved on the (1) the implied covenant to drill; transfer of an oil and gas lease, the transaction bears (2) the implied covenant of reasonable a certain resemblance to a leasing transaction. The development after discovery; grantor has granted full operating rights and has (3) the implied covenant to protect the lease retained a nonoperating interest that can only be enjoyed if the operating rights are exercised by the from drainage (also known as the offset well 106 covenant or protection covenant); and grantee. (4) the implied covenant to operate diligently In Professor Kuntz’s opinion, the principles described above also apply to the grant or the and prudently (which includes the duty of the 107 lessee to market oil and/or gas from the reservation of a production payment. lease).104 The weight of authority is to the effect that a covenant to drill a well is not to be implied from the Recent legal decisions holding that an assignor or 108 assignee of an oil and gas lease who retains an severance of an overriding royalty or oil payment. overriding royalty interest has legal standing to In the absence of an express provision in an enforce implied covenants are still maligned in some assignment of a lease requiring the assignee/lessee to jurisdictions as an attempt to rewrite assignments, commence a well prior to expiration of the primary but embraced in others as a logical extension of the term, an assignor who reserves a production payment duties that a lessee owes a lessor in order to cannot enforce an implied drilling covenant against effectuate the intent behind the lease. The editors of the assignee/lessee if the latter has the contractual W.L. Summers’s The Law of Oil and Gas have choice, during the primary term of a lease, to either drill or pay delay rentals and has chosen to pay expressed a strong aversion to the idea that an 109 assignor-overriding royalty interest owner can rentals. If the assignor of a lease reserves an enforce implied covenants, arguing that it violates override and the assignment does not, by its express “the privity concept on which the implied covenants terms, require the lessee to drill on the lease during between lessor and lessee sides of the leasing the primary term, the assignor cannot force the lessee transaction is based.”105 to drill by asserting the implied covenant to protect the lease from drainage.110 Professor Eugene Kuntz has taken a more moderate approach, recognizing that the propriety of Generally, covenants will be implied with respect to allowing overriding royalty interest owners to a nonoperating interest if the transaction giving rise enforce implied covenants under an oil and gas lease to such interest creates a continuing relationship depends on whether the override was created by between the parties and the benefits of one party are grant or by reservation: dependent upon the development or operations of another. The covenants primarily recognized are the [T]he grant of an overriding royalty by the owner of covenants of protection against drainage, of the lease as distinguished from an exception or reservation bears no resemblance to a leasing or 1065 Kuntz, supra note 1, § 55.3(e), at 34, 35 (emphasis subleasing transaction. The relation is that of grantor added). 107Id. § 55.3(f), at 37. 1035 Williams & Meyers, supra note 1, § 802.1, at 11. 1082 Williams & Meyers, supra note 1, § 420.1, at 363. 1045 Williams & Meyers, supra note 1, § 815, at 70.1; 109Simms Oil Co. v. Colquitt, 2 S.W.2d 421 (Tex. Comm’n Garman v. Conoco, Inc., 886 P.2d 652 (Colo. 1994). App. 1928). 1053 W.L. Summers, The Law of Oil and Gas, § 554, at 74 110Kile v. Amerada Petroleum Corp., 247 P. 681 (Okla. (Supp. 2003). 1925).

13 reasonable development, and of fair dealing and the premises against drainage when the assignor good faith.111 reserves an overriding royalty.”117 [1] Enforcement of Implied Covenants as “Running In the case of Garman v. Conoco, Inc.,118 the With the Land” Colorado Supreme Court held that an implied covenant to market gas (i.e., “to engage in marketing The decision by the Fifth Circuit, in the case of efforts which ‘would be reasonably expected of all Phillips Petroleum Co. v. Taylor,112 was one of the operators of ordinary prudence, having regard to the first to recognize that the owner of a reserved interests of both lessor and lessee’ ”119) extends to a overriding royalty interest in a lease has standing to Colorado overriding royalty interest owner, thereby enforce the lessee’s implied covenant to protect the excusing that owner from paying any share of post- lease from drainage. Applying Texas law, the court production costs necessary to make that owner’s held that: share of gas marketable. The rationale behind the an overriding royalty, created by assignment, is an ruling is obscure: interest in real estate regarded as a covenant running Implied lease covenants related to operations with the land as between the assignor and assignee, typically impose a duty on the oil and gas lessee. and enforceable by the assignor against the Accordingly, the lessee bears the costs of ensuring assignee.113 compliance with these promises. . . . The purpose of Under the facts of this case, the only interest to be an oil and gas lease could hardly be effected if the enforced by [the assignor-override owner] was the implied covenant to drill obligated the lessor to pay overriding royalty. The oil having been drained, the for his proportionate share of drilling costs. In our only recourse by which his injury could be view the implied covenant to market obligates the compensated lay in a suit for damages. His interest lessee to incur those post-production costs necessary being a covenant running with the land, and to place gas in a condition acceptable for market. enforceable as such, it certainly follows that his Overriding royalty interest owners are not obligated protection and the administration of justice require to share in these costs.120 121 that the right to sue be awarded to him. . . . 114 [A] The mystery of the Garman decision dwells in contract which requires the assignee to advance footnote 23 wherein the court acknowledges that money for drilling implies a covenant to develop. “[s]ome question exists whether the implied The same reasoning . . . raises an implied covenant covenants under an oil and gas lease extend to in this case where the duty [to protect from drainage] overriding royalty owners. However, the rationale for was owed to the lessor and where the only application of the covenants to protect the lessor consideration moving to the assignor for a similarly extends to the interest of an overriding conveyance of minerals . . . was an overriding royalty owner.”122 Whether this footnote is royalty from the first oil produced. Unless such an tantamount to a ruling that Colorado overriding obligation be imposed, the conveyance is wholly royalty interest owners can enforce any and all without consideration.115 implied covenants against a lessee remains to be The Texas Supreme Court has since ruled that the established. assignor of an oil and gas lease who retains an The Tenth Circuit has ruled that the assignor of a overriding royalty has the right to enforce the federal oil and gas lease located in New Mexico, implied covenant to protect its lease from drainage. who retained an overriding royalty interest in an In Bolton v. Coats116 the court held that: “[u]nless the assignment of that lease, has the right to enforce an assignment provides to the contrary, the assignee of implied covenant to protect against drainage against an oil and gas lease impliedly covenants to protect the assignee-lessee.123

117Id. at 916. 111Hubert & Taylor, supra note 18, at 14-26. See also 5 118886 P.2d 652 (Colo. 1994). Kuntz, supra note 1, § 55.3(e), at 36. 119Id. at 659 (quoting Davis v. Cramer, 808 P.2d 358, 363 112116 F.2d 994 (5th Cir. 1941). (Colo. 1991)). 113Reserved. 120886 P. 2d 652, 659 (citations omitted). 114Reserved. 121Reserved. 115Id. at 995-96. See also Cook v. El Paso Natural Gas Co., 122Id. at 659 n. 23 (citing 2 Williams & Meyers, supra 560 F.2d 978 (10th Cir. 1977). note 1, § 420 and Bolton v. Coats, 533 S.W.2d 914, 916 116533 S.W.2d 914 (Tex. 1976). (Tex. 1975)).

14 [2] Enforcement of Implied Covenants Arising Out Colorado Supreme Court in Garman concerning an of Express Covenants in the Assignment overriding royalty owner’s right to assert that its assignee-lessee had breached the implied covenant to The Oklahoma courts will extend the protection of market oil and gas by deducting from the revenues implied covenants in an oil and gas lease to an generated by the override the “post-production” costs assignor who retains an override, but only when the incurred by the lessee to render the gas “marketable.” instrument creating the override contains an express The court discussed in detail the evolution of the laws provision that gives rise to an implied covenant. In in Colorado129 and Texas130 granting overriding Kile v. Amerada Petroleum Corp.,124 Kile took a lease royalty interest owners the right to enforce selective on 20 acres of land which provided, among other implied covenants in an oil and gas lease. terms, that the lessee could extend the lease through Unfortunately for SMR, the override owner, its the primary term by either drilling or paying annual interest was created pursuant to a grant, not a delay rentals. Kile assigned the lease to Amerada, reservation.131 Citing the above-quoted statement of reserving a 1/8th overriding royalty interest. The Professor Kuntz that an override created by a grant, as assignment did not contain any requirements opposed to a reservation, should not reap the benefit concerning drilling or development. Kile of implied covenants in a lease,132 the court reaffirmed subsequently sued Amerada for damages resulting its ruling in Kile133 that the right to enforce the from the alleged drainage of his lease by offsetting implied covenants of an oil and gas lease does not production. The court, ruling in favor of Amerada, extend to an overriding royalty interest owner absent held that “[t]he relationship thus created between an express provision in the instrument creating the [Kile] and [Amerada] was purely contractual . . . override giving rise to the implied covenant.134 [and] . . . the rights of the parties hereto must be governed entirely by the provisions of the contract of Like its neighbor to the west, Arkansas does not assignment [of the override].”125 The court permit the owner of an overriding royalty interest or a specifically rejected Kile’s argument that the production payment to enforce implied covenants obligation to drill an offset well was implied from the against a lessee.135 The Arkansas Supreme Court obligation to pay him an override. refused to accept “as a matter law” an implied duty of the assignee-lessee to reasonably develop an oil and The implied obligation is to diligently develop gas lease and protect it against drainage when the where there is some express obligation to drill only consideration for the assignment of the lease was assumed by the lessee, and, in such case, to protect the reservation of an override. Instead, it followed its the [lease] lines from drainage by offset earlier ruling in Henderson Co. v. Murphy,136 which wells. . . .126There must be some express covenant involved an oil payment, and held that Arkansas does entered into upon which to base the implied not recognize the right of an overriding royalty obligation, and, if the court should undertake to interest owner to enforce the implied covenants under supply the primary framework of the agreement a lease.137 “In assignments, such as these in the instant which the parties themselves have omitted, it would case, the assignor and assignee are usually constitute an invasion of the domain of private experienced in the oil business and knowledgeable contract reserved to individuals under the law. . . enough to make certain any uncertainty by inserting The contract involved here was an ordinary provisions which protect the assignor’s interest if he assignment of an oil and gas lease, reserving to the deems it necessary.”138 assignor a certain interest out of the working interest Another of the objections raised in W.L. assigned, but without any specific agreement or Summers’s The Law of Oil and Gas with regard to covenant on the part of the assignee to drill on the the enforcement of implied covenants in an oil and premises covered by the assignment.127 gas lease by an overriding royalty owner was the In a subsequent opinion,128 the Oklahoma Supreme 129 Court confronted the same issue decided by the Garman v. Conoco, Inc., 886 P.2d 652 (Colo. 1994). 130Bolton v. Coats, 533 S.W.2d 914 (Tex. 1975). 123Cook v. El Paso Natural Gas Co., 560 F.2d 978 (10th 131XAE Corp., 968 P.2d at 1202. Cir. 1977). 1325 Kuntz, supra note 1, § 55.3(e), at 34, 35. 124247 P. 681 (Okla. 1925). 133Kile v. Amerada Hess Corp., 247 P. 681 (Okla. 1925). 125Id. at 682. 134XAE Corp., 968 P.2d at 1207. 126Reserved. 135McNeill v. Peaker, 488 S.W.2d 706 (Ark. 1973). 127Id. at 683. 13670 S.W.2d 1036 (Ark. 1934). 128XAE Corp. v. SMR Property Mgmt. Co., 968 P.2d 1201 137McNeill, 488 S.W.2d at 707. (Okla. 1998). 138Id.

15 advantage that the owner would have in any consuming. Once the operator has obtained the determination of the economic viability of necessary percentage of committed working interest development: ownership in a proposed unit area required by the authorizing governmental agency, the tendency is to It [permits] an interest owner who has further pull back on efforts to ensure the commitment of the diminished the production entitlement of the remaining owners, especially owners of royalty and leasehold working interest to enforce his claims in overriding royalty interests. Unfortunately, once the terms of a standard of paying quantities in the case unit has been approved, sophisticated overriding of the drainage and development covenants, which royalty interest owners may not consider subsequent was larger than the working interest entitlement after joinder to be in their best economic interest. By its diminishment by retention of an overriding failing to secure the commitment of nonoperating royalty.139 interests in the unit area, the operator runs the risk of A solution to this potential inequity has been becoming obligated to pay uncommitted overriding suggested by Williams & Meyers: royalty interest owners on a “lease” basis (i.e., based Both the lessor and the owner of an override, suing upon their ownership in the drillsite lease), while on an implied covenant to protect against drainage, paying committed owners on a “unit” basis (i.e., may be required to prove that an offset well, if according to their proportionate interest in a spacing drilled, would have been profitable. In proving unit or a participating area). As a result, the working profitability, the lessor would need [to] prove only interests may find themselves forced to bear out of that the return from production after deducting their share of production a disproportionately large landowner royalty would have been sufficient to burden of landowner and overriding royalties. yield a profit to the lessee; the owner of the override “Unilateral” pooling and unitization provisions in would be required to deduct the override as well as an oil and gas lease give the lessee the right to pool the landowner royalty in determining whether an or unitize the royalty interest in the lease without the offset well would have been profitable.140 necessity of the lessor’s consent. There is a common For obvious reasons, any instrument creating an belief that the nonoperating interests in a lease that overriding royalty interest should include a contains a unilateral pooling and/or unitization provision stating that any and all implied covenants provision, including overriding royalty interests, are in the lease will run to the owners, successors, and also subject to the provision, obviating the need for assigns of operating or nonoperating interests in the their consent. lease.141 A provision in an assignment such as that Even in Texas, we think a persuasive argument which follows, prohibiting the owner of an override can be made that the owner of a working interest or production payment from asserting any rights burdened by a nonoperating interest does have the arising out of implied covenants, is also power to pool the nonoperating interest if the oil and enforceable.142 gas lease contains a pooling clause, unless the Development of, and operations on the premises, if assignment or other instrument creating the nonoperating interest clearly negates the [working any, and the extent and character thereof, as well as 144 the preservation or forfeiture of the leasehold, shall interest owner’s] ability to do so. be solely at the will of said [operator] or its A decision by the Texas Court of Appeals in successors or assigns, and, upon termination of the Union Pacific Resources Co. v. Hutchison145 leases covering the lands above described, for any supports the proposition that a lessee can pool or cause whatsoever, there shall be no further liability unitize the royalty interest in an oil and gas lease hereunder.143 pursuant to a unilateral pooling or unitization clause, § 21.05 Pooling and Unitization and thereby pool or unitize any overriding royalty interests burdening that lease without the necessity The formation of voluntary units, federal of the owner’s consent.146 exploratory units in particular, is tedious and time In an assignment dated one day after the lease, [the 1393 Summers, supra note 105, § 554, at 74. assignor] assigned the leasehold in its entirety . . . 1402 Williams & Meyers, supra note 1, § 420.1, at 362- 362.1. 1412 Williams & Meyers, supra note 1, § 429, at 489. 144Hubert & Taylor, supra note 18, at 14-25. 142Id. 145990 S.W.2d 368 (Tex. App.—Austin 1999). 143Bond v. Midstates Oil Corp., 53 So. 2d 149 (La. 1951). 146Id. at 369.

16 except for her overriding royalty, vesting in Citing the fact that “[c]ommitment of a tract to [assignee-lessee] by her own act all executive rights. unitization obviously involves a calculated weighing of the benefits and detriments involved in unitizing . . . . the subject lands,”150 the Wyoming Supreme Court Nothing in the assignment purports to reserve in ruled in favor of Harvey, holding that: [assignor] any executive rights and nothing purports [T]he word “lessee” as used in the unitization clause expressly to prohibit pooling of the mineral estate was intended to cover lessee/assignors who retain an without [assignee’s] consent.”147 interest in the lease. A lessee/assignor who retains an . . . . interest is subject to many of the same risks as the [Assignor] assigned the leasehold in its entirety to assignee if the leasehold is unitized without his [assignee], except for her overriding royalty. . . . The consent. . . . We hold that the unitization clause legal effect of her unqualified assignment was to could not unitize Harvey’s overriding royalty interest without his consent, and his consent was vest in [assignee] . . . the identical rights, privileges 151 and benefits [assignor] possessed under the . . . never given. Lease.148 In another decision,152 the Wyoming Supreme Unfortunately, the Wyoming Supreme Court has Court held that an overriding royalty interest in a turned conventional thinking on its ear with its lease with no unitization clause that had been decision in Moncrief v. Harvey149 concerning the committed to the unit by the lessor but not by the calculation of an overriding royalty interest in a State owner of the overriding royalty will still be deemed of Wyoming oil and gas lease within a federal “committed” to the unit when the override is to be exploratory unit. Harvey, the original lessee under the “computed and paid on the same basis, in the same state lease which covered 560 acres, assigned the lease manner, at the same time and on the same products, substances and elements, as is the royalty payable to to Texaco, reserving a 5% of 8/8ths overriding royalty 153 interest. There was no applicable language in the the Lessor.” According to the court, the language assignment from Harvey to Texaco with regard to concerning the payment of the override was clear unitization, but a provision in the lease gave the state and unambiguous. Since the lessor had joined the the right “with consent of the lessee, to commit the unit, and the landowner royalty was being paid on a prorated unit basis, the same method of payment [lease] in a unit . . . and to establish, alter, change or 154 revoke the drilling, producing, and royalty should apply to the override. requirements of the lease to conform therewith.”149.1 § 21.06 The Nonoperating Interest and Bankruptcy Texaco and the State of Wyoming voluntarily Section 541(a)(1) of the U.S. Bankruptcy Code committed their interests in the lease to the unit, but defines a bankrupt’s estate as “all legal or equitable Harvey refused. A producing well was drilled on the interests of the debtor in property as of the subject lease resulting in the creation of a participating commencement of the case.”155 This provision has area (PA) covering 1,440 acres, including the 560 protected owners of overriding royalty interests acres in the subject lease. Moncrief and Texaco, the whenever the working interest owner who bears the working interest owners of the well, argued that under override files bankruptcy (assuming that the the terms of Harvey’s lease, the fact that the State and conveyance creating or reserving the override has Texaco had committed their interests to the unit been properly executed and recorded). Section 541(b) resulted in the commitment of Harvey’s override, with (4)(B)(i) of the Bankruptcy Code specifically or without his express consent. Consequently, excludes an interest that the debtor has conveyed Harvey’s override should be paid on the basis of the “pursuant to a written conveyance of a production PA, meaning that his 5% overriding royalty interest payment to an entity that does not participate in the would be proportionately reduced by a fraction of operation of the property from which such production 560/1440ths. Harvey countered with the allegation payment is transferred.”156 that his override could not be committed without his express consent, and claimed that he was entitled to a 150Id. at 104. 151 full 5% of 8/8ths override, payable on a “lease” basis. Id. at 103. 152Wolter v. Equitable Resources Energy Co., 979 P.2d 948 (Wyo. 1999). 147Reserved. 153Id. at 950 (emphasis added). 148Id. at 369, 371. 154Id. at 952. 149816 P.2d 97 (Wyo. 1991). 15511 U.S.C. § 541(a)(1). 1 49.1Id. at 103 (emphasis added). 15611 U.S.C. § 541(b)(4)(B)(i).

17 The case of Boyd v. Martin Exploration Co.,157 a interest itself. The case was originally filed by U.S. district court decision applying Louisiana law, Grynberg in the Denver district court, subsequent to illustrates the Bankruptcy Court’s traditional the approval of this Chapter 11 reorganization plan approach towards overriding royalty interests by the U.S. Bankruptcy Court, seeking a declaratory created prior to a bankruptcy filing. Martin judgment that overriding royalty interests previously Exploration Co. (MECO) had an incentive program, assigned to Waltman while he was employed as embodied in an “Employee ORI Agreement,” which exploration manager for Grynberg were provided that key employees would receive extinguished as a result of confirmation of the plan. overriding royalty interests in all nonproducing oil Waltman had left Grynberg’s employ sometime and gas leases that the company acquired. Initially, prior to the bankruptcy filing, whereupon Grynberg assignments of these overrides were made to the key stopped paying Waltman the overrides he had been employees as soon as the leases were acquired, but assigned, and informed Waltman that no further as the business grew and the demands on the overrides would be paid. After his filing for employees’ time increased, the assignments were Chapter 11 protection, Grynberg named Waltman as neglected. In an effort to fix the problem, the a creditor with a disputed claim. Waltman knew company started transferring the overrides due key about the bankruptcy proceeding, and even testified employees to a nominee, pursuant to a nominee in hearings related to the case, but failed to file a agreement, to be administered on the employees’ proof of claim with regard to the disputed override behalf. Nevertheless, some overrides were never in spite of an order from the court instructing every assigned to the employees or the nominee. When the creditor to do so. Grynberg’s plan was eventually company filed for Chapter 11 bankruptcy protection, approved free of any further obligation to Waltman. the key employees initiated an adversary proceeding Waltman acknowledged that payments due on seeking assignment of the overrides that had never production prior to the bankruptcy petition were been conveyed. personal property, and dischargeable as a debt, but The overriding royalty interests that had actually argued that the overriding royalty interests that had been assigned to the employees were never an issue been assigned to him were his own real property since MECO had no legal or equitable claim to them. interests not subject to discharge in Grynberg’s With regard to the overrides that had been assigned to bankruptcy. The district court and the Colorado Court the nominee, or were earned under the Employee ORI of Appeals disagreed, holding that “according to 11 Agreement but never assigned to the employee or U.S.C. §1141(b)(1994), upon confirmation of a nominee, the district court held that: (1) the Employee bankruptcy plan, all property of a debtor’s estate is ORI Agreement was sufficient to transfer title to the vested in the debtor free and clear of any claim or overrides provided for in the agreement from the interests of the creditors . . . [and that] [u]nder 11 company to the employees, citing Louisiana law U.S.C. §1141(d)(1)(B) (1994), confirmation of such holding that “[a]ll sales, contracts and judgments plan terminates all disputed rights and interests of affecting immovable property, which shall not be equity security holders. . . .”161 recorded, shall be utterly null and void, except Here, [Waltman] has acknowledged in his motion between the parties thereto”;158 and (2) MECO did for summary judgment that both parties were aware not have any beneficial interest in the overrides that the ownership of the overriding royalty interests assigned to the nominee since the overrides were was in dispute at the time of plaintiff’s bankruptcy being held “in trust” for the employees, and both proceedings. [Grynberg’s] bankruptcy estate MECO and the nominee were under a fiduciary duty included the oil and gas leaseholds and necessarily to assign those interests to the employees.159 dealt with the overriding royalty interests connected The antithesis of Boyd is an opinion by the with them. Colorado Court of Appeals in the case of Grynberg Once the claim to royalty payments based on the v. Waltman,160 which upheld a Bankruptcy Court’s overriding royalty interests was disputed, the decision discharging not only a debt owing for ownership of that interest was called into question unpaid production revenues attributable to an and was, therefore, before the bankruptcy court. . . . overriding royalty interest, but the overriding royalty Subsequently, by operation [of] 11 U.S.C. §1141(b) 15756 B.R. 776, 779 (E.D. La. 1986). (1994), plaintiff’s estate, including the oil and gas 158Id. at 779 (emphasis added). leases, vested in him free of defendant’s contested 159Id. at 780-81. 160946 P.2d 473 (Colo. Ct. App. 1996). 161Id. at 477.

18 royalty interests when the bankruptcy plan was of claims’ [or] the restructuring of debtor-creditor confirmed.162 relations” under the jurisdiction of the bankruptcy court, and was liable for its proportionate share of The downfall of Waltman appears to have been his “administrative expenses” under 11 U.S.C. failure to file a proof of claim. § 506(c).167 A proof of claim is a written statement that apprises § 21.07 Matters to Be Considered in Drafting an the court of the existence, nature, and amount of the Assignment or Reservation of an Overriding Royalty claim. . . . A creditor whose claim is not listed on the Interest [debtor’s] schedules or whose claim is listed as disputed, contingent or unliquidated must file a Honorable people will abide by commercially proof of claim by the claims “bar date” or he may reasonable provisions included in a grant or not vote on a plan of reorganization or share in any reservation of an overriding royalty interest or other distribution of property of the debtor’s estate. . . . form of nonoperating interest. In the absence of honor, commercially reasonable terms written in By filing a claim against a bankruptcy estate, a clear, concise, and unambiguous language usually can creditor triggers the process of allowance and be enforced in a court of law, assuming money is no disallowance of claims, thereby subjecting himself object. In the absence of honor or money, the parties to the bankruptcy court’s equitable power. Thus, to a grant or reservation of a nonoperating interest once the creditor files a proof of claim, neither the have nothing to lose by defining their respective debtor nor the creditor is entitled to a jury trial.163 rights and obligations. The following is a checklist of A production payment, like an overriding royalty items to be considered in conjunction with grants or interest, is usually classified as an interest in real assignments of overrides, production payments, and property. But a “hybrid” production payment, created net profits interests:168 under a “Production Payment Loan Agreement,” (1) How is the nonoperating interest to be secured by a lien on the assignor’s mineral interest calculated? and classified as a “loan” for federal tax purposes, can be deemed a secured loan in a bankruptcy proceeding. (2) What expenses, if any, are to be borne by the If so, the owner of the “hybrid” will be deemed a interest? “secured creditor” by the Bankruptcy Court, and can (3) How should the interest that the parties intend to be held liable for administrative expenses incurred by reserve or convey be expressed to allow for, or the bankrupt’s estate that are necessary to maintain avoid, proportionate reduction? the secured creditor’s collateral. The foregoing set of facts was behind the ruling in the Fifth Circuit case (4) Will the interest attach to: (a) extensions, captioned In re Senior-G & A Operating Co. v. renewals, and/or modifications of the original lease Aguillard,164165wherein the court held that under the and/or (b) new leases taken by the assignee, its terms of the Production Payment Loan Agreement agents, or assigns within a specified time after the between Senior-G & A Operating Co. (the assignor of expiration of the original lease? Is a rule of the production payment) and PSI, Inc. (the holder of perpetuities savings clause necessary with regard to the production payment), “Senior mortgaged—it did future rights in “new” leases? not transfer—its mineral interest in the well to PSI (5) Should the instrument creating or reserving the (and also pledged its production), and under interest give the owner the right to enforce all Louisiana law, PSI must be classified as a secured implied covenants under the burdened lease? creditor as opposed to a royalty owner.”166 (6) Should the instrument creating or reserving the When PSI asserted rights against Senior’s interest interest contain express drilling and development in the well pursuant to the loan agreement it became obligations, especially with regard to the primary part of the “ ‘process of allowance and disallowance term, that go beyond those implied in an oil and gas lease? 162Id. 163Tony M. Davis & Mary Millwood Gregory, “How to Prepare For and Survive a Producer’s Bankruptcy Filing: What You Don’t Know Can Hurt You,” 44 Rocky Mt. 167Id. Min. L. Inst. 16-1, 16-27 (1998). 168The author acknowledges the material contributions to 164957 F.2d 1290 (5th Cir. 1992). this list of Hubert & Taylor, supra note 18, at 14-33, and 165Reserved. Richard W. Hemingway, The Law of Oil and Gas, § 9.9, 166Id. at 1297. at 635 (West Practitioner Treatise Series 3d ed. 1991).

19 (7) Is the interest entitled to share in advance payments or “take-or-pay” payments received by the lessee under gas purchase and processing agreements? (8) Is the owner of the interest entitled to take production in kind and, if so, how will revenues be calculated on (a) the share of the owner’s oil and gas that is used to produce the well, (b) the share of the owner’s oil and gas that is lost in the course of production, and (c) the share of the owner’s oil and gas that may be reinjected into the well for pressure maintenance and other purposes? (9) Can the assignee/lessee pool or unitize the interest without the owner’s consent and, if so, how? (10)Should any dispute with regard to the interests be subject to binding arbitration, mediation, or other methods of alternative dispute resolution? (11)Should attorneys’ fees and costs be recoverable in the event of a dispute or litigation concerning the interest and, if so, from whom? (12)Should the instrument creating the interest contain a provision binding the burdened party and its successors from disputing the interest or claiming a right to the interest in a bankruptcy or insolvency proceeding affecting the burdened party? In the event all efforts to include special provisions in an instrument creating an override or other form of nonoperating interest are rebuffed, just remember the words of Professor Kuntz, paraphrased for the proper effect, who said that “It is better to reserve than to receive.”

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