"Common" Oil and Gas Law
As time passes, the "academic minds" have recognized more and more that Oil and Gas Law is not simply a mixture of advanced property law and advanced contract law. To the contrary, the advent and progression of the energy era as well as continued advancement into non-conventional plays has seen the formation of a robust energy culture, so sophisticated and business savvy that its typical negotiations have become forms, those forms became largely standardized, and has allowed a body of case law to envelope its every detail to the point that a new body of law has emerged: oil and gas law. ((See Bruce M. Kramer, "Property and Oil and Gas Don't Mix: The Mangling of Common Law Property Concepts," 33 Washburn LJ 540 (1993).))
Naturally, the Federal government has attempted to further define and classify the principles underlying oil and gas transactions negotiated with the Federal government as a lessor. The result is that, while the industry has defined several terms we all use on a daily basis, transactions involving leases taken from the federal government involve seemingly counter-intuitive definitions that differ from ordinarily understood concepts. ((Cf. Williams & Meyers, Manual of Oil & Gas Terms, p. 56.))
Last year I was in the middle of a due diligence project for a transaction with an allocated value exceeding a Billion dollars; and almost all the leases were Federal Leases. We were attempting to rely on Prior Opinions and then just verify title going forward. However, it became clear to us that the examining attorneys had messed up big time: they mistook the federal statutory term "Operating Rights" as being synonymous with what the industry typically thinks of as an "operator", and mistook "Record Title" for being 'title as it appears on the county records.' We had to completely rework our plan forward, and basically had to throw the Title Opinions in the trash.
Lesson to be learned: It is important that a landman and his attorney intimately understand the terminology behind federal leasing and conveyancing.
The Standard Framework
In a standard oil and gas transaction, we find the following types of transfers of leasehold interests:
- Assignment - a transfer of the entire leasehold estate; sometimes also refers to a transfer of an undivided share of the working interest;
- Partial Assignment - a transfer of a segregated portion of the leasehold estate or to certain strata or formations;
- Sublease - a transfer of the working interest for a primary term shorter than the unexpired primary term of the lease; and
- Working Interest - Generally, the right to drill and produce the leased interest, and the obligation to share costs of production and drilling.
The Federal Framework
However, the statutory framework encompassing oil and gas leasing and conveyancing of federally owned lands involves dealing with the following terminology:
- Assignment - Federally, this means the transfer of Record Title. This can cause confusion, because it does not mean "transfer of the entire lease." Once a company is assigned Record Title, it becomes fully liable, and essentially "steps into the shoes of the assignor." The assignor, however, retains a few minimal obligations which will be shared with the assignee, such as the responsibility for plugging and abandonment.
- Transfer of Operating Rights and Sublease - while there are distinctions between a sublease, novation, transfer, etc., they are outside the scope of this article. Essentially a Transfer of Operating Rights ("TOR"), is an assignment of the Operating Rights, which is an interest carved out of the Record Title that has been reserved to the transferor or his predecessor.
- Record Title - Federally, this means a lessee's interest in a lease which includes the obligation to pay rent, and the rights to assign and relinquish the lease, and the ability to sever overriding royalty and operating rights. This can cause confusion, because this same term, "record title," usually refers to the holder of title as it appears in the county records. They are not the same!
- Operating Rights - the right to enter upon the leased lands to conduct drilling and related operations, including production of oil or gas from such lands in accordance with the terms of the lease. Note that this should not be confused with "Operator."
- Operator - any person or entity, including, but not limited to, the lessee or operating rights owner, who has stated in writing to the authorized officer that it s responsible under the terms and conditions of the lease for the operations conducted on the leased lands or a portion thereof.
A Couple Clarifications
The distinction between operating rights and record title has been a matter of considerable controversy. Attorneys frequently disagree as to their exact meanings. Ordinarily, however, practitioners have presumed that operating rights are largely akin to working interest. The distinction has become somewhat muddied, however, as "current regulations make both an approved assignee of record title and a transferee of operating rights directly responsible to the department for various lease obligations." ((Terrell, Law of Federal Oil and Gas Leases § 10.02 [4].))
Lastly, I'd like to point out one important common misconception briefly noted above. Owning "Operating Rights does not make you an Operator. Similarly, an Operator does not necessarily have Operating Rights. These two terms have important distinctions. To obtain Operating Rights, the instrument involved is either an Assignment of Record Title or Transfer of Operating Rights, both of which must be approved by the BLM. This approval is of key importance here, because each requires some level of actions by the BLM, and the resulting approval or denial has a different effect on the liabilities and obligations of the parties with regard to the federal government.
Conversely, no approval is required for designation of Operator. ((See Devon Energy Corp., 145 IBLA 136 (1998).)) To be recognized as a lease Operator, the only action required is that one notify the BLM that it is "responsible for all obligations under the lease," and satisfy the requisite bond requirements. ((Id.)) In other words, the BLM does not approve the designation of a lease Operator. Additionally, simply being granted the status of Operator conveys no rights to conduct operations on a federal lease! ((Id. at 25.))
The conclusion, is that the designation or establishment of an entity as Operator, has no practical effect on the duties, obligations or rights of the holders of Record Title and Operating Rights.
Conclusion
Federal leasing is an interesting and unique framework. Because the terminology varies from common oil and gas parlance, it is important that a landman and his attorney brush up on the distinctions and keep up to date with the underlying law.
In the comments below, what issues have you encountered in your experiences with federal leasing?
