28Jan
Dense Oilfield

NPRI’s Part Three: Community Lease Principles

Non-participating royalty interests (“NPRI”) are extremely common in the oil patch, and it is imperative that every land professional be familiar with the basic NPRI attributes and rights.  The shale boom has spurred an unprecedented movement in landowner education, and NPRI owners have become more and more sophisticated.  Therefore, it is important to understand the bargaining power and goals of the sophisticated NPRI owner.

Recap of Parts One and Two

NPRI’s Part One:Fundamental Characteristics

  • Royalty Only: a right only to royalty, independent of a lease;
  • Executive Negotiates Lease: the holder of the executive right (usually the mineral interest owner) negotiates the associated lease
  • Two “Sizes:” NPRI’s can be in two sizes, fixed and floating;

NPRI’s Part Two:Pooling, Allocation and Ratification

  • Pooling: While an NPRI owner is bound to most of the lease negotiated by the Executive, an NPRI cannot be pooled without his own consent;
  • Option One: Not Pool:
    • Can wait until a well is drilled, then decide whether to pool his interest;
    • Non-pooled interests are not diluted, and can therefore be much larger;
    • CATCH: non-pooled interests only receive royalties if well is located directly on his/her property;
  • Option Two: Pool by Ratification:
    • An NPRI owner can pool his interest by ratifying the oil and gas lease;
    • This authorizes all subsequent pooling under terms of lease;
  • Option Three: Selective Pooling:
    • NPRI owner can execute Pooling Agreement;
    • Can allow for limited pooling authority;
    • Often allows NPRI to selectively decide, well by well, whether pooling or not pooling is most beneficial for his interest.

Overview of NPRI’s and Community Lease Concepts

In Part Three, we’re going to skim the surface of a somewhat “advanced” concept.  NPRI’s can cause issues under the “community lease” doctrine. Generally, an NPRI will fall under the “community lease” doctrine when the NPRI is owned upon only a portion of the land covered by an oil and gas lease.

Basics of Community Lease Principles

Before we can understand the implications on NPRI’s, we must first understand what a community lease is.

Community Lease Definition: A community lease is one in which the owners of two or more tracts join in the execution of a single lease covering those tracts.

Effect of Community Lease: Unless the lease contains a provision to the contrary, a community lease pools the interests of the multiple executing lessors.  Thereafter, their interests will be “apportioned,” meaning they will share the royalty on an acreage basis, pro rata, no matter which of the covered properties a well is drilled on and no matter which of the covered properties is included in a pooled unit. 1)Parker v. Parker, 144 S.W.2d 303 (Tex. Civ. App.–Galveston 1940, writ ref‟d); French v. George, 159 S.W.2d 566 (Tex. Civ. App.–Amarillo 1942, writ ref‟d).

Community Lease Principles and NPRI’s

Texas courts have held that community lease concepts may apply to NPRIs, reasoning that the execution of a community lease is the equivalent of an “offer to pool” made to the NPRI owners, of which the NPRI owner can accept or reject. 2)Ruiz, 559 S.W.2d at 843.  Therefore, an NPRI will fall under a “community lease issue” where the NPRI is owned upon only a portion of the land covered by an oil and gas lease.

When the community lease principles were originally created, the courts probably believed that the community lease concepts would only apply where it was plainly obvious: multiple lessors and multiple tracts of land.  However, as many land professionals can attest, mineral owners often have no idea their interest is burdened by an NPRI.  Therefore, it is not uncommon to see an Oil and Gas Lease  where an NPRI burdens only part of the land covered by the lease.  And this situation may cause the lease to be a community lease!  Why: again, we have multiple owners, multiple tracts, and a single lease.

So why do we care?  Two basic reasons.  First, if you have a unit which includes the lease, but not the NPRI portion of the lease, then you still may have to allocate royalties to the NPRI owner even though his interest lies entirely outside the unit.  Second, a typical title examination and curative effort applies only to the land covered by the lease.  When land professionals are required to open their examination to lands outside the unit, costs can substantially increase.

Avoiding Application of the Community Lease Principle

There are two common methods of avoiding this consequence of the community lease.  First, lessors can sign separate leases for each tract of land.  Second, parties can include an anti-communitization (aka anti-apportionment or anti-entireties) clause in the lease.  An anti-communitization clause, essentially, states ‘if this lease covers multiple tracts, it shall not be treated as a community lease, and no pooling or unitization is hereby intended.”

However, Texas courts have refused to enforce anti-communitization clauses in leases in relation to NPRI’s, without the direct agreement of the nonparticipating royalty owner. 3)London v. Merriman, 756 S.W.2d 736 (Tex. App.–Corpus Christi 1988, writ denied) (holding that the ratification of a lease containing an anti-communitation clause still effected a communitization of the NPRI, under the concept of a community lease being an “offer to pool”).

The result is that an NPRI owner, even though his tract lies outside of a unit, but within a lease included in that unit, may be able to ratify the lease, thereby communitizing his interest, and thereafter be entitled to his share of royalties from the unit.  This is an incredible power afforded to NPRI owners!  An NPRI can “force” its way into an apportionment of royalties even though these “community leases” can often times be unintentional, and even where there is a direct effort to avoid communitization.

Curing the Community Lease “Issue”

As stated above, these community lease principles can be somewhat burdensome to land professionals, because: (1) they can cause the need to examine title outside the unit, (2) they can cause the need to cure title outside the unit, and (3)  they can cause a dispute or strained relations with the lessor.

Operators have attempted several different “curative” measures aimed at preventing these burdens.  Many of these are questionably effective, and some could, in my opinion, subject an attorney recommending these measures to malpractice liability.  If you are faced with a community lease issue that you would like to “cure,” I suggest you speak to a licensed attorney who will examine the specific lease and chain of title in question to develop a recommended game plan.  Potential measure include, but are not limited to, the following:

  1. Partial release; 4)Duffy v. Callaway, 309 S.W.2d 853 (Tex. Civ. App.–Eastland 1958, writ ref‟d), and Callaway v. Duffy, 337 S.W.2d 388 (Tex. Civ. App.–Eastland 1960, no writ).
  2. Top-leasing followed by bottom lease release;
        1. DISCLAIMER:  I’m not discussing the effectiveness or legality of any of these curative measures, but I can’t keep my mouth closed on this one.  I have seen this curative requirement all over the place.  I personally believe the recommendation of this curative requirement would subject an attorney to potential malpractice risk.  Why?  What happens if there is a pre-existing top lease?  You’ve just released your bottom lease!  Here’s the deal: you’ve already negotiated or purchased a lease, and there is no reason to go back and completely rehash the deal.  Additionally, I wouldnt’ be surprised if a court saw this as a breach of duty owed to the NPRI owner.
  3. Seeking express partial acreage ratification from the NPRI owner;
  4. Obtaining execution of separate anti-communitization agreements with each of the nonparticipating royalty owners in a community lease prior to beginning development. 5)Cummings, supra n. 12, at 35.  Note also that a distinctly separate set of issues is presented by the inclusion of an entireties clause within a lease, which apportions royalties once tracts are divided after the execution of a lease.

DISCLAIMER: The effectiveness or legality of each of these methods is outside the scope of this article.

 

Photo Credit: some rights reserved by Loco Steve

Footnotes   [ + ]

  • Chris Huff

    Hello again Austin,

    This post reminds me of a question I’ve had over this topic – do community leases and community leases apply on a given set of tracts in which the lease does not fully bind the entire mineral estate for each tract (in other words, one or more mineral cotenant did not join in the “community lease”). So for instance, Elmo leases Tract A (40 acres) and Tract B (20 acres). Elmo owns a 100% MI in Tract A, but only a 50% MI in Tract B – Bert and Ernie split the remaining 50% MI in equal shares. Ernie joins in on Elmo’s lease, but Bert is too busy feeding his pigeons to execute a lease so he remains unleased. The Ernie/Elmo lease does NOT have a separate tract (or anti-communitization) clause.

    To add to the fun, Oscar the Grouch owns a 1/16 NPRI in Tract B that burdens the entire mineral interest.

    The Lessee drills a well on Tract A. Tract B is non-drillsite.

    Did Elmo and Ernie inadvertently create a community lease such that Ernie can share in the production from Tract A, or does Bert’s non-joinder in the Elmo/Ernie lease nix that? For some reason, I thought I remember coming across something saying that it’s necessary for all mineral cotenants to join in on a multi-tract lease in order to create a community lease. Maybe I’m thinking of Guaranty Nat. Bank v. May and how it ruled that all NPRI’s must ratify to affect a communitization, but I’m not entirely sure that is still considered good precedence (it doesn’t seem to apply to the way NPRI owners are treated these days), and I don’t necessarily think it would be something one could really extrapolate to the situation I’m talking about. So maybe I’m confusing things (wouldn’t be the first time).

    Along those lines, would Oscar be able to jump up and unilaterally ratify the lease thereby communitizing his NPRI in Tract B in order to receive a portion of the production on Tract A, despite the fact that the lease only covers 75% of Tract B’s mineral estate? And would that still apply even in the event that Ernie didn’t execute the same lease as Elmo, making Elmo the only lessor of his multi-tract lease that Oscar is trying to ratify?

    • Austin W. Brister

      Hey Chris,

      It’s NAPE week so I dont’ have time to fully answer yet, but this is a great question. Wanted to tell you thank you, and that I’ll answer as soon as NAPE is over!

      Take care,

      Austin

    • Austin W. Brister

      Chris, you should forget Guaranty Nat. Bank v. May. It has since been overturned. Check out http://scholar.google.com/scholar_case?case=15492646917446274102&hl=en&as_sdt=4,44&kqfp=16777872120450339621&kql=231&kqpfp=687088805039748590#kq for a discussion of how the court cited no law in its conclusion and provided no rationale.

      So to answer your questions: (1) it is still a community lease, (2) Oscar can ratify the lease and therefore argue that his interest is communitized, and (3) the same arguments could still apply even if the lease isn’t facially communitized (the lease would only appear on its face to have one lessor and one mineral tract).

      This has caused problems, and I believe parties could still argue that this isn’t a community lease, but the existing precedent is somewhat foggy. That’s why I always make a Requirement in my opinions to get rid of this issue any time there is a Subject Lease that is not entirely included in the Captioned Land… because I have not examined these outside lands, how am I supposed to know if there is an NPRI burdening these tracts, and even if there are NPRI’s how do I know if the NPRI is going to try to claim that it is a community lease?

      • Chris Huff

        Very interesting, I appreciate the response, as well as the case you brought up – they hammer the reasoning of the Guaranty opinion pretty hard in there.

        So does the fogginess of the existing precedence mean that there isn’t a set-in-stone way to calculate the above situation? With the joinder of all parties, calculation of this seems pretty cut-and-dry – just calculate as if the operator had pooled together a 60 acre pooled unit.

        Without the joinder of all parties, it seems to at least potentially raise questions on how you would treat the non-joining parties. For instance, would you treat them exactly like a unpooled, non-drillsite interest owner in a pooled unit? From my understanding of Texas law on pooling, the Lessee can absorb these interests and essentially keep the production credited to any non-drillsite interest refusing to lease and/or provide the Lessee with the proper authority to pool the interest into the unit. If that’s the case, it almost seems to be to the operator’s benefit, as you could dilute the drillsite mineral owner(s) to account for the parties that did not join in the act(s) creating the community lease and/or communitization. Granted, there are obviously extra costs regarding all the extra time spent resolving the unexpected communitization issue which somewhat (or perhaps, completely) offsets this, but this method of calculating could theoretically break out to the operator’s benefit due to the extra revenue they receive from not paying the full lease royalty to the drillsite mineral owner on a single tract basis (and instead diluting it on a unit basis). Just to illustrate what I’m saying using the scenario painted in my first comment, instead of receiving the full 24% NRI stemming from a 24% lease royalty reserved in his lease, Elmo would only be receiving an NRI of 20% from that Tract A well after Oscar ratifies [(24%*100%*40/60)+(24%*50%*20/60)]. Add in the NRI you are crediting Oscar due to communitization, and the Operator is still paying out less than the 24% NRI it was set to pay out on a single tract basis. Even though this method of calculating the communitized interests seems to match up best with the pooling theory as I understand it, something seems off about it.

        And for Oscar’s NPRI, does the portion thereof burdening the unleased portion of the mineral estate still get communitized (i.e. would his full 1/16 NPRI get communitized – obviously diluting by the 20/60 proportion of his tract acreage to total lease gross acreage)? Or would only the portion burdening the mineral interest bound by the multi-tract lease get communitized (i.e. only the 1/32 NPRI under the latter scenario outlined above where Elmo is the only party to execute his multi-tract lease – again diluting by that 20/60 proportion)? The latter calculation method seems more intuitive, but I don’t have anything solid to base that on.

        I’m guessing this is one of those cases where the operator has no real clear legal lines drawn to rely on and would just need to get the drillsite parties, in addition to those who could claim to be under the terms of a Community lease (this would obviously exclude those mineral owners who did not join in the execution of the multi-tract lease) to come to some sort of agreement amongst themselves on how to distribute all of the lease royalty under that “Community” multi-tract lease, no?

        Sorry for all the questions, but Community Leases and Communitization are one area that I haven’t found a lot of legal literature to answer all of the questions that have come up as I’ve learned more about it (perhaps because, as you say, it starts to get a little foggy as to what the legal precedence allows and requires).

        • http://oilandgaslawdigest.com/ Austin Brister

          Chris,

          Late reply…. it’s been months. But I just wanted to let you know that I’m actually getting ready to write another article on this issue at the moment.

          • Chris

            Not a problem on the late reply. I haven’t seen anything else on the subject in the meantime so I’ll be looking forward to it!

  • Chris Huff

    Austin,

    That sounds good. I hope NAPE treated you well, and I’ll be looking forward to your response when you get a spare moment.

© Copyright 2014, Austin W. Brister. All Rights Reserved. DISCLAIMER: The information in this article is for general information purposes only. This article should not be substituted for legal advice and should not be taken as legal advice for any individual case or situation. This information is not intended to create, and receipt or reading this article does not constitute, an attorney-client relationship. You are encouraged to contact an attorney for legal advice concerning the information provided in this article.
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