16Jan
Texas Windmill

NPRI’s Part Two: Pooling, Allocation and Ratification

NPRI’s: a simple and innocent concept, accompanied by a complex and convoluted legal framework. The associated rules regarding pooling, royalty allocation, and ratification by NPRI owners are important concepts of which oil and gas professionals absolutely must be aware.  Last week we discussed the basics of what NPRI’s are, what they burden, and how they are measured.  This week we take it one step further.

(This is Part Two of a series, continuing from last week’s NPRI’s Part One: Fundamental NPRI Characteristics.)

Recap of Part One

Just to recap what we had discussed last week:

  • Royalty Only: An NPRI is a right only to royalty, which burdens (comes out of) an associated mineral interest;
  • Independent of Lease: An NPRI owner gets his royalty whether the mineral interest owner leases or self develops;
  • No Executive Right: An NPRI owner cannot negotiate leases or develop the minerals himself;
  • The Executive Owner Negotiates: The mineral owner is said to own the Executive Right, meaning he can negotiate most lease terms on behalf of the NPRI owner; and
  • Two General “sizes:”
    • floating (you multiply its fraction with whatever royalty fraction the associated mineral owner negotiates); and
    • fixed (the NPRI owner simply gets his fraction with no further math).

NPRI Lease Terms and Pooling Authority

Texas law clearly states that the holder of the executive right has the authority to bind NPRI owners to most lease provisions. 1)Manges v. Guerra, 673 S.W.2d 180, 183 (Tex. 1984) (citations omitted); Montgomery v. Rittersbacher, 424 S.W.2d 210, 212-13 (Tex. 1968). But there is one major exception: courts consistently hold that “pooling on the part of the holder of the executive rights cannot be binding upon the non-participating royalty owner in the absence of his consent.”   In other words, sure, the NPRI owner will be held to the lease the executive owner negotiates, but the NPRI owner himself must grant a lessee some form of pooling authority before his interest can be pooled. 2)Benjamin Holliday, New Oil and Old Laws: Problems in Allocation of Production to Owners of Non-Participating Royalty Interests in the Era of Horizontal Drilling, 44 St. Mary’s L.J. 771, 800 (2013); see also Montgomery, 424 S.W.2d at 213 (citing Minchen v. Fields, 162 Tex. 73, 345 S.W.2d 282, 285 (1961) ).  While a mineral owner typically has a single opportunity to negotiate pooling authority in a lease, the same is not true for an NPRI owner. If an NPRI owner decides he does not want to pool his interest, he has this ability as well.  This gives the NPRI owner a sort of superior right or ability – he can decide whether to pool his interest after the cards have already been dealt.  How many wells will be drilled, where, in what time frame?  All these factors can be weighed in deciding whether to pool, and how to pool his interest.

Methods of Pooling an NPRI

Method One: Ratify the Oil and Gas Lease

The most common form of pooling ratification given by NPRI owners is to ratify the relevant oil and gas lease. 3)See James E. Key, The Right to Royalty: Pooling and the Capture of Unburdened Interests, 17 Tex. Wesleyan L. Rev. 69, 81 (2010). This will have the same effect as if the NPRI owner had executed the lease, and will ratify all subsequent pooling efforts made by the operator under the terms of that lease. 4)Ruiz v. Martin, 559 S.W.2d 839, 844 (Tex. Civ. App.—San Antonio 1977, writ ref’d n.r.e.) (holding that the ratification of a lease was the same as execution of the lease, and thus their interests were pooled or unitized as a matter of law with all other interests in all three tracts covered by the lease). Where an NPRI owner ratifies the lease, his interest will be diluted by the pooling of the leased land with any other lands.  In other words, if the NPRI owner owns 20 acres, and ratifies a lease covering that 20 acres, and that leased land is pooled with a neighboring 80 acre tract, then the NPRI will receive his royalty interest, but it will be diluted by 20/100.  This can greatly reduce the value of his interest.

Method Two: Chose Not To Ratify

However, an NPRI owner also has the power to decide not to pool his interest. Where the NPRI is on a “drillsite tract,” it can be highly beneficial for an NPRI owner to refrain from entering into any pooling agreements or ratifying the lease, because he will then receive his interest undiluted by pooling. Sophisticated NPRI owners will weigh several factors in determining whether pooling or not pooling his interest is the most beneficial tactic to employ in his particular scenario.

NPRI On Drillsite Tract

For example, where a well is placed within the NPRI owner’s tract, a non-pooled NPRI owner is entitled to his full fractional share (fixed or floating) of the production from that that tract, not diluted by pooling with other tracts included in the unit. 5)See MCZ, Inc., 708 S.W.2d at 53 (stating that an NPRI owner is entitled to an undiluted full fractional royalty interest from a well within his tract where his interest has not been properly pooled).  So who has to pay for this larger royalty owed to the NPRI owner? Texas law makes it clear that the owner of the burdened mineral interest will bear the cost of this excess royalty to the extent his royalty interest will allow, and any further excess must be sustained by the working interest owner. 6)Id. (rationalizing this ruling in part due to the fact the lease signed by the burdened mineral interest owner contained a proportionate reduction clause).

In other words, if a mineral owner has executed a lease, of which is later largely diluted by pooling, a well is placed on this tract, and an NPRI burdening this mineral owner refuses to grant pooling authority, things can get messy.  This can frequently lead to a scenario where the NPRI owner is entitled to more royalty than would be “divvied out” to that mineral interest owner.  If this is the case, the mineral interest owner would essentially receive no royalties in that tract, and the working interest owner would have to make up any difference in compensating the NPRI for his full undiluted royalty.

NPRI’s on Non-Drillsite Tracts

Conversely, if a well is placed outside the NPRI owner’s tract, and his tract is included within the unit, the NPRI owner will likely prefer to grant pooling authority. This is because, in Texas, where an NPRI owner fails to pool his interest, where the drillsite is not on his tract, and where community lease concepts are not applicable, he is generally entitled to no royalties.  An NPRI owner has considerable power in this regard, as they are able to wait to see where the wells are drilled prior to taking action.  If it is drillsite, don’t ratify, and it is not, then ratify. 7)However, i will later discuss “When Must the NPRI Owner Ratify” for a discussion of the possible defense of laches for a particularly delayed ratification.  

Method Three: Separate Pooling Agreement

Where an NPRI owner generally ratifies an Oil and Gas Lease, his interest will be pooled (diluted) with all wells drilled under the terms of that lease.  Generally, an NPRI owner cannot later change his mind, or make different pooling elections for future wells. However, with the recent proliferation of oil and gas development, horizontal drilling and fracking 8)spell it how you’d like.. fraccing, fracing, hydro-fracking, etc. Honestly, whatever keeps the combative-enviros off my back, NPRI owners have become much more sophisticated, and have increasingly rejected the far-reaching consequences of a blanket ratification of an oil and gas lease. 9)Allen D. Cummings, Pooling and Community Leases: Problems and Options for the Executive Owner, the Non-Executive Owner and the Lessee, in State Bar of Texas, 15th Annual Advanced Oil, Gas and Mineral Law Course, at I-1, I-30-31 (1997).

NPRI owners are more frequently granting a lessee pooling authority by use of a pooling agreement or other form of limited pooling authorization. 10)Id.  Sophisticated NPRI owners, instead of ratifying the entire lease, will negotiate a separate Pooling Agreement with the lessee that grants the limited authority to pool the NPRI owner’s interest only for the specific pooled unit. 11)Cummings, supra n. 12, at 34.  This will allow the NPRI owner to repeat the process of determining whether to ratify or not ratify in the future, based on which action would be most beneficial to his interest. 12)Compare Montgomery, 424 S.W.2d at 215 (allowing NPRI owner to ratify lease, entitling owner to proportion of production from pooled unit, but binding NPRI to full authority of all leasing provisions), with MCZ, Inc., 708 S.W.2d at 53-54 (permitting an NPRI owner to ratify a pooling provision for one pool and reject provision for a second pool, thus allowing the collection of proportional royalties from the former pool and full royalties from the latter pool).

Method Four: Community Lease

Perhaps the most simplified definition of a community lease is this: a single lease, executed by multiple parties, covering multiple tracts of land.  Texas courts have also classified a lease as a community lease where one the NPRI burdens differed as to the tracts covered by the lease.  Where there is a community lease, all the tracts covered thereby are presumptively pooled together.  We will cover more on this topic in Part Three.

Conclusion

In conclusion, NPRI owners are generally presented with three options: (1) refuse to ratify ( which is frequently a good decision where the well is located within his lease, because he is then entitled to an undiluted royalty), (2) ratify the lease (which authorizes all pooling authority in the lease), or (3) selectively ratify the pooled unit by way of a pooling agreement (which can strategically provide for limited pooling authority).  This places NPRI owners in enormously powerful bargaining positions, of which Texas courts have tended to protect. 13)Seee.g., Montgomery, 424 S.W.2d at 215 (expanding the ability of an NPRI holder to either ratify or repudiate a provision of a lease).

Photo: “Texas Landscape” by David Spigolon is licensed under CC BY 2.0.

Footnotes   [ + ]

  • kathleen O’Byrnes

    My title insures 1/8 of all landowners royalties on 160 of her acres. It includes 2 tracts on the lease. The unit division order adds 3 acres of my land ( didn’t know I had any) with 130 of owners acres divided by 525 total acres of unit, in order to start the math for decimal interest (133/525 x .125 x .25 [ percentage of owners royalties on lease]). Why do they describe my interest as actually having acres, and do I still have 157 acres floating around out there as part of the owners interest?

    • http://oilandgaslawdigest.com/ Austin Brister

      I’m not 100% sure I follow you on this one, Kathleen. The math will describe acres, because this is called a “Tract Factor.” Your land only makes up a portion of the unit. The oil and gas company, ordinarily, doesn’t have to include all your land in the unit. The exception to this rule would be if your lease includes an “Anti-Dillution” provision.

  • Lissa

    Thank you for all of the very interesting and helpful information. My question is: If I ratify the lease, what consideration, if any, can or should I expect?

    • Austin W. Brister

      Lissa,

      Thanks for the compliments! As far as the consideration for lease ratification, that is goign to depend on a vast number of variables. Horizontal drilling? Drillsite tract? How big is the tract? What state and shale play? How big is your interest? Will obtaining your ratification be beneficial for future operations as well, and if so what is the extent of future plans?

      There are probably many more variables I’m not thinking of at the moment.

  • Harrison Kraft

    Excellent series and I appreciate you taking the time to put this information out there. Some of the complexities of royatly payments in Texas can get pretty out there. You mentioned that “NPRI owners have considerable power in this reguard, as they are able to wait to see where the wells are drilled prior to taking action” and I am wondering if the Lessee/Operator is compelled to allow a ratification after the wells have been drilled. It would seem the NPRI owner could be left out in the cold if they opt to wait.

    Slightly off topic, what I am actually researching is whether an operator is bound by post production deduction restrictions within the lease language when it comes to the NPRI owners. IE. If a mineral owner signs a lease that restricts the deduction of post production costs from their royalty, can these costs be deducted from the NPRI portion? What complexities may complicate this matter and does ratification of the lease have any effect?

    I know this may not be a cut and dry answer, but any input you could provide would be appreciated.

    • Austin W. Brister

      All lease terms (except pooling) are generally negotiated by the holder of the executive right, and these terms then apply to all the interests that executive right binds. In the most typical context, the mineral owner negotiates the lease, and then those terms (except pooling) apply to the MI and the NPRI. This would also bring in post production deduction terms.

      What could complicate this? Well the instrument conveying/reserving the NPRI could specify otherwise.

      Ratification generally would not have any effect. However, if the ratification also has other terms in it that modify these cost deduction provisions (or any other provision for that matter), and the NPRI owner executes it, then the NPRI owner could essentially be modifying the terms they wish to be bound to. This is commonly done to avoid community leases, in having the NPRI owner execute a ratification that includes anti-communitization language.

  • KK

    I have a 1/16 NPRI on 50 acres of a 1000 Unit and am being asked to ratify the oil & gas lease the mineral rights holder of the 15/16th signed with the drilling co. and I understand I might want to hold off signing to be part of the pool to see if they drill on “my” 45 acre tract (I don’t own surface rights) as then my percentage isn’t diluted. BUT, my question is do I have a time limit to decide on when to ratify? If I do decide to ratify and join the pool do I get paid since day one of the first well drilled on the Unit, or not?

    Lastly, they are doing horizontal drilling and I already know one of the drilling sites runs under/through my acre track . What, with horizontal drilling, constitutes “drilling on you tract”? Does just crossing your tract count as the “well bore”? You might be able to tell I’m trying to learn the lingo! :)

    This is all so very complicated and your article was one of the best out there and I appreciate your response. Thank you.

    Quick Edit: Sorry, I wasn’t specific, but this is in Texas as part of the Eagle Ford Shale.

  • Randy

    If a lessor executes a lease allowing for pooling, but also has an NPRI, carved out of not only that same lease but other leases that have been executed on the lands, must they also ratify? Because they only leased as to their mineral interest, not their NPRI. I guess I am asking if an NPRI merges back into the mineral interest or if it remains separate. Maybe this is something I covered in school, but I cannot find the answer.

    • Austin W. Brister

      Typically any new lease will need to be ratified. Your ratification may have some sort of broad, overarching, perpetual ratification language, but this is rare.

  • Josh

    Austin, is there any authority that would allow an Npri owner to expressly refuse to ratify a unit and get paid on a lease basis when the horizontal unit well bore runs right through her tract, but later decide to ratify the unit when a 2nd unit horizontal well is drilled and does not run through her tract

    • http://oilandgaslawdigest.com/ Austin Brister

      Josh,

      Thanks for the question! In Texas, practically speaking, there is little to no limit to the amount of time an NPRI owner may wait to ratify the lease/unit. One theory that has been suggested is “laches,” which is an equitable defense based on an unreasonable delay pursuing a right or claim, where the court refuses to enforce your right or claim because doing so after your delay would prejudice the opposing party. I am not aware of any precedent on the issue, however, because most people don’t really want to sit around and let a bunch of money collect in an account before they decide whether to ratify. Your example is unique, however, because the NPRI owner expressly refused to ratify, and now wishes to ratify due to changed circumstances. I’m not sure how effective the laches defense would be, but I would be very cautious in relying on the defense.

© 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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NPRI’s Part One: Fundamental NPRI Characteristics

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