Industry Agreements Affecting Record Title Sam Niebrugge

Davis Graham & Stubbs LLP – Denver, CO

Randy Pharo

Magellan Petroleum Corporation – Denver, CO

Overview • Types of industry agreements: – – – – – – –

Joint operating agreements (JOAs) Farmout, participation, and joint venture agreements Area of mutual interest (AMI) agreements Preferential rights to purchase or rights of first opportunity Gas transportation, gathering, purchasing agreements Unitization and enhanced recovery agreements Letter agreements

• Is a subsequent purchaser bound?

– Bona fide purchaser for value without notice – Real covenants and equitable servitudes – “Subject to” 2

Backbone Issue to Presentation • Are subsequent purchasers bound by the terms of the ____________? – Blank could be joint operating agreement, farmout, area of mutual interest, preferential right to purchase, or duty to assign overriding royalty interest, etc.

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Joint Operating Agreements • Commonly encountered in all producing regions – Caveat: Common industry practice for no JOA, especially in ND

• Provides for orderly development of contract area – Allocating costs and production – Provides for recourse in event of default

• Focus on the 1989 AAPL Model Form 610 4

Joint Operating Agreements (cont’d) • All Model Form versions intend for JOA to be binding on successors and assigns – 1982 Model JOA: “This agreement shall be binding upon and inure to the benefit of the parties hereto and to their respective heirs, devisees, legal representatives, successors, and assigns”

• 1989 Model Form goes one step further: “shall be deemed to run with the Leases or Interests included in the Contract Area” – Covenant running with the land concepts 5

How the JOA Affects Record Title • Contractual pooling agreement (Art. III.B) – Parties not entitled to 100% of production even if well is on lease

• Non-consent to operations (Art. VI) – Forfeiture of right to production and revenues from well until certain time (Art. VI.B.2(b)) – Frequent provision: permanent forfeiture of leasehold working interest (Art. XVI)

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How the JOA Affects Record Title (cont’d) • Gas Balancing (Art. VI) – JOA requires parties to take production in kind – Subsequent purchaser may not be entitled to 100% of production because of makeup

• Liens and Security Interests (Art. VII.B) – JOA creates mortgage (real property) and security interest (UCC; personal property) – Questions of perfection and priority 7

How the JOA Affects Record Title (cont’d) • Maintenance of Uniform Interest (Art. VIII.D) – Parties prohibited from conveying or encumbering less than an undivided interest in contract area

• Preferential right to purchase (Art. VIII.F) – Frequently deleted

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Farmout, Participation, and Joint Venture Agreements • Farmout

– Typically, farmor agrees to relinquish working interest to farmee upon drilling event, farmee drills well to earn leasehold rights, farmor assigns interest, and upon payout, farmor gets back-in working interest – “Before payout” and “after payout”

• Participation

– Outgrowth of and typically larger area than farmout

• Joint Venture

– Shorthand for combining leasehold with cash – “Carried” party 9

Farmout, Participation, and Joint Venture Agreements (cont’d) • Common elements: – Rarely recorded – Record title subject to diminution if earning requirements met – Frequently contain AMI or restrictions on alienation

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Area of Mutual Interest (AMI) Agreements • Contractual obligation to assign any acquired oil and gas interest – Fee, working interest, overriding royalty, options, farmouts, etc.

• Reason: Parties do not want to compete • Can be assignment of working interest, overriding royalty interest, net profits interest, etc. 11

Preferential Rights to Purchase or Rights of First Opportunity • Preferential right to purchase: – Non-selling party has opportunity to acquire interest from selling party under same terms and conditions as offered by third party – May affect value of property

• Rights of First Opportunity – Lesser burden than preferential right to purchase – Gives non-selling party first bite, but if parties cannot agree, selling party free to sell to third party 12

Gas Transportation, Gathering, and Purchase Agreement • Lessees make a “trade”: Oil and gas transporter/gatherer/purchaser builds infrastructure in return for lessee dedicating oil or gas for certain periods • Oil purchase contracts typically shorter duration – Lower capital costs (usually)

• Gas purchase contracts typically longer duration – High capital costs (usually)

• Lessee obligated to deliver production to transporter/gatherer/purchaser 13

Unitization and Enhanced Recovery Agreements • These agreements provide for contract-based sharing of production and expense • May contain forfeitures • Lien rights • AMI • Ownership interest subject to recalculation

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Letter Agreements • Purposely ambiguous term for all agreements that don’t necessarily have formalities of others discussed • May contain: – Cost sharing – Overriding royalty obligations – AMIs

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Unrecorded Agreements • Is it referenced in your chain of title? • If not, do you qualify as a bona fide purchaser for value without notice? – Notice • Actual • Constructive • Inquiry

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Referenced Unrecorded Agreement • The Most Confusing Clear Phrase in Conveyancing: “Subject to.” • So just what does it mean that somewhere in the text or worse in an exhibit when the document provides that this conveyance is subject to some unrecorded agreement?

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Real Covenants • Real covenants or covenants that run with the land. • Elements: – Traditional • • • •

Horizontal privity: original privity of estate Vertical privity Touch and concern the land Intent of the creating parties that the covenant run with the land, i.e. bind subsequent purchasers 18

Equitable Servitudes • Elements: – Traditional requirements: • The intent of the original creating parties that the promise run with the land • Notice • The subject of the servitude must touch and concern the land

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Modern Trend • Real covenants traditionally considered legal rights enforceable at law (damages) whereas equitable servitudes were enforceable in equity (injunctive relief) • Turned on very technical interpretations • Courts at law and in equity are now merged and generally will attempt to apply the “appropriate” relief • See the relatively new Restatement (Third) of Property (Servitudes) to see how requirements have been merged 20

So, What Does “Subject To” Mean? • Words of qualification and notice and not words of assumption • Term of qualification and not of contract • There is noting in the use of the words ”subject to” in their ordinary use , which would even hint at the creation of affirmative rights

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• What this really gets to is: are you bound by the terms of the unrecorded agreement, and by bound, do you get just the benefits or just the burdens, or both? • See Mbank Abilene, N.A. v. Westwood Energy, Inc. • But see: Winegar v. Froerers Corp.

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How to Bind • Express assumption language • Think about this at the time of drafting the potentially unrecorded agreement • Don’t forget how hard it can be to undo obligations created by contract • Contract law vs. property law – Seagull Energy E&P, Inc. v. Eland Energy, Inc. – But see Gallagher v. Bell 23

Are You Bound? Should You Be? • Crucial inquiry is what was the parties’ intent? • Letter agreement with the consulting geologist • Is the unrecorded agreement personal?

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