Written by Tim Lester Reviewed by Judy Moreland, CDOAhadoa.memberlodge.org/resources/Documents/01_CDOA... · • The Texas Railroad Commission is the governmental regulatory body

Written by Tim LesterReviewed by Judy Moreland, CDOA

Denbury CDOA ReviewMarch 25 & 26, 2015

• The Texas Railroad Commission is the governmentalregulatory body of the oil and gas production industry inTexas.

• The other two state agencies regularly involved in thedevelopment of oil and gas are the Texas General LandOffice (GLO) and the Texas Comptroller.

• The GLO is responsible for leasing state property(approximately 20.4 million acres) for oil and gasdevelopment.

• The Comptroller is responsible for collecting severancetaxes on the production of oil and gas.

• Severance taxes in Texas are 4.6% on oil andcondensate and 7.5% on natural gas.

• Severance taxes are due the 20th day of the 2nd monthfollowing the production month.

Introduction

Introduction

• Out of 254 Texas counties, only about 35 do not have anyrecent oil and gas production.

• Texas is often thought to have the largest and bestdevelopment body of oil and gas jurisprudence in the world.

Types of Ownership of Real Property

• The Rule of Capture originated from English hunting lawbut ended up as the basic rule allowing for the taking of oiland gas from beneath the surface even though it may haveoriginated under someone else’s land and migrated toanother owner’s land.

• The biggest modification to the Rule of Capture is thecorrelative rights doctrine.

• The correlative rights doctrine allows equal rights betweenadjacent land or mineral owners.

Types of Ownership of Real Property• Ownership of minerals in Texas is often analogized as a

bundle of sticks with each stick being a specificownership right able to be conveyed or held. Some of therights or “sticks” belonging to the mineral owner are:• Right of ingress and egress• The right to sign a lease• The right to receive bonus payments• The right to receive delay rentals• The right to produce the minerals• The right to receive royalty


• The right to lease is usually referred to the executory orexecutive right.

• Bonus is compensation for granting a lease.• Delay rentals are compensation for deferring drilling.• Royalty is a share of production which is free of the cost of

production.• Each of these “sticks” is alienable, divisible, and inheritable.

The mineral owner can transfer a portion of the mineralestate, thereby creating a cotenancy, or transfer anyindividual incident of mineral ownership such as theexecutory right, the royalty, etc.

• Fee simple ownership is ownership of the property in total.


• Fee simple ownership is ownership of the property in total.• Fee simple determinable is ownership of property only

when a certain event happens, like a future date or event orafter a specific death.

• Life estates are fee simple determinable ownerships. Thelife tenant is given property for his life and upon thatperson’s death it automatically passes to a remainderman.

• The remainderman holds a future interest that willbecome a current interet only at the death of the lifeestate holder (life tenant).


• Life estates are usually created by testament, intestacy, orby a conveyance.

• Texas intestacy law may create a statutory life estate forthe benefit of a surviving spouse under certainconditions.

• Life tenants ca live on and use the land but cannotcommit waste. Waste is an act which decreases the valueor which uses up something that cannot be replaced,such as oil and gas production, unless the Open MineDoctrine applies.


• The Open Mine Doctrine holds that if a life estate iscreated while waste is already being committed the lifetenant is entitled to continue that same waste to his or herbenefit.

• The life tenant gets the revenue and does not share it withthe remainderman.

• If the life estate is created by will or deed, then the rulesfor waste and income can be determined by thetestator/grantor.

• Because the remainderman has no present right ofpossession and the life tenant is obliged not to commitwaste, both must execute the lease.


• The life tenant cannot commit the remainder interest. If alease is taken only from the life tenant and not theremaindermen, the interest would be considered unleasedat the death of the life tenant.

• Who receives money hinges on whether the distribution isfrom the corpus, which goes to the remaindermen(although held in suspense until the life tenant dies) orfrom current income and interest on the proceeds from thecorpus, which goes to the life tenant.


• Delay rentals are considered current income and paidto the life tenant.

• Royalty and bonus are considered corpus.• The proceeds from the corpus are suspended and

placed in an interest bearing account. The life tenant isentitled to the interest and the remaindermen willreceive the proceeds upon the death of the life tenant.

• The life tenant and remaindermen can amend the waythe distributions are made by written agreement or byapplication of the Open Mine Doctrine.

• A reversionary interest is similar to a fee simpledeterminable except that with a reversionary interest,upon the occurrence of a specified event, the interestreverts to the grantor. With a fee simple determinable theinterest could revert to any third party.


• Cotenancy is the ownership or possession of property bytwo or more entities. They frequently own equally but itcould be owned in any ratio.

• A Texas cotenant can explore, drill, and produce theminerals or lease their share of the minerals without theconsent of the other cotenants.

• One cotenant alone – no matter how large or small – cansign an oil and gas lease to access all of the minerals.

• The operating cotenant (aka the developing cotenant)bears the entire cost and risk of drilling a well, and theymust account to the other cotenants (aka non-consentingcotenant) for their share of the net profits.


• When an off lease pipeline carries gas not associatedwith a lease across their tract, it requires the approval ofall cotenants, although in practice many companiesobtain the approval of as many cotenants as possible andgo ahead and lay the pipeline. The courts generally justrequire damages for the trespass against the unsignedcotenant, although they could require that the companyremove the pipeline.

• Many pipeline companies become registered as publicutilities and therefore acquire the right ofcondemnation, which can be used against unsigned oruncooperative cotenants.


• In Texas, a cotenant has an absolute right to partitionproperty, regardless of any inequalities caused by thepartition to other cotenants.

• Partition is a judicial proceeding and partitions can begranted either in kind or by forced sale and diving theproceeds.

• The right to partition does not extend to non-possessory interests, such as a royalty interest.

• The judicial cost to bring a partition action is borneamong all contenants in their proportionate share basedon ownership, regardless of which cotenant brings theaction.

Community Property and Separate Property

• Texas is a community property state. Property acquiredduring marriage is presumed to be community propertybut property inherited, acquired while single, acquired assettlement for personal injuries, or acquired exclusivelywith separate funds will be considered separate property.

• Normally both spouses execute oil and gas leases jointly,whether the mineral interest is community or separate.

• If the mineral interest is separate property, the owningspouse along can execute a binding oil and gas lease,unless the lease is upon a homestead property in whichcase joinder by both spouses is required.

Homestead

• The Texas Property Code defines two types ofhomesteads: urban and rural, both of which aredetermined at the time they are designated.

• It is possible for a rural homestead to exist in amunicipality if it was created prior to meeting the rulesfor an urban homestead.

• An urban homestead must be serviced by at least three ofthe following services: electric, gas, sewer, storm sewer,and water.

• Between 1983 and 1999 the urban homestead was limitedto 1 acre, but in 1999 it was amended to 10 acres. Multiplelots can make up an urban homestead as long as all thelots are adjacent and total no more than an aggregate of10 acres.

Homestead

• Rural homesteads, which is any homesteadnot qualifying as urban, may consist of nomore than 200 acres for a family and 100 acresfor a single person . A tract containing morethan that can still qualify as a homestead, butthe acreage in excess of the allowed amountwill not qualify.

• Homestead rights do not extend to severedminerals.

Types of Ownership

• Net revenue interest is the fraction of production thatthe lessee gets to keep once all other interests arededucted.

• An overriding royalty interest is an interest carved out ofthe lessee’s interest, usually created by the lessee inreturn for something of value provided in direct relationto the prospective development of an oil or gas well. Thistype of interest is generally tied to a specific lease.

• A non-participating royalty interest is an interestconveyed or reserved by a mineral or royalty owner. Itcan be perpetual or limited to a specific term. It iscarved out of the lessor’s interest, but unlike an ORRI itis not tied to a lease and does not expire with the lease.

Types of Ownership

• NPRI’s do not generally have an executory right unlessthat right has specifically been granted. The executoryowner has an obligation to execute a lease with utmostgood faith and fair dealing with respect to the NPRI.

Importance of Legal Descriptions

• Without a proper legal description, a conveyance is voidfor vagueness. It must be specific enough to tell wherethe property is located.

• “All my property in Denton County” is a sufficientdescription but “All my property in Texas” is not.

• The Texas statute does not mention the requirement of alegal description, but the Texas Supreme Court hasruled that a sales contract must contain or at leastreference an existing document that describes the landwith reasonable certainty.

Legal Descriptions• Most of Texas uses metes and bound descriptions for

property descriptions in Texas.• Metes and bounds can be any shape or size.• West Texas does have several counties which do

subscribe to township and range descriptions.• Early Texas measurements were of Spanish origin,

such as the vara. Vara is Spanish for yard. The exactmeasurement in eastern Texas was historicallyslightly different than that used in western Texas, butin 1919 the measurement was set at 33.3333 inches.

• Labors and leagues were common measurements inearly Texas.• A labor is 177.14 acres or 1 million square varas• A league is 25 labors or 4428 acres.

Surface and Mineral Estate• In Texas, once the minerals are severed, they are always

severed unless a merger occurs. Severance can beaccomplished in several ways but it is most often created ina conveyance with a reservation of the minerals to grantor.

• In most states, including Texas, the mineral estate is thedominant estate. The mineral owner can use as much ofthe land as reasonably necessary to produce the minerals.

• The mineral owner does not have to compensate thesurface owner, although most operators chose to paysurface damages for the fair use of the surface as a show ofgood will.

Warranty Deeds• Generally deeds to real property come in three types:

general warrant deed, special warranty deed, andquitclaim deed.

• A general warranty deed warrants to the grantee that thegrantor has done nothing to cloud the title and subrogatesthe grantor’s rights of action and transfers any guaranteesowned by grantor from previous owners for possible pasttitle clouds.

• A special warranty deed just warrants to grantee thatgrantor has done nothing to cloud the title, but offers noprotection for clouds by previous owners.

• A quitclaim simply gives to the grantee whatever thegrantor owned if anything.

After Acquired Title• If a person over-conveys property with a deed other than a

quitclaim, and that person later acquires more ownership ofthe same property that was over-conveyed, that newacquisition, by rule of law, automatically transfers to theperson who was conveyed less than originally purported.Example: “Five brothers and sisters inherit 100 acres from their mother.The siblings each believe they own 20 undivided net acres out of 100. Oneof the siblings, Joe sells his 20 acres to Jack. However, what the siblingsdid not know is that their mother had actually sold ten acres out of the100 to Harold a long time ago. So, what each sibling inherited was 1/5th

of 90 acres, or 18 undivided net acres. As a result, the conveyance of 20acres from Joe to Jack only contained 18 acres because that is all Joeowned. Now, five years later, Joe decides that he would really like to ownsome of the family land, so he buys five undivided acres from his sister.Instantly at the time of Joe’s acquisition of the five acres, two of the fiveacres immediately flowed from Joe to Jack to make Jack’s acquisition of20 acres whole and Joe is left with the remaining three acres.”

Reasonable Accommodation Doctrine

• The Reasonable Accommodation Doctrine simply statesthat when a pre-existing surface use can be easilyaccommodated by the oil and gas company, then the oil andgas company must accommodate.

• In Getty Oil Co. vs. Jones (1971) a farmer who had beenusing a rolling, circular irrigation system to water his cropswould have been prevented from watering his crops by theheight of the production equipment on his surface estate.The court ruled that the oil company had to dig down a fewfeet and locate the production equipment in the loweredarea so the circular irrigation system could pass withoutobstruction.

• This doctrine requires the use to exist prior to the lease.

Fraction of a Fraction

• When a royalty owner conveys a one-half royalty to anotherperson, it is critical to read carefully for the word “of”.

• A one-half royalty is a flat 50% royalty.• One half of the royalty is half of whatever the royalty is

or will be in the future.

Duhig• An over-conveyance can occur when prior fractionalmineral reservations occurred in the title, yet theexisting reservations are not recited in a currentconveyance where the grantor is also reserving afractional mineral interest.

• According to Duhig, if a subsequent conveyance does notspecifically exclude a prior reservation or conveyance,then it is deemed to be included in the reservation.

• Example: John conveys Blackacre to Andrew butreserves ¼ of the minerals. Andrew later conveysBlackacre to Brent, and reserves one-half of the mineralswithout reciting anything about the prior conveyance.Applying the Duhig Rule, the court would leave Johnwith ¼, Andrew with ¼, and Brent with ½.

Duhig

•Duhig applies to both minerals and royalty but does notapply to oil and gas leases.•The proportionate reduction clause effectively eliminatesthe need for the Duhig rule.

Duties of the Mineral Estate to Surface Estate

• There is no implied duty of an oil and gas lessee or ownerto restore the surface to its original condition so long as theproduction activities were conducted in a non-negligentmanner. The duties of the mineral estate holder can besummarized as being required to:• Exercise its implied easement over the surface non-

negligently• Use only as much of the surface as is reasonably

necessary• Operate with due regard to the rights of the surface

owner in cases where reasonable alternatives areavailable on the leased premises.

Adverse Possession

• It is possible to get legal title to land in Texas by adversepossession. Texas has several different terms required foradverse possession, based on how good the possessorcould have believed the title to be.

• Under color of title, where the title on its face is good andis not a quitclaim, adverse possession can be had after only3 years.

• The maximum adverse possession period in Texas is 25years. An owner must bring suit within 25 years of theadverse possession even if a disability exists or existed bythe rightful owner.

Adverse Possession• The time periods for adverse possession do not require the

same person to physically occupy the land the entireperiod. Successive possessors can tack periods ofoccupancy together to meet the adverse possession timerequirements, but successive possessors must takeimmediate possession with no gaps of possession between.

• Possession must adhere to these rules:• It must be open• It must be hostile (adverse to the interest of others, not

necessarily violent)• Continuous (can even include time periods of

subsequent possessors)• Peaceable (no one trying to force the possessor off the

land.

Adverse Possession• When one adversely possesses property, he or she can

adversely possess what he or she is not using, not necessarilythe entire property. Under the statute, if land is notenclosed, the claim is limited to 160 acres.

• Adverse possession of minerals requires adherence to theabove rules, but it also requires the actual production of theminerals.

• Adverse possession of severed mineral interest isaccomplished by drilling a well and producing itcontinuously, openly, and visibly.

• Adverse possession of minerals generally involves theproduction of minerals after a lease has expired due tocessation of production where the operator began producingagain without obtaining a new lease.

Adverse Possession• To adversely possess a property interest against a

cotenant, one must also give actual orconstructive notice to the other cotenants of his orher intent to adversely possess.

The Lease

• The oil, gas, and mineral lease in Texas is actually a feesimple determinable with possibility of reverter. Theyare considered executory contracts, meaning that onlythe lessor needs to sign it for it to be effective.

• The payment and acceptance of consideration by thelessor, delivery of the instrument to the lessee withoutrejection, and further actions upon it by the lessee makeit mutual.

• Once an oil and gas lease has been signed and acceptedto change it technically requires the signature of bothlessor and lessee, even to correct a simple typographicalerror.

The Lease

•Conditions which are breached can terminate the lease.•Covenants that are breached simply allow for an action fordamages and generally will not cause a lease to terminate.

•In Texas failure to pay royalties normally does not resultin termination of the lease, but rather, merely an actionfor damages. (covenant)•Failure to properly pay delay rentals is a conditionresulting in forfeiture.

Canons of Construction

• Canons of construction are not rules of law, but ratherstatements of judicial preference. Some canons applied toleases include:• Instruments are construed against the party preparing

the instrument.]• Typewritten or handwritten provisions prevail over

inconsistent printed provisions.• In the event of conflict between provisions, specific

provisions prevail over general provisions.• The Four Corners canon is the primary canon of

construction. Courts will look to the four corners ofthe instrument to determine the intent of the parties.

Canons of Construction

• The Greatest Estate canon states that a deed that does notspecifically limit the size or nature of the interest conveyedwill be interpreted as conveying everything that thegrantor owns, except for those things specifically reserved.

• The In Sequence canon allows the court to interpret thelanguage reciting what was granted before they interpretthe language telling what was reserved. When a clashbetween the language in the granting clause andreservation clause exists, then using positioning thegranting clause will trump the reservation clause.

Common Lease Clauses or Riders• A common rider is a royalty substitution clause which

substitutes a higher royalty for what is printed on thelease.

• An option to extend allows you to extend the primaryterm for a specified term for a fee, usually tied to thebonus amount.

• A horizontal pugh clause provides that operations orproduction will only preserve that portion of the leasewithin a pooled unit or proration unit.

• A vertical pugh clause severs depths below a specifiedlimitation, usually so many feet below the deepest depthdrilled or complete.

• A pugh clause is also known as a freestone rider in Texas.

Common Lease Clauses or Riders• A depth limitation limits the depths a lease will cover.• Consents to assign are sometimes included in a lease so

the lessor knows or has some control over who the lease isconveyed to.

• Many leases in Texas are never released of record unlessthere is a requirement in the lease that it be released.

• Some leases have provisions that require payment ofroyalty in a specified time frame or pay a specified interest.

• Free royalty provides that the lessee shall not deduct thecost of treating, gathering, transporting, dehydrating,compressing, extracting processing, manufacturing,marketing or any other clause.

Common Lease Clauses or Riders

• An in kind clause gives the lessor the ability to take oilor gas in kind based on royalty provided instead ofmoney.

• A favored nations clause provides that the lessee mustoffer the lessor the same deal as owners on adjacentproperties.

• Top leasing allows a lessee to take a lease on landsalready covered by an oil and gas lease. Uponexpiration of the bottom lease, the top lease takeseffect. If the bottom lease is perpetuated the top leasedoes not take effect.

Implied Covenants

• There is an implied covenant to protect against drainage.The reasonably prudent operator may be required to drillreplacement wells, rework existing wells, drill additionalwells or off-set wells, or seek Rule 37 exceptions from theRRC. A lessor is entitled to recover damages from a lesseefor field-wide drainage upon proof of substantial drainageof the lessor’s land with additional facts that support thereasoning that a reasonably prudent operator would haveacted to prevent substantial drainage from the lessor’sland.

Implied Covenants

• Texas does not recognize any implied covenant to drillbut it does recognize the implied covenant to develop.This covenant requires that once the lessee has drilleda well and the lease is held by production, the lesseemust continue to develop as a reasonably prudentoperator would under the circumstances.

• The implied covenant to market requires a lessee tomarket the production obtained within a reasonabletime and at a reasonable price.

• The implied covenant to operate diligently andproperly requires every operator to industriouslyexplore for minerals and diligently operate anyproducing well.

Recording Statutes

• Texas is a notice state which means that the statuteprotects a subsequent purchaser who has paid value andhas no notice of the prior grant. That purchaser is knownas a bona fide purchaser.

• To gain benefit of the recording statute in a noticejurisdiction, a grantee must record before thecompletion of the conveyance to a subsequent BFP.

• An instrument to be recorded obviously must be inwriting.

• Recording an instrument in the wrong county has thesame effect as not filing it at all.

Recording Statutes

• In Texas for an instrument to be properly recorded, it mustbe eligible for recording which means it must beauthorized by statute to be recorded, and it must beproperly acknowledged.

• An instrument that is not authorized by statute to berecorded, but nonetheless gets recorded is void and doesnot give constructive notice to anyone.

• To be protected by the Texas recording statutes, a buyermust be a bona fide purchaser. A BFP is a buyer who haspaid valuable consideration, and had no constructivenotice of another’s interest.

• A gift deed cannot be a BFP because there is noconsideration paid.

• A quitclaim deed grantee cannot be a BFP.

Statute of Frauds

• The Statute of Frauds usually has 4 requirements when itcomes to contracts: A contract must contain the names ofthe parties, the important terms of the agreement, areasonably certain description of the subject matter, andthe signature of the granting party.

Elements of a Deed

• The essential elements of a deed are that:• It must be in writing• It must contain words of grant• It must involve a competent grantor• It must identify the grantee• It must provide for consideration• It must contain an adequate legal description• It must be signed by the grantor• It must be delivered to the grantee.

Taxes and Tax Records

• Tax assessors or collectors of each county maintain acurrent list of all surface owners and owners of producingoil and gas interest.• Texas does not tax minerals which are not being

produced• Oil and gas production is taxed ad valorem (according

to value)• When oil and gas production does occur, the operator

must pay his fair share of taxes and pass on royaltyowner information to the taxing district.

Taxes and Tax Records• Patents do not reflect state ownership so to find out

whether the state owns minerals it is best to look at thepatent date.• On patents issued before 9/1/1895 the state did not

reserve any minerals.• For lands patented on or after 9/1/1895 and before

8/21/1931 the surface and state shared the economicbenefit.

• Between 8/21/1931 and 6/19/1983 the state reserved anon-participating royalty of 1/16 of all mineralsincluding oil and gas.

• The general rule on well bore assignments is that thelessee can recomplete up hole but cannot deepen the well.

Unleased Interests

• In Texas, an unleased mineral owner may be left out of avoluntary unit, but the unleased cotenant’s property can beincluded in unit as long as one cotenant is included.• As long as the unleased cotenants are not in the drillsite

tract, they can elect to participate in the drilling of thewell an become a working interest owner, or they can sitback and wait for the well to pay out and then get theirfull share of production.

• If the operator were to drill on a tract with an unleasedmineral interest owner, the unleased owner is entitledto his or her actual share of production from thebeginning of production.

Unleased Interests

• When an owner cannot be found, a judicial procedure canbe started to obtain a receiver’s lease.

• The court appoints an attorney a litem (for the purposesof the suit) who represents the missing person.

• Proceeds from the lease are put into the registry withthe county clerk and if no one claims these funds after aperiod of time, the monies escheat to the state.

Succession

• When a mineral owner dies with a will, whether or not anexecutor or administrator can convey and bind realproperty without court intervention depends on if theprocess is independent or dependent.

• A small estate may be probated with a simple form ofprobate called a Muniment of Title.

• Affidavits of heirship are frequently used to determinefacts when an owner dies intestate. These are frequentlyrelied on as a business risk. The affidavit should be astatement of the decedent’s family history, genealogy,marital status, and identify any heirs. The affidavit’svalidity is premised upon it being executed by the maker,acknowledged before a notary public, and having been ofrecord for 5 years.

Succession• Rules of Descent and Distribution (sometimes called

Intestate Succession) in Texas are as follows:• Decedent’s Community Property

• Dies with no children then all to surviving spouse• Dies with spouse and children –

• If the decedent died before September 1, 1993 then thedecedent’s share of the community to the decedent’schildren, per stirpes

• If the decedent died on or after September 1, 1993 then –• If all of the decedent’s children are of the decedent’s

marriage to the surviving spouse the decedent’s shareof the community goes to the surviving spouse

• If at least one or more of decedent’s children are notborn of the decedent and current spouse, thedecedent’s share of the community goes to thechildren per stirpes.

Succession

• Decedent’s Separate Property –• If survived by spouse and children then 1/3 life estate

to the spouse with remainder in children. Two-thirds in fee to children (real estate only).

• If survived by spouse and no children, then half tospouse and half to “heirs at law” which are:• Surviving parents – half to each• If only one parent survives, the other one half to

brothers and sisters per stirpes.• If no parents, brothers, sisters, nieces, or

nephews then all to the surviving spouse.

• If the unmarried person dies intestate and has nosurviving heir, the property will escheat to the State ofTexas.

Succession• Texas adopted a rule that provides that half-blood

collaterals receive half share of intestate property.• Stepchildren may not inherit from their stepparents under

Texas intestacy law but can inherit under a will.• If a person dies intestate in another state, the intestacy laws

of the place where the property is decides what happens tothe property.

• Per stirpes means devised equally based on survivinglineage. For example, John dies with 3 children (Alex,Bailey,and Chad) but no spouse. Chad predeceased hisfather but left two surviving children. If John’s childrenwere to receive per stirpes, Alex and Bailey would eachreceive 1/3 and Chad’s children would each get 1/2 of 1/3.

Regulatory• The Railroad Commission handles the regulatory side of oil

and gas permitting and was set in place with a mission toprotect correlative rights and to assure that productionactivities continue in an organized safe manner.

• The Texas Commission on Environmental Quality (TCEQ)formerly known as the Texas Natural Resource ConservationCommission determines what is necessary to protect water.

• Monthly production reports must be filed with the RailroadCommission on both oil and gas wells.

• A permit must be obtained from the RRC prior to drilling awell or plugging a well.

Railroad Commission Rules

• Rule 37 establishes the general minimum well spacing rulesin the absence of special field rules:• Currently under Rule 37 wells, wells must be at least 467’

from any lease, property or subdivision line, and 1200’between each other in the same reservoir.

• An exception to a Rule 37 requires a hearing before theRRC.

• Rule 38 sets the minimum spacing density per well at 40.• Rule 11 requires that all wells be drilled as nearly as

vertical as possible by normal, prudent, practical drillingoperations.

Pooling and Unitization• Pooling in Texas is usually accomplished voluntarily

due to pooling language in the lease.• Although pooling and unitization are distinct concepts

these terms are often used interchangeably. The 5types of common units in Texas are:• Drilling unit – the acreage area shown on the W1

application for Permit to Drill• Proration Unit – the acreage designated on form P15

showing the acreage assigned to the well forproration purposes where field rules provide for thesetting of allowables on an acreage basis. Theproration unit is designated after the well is drilledand completed and only productive acreage can beassigned to a proration unit.

Pooling and Unitization• The most common form of pooling in Texas is a voluntary

pooled unit formed by the voluntary joinder of separateownership interest. A voluntary pooled unit is created bythe community lease (where more than one tract isshown on the lease.)

• Pooling and cooperative agreements are RRC approvedunits necessary to effect secondary or tertiary recoveryoperations for oil or gas, usually for water flooding.

• The force pooled unit under the Mineral Interest PoolingAct.

• Holding a unit with a single or a few wells helps operatorsdevelop PUDs (proven undeveloped well locations)which the operator can sell for a profit without expendingany money to develop them.

Pooling and Unitization• Most units are allowed to be 640 acres (plus 10 percent

tolerance, bringing the total to 704 acres); however, unitscan be other maximum sizes based on RRC regulation.

• Forty acre oil units are common as well as tract wells. TheRRC allows production for a single tract even if it is notlarge enough to meet minimum size requirements, but thewell will be given a reduced allowable.

• Normally the RRC requires that at least 65% of the royaltyinterest and 85% of the working interest commit to the unitagreement before a hearing on approval will be granted.

• Drilling and proration units have no effect on title. Theseare simply regulatory depictions.

Pooling and Unitization

• Texas has a force pooling act, the Mineral InterestPooling Act, but it is so rarely used it might as well notexist.

Division Orders and Calculating Royalties and Interests• One of the most important tasks of the division orderanalyst is to create the net revenue.• A NRI of 75% or greater is the usual desire of a lessee

and could be considered a minimum industrystandard.

• The generally accepted rule of thumb is to use eightdecimal places when determining interest.

• An individual tract may be covered by one or moreleases. A pooled unit always involves more than onelease.

• Production from a unit may be sold under more thanone contract.

Division Orders and Calculating Royalties andInterests

• Texas uses the tract allocation rule to separate gas salesproduced from pooled units. The tract allocation methodrequires royalty owners to be paid on the basis of theamount received by their individual lessee from the saleby their lessee of production of gas from the unit allocatedto the tract in which the royalty owner owns an interest.

• The language in the oil and gas lease usually provides forroyalty allocation on a surface acreage basis.

• Without express language in an oil and gas leaseindicating otherwise, Texas courts allow lessees to deductpost production expenses regardless if the lease has amarket value royalties clause or a proceeds royalty clause.

Division Orders

• Case law in Texas permits the following post-productionexpenses to be deducted from royalties:• Gross production and severance taxes; transportation

charges• Expenses of treatment to make the gas marketable,

such as hydrogen sulfide removal• Expenses of compressing the gas to make delivery into a

pipeline.• Processing costs incurred in extracting the liquids

(dehydration) and other value adding costs.

Division Orders• The Texas State Comptroller allows operators to deduct

many expenses when determining the taxable value ofgas for severance purposes, including some marketingexpenses. Normally the deductible expenses the stateallows for severance tax purposes include compression,dehydration, sweetening, and delivering the gas to thepurchaser.

• The Texas Natural Resources Code contains the lawrequiring timely payment of proceeds from the sale ofoil or gas.• The proceeds must be paid to the proper party on or

before 120 days after the end of the month of firstsale of production from the well. After thatpayments must be paid as specified in the lease orother agreement.

Division Orders• If the lease or other agreement does not specify the time

for payment, subsequent proceeds must be paid no laterthan 60 days after the end of the calendar month in whichsubsequent oil production is sold.

• Payment must be made 90 days after the end of thecalendar month in which gas is sold.

• Payments may be withheld without interest beyond thetime limits above when:1. There is a dispute concerning title that would affect

distribution of payments2. A reasonable doubt exists:

• That the payee has sold or authorized the sale of itsshare of the oil or gas to the purchaser of suchproduction

• The payee has clear title to the interest

Division Orders3. A requirement in a title opinion places in issue the title,

identity, or whereabouts of the payee and that has not beensatisfied by the payee after a reasonable request for curativeinformation has been made by the payor.

• In Texas a division order may not amend any lease oroperating agreement between the lessee or operator or anyother contracts for the purchase of oil or gas.

• A payor shall be entitled to receive a signed division orderfrom the payee containing only the following provisions:• The effective date of the division order, transfer order, or

other instrument• A description of the property from which the oil or gas is

being produced and the type of production

Division Orders• The fractional and/or decimal interest in production

claimed by payee, the type of interest, the certification oftitle to the share of production claimed, and unlessotherwise agreed to by the parties, an agreement toindemnify the payor and reimburse the payor for paymentsmade if the payee does not have merchantable title to theproduction sold.

• The authorization to suspend payment to payee forproduction until the resolution of any title dispute oradverse claim asserted regarding the interest claimed.

• The name, address, and taxpayer ID of payee• Provisions for the valuation and timing of settlements of

oil and gas production to the payee• A notification to the payee that other statutory rights may

be available to a payee with regard to payments.

Division Orders

• If an owner in a producing property will not sign adivision order because it contains provisions in additionto those provisions provided for in the above section,payor cannot withhold payment solely because of therefusal to sign the division order.

• If an owner refuses to sign a division order whichincludes only these provisions specified in the statute,the payor may withhold payment without interest untilthe division order is signed.

• Payment may be remitted annually for the aggregate ofup to 12 months of proceeds if the payor owes the payeea total of $100 or less.

Division Orders• The payor may hold accumulated proceeds of less than

$10 until production ceases or the payor’s responsibilityfor making payment for production ceases, whichevercomes first.

• On the written request of the payee, the payor must remitpayment of accumulated proceeds to the payee if thepayee owes the payor less than $10.

• On the written request of the payee, the payor must remitpayment of proceeds to the payee monthly if the payorowes the payee more than $25 but less than $100.

• Division orders are binding for the time and to the extentthat they have been acted on and made the basis ofsettlements and payments.

Division Orders• From the time that notice is given that settlements will

not be made on the basis provided in them, divisionorders cease to be binding.

• Division orders are terminable by either party on 30 dayswritten notice.

• The execution of a division order between a royaltyowner and a lessee or between a royalty owner and aparty other than the lessee does not change or relievethe lessee’s specific, expressed, or implied obligationsunder an oil and gas lease, including any obligation tomarket production as a reasonably prudent lessee. Anyprovision of a division order between payee and itslessee is invalid to the extent of the contradiction.

Division Orders• Every payment must have the following information

reported with it:• Property identification (name, number, or both and

county and state)• Sales month and year• Volume sold• Price per barrel or mcf• Severance or other taxes deducted• Other deductions or adjustments• Net value• Owner decimal interest• Owner gross value• Owner net value• Address and phone number where additional

information can be obtained.

Division Orders

• If a royalty owner notifies the payor in writing of failureto make timely payment, the payor must either makepayment or respond in writing within 30 days of receiptof the notice.• Requests sent by certified mail for information

regarding itemized deductions, adjustments, theheating value of gas, or the Railroad Commission ofTexas identification number for the lease, property,or well must be responded to within 60 days ofreceipt.

• Additional requests sent by certified mail forinformation not covered by the statutes must beresponded to within 30 days of receipt.

Division Orders• If payment has not been made for any reason within the

time limits specified, the payor must pay interest to apayee beginning at the expiration of those time limits attwo percentage points above the percentage rate chargedon loans to depository institutions by the New YorkFederal Reserve Bank, unless a different rate of interest isspecified in a written agreement between payor andpayee.

• If a payee seeks relief for the failure of a payor to maketimely payments of proceeds from the sale of oil or gas asrequired, the payee must give the payor written notice bymail of the failure as a prerequisite to beginning judicialaction against the payor for nonpayment.

Division Orders

• The payor has 30 days after receipt of the required noticefrom the payee in which to pay the proceeds due, or torespond by stating in writing a reasonable cause for non-payment.

• A payee has cause of action for nonpayment of oil or gasproceeds or interest on those proceeds in any court ofcompetent jurisdiction in the county in which the oil or gasis located.

• If the court finds in favor of the plaintiff, the finaljudgment must include an award of reasonable attorney’sfees and a minimum of $200 in actual damages.

Division Orders• Following a change in payor, the new payor must give

written notice to each payee to whom the payor isresponsible for distributing oil or gas proceeds.• This notice should include the payor’s phone number.• The notice may be given by any writing, including a

division order, a check stub, or attachment to a paymentform.

• A payor that is obligated to pay interest to a payee andthat does not give the payee a notice required is liable tothe payee for interest at a rate that is two percent morethan the rate provided by the Texas Natural ResourcesCode.