Celia Flowers and Eric Schmalbach March 20, 2014 FLOWERS DAVIS, P.L.L.C. NOW THAT THERE IS NO STANDARD LEASE FORM – WHAT PROVISONS CAN WE EXPECT TO SEE MINERAL OWNERS NEGOTIATE?

The Oil and Gas Lease is No Longer a Form + = No Standard Form

How to Determine What New Terms Mean –Understand how courts interpreted old provisions –Contract Interpretation: Read the lease carefully

Roadmap –Initial Lease Negotiations: Bonus and Royalty –Secondary Lease Negotiations: Lease Clauses –Unusual Clauses –Surface Use

Initial Lease Negotiations - BONUS What to Expect from Lessor: –Unconditioned check –Clause increasing bonus if more net acreage is discovered

Initial Lease Negotiations - ROYALTY VALUATION: –Amount realized vs. Market value –Lessor may add language protecting decline in market value POST PRODUCTION EXPENSES: –Dehydration, Processing, Transporting –Lessor may add “no costs provision”

Secondary Negotiations – Lease Clauses Habendum Clause Shut-In Royalty Clause Temporary Cessation of Production Clauses Force Majeure Clause Pugh Clauses

Habendum Clause Defines duration of lease –“So long thereafter as operations are conducted” Lessor Wants: –So long thereafter as oil, gas, and minerals are being produced

Shut-In Royalty Clause Payments in lieu of production No market Lessor may attempt to negotiate: –The amount paid –The amount of time can be used –The number of times which can be used

Shut-In Royalty Clause - Examples Make sure to read carefully for problems: AVOID: “Lease may not be maintained by shut-in longer than two years past primary term.” AVOID: “Shut-in royalty paid in same amount as delay rentals” if no delay rental clause.

Temporary Cessation of Production Implied judicial doctrine –Mechanical problems –Operations Clause strictly interpreted Lessor Wants: –Limit or define operations –Limit the time to get production restored

Force Majeure Clause Lessee wants: –Events that are unforeseeable AND –Events that are inconvenient –Long list of events Lessor Wants: –Limit the events –Strike or omit inconvenient acts

Pugh Clauses Vertical Pugh Clause Horizontal Pugh Clause (Depth Severance)

Horizontal Pugh Clauses – Examples Lessor wants to release everything above and below depth Severance at a particular depth: –10,000’ below the surface –100’ below the stratigraphic equivalent of the deepest well drilled Avoid using terms which could be open to interpretation (zone, strata, horizon)

Insertion of Unusual Clauses by Lessor Entire tract to be included in unit Anti-dilution provisions Assignment upon approval of lessor Changes to warranty language Rights to title opinions, accounting and other documents, access to rig floor Payment clauses for tracts with a horizontal wellbore

Surface Estate – Rights to Use Surface Rights of Lessee: –Rights to develop and produce –Rights to ingress/egress –Rights to use as much of tract as reasonably necessary

Surface Estate – Limitations Limitations of Lessee to use surface: –Not to use more than is reasonably necessary –Non-negligent use –Due regard/Accommodation –City ordinances –Express provisions

Surface Estate – Use by the Mineral Owner Rights under the lease and case law Roads? Use of sand/gravel? Well location? Can lessee drill the opening weekend of deer season? ?

Surface Estate – Use by the Mineral Owner Can lessee conduct seismic operations on the land without further permission? Does Lessee have to pay damages? Even to crops? Improvements? Any duty to fence? Any duty to restore? Can Lessee use the water from a lake, drill a well?

Surface Estate – Lease Granting Clause Grants the ability of the lessee to produce and explore for minerals –Watch for the placement of the word “exclusive”

Surface Estate – Express Provisions Restrictions to Lessee’s use of surface –Limit the location of drilling –Limit the location of roads, pipelines, etc. –Require the lessee to bury pipelines –Require the surface to be restored to its original condition –Restrict the Lessee’s use of both surface and subsurface water

Surface Estate – Express Provisions Damages for Use –Pay for reasonable damages to land, pastures, crops, fences –Pay for use of water –Payment may be a rate or fee schedule –Limited to the imagination of the drafter

Lease Negotiation Checklist Get preliminary information on the operation Look at the tract size Know the lease form you are sending Read Carefully: –Use the same terminology –Modifications/Alterations –Logical Consistency

Questions?