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Energy & the Law

Perils of Proportionate Reduction, and a Detour Through D-Day

Posted in Title Issues

First, an admission and a regret:  My June 6 post missed the 69th anniversary of an episode as significant as any in our country’s history: D-Day.  I think I know why.  As time passes and the participants in that venture become fewer, there aren’t as many left to tell the story, the celebrations dwindle, and the meaning of D-Day becomes further removed from our collective memory.  (Note to middle schoolers and those who don’t read much: Abraham Lincoln was not the president during WW II).

The pics are of my uncle, Judge Lenton Sartain, then and now. Then he was a 23 year old lieutenant-soon-to-be-captain in the 82nd Airborne Division. On the night of  June 6 he and his troops and their artillery were packed into plywood gliders and cut loose several miles beyond the beaches. From there they helped to blast the advance out from the coast and pressed on to Holland, Belgium and Germany. I could go on but, as you’ve heard, the rest is history.  Now he is 92 years old, in well-deserved retirement, and feeling pretty good.

Now, on to business.

Our co-author today is Alexandra Crawley

Today’s post is about blocking and tackling – no lofty public policy considerations to get the electorate all fired up.  We see a recurring issue with the proportionate reduction clause in leasehold assignments that reserve an overriding royalty interest. The interpretation of these assignments – i.e. who gets the money – hinges on whether proportionate reduction covers the “mineral estate”, the “leasehold estate”, or both. Learn from the following examples:

The Deal

Tiger Drilling takes an Oil and Gas Lease with a lessor’s royalty of 15%. Tiger assigns 50% of its interest in the lease to 12th Man Operating, reserving an ORRI equal to the difference between existing lease burdens and 18%.

The First Scenario: The “Mineral” Estate

The assignment contains the following proportionate reduction clause:

If any lease assigned to Assignee covers less than a full mineral interest or if Assignor’s interest in such lease is less than the full mineral estate, then each overriding royalty interest reserved by Assignor in each such lease shall be reduced proportionately.  (all emphasis is ours)

It appears that 12th Man’s scrivener was not as slick and quick as their pesky quarterback.  Tiger would be credited with an ORRI equal to the difference between existing lease burdens and 18% applicable to 100% of the mineral interest assigned, not an ORRI equal to the difference between existing lease burdens and 18%, applicable to 50% of the mineral interest.

This is because there is no proportionate reduction clause reducing the reserved ORRI to the 50% leasehold interest being assigned. Therefore, Tiger would have the full 3% overriding royalty (18% minus the lessor’s royalty of 15%), all of which burdens 12th Man’s 50% leasehold interest in Subject Lease.

Second Scenario: The “Mineral” and the “Leasehold” Estates

The assignment contains the following proportionate reduction clause:

If any lease assigned to Assignee covers less than a full mineral interest or if Assignor’s interest in such lease is less than the full mineral estate, then each overriding royalty interest reserved by Assignor in each such lease shall be reduced proportionately. If the interest conveyed to Assignee herein is less than the entire leasehold estate, the overriding royalty shall be reduced proportionately to the interest conveyed.

Here, Tiger would be credited with an ORRI equal to the difference between existing lease burdens and 18%, applicable to 50% of the mineral interest assigned, rather than an ORRI equal to the difference between existing lease burdens and 18% and 100% as above. Pay attention to that second sentence. The clause now addresses both the mineral and leasehold estates.

The result is that Tiger would have a 1.5% overriding royalty (18% minus the lessor’s royalty of 15% multiplied by 50%), burdening 12th Man‘s 50% leasehold interest in the lease.

The Lesson

Double-check your proportionate reduction language. Does it reflect the parties’ intentions? If you intend to proportionately reduce the ORRI to the leasehold interest assigned, be sure to include “leasehold” language.