Robert May et al v. Ineos USA Oil & Gas, LLC et al, could, if you are so inclined, serve as a tutorial on terms used in oil and gas transactions or, if you are further along than that, it could be your guide for negotiating and drafting farmouts.
The agreements between the plaintiffs/farmors and defendants/farmees were sui generis, so this result will not necessarily translate to other disputes. The significance of the decision is the Court’s definition and application of common oil and gas terms. For example: “fee simple determinable”, “possibility of reverter”, “special limitation”, “condition”, “covenant” and “farmout agreement” (our self-imposed space limitations do not allow elaboration).
The facts
Farmees drilled wells under the farmout agreement and farmors executed partial assignments of acreage, retaining a reversionary back-in interest in two leases. The back-in, which excluded assets earned by farmees, was effective at “Payout”. The contractual trigger that could cause lease termination and reversion of undrilled acreage was the cessation of continuous drilling operations.
The issues
After being sued by the farmors, defendant/farmees sought summary judgment raising these questions:
- Did the contracts convey the leases up-front or merely grant a right to earn property?
- Which events could trigger lease termination?
- Were farmees’ contractual obligations covenants or conditions?
- What method would be used to calculate payout?
Assignment or agreement to assign?
The Court explained that when a farmout agreement requires compliance with conditions before the assignment occurs, the farmout is an “agreement to transfer” after performance. In contrast, a conditional assignment is created when the contract assigns interests that vest immediately, subject to later divestment. Parties are free to do it either way.
The transaction was a conditional assignment of a vested fee simple determinable, immediately conveying the leases to farmee/defendants. There was granting language and a specific effective date. It was not a “drill to earn” arrangement. Immediately upon assignment. Defendants held an immediate, fixed right of present or future enjoyment of the interest conveyed. A carveout for “assets earned” was drafted as an exception to the farmors’ reversionary interest, not an exception to the assignment.
Retained acreage clause – a covenant, a condition, a special limitation?
Breach of a condition results in automatic termination of the leasehold estate upon the happening of stipulated events. Breach of a covenant subjects a breaching party to liability for monetary damages or, in extraordinary circumstances, the remedy of a conditional decree of cancellation.
Both a special limitation and a condition call for termination. A retained acreage provision can impose a special limitation on a general grant of interests only if the language is so clear, precise and unequivocal that a court can reasonably give it no other meaning.
The earned‑acreage/retained‑acreage language operated as a special limitation on defendants’ estate. Upon cessation of continuous drilling operations farmees’ interests in the leases automatically terminates as to acreage not retained or “earned”. This is not a forfeiture and does not require breach or default.
Payout
Under the language of these contracts a well drilled on acreage that had already been earned would not be an “Earning Well” and could not trigger Payout. In arriving at this conclusion, the Court construed the unambiguous terms of the operative provisions of contracts and declined to consider contract recitals.
Parol evidence rejected
The Court denied plaintiffs’ tender of extrinsic evidence, in particular on how the parties interpreted the contracts and the course of performance after execution. A court cannot consider course of performance evidence to interpret an unambiguous contract.
Partial summary judgment granted for defendants.
Unresolved issues
See Opinion p. 6 for questions that were left for another day.
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