New Lease or Top Lease? Lessor’s Intent Will Govern

In Anadarko Petroleum Corp. v. TRO-X, L.P., No. 08-15-00158-CV, 2016 Tex. App. LEXIS 2861, the El Paso Court of Appeals concluded that the execution of new leases operated to terminate and release old leases covering the same lands. Id., at *22. The Court recognized that there was not enough evidence to show (i) that the Lessors placed any emphasis on the execution of a separate release of the old leases to make the new leases effective, or (ii) that the Lessors intended for the new leases to be top leases that would come into effect only upon the recordation of a Release Agreement. Id., at *21-22.

In February 2007, David E. Cooper, Hill-Cooper, Ltd., Richard W. Cooper, Kendall C. Hill, and Shirley Cooper (the “Lessors”) executed five oil and gas leases in favor of TRO-X, as Lessee (the “2007 Leases”). Id., at *2. The 2007 Leases contained an Off-Set Well Provision that required TRO-X to protect against drainage from wells completed outside of the lease boundaries. Id. The Provision stated that “[i]f Lessee should fail to timely commence operations for the drilling of an offset well, then, on demand of Lessor, Lessee shall surrender this Lease as to that portion of the Leased Premises . . . .” Id., at *3.

In March 2007, TRO-X assigned its interest in the 2007 Leases to Eagle Oil & Gas Co. (“Eagle”), and reserved a limited contingent reversionary interest (the “Assignment”). Id., *3-4. Once Eagle reached payout on its drilling activity on the 2007 Leases, then TRO-X could exercise a “back-in” option allowing TRO-X to receive five percent (5%) of its original working interest in the 2007 Leases. Id., at *4. Subsequently, Eagle assigned all of its interest in the 2007 Leases to Anadarko, which began drilling operations on the leasehold. Id.

On November 15, 2008, Anadarko completed a well on non-leasehold land that was 550 feet from the boarder of the 2007 Leases. Id., at *6. The parties disputed whether Anadarko’s off-lease well fell within the 2007 Leases’ off-set zone in light of an administrative change to the Railroad Commission’s drilling patterns in the Phantom Wolfcamp Field. Id. The parties did not dispute that if the off-set provision was triggered, then Anadarko failed to drill a reciprocal off-set well as required by the 2007 Leases. Id. However, the issue of whether the off-set well provision in the 2007 Leases was breached was not before Court.

Rather, two years later, on May 25, 2011, the Lessors sent Anadarko a demand letter alleging that they had the right to terminate the 2007 Leases for breach of the Off-Set Well Provision, stating “[t]his letter shall serve as the above mentioned Demand of Release. I would appreciate your timely review and preparation of the Release of Oil and Gas Lease.” Id. Upon review, Anadarko determined that it had, in fact, breached the Off-Set Well Provision, and that the Lessors’ written demand automatically re-vested the leased mineral interests back with the Lessors. Id., at 6-7. As a result, Anadarko and the Lessors entered into lease negotiations. On June 6, 2011, Anadarko sent an e-mail to the Lessors, stating in relevant part:

“Anadarko would be prepared to offer you and the other Hill/Cooper family members a new lease – on the full 640 acres – for $400 per acre, at a one year primary term. The lease would be made on a form practically identical to our existing lease. Ideally, the lease would be dated effective, on or about June 24, 2011 – and we would file a release of the existing lease concurrent with the execution of the new lease[.]” Id., at *7.

The Lessors responded that if Anadarko increased their offer to $800 an acre, then they would be amenable to accepting the offer. Id at 7-8. Anadarko replied asking if the suggestion could be restated as a formal counter-offer that could be presented to Anadarko for approval. The Lessors then sent the following response e-mail:

“I will give you an answer before 5. I am also assuming that the document would be an extension of the current lease so we do not have to deal with renegotiating any other point in the 2007 lease and the addendum A thereto. I believe you stated so earlier, but I just wanted to be sure.” Id., at *8.

Anadarko responded, in relevant part:

“Yes. The document would be on the same form and content as the current lease so you are correct there would not be any other renegotiating point. It would not be an ‘extension’ so much as a new lease (again, of the same form and content as the old) made effective this month (with a concurrent release of the old lease)[.]” Id.

Eventually, the Lessors and Anadarko reached an agreement, and on June 17, 2011, the Lessors executed new leases (the “2011 Leases”) naming Anadarko as lessee with respect to all of the mineral interests covered by the five original 2007 Leases. Id., at *8-9. The new leases required Anadarko to pay a higher rate per acre, shortened the length of the primary term from three years to one year, and imposed a 240-day drilling commitment on Anadarko. Id. On June 30, 2011, Anadarko executed a release of any interests it held on the 2007 Leases (the “Release Agreement”). Id. The 2011 Leases were recorded on June 30, 2011, but the Release Agreement was not recorded until August 4, 2011. Id.

TRO-X then brought suit against Anadarko, as assignee of Eagle, alleging that it was entitled to five percent of Anadarko’s interest in the 2011 Leases, pursuant to the “back-in” provision under the Assignment. Id., at *10. The trial court concluded that the 2011 Leases were top leases and that TRO-X was entitled to its 5% back-in working interest. Id.

The Court of Appeals disagreed and reversed the trial court’s determination. The central question on appeal was whether, the delay between the execution of the new leases and the execution of a written release of the old leases was evidence of the Lessors’ intent that the 2011 Leases were to be top leases that came into being only upon recording the Release Agreement for the 2007 Leases. Id., at *10-11. If the 2011 Leases were determined to be top leases, then TRO-X would be entitled to the five percent back-in working interest pursuant to the “back-in” provision under the Assignment. Id.

The Court of Appeals did not address whether Anadarko breached the Off-set Well provision in the 2007 Leases. Instead the Court focused on whether the execution of new leases by the Lessors was sufficient to demonstrate the Lessors’ intent to terminate the prior leases. The Court explained that executing and recording a Release Agreement after executing the new leases is not sufficient to show that the Lessors intended for the leases to function as top leases until the release was executed and recorded. Id., at *15. In Sasser v. Dantex Oil & Gas, Inc., 906 S.W.2d 599, 603-05 (Tex.App.–San Antonio 1995, writ denied), the San Antonio Court of Appeals concluded that “by signing a new lease with the intent to terminate a prior lease, a lessor waives strict compliance with a surrender clause and effectively terminates or releases the prior lease.”

Here, TRO-X was unable to meet its burden to establish that Lessors’ intended the 2011 Leases to be top leases. The evidence before the Court suggested that it was the Lessors’ intent that new leases would be executed and the 2007 leases would be terminated. For example, the e-mails showed that Anadarko did not request an extension of the 2007 Leases, but instead proposed new leases covering the same mineral estate on different terms. Id., at *19-20. Moreover, the Lessors never (i) questioned the characterization of the leases as being “new,” (ii) objected that the new leases and the release of the old leases would go into effect simultaneously, and (iii) voiced any other wishes to structure that transaction using top leases as legal scaffolding around the deconstruction of the old leases. Id., at *20. Instead, the focus of the negotiations between Lessors and Anadarko was on a new price point and new drilling terms. Therefore, the Court determined that nothing in the record showed that the Lessors intended for the 2011 Leases to be top leases that would come into effect only upon execution of a release. Id.

In summary, the lessor’s intent will have a significant role in determining whether new leases will be characterized as top leases or as new leases terminating any prior leases. It is important that when operators are negotiating with mineral owners that the negotiations are well documented and it is clear between both parties whether the newly executed is a top lease and will not be effective until the prior lease is released or if the lease is a new lease and the prior leases are terminated and washed out.