Term Royalty Interests Burdening Partially Pooled Non-Drillsite Lands

In Cottrell v. Keystone Grazing Ass’n, No. 110,649, 2014 Kan. App. Unpub. LEXIS 606, 329 P.3d 1254 (Kan. Ct. App. Aug. 1, 2014), the Court of Appeals of Kansas concluded that production from a gas unit did not extend term royalty interests as to lands covered by the term royalty interests but not included within the unit boundaries.

The dispute in Cottrell focused on the ownership status of term royalty interests under an Oil and Gas Lease dated May 26, 1971, from J.R. Cottrell and Willa Cottrell, as Lessors, to Ralph M. Reynolds, as Lessee (hereinafter “Reynolds Lease”).  The Reynolds Lease covered more than 1,000 acres of land in Meade County, Kansas, and had a primary term of five years.  In Cottrell, the parties disputed the status of the following term royalty interests (collectively “Cottrell Term Royalty Interests”):

  1. A 1/3 term royalty interest for a term of 20 years beginning May 5, 1971, and as long thereafter as oil, gas and other minerals may be produced, claimed by Elsie E. Cottrell, as Trustee of the Elsie E. Cottrell Revocable Trust dated June 24, 1998;
  2. A 1/3 term royalty interest for a term of 7 years beginning October 29, 1971, and as long thereafter as oil, gas and other minerals may be produced, claimed by J. Marc Cottrell, personal representative of the Estate of J.R. Cottrell, Deceased, owned; and
  3. A 1/3 royalty interest, all reversionary rights under the 2/3 term royalty interests named above, and a 100% mineral interest claimed by Keystone Grazing Association, Inc. (“Keystone.”) Id. at 1-6.

In 1972, following a series of working interest assignments, Imperial Oil Company established the 640-acre Roberts Unit, which included 40 acres of the lands covered by the Reynolds Lease.  Id. at 7.  A well was drilled in the Roberts Unit that continues to produce to the present day, but no well was ever drilled on the 40 acres covered by the Reynolds Lease.  Id.  There were no other wells drilled on any of the lands covered by the Reynolds Lease outside the Roberts Unit during the respective terms of the Cottrell Term Royalty Interests.  Id. at 9.  Therefore, the Reynolds Lease remained in effect past its primary term solely as a consequence of production on the 40 acres included in the Roberts Unit.  Id. at 8.  None of the parties challenged the extension of the Reynolds Lease based on production from the Roberts Unit.  Id. at 15.

In 2011 and 2012, after the expiration of the respective primary terms of the Cottrell Term Royalty Interests, and following another series of assignments, Edison Operating Company, LLC (“Edison”) obtained a working interest in the Reynolds Lease.  Edison obtained production from two additional wells drilled on lands covered by the Reynolds Lease but not included in the Roberts Unit.  Id. at 8.    Keystone asserted that because there were no wells drilled on any of the lands outside of the Roberts Unit during the respective primary terms of the Cottrell Term Royalty Interests, those interests lapsed as to all lands outside said Unit and reverted to Keystone.  Id. at 7-9.  Keystone, therefore, claimed that they were entitled to 100% of the royalties due on those lands outside of the Roberts Unit.  Id.

Keystone’s assertion that it was entitled to all royalties from production on lands outside the Roberts Unit resulted in competing quiet title actions filed by Keystone and the Cottrells.  Id. at 9.  Pursuant to those dueling claims, the District Court addressed the question of “whether a terminable mineral royalty interest in contiguous tracts of land over 1,000 acres in size subject to a single lease is perpetuated in the total acreage solely by reason of inclusion of a 40-acre tract of that land in a petroleum production unit.”  Id. at 11-12.  The District Court concluded that the terminable royalty interests were only maintained as to that 40-acre portion of the lands lying within the Roberts Unit, and granted summary judgment in favor of Keystone.  Id. at 10-11.

The District Court explained that “a defeasible term mineral interest cannot be extended unless there is a well physically located on the land which is subject to the grant.  However, if a portion of the land is effectively pooled or unitized, the duration of the grant will be extended to acreage which actually participates in production from the pooled or unitized operation.  Acreage included in the grant, but not participating in unit production, will not be held by pooled or unitized operations.”  Cottrell, at 18-19 (citing Friesen v. Federal Land Bank of Wichita, 608 P.2d 915 (Kan. 1980) and Classen v. Federal Land Bank of Wichita, 608 P.2d 1255 (Kan. 1980)); 1 David Pierce, Kansas Oil and Gas Handbook § 9.21 p. 9-20 (1986).

The Cottrells appealed and asserted that Friesen and Clausen did not apply because the Cottrell Term Royalty Interests were royalty interests that arose from the Reynolds Lease as opposed to term mineral interests that are appurtenant to the land.  Id. at 20.   The Cottrells argued that “when a royalty is conveyed for a term of years and so long thereafter as oil or gas is produced from said land subject to that interest, then production under the oil and gas lease to extend the lease must also be regarded as production for purposes of determining the duration of the royalty interest.”  Id. at 20-21.  The Cottrells attempted to bolster their position by emphasizing that, in Kansas, royalty interests are considered personal property, and mineral interests are considered real property.  Id. at 24.  Therefore, they argued that their personal property interest in the term royalties should be maintained, by virtue of continuing production from the Reynolds Lease.  Id. at 26-27.

The Court of Appeals of Kansas rejected the Cottrells’ argument, concluded that Friesen and Classen control, and affirmed the District Court’s decision in favor of Keystone.  Id. at 29, 34.  The Court of Appeals explained that “for all relevant purposes, the facts of this case are indistinguishable from Classen except for the [type of] reserved interests.  In Classen, it was a one-fourth mineral interest.  Here it is a one-third royalty interest . . . We cannot justify a different result from Classen under the present facts.  In the hierarchy of interests, a royalty interest is derivative of the mineral interest.”  Id. at 31-32, 34.

However, the Court of Appeals indicated that its decision may have been different depending on the specific language of the instruments involved, and depending on whether production occurred “on the premises” of the property, as opposed to production occurring on property in a pooled unit that was not in the original grant.  Id. at 27-28; Fritschen v. Wanek, 924 P.2d 1288 (Kan. Ct. App. 1996).  The Cottrell court also acknowledges that the facts in this case might be determined differently in other jurisdictions.  Cottrell, at 30; Williamson v. Fed. Land Bank of Houston, 326 S.W.2d 560 (Tex. Civ. App.—Texarkana 1959, no writ).[1]

Cottrell is significant for operators in determining the correct amount and allocation of production payments.  Under Cottrell, defeasible term royalty interests that are voluntarily pooled with other lands will remain in force and effect only as to that portion of the property actually included in the unit.  However, if the land covered by the term royalty interest is a drillsite tract, then production will likely continue the term royalty interest even as to those lands lying outside a pooled drilling unit.  Cottrell also indicates that maintenance of a terminable royalty interest will depend on the language of the instruments creating the interest, and the pooling provisions of the lease.

[1] The dispute in Williamson v. Fed. Land Bank of Houston centered on a lease that covered a 201-acre tract and a 25-acre tract.  Both tracts were subject to a 1/16th term non-participating royalty interest.  The 25-acre tract was subsequently committed to a pooled unit, but no portion of the 201-acre tract was included in the unit.  Production was obtained on other lands lying outside the lease, but no well was drilled on either the 201-acre tract or the 25-acre tract.  Based on the broad pooling language in the lease, the Texas Court of Civil Appeals held that the term royalty interest was maintained by production as to all lands covered by the lease, including those lands lying outside the pooled unit.