On September 27, 2023, the El Paso Court of Appeals rendered its decision in Cromwell v. Anadarko E&P Onshore, LLC[1], whereby it upheld and expanded its 2019 decision in Cimarex Energy Co. v. Anadarko Petroleum Corp.[2] The outcome in both cases will cause owners of “non-ops” to reevaluate whether their leases are held by a lessee cotenant’s production and to search the records for any top leases covering their interest in the land.Below is a brief summary of both cases and their potential consequences for non-operators moving forward.
Cimarex Energy Co. v. Anadarko Petroleum Corp.
In 2009, Cimarex Energy Co. leased a 1/6 mineral interest in 440 acres in Ward County. By 2010, Anadarko Petroleum Corp. had acquired the remaining 5/6 mineral interest in the same property. In June 2012, Anadarko top leased Cimarex’s lessors. Anadarko drilled and completed two wells on the land, both of which reached payout by December 2012.
In September 2012, Cimarex formally requested a joint operating agreement (“JOA”) with Anadarko and an immediate accounting. Anadarko provided Cimarex with accounting information but did not make payments to Cimarex for its share of production. Cimarex sued Anadarko for failure to account, and in June 2013, the parties reached a settlement agreement (the “Settlement Agreement”) by which Anadarko agreed to pay Cimarex for its 1/6 nonparticipating cotenant share of production less its share of drilling, completion, and operations costs. Cimarex in turn paid its lessors the full amount of royalties owed to them. Anadarko ceased making payments to Cimarex on December 21, 2014, the date on which the primary term of Cimarex’s lease ended, believing the Cimarex lease had expired and that Anadarko’s top leases had become effective as to the 1/6 mineral interest. Cimarex sued Anadarko for breach of contract under the Settlement Agreement. For the reasons discussed below, the Cimarex lease was deemed by the court to have terminated at the end of its primary term.
The main issue before the court was whether the habendum clause of the Cimarex lease required the lessee to directly cause production on the land, or whether any production on the land by another party would satisfy the habendum clause and thereby perpetuate the lease into its secondary term. The Cimarex lease contained a generic habendum clause which provided that the lease was to remain in effect after the expiration of the primary term for “as long thereafter as oil or gas is produced from said land or from land with which said land is pooled.” Cimarex argued that the use of the passive voice in the habendum clause allowed any production on the land to extend the lease and did not require Cimarex itself to actually cause the production.
Texas courts have generally held that production from a lessee’s cotenant will not maintain the non-producing lessee’s lease. The court in Cimarex referred to its 1976 decision in Hughes v. Cantwell where it reasoned that since the stated purpose of the lease was for the drilling and producing of oil and gas, it naturally followed that the lessors expected the lessee to “do something to bring about that exploration and production of oil and gas,” such as drilling a well itself, assigning the lease to another operator for drilling, or pooling the lease with other producing leases.
Further, the court noted that the Cimarex lease contained various lease provisions which imposed requirements on Cimarex to take action to maintain the lease. These provisions included the obligation to pay royalties, the continuous operations clause, the power to pool or assign the lease, the force majeure clause, the right to use oil, gas, and water from the land, and the right to remove property from the land. The court again relied on Hughes v. Cantwell in stating that these provisions imply that the lessors intended for Cimarex to be the one to cause production to perpetuate the lease into its secondary term. The court therefore concluded that the lease required Cimarex to directly cause production to maintain the lease and that Cimarex could not simply rely on a cotenant’s production, despite the use of the passive voice in the lease’s habendum clause.
Cimarex also argued that the Settlement Agreement was the equivalent of a joint operating agreement. Texas courts have held that a non-operator may rely on a cotenant’s production if the parties enter into a JOA. In this case, the court disagreed with Cimarex and stated that the Settlement Agreement merely served to satisfy Anadarko’s duty, as producing cotenant, to account to other cotenants for their share of the value of the minerals, less reasonable costs of production and marketing. Further, the Settlement Agreement was deemed to contain none of the common characteristics of a JOA such as an agreement to jointly develop the property, designate an operator, and, most importantly, share not only the costs but also the risks, liabilities, or losses that might be incurred.
The court also rejected Cimarex’s argument that the parties’ conduct (such as referring to Cimarex as a “working interest owner” in correspondence and exchanging information regarding Cimarex’s share of repairs and other expenses) caused the Settlement Agreement to serve as a JOA by noting that the Settlement Agreement expressly identified Cimarex as a “non-participating cotenant” and by reiterating that Cimarex did not agree to shoulder any of the costs or liabilities of production. Moreover, the court stated that Cimarex “knowingly took the risk” that its cotenants might refuse to execute a JOA, thereby forcing Cimarex to cause production on its own.
Finally, Cimarex argued that it would be inequitable, under the principles of estoppel, to not allow Cimarex to rely on Anadarko’s production to perpetuate the lease into its secondary term since the lessors accepted royalties during the primary term. However, the court held it is not contradictory to require lessee to pay royalties on any production during the primary term, while also requiring lessee to directly cause production to extend the lease into its secondary term. The court reasoned that there would be no point in dividing the habendum clause into two terms if the requirements under each term were the same.
Cromwell v. Anadarko E&P Onshore, LLC
The facts in Cromwell are very similar to the facts in Cimarex. In 2009, David Cromwell acquired two oil and gas leases in Loving County providing him with a minor working interest in a tract of land in which Anadarko E&P Onshore LLC owned substantial working interests. Cromwell’s leases contained the same “typical” habendum clause which utilized the passive voice. As in Cimarex, Cromwell requested a joint operating agreement with Anadarko, but his requests were ignored. In August 2009, one of Anadarko’s wells reached payout.
Anadarko sent Cromwell JIBs for lease operating costs, including equipment, labor, and environmental remediation. Anadarko netted such costs from Cromwell’s share of production, such that in some months Cromwell paid Anadarko and in other months he received a revenue check. Cromwell also signed an AFE which listed him as a “Working Interest Owner” and asked him to participate in the installation of a new compressor pursuant to the terms of the governing operating agreement. The primary terms of Cromwell’s leases ended in February 2012 and March 2014; however, Anadarko acted as if the leases were still effective by continuing to send Cromwell JIBs, listing him as a working interest owner in a JOA, and reporting one of his leases as held by production in its internal records.
In January 2017, Anadarko top leased Cromwell’s lessors, and in March 2018, Anadarko informed Cromwell that his leases had expired due to failure to execute a well election or JOA. Cromwell filed suit against Anadarko. Cromwell contended that his actions differed from Cimarex’s in that he “constructively participated” in the operations by shouldering his share of the costs, risks, and liabilities of production. Cromwell pointed to the JIBs, AFE, and costs he paid pertaining to risks and liabilities of production, such as damages, spill containment, cleanup, and remediation, as evidence of “constructive participation” sufficient to perpetuate the leases into their secondary terms.
The court did not find any distinctions between the costs paid by Cromwell and those paid by Cimarex and stated that Cromwell only paid operating expenses ordinarily owed by a nonparticipating cotenant. Cromwell, like Cimarex, was deemed to have merely acquiesced in deductions and did not shoulder any of the risks or liabilities of drilling and operating a well (such as the risk of drilling a dry hole), and therefore, his actions did not amount to “constructive participation.”
The court also rejected Cromwell’s argument that the parties’ conduct (such as referring to Cromwell as a “working interest owner” in correspondence, sending him an AFE subject to a JOA, and treating his leases as valid for years after their primary terms ended), gave rise to a joint operating relationship, by stating that such conduct cannot overcome the lack of an agreement to share expenses of development and operation. Based on the foregoing, and because he did not directly cause production on the land, the court ruled that Cromwell’s leases terminated at the end of their primary terms.
Cromwell also asserted that he and Anadarko formed a partnership under the Texas Business Organizations Code resulting in a fiduciary relationship that Anadarko breached by executing the top leases. The court found there was evidence to support only one of the five factors for determining whether a partnership exists under the TBOC, that being the sharing of profits; however, the court stated that such profit sharing was equally consistent with Anadarko accounting to Cromwell as a cotenant. Further, without a written agreement, the evidence could not satisfy the statute of frauds.
Conclusion
Cimarex established that, absent a JOA, pooling agreement, or lease language to the contrary, a lessee must directly cause production to maintain its lease even if the lease does not expressly require the lessee to be the producing party (i.e., use of the passive voice in the habendum clause). Cromwell established that a lessee cotenant cannot rely on “constructive participation” to maintain its lease. In the wake of these decisions, non-operators who own small working interests may have a tough time convincing operators who own substantial working interests to execute a JOA, when the operators have the option of acquiring top leases and waiting until the non-operators’ leases expire. Courts may decide that minority working interest owners “knowingly took the risk” that their cotenants might refuse their requests for a JOA. Moving forward, non-operators should determine whether they actually signed a JOA rather than rely on accounting agreements (ones that apportion proceeds and costs), settlement agreements, or relying on their course-of-conduct as establishing a joint operating relationship. For the time being, paying JIB invoices, approving AFEs, and paying other operating costs may not be sufficient to perpetuate a non-operator’s lease.
Cromwell has filed an appeal to the Supreme Court of Texas. If the petition for review is granted, the Court may provide some additional guidance as to what non-operators can do to maintain their leases.
[1] 676 S.W.3d 860 (Tex.App.—El Paso 2023, pet. filed)
[2] 574 S.W.3d 73 (Tex.App.—El Paso 2019, pet. denied)