TRO-X v. Anadarko: Participation Agreements, Top Leases, and Releases

Landmen and upstream counsel should take note of a case set to be argued in the Texas Supreme Court in early 2018: TRO-X v. Anadarko. The case involves several important issues: negotiating with landowners when they claim a lease has expired, how to draft “anti-washout” language in a participation agreement (or similar contract), and the significance (or lack of significance) in executing formal releases of expired leases.

The basic facts are that TRO-X took a lease in 2007 out in the Permian. TRO-X later assigned the lease but reserved the right to “back in” for a 5% working interest if the lease reached payout (i.e. total revenues = total costs of development). This back-in right was contained in a participation agreement with the assignee. Eventually, Anadarko acquired the lease, subject to the participation agreement.

Notably, the participation agreement contained a clause stating that the back-in right “shall extend to and be binding upon any . . . top lease(s) taken [on the original lease] within one (1) year of termination [of the original lease].” (emphasis added by me)

Williams & Meyers Manual of Oil & Gas Terms defines a “top lease” as: “A lease granted by a landowner during the existence of a recorded mineral lease which is to become effective if and when the existing lease expires or is terminated.” (citing almost 3 pages of case citations). More on this in a minute.

While Anadarko was operating the lease, the lessors claimed that Anadarko had violated its contractual duty under the lease to drill an offset well. That is, Anadarko had drilled a well on the lease next door, which the lessors claimed triggered a lease provision requiring Anadarko to drill on well on their lease, too, in order to prevent drainage of the oil under their land. According to the lease, such a failure was grounds for termination. Anadarko apparently conceded this failure but entered into negotiations with the lessor over how to fix things.

TRO-X and Anadarko dispute what happened next. Anadarko claims the original lease expired and it took an entirely new lease on the property. Because an entirely new lease is not the same thing as a “top lease” (per the definition above), Anadarko argues that it does not owe TRO-X the 5% back-in under the participation agreement. In other words, Anadarko effectively “washed out” TRO-X’s back-in.

TRO-X, on the other hand, claims that Anadarko did, in fact take a “top lease.” As evidence, TRO-X noted that the new lease was signed 13 days before a formal release of the 2007 lease was executed. According to TRO-X, there is at least an inference that the new lease was signed while the 2007 lease was still in effect; thus, the new lease was a “top lease” triggering the back-in right under the participation agreement.

After a one day bench trial, the trial court entered judgment in favor of TRO-X, concluding that TRO-X had a back-in right to the new lease and ordering Anadarko to produce financial information to determine whether payout had been reached.

On appeal, the El Paso Court of Appeals framed the issue as whether there was legally sufficient evidence to support the trial court’s conclusion that the new lease was, in fact, a “top lease.” This is a question of intent (both Anadarko’s and the lessors’). The Court concluded that the only evidence supporting the trial court’s decision that the lease was a top lease was the 13-day gap between the signing of the new lease and the execution of the release. The Court noted, however, that “the presence or absence of a written release is not outcome-determinative” of the leasing parties’ intent, and absent some other evidence (email, deposition testimony, etc.) besides the 13-day gap that the new lease was intended to be “top lease,” there was not enough evidence to justify the trial court’s decision.

Based on the briefing the parties submitted to the Texas Supreme Court, the high court looks as if it will primarily address: (a) who bears the burden of proof in proving or disproving that the new lease was a “top lease”; and (b) whether a 13-day delay in executing a formal release is, standing alone, sufficient to support a finding that the original lease was still in effect when the new lease was signed.

But there are more takeaways from this case. One is that this entire case could have been avoided had TRO-X drafted a more robust “anti-washout” clause in the participation agreement. By limiting its back-in rights to “top leases,” TRO-X opened itself up to washout via other forms of leasing.  Better to include all forms of renewals, extensions, top leases, and brand new leases taken on the same property within a given time frame and specified area. Moreover, the argument that a delay in execution of a formal release could mean the original lease remained in force is surprising to me. The original lease here apparently (and I am not 100% certain) made compliance with the offset clause akin to a special limitation (as opposed to a covenant), where any breach of the clause results in automatic termination and reversion of the lease to the lessor. If so, execution of a formal release is a more of housekeeping matter for title record purposes than a necessary condition for reversion of the lease.

We’ll have to wait and see how this one turns out – oral argument is set for January 9, 2018.

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