8. Interests of the Parties in Costs and Production
Article III.A.: Oil & Gas Interests Provisions
Article III.B: Interests of the Parties in Costs and Production
Amending Exhibit A
Possible Cross-Conveyance
Royalty and Other Burdens
INTERESTS OF PARTIES
A.?Oil and Gas Interests:?
???????????????????If any party owns an Oil and Gas Interest in the Contract Area, that Interest shall be treated for all purposes of this agreement and during the term hereof as if it were covered by the form of Oil and Gas Lease attached hereto as Exhibit "B," and the owner thereof shall be deemed to own both royalty interest in such lease and the interest of the lessee thereunder.?
B.?Interests of Parties in Costs and Production:?
???????????????????Unless changed by other provisions, all costs and liabilities incurred in operations under this agreement shall be borne and paid, and all equipment and materials acquired in operations conducted under this agreement shall be owned, by the parties as their interests are set forth in Exhibit "A."?In the same manner, the parties shall also own all production of Oil and Gas from the Contract Area subject, however, to the payment of royalties and other burdens on production as described hereafter.?Operator shall amend Exhibit “A,” from time to time, in order to correct mistakes therein or to reflect changes in ownership within the Contract Area.??Operator’s duty to amend Exhibit “A” shall be subject to the following:??
1.?If such amendment is a correction of the initial Exhibit “A,” it shall be effective, retroactively as of the effective date of this agreement.?If such amendment reflects a change occurring after the effective date of this agreement, it shall be effective, retroactively, as of the effective date of such change.?In either event, if the amendment changes the interests of any parties in the Contract Area, the accounts of the affected parties shall be thus adjusted.
2.?If a proposed amendment to Exhibit “A” involves only one of the parties, Operator shall amend Exhibit “A,” upon the written consent of such affected party.
? 3.?If a proposed amendment to Exhibit “A” results in an increase or decrease in the percentage of ownership of one or more parties, Operator shall amend Exhibit “A”?upon the written consent of all affected parties.
? 4.?If any party affected by a proposed amendment to Exhibit “A” fails to give written consent to such amendment, Operator may nevertheless make such?amendment, in order to conform Exhibit “A” to ownership as reflected in an opinion issued by a licensed attorney, who is neither an employee of a party that is affected by the amendment nor?of any Affiliate of such party.?Such amendment shall be binding upon the parties until and unless determined otherwise pursuant to Article III.B.6.
? 5.?Whenever any amendment is made?to Exhibit “A,” Operator shall promptly furnish each party with a copy of the amended Exhibit “A,” together with a copy of the attorney’s opinion upon which such amendment is based, when applicable, irrespective of whether such party is affected by the amendment.
? 6.?Any party who?has not consented to an amendment to Exhibit “A,” may pursue litigation as to the validity of the basis for the?amendment?in a court of competent jurisdiction, by joining all other affected parties as parties to such litigation.?If such litigation results in a determination which is contrary to the amendment, Operator shall conform Exhibit “A” to such determination, retroactive to the effective date determined?pursuant to Article III.B.1, and the accounts of the affected parties shall be thus adjusted.
????????????????????Regardless of which party has contributed any Oil and Gas Lease or Oil and Gas Interest on which royalty or other burdens may be payable and except as otherwise expressly provided in this agreement, each party shall pay or deliver, or cause to be paid or delivered: ?
□?Option No. 1: all burdens on its share of the production from the Contract Area up to, but not in excess of?____________________ and shall indemnify, defend and hold the other parties free from any liability therefor. Except as otherwise expressly provided in this agreement, if any party has contributed hereto any Lease or Interest which is burdened with any royalty, overriding royalty, production payment or other burden on production in excess of the amounts stipulated above, such party so burdened shall assume and alone bear all such excess obligations and shall indemnify, defend and hold the other parties hereto harmless from any and all claims attributable to such excess burden.
□?Option No. 2:?all burdens on its share of production from the Contract Area except Subsequently Created Interests of other parties to this agreement.
? Notwithstanding anything set forth in this Article III.B above, as long as the Drilling Unit for the productive Zone(s) is identical with the Contract Area, each party shall pay or deliver, or cause to be paid or delivered, all burdens on production from the Contract Area due under the terms of the Oil and Gas Lease(s) which such party has contributed to this agreement, and shall indemnify, defend and hold the other parties free from any liability therefor.????
??????????????No party shall ever be responsible, on a price basis higher than the price received by such party, to any other party's lessor or royalty owner, and if such other party's lessor or royalty owner should demand and receive settlement on a higher price basis, the party contributing the affected Lease shall bear the additional royalty burden attributable to such higher price.
????????????????????Nothing contained in this Article III.B. shall be deemed an assignment or cross-assignment of interests covered hereby, and in the event two or more parties contribute to this agreement jointly owned Leases, the parties' undivided interests in said Leaseholds shall be deemed separate leasehold interests for the purposes of this agreement.?
Article III.A: Oil & Gas Interests
Under Article III.A, any Oil & Gas Interests in tracts of land lying within the Contract Area that are owned by the JOA parties are deemed to be covered by an oil & gas lease in the form attached as Exhibit B. This subjects any mineral fee interests owned by the JOA parties in the contract area to a virtual oil and gas lease. Article III.A:
????????????Does not anticipate that the parties intend to execute the lease form in Exhibit B but instead that the parties agree the interest is to be treated as if the interest is leased so that the royalty interest is paid without being subject to the JOA.
??????????????Expects the form of lease to be used if a party surrenders its oil and gas interest so that if the lien granted in Article VII.B is exercised, the exercise takes only the surrendering party's expense-bearing interest (the WI) instead of its entire mineral interest (which includes the royalty and reversionary interests) (see Article VII.B: Liens and Security Interests).
??????????????The mineral owner or the fee simple estate owner should execute and record an oil and gas lease to protect against bankruptcy and third-party lien risks. Merely treating the interest as if it is subject to an oil and gas lease is likely ineffective to invoke the recording statutes' protections.
Article III.B: Interests of the Parties in Costs and Production
? Article III.B addresses the JOA parties' obligations to share costs and liabilities and their ownership in equipment, materials, and production. It states that:
????????????Each party bears its share of costs and obligations incurred in operations according to its interest ratio in Exhibit A.
????????????The parties own acquired equipment and materials in the interest ratios set out in Exhibit A.
????????????The parties own all oil and gas production from the contract area, subject to royalties and other burdens, in the interest ratios set out in Exhibit A.
The JOA does not determine the ownership of the leases and lands. Changing the Exhibit A ratio does not change how the leases are owned, except that:
????????????If title fails under Article IV.B.1(b), the parties' interests must be adjusted on Exhibit A (see Article IV.B.1: Failure of Title).
????????????Article IV.B.4 provides that the owner of the failed or lost interest may be offered (at cost) a lease or interest as stated in Article IV.B.4, which further adjusts the parties' interests on Exhibit A (see Article IV.B.4: Curing Title).
Parties have argued that well proposal letters are contractual offers to participate in a new well with the owner's interest listed on Exhibit A even though the exhibit is later amended to exclude that owner's interest once the title opinion is completed for the well. Operators should obtain title opinions and update Exhibit A before proposing any new wells in the contract area; alternatively, the interest reflected in an AFE (the “contractual offer”) should be made subject to title examination.
Article III.B historically specified that unless otherwise amended, the parties bear all costs and liabilities incurred in the Contract Area in the interest ratio specified in Exhibit A. In the 2015 Form, it now states that any operations conducted under the JOA and not only in the contract area are shared by the JOA parties.
Amending Exhibit A
This section is new and imposes a duty on the operator to amend Exhibit A:
????????????When there is an ownership change.
????????????To correct errors based on title opinions.
Previous versions of the JOA had no set way of amending the JOA so Exhibit A was rarely amended and the operator would simply change pay deck when ownership changed.?There is now a six-step process to amend Exhibit A, which essentially requires that the operator:
????????????Notify all affected parties of the change.
????????????Either change Exhibit A with each affected party's consent or, if consent is not given, change the exhibit based on an opinion by an attorney not affiliated with any of the JOA parties.
An owner who disagrees with the operator's amendment to Exhibit A may sue the operator. If the owner prevails, the operator must again amend Exhibit A to conform to the judgment.
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Possible Cross-Conveyance
Some earlier versions of JOA forms contained language that may have created cross-conveyances of the interests so that each owner would hold legal title in each lease described in Exhibit A. To address this concern, Article III.B of the 2015 Form (lines 28 to 30 on page six) states that:
? Nothing contained in the text of the article is deemed an assignment or a cross-assignment of interests covered by the JOA.
If two or more parties contribute jointly owned leases to the JOA, the parties' undivided interests in those leaseholds are deemed separate leasehold interests for JOA purposes.
This situation was actually addressed by a Texas court in 1981:
·???????There was a 1976 JOA that covered 401 acres which were subject to several leases.
·???????A gas well was drilled and a unit designation of 320 acres was filed.
·???????The 320 acre unit was entirely within the 401 acre contract area.?
·???????If the owner's interest was calculated on the proportion that his contributed tract bore to the 320 acre unit his percentage would have been 7.8125% but his share of the 401 acre Contract Area was 6.6256%.?
·???????The tracts not included in the unit were tracts in which the owner held no interest.
·???????The owner sued to have production distributed on the basis of the parties' ownership in the unit rather than according to Exhibit A to the JOA.?
·???????The Court of Appeals found that:
o??the owner's WI contribution under the JOA entitled the owner to a WI in the 401 acre unit, with income to be paid on the basis of each party's acreage contribution to the whole unit;
o??income is to be paid to each party according to its ownership in the entire tract; and
o??by executing the JOA, the owner had relinquished 75% of its ownership in the 25 acres in exchange for a 6.23% interest in each acre within the 401 acre unit.
(see Gillring Oil Co. v. Hughes, 618 S.W.2d 874 (Tex. Civ. App.—Beaumont 1981, no writ).)
Given the similar noncross-conveyance language in the 1977, 1982, 1989 and 2015 AAPL JOA forms, the lack of the pertinent language in the 1956 form, and the lack of any language in the 1956 form stating that the leases themselves had been cross-assigned, it is unlikely that a Texas court will conclude that the subsequent AAPL Form JOAs result in a cross-conveyance of interest in the Exhibit A leases.
However, in a situation in which the operating agreement has actually resulted in a cross-assignment of interest as, potentially, under properties still governed by the 1956 form, or where the parties have deleted the language denying cross-assignment, there can be several implications. For example:
·???????All the parties to a JOA where cross-assignment is found are in privity of estate with each lessor, which makes each party to the JOA liable for the performance of the express and implied covenants under each lease.
What is not addressed is whether:
·???????the cross-assignment might be a sublease for IRS rules; and
·???????the putative cross-assignee is receiving an interest in a separate property for purposes of IRS Revenue Ruling 77-176.
·???????A post cross-assignment conveyance of the interest must be drafted carefully to include a conveyance of interest throughout the contract area, or a standard assignment may result in the grant being interpreted as only conveying an interest in the original lease.
·???????The implied cross-assignment may violate a prohibition on assignment contained in a lease. There is no Texas case law on this issue.
·???????The state law based cotenancy arrangement is substantially modified by the JOA:
·???????A cross-conveyance changes the royalty obligation of the lessee/WIO. If one party to the JOA contributes leases with a low royalty burden and another contributes leases with a high royalty burden, the relative advantage or disadvantage of the royalty burden is maintained in Exhibit A because, on the same number of acres, the low burden contributor will have a higher net revenue interest on Exhibit A (a greater share of oil and gas production), but the same working interest share (expense burden) than the high burden contributor. However, on a cross conveyance, each party to the JOA will own an identical interest in each lease so:
o??the high burden contributor loses its disadvantage; and
o??the low burden contributor loses its advantage.
Royalty and Other Burdens
Article III.B also addresses royalty and other burdens. It states how the parties are to handle the burdens and royalty obligations that are subject to the JOA. Parties must select either option:
·??????????One (line 14 on page six). Under this option, the parties share burdens up to a maximum stated percentage or fraction. The party contributing a lease or interest exceeding the determined burden rate (called the excess burden) must bear that excess burden and indemnify the other parties for:
o??????????the contributing party's share up to the burden rate; and
o??????????the excess burden.
·??????????Two (line 19 on page six). The second option requires the contributing party to bear all burdens on what was contributed, other than SCIs contributed by other parties. However, if:
o??????????the drilling unit for a well and the contract area are identical, each party must pay its lessors all royalties and other burdens due under the leases it contributed and provide indemnification to the other parties; and
o??????????a royalty owner demands and receives a higher price on a contributed lease than the price received for oil or gas, the party contributing that lease bears the higher burden.
The scrivener should consider these issues regarding royalty and other burdens:
·???????Where Option 1 is selected, and if there are excess burdens being carried by the parties who contributed the lease, and if the producing unit is contracted (the contraction of a gas unit to a smaller oil unit), then it may cause those who contributed the lease to bear a heavier relative burden. Some have suggested amending Exhibit A to adjust for this. The parties may want to consider:
o??whether this is likely to be a problem; or
o??adding revised language in Article XVI.
·???????It is not entirely clear whether the contributing party would have to repay amounts received based on a calculation of post-production costs borne by the royalty interest if the royalty owner sued and won.
·???????The Task Force explained that the insertion of the royalty and other burdens language was necessary because:
o??of industry practice; and
o??the number of JOAs forming a single spacing unit dwarfed those JOAs forming working interest units.
o??Contributed leases are not considered mutual cross assignments in Option 2, lines 28-30, p. 6 and in section 2.D. of the AAPL Recording Supplement, Exhibit H.
For a complete discussion of the 2015 JOA form, see Model Form of Onshore Oil & Gas Joint Operating Agreement AAPL 610-2015: Overview by Westlaw's Practical Law, Oil & Gas.