Don’t Count on Your Cotenant to Save Your Lease

One of the most important clauses in any oil and gas lease is the habendum clause—the provision that defines the duration of a mineral estate under a lease. The Texas Supreme Court has noted that “a typical habendum clause states that the lease lasts for a relatively short fixed term of years (primary term) and then ‘as long thereafter as oil, gas or other mineral is produced’ (secondary term).” Anadarko Petroleum Corp. v. Thompson, 94 S.W.3d 550, 554 (Tex. 2002) (citation omitted).

The use of passive voice in the secondary term language—“is produced”—could suggest that it does not matter who is actually producing the oil or gas. So long as production in paying quantities is taking place on the property (even if you are not the one producing), your lease should stay alive, right?

Wrong. As the appellant in Cimarex Energy Co. v. Anadarko Petroleum Corp., 08-16-00353-CV, 2019 WL 1146790 (Tex. App.—El Paso Mar. 13, 2019, no pet. h.) found out the hard way, a lessee cannot count on its cotenant’s production to keep an oil and gas lease in effect during the secondary term.

This situation arises when multiple lessees take leases on only a fraction of the undivided minerals for a particular property. These lessees serve as cotenants for the property, and each have the right to develop oil and gas resources from that property without the consent of the other. See Byrom v. Pendley, 717 S.W.2d 602, 605 (Tex. 1986). But any cotenant that produces oil or gas “must account to [the other cotenants] on the basis of the value of any minerals taken, less the necessary and reasonable costs of production and marketing.” Id.

Cimarex and Anadarko found themselves in such a situation when each company leased fractional interests of a 440-acre tract in Ward County, but did not have a joint operating agreement to govern operations on that property. Anadarko drilled wells on the property, which resulted in Cimarex filing a lawsuit and a forced pooling action with the Texas Railroad Commission. The parties ultimately settled their disputes, with Anadarko agreeing to pay Cimarex for its “non-participating co-tenant share of the value of production” from the wells at issue.

Cimarex never drilled a well on the property, but it received payments from Anadarko for this production until December 21, 2014—the expiration date of the primary term for Cimarex’s lease. Cimarex’s lease featured standard habendum clause language, which stated that the lease remained in effect for five years and then for “as long thereafter as oil or gas is produced from said land or from land with which said land is pooled.” Anadarko claimed that Cimarex’s lease terminated because Cimarex never produced oil or gas, therefore Cimarex was no longer a cotenant for the property. Cimarex disagreed, and litigation ensued.

Cimarex noted that the habendum clause was written in the passive voice and that the parties drafted this language so that “any production on the subject property [would] suffice to extend the lease into the secondary term, regardless of who caused the production.” The El Paso Court of Appeals disagreed. Although the habendum clause was written in the passive voice, numerous other clauses imposed requirements on Cimarex alone to keep the lease alive. Additionally, other clauses (e.g., the pooling clause & the cessation clause) specifically imposed obligations on Cimarex. The appellate court noted that these provisions showed “that the lessors intended for Cimarex to be the one to cause production on the property in order to extend the lease into the secondary term.” Additionally, two older decisions—Hughes v. Cantwell, 540 S.W.2d 742 (Tex. App.—El Paso 1976, writ ref’d n.r.e.) and Mattison v. Trotti, 262 F.2d 339 (5th Cir. 1959)—had examined similar fact patterns and held that oil and gas production by one cotenant did not keep leases alive for non-producing cotenants. The court dismissed Cimarex’s attempts to distinguish these cases.

The court also examined and rejected Cimarex’s other arguments. For example, Cimarex said that it was at a “distinct disadvantage” as a minority cotenant and that Anadarko had refused to agree to let Cimarex participate in its drilling operations. Thus, Cimarex said, as a matter of public policy its lease should stay in force and effect. The court disagreed, noting that Anadarko owed Cimarex no duties and that Cimarex presumably knew Texas cotenant law before it executed its lease.

My suggestion for E&P companies that find themselves as cotenants in this situation: sign a JOA. The court made clear that “if a lessee enters into a joint operating agreement with a cotenant, who then causes production on the land, this may fulfill the lessee’s requirement of causing production on the land.” Of course, this is not always an option; Cimarex had requested that Anadarko enter into a JOA and been rebuffed. In such a situation, drilling another well on the property may be the only way to save the lease.