The Second Time Around: Issues Leasing Prior-Leased Property

The Second Time Around: Issues Leasing Prior-Leased PropertyParties to oil and gas leases on property that is, or may be, subject to a prior lease may want to take greater care when memorializing their intent with respect to the new lease’s effect on prior leases. The Texas Supreme Court heard arguments early this year in a case that has the court deciding whether an original lessee should have the burden of proving that a new lease, executed by the assignee of its rights under the original lease, was actually a top lease subject to the original lessee’s back-in rights, or whether the execution of the new lease “washed out” the back-in rights.TRO-X L.P. leased property in Ward County in 2007 from five lessors, each with an undivided interest in the property, and entered into a participation agreement with a third party, under which TRO-X assigned its rights in the lease but retained a right to a five percent “back-in” once the project reached payout.  The Participation Agreement also included an anti-washout provision that extended TRO-X’s back-in right to any renewals, extensions, or top leases.  The third party conveyed its rights in the lease to Anadarko Petroleum Corp. subject to the Participation Agreement (including the back-in rights). In 2011, one of the lessors sent Anadarko a demand letter alleging non-compliance with an Offset-Well provision contained in the original leases (“2007 Leases”). Anadarko subsequently entered into negotiations of, and eventually executed, new leases (“2011 Leases”) with the same subject property under substantially the same terms as the 2007 Leases.TRO-X brought suit alleging that, pursuant to the anti-washout provision in the Participation Agreement, it was entitled to the five percent back-in under the 2011 Leases. The trial court agreed with TRO-X and found that the 2011 Leases were top leases and, pursuant to the anti-washout provision, were subject to the terms of the Participation Agreement. Anadarko appealed asserting insufficiency of evidence for the trial court’s finding. The Eighth Court of Appeals reversed and rendered judgement for Anadarko, finding that the trial court did not have legally sufficient evidence to discern the lessor’s intent that the 2011 Leases were top leases rather than a revocation of the 2007 Leases coupled with new and independent leases. Anadarko Petroleum Corp. v. TRO-X, L.P., 511 S.W.3d 778, 779 (Tex. App.—El Paso 2016, pet. granted).TRO-X appealed the court of appeals’ ruling contending, among other arguments, that the court errantly placed the burden of proving that the 2011 Leases were top leases on TRO-X, and that the 2011 Leases were top leases as a matter of law.Regardless of how the court rules, parties to oil and gas leases will find it prudent to memorialize their intent with respect to the effect of a new lease on prior leases to which the leased property may be subject. In addition, parties to participation agreements should carefully consider the wording of any anti-washout provision included in such agreements.Cesar LeyvaThompson & Knight LLP