Under Michigan common law, the surface owner of the land owns oil, gas and minerals in place beneath his or her land, and the minerals are part of the realty until they are severed. These mineral rights are often leased to oil companies for the production of oil and gas. The instrument used to lease mineral rights is an oil and gas lease.
An oil and gas lease is the core legal document of oil and gas development. Oil and gas leases are structured quite differently from ordinary real-property leases. Oil and gas leases are contracts between the property owner, who generally lacks the ability and expertise to explore and develop minerals, and an oil company, which has the resources and expertise required to develop the leased property. Oil and Gas leases contain many terms that may be negotiated for the property owner’s benefit and may not include important terms that are designed to protect the property owner.
As a property owner you should thoroughly read the oil and gas lease. If you are uncomfortable with or don’t understand lease terms it is wise to contact an attorney to help protect your interests. The following is an overview of oil and gas lease terms and negotiation tips regarding these provisions.
This clause is found in the opening paragraph of the lease and outlines the purpose of the lease and describes the substances that can be explored and produced. To avoid any disputes the extraction method should be specified as borehole only. This eliminates mining techniques that have a potential to damage the surface property.
Surface Operations Use Permitted by the Lease
A standard oil and gas lease allows for an oil company the right to reasonable use of the surface land to locate, develop, and produce oil and gas from the land. This reasonable use generally includes drilling, installing pipelines, and road building. It is wise for the property owner to limit this use in the lease by requiring that wells cannot be established within a certain distance from homes, or certain farming operations on the property.
Most oil and gas leases also contain lease terms providing for compensating the owner for damage causes by operations. It is important to make sure that damage to crops, timber, and water resources are covered under a surface damage compensation term.
Duration of the Lease
Leases are divided into two periods. The primary period is a set amount of time (usually several years) that drilling operations must begin by or delay rentals must be paid. Generally a lease states that if drilling operations have not begin within one year the lease terminates unless a sum called the delay rental is paid to the property owner. If production has been established during the primary term the lease will continue into its secondary term and will continue as long as the substances covered by the lease continue to produce. To force early exploration property owners can sometimes negotiate a short primary term.
The standard royalty is 1/8, although some leases will have higher royalties such as 3/16 or 1/5. The lease often states that the landowner can be paid in kind; this means that the property owner may be paid in oil. This can be beneficial to the property owner if the market provisions. For this reason it makes financial sense to have the payment in kind term to be solely at the option of the property owner.
Pooling is defined as bringing together small tracts of mineral interests for the drilling of single well, this is often done to comply with well spacing issues. In Michigan the Department of Natural Resources dictates the spacing of wells. In a pooling situation property owners’ compensation is based on the percentage of land they own in the entire drilling unit.
“Mother Hubbard” Clause
A “mother hubbard” clause or a “cover-all” clause is designed to protect the lessee against inaccuracies in the legal description by including all land owned by the lessor, even if some of the land has been accidentally omitted. These clauses should generally be removed from the lease agreement or limited in scope.
Most oil and gas leases contain a provision that permits both the lessor and the lessee to assign their rights and interests under the lease. Property owners should require notification of each assignment, and also specify that assignment will not release any prior lessee.
Most oil and gas leases include a force-majeure clause to allow the lessee to preserve the lease when circumstances beyond its control prevent it from operating. It is to the benefit the property owner to limit this clause to truly catastrophic events and not equipment failure or other similar events.
Leases generally contain a provision requiring property owners to defend their interests in the leased premises should a dispute arise. To avoid litigation and limit their liability property owners should offer a limited or special warranty.
Negotiating an oil and gas lease requires legal knowledge and common sense. The information contained in this article describes some possible alternative clauses and negotiating techniques. This article is for information only and not a substitute for qualified legal advice from an attorney who understands your particular situation and needs.