Presenting a live 90-minute webinar with interactive Q&A Oil and Gas E&P Bankruptcies: Tackling the Unique Complexities of E&P Restructuring Navigating Characterization of Oil and Gas Leases Under Sec. 365, Treatment of JOAs in Bankruptcy, Lien Priority, and DIP Financing WEDNESDAY, AUGUST 31, 2016 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Sarah Link Schultz, Partner, Akin Gump Strauss Hauer & Feld , Dallas Randy W. Williams, Partner, Thompson & Knight , Houston The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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TREATMENT OF OIL AND GAS LEASES IN BANKRUPTCY 5 5
The Foundation of All Other Rights: the Oil and Gas Lease As a general rule, oil and gas leases are the foundation of all other rights an oil and gas company has to explore for, produce, own, and sell the oil and gas. ● The one exception to this general rule is that, occasionally, an oil and gas company will own the actual mineral interest in the ground. In a typical acquisition agreement or mortgage, the oil and gas leases of the seller or mortgagor may be defined as follows: ● “ Leases ” – the oil, gas, and mineral leases described on Exhibit “A ”, and any other oil, gas, or mineral leases that are pooled or unitized with any of the Leases described on Exhibit “A , ” and any amendments, extensions, and/or ratifications affecting such leases, whether or not such instruments are described on Exhibit “A” , together with the leasehold estates (including all royalty interests, overriding royalty interests, net profits interests and similar interests) created thereby and all interests derived from such leases in or to any pools or units that include any lands covered by any such leases or all or a part of any such leases or include any Wells, and all tenements, hereditaments, and appurtenances belonging to such leases and such pooled areas or units. 6
The Oil and Gas Lease - The primary transaction document precedent to virtually all U.S. oil and gas exploration and production activity Nature and Purpose ● Oil and gas leases are the foundation on which an E&P company’s house is built. There is no “standard” form, and even those using preprinted “Producers 88” forms often include amendments and/or addenda. Although there is great variance among the specific terms of oil and gas leases, all share the same fundamental business purposes and are treated similarly in a bankruptcy. ● In an oil and gas lease transaction, the lessee seeks the right to develop the leased land for an agreed term, with a right to develop, but as little obligation to develop as the law will allow. 7
The Oil and Gas Lease - Basic Economic Terms Bonus ● A bonus is an upfront payment for granting the lease – typically based on the number of net mineral acres covered by the lease, but usually stated as a price per net mineral acre . Royalty ● Royalty is a cost-free fraction of the production sold from the lease. ● It generally ranges from 1/8 to 1/4, depending on market terms and competition, proximity to known reserves, etc. Length of Term ● Primary and secondary terms ● If production is established during the primary term, the lease continues for so long thereafter as it continues to produce in paying quantities. This is known as the “secondary term.” A lease that is being continuously maintained by commercial production is commonly referred to as “ HBP ” (meaning “held by production”). ● Delay rentals: Even in the primary term, some leases provide for an annual rental payment, known as a “delay rental ,” in order to maintain the lease in force if drilling has not been commenced during the preceding year. The delay rental is a special limitation on the grant – if not timely paid, the lease automatically terminates. Leases that do not include a delay rental provision are referred to as “paid -up leases .” 8
The Oil and Gas Lease - Other Key Terms Termination ● As a general rule, the oil and gas lease remains in effect for so long as there is continuous commercial production from the leased premises. Commercial Production ● As a general rule, in order to continue a producing lease in force beyond its primary term, the production must meet a “paying quantities” test. ● In the absence of express language in the lease, the standard for what constitutes paying quantities is a matter of state law, and there are minor variances among the producing states; however, the basic rule is that operating the well must yield a profit to the lessee over a reasonable period of time (i.e., the production revenues must exceed the operating costs, without any regard to the capital expenditures made by the lessee in drilling the well). Savings Clauses ● Dry-hole or Operations Clause – gives the lessee a grace period to commence operations to restore production or drill a new well ● Shut-in Royalty Clause – allows the lessee to make a “shut - in” payment to keep the lease in force when there is no market available for production (typically applies only to gas production) 9
Classification of Interests Under an Oil and Gas Lease - The Leasehold Interest, or “Working Interest” The leasehold interest refers to the interest granted to the oil company-lessee. ● It is similar to a mineral interest in that the lessee receives all incidents of the mineral interest, except those reserved to the mineral owner (lessor). During the term of the lease, the lessee holds the right to use the surface, incur costs, and retain profits (subject to the lessor’s royalty). ● If unexpired lease of non-residential real property – be aware of time frame for assumption under § 365(d)(4). ● Frequently see prophylactic motions assuming oil and gas leases to avoid risk the oil and gas lease is considered an executory contract Due to the cost-bearing nature of the leasehold interest, it is sometimes also called the “working interest” (or less commonly, the “operating interest”). ● One subtle distinction is that it is possible to have a contractual “working interest” without actually owning title to the leasehold interest – that is, a lessee can bring in partners to share in the drilling of a well. Usually, the partner will get an assignment of an interest in the lease equivalent to its contractual interest in the costs, but not always. “Working Interest” – for any well or lease, that share of costs and expenses associated with the exploration, maintenance, development, and operation of such well or lease that the company is required to bear and pay. In the simplest case where there are no co-owners or partners, the oil company is said to own a “100% working interest,” or “WI.” 10
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