Feature

The Right to Limit or Prohibit Mineral Lease Transfers

By Blake A. Watson

Suppose one is considering two offers to lease mineral rights. The leases differ only as to the right to transfer. The first lease “may not be assigned or otherwise transferred without the consent of the lessor.” The second lease “may not be assigned or otherwise transferred without the consent of the lessor, which consent shall not be unreasonably withheld.”

Minerals being mined in stone quarry

Minerals being mined in stone quarry

iStockphoto.com

The first lease, without a constraining reasonableness standard, would appear to give the lessor greater control over transfers. There are, however, two potential problems. It is possible that any limitation on transfer would be held to be an impermissible restraint on alienation. If so, neither provision is valid. Second, even if transfer restrictions are allowed, in some states the only difference between the two leases is that the reasonableness standard in the latter lease is expressly stated rather than implied. It is thus possible that, despite the differing language, the two leases set forth identical transfer rights.

This article is limited to the issue of whether a lessor has the right to restrict or prohibit the transfer of mineral leases. In contrast to the long line of cases upholding transfer restrictions in occupancy leases, there are surprisingly few decisions addressing the validity of transfer clauses in oil and gas and other mineral leases. Because of this dearth of judicial authority, the right to restrict mineral lease transfers has been described as “a theoretical question.” Eugene Kuntz, 4 A Treatise on the Law of Oil and Gas 307-08 (1990). The Texas Supreme Court recently addressed whether a lessee, who agreed to “farm out” its drilling obligation to another operator, had bargained for an absolute right to withhold consent to a transfer of the agreement. Barrow-Shaver Res. Co. v. Carrizo Oil & Gas, Inc., No. 17-0332, 2019 WL 2668317 (Tex. June 28, 2019). As discussed in greater detail below, the court divided over the meaning of the transfer restriction in the farmout agreement, but the restriction’s validity was not challenged.

For a more detailed treatment of this topic, including the interpretation of “silent consent” clauses, see the author’s article, Do I Have to be Reasonable?: The Right To Arbitrarily Restrict Transfer of Occupancy and Mineral Leases, 47 Cap. U. L. Rev. 27 (2019).

Why Mineral Owners Desire the Right to Restrict Lease Transfers

Mineral owners generally want the power to restrict transfers of their leases for three reasons: (1) concerns about the transferee; (2) concerns about the transferee’s business; and (3) the desire to use the transfer request as an opportunity to extract concessions from the lessee or otherwise improve one’s economic position. Landowners often choose to lease their minerals to producers with reputations for honesty and reliability and would prefer that their leases not be subsequently acquired by disreputable companies. The landowner is also concerned about fair treatment in terms of operational issues, such as surface disturbance, and royalty calculations. Lessor mistrust is not unwarranted, as evidenced by lawsuits alleging fraud and breach of contract for improper deductions and underpayment of royalties. See, e.g., Paul Monies, Chesapeake to Pay $119 Million in Settlement to Royalty Owners Over Natural Gas Marketing Costs in Oklahoma, Oklahoman, Jan. 23, 2015 (settlement of claims that Chesapeake improperly deducted expenses for marketing, processing, compression, and other midstream services for more than 11,800 gas wells in Oklahoma). Landowners interested in prompt development will want to prevent transfers to “lease flippers” or companies that engage in minimum production to hold the lease. Finally, by retaining the right to restrict transfers—and the right to terminate leases for violating assignment restrictions—lessors can negotiate increased royalties or otherwise bargain for better financial terms.

Mineral Lease Transfer Restrictions and the Restatements of Property

A logical starting point for examining the validity of mineral lease transfer restrictions is the American Law Institute’s Restatement of the Law. In particular, there are three relevant Restatements: the 1944 Restatement (First) of Property; the 1977 Restatement (Second) of Property: Landlord and Tenant; and the 2000 Restatement (Third) of Property: Servitudes. When reviewing the Restatements, it is important to note the distinctions made between “fee” and “leasehold” interests, particularly in light of the ongoing debate of whether a mineral lease is a conveyance of a defeasible fee, a grant of some other type of property interest, an extraction contract, or some combination of property and contractual rights.

There are three types of restraints on alienation: disabling restraints, forfeiture restraints, and promissory restraints. If a transfer restriction is a valid disabling restraint, the lessor can prevent the transfer and keep the lease in effect. If the restriction is a valid forfeiture restraint, an attempt to transfer either automatically terminates the lease or entitles the lessor to end the lease. If the lease provision is a valid promissory restraint, the transfer will be permitted, but the lessee will be liable for breach of promise. With regard to “fee” interests, the 1944 Restatement notes that disabling restraints are most susceptible to being held invalid as impermissible limits on alienation. The Restatement observes that promissory and forfeiture restraints are valid only if the limitation is reasonable, does not create a perpetuities problem, and “is qualified so as to permit alienation to some though not all possible alienees.” Restatement (First) of Prop. §§ 404, 406. The 1944 Restatement treats “leasehold” interests differently, upholding alienation restraints when they are created as the result of business transactions and either imposed at the outset of the lease or “agreed to thereafter as a business transaction by the persons who are in the relationship of landlord and tenant.” Id. at § 410(a).

The 1977 Restatement endorses the landlord’s right to bargain for an absolute right to withhold consent “to an alienation by the tenant.” Restatement (Second) of Prop.: Landlord & Tenant § 15.2(2). It does not, however, purport to address the validity of transfer provisions in mineral leases. Similarly, the 2000 Restatement covers profits and covenants but expressly states that—to the extent that “special rules and considerations apply”—lease covenants and “profits for the removal of timber, oil, gas, and minerals” are not covered. Restatement (Third) of Prop.: Servitudes § 1.1. To the extent that it is relevant, the 2000 Restatement notes that “[p]ermissible restraints on alienation of leaseholds are often greater than on fee-simple estates, and greater restraints on alienation of easements, profits, and covenant benefits are often permitted than on leaseholds.” Id. at § 3.4 comment c.

The Restatements do not provide a definitive answer to whether there is a right to restrict or prohibit mineral lease transfers. A mineral lease transfer provision can be worded as a disabling restraint, a forfeiture restraint, or a promissory restraint. Section 406(b) of the 1944 Restatement posits that the restraint must be “qualified so as to permit alienation to some though not all possible alienees,” a limitation not imposed by the typical anti-assignment provision. The 1977 Restatement, on the other hand, clearly endorses a right to restrict lease transfers but is focused on occupancy leases. The 2000 Restatement focuses on the reasonableness of the restraint, which does not provide a bright-line rule but rather directs the inquiry to an assessment of the beneficial and harmful consequences of the transfer restriction. It is evident, however, that under all three Restatements, restraints on the alienation of both leasehold and fee interests are permitted in some circumstances.

Judicial Authority on the Right to Restrict Mineral Lease Transfers

In the few cases that address the validity of transfer restrictions in mineral leases, courts have: (1) invalidated the clause as an undue restraint on alienation; (2) narrowly construed the clause to allow lessors to sue for damages but not to prevent transfers; (3) avoided the issue; (4) applied the clause without discussion; and (5) upheld the clause as a permissible restraint on alienation.

A decision by the Oklahoma Supreme Court, Shields v. Moffitt, 683 P.2d 530 (Okla. 1984), is the most prominent case—and possibly the only case—to invalidate an anti-assignment provision in a mineral lease. The clause at issue provided that the oil and gas lease “may be assigned only with the written consent of the lessors.” Noting that the clause “provides neither penalty, forfeiture, termination, reversion, or other consequences inuring to the lessors by reason of . . . breach,” the court relied on a prior precedent involving a fee simple conveyance and held that the provision was a disabling restraint and void. Id. at 533–34. The case, however, is a limited authority for two reasons. The court construed the veto power to belong “only to the plaintiffs/lessors personally and not to their successors, grantees, heirs or assigns” and emphasized that there was no forfeiture or penalty provision attached to the clause. Id. at 534. If the anti-assignment provision in Shields had been worded as a covenant running with the land, and if the provision had expressly provided for forfeiture or damages, it might have been upheld and enforced.

Of equal importance is Outlaw v. Bowen, 285 S.W.2d 280 (Tex. App. 1955), a case which involved the conveyance of a mineral interest. In contrast to the oil and gas lease in Shields, the mineral deed in Outlaw expressly provided a penalty of forfeiture for breach of a prohibition against assignment. Nevertheless, the court agreed with the appellee’s contention that the clause was “unenforceable and void.” Id. at 283. This case supports the view that transfer provisions in mineral leases worded as forfeiture restraints may be declared void as unreasonable restraints on alienation.

Rather than invalidate transfer restrictions as impermissible restraints on alienation, other cases have upheld such provisions but have limited the lessor to damages for breach of covenant. In a 19th century decision, the United States Court of Appeals for the Third Circuit allowed the assignment of an oil and gas lease despite the fact it was “not to be sold, assigned, or transferred without the written consent of the [lessor].” Hague v. Ahrens, 53 F. 58, 58 (3d Cir. 1892) (applying Pennsylvania law). In contrast to Shields, the court in Hague did not invalidate the clause as an impermissible disabling restraint but rather interpreted the restriction to be a promissory restraint and limited the remedy to damages. Id. at 60 (“The terms . . . convey no suggestion even that the lease may be lost by such transfer. They express simply an agreement by the lessee, who alone could make the transfer, that he will not do it.”). Other courts have taken a similar approach. One recent example is Stricklin v. Fortuna Energy Inc., No. 5:12CV8, 2012 WL 1805305 (N.D. W.V. May 17, 2012), in which landowners sought to terminate oil and gas leases that had been assigned without consent. The assignees argued that the anti-assignment provision was void as an impermissible restraint on alienation but also contended that—if the consent clause was valid—the landowners should be limited to monetary damages. Id. at *5. The court held that forfeiture was not appropriate, noting that West Virginia law requires that covenants should not be construed to support forfeiture unless there is no other possible interpretation. Id.

In a third group of cases, courts avoided addressing the validity of transfer clauses by narrowly construing their scope or applying principles of estoppel and waiver. The validity of a restrictive transfer clause in an oil and gas lease was litigated in Knight v. Chicago Corp., 183 S.W.2d 666 (Tex. App. 1944), aff’d, 188 S.W.2d 564 (Tex. 1945), but the clause was held not to apply to the unitization transaction. Likewise, in Godley v. Kentucky Resources Corp., 640 F.2d 831 (6th Cir. 1981), the court avoided addressing whether a transfer restriction constituted an invalid restraint on alienation by holding that the restriction was not intended to apply to assignments. Id. at 836.

There are numerous cases where the parties challenge the application—but not the validity—of mineral lease transfer restrictions. See, e.g., Walls v. Petrohawk Props., LP, 812 F.3d 621, 625–26 (8th Cir. 2015) (upholding the transfer of an Arkansas oil and gas lease not because restraint was void, but because the lessor unreasonably withheld consent); Cedyco Corp. v. PetroQuest Energy, LLC, 497 F.3d 485, 487–90 (5th Cir. 2007) (assuming the validity of a transfer restriction in a Louisiana oil and gas lease in a dispute over whether the lessor could condition its consent); Moherman v. Anthony, 175 P. 676, 677 (Kan. 1918) (lessee did not challenge the validity of the restraint but argued that the damages for unauthorized transfer were excessive); Curtis v. Am. Energy Dev., Inc., No. 2000-L-133, 2002 WL 1357726, at *5 (Ohio App. June 21, 2002) (upholding the termination of the oil and gas lease due to unauthorized assignments without addressing the validity of the transfer clause); and Barrow-Shaver Co. v. Carrizo Oil & Gas, Inc., 2019 WL 2668317 (Tex. June 28, 2019) (holding that the lessor held an absolute right to withhold consent to a proposed transfer of an oil and gas farmout agreement without addressing whether the lessor could validly restrict the right of transfer).

In direct contrast to Shields v. Moffitt, a few courts have upheld the right to prohibit mineral lease transfers. In Stanolind Oil & Gas Co. v. Guertzgen, 100 F.2d 299, 300–01 (9th Cir. 1938), the court rejected the argument that a restrictive transfer clause in an oil and gas lease did not authorize the lessors to terminate the lease, and in Teltow v. Tiger Dev., LLC, No. 223070, 2001 WL 1699711 (Mich. Ct. App. Dec. 28, 2001), the court held that a transfer restriction in an oil and gas lease was not per se invalid, stating that “[w]hether a restraint on alienation may occur is contingent upon the type of interest at issue and whether the restraint is reasonable.” Id. at *2. The validity of a transfer restriction was also litigated in Harding v. Viking International Resources Co., Inc., 1 N.E.3d 872, 873–74 (Ohio Ct. App. 2013), although the assignee’s primary argument was that the lessors were estopped from seeking cancellation of the leases. Without directly addressing the question of whether transfer restrictions in mineral leases are impermissible restraints on alienation, the court held that “Ohio enforces anti-assignment clauses where there is clear contractual language prohibiting an assignment.” Id. at 876. See also Love v. Beck Energy Corp., No. 14NO415, 2015 WL 1453338, at *3 (Ohio Ct. App. Mar. 31, 2015) (noting that the trial court found that the mineral lease transfer restriction was not a restraint on alienation).

Scholarship on the Right to Restrict Mineral Lease Transfers

Commentary on the authority to veto the transfer of mineral leases and related agreements includes elements of prognostication and advocacy. In a 2018 law review article two lawyers argue that Texans cannot bargain for an unqualified right to veto mineral lease transfers. T. Ray Guy & Jason E. Wright, The Enforceability of Consent-to-Assign Provisions in Texas Oil and Gas Leases, 71 SMU L. Rev. 477 (2018). In the authors’ view, all transfer restrictions worded as disabling restraints are void, and transfer clauses worded as forfeiture restraints are also void unless the class of prohibited transferees is limited. Id. at 491–92. Guy and Wright consider a consent clause that is silent as to whether the lessor must act reasonably in withholding consent (“this lease shall not be assigned without lessor consent”) to be a promissory restraint and “likely invalid” because it restricts alienation without qualification. Id. at 497–99. In contrast, they believe that a “reasonable” consent clause worded as a promissory restraint (“this lease shall not be assigned without lessor consent, such consent not to be unreasonably withheld”) is likely valid, but only enforceable by proof of damages. Id. at 497–500.

In contrast, two professors at Baylor Law School contend that alienation restraints in mineral leases should generally be enforced. Luke Meier & Rory Ryan, The Validity of Restraints on Alienation in an Oil and Gas Lease, 64 Buff. L. Rev. 305, 307–08 (2016). Their argument is based on five points: (1) “fee” and “lease” labels should not dictate whether a restraint on alienation is reasonable; (2) an oil and gas lease creates an on-going relationship; (3) as a commercial transaction, an oil and gas lease is best viewed from a contract perspective; (4) the finite amount of producible minerals limits the duration of an oil and gas lease; and (5) the reasons that disabling restraints are usually problematic do not apply to the typical oil and gas lease. At its core, this persuasive argument for upholding restrictive transfer provisions in mineral leases is predicated on the notion that a “mineral extraction” fee simple determinable should not be equated to a “surface ownership” fee simple determinable. Id. at 339-40. In other words, for purposes of determining whether a restraint on alienation is unreasonable, mineral leases should be treated in the same fashion as commercial occupancy leases.

Meier and Ryan emphasize the dual property and contract nature of an oil and gas lease and demonstrate that it is fallacious reasoning to conclude that transfer restrictions are invalid restraints because of the characterization of a mineral lease as a conveyance of a fee interest. As in the case of many commercial occupancy leases, an oil and gas lease creates an ongoing relationship that is typically defined by numerous negotiated agreements. In their view, absent fraud, adhesion, or unfair dealing, the mutually agreed-upon contract provisions in a mineral lease should be enforced.

The argument for invalidating transfer restrictions in mineral leases is based on the assumption that the more relaxed view of restraints against the alienation of occupancy leases has no relevance because a mineral lease is a conveyance of a fee simple estate. Residential and commercial leases are increasingly viewed as contracts for occupancy, and a mineral lease should likewise be viewed as a contract for extraction rights. See Alford v. Collins-McGregor Operating Co., 95 N.E.3d 382, 385 (Ohio 2018) (“[o]il and gas leases are contracts”). When a mineral owner bargains for the right to limit or prohibit lease transfers, the bargain should be honored.

Texas Supreme Court Recently Enforced an Absolute Right to Withhold Consent

The Texas Supreme Court in June 2019 addressed the scope—but not the validity—of a transfer restriction in an agreement between two energy companies. In 2011, Carrizo Oil & Gas, Inc. entered into negotiations regarding one of its oil and gas leases with Barrow-Shaver Resources Company. Rather than transfer the lease, Carrizo proposed a farmout agreement that would enable Barrow-Shaver to drill on the leased land. Near the end of the negotiations, Barrow-Shaver submitted a draft that conditioned a transfer of the agreement upon Carrizo’s consent, but provided that “consent shall not be unreasonably withheld.” When Carrizo countered with an unqualified right to restrict a proposed transfer, Barrow-Shaver objected but eventually signed the agreement. After Barrow-Shaver spent $22 million drilling wells on the leased property (with no tangible results), Raptor Petroleum II, LLC, offered more than $27 million for the farmout agreement. Carrizo, however, conditioned its consent to the proposed transfer on being paid $5 million for its lease. Barrow-Shaver refused Carrizo’s terms and sued for breach of contract, fraud, and tortious interference with a contract. See Barrow-Shaver, 2019 WL 2668317, at **1–2.

The issue presented to the Texas Supreme Court was “whether . . . Carrizo’s right to refuse consent to an assignment is unqualified, or whether . . . that right is qualified by a reasonableness standard.” Id. at *5. The court held that the right is unqualified, finding that “the plain language of the contract unambiguously entitled the defendant to withhold its consent to a proposed assignment.” Id. at *1. The language in the farmout agreement (“[t]he rights provided . . . may not be assigned, subleased or otherwise transferred in whole or in part, without the express written consent of Carrizo”) is virtually the same as the silent consent clause (“this lease shall not be assigned without lessor consent”) that Guy and Wright argue is “likely invalid” as an impermissible restraint on alienation. Yet Barrow-Shaver did not challenge the validity of the transfer restriction. See id. at *5 (stating that the parties “agree that the agreement . . . gives Carrizo a right to withhold consent to a proposed assignment”). In addition, the energy companies that filed briefs as amici curiae informed the court “that consent requirements are a common feature in oil and gas leases, farmouts, and assignments . . ..” Id. at *9. Although the Texas Supreme Court was not asked to address the validity of the farmout transfer restriction, it did hold that it was unnecessary to read a reasonableness requirement into the provision “as a way to avoid any impermissible restraint on alienation.” Id. at *15.

The decision in Barrow-Shaver does not resolve whether there is a right in Texas to limit or prohibit mineral lease transfers. The issue was not presented to the court, and the case did not involve a proposed transfer of a mineral lease. A farmout agreement, however, is an agreement whereby “the mineral interest is conveyed to the farmee after the farmee’s services are rendered and obligations satisfied.” Id. at *16. See also Farmout Agreement, Williams & Meyers Manual of Oil and Gas Terms (16th ed. 2015) (defining a farmout agreement as an “agreement between operators, whereby a lease owner not desirous of drilling at the time agrees to assign the lease, or some portion of it . . . to another operator who is desirous of drilling the tract”). Because the transfer of lease rights is involved, the validity of transfer restrictions in farmout agreements is relevant to the issue of the validity of transfer restrictions in mineral leases. The Texas Supreme Court itself noted that, while a farmout agreement is not a lease, certain principles that apply to oil and gas leases (such as the refusal to impose more stringent obligations when the lease expressly defines a duty) should also apply to farmout agreements. Id. at *15.

Conclusion

There are surprisingly few decisions addressing the validity of transfer restrictions in mineral leases, and the reported decisions to date have both invalidated and upheld such clauses. Parties frequently bargain for the right to limit or prohibit the transfer of mineral leases or related agreements. The fact that a mineral lease is both a conveyance and a contract suggests that transfer restrictions should not be regarded as invalid restraints based on a mechanical characterization of a mineral lease as a conveyance of a “fee” interest. If the issue is presented to the Texas Supreme Court, or any other court, the right to limit or prohibit mineral lease transfers should be upheld.

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By Blake A. Watson

Blake A. Watson is the Samuel A. McCray Chair in Law at the University of Dayton School of Law in Dayton, Ohio.