Texas Appellate Court Takes a Deep Dive on Retained-Acreage Clauses

by Christopher Hogan, Trial Attorney & Founding Partner, Hogan Thompson LLP 

In late February, while many of us in Texas were recovering from a not-so-fun week without power, water, and/or heat, the El Paso Court of Appeals issued the most detailed opinion I have ever seen on retained-acreage clauses: PPC Acquisition Co. LLC v. Delaware Basin Resources, LLC, 08-19-00143-CV, 2021 WL 651666 (Tex. App.—El Paso Feb. 19, 2021, no pet. h.). In the case, the court looked at three different leases—the Northern Trust Lease, the Lowe Lease, and the Colt Lease—each of which had different retained-acreage clauses and presented different issues for the court. Additionally, the appeal at issue came out of the 143rd Judicial District Court, which has one of Texas’ most knowledgeable judges when it comes to oil and gas law (Judge Swanson) and covers most of the Delaware Basin in Texas. 

Any operator that has leases with retained-acreage clauses should take the time to read through the entire opinion. But I have highlighted some of the major issues that the court addressed in the case and included some practice pointers based on the decision.

Retained-Acreage Clauses: “Snapshot” Versus “Rolling”

Retained-acreage litigation has increased over the last decade as oil and gas properties have increased in value. Two of these cases have landed in the Texas Supreme Court—Endeavor Energy Res., L.P. v. Discovery Operating, Inc., 554 S.W.3d 586 (Tex. 2018) and XOG Operating, LLC v. Chesapeake Expl. Ltd. P’ship, 554 S.W.3d 607 (Tex. 2018)—while numerous others have been examined by Texas Courts of Appeals. Often the question will arise whether the retained-acreage clause is a “snapshot” provision or a “rolling” provision:

“A retained-acreage clause functions as a ‘snapshot’ provision when it can only be triggered once, such as at the end of the primary term or when all continuous operations have ceased, requiring the lessee to release the designated amount of unretained acreage at that time.”

“[A] ‘rolling’ retained-acreage clause may be triggered at various specified times throughout the life of the lease.”

PPC Acquisition Co., 2021 WL 651666, at *8.  The PPC Acquisition court recognized that “a retained acreage clause in a lease will not be considered to be rolling unless it contains clear and unequivocal language to that effect,” id., and all the recent cases I can think of interpreting these clauses have found the clauses at issue to be snapshot provisions. These cases usually foreclose lessors from prevailing on claims that events taking place after the initial retained-acreage-clause event (such as Texas Railroad Commission changes to field rules, operator changes to proration units, or changes of a well’s designation from oil to gas or vice versa) can shrink the acreage the lessee holds under the provision.

But the PPC Acquisition court held that the retained-acreage clause in the Lowe Lease was a rolling clause. It reached this conclusion because language in the clause “clearly and unequivocally provides that the clause can also be triggered at other times in the future” beyond just the end of the primary term. Id. at *13. The key language in the retained-acreage clause was language noting that the lease terminated when “production from and operations with respect to a particular Well Production Unit ceases.” Id. (brackets omitted). More notably, the court held that the lessee’s decision to change the designation of its well from a gas well (which could hold 640 acres under the applicable field rules) to an oil well (which could hold only 160 acres) was an event that triggered the rolling retained-acreage clause. 

“Permitted” or “Prescribed” Revisited

The Texas Supreme Court’s decision in Jones v. Killingsworth, 403 S.W.2d 325 (Tex. 1965) is in the pantheon of famous oil and gas decisions in the state. The majority in the case held that the field rules at issue “prescribed” a proration unit of 80 acres for a gas well, though the rules “permitted” a larger proration unit. Because retained-acreage clauses often tie the acreage retained under a lease to proration units that are either permitted or prescribed by the Texas Railroad Commission field rules, parties often fight about the definition of these terms. The problem is that other than Jones and the Texas Supreme Court’s decision in XOG Operating, there is not a plethora of caselaw on the subject.

The PPC Acquisition case provides more insight on what it means to have a prescribed proration unit. The Lowe Lease permitted the lessee to retain a proration unit of either 160 acres or “such larger area as may be prescribed by the Texas Railroad Commission . . .” PPC Acquisition Co., 2021 WL 651666, at *9. The appellants argued that applicable field rules set a maximum proration unit of 640 and no minimum proration unit. Appellants equated “permitted” with the “maximum” and “prescribed” with the “minimum.” Thus, according to appellant, the field rules permitted a 640-acre unit, but did not prescribe any particular kind of unit.

The court disagreed. The court stated that the prescribed proration unit could be the standard proration unit and that the standard unit under the applicable field rules was a 640-acre unit. Thus, this standard unit was also the prescribed unit under the rules. The court also rejected the argument that field rules must expressly use the word prescribe to set a prescribed proration unit.

“Covenant” Versus “Special Limitation”: A Trap for the Unwary

One problem that stung several appellants in the case was the relief that they requested from the trial court and on appeal. Two appellants argued that the Northern Trust lessee’s failure to file a P-15 until after the end of the primary term meant that the lease terminated in its entirety. This is an interesting issue, as operators often do not file P-15 forms until after a primary term has expired (assuming the operator drilled the well near the end of the lease). But the Court did not decide the issue. Rather, it held the retained-acreage clause in the Northern Trust Lease to be a “covenant” under which the lessee agreed to release acreage, rather than a “special limitation.” As a practical matter, this meant that the Northern Trust Lease would not have automatically terminated based on the P-15 issue but instead the plaintiffs would have to file a breach-of-contract lawsuit asking for specific performance of the acreage-release promise. Because the appellants did not pursue this claim at the trial court, the Court rejected the appellants’ argument on this point.

The same covenant-versus-special-limitation issue thwarted the appellants dealing with the Colt Lease as well. Like the Northern Trust Lease appellants, the Colt Lease appellants argued that the lessee’s failure to properly designate a “drilling or producing unit” meant that the lease at issue terminated. Again, the Court held that any designation requirement in the Colt Lease was a covenant and would have required the appellants to sue for specific performance. Because they failed to request this relief in their motion for summary judgment or in their initial appellate brief, the Court held that they had waived the issue.

Considering the detail and breadth of the PPC Acquisition case, I think practitioners in the Delaware Basin will be seeing this case cited in a lot of cases going forward.