Cancellation of leases by some oil and gas companies

The leasing boom of early summer 2010 came to an abrupt halt in August of that year. In the midst of the boom in mineral rights leasing, landowners were negotiating and signing leases that would pay bonus payments of hundreds to thousands of dollars per acre. In August, people began receiving letters stating that their signed lease was null and void. One person reportedly told a landowner it was the fastest boom to bust he had ever seen in the oil industry. It is also the first time he ever saw oil and gas companies reject a signed, valid lease. Landowners expecting the oil and gas companies to follow through on the commitments agreed to in the lease became disappointed and frustrated. A number of them joined together to file a class-action suit and plan to sue the companies to honor those signed leases.

The decision to cancel leases may be due to the failure of the Pioneer well drilled in Kalkaska County by Canadian company Encana Resource to measure up to initial expectations. The well underwent testing that initially indicated the Collingwood shale would be a new discovery for Michigan, but the longer the well was tested, the poorer the results appeared.

In regards to lease cancellations and the reasons given by the oil and gas companies for those cancellations, attorney Susan Hlywa Topp provided these comments and answers the question:

Does having a mortgage on my property affect my ability to obtain an oil and gas lease? The cancellation letters sent by the oil and gas company frequently state that the property has a mortgage, is outside the oil company’s target area or a deadline was missed for an agreement. 

Topp:  Those are not legally valid reasons to cancela signed lease. They are trying to justify what I think is a business decision. Prior to the mass lease cancellations that occurred, having a mortgage on your property was not an issue. Most mineral lessors have mortgages on their property. The bank is usually very agreeable to a subordination agreement and welcome the fact that they have a source of revenue they can use should the landowner default on the loan. Just because certain companies have cancelled leases on properties with mortgages does not mean such action is correct. Keep in mind that for mineral rights, the standard is drillable or curable title,not perfect title.

What is a subordination agreement?

Topp: It is a legal document that allows (subordinates) the rights of what would be a junior lienholder (oil and gas lease) to precede the senior lien holder (mortgage company). Both a mortgage and an oil and gas lease are considered encumbrances to a property. Normally, the mortgage company is the senior encumbrance. In the case of oil and gas, the oil and gas company wants their lease to be the most senior encumbrance. Most mortgage companies do not object to this because most oil and gas leases state that if the landowner defaults on the mortgage, the oil and gas company has the right to begin paying the mortgage and deduct the payment from any royalty the landowner would receive. This allows the oil and gas company an unfettered right to continue accessing the property to produce their wells and allows the mortgage company to continue to receive payments, even though their borrower (landowner) has defaulted on the mortgage.

As a result of these cancellations what are landowners also doing? According to Joe Quandt, an oil and gas attorney in Traverse City, Mich., “landowners are consolidating into large blocks for the purpose of leasing and for the most part, they are not signing standard leases anymore.” Besides setting lease rates and royalties, the leases can specify where wells can be drilled and how any effects on the environment are handled.

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