Tracey Stock Articles

Finding Gold But Missing Gems - April 14th, 2008

Categories: Business Practises, Land A&D, Oil & Gas
Author: Tracey Stock

Business is chin-deep in paper, email, and spreadsheets. So, it’s probably not surprising that people get fatigued by the blizzard of words and numbers and try to find ways to shovel them aside as quickly as they can. All anyone really wants is the golden nugget of information buried somewhere in the pile. Unfortunately, our efficient hunt for that golden piece of information can miss many other valuable information gems. An example in petroleum land is a common preference to use standard forms and agreements that use blanks and tick-box elections and a tendency for analysts to quickly flip through most of a document and only read those variable fields. Many people haven’t actually read the whole document in years and may have forgotten how some key operating paragraphs really work. The result can jeopardize ROFR management or confound land administration and erode relationships with private mineral rights owners.

ROFR management is an issue because of unfortunate language used in all of the CAPL operating procedures. The darn things say that ROFR’s are triggered when a party “wishes” or is “wishing” to dispose of its interest, but it doesn’t define when wishes or wishing occurs or what triggers wishing. It’s a sloppy word with ambiguous meaning. If it said “want” it would be clearer because wanting suggests a definite intention to do something and can be measured by overt acts. If it said nothing it would also be better because then it would say, a party “disposing” of its interest, and that too is a measurable act. But, they all say “wishes” or “wishing” and that could mean anything from the moment a landman or evaluations engineer gets a twinkle in their eye, or the letter of intent gets signed, or the sale agreement is signed, or when the deal actually closes. Nobody really knows. But, few people remember this language is in the CAPL procedure. It’s a lost gem. All that most want to know whether the election blank is filled in with an “A” or a “B” because “A” invokes the consent paragraph and “B” invokes the ROFR one. That’s the gold nugget. So, they flip through a contract until they find the right page and quickly glance for the “A” or “B”.

An unfortunate implication of the “wishing” language is that the industry is all over the map when it comes to timing when consents and ROFR’s are issued. Some will do it when the letter of intent is signed. Others wait for execution of the sale agreement. A letter of intent is probably a clear signal that a company is wishing to divest. Therefore, issuing consents and ROFR’s at this stage appears to comply most closely with the expectation described by the operating procedure. Waiting for execution of the sale agreement stretches the ordinary meaning of wishing. It may be common practice and may not generally attract objections, but it is still wise to remember that the actual language of the procedure uses “wishing” to trigger the consent and ROFR obligation. To minimize risk it is probably best to issue consents and ROFR’s at the letter of intent stage. So, the value in this pile of information isn’t only the golden nugget of the “A” or “B” election. There’s a gem of information in remembering about the wish.

Freehold leases provide another example. I was leading a land acquisition and divestiture team and an A&D analyst brought 16 freehold leases to my attention. The analyst believed that the vendor’s land schedule showed these 16 leases with incorrect delay rentals because it showed that each individual one as being net $1280. This was about a family sharing fractional undivided mineral interests in a full section of land. The vendor’s information appeared to show an annual rental obligation of $20,480 for all 16 leases. Fortunately for the purchaser, the land analyst was correct. The gross rent for all 16 leases was $1280, not $20,480. This was just one example. The schedule was long and this problem showed up many times. The total rental error was over $250,000 and this is a large enough sum to impact land valuation. The missing information gem was in the innocuous and seldom noticed “Lesser Interest” clause in each freehold lease. It said,

If the Lessor’s interest in the leased substances is less than the entire and undivided fee simple estate, the royalties, rentals and suspended well payments herein provided shall be paid to the Lessor only in the proportion which such interest bears to the entire and undivided fee.

The math is simple. The $1280 rent has to be divided by the fractional mineral interest. So, the lessor holding a 10% undivided interest gets a rent of $128 even though page one of their lease quotes a rent of $1280. The schedule incorrectly listed the gross rent as the net rent because it was picking up the big bold number filled in above the blank line on page one of the lease and neglecting to apply the language of the skinny little “Lesser Interest” clause on page two. I’ve seen this kind of mistake before. People often forget that a there is usually a “lesser interest” clause somewhere in all freehold leases. A common example is found at Clause 5 of the C.A.P.L. 91 ALTA form of lease.

The bottom line is that quality A&D work needs professionals who maintain a breadth of knowledge that reaches beyond schedules, summaries, and abstracts. It needs people who take time to read and understand more about leases and contracts than is found by glancing at the filled-in blanks and election tick-boxes. Fortunately, in A&D work the industry is aided by land professionals and lawyers. Their input can minimize ROFR management risks. Their careful analysis of something as basic as mineral lease rents can impact valuation, reduce adjustments, and minimize post-closing maintenance costs.

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