Oil & Gas Lease Consideration

Consider this scenario…

A Texas landowner was approached by an oil and gas operator seeking to lease and develop the oil and gas under the landowner’s property.  After a period of negotiation, the landowner, fully expectant to receive a bonus payment from the operator at the outset of their agreement—per its terms—executed an oil and gas lease for his property, which was filed for record by the operator.

Months pass since the landowner executed his lease, yet he never receives the promised bonus payment from the operator.  Now, a second operator seeks to lease the landowner’s property, offering a guaranteed cash bonus payment at closing.

However, under Texas law, an oil and gas lease that is executed subsequent to an earlier lease, filed for record and within its primary term or held by production, is considered a “top lease” and will not become effective until the preceding “bottom lease” has been released by the lessee/operator or expires or terminates by its terms or operation of law.  Given this fact, the second operator has little incentive to execute such a lease, much less pay the landowner a bonus payment for it. 

This scenario presents a troubling predicament for Texas landowners.  Specifically, it highlights the potential for an oil and gas interest to be essentially blocked from development for an extended period of time with the lessor/landowner receiving no benefit or value whatsoever for the lease that is burdening his property.  Additionally, a lessor/landowner in this situation may also lose out on opportunities to be leased by competing operators guaranteeing more immediate delivery of a bonus payment for its lease.

This predicament raises an interesting question:  Why should the lessor landowner’s ability to lease their property be limited when they received nothing in return from the initial lessee/operator?  Shouldn’t the fact that the landowner never received the bonus payment promised to them in their lease have consequences for the lessee/operator? 

First, a little background…

Under traditional Texas contract principles, the oil and gas lease with the initial lessee/operator in this scenario should be void for lack of consideration.  Consideration is value that is given in exchange for a promise, the lack of which renders a contract or agreement void.  In this scenario, the initial lessee operator obtained an oil and gas lease from the lessor/landowner without giving any consideration in return.  Accordingly, it would seem that the oil and gas lease between the lessor/landowner and the initial lessee/operator should be void for lack of consideration, thus enabling the landowner to then execute a new lease with the second operator and receive a more immediate bonus payment.  However, Texas courts treat oil and gas leases as conveyances of land and not as contracts.  Further, under Texas law, conveyances of land require no consideration to be valid.  Therefore, oil and gas leases require no consideration to be enforceable. 

This concept was introduced in the 1993 Beaumont Court of Appeals case styled, Jones v. Bevier, 59 S.W.2d 945 (Tex. Civ. App.—Beaumont 1933, writ ref’d).  In Jones, a landowner executed and delivered an oil and gas lease to a lessee.  The lessee recorded the instrument but failed to pay any bonus for the lease. The lessor landowner sued to cancel the lease as being ineffective for lack of consideration.  The court ruled in favor of the lessee, holding that an oil and gas lease is a conveyance of a determinable fee interest in the oil, gas and other minerals in and under the acreage described in the lease.  Consequently, it is a conveyance of land and requires no consideration.  Accordingly, nonpayment of the bonus was immaterial and did not void the lease.  Id. at 948.

This holding in Jones was later confirmed by the Texas Supreme Court in Shell Oil Co. v. Howth, 159 S.W.2d 483 (1942).  Howth dealt with the issue of whether a lessor/landowner had a valid claim against a lessee/operator for cancellation of its lease and for damages arising from slander of title.  While the facts of Howth were not analogous to Jones, in that it did not involve an issue of consideration, the Texas Supreme Court did cite Jones in its reasoning when it noted that “[t]he lease executed by Howth to Shell Company was an ordinary lease, and was a conveyance of the minerals.” Id at 490.

Since Howth, the rule that an oil and gas lease is a conveyance of property and not a contract has gone unchallenged and is considered to be well-settled in Texas.  Consequently, with respect to the scenario above, the fact that the landowner never received the bonus payment promised to him under the terms of the initial lease has no effect on the validity of that lease.  Rather, the lease remains in effect, probably resulting in the landowner’s property being burdened for the duration of the lease’s primary term—which could be several years—without receiving any value for such burden.

Wait, what? — The Bottom Line.

This may seem like an inequitable result, but it is the law in Texas.  That said, while an oil and gas lease cannot be voided for lack of consideration, lessors that were not paid their bonus payments still have a valid claim against their nonpaying lessee counterparts.  Further, landowners have the ability to avoid this situation by conditioning their execution of oil and gas leases, or leases’ validity, on receipt of the bonus payment.  Additionally, landowners may also execute supplemental agreements with operators in addition to an oil and gas lease, which provide conditions that would cause the oil and gas lease to become void or terminate, one of these conditions obviously being the landowner’s receipt of the bonus payment that the parties agreed to in the lease.

While these solutions may appear relatively straightforward, the most effective way to protect your rights as a landowner lessor or a lessee in an oil and gas lease is to consult an attorney.  If you have questions about an oil and gas lease or your rights as a a lessor or lessee, please contact us and connect with our team of attorneys that are experienced in this area of the law.