Note: The following legal update was featured in NADOA’s 2023 Q3 Magazine.
Can non-operating (“non-op”) working interest rights in an oil and gas lease be adversely possessed? That is the primary question asked and (ostensibly) answered by the Seventh District Court of Appeals in PBEX II, LLC v. Dorchester Minerals, L.P.[1] The undisputed facts in Dorchester are as follows.
Prior to 1983, Felmont Oil Corporation (“Felmont”) had acquired a 25% working interest in a tract of land in Midland County, Texas (the “Subject Land”). In 1983, Felmont entered into a Joint Operating Agreement (“JOA”) on the Subject Land with other working interest owners, resulting in two producing wells. In 1989, Torch Oil & Gas Company (“Torch”) succeeded to Felmont’s interest. Torch then apparently assigned its interest in the Subject Land to SASI Minerals Company and Baytech, Inc., who later conveyed it to Dorchester Minerals, L.P. (“Dorchester”). Consequently, Santa Fe Minerals, Inc. (“Santa Fe”), the Operator under the JOA, issued a new division order to Torch confirming that its interest under the JOA was now “0%.” Torch signed the new division order.[2]
From May 1990 to September 2016, Dorchester acted as a non-op under the JOA, paying its share of the costs of production, receiving revenue from the sale of gas, paying landowner royalties, and making elections under the JOA. However, in June 2016, Torch purported to assign its interest in the Subject Land to PBEX II, LLC (“PBEX”). Torch then notified Dorchester that back in 1990 it had mistakenly notified Santa Fe that it had assigned out its interest. Dorchester, after 26 years of paying joint interest billings (“JIBs”), obviously refused to execute a “correction” instrument confirming that Torch owned its interest.[3] Torch, in response, filed this suit.
Of primary concern in this case is whether, regardless of the existence of a valid conveyance in 1990, Dorchester adversely possessed the non-op working interest of Torch in the Subject Land. In finding that Dorchester had in fact divested Torch’s interest, the court looked to the so-called “25-Year” Adverse Possession Statute.[4] The court’s analysis was divided into three primary inquiries.
- Can non-operating working interests be adversely possessed in Texas?
Although Torch argued that the working interests at issue aren’t possessory, and thus are not subject to adverse possession because they are non-operated rights, the court disagreed. The court notes that there is no distinction in Texas between operated or non-operated working interests in terms of possession, and that “all working interests are possessory.”[5]
- What constitutes actual, visible appropriation of a working interest?
Adverse possession requires “actual, visible appropriation” of leasehold working interests. Actual, visible appropriation is generally satisfied by oil and gas drilling and production. Although Torch argued that Dorchester itself never set foot on the property, the court notes the surface estate is not at play here. Under the lease at issue, the minerals were drilled and produced by the operator, which satisfies the appropriation component of the rule.[6]
- Does non-consent status interrupt the continuous possession requirement?
Although Dorchester was at times considered “non-consent” in the operations under the subject lease, this status does not constitute an interruption in continuous possession. The uninterrupted possession requirement is intended to incentivize those with a competing claim to initiate an adverse suit. Further, the court notes the non-consent argument fails because non-consent does not constitute “relinquishment of title to the working interest.”[7]
Ultimately, the court recognizes that Dorchester “performed all functions of the Working Interest owner…”[8] including: (i) paying its proportionate share of production costs in the form of JIBs; (ii) receiving its proportionate share of revenue; (iii) paying lease royalties; (iv) responding to and making elections under the operative JOA; (v) paying taxes; and (vi) making “public filings reflecting ownership.”[9]
Per the court, Dorchester performed these functions of a working interest owner for more than the required twenty-five years under the adverse possession statute. Torch therefore had ample time to bring suit long before 2016 and its non-op working interest was adverse possessed.
This case leaves open some interesting questions with regard to the rights between working interest owners subject to a JOA. If an operator can adverse possess a non-operating working interest on behalf of another non-op party, are there circumstances where the operator itself could adversely possess a non-operated interest? At what point would the law of cotenancy and the heightened requirements of cotenant ouster potentially apply? Is the distinction here that one non-op is adversely possessing another non-op’s claim to the same interest? Is this decision at its heart based on equitable principles such as unjust enrichment, detrimental reliance, and estoppel? Or perhaps this case will be ultimately relegated to its somewhat unusual facts.
In a strong dissent, Justice Lawrence M. Doss hinted at some of these concerns and others. For one thing, he argues that adverse possession shouldn’t apply at all because Dorchester, as a non-operator, did not actually drill the wells and produce the minerals (disclaiming the theory that the operator could adversely possess a non-operated interest on Dorchester’s behalf). Even if this “appropriation by proxy” theory is sound, Justice Doss argues that continuous possession was interrupted by multiple periods of non-consent under the JOA between 1990 and 2016. After all, he reasoned, when a party goes non-consent, they are deemed to have relinquished their interest under a JOA until applicable costs and risk penalties are recovered.[10]
As of the date of this article, a Motion for Extension of Time to File a Petition for Review has been granted by the Supreme Court of Texas. It thus appears that the Amarillo Court’s decision may be reviewed by the Supreme Court.
[1] 2023 Tex. App. Lexis 2847 (Tex. App.—Amarillo 2023, writ pending).
[2] Id. at 4-5.
[3] Id. at 5-6.
[4] Tex. Civ. Prac. & Rem. Code §§ 16.027 and 16.021.
[5] 2023 Tex. App. Lexis 2847, at 9.
[6] Id. at 11.
[7] Id. at 19.
[8] Id. at 5.
[9] Id. at 21-22.
[10] Id. at 27-29.
Brad represents clients in connection with upstream energy transactions, complex mineral titles, pooling issues, lease analysis, joint operating agreements, surface use issues, title curative and general oil and gas business matters.