#27147-rev & rem-SLZ

2015 S.D. 27

IN THE SUPREME COURT

OF THE

STATE OF SOUTH DAKOTA

* * * *

IN THE MATTER OF THE PETITION

OF LUFF EXPLORATION COMPANY,

DENVER, COLORADO, FOR AN

ORDER POOLING ALL INTERESTS IN

A SPACING UNIT FOR THE SOUTH

MEDICINE POLE HILLS FIELD

DESCRIBED AS THE E/2 OF SECTION

33 AND THE W/2 OF SECTION 34,

TOWNSHIP 23 NORTH, RANGE 4

EAST AND THE NW/4 OF SECTION 3

AND THE NE/4 OF SECTION 4, 

TOWNSHIP 22 NORTH, RANGE 4

EAST, HARDING COUNTY, SOUTH

DAKOTA, AND TO AUTHORIZE THE

RECOVERY OF RISK COMPENSATION

IN ADDITION TO THE PRO RATA

SHARE OF REASONABLE ACTUAL 

COSTS FROM THE INTEREST OF ANY

LESSEE OR UNLEASED MINERAL

OWNER WHO ELECTS NOT TO 

PARTICIPATE IN THE RISK AND COST

OF DRILLING AND COMPLETING A

WELL ON SAID SPACING UNIT; AND

FOR OTHER RELIEF AS THE BOARD

DEEMS APPROPRIATE.

* * * *

APPEAL FROM THE CIRCUIT COURT OF

THE SIXTH JUDICIAL CIRCUIT

HUGHES COUNTY, SOUTH DAKOTA

* * * *

THE HONORABLE MARK BARNETT

Judge

* * * *

ARGUED FEBRUARY 18, 2015

OPINION FILED 05/06/15
SCOTT SUMNER

Rapid City, South Dakota Attorney for appellant 

Linda Golden. 

JOHN W. MORRISON of

Crowley Fleck, PLLP

Bismarck, North Dakota

and

BRETT M. KOENECKE of

May, Adam, Gerdes & Thompson, LLP

Pierre, South Dakota Attorneys for appellee Luff 

Exploration Company.

MARTY J. JACKLEY

Attorney General

RICHARD M. WILLIAMS

Assistant Attorney General

Pierre, South Dakota Attorneys for appellee 

South Dakota Department of 

Environment and Natural 

Resources.
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ZINTER, Justice

[¶1.] Linda Golden owned a mineral interest that was within a “spacing 

unit”1 in which Luff Exploration Company desired to drill for oil. Because Golden 

rejected Luff’s offer to lease her mineral interest or participate in the cost of 

drilling, Luff petitioned the South Dakota Board of Minerals and Environment 

(Board) to “compulsory pool”2 the mineral interests in the spacing unit. Luff also 

sought “risk compensation”3 from Golden. Over Golden’s objection, the Board 

granted Luff’s petition for compulsory pooling and risk compensation, and the 

circuit court affirmed. On appeal to this Court, Golden argues that the Board erred 

 

1. “When necessary to prevent waste, to avoid the drilling of unnecessary wells, 

or to protect correlative rights, the Board of Minerals and Environment shall 

establish spacing units for a pool . . . .” SDCL 45-9-20. A “pool” is “an 

underground reservoir containing a common accumulation of oil or gas or 

both[.]” SDCL 45-9-2(10). Orders establishing spacing units for pools

“specify the size and shape of each unit and the location of the permitted well 

thereon in accordance with a reasonable uniform spacing plan, with 

necessary exceptions for wells drilled or drilling at the time of the filing of the 

application.” SDCL 45-9-26.

2. Pooling is “[t]he bringing together of small tracts of land or fractional mineral 

interests over a producing reservoir for the purpose of drilling an oil or gas 

well.” Black’s Law Dictionary 1348 (10th ed. 2014). Compulsory pooling 

occurs when the pooling is “done by order of a regulatory agency.” Id. Its 

purpose “is to prevent the physical and economic waste that accompanies 

unnecessary wells . . . [and] to protect the correlative rights of landowners 

over a reservoir.” 6 Howard R. Williams and Charles J. Meyers, Oil and Gas 

Law § 901 (1990).

3. In the oil and gas industry, “risk compensation”—also known as “risk bonus,” 

“risk penalty,” or “compensation for risk”—“is intended to relieve the 

nondrilling interest owner from having to advance his proportionate share of 

the drilling costs but provide extra compensation from production (if oil is 

found) to the drilling party who has advanced the entire drilling costs and 

who would absorb the entire cost of a ‘dry hole.’” Application of Kohlman, 

263 N.W.2d 674, 675 (S.D. 1978).
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in failing to order a time and manner for Golden to elect to participate in the well by 

paying her proportionate share of the cost of drilling, equipping, and operating the 

well. Golden also argues that Luff was not entitled to risk compensation. We 

reverse and remand.

Facts and Procedural History

[¶2.] The Secretary of the Department of Environment and Natural 

Resources (DENR) issued an order that established a 960-acre spacing unit for oil 

drilling in the South Medicine Pole Hills field in the Red River B reservoir in 

Harding County. Golden owned a 50% mineral interest in two lots—totaling eighty 

acres—in that spacing unit. Luff planned to drill a horizontal well for oil, and

Golden was the only mineral owner in the spacing unit who had not leased her 

interest or agreed to participate with Luff in the cost of the well.

[¶3.] Golden and Luff had a pre-existing relationship regarding oil and gas 

production. Luff operated another well in which Golden was an unleased mineral 

owner. Golden chose not to lease or participate in the prior well and was forced to 

pool her interest with Luff and pay 100% risk compensation. 

[¶4.] Clayton Chessman, an oil and gas “landman” employed by Luff,

interacted with Golden on the well at issue in this case. Chessman emailed Golden

on June 25, 2013, proposing to lease her mineral interest. Luff offered $100 per net 

acre with a one-sixth royalty for a three-year primary term. Luff indicated that it 

preferred to lease Golden’s interest because if it “force pooled” her interest, Golden 

would be responsible for risk compensation. Golden did not respond to Chessman’s 

email. 
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[¶5.] On July 17, 2013, Chessman sent Golden a certified letter and an 

email, which had the June 25 email attached. Chessman disclosed the estimated 

costs of drilling and included an “authority for expenditure” in the event Golden 

elected to participate. Alternatively, in the event Golden elected to not participate, 

Chessman offered to double Luff’s lease to $200 per net acre. Chessman also 

attached a proposed lease. The increased offer was also in Chessman’s email. 

Golden was requested to make her election within thirty days of July 17, 2013. 

Chessman warned Golden that if she did not lease or elect to participate, Luff would 

request the Board to authorize the recovery of risk compensation from Golden.

[¶6.] On July 18, 2013, Golden emailed Chessman declining Luff’s offer

regarding the well. Golden stated: “Thank you for your generous offer. I have 

spoken with my attorney . . . and decided that I want to continue my status as an 

unleased mineral interest [owner].” Although Golden did not receive the letter until 

July 25, 2013, she did not change her position.

[¶7.] Luff, for its own logistical reasons, had decided to proceed with drilling 

before obtaining a pooling order. Luff applied for a permit to drill the well on July 

2, 2013. The permit was issued on July 11, 2013. On July 23, 2013, Luff petitioned 

the Board for the compulsory pooling order. Notice, including the opportunity for 

hearing, was sent to interested persons. Luff began drilling on July 28, 2013. At 

that time, Luff did not have a lease or voluntary pooling agreement with Golden,

and Luff had not obtained the compulsory pooling order. 

[¶8.] Golden received notice of the compulsory pooling order request on 

August 9, 2013. On August 28, 2013, Golden filed a petition to intervene. A 
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contested case proceeding was scheduled for October 17, 2013. At the time of the 

hearing, the well had been successfully drilled, but it had not been made 

operational. 

[¶9.] Chessman was the only witness to testify at the hearing. He testified 

that because the well had already been drilled, Golden received an advantage over 

other mineral interest owners: she knew the well was mechanically successful. He 

also testified that the lease terms offered were reasonable and were based upon 

lease terms negotiated with another mineral owner in the spacing unit. Chessman 

further testified that the thirty-day time period to make an election to lease or 

participate was reasonable and in accord with the practice in the oil and gas 

industry. Golden did not dispute the reasonableness of Luff’s terms. 

[¶10.] Chessman also testified regarding the risks associated with drilling 

and development of oil wells.4 Even though mechanical drill risks had been 

resolved in this case because the well had been drilled, risks of production still 

existed. Chessman testified that some wells in the Red River B reservoir were

successful and others produced too much water or were otherwise not economically

feasible to operate. Therefore, Chessman testified that 100% risk compensation 

was not only reasonable, but was low considering industry standards. Chessman 

“[had not] seen anything less than 300 percent [risk compensation] in many years, 

and more recently with the horizontal drilling [he had] seen it as high as 4[00] and 

500%.” 

 

4. Chessman’s testimony was disputed through cross-examination. 
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[¶11.] At the conclusion of the hearing, the Board issued a compulsory 

pooling order. The Board also found that 100% risk compensation was just,

reasonable, and should be paid by Golden. The order did not contain a provision 

setting a time and manner for Golden to elect to participate in the well.

[¶12.] Golden appealed to the circuit court, which affirmed the Board’s 

decision. Golden now appeals to this Court, arguing that the Board erred in not

ordering a time and manner in which Golden could elect to participate in the well. 

Golden also argues that she should not be subject to risk compensation. Golden

contends that risk compensation should not have been awarded because: (1) the 

Board erred in finding that Luff made an unsuccessful, good-faith attempt to have 

Golden participate in the well, (2) Luff had already drilled the well, and (3) 100% 

risk compensation was arbitrary, unjust, and unreasonable.5 

Decision

[¶13.] Golden first argues that the Board erred in granting a pooling order

that contained no provision specifying a time and manner for her to elect to 

participate. SDCL 45-9-32 provides:

Each such pooling order shall authorize the drilling, equipping, 

and operation of a well on the spacing unit; shall provide who 

may drill and operate the well; shall prescribe the time and 

manner in which all the owners in the spacing unit may elect to 

participate in such well drilling, equipping, and operation; and 

shall provide for payment of the reasonable actual cost of the 

well drilling, equipping, and operation by all those who elect to 

 

5. “Our standard of review is governed by SDCL 1-26-37. The agency’s findings 

are reviewed for clear error. . . . Questions of law are . . . reviewed de novo.” 

Martz v. Hills Materials, 2014 S.D. 83, ¶ 14, 857 N.W.2d 413, 417 (citations 

omitted). We also review statutory interpretation de novo. Trumm v. 

Cleaver, 2013 S.D. 85, ¶ 8, 841 N.W.2d 22, 24.
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participate, plus a reasonable charge for supervision and 

interest.

(Emphasis added.) Golden contends that the emphasized language requiring that

the order “shall” contain a provision prescribing a time and manner for her to “elect 

to participate” was mandatory. 

[¶14.] Luff responds that an elect-to-participate term was not required in the 

pooling order in this case because Golden had elected not to participate when she 

rejected Luff’s offer before the hearing. Luff contends that the statute “clearly 

presumes” the election requirement applies only if the owner has not made an 

election prior to the hearing. Luff points out that the Board found “Golden’s 

response and position was clearly unequivocal that she wished to continue her 

status as an unleased mineral interest [owner].” Therefore, Luff contends that 

Golden had elected not to participate before the hearing and there was no need to 

prescribe a time and manner to elect to participate after the hearing. We disagree.

[¶15.] SDCL 45-9-32 is unambiguous. It contains no language permitting the

Board to waive the opportunity to participate in cases where owners have declined 

to participate prior to the hearing. On the contrary, the statute contemplates future 

conduct. It provides that in pooling proceedings “[e]ach . . . pooling order . . . shall 

prescribe the time and manner in which all the owners in the spacing unit may elect 

to participate in such well drilling, equipping, and operation[.]” (Emphasis added.) 

Thus, the Board was required to include in its order a time and manner for Golden

to elect to participate. Concededly, in this case, such a provision allows Golden to 

know the results of the drilling before making her election. But the order 

prescribing a time for participation may only be issued after a hearing in cases 
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where an owner has objected. See SDCL 45-9-31. Therefore, any advantage Golden 

obtained by knowing the results of the drilling accrued only because Luff elected to 

drill before it obtained a pooling order.6 We conclude that the Board failed to 

comply with the plain language of SDCL 45-9-32.7

[¶16.] Luff, however, argues that SDCL 45-9-32 should be “harmonized” with 

ARSD 74:12:10:01, which implements the statute. The rule allows a driller in a 

pooling proceeding to obtain risk compensation “from an owner who elects not to 

participate.”8 See id. The rule provides that risk compensation may be obtained 

 

6. Luff acknowledged that it had given Golden this advantage. Chessman 

testified that Luff gave Golden thirty days to respond to their offer even 

though they were going to drill before the time to respond expired. Chessman

acknowledged that “meant that [Luff was] assuming some of the risk in the 

initial drilling by giving her the full 30 days even though [Luff] had 

commenced [drilling.]” 

7. This case involves an owner who had declined to lease or participate before 

the hearing. We express no opinion on those cases where an owner has 

contracted to lease or participate before the hearing. 

8. ARSD 74:12:10:01 provides:

In an application for a compulsory pooling order made pursuant 

to SDCL 45-9-31, the applicant may request the board to provide 

for the recovery of risk compensation, in addition to actual 

prorated costs, from an owner who elects not to participate in 

the risk and cost of drilling and operating a well in an 

established spacing unit. Before an order is entered with such a 

provision, the applicant must:

(1) Provide proof that an unsuccessful, good-faith attempt 

was made to have the nonparticipating owner execute a 

lease or participate in the risk and cost of drilling and 

operating the well; and

(2) Notify the nonparticipating owner with proof of service 

that the applicant intends to request the board to provide 

for the recovery of risk compensation and that the 

(continued . . .)
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only upon proof that a “good-faith attempt was made to have the nonparticipating 

owner execute a lease or participate in the risk and cost of drilling and operating 

the well[.]” Id. (emphasis added). Unlike the statute, this rule looks to the past to 

determine if a good-faith attempt was made to obtain a lease or participation 

agreement. Considering the past-tense language of the rule, Luff contends the

“elect” language of the statute should be interpreted to be a condition precedent

that only refers to mineral interest owner’s elections made prior to the pooling 

hearing. Luff argues that the condition precedent was satisfied in this case because 

Golden had indicated she desired to remain an unleased mineral interest owner

before the hearing. Therefore, Luff contends that the statute did not require the 

order to provide a time and place for Golden to elect to participate after the hearing.

[¶17.] The rule, however, does not set the time in which mineral interest 

owners must make the election. More importantly, an administrative regulation 

cannot adopt requirements that “expand upon the statute that it purports to 

implement.” State Div. of Human Rights, ex rel. Ewing v. Prudential Ins. Co. of 

Am., 273 N.W.2d 111, 114 (S.D. 1978). “Furthermore, ‘rules adopted in 

contravention of statutes are invalid.’” Paul Nelson Farm v. S.D. Dep’t of Revenue, 

2014 S.D. 31, ¶ 24, 847 N.W.2d 550, 558 (quoting In re Yanni, 2005 S.D. 59, ¶ 16, 

697 N.W.2d 394, 400). Luff’s interpretation of the rule would not only expand the 

statute, it would nullify SDCL 9-45-32’s requirement that the pooling order, which 

________________________

(. . . continued)

nonparticipating owner may object to the risk 

compensation provision by responding in opposition to the 

application for the compulsory pooling order.
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can only be issued after a hearing in this type of involuntary pooling case, contains

a provision allowing each owner in the spacing unit a time and manner in which 

they “may elect” to participate.9

[¶18.] We reverse and remand to the Board for entry of a pooling order that 

affords Golden a time and manner of electing to participate by paying her 

proportionate share of the cost of drilling, equipping, and operating the well. 

Although Golden also requests that we determine the issue of risk compensation, 

that issue will be mooted if Golden elects to participate. Therefore, we decline to 

address that issue. 

[¶19.] GILBERTSON, Chief Justice, and SEVERSON, WILBUR, and KERN, 

Justices, concur.

 

9. At oral argument, DENR suggested that such an interpretation could create 

a constitutional problem because mineral owners who voluntarily contracted 

to participate or lease might claim a “taking” if better terms became available 

under a Board’s subsequent pooling order. DENR did not, however, explain 

how a taking can occur following an owner’s voluntary contractual agreement 

alienating property rights. Additionally, the plain language of the statute 

controls our interpretation.