Opinion ID: 895065
Heading Depth: 1
Heading Rank: 2

Heading: Does Termination of the Lease Also Terminate the Unit?

Text: Sheppard's 1994 lease contained a standard industry pooling clause that provided: Lessee shall have the right but not the obligation to pool all or any part of the leased premises or interest therein with any other lands or interests.... Production, drilling or reworking operations anywhere on a unit which includes all or any part of the leased premises shall be treated as if it were production, drilling or reworking operations on the leased premises, except that the production on which Lessor's royalty is calculated shall be that proportion of the total unit production which the net acreage covered by this lease and included in the unit bears to the total gross acreage in the unit.... In the absence of production in paying quantities from a unit, or upon permanent cessation thereof, Lessee may terminate the unit by filing of record a written declaration describing the unit and stating the date of termination. Pooling hereunder shall not constitute a cross-conveyance of interests. The Designation of Unit signed by the lessees of the various leases and lands included in the pool provided that they hereby pool and combine said leases and the lands ... into a single pooled unit or unitized area for the development of and production of gas and associated hydrocarbons.... We disagree with Wagner & Brown that the portion of Sheppard's pooling clause regarding termination for lack of production resolves this case. That clause provides that the unit  may terminate if production ceases, but there is nothing to show this was intended to be the exclusive means. The documents do not specify what happens to the unit when one lease terminates, so this case calls for interpretation rather than plain reading. But we agree that a proper interpretation of these documents indicates the termination of Sheppard's lease did not terminate her participation in the unit. A lease is not necessarily required for pooling; mineral owners can join a pool even if no lease exists. [9] Here, both Sheppard's lease and the unit agreement pooled certain premises and lands, not just their leased interests. Although Sheppard's lease expired, the lands themselves obviously did not. Thus, while termination of Sheppard's lease changed who owned the mineral interests in the unit, it did not cause the unit to terminate because it was a pooling of lands, not just leases. On precisely this basis, the Second Court of Appeals held in Ladd Petroleum Corp. v. Eagle Oil & Gas Co. that termination of a lease does not terminate a unit. [10] The lease in Ladd allowed pooling with other lands as well as other leases, so the unit survived the termination of one lease because the continuing validity of any such pooling was not dependent upon a subsisting leasehold estate in the adjacent land. [11] In this case as in Ladd, lands as well as leases were pooled, so the tracts dedicated to the unit survived even if the related leases did not. The court of appeals here distinguished Ladd on the ground that it involved termination of an entire pool, while Sheppard seeks only termination of her participation in it. [12] But there cannot be one rule of contract interpretation for small mineral interests and a different rule for large ones. If Sheppard's original mineral interest had been 8/8ths rather than 1/8th, the ruling she seeks would have cut off all production for the other members in the pool just as occurred in Ladd. And if her original interest had been 5/8ths or more, her share would have curtailed their share, even though they had nothing to do with letting her lease terminate. [13] The court of appeals relied on Texaco, Inc. v. Lettermann, in which the Seventh Court of Appeals held that the termination of two out of the three leases in a unit resulted in termination of the pool. [14] But the lease in Lettermann only authorized pooling with the gas leasehold estate of adjacent lands. [15] Thus, when those leasehold estates terminated, so did the pool. But that does not mean a unit formed by pooling lands must terminate on the same basis as one formed by pooling only leases. The court of appeals also reasoned from the premise that the pooling agreement transferred only the operator's interest, leaving Sheppard's possibility of reverter unimpinged. But her lease allowed pooling of all or any part of the leased premises or interest therein, and Sheppard's reverter was certainly an interest in the leased premises. When a unit is properly pooled, the owners of the minerals or reversionary interests in a separate tract within the unit surrender their right to receive their interest in all production from wells located on their own tract.... [16] Just as pooling impinges on a mineral owner's royalty interest, [17] it also may impinge on an owner's possibility of reverter. The parties invite us to decide the question here based on general principles rather than the terms of the particular documents involved. Wagner & Brown urges that termination of a lease should never terminate a pool, pointing out that pooling benefits mineral owners, operators, the state, and the environment by reducing the number of wells needed to maintain efficient production while protecting correlative rights. [18] Sheppard urges adoption of a treatise's view that pooling can extend no longer than the lease itself because a lessor grants only a power to pool the leasehold rights. [19] But oil and gas leases in general, and pooling clauses in particular, are a matter of contract. [20] Just as owners and operators generally must agree to create a pool, [21] they should also be able to agree when one terminates. If the parties want pooling to expire (or not) upon termination of one lease, they should be free to say so. [22] The lease here allowed the Sheppard tract (rather than just the lease) to be pooled for purposes of production, and that is what the unit designation did. As termination of the lease changed none of the lands committed to the unit, we hold that it did not terminate the unit. Thus, while Sheppard is entitled as a co-tenant to 1/8th of the proceeds due to the mineral owners of her tract, that does not entitle her to 1/8th of the proceeds that must be shared with mineral owners of other tracts by the terms of the unit agreement.