Division Orders Clause in an Oil and Gas Lease
As of the current printing of this book, Texas is the only state allowing production revenues to be withheld from an owner, and interest to be paid on those revenues, until that owner signs a division order complying with the statutory restrictions on content. By contrast, Louisiana statutorily prohibits a payer from withholding production revenues for the sole reason of unsigned division order (2006 Louisiana Laws – 31:138:1, Acts 1992, No. 1110, §1). The consensus of in-house counsel with virtually every producer oil company in the industry, if a licensed title attorney advises obtaining a signed division order as a method of curing a specific title requirement, Louisiana law allows a signed division order to be required in that instance.
Other states vary in their statutes regarding efficacy of division orders, but case law is applied arbitrarily by the various companies in the industry based on their comfort level with the financial risk involved. It is becoming more common for a Lessor to include a division orders provision in the lease. This clause sets out in writing the agreement between the parties as to when, or if, signed division orders can be required of the Lessor and other royalty owners under the lease before paying revenues.
“As a prerequisite to timely receiving the royalty payments above provided, Lessor shall NOT be required to sign any division order which materially differs from the provisions of a division order as recited in the Texas State Statutes in force and effect on the date such division order is issued by Lessee.”
Simplified: “As a prerequisite to receiving royalty payments, Lessor shall NOT be required to sign any division order which materially differs from the provisions of a division order as recited in the Texas State Statutes.”
This clause as written is straightforward, stating that a royalty owner under this lease can never have royalty payments withheld solely because a signed division order has not been received. Texas allows royalties to be withheld until a signed division order or transfer order is received, but only under specific circumstances. The clause in this example does not mean that a signed division order or transfer order cannot be required if it is needed for the purpose of curing a title requirement, especially if it is stated as a specific title requirement in a title opinion rendered by an attorney. An example not requiring a title opinion requirement would be when remaindermen (called naked owners in Louisiana) need to sign the division order or transfer order showing they understand and approve that 100% of the royalties will be paid to the life estate holder (or usufructuary, in Louisiana).
The analyst should take note that this clause expressly states that it applies only to royalty payments. It does not apply to ownership transfers affecting future rental payments, shut-in payments, or an exercise of an option to extend the primary term (if the lease contains one) in the case of death of the Lessor or conveyance of the Lessor’s interest after the lease is delivered.
If Management policy requires receipt of signed division orders before releasing production revenues for all leases covering Texas lands, that policy should make allowance for lease provisions stating otherwise. Doing so reduces the financial risk of future legal action by royalty owners under a lease containing such a clause.
Many companies that operate oil and gas wells require a notation in the lease data record setting out this restriction, so that it will appear in reports if queried.
This clause takes affect only after the lease begins to produce. At that time it is necessary for the division order analyst to be aware of this clause. It may, or may not, be the responsibility of the lease analyst to advise the division order analyst of each lease for the producing well containing this restriction. Some companies require the division order analyst to personally review each lease for this clause and others directly affecting the manner and timeliness of production royalty payments.
“The execution by Lessor of a division order in favor of a third party purchaser of production shall not relieve Lessee of Lessee’s obligations hereunder to pay royalties timely and properly to Lessor in the event such third party purchaser declares bankruptcy or otherwise fails or refuses to pay royalties in a timely and proper manner.”
Simplified: “[E]xecution by Lessor of a division order of a third party purchaser of production shall not relieve Lessee of obligations to pay royalties timely in the event such purchaser declares bankruptcy or otherwise fails to pay royalties timely.”
Each Lessee has the right to sell its share of oil or gas production through a private contract with a purchaser, and are not required to market its share of oil or gas with the operator. Typically, the oil or gas purchaser remits 100% of the sale proceeds to the Lessee, and the Lessee must then distribute the royalties out of those proceeds. Many smaller Lessees (called “producers” in this context) do not have the software, personnel, or capacity to distribute royalties themselves. Instead, they include royalty distribution service to the contract and pay a fee for the purchaser to distribute royalties for them, and remit to the producer only the producer’s net working interest.
It is not unlikely for a royalty owner under a lease to receive the division order and subsequent payments directly from the purchaser of production, such as Sunoco, Plains, Energy Transfer Partners (ETC), or other oil or gas purchaser for end use. The clause in this example serves as an agreement between the Lessor and Lessee (and successors) in this lease in case the purchaser fails to pay timely or properly. The Lessee agrees that the Lessor reserves the right to sue the Lessor for full payment if the purchaser “otherwise fails to pay”, meaning fails to pay for any reason.
There is no need for the lease analyst to capture the data from this clause for the lease data record. There is no action the Lessee can take to prevent bankruptcy or other reason for failure-to-pay. At the point the Lessee learns of non-payment, this lease and all supporting documents and records will be reviewed, most likely within the context of a legal action.
If at any time the purchaser distributing production revenues should file bankruptcy or cease to exist, the operator (also receiving its revenues from this purchaser) would immediately take action on its own behalf and behalf of all of its royalty owners under the lease. If the purchaser should simply stop paying this owner for any reason, the operator will not know about it unless the royalty owner (Lessor) contacts the operator to demand payment. The division order analyst working for the operator typically will work with the purchaser to determine the problem, which may be as simply as mail having been returned to the purchaser and the purchaser needs a new address for this royalty owner, to resume payments.