412 SM Energy Co. v. Sutton

Richard F. Brown

 
The following is not a legal opinion.  You should consult your attorney if the case may be of significance to you.
 
SM Energy Co. v. Sutton, 376 S.W.3d 787 (Tex. App.—San Antonio 2012, pet. filed) held that when a lease has a provision that relieves lessee of all obligations related to any released acreage or interests, an overriding royalty interest (“ORRI”) on the entire lease is extinguished as to the acreage included in a partial release of lease, unless the instrument creating the ORRI expressly provides otherwise.  Sutton Producing Corporation (“Sutton”) obtained a 1966 lease on 40,000 acres for oil and gas exploration.  The lease provided that lessee could release “any part or all of said land or of any mineral or horizon thereunder, and thereby be relieved of all obligations as to the released acreage or interest.”  Sutton assigned the 1966 lease and reserved an ORRI.  The assignment contained a savings provision that the ORRI would apply to “all amendments, extensions, renewals or new leases taken on all or part of the lease premises within one year after termination of the present lease.”  There was a partial release of lease by the successor lessee, Crimson Energy Company, L.P. (“Crimson Energy”), as to 22,000 of the 40,000 acres, and, over one year later in 2001, lessor granted three new leases to Crimson Energy covering the same 22,000 acres.  The 2001 leases were eventually assigned to SM Energy Company (“SM Energy”).  The 1966 lease continued in effect as to the other 18,000 acres not included in the partial release of lease.
 
The issue in the case was whether the effect of Crimson Energy’s partial release of the 22,000 acres and subsequent leasing of the same 22,000 acres was to wash out Sutton’s ORRI on those 22,000 acres.  The case was tried on competing motions for summary judgment.
 
The general rule in Texas is that “an ORRI does not survive the termination of the leasehold which it burdens absent an express provision to the contrary.”  It was undisputed that the ORRI terminated under the 1966 lease as to the 22,000 acres included in the partial release of lease.  The parties disagreed as to whether the savings clause in the assignment made the ORRI applicable to the 22,000 acres under the 2001 leases.  The court held that the ORRI on the released 22,000 acres was extinguished because the 1966 lease allowed for a full or partial release accompanied by relief from any obligations as to the released portion and there was no applicable savings clause.
 
The successors to Sutton argued that the savings provision applied to their ORRI because the provision required termination of the “present lease” and the 1966 lease never terminated.  Therefore, the 2001 leases were not taken more than one year after the termination of the present lease.  The court held that termination of the “present lease” included a partial termination because: (1) the lease contemplated partial terminations; (2) the parties knew that ORRIs could be easily destroyed; and (3) “[i]t was the ORRIs’ owners’ burden to include an express provision to save their ORRIs from being extinguished by a partial termination that the lease expressly contemplated.”  Because no express savings provision was included to address a partial release, the effect of the partial release was to wash out Sutton’s ORRI as to the 22,000 acres.
 
Texas case law has not been kind to overriding royalty owners.  It is widely understood that a release or termination of lease generally extinguishes an overriding royalty interest burdening the leasehold.  It is also understood that the ease with which an overriding royalty can be destroyed encourages manipulation and collusion to wash out an unwanted lease burden.  The savings provision in this case is a provision commonly found in assignments or reservations of overriding royalty.  It is a reasonable attempt to lessen the risk to the overriding royalty owner of collusion or manipulation, but it is also reasonably limited in time to avoid a continuing restraint on the lessee’s right to enter into a new lease.  The significance of this case is the confirmation that the general rule of automatic release of overriding royalties will apply to partial releases, but, perhaps more importantly, it is a warning that if the owner of the overriding royalty wants more protection, the owner must clearly protect himself.