A recent decision handed down by the U.S. Fifth Circuit of Appeals makes it clear that great care should be taken with how the consideration clause of Texas oil and gas leases are drafted. The case of In the Matter of: Goodrich Petroleum Corporation, 894 F3d 192 (5th Cir.) illustrates that you should NOT use the standard verbiage with respect to consideration paid if additional consideration for the lease is due. The additional consideration should be fully described, thereby providing notice of record to third parties of the additional consideration due.
Often, almost as a matter of rote, Texas oil and gas leases use language similar to this:
“NOW, THEREFORE, for the promises and covenants exchanged below, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the Parties agree …”
If you are signing an oil, gas, or mineral lease, do NOT use this usual language if some portion of the consideration is still to be paid. According to the Fifth Circuit, third parties, including those involved in bankruptcy proceedings, are entitled to rely on the representation that the all the consideration has been paid, which is the legal consequence of the words “… the receipt … of which is is hereby acknowledged…”. If your lease uses the usual language, the obligation to provide the additional consideration can be voided by a bankruptcy court.
Texas Oil, Gas, and Mineral Leases: Legal Principles
Under Texas law, for a contract such as an oil and gas lease to be valid, the parties must exchange some sort of consideration. “Consideration” is a legal term that means “something of value.” Money is the most common form of consideration, but mutual promises and other things of value can be consideration. Often, consideration is paid in installments and over time. Most houses and real property are financed in this manner. Generally, lawyers add a clause similar to the above-listed clause reciting the consideration. However, the Goodrich Petroleum case teaches that a practitioner must describe all of the consideration and should avoid stating that the consideration has been paid if, in fact, part of the consideration is to be paid in the future. This is particularly important if the contract is to be recorded.
Under Texas law, documents conveying real estate interest must be recorded with the county clerk’s office to be valid against third parties. Recordation makes the document available for public inspection. Recording a deed or conveyance gives notice to everyone that this land/estate belongs to the person or entity listed as the grantee on the deed. Third parties — members of the general public — are entitled to rely on what the recorded documents say.
The Goodrich Petroleum Case
In Goodrich Petroleum, the parties were involved previously in a dispute over a mineral lease dating back to 1954 covering a 487-acre tract of land in Caddo and DeSoto Parishes, Louisiana. Disputes arose in the late 2000s and early 2010s between and among the various successors-in-interest to those persons that signed the 1954 lease. To resolve and settle the disputes, in 2014, the various parties entered into a settlement agreement by which Goodrich Petroleum paid the Fallon Family $650,000 and agreed to pay an addition $1 million over the ensuing two and a half years ($100,000 every quarter for 10 quarters). Because the settlement agreement and modified lease related to oil, gas and mineral rights, Louisiana law required such to be recorded. With respect to the consideration, the settlement agreement stated:
“NOW, THEREFORE, for the promises and covenants exchanged below, and other good and valuable consideration exchanged by the Parties on or near this date, the receipt and sufficiency of which is hereby acknowledged, the Parties agree [to the listed promises and covenants].” The settlement agreement did not list the additional $1 million that was due as part of the settlement.
Goodrich Petroleum paid the first installment ($100,000), but then filed for bankruptcy. The Fallon Family filed papers with the bankruptcy court seeking to either enforce the remaining installment payments or to have the settlement agreement nullified. The bankruptcy court refused to do either and held that the bankruptcy estate was entitled to rely on the recorded statement in the agreement that “… the receipt [of the consideration] … is hereby acknowledged.” This was affirmed by the Fifth Circuit.
The Bankruptcy Code creates a legal fiction that the same legal entity can “stand in three pairs of shoes.” Here, the legal entity was Goodrich Petroleum. In 2014, it entered into the settlement agreement — first pair of shoes. Then, it filed for bankruptcy in 2016 becoming the “debtor” — second pair of shoes. Then § 544(a) of the Bankruptcy Code says that Goodrich Petroleum can step into a third pair of shoes and become what is known as a “debtor-in-possession” — that is, a debtor who continues to control all the property that it controlled prior to filing for bankruptcy protection. Under the Bankruptcy Code, a “debtor-in-possession” is considered to have all the rights and powers of a bona fide purchaser of any real property or real property rights as though the debtor-in-possession was a third party stranger. Such a third party stranger can rely on documents that are recorded. As such, Goodrich Petroleum as a debtor-in-possession was entitled to rely on the statement in the settlement agreement that all consideration had been received.
Lesson for Legal Practitioners
While the leases in this case were in Louisiana, the outcome of this case would be the same had the leases been located in Texas because the Court followed federal bankruptcy law. The lesson in any event is clear: do not state in a lease that all consideration has been received if some portion of the consideration is due in the future.
For more information, contact attorney Aimee Hess at 214-236-9936 or toll-free at 888-818-5880. Ms. Hess focuses her practice on Texas law with respect to oil, gas, and mineral leases.