Why Property Owners Should Consult Lawyers Before Signing Gas Leases

We have been sharing and commenting on articles discussing how lenders are becoming increasingly concerned about borrowers who lease their property to allow hydraulic fracturing (“fracking”). The operations permitted by the leases on what is typically rural or agricultural land include storage of hazardous substances and wastewater that likely would constitute defaults under the mortgages.

Now comes another article published by the New York Times that discusses how the bulk of the eight million oil and gas leases that have been entered nationwide often fail to adequately protect property owners from risks associated with what amounts to industrial activity on their property. http://www.nytimes.com/2011/12/02/us/drilling-down-fighting-over-oil-and-gas-well-leases.html?_r=1&ref=todayspaper

The article reports that the leases are often presented to property owners on a “take-it-or-leave-it basis” by the brokers who are retained by the energy companies. The article says that these agents, known as “landman” often try to pressure property owners to sign the leases by warning them that their neighbors have signed leases and that if the property owner does not sign the lease, the gas under its land will simply be drained by the adjoining operations.

The New York Times obtained copies of 110,000 leases used in Texas, New York, Pennsylvania, Ohio, Maryland and West Virginia. The vast majority of the leases were from Texas. Following are some of the key observations from the lease review.

  •  Most of the leases reviewed did not require periodic sampling of drinking water. As a result, it is often difficult for property owners to link contaminated groundwater with the fracking operations;
  •  Less than half of the leases required the companies to compensate landowners for contamination of groundwater. While eight states require energy companies to provide some sort of indemnification, the terms of the indemnity are to be negotiated;
  •  When companies are obligated to provide alternative drinking water for properties with contaminated groundwater, the owner often has to pay the increased electric bills resulting from the need to prevent the water from freezing during the winter;
  • Most leases do not establish “setbacks” from various structures or areas on a property but instead grant the companies broad discretion where to build roads, store chemicals and cut down trees;
  • Most leases do not contain any disclosure about the potential environmental risks associated with the drilling activity;
  • Many leases allow companies to store waste generated by the fracking operations in pits or underground. Indeed, some of the leases reviewed in the article allowed the energy companies to simply cap the waste;
  • Those leases that did require the company to remove waste often offset those costs against the royalties to be earned by the property owner;
  • Most leases contain clauses that enable companies to extend leases beyond the negotiated term which is typically three to five years in length. For example, some companies have invoked the “force majeure”  clause in New York because of the drilling moratorium that was established while the state Department of Environmental Conservation adopts fracking regulations;
  • Less than 20% of the Texas leases and virtually none of the leases in the eastern states contained the so-called “Pugh Clause” which prevents leases from being indefinitely extended;
  • Another clause that has been used to extend leases is the “preparations” for drilling provision. The article says the term is broadly construed by companies and cited to an example where an oil company sought to invoke the clause a day before a lease was to expire. The company had not yet drilled any wells but said it had engaged in “preparations” by locating a bulldozer near the  leased property and had surveying for an access road;
  • Most leases allow the rights to be freely assigned to other companies without the prior approval of the property owner, thereby preventing an owner from terminating a lease that might be assigned to a company that may not be financially stable or perhaps does not have a good environmental track record.

The state attorney generals of New York, Ohio and Pennslyvania have published advisories about leasing land for drilling. While there are a number of websites that can assist property owners with such leases, the article should be a wakeup call to landowners to retain a lawyer before signing such a lease. Without legal review, you could be committing your grandchildren to the terms of an unfavorable lease.