We’re going to dive into a topic that may be unfamiliar to many mineral and royalty owners: top leasing. In this episode we explore the ins and outs of top leasing including the pros and cons, how it can impact your mineral rights, and two important lease clauses that can help you if you are faced with this situation. If you find yourself in a competitive oil and gas market, this episode is a must-listen.
Be sure to also subscribe on Apple Podcasts via the link above and please leave us an honest rating and review. We read every one of them and sincerely appreciate any feedback you have. To ask us a question to be featured on an upcoming episode, please leave a comment below or send an email to feedback@mineralrightspodcast.com.
What is Top Leasing?
Top leasing is the practice of leasing your mineral rights even when there is an existing valid lease in place. We refer to this existing lease as the “bottom lease.” The top lease acts as a present grant of a future interest in oil and gas, and it can come into effect once the bottom lease expires.
The Bottom lease will typically still be in the primary term when the top lease is offered but that doesn’t have to be the case. A less common situation might be where you have an existing bottom lease in the secondary term where your existing wells are no longer producing or are not producing in paying quantities (e.g. 1 bbl per month) and the top lessee would look to try to force the operator to plug the wells and give up the bottom lease or force them to drill new wells to extend the lease.
We discuss different scenarios where top leasing can be beneficial, such as when operators are not actively drilling, and speculators use top leasing to secure an option for future development. We also touch on the importance of understanding “paying quantities” and how it affects lease extensions.
Types of Top Leases
Two Party Top Lease
In a two party top lease, the existing lessee offers a top lease on existing acreage so that it does not expire. In other words, there are just two parties involved (you and the original lessee who holds your bottom lease). This type of top lease is used to protect leasehold interests where the lessee might not ready to drill a well before the expiration of the original lease. Without a top lease, if the original lease expires then it is possible that another company could lease the acreage and the original lessee would lose that leasehold.
Three Party Top Lease
With a three party top lease, there are three parties involved (you, the bottom lessee, and the top lessee). In this situation, you might have a bottom lease with Company A that is still in the primary term (typically, but doesn’t have to be). You are approached by Company B to sign a top lease for the same acreage but in this case the lease does not go into effect until the lease with company A expires. Company B might offer to pay you a percentage up-front (say 10% of the lease bonus) and then if the lease with Company A expires, they will pay you the remaining 90% to secure the top-lease. Then it would be like any other situation where your mineral rights are leased.
Pros and Cons of Top Leasing
There are advantages and potential drawbacks with top leasing. One of the benefits of top leasing is it allows you to re-lease your mineral rights immediately after your existing lease expires. Another potential benefit of a top lease is it might help spur the development of your minerals by the bottom lessee (otherwise, they might miss out on the opportunity). Finally, a top lease presents the potential opportunity to negotiate better lease terms such as a higher royalty rate, as compared to your existing lease.
That said, there are some potential pitfalls with top leasing, especially if top leasing leads to conflicts between top lessees and bottom lessees. Also, since top leasing is most common in areas where there is a lot of activity, if you go with the first top lease you are giving up the opportunity to competitively lease your minerals and get the best terms (lease bonus, royalty rate, and lease language). In other words, as compared to the other option of letting your bottom lease expire and then leasing again for the best terms possible by shopping your interests to several companies.
Legal Considerations and Favored Nations Clause
As with any oil and gas lease, there are important legal considerations when it comes to top leasing. You may find that your bottom lease includes what is called a “Right of First Refusal” clause, which gives them the option to match any top lease offers. This language acts as an option to extend the lease, but only if a third party tries to top lease your interests.
If Lessor, during the primary term of this lease, receives a bona fide offer from a third party to purchase from Lessor a lease covering any or all of the substances covered by this lease and covering all or a portion of the leased premises. with such lease to become effective upon expiration of this lease, which Lessors willing to accept from the offering party, Lessor hereby agrees to notify Lessee in writing of said offer immediately. including in the notice the name and address of the offeror, the price offered and all other pertinent terms and conditions of the offer. Lessee, for a period of fifteen (15) days after the receipt of the notice, shall have the prior and preferred right and option to purchase the lease or part thereof or interest therein covered by the offer at the price and on the terms and conditions specified in the offer. All offers made up to and including the last day of the primary term of this lease shall be subject to the terms and conditions of this paragraph. Should Lessee elect to extend and/or renew the lease pursuant to the terms offered, it shall so notify Lessor in writing by mail, telefax, or telegram prior to expiration of said fifteen (15) day period. Lessee shall promptly thereafter furnish to Lessor the extension and/or renewal lease for execution by Lessor along with Lessees sight draft payable to Lessor in payment of the ‘ amount as consideration for the new extension and/or renewal lease such draft being subject to approval of title according to the terms thereof. Upon receipt thereof. Lessor promptly execute said extension and/or renewal lease and return same along with the draft through Lessor’s bank of record for payment.
Example Right of First Refusal Language in an Oil & Gas Lease
Favored Nations Clause
Rather than trying to break your bottom lease and negotiate a top lease with more favorable terms should the opportunity arise, you can leverage the favored nations clause to ensure that the terms of your bottom lease are as good as the market will allow.
If you’re concerned about a situation where a neighboring lease has better terms or higher compensation, you can add a favored nations provision to your lease. This provision allows you to go back to the lessor to obtain the same terms if a better lease is offered to a neighbor. The provision can specify more favorable terms for the lease bonus, royalty, and other clauses, and you can adjust it as you see fit. Adding a favored nations provision can be a useful strategy if you have a small interest and limited time to negotiate specific clauses. It can help you avoid seller’s remorse by preventing you from giving up more than you should or accepting a lower lease bonus or royalty rate.
Again, instead of signing another lease and trying to break the first one, adding a favored nations provision up front to your bottom lease is the preferable way to handle the situation.
Conclusion
Top leasing can be an effective strategy in certain situations, especially in highly competitive oil and gas markets. It offers mineral owners an opportunity to secure better lease terms and expedite development. However, it’s crucial to approach top leasing with caution and seek legal advice to navigate potential complexities and disputes. As always, the key is to take your time, negotiate carefully, and ensure that the terms you agree to align with your goals and expectations as a mineral owner. If you’re ever unsure or feel overwhelmed, don’t hesitate to consult a qualified attorney to protect your interests.
Resources Mentioned in this Episode
- MRP 6: How to Negotiate an Oil and Gas Lease
- MRP 76: Leasing Mineral Rights for Mining Potash and Other Critical Minerals
- Top Leasing for Oil and Gas: The Legal Perspective
- Most Favored Nations – Texas Agriculture Law
Thanks for Listening!
To share your thoughts:
- Leave a comment or question below (we read each one and your question may be featured in a future episode)!
- Ask a question or leave us feedback via email.
To help out the show:
Click the Apple Podcasts Logo Above to leave us a rating & review. It really helps us reach those that need to hear this information and only takes a minute. We greatly appreciate it! Plus, you can get a shout out on a future episode!
Thanks again – until next time!
