First and foremost, anytime a gas or pipeline company wants you to sign any contract you must thoroughly understand the document and any and all consequences that may result upon execution of the document. Unfortunately, I have seen landowners lose hundreds of thousands and even millions of dollars where they blindly executed serious legal documents without fully understanding their leverage and options. It is important not to repeat these costly mistakes and make certain you completely understand the document you are signing and the potential consequences of your signature.
In that regard, many gas companies in Pennsylvania are approaching landowners and asking them to agree to a Modification and Amendment (“Modification”) of their existing Lease. Modifications can take many forms. Many Modifications are non-negotiable, but some Modifications are absolutely negotiable and should be carefully negotiated to maximize landowner benefits.
The first crucial step for the landowner is to properly evaluate your leverage in Modification negotiations. Equally important is that the landowner must completely understand the original gas lease and the Modification request. The landowner must understand precisely what changes the Modification presents and what are the likely consequences of their decision to accept or decline the Modification. Modifications can be fairly simple or extremely technical and present many complex issues for the landowner to consider.
Pooling and Production Unit Size Modifications
One common Modification request over the past several years in northern Pennsylvania seeks to modify the original Lease to increase the maximum unit size beyond that authorized in the original Lease. Many active Leases in Pennsylvania limit production units to a maximum size of 640 acres. Many gas companies have approached landowners with 640 acre maximum unit Leases requesting that the landowner agree to modify the existing Lease to permit units up to 1280 acres or even more.
Another important Modification request now sweeping across western Pennsylvania is where gas companies are asking landowners to modify their original Leases to allow pooling, or combining neighboring acreage into a production unit, well beyond the pooling and maximum unit size permitted in their original Lease. Many older leases in western Pennsylvania contemplated only conventional vertical wells and did not permit any pooling with neighboring properties or set maximum unit sizes of 320 acres or smaller. Leases with significant pooling limitations can severely restrict or even eliminate a company’s ability to effectively develop that parcel by horizontal drilling.
Typically, what I see occurring is the current gas company holding the Lease will seek a Modification to allow pooling and setting a higher or even unlimited unit size restriction. The current gas company will then seek to sell, assign or otherwise transfer the entire modified Lease, or only the deep rights, to a larger company who intends to horizontally drill the Marcellus or Utica formations. This is a great deal for the original gas company as they typically receive per acre compensation and/or future royalty interest in gas production from any future horizontal well production. Many people view this as another example of the gas companies benefiting off the backs of the landowner.
Landowners often view Modifications as an opportunity to re-negotiate their original Lease for a per acre bonus payment or a higher royalty percentage with more favorable royalty calculation language in exchange for agreeing to a Modification of their original Lease. I cannot stress enough how cautious landowners must be when they tread in Modification waters. Landowners must fully understand their leverage as the wrong decision can result in completely missing out on the opportunity to participate in future production units. Many landowners have preferred to accept Lease Modifications without any financial or other consideration and avoid risking the serious potential of completely missing out on future horizontal well royalties. In many situations this is a sound decision, but not all situations are identical. Landowners should never blindly sign Modifications without understanding their leverage and exploring the possibility of negotiating a financial benefit or other more favorable Lease terms.
As always, quality information is vital for landowners to make the right decision when facing a Modification request. Often there is not an easy answer when asked to modify your original Lease. What is known is that the landowner must acquire credible and reliable information in order to make the best possible decision for their particular circumstance.
“Group Lease” Modifications
I have also been working on many Modifications in northeastern Pennsylvania where landowners entered into complex Leases with many development and operational restrictions or requirements. Often what occurs is that a landowner has entered into a detailed Lease as a member of a “Landowner Group”. Many of these “group leases” have operational restrictions and requirements to drill a minimum number of wells in a designated timeframe which most companies adamantly want to avoid. There are almost always other terms in the original Lease that the companies want to modify, but a minimum well obligation is a great example.
Modifications to “group leases” require extreme attention to detail and careful negotiations to maximize any potential financial benefit and to reduce the negative impact of the requested Modification. These negotiations are complex and I highly recommend experience legal counsel to assist you in these matters. The wrong decision with any Modification can result in significant negative financial consequences or even preclude you from participating in future production opportunities. Quite simply, a wrong decision could completely eliminate your ability to receive any future gas royalties.
Some Factors to Consider
There are many variables that come into play when considering signing a Modification and there is no “cookie cutter” answer to whether a landowner should sign a Modification. Common considerations include, but certainly are not limited to the following in no particular order:
1.) A complete and total understanding of your existing Lease and exactly how the Modification will change the terms of your Lease;
2.) The size and location of the parcel under lease;
3.) Do surrounding landowners have the same Modification request and similar original Lease terms;
4.) What position have your neighbors taken with the same Modification request;
5.) What is the market in your area to sign the Modification requested, i.e. has the company paid compensation for this type of Modification in the past and has the company previously shown flexibility to negotiate the Modification to minimize the negative impact to the existing Lease;
6.) Are you able to join forces with neighboring landowners to increase your negotiation leverage;
7.) Are you currently in a production unit;
8.) Is there a horizontal well bore already beneath your property;
9.) Is there any drilling or other activity on the surface of your property;
10.) The current status and future plans for development in your immediate area;
11.) The location of the parcel in a proposed production unit and any planned well;
12.) When is your Lease set to expire and does your Lease contains an extension clause; and
13.) The drilling plans and historical patterns of the natural gas company making the Modification request.
These are all factors that a landowner must consider when deciding whether to execute any Modification. However, these factors are not exhaustive and do not always carry the same weight in each Modification evaluation. There are always specific and unique circumstances facing the individual landowner that will influence the evaluation process.
I have experienced companies offering financial compensation and showing a willingness to negotiate the terms of Modifications. However, that is not typically the case. It is critical that the landowner understand their individual options when facing these powerful Modifications. Ultimately the landowner may reluctantly decide to execute the proposed Modification as the potential consequences of refusing to sign are simply too severe. However, the key is to completely explore and understand your options to make the best decision for your particular circumstances.
Douglas A. Clark, Esq.
The Clark Law Firm, PC
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