Salt Water Disposal Well Leases Can Pose a Trap for the Unwary
The victor in a lawsuit involving a salt water disposal well lease may depend on whether a Texas court treats the lease as being a mineral lease or simply a lease of real estate. That is because Texas law applies different bodies of law for the two. For example, Texas law permits greater restraint on the right of alienation in real estate leases, such as permitting the right to enforce consent-to-assignment clauses, while generally prohibiting the same in oil and gas leases. Compare Tex. Prop. Code 94.0057 (permitting a landlord to prohibit a tenant from assigning or subleasing a real estate lease in toto) with T. Ray Guy and Jason Wright, The Enforceability of Consent-to-Assign Provisions in Texas Oil and Gas Leases, 71 SMU L. Rev. 477 (2018) (examining when consent-to-assignment clauses in an oil and gas lease are enforceable). This post briefly examines the Fort Worth Court of Appeals’ decision in Royalco Oil & Gas Corp. v. Stockhome Trading Corp., 361 S.W.3d 728, 731 (Tex. App.—Fort Worth 2012, no pet.), where the court held that a salt water disposal well lease was one of real estate, and highlights the need to carefully contemplate transactions involving salt water disposal leases prior to agreeing to do them.
In Royalco, a third party to a salt water disposal well lease argued it had standing to cure the lessee’s default because the lessee assigned its lease interest to the third party (as opposed to the transaction simply being a sublease) under Texas oil and gas law. 361 S.W.3d 728, 731 (Tex. App.—Fort Worth 2012, no pet.). The success of this argument turned on whether the lease was an oil and gas lease or simply one of real estate. Id. at 730-31. The court of appeals held that the lease was for real estate. Id. In so doing, the court examined the evidence and terms of the lease, finding that “[n]othing . . . gives any indication that the Lease was for the recovery of minerals from the property” and “the Lease by its plain terms was instead for the purposed of drilling and operating a disposal well on the premises.” Id. at 730. In short, the court found dispositive whether a substance was taken out of the earth or put back in. Id. at 730-32. As a result of the decision, the lessor was able to terminate the lease leaving the third party high and dry.
The bases for the court’s holding is interesting. At first glance there does not appear to be much difference between an oil and gas well and a saltwater disposal well. Both are comprised of holes drilled into the earth, casing and tubing, and equipment located on the surface estate. In fact, many salt water disposal wells are simply old oil and gas wells that are no longer productive. Both types of wells are also typically governed by leases. The primary practical difference between the two wells is one of function. As the Royalco court found persuasive, an oil and gas well takes a substance out of the earth while a saltwater disposal well puts a substance into the earth.
The Royalco decision is significant because it impacts a growing industry. Since the first documented salt water disposal well was created in the 1930s, the number of salt water disposal wells has increased dramatically with over 8,000 active permitted wells in Texas.1 As the number of these wells increase, so do the number of interested parties. Third party creditors often finance these wells and the leases may be pledged as collateral and backed by personal guaranties. How a Texas court characterizes a salt water disposal well can impact these parties as well. Whether or not the basis for the Royalco court’s holding is ultimately correct, the decision highlights the need to seek legal counsel and consider “what if” scenarios prior to entering into a transaction involving a salt water disposal lease.
1 Railroad Commission of Texas, Oil & Gas FAQ, https://www.rrc.texas.gov/about-us/faqs/oil-gas-faq/injection-and-disposal-wells-faqs/.