The Basics of Land Lease Agreements in Texas
Land lease agreements are a common practice in Texas as they can allow a landowner to retain ownership of their land while providing another party the right to use and occupy the property for a specific purpose for a fixed period of time in exchange for consideration. The terms of a land lease agreement and the respective rights of the parties are determined by the language contained in the lease itself.
Depending upon the industry, there can be a number of different types of land leases utilized in Texas . For example, the leasing of residential or commercial office space or the leasing of mineral sub-surface rights can be types of land lease agreements. Even lease agreements for unconventional oil & gas development contain elements of a land lease. It is important that parties to these agreements understand the legal framework that governs such agreements in Texas, pursuant either to the common law, or by statute.
Key Terms of a Texas Land Lease
In drafting a Texas Land Lease, the parties address and set forth the various issues relevant to the deal. These agreements are typically longer-term arrangements than many commercial leases and are generally entered into between parties who already have a long-standing relationship. Due to their lifetime nature, an executed Texas Land Lease is set up to accommodate the day-to-day operations associated with the land use over the life of the agreement. As such, the following list contains just the basic terms that must be included in any Texas Land Lease and is not intended to be an exhaustive list of all of the issues that should be addressed.
Subject Property: Description of the surface tract of land subject to the lease and the use thereof (sub-surface use may also be covered).
Term: Term of the lease and commencement date including the renewal terms and how they are exercised.
Purchase Price: How the lease payments are calculated and the frequency of payment (such as annually, semi-annually, quarterly, etc.). A second method of rent calculation is an escalator clause, which increases the rental amount after a certain number of years, usually based on either a predetermined increase or a base year Consumer Price Index increase.
Royalties: If applicable, allocations of costs to the lessee and payments to the lessee as would be appropriate for the land type. If the lease does not cover oil, gas or mineral rights, then these payments are not applicable.
Land Use: Both the uses of the land and any limitations on those uses as well as any exclusions for subleases, assignments, mortgages, and conveyances.
Maintenance/Improvements/Restoration: Maintenance issues for the leased premises and whether or not improvements are to be made and, if so, who will make and fund the improvements and to what extent. Any required restoration at the termination of the lease should also be addressed.
Termination: Termination rights of the parties and any exclusions to those rights.
General Relating to the Parties: Who can perform under the terms of the agreement, any exclusions for assignments, mortgages, and conveyances, remedies, waiver rights, and enforcement rights.
Texas-specific Issues: Applicability of Texas Water Code, Surface Damage Act, Oilfield Cleanup Act and how the parties address same.
Rights and Duties of Lessors and Lessees
The lessor in a Texas land lease has the right to receive the agreed upon rent and royalties at the times required under the agreement. In addition, the lessor has the right to receive timely payment for rentals usually referred to as delay rentals during the primary term or as shut in royalties in the secondary term. Thus, in both cases, unless the lessee is acting in bad faith, it would generally be required to keep the agreement in effect by timely paying delay rentals or shut in royalties.
If the lessee fails to timely pay such royalties or rentals, the lessor has the right to terminate the lease under the terms of the agreement and applicable statutes. The lessor further has the right to receive the proper notice of termination under the royalty agreement or for lease termination.
The lessors, whether individual or corporate entities, are not responsible for any costs associated with the development of the mineral estate. It is the lessee’s duty to properly develop and explore for hydrocarbons in a reasonable and prudent manner. Under Texas law, the lessee is not should be required to receive permissive use to enter upon the subject property where the lease is. Most agreements will have a provision giving the lessee permission to conduct its activities on the property which will preempt the need to obtain separate permission from the lessor.
Typical rights of the lessor include the right to receive notice of intent to drill, use or dispose of fresh water, complete payment of rental and royalties, and to receive notices of force pooling and unitization elections.
The lessee’s rights are to receive free and clear access to the property, to drill the mineral estate, produce products in paying quantities and to use the fresh water located underneath or upon the surface of the subject property.
The lessor has the responsibility to pay taxes upon the land itself and is entitled to receive the same after deducting a reasonably apportioned amount of production taxes.
Texas Land Lease Laws
For those who are less familiar with it, the concept of a "land lease" is fairly straightforward. A land lease is essentially just like a standard lease, except that instead of leasing a building or a structure, one party leases the underlying land to another party for a period of time in exchange for rent. Land leases can be an attractive option for someone that has a business model that will operate well on the land but not necessarily want to own the land on which they operate as the business may potentially relocate to other markets.
While land leases are very common, there are a few key considerations to keep in mind if you are thinking about entering into a land lease agreement in Texas.
Because land is considered real property under Texas law, non-payment of rent and other failures with respect to the land lease agreement are treated differently than residential property leases. For instance, eviction from the leased land in the event of a default or non-payment of rent is known as a "forcible entry and detainer" action. A "forcible entry and detainer" allows a landowner to forcibly enter the premises and take possession of the property (if necessary). Court proceedings (which include a court appearance by the landlord) are required to initiate the process.
Lease agreements for land often require liability insurance and/or payment of property taxes by the lessee (tenant). Check the land lease agreement carefully for these requirements and whether or not the lease is nontaxable.
Texas companies cannot enter into land leases with any entity that conducts business in Texas, except in limited circumstances. In order to conduct business in Texas, the entity must meet certain monetary requirements. The monetary requirements are especially onerous for certain industries such as oil/gas, cattle raising and the like. Healthy legal and tax discussions with the your counsel is recommended if you have questions on this issue.
How to Negotiate a Reasonable Land Lease
When negotiating a land lease agreement, you should keep in mind that it can be a powerful tool in defining the relationship between the lessor and lessee. Accordingly, when negotiating a lease, you should consider not only the division of royalty (discussed in the previous section), but many other factors as well. The following is a non-exhaustive consideration list:
- Will a surface use agreement be used in conjunction with the land lease agreement?
- Is the use of casinghead gas authorized?
- Is dissipating water authorized?
- How will water be handled?
- How will taxes and other cost of production be allocated (principal , or premium)?
- Is the lessee obligated to maintain fences and/or drainage on its surface?
- How will lessee access the surface?
- What happens to a lessee’s improvements if the lease is terminated?
- Is the lessee required to remediate its surface for surface contamination?
- Will an attachment be included that defines the scope of the boundaries of the lessor’s property?
- Is the lease drawn as a recordable form? Is the lease registered with a county or local authority?
- Is a standard form of lease requested or accepted by the lessee?
- Is rent reserved by the lessee rather than an overriding royalty?
- Can the lessee assign the lease, or must it be jointly signed?
- Is a time for payment of excess proceeds after oil and gas is sold required?
- Is an accounting of all expenses required?
- Is a provision for free gas for the surface owner incorporated into the lease?
- Are "subsequent" operations subject to the same provisions as the initial operations contemplated under the lease?
- Must the lessee provide or update interpretations, maps, and other data collected during operations?
- Is a delay rental payment provision included?
- How are drainage and offset royalties treated?
Tips for Drafting and Signing a Texas Land Lease
One of the initial steps in taking land out to lease is to discuss an initial vision for the structure of the deal with your legal counsel. For example, a surface lease for most leasing purposes among focused parties with few restrictions is 30 pages and a typical oil and gas lease is 40-60 pages. We recommend in most cases running the draft by your land counsel before presenting the draft to the tenant or producer so they match our vision. The landman or land department will usually try to finalize that draft without counsel. That’s fine, but we suggest he or she be instructed to get "litigation comfortable" drafts before going to the other side. The key here is to develop language that clearly states what the parties intended from the outset, and avoids later ambiguity, contention and litigation.
A negotiated term sheet will save everyone a lot of time and expense as long as the parties are able to reach a meeting of the minds on key points. For instance, if you immediately agree that you want royalty payments to be calculated at the wellhead, there’s no need to brainstorm about which point to measure the leases. Be sure to put down any terms that you thought were natural and didn’t need to be discussed. For example, no one ever thinks to talk about the timing of rent payments throughout the term of the lease. Without specifying the time frame, all money owed under the lease would be due and payable upon termination of the lease. This is not typically what would be expected by the lessor. It’s generally more common to have rent due on the anniversary date of the term of the lease.
One alternative is to draft a form lease that reflects your approach to these agreements. This way, when you have a party that is agreeable to that approach, you are almost there. However, as stated above, beginning negotiations about the terms on which the land is to be leased before a written lease is prepared for negotiation will avoid time-consuming revisions after preparation of a first draft lease. The time spent preparing an initial draft is significantly less than the time spent drafting subsequent drafts – and in most cases saves the company from having to read the entire document. Once a draft is in place, it is more efficient and organized to have two negotiating parties or their counsel work from that draft.
As a lessor, you will want to have an attorney draft or at least review the lease terms and conditions before presenting them to the proposing party. Conditions precedent to drilling, rental requirements, and other general lease provisions can be tailored to meet your specific needs. Examples include calculated water usage, stacking up for 2nd and 3rd exploratory holes, and a minimum annual rental payment.
Your counsel will want to review the title implications of the lease so that you don’t hit a snag during the lease process or while drilling. Counsel can also be helpful in drafting drilling title opinions, curative documents, assignment documents, releases, and any other required documents. Your attorney should also be consulted when answering the operational questions that may arise during the negotiation process.
Resolving Conflicts in Texas Land Lease Agreements
Mediation is the most common method we and many other law firms use to resolve disputes with customers. The costs to prepare for, attend and prepare a mediation typically are significantly lower than the costs to prepare for, attend and prepare for a trial. Particularly when your agreement contains provisions that obligate the customer to pay your attorneys’ fees if you prevail, the costs you would incur for a trial are likely to be significantly higher than the amounts you are trying to collect.
The information you receive from the mediation will give you good insight into the likelihood of success in the event collection efforts are required after the initial attempt at collection. Arbitration is another method of resolving disputes. Again, we and most other law firms do not frequently use arbitration to resolve customer disputes, but we have observed the following pros and cons to the use of arbitration: There are various types of dispute resolution provisions that are included in land lease agreements. Some of the more common provisions are for mediation alone, mediation followed by arbitration , or arbitration alone. We sometimes see provisions that obligate the parties to settle disputes in accordance with "the rules" applicable to disputes. Though these so-called rules for resolving disputes vary considerably from case to case, they frequently contain language obligating the customers to pay your attorneys’ fees and specifying a single arbitrator to resolve your disputes. Some of these rules can be found on the web, while others are private and may be requested by the party seeking to enforce the provisions. One practical consequence of a single arbitrator deciding a dispute is the finality of the decision reached by the single arbitrator. In addition to the typically heavy costs of preparing for the hearing required for an arbitration to take place, a party who wants to challenge the decision of the arbitrator is likely to be prohibited from using traditional methods of appeal to reverse the decision of the arbitrator. A recent court decision, Lake Highlands v. Floating Point, 2005 Tex. App. LEXIS 12408 (Oct. 27, 2005), appears to confirm that a challenge to the assessment of attorney’s fees may not be appealed.