Environmental and Energy Law Blog

Monday, January 28, 2019

What is a Farmout Agreement?

Farmout agreements are common in the oil and gas industry.  A farmout agreement is a contract in which an interest owner (“farmor”) agrees to assign interest to another party (“farmee”) in exchange for certain services. Once these services have been rendered, the farmee has earned what is known as an assignment. The assignment, which is a royalty interest, is also called a convertible override, which means that the farmor can elect to convert this override into a portion of the working interest following payout. The decision of whether to convert or not is dependent upon whether the farmer wants to share production costs in exchange for a possible increased return.  If a farmor wants to avoid the risks associated with cost sharing, then he or she will not convert the override. However, if a farmor is comfortable with the project costs, then he or she will convert the override. This information is all included in the farmout agreement. 


About farmout agreement negotiations    

Negotiations typically take place prior to the execution of a farmout agreement. When negotiating the terms of a farmout agreement, it is necessary to understand the other party’s motivations and interests. This understanding gives each party an idea of what must be included in the agreement in order to make it work. In addition, it is essential that each party know what must be included in the agreement in order to reach the execution stage of the deal. Each party typically has at least one or two terms that they insist be included in the agreement. Identifying these requirements prevents unnecessary delays and ensures that the deal doesn’t fall apart. Additional reasons for identifying each party’s motivations include:

  1. Each party will know how far they can push the other to obtain favorable conditions and terms,
  2. Each party will have a better idea of which terms the other side will insist on, and 
  3. Each party can make the other side’s alternatives harder to implement, less attractive, or less valuable. 

Texas Oil and Gas Attorney

Oil and gas laws are always changing. Therefore, it’s imperative that those involved in the energy industry have reliable, experienced, and knowledgeable legal representation to help guide them through the ever-changing energy landscape. In the areas of oil and gas, it’s particularly important to ensure that all contracts, including farmout agreements, are properly drafted. Oil and gas contracts are sophisticated documents, and it’s important that they be drafted in a manner that ensures the rights and responsibilities of all parties involved. At the Law Office of C. William Smalling, P.C., we are highly experienced in the drafting and review of such contracts, including joint operating agreements, farmout agreements, master service agreements, drilling contracts, licensing agreements for use of seismic or technical data, and nondisclosure agreements. If you are in need of expert oil and gas legal representation, contact us today for a consultation. 

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