Farmout Agreement Template for the United States

A Farmout Agreement lets an incoming party earn an oil and gas leasehold interest by drilling rather than by buying. Under United States law the assignment is an interest in real property in most producing states, so it must be in writing, and where the acreage is federal it is not effective until the Bureau of Land Management approves it.

When do you need this document?

You need a Farmout Agreement when a lease owner wants a well drilled without funding it, when acreage is approaching the end of its primary term and needs production to hold it, or when an operator wants into a prospect without an upfront acquisition. It is also used to satisfy a continuous drilling obligation the current owner cannot meet alone.

What does it cover?

The agreement fixes the test well: where it is drilled, to what depth or formation, by when, and what counts as completion. It states what is earned, whether that is the drilling unit alone or all farmout acreage, and what the farmor keeps by way of an overriding royalty and any back-in working interest after payout. It provides for title examination and defects, for the operating agreement that governs the parties once the well is drilled, and for plugging, abandonment and environmental condition.

Common pitfalls

The most damaging problem is an earning provision tied to a term that is not defined, such as completion or a commercial well. If the farmee drills a dry hole to the target depth, the agreement must say plainly whether anything is earned. The second is the interaction with payout: an overriding royalty convertible to a working interest after payout needs a precise payout definition, including which costs are recoverable, or the conversion date is disputed. The third is timing against the primary term of the underlying lease, which no amount of good drafting can cure once the lease has expired.