Farmout Agreement

A farmout agreement is a contract in which the holder of an oil and gas lease (the farmor) assigns all or part of the working interest to another party (the farmee) in exchange for the farmee's commitment to drill a well or perform other development obligations on the leased acreage.

• Farmor: The party assigning the working interest (typically the current leaseholder)
• Farmee: The party receiving the working interest (typically the party willing to drill)
• Earning well: The well the farmee must drill to earn the assigned interest
• Earning requirement: The specific obligations the farmee must complete (drill to a certain depth, test certain zones, etc.)
• Retained interest: The interest, if any, the farmor retains (often an overriding royalty)

Why farmouts occur: - The farmor lacks capital or technical ability to drill - The farmor wants to maintain its lease position without spending its own capital - The farmee wants to gain leasehold in a prospective area - The farmor's lease is approaching expiration and must be drilled to maintain it

Common farmout structures: - Farmee earns 100% WI (working interest) and farmor retains an ORRI (overriding royalty) - Farmee earns a percentage of WI (e.g., 75%) and farmor retains the remainder - Farmee earns WI in specific formations or depths - Back-in provisions allowing farmor to convert ORRI to WI after payout

Due diligence considerations: - Verify the farmor has the right to assign the interest - Review the underlying lease terms and obligations - Confirm the earning requirements are clearly defined - Ensure the agreement addresses post-earning operations

Farmout agreements are one of the most common transaction structures in the oil and gas industry.