Oil and gas leases are complex contracts, and a misunderstanding of termination provisions can be costly. By an oil and gas lease, a mineral estate owner (known as the lessor) grants an individual or company (known as the lessee) the right to extract and market the oil and/or gas from their land for some time. The terms of each specific oil and gas lease govern the length of the lease and the circumstances under which it will terminate, as well as the lessee’s operations and the payments due to the lessor (known as royalties). Lessees must carefully draft their lease termination provisions and entirely understand those appearing in acquired leases to avoid untimely termination of their interests or committing trespass on expired portions of the lease.
The “primary term” of an oil and gas lease sets forth the initial amount of time the lease is valid, usually without further action of the lessee. The “secondary term” of the lease, rather than being a set period, begins at the expiration of the primary term and generally continues as long as operations and/or oil and gas production are ongoing. The primary and secondary terms usually appear in a single provision, such as: “This lease shall be for a term of two years from this date and as long thereafter as oil, gas or other minerals are produced from said land hereunder.” If, at the end of the primary term, oil or gas is not being produced under the lease, but the lessee is conducting operations to obtain production, such as drilling a well, the primary term will be extended if the lease contains a “continuous operations” provision. The exact conditions, such as what constitutes sufficient drilling, operations, or production that will perpetuate the lease, can vary greatly and may be negotiated and written to favor either the lessor or lessee.
For example, a lease may contain so-called “savings clauses” that maintain the lease despite the lack of actual oil and gas production, such as a shut-in clause, temporary cessation of production clause, or a force majeure clause. While “production” under Texas law indicates both production and sale of the oil or gas produced, a shut-in clause allows the lessee to maintain the lease when oil or gas is, or is capable of, being produced but temporarily cannot be sold in the market for various reasons. (However, note the necessity to actually pay the shut-in royalties to the lessor to maintain the lease under such a clause will be governed by the express terms of the lease or otherwise by state law.) A temporary cessation of production clause is a standard provision in an oil and gas lease that keeps the lease from terminating if production of oil and/or gas stops and the lessee begins operations to restore the production or begins drilling a new well. Lastly, a force majeure clause prohibits termination of a lease when operations or production cannot be maintained due to events reasonably out of the lessee’s control.
Conversely, a lease may contain lessor-friendly clauses terminating the lease as to portions of the land despite ongoing oil and gas production. For example, “Pugh” clauses provide that the lease will automatically terminate as to unproductive acreage covered by the lease at the end of the primary term, whereas depth termination clauses cause the lease to terminate as to certain unproductive subsurface depths and/or formations at the end of the primary term. A lease may contain a continuous drilling clause, delaying the Pugh and depth termination clauses from taking effect until the lessee fails to comply with the drilling program defined in the clause. Terminating leases to only particular acreage and/or formations is difficult to track, especially when they are subject to continuous drilling program requirements. However, trespass penalties awarded to mineral owners due to unintentional operations on unleased lands can be costly. Therefore, it is crucial that lessees fully understand any termination provisions within their leases and are aware of any partial terminations as they occur.
The strategy of either party is particular to each lease and requires a thorough and careful understanding of the specific provisions. Whether drafting a tailored oil and gas lease, providing clarity on existing provisions, or interpreting complex Pugh and depth clauses within a title opinion, RR&A has the experience your operations require.
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