We are thrilled for our clients that we successfully resolved a North Dakota Supreme Court appeal of a case interpreting an oil and gas lease’s termination provisions in our clients’ favor. See Johnson v. Statoil Oil & Gas LP et al., 2018 ND 227. While we are pleased with the result, the case also carries a number of considerations and important reminders for landowners and mineral owners going forward. In this post, we explain some of the background about oil and gas leases, Pugh clauses that can terminate portions of leases, and lessons from the Johnson case for mineral owners and landowners.
Before turning to the case itself, we will briefly review some key elements of oil and gas leases. Under the typical oil and gas lease, there are two terms: a primary term and a secondary term. In general, if an oil company begins producing oil from the property or lands pooled with the property during the primary term, then the lease continues until production ceases. Additionally, most oil and gas leases also contain some form of a continuous operations or continuous drilling clause that allows the oil company to hold the entire lease after the primary term if it is engaged in drilling operations anywhere on the leasehold. The end result is that under a typical oil and gas lease, an oil company can hold thousands of acres under one lease by drilling and producing from just one well.
A Pugh clause prevents this inequitable result. A typical Pugh clause severs the oil and gas lease into producing and non-producing portions and then terminates the lease on those portions of the property that have no production. The idea behind the Pugh clause is to reward efficient drilling operations by the operator and to protect the mineral owner and landowner from being encumbered by an oil and gas lease when there is no production on certain portions of the property.
At issue in Johnson was the meaning of a Pugh clause in two oil and gas leases. The Plaintiffs, Robert Johnson and A.V.M. Inc. had negotiated their own version of a Pugh clause that was added to a form oil and gas lease at their express request. The Pugh clause in Mr. Johnson and A.V.M’s leases specifically stated:
Notwithstanding anything to the contrary, on expiration of the primary term of the lease, the lease shall terminate as to any part of the property not included within a well unit or units, as established by appropriate regulating authority, from which oil or gas is being produced in paying quantities and shall also terminate as to 100’ below geologic strata or formations from which production has not occurred during the primary term.
The Plaintiffs argued that the Pugh clause, as its terms suggest, caused the leases to terminate as to non-producing units at the end of the primary term. Statoil and its assignees, however, argued that because the Pugh clause said nothing about drilling operations, the lease contained a typical drilling operations clause, and because Statoil was drilling for oil at the end of the lease’s primary term, the Pugh clause should not be given effect. In other words, Statoil argued that the Pugh clause had to directly state that the drilling operations would not hold the lease as to nonproducing units.
Justice Jensen, writing for the Court, agreed with the Plaintiffs and held that the language of the Pugh clause controlled. Having concluded that there was an irreconcilable conflict between the two clauses, Justice Jensen then turned to rules of contract interpretation for guidance. Specifically, N.D.C.C § 9-07-16 instructs that the parts of the contract that are purely original control those parts which are copied from a form. In Johnson, the Plaintiffs had requested that the Pugh clause be specially added to leases, while the continuous drilling operations and habendum clauses were simply form lease language. Additionally, the Pugh clause contained the language “notwithstanding anything to the contrary,” which indicates that it must control if it conflicts with any other provision. Under the direction of N.D.C.C. § 9-07-16, then, the Pugh clause controlled, and caused the leases to terminate as to the units on which there was no production in paying quantities at the end of the primary term.
While we are pleased with the Supreme Court’s ruling, it also offers some key lessons for mineral owners going forward. First, it’s important to consider how changes to an oil and gas lease interact with the rest of the terms in the lease. For example, this might include reviewing form language for any potential ambiguities or conflicts with the changes. Second, while the Pugh clause language used in the Johnson case may provide an example of “safe” language for future Pugh clauses, Statoil’s position was that the Pugh clause needed to directly address drilling operations in the clause itself. In other words, a Pugh clause like the one in Johnson that also explicitly states that the continuous drilling clause will not hold nonproducing units at the end of the primary term might be even better, even if it seems to be overkill. Oil and gas leases are complicated instruments, and even small changes can have significant meaning. Often, there may be other approaches as well, such as signing multiple leases rather than signing one lease with a Pugh clause.