Production Cessation Increases Lease Termination Risk
In general, when a lessee experiences a cessation (or significant reduction) of production or development operations, the lessee should be aware of a heightened risk of lease termination claims. In Texas case law, that analysis would typically turn squarely on the unique terms of the lease at issue. However, as In re EP Energy E&P Co. LP, No. 4:21-CV-04148, 2024 WL 4356581 (S.D. Tex. Sept. 30, 2024) shows, sometimes courts’ lease analysis is also heavily persuaded by general rules or concepts that have developed in regard to traditional oil and gas leasing.
COVID-19 Shutdown Spurs Dispute Over Non-Standard Leases
In this recent case, lessors in South Texas claimed that several “non-standard” leases terminated when the lessee voluntarily turned off hundreds of wells for up to forty days at the onset of the COVID-19 pandemic.
One focus of the case was on the cessation clause, which provided as follows:
If production should cease … this lease shall terminate … unless lessee commences drilling or reworking operations… within one hundred twenty (120) consecutive days …; and if production is restored from this unit, this lease shall remain in effect as to the lands and depths included therein as long as oil or gas is produced from such unit.
Lessors Argue for Strict Interpretation of Clause Structure
The lessors argued that the phrase “shall terminate unless” created a “special limitation” that would terminate the lease unless the lessee conducted timely drilling or reworking. The lessors contrasted this language with traditional cessation clauses using “shall not terminate if” language. They contended that drilling or reworking were the only two exceptions provided after “unless,” and that restored production was an “additional and subsequent” requirement due to the semi-colon and “and if” preface. The lessors acknowledged that no drilling or reworking was needed in this case to resume production, the lessors argued that the clause’s structure indicated the parties never intended to allow the lessee to voluntarily cease production in circumstances where no drilling or reworking were required.
The Court rejected this interpretation, instead characterizing the provision as a “savings clause” that provided three optional means of maintaining the lease: drilling, reworking, or resumed production within 120 days. The Court said this was proper due to a “basic grammar rule” it described as dictating that, when two clauses are separated by a semicolon and the word “and,” that means “each clause stands alone.” In the Court’s view, that meant that the restoration of production clause was not something required in addition to drilling and reworking, but instead served as an alternative stand-alone option.
No Special Limitation Without Clarity
The Court acknowledged that “shall terminate unless” language is indicative of a special limitation but, in its view, that language “isn’t dispositive.” The Court cited precedent as holding “we will not find a special limitation unless the language is so clear, precise, and unequivocal that we can reasonably give it no other meaning.” In the Court’s view, this clause could not be enforced as a special limitation because it was not “clear, precise, and unequivocal” in requiring drilling or reworking even where unnecessary.
The Court’s reasoning relied heavily on “typical practice of oil-and-gas leases” and analogies to other savings clause cases where restored production maintained a lease. The Court acknowledged that those other cases did not use “shall terminate unless” language and did not involve cessation provisions, it nevertheless concluded they “still support the general proposition that the ‘drilling or reworking’ requirement in a savings clause doesn’t preclude maintaining the lease by production.”
Business Purpose and Temporary Cessation Doctrine
The Court also stated that, in its view, its interpretation was consistent the lease’s “business purpose” of production, given that drilling or reworking would have been unnecessary and expensive in these circumstances. The Court also invoked the “temporary cessation of production” doctrine as supporting its analysis,[9] but the Court did not address how that doctrine does not apply to leases with express cessation provisions.
The second dispute involved a “separate lease” clause specifying that each production unit surrounding a drilled well could only be maintained by production or operations from that specific unit. The provision was triggered “[a]fter the occurrence of any event described in subparagraph (a).” That referenced subparagraph was retained acreage provision that was triggered “upon the expiration of the primary term or upon the cessation of continuous drilling operations…whichever occurs later.” The lessors argued that the separate lease clause did not say “whichever occurs later,” but instead said “any event,” meaning “either event” including the expiration of the primary term.
The Court rejected that interpretation, holding that when properly harmonized in the context of the entire lease, the phrase “any event” meant “any termination event.” Because a termination would only occur upon the conclusion of continuous development, which had not yet occurred, the separate lease clause was not yet in effect. The Court also emphasized that the continuous development provision indicated that it maintained the “leased premises,” and characterized the lessors’ interpretation as rendering that language meaningless.
Court's View on “Typical” Clause Triggers
The Court again relied heavily on the “typical practice of oil-and-gas leases,” and said “[c]ourts have held that separate-lease clauses ‘typically do not take effect until after the continuous drilling or other savings provisions reach their end.’” The Court concluded that “if the parties had wished to deviate from this typical formula, they would have done so with clarity of intent reflected in their language.” The Court did not address how “typical” practices would govern admittedly “nonstandard” lease forms. Also, of the two cases cited for this “typical” outcome, one involved a retained acreage clause rather than a separate lease clause, and the other involved a separate lease clause that expressly provided that it was triggered after an extension of the primary term pursuant to the continuous development provision.
Final Holding: Leases Maintained Without New Operations
Ultimately, the Court held that several leases were maintained in their entirety by continuous development, that the separate lease clauses were inapplicable during continuous development, and the temporary cessation clauses allowed lease maintenance through resumed production without drilling or reworking.
