The Oil and Gas Addendum

Let’s assume you signed a new oil and gas lease with XYZ Drilling in August 2018 (the “2018 Lease”).  Your lease contains a “continuous drilling” clause which requires XYZ  Drilling to commence a new well within ninety (90) days upon completion of the prior well.  If the new well is not commenced within the ninety (90)-day period, the 2018 Lease will expire as do all non-pooled acreage. Continuous drilling clauses are relatively common throughout the Marcellus Shale region.

In January 2023, XYZ Drilling pools one and fifty (150) of your three hundred and fifteen (315) acre farm into the Beck Unit.  Three wells are drilled in the Beck Unit, the last one being drilled on February 1, 2023.  Pursuant to the “continuous drilling” clause, XYZ Drilling had until May 1, 2023 to commence a new well or the 2018 Lease would expire as to the non-pooled acreage.  No new well is drilled as of May 1, 2023 and you assume the XYZ Drilling will release and surrender the non-pooled acreage (i.e., 165 acres).

Three weeks later, you are surprised when XYZ Drilling shows up on your farm and begins construction of a new well pad on your farm.  You call XYZ Drilling and inform them that the 2018 Lease expired as to the all non-pooled acreage (the exact area where they are now building a pad) because a new well was not commenced within ninety (90) days.  The representative from XYZ Drilling says the 2018 Lease did not expire because i) XYZ Drilling was delayed in making the May 1 deadline because of an internal scheduling mistake and ii) the 2018 Lease was therefore maintained by something called the “force majeure” clause.  You are angry, frustrated and confused.  What is a force majeure clause? And how can an internal scheduling error be excused as such a clause?  A recent decision by the Texas Supreme Court suggests that XYZ Drilling cannot rely on the force majeure clause to excuse a scheduling error.  This is good news for landowners.

Before we address the Point Energy Partners Permian LLC v. MRC Permian Company (Texas Supreme Court, No. 21-0461, April 22, 2023) decision, a brief review of the unique nature and duration of an oil and gas lease is warranted.

When an oil and gas lease is executed, the lessee’s initial interest is “inchoate” for exploration and development of oil and gas. T.W. Phillips Gas and Oil Co. v. Jedlicka, 42 A.3d 261, 267 (Pa. 2012). But, if oil or gas is found, the lessee’s rights transition into a fee simple determinable. Id. “A fee simple determinable is an estate in fee that automatically reverts to the grantor upon the occurrence of a special event.” Jacobs v. CNG Transmission, 332 F.Supp.2d 759, 773 (W.D.Pa. 2004). As such, it is important to note that while an oil and gas lease is a contract, the interest created by the contract (i.e., fee simple determinable) is governed by property law. See, Jedlicka , 42 A.3d at 267 (“[a]n oil and gas lease reflects a conveyance of property rights within a highly technical and well-developed industry….”); See also, Nolt v. TS Calkins & Associates, 96 A.3d 1042 (Pa. Super 2014) (“[A] fee simple determinable is an estate in fee that automatically reverts to the grantor upon the occurrence of a special event.”).

The “special event” or “limitation event” that automatically terminates the fee simple determinable estate is non-production. See, Jacobs, 332 F. Supp. 2d at 777-78. So, if at the end of the primary term there is no production of oil and gas, then the leasehold interest automatically terminates. See, Non-Production During the Secondary Term Results in Termination of Lease (November 2011). This is known as the “automatic termination rule” and has been a part of Pennsylvania oil and gas law for over a hundred years.

This rule provides that the property interest acquired by the driller upon execution of an oil and gas lease will automatically terminate if the driller fails or ceases to produce hydrocarbons any time after expiration of the primary term. See, Brown v. Haight, 255 A.2d 508 (Pa. 1969) (“[T]herefore, in 1947 when oil and gas were not produced in paying quantities, the grantee’s fee interest terminated automatically and the property reverted to the grantor”); Cassell v. Crothers, 44 A. 446 (Pa. 1899) (“[W]here oil was no longer being produced in paying quantities, the lease was liable to be terminated”); Hite v. Falcon Partners, 13 A.3d 942 (Pa. Super. 2011) (“…when that primary term ended and Falcon failed to commence production, the agreement expired.”); Heasley v. KSM Energy, 52 A.3d 341 (Pa. Super. 2012) (“[W]hen production ceased, the lease became an at-will tenancy, subject to termination by the lessor at any time”). The hallmark of the “automatic termination rule” is that it is automatic: cessation of production, unless excused by a savings mechanism in the parties’ lease, terminates the driller’s property interest by operation of law.  A common savings mechanism familiar to many landowners is the shut-in royalty clause.  See, Can the Payment of a Shut-In Royalty Maintain a Lease Indefinitely? (March 2022).  Another savings mechanism that can suspend application of the “automatic termination rule” is the so-called force majeure clause.

At issue Point Energy Partners was an oil and gas lease signed in 2014 concerning approximately four thousand (4000) acres in Loving County, Texas (the “2014 Lease”).  The 2014 Lease had a primaryterm that expired on February 17, 2017.  The lessee could suspend termination of the 2014 Lease as to all non-producing acreage so long as it drilled a new well every one hundred and eight (180) days.  The last well drilled on the leasehold was spud on November 22, 2016.  As such, the lessee had until May 21, 2017 tospud a new well or lose the non-producing acreage.

In the late spring of 2017, the lessee, MRC Permian Company (“MRC”), created a new drilling schedule regarding the next leasehold well, the Toot 211 well.  The schedule, however, mistakenly listed the anticipated commencement date as being June 2, 2017.  This was twelve (12) days after the May 21, 2017 lease expiration deadline.

MRC discovered the scheduling error in early June.  Around this same time, MRC also determined that the drilling rig scheduled to drill the Toot 211 well experienced “operational issues”  back on April 21, 2017 which would have caused a delay in meeting the June 2, 2017 start date.  Having missed the May 21, 2017 deadline, MRC invoked the force majeure clause in an effort to retroactively extend that deadline.  The force majeure clause provided as follows:

Force Majeure.  When lessee’s operations are delayed by an event of force majeure, being a non-economic event beyond Lessee’s control, if Lessee shall furnish Lessor a reasonable written description of the problem encountered thereafter use its best efforts to overcome the problem, ,this lease shall remain in force during the continuance of such delay, and Lessee shall have 90 days after the reasonable removal of such majeure within which to resume operations; provided, however, this paragraph shall not extend this lease or relieve Lessee for liability for any breach thereof for a period in excess of 180 days, and Lessee’s obligation to pay sums due hereunder shall not be affected by an event of force majeure.

MRC argued that the “operational issues” associated with the drilling rig “caused a delay in drilling the Toot 211 well…..beyond MRC’s control”  The purported delay was caused when a wellbore collapsed during the drilling of a separate well. The rig working on that well was the same rig that was scheduled to drill the Toot 211 well on June 2, 2017.  As such, MRC informed the landowner that, pursuant to the force majeure clause, it now had ninety (90) days from April 21, 2017 to re-schedule the rig and commence drilling of the Toot 211 well.  Under MRC’s interpretation of the force majeure clause, missing the May 21, 2017 was now excused since the clause itself provided that the 2014 Lease would “remain in force during the continuance of the delay” and that MRC would have ninety ( 90) days “to resume operations”. 

In the meantime, the landowner, Point Energy Partners Permian LLC (“Point Energy”), believing that the 2014 Lease had terminated as to the non-producing acreage on May 21, 2017, entered into a new lease as to that same acreage on June 7, 2017. Shortly thereafter, MRC filed suit against Point Energy and the new lessee seeking a declaratory judgment that the 2014 Lease remained in effect as to the non-producing acreage by virtue of the force majeure clause.

Point Energy defended the lawsuit by arguing that the force majeure clause did not apply because the failure to meet the May 21, 2017 deadline was the result of an internal scheduling error, not the availability of the drilling rig. As such, the purported wellbore collapse that allegedly delayed the drilling rig was immaterial and had no bearing on the missed deadline. Central to Point Energy’s defense was that MRC would not had met the May 21, 2017 deadline even if the alleged wellbore collapse had never occurred- the drilling rig was not even scheduled to commence drilling until June 2, 2017.  The trial court agreed and held that the 2014 Lease expired as to the non-producing acreage on May 21, 2017.

MRC then appealed to the Court of Appeals to the Eighth District of Texas. The court of appeals reversed, opining that the force majeure clause itself did not require the force majeure event ( i.e. availability of the drilling rig) to cause MRC to miss a deadline in order to be applicable. Instead, the panel held that the clause was triggered and became applicable as soon as any operation was delayed. Under the court of appeals logic, as soon as the drilling rig was delayed, the force majeure clause automatically applied and granted MRC ninety (90) days from that moment. The fact that even if there had been no delay, MRC would still have not met the May 21, 2017 deadline was irrelevant to the court of appeals. Point Energy appealed to the Texas Supreme Court.

The Texas Supreme Court reversed and rejected court of appeals broad interpretation of the force majeure clause. Mere delay in performing any operation is not enough. There must be a causal link between the force majeure event, the corresponding delay and a missed lease expiration deadline. Because the scheduled drilling operation (i.e. June 2, 2107) was already past the May 21, 2017 deadline, any delay in performing that untimely operation could not be excused under the force majeure clause: 

“Force majeure clauses like this one generally exist to allocate risk when a lessee encounters an irresistible force beyond a party’s control that may lead to the harsh result of lease termination. Here, the language the contracting party chose evinces that this force majeure clause’s purpose is the same. But if an untimely operation would not otherwise suspend termination of the lease- even absent any delay- the alleged force majeure event does not impose any risk of lease termination. The risk of lease termination derives from the scheduling error, which the parties agree the force majeure clause is not designed to remedy….”

According to the Texas Supreme Court, the delayed operation must impact satisfaction of a lease expiration deadline. If such an operation is delayed by a force majeure event out of the lessee’s control, the force majeure clause will operate to keep the lease in effect during that delay. In Point Energy, however, the force majeure event ( i.e. wellbore collapse and corresponding delay in the availability of the scheduled drilling rig) had no bearing or impact on meeting any lease expiration deadline- even without the delay, MRC would not have met the already passed May 21, 2017 lease expiration deadline. So, any delay in meeting the mistaken June 2, 2017 commencement date was simply immaterial and did not trigger the force majeure clause. Accordingly, the Texas Supreme Court ruled that the 2014 Lease expired as to the non-producing acreage on May 21, 2017.

This author submits that the Texas Supreme Court made the right call. One of the primary purposes of a force majeure clause is to give the lessee more time to conduct operations necessary to maintain a lease.  If the clause can be invoked any time and without regard to meeting an actual lease expiration deadline, then the clause itself can be subject to manipulation and abuse. Although not binding on Pennsylvania courts, the logic and rationale espoused by the Texas Supreme Court is sound and should be considered when interpreting force majeure clauses here in Pennsylvania.  Nonetheless, the application and effect of force majeure clauses often depends on the precise language in the clause itself. Force majeure clauses can be complex and confusing. If you believe that your lease is being wrongfully extended or maintained by operation of a force majeure clause, please consult with an experienced oil and gas attorney to review the clause and its application.