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CASE STUDY: SUTTON VS. SM ENERGY CO – Perpetuating ORRIs By Continuous Operations Clauses

Posted 6:45 AM, May, 5th 2015 by Manning Wolfe & filed under Blog, Case Studies, Legal

Issue:  SM Energy Company filed a declaratory judgment action in Texas seeking confirmation of a lower court decision that a 1966 oil and gas lease terminated with respect to approximately 18,000 acres; that appellants' ORRIs carved out of assignments of the lease were extinguished; and that SM was not obligated to pay appellants royalties based on their claimed ORRIs following execution of a new lease executed on the same 18,000 acres in 2010.

Background: 1.  In 1966 Sutton Producing Corporation leased 40,000 acres from Briscoe Ranch. About 2 months later, Sutton assigned its interest in the 1966 lease to Kenoil, et al, but reserved for itself a 5.46875% ORRI. The assignment contained a savings provision that extended the ORRI to any new leases:  ORRI…“is to apply to all amendments, extensions, renewals or new leases taken on all or a part of the lease premises within one year after termination of the present lease”.

2.  In 1978, Kenoil assigned its leasehold interest to a third party, reserved an ORRI of 2.00%, and included a savings provision that extended the ORRI to any new leases.

3.  Over the years, drilling and production operations continued under the 1966 lease, which was amended several times. In March 2000, Crimson Energy, a successor lessee under the 1966 lease and SM's predecessor, released about 22,000 of the original 40,000 acres under the 1966 lease back to Briscoe Ranch. Briscoe Ranch and Crimson also amended the 1966 lease as to the remaining 18,000 acres. The amendment required Crimson to complete certain tasks by December 31, 2000 and contained a continuous drilling provision that required Crimson to commence drilling operations within 120 days, or “this lease shall automatically terminate as to all of the lease premises…except the acreage included within each well tract...”

4.  In 2007, the parties again amended the lease and included a continuous drilling provision, with similar language to that of the lease, which required in part that actual drilling occur within 120 days after completion of prior wells.

SM’s Argument:  In its motion for summary judgment, SM contended it completed the drilling of the Briscoe E 1272 well on the 18,000 acres on October 5, 2008. SM also contended that it stopped drilling wells under the 1966 lease after that completion. Under the continuous drilling provision SM was required to commence the actual drilling of an additional well within 120 days of completing the Briscoe E 1272 well (February 5, 2009).

In a filed affidavit, SM's landman, Mark Cody, attested SM asked Briscoe Ranch in late 2008 to allow the lease to remain in effect even if the continuous drilling requirement was not met. Briscoe Ranch refused, and no other wells were drilled on the land.

Cody also attested that in late 2009, SM drilled a successful Eagle Ford well on land not part of the 1966 lease. Based on this new find and improved market, SM contacted Briscoe Ranch about again leasing the 18,000 acres. On May 1, 2010, Briscoe Ranch and SM entered into a new lease for this land. SM did not commence drilling another well on the 18,000 acres until May 1, 2010, well past the 120 day continuous drilling deadline. SM asserted the 1966 lease terminated on February 5, 2009, and Sutton’s ORRIs expired.

Sutton’s Argument:  Appellants expressly did not contest the termination of the 1966 lease or the existence of the 2010 lease. Instead, they contested SM's contention that the 1966 lease terminated on February 5, 2009. Sutton acknowledged both the 1966 lease and the 2007 amendment contained a continuous drilling provision. However, they contended the continuous drilling clause in the 2007 amendment did not state what happens when continuous drilling ceases. Therefore, “nothing happened” on February 5, 2009, and the 1966 lease remained in existence because “operations” continued under the habendum clause until the new lease was executed in 2010 - at which time the 1966 lease finally terminated.

Rationale:  The Texas Appeals Court: “…Oil and gas leases generally...include a continuous drilling or continuous operations clause to prevent the lease from expiring at the end of the primary term while drilling operations are in progress. These clauses, in effect, make drilling operations the equivalent of production for purposes of the habendum clause.” A lessee should be aware of the type and level of activity required to maintain a lease, including operations, drilling and re-working operations, etc. Unless these terms are specifically defined in the lease, the court should strive to apply the generally accepted industry meanings.

The court asserted that even if there was some ambiguity in the 2007 amendment as to the method of determining the size of the retained well tracts or depth, it does not mean “nothing happened”. They found no ambiguity in the continuous drilling clause contained in the amendment with regard to the circumstances under which the 1966 lease would terminate.

Harmonizing all the provisions together, the court concluded the unambiguous intent of the parties is that the 1966 lease (and amendments) would terminate unless the lessee commenced drilling an additional well within 120 days after completion of the previous well. When the lease terminated, all interests of parties to the lease terminated, including the ORRIs.

Final Judgment: Because Appellants did not dispute that SM completed a well on October 5, 2008 and did not commence drilling another well on the 18,000 acres until May 1, 2010, the appellate court concluded under the 1966 lease terminated on February 5, 2009. With no new lease being executed within twelve months of that date, appellants' ORRIs expired. They agreed with the trial court’s granting SM's motion for summary judgment.

Judgment affirmed.

Reference:  Sutton vSM Energy Co., 421 S.W.3d 153, 158 (Tex. App.—San Antonio 2013, no pet.)

 


 

In harmonizing all the clauses of the leases and amendments, the Appellate Court referenced the following cases:

Termination of an oil and gas lease is a contractual matter. See Wagner & Brown, Ltd. v. Sheppard, 282 S.W.3d 419, 424 (Tex.2008); Tittizer v. Union Gas Corp., 171 S.W.3d 857, 860 (Tex.2005) (oil and gas lease is a contract and its terms are interpreted as such). In construing an unambiguous oil and gas lease, we seek to enforce the parties' intent as expressed within the four corners of the lease document. Tittizer, 171 S.W.3d at 860; Anadarko Petroleum Corp. v. Thompson, 94 S.W.3d 550, 554 (Tex.2002). We construe the lease as a whole, attempting to harmonize all its parts, and attribute to the lease's language its plain, grammatical meaning unless it would undermine the parties' intent. Anadarko, 94 S.W.3d at 554; see also City of Keller v. Wilson, 168 S.W.3d 802, 811 (Tex.2005) …We construe lease and its amendments as a whole if amendments pertain to same transaction.

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