Chapter 7 Evolving Theories of Lease Termination Litigation · Evolving Theories of Lease Termination Litigation ... — Notice and Demand ... Remedy for Breach of Implied Covenants

Chapter 7Evolving Theories

of Lease Termination LitigationLyle B. Brown

Steptoe & Johnson PLLCColumbus, OhioKaren E. Kahle

Melanie Morgan NorrisSteptoe & Johnson PLLC

Wheeling, West VirginiaSynopsis

§ 7.01. Introduction ................................................................................ 233§ 7.02. Theories of Lease Termination Reliant Upon the Habendum Clause ..................................................... 233

[1] — What Constitutes a “Commencement ofOperations”SufficienttoWithstand anAttackUndertheHabendumClause? ......................... 234

[a]—ActualDrillingNotRequired ................................ 234[b]—ThereMustBePreliminaryActivities NecessaryforDrilling ............................................236[c]—PreliminaryActivitiesMustBeDone inGoodFaith,withaBonaFideIntent toProceed,andDiligenceToward CompletionandProduction ....................................236

[2]—DefensestoTimelyCommencement ofOperations/DoctrineofEquitableExtension ................237[3]—Terminology—TheLanguageUsed intheLeaseIsCritical .......................................................239[4]—CommonThreadsinCaseLawonCommencement ........ 240[a]—TypesofPreparatoryActivitySufficient to Constitute Commencement .......................................... 240

[i]—SiteSelection ................................................241[ii]—OfficialPaperwork ......................................241[iii]—SitePreparation ..........................................242[iv]—MovingEquipmentandSupplies ...............243[v]—ErectingStructures ..................................... 244

[b]—TimingofthePreliminaryActivitiesVis-à-vis theExpirationDateofthePrimaryTerm ............. 244[c]—PreliminaryActivityUndertakeninGoodFaith, andOperationsContinuedwithDueDiligence toCompletionandProduction ...............................245

[5]—Summary ........................................................................... 246

CITEAS35 Energy & Min. L. Inst. 7 (2014)

ENERGY & MINERAL LAW INSTITUTE

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SYNOPSIS

§ 7.03. Production Sufficient to Prevent Termination ...................... 247[1]—ProductioninPayingQuantities.........................................247

[a]—ActualProductionandMarketing VersusCapability....................................................247

[2]—StandardsUtilizedforDeterminingProduction inPayingQuantities .......................................................... 250

[a]—ObjectiveMathematicalTest .................................. 250[b]—SubjectiveTest ........................................................251[c]—CombinationofApproaches ...................................252

[3]—ConsiderationsintheProfitabilityAnalysis ......................252[4]—Summary ........................................................................... 254

§ 7.04. Equitable Remedies for Breach of Implied Covenants in Oil and Gas Leases .......................... 255

[1]—GenesisofCovenantsImpliedinOil andGasLeases ..................................................................255[2]—RemediesforBreachofImpliedCovenants ......................255[3]—ABriefDiscussiononLegalorMoneyDamages .............256[4]—InSomeJurisdictions,EquitableRemedies ArePreferred .....................................................................258[5]—MostJurisdictionsAcknowledgeaMore Open Approach ..................................................................259 [6]—ConditionalCancellationIstheMost “Equitable”Remedy ..........................................................259 [7]—ASpectrumofEquitableRemedies ..................................261[8]—NoticeandDemand ............................................................263[9]—JudicialAscertainmentClauses ........................................ 264[10]—IdentificationbyJurisdictionastoFavored RemedyforBreachofImpliedCovenants ....................... 264

§ 7.05. Non-Payment of Delay Rentals and Shut-In-Royalties as Grounds for Terminating Oil And Gas Leases in the Primary and Secondary Terms ..................................... 265

[1]—Introduction.........................................................................265[2]—FailuretoPayDelayRentalsinthePrimaryTerm ...........265

[a]—DifferenceBetween“Unless”and “Or”DelayRentalClauses .....................................265[b]—“Unless”DelayRentalClauses ..............................267[c]—“Or”DelayRentalClauses ......................................270[d]—DefensestoLeaseTerminationDue toFailuretoPayDelayRentals ..............................270

[i]—LackofForfeitureClause intheOilandGasLease .............................271[ii]—LateAcceptanceofDelayRentals ..............271[iii]—LateDeliveryofDelayRentals AttributabletotheMailService .................271

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[iv]—LessorHasWaivedaPossibleDefault bytheLessee ...............................................272[v]—UnilateralorMutualMistake ......................272[vi]—AttackonLessee’sTitle ..............................273

[3]—FailuretoPayShut-InRoyalties intheSecondaryTerm ......................................................273

[a]—PrerequisitesforaWelltoBe DeemedShut-In ......................................................273[b]—ConsequencesofFailuretoPay Shut-InRoyalties ....................................................275[c]—DefensestoLeaseTerminationDue toFailuretoPayShut-InRoyalties .........................277

[i]—LackofForfeitureClause intheOilandGasLease .............................277[ii]—EstoppelDuetoAcceptance ofShut-InRoyalties .....................................278[iii]—UnilateralMistake ......................................278[iv]—Force Majeure ............................................278

[4]—Summary ............................................................................279

§ 7.01. Introduction. Thischapterisanoverviewofclassicandevolvingleasetermination

theoriesasreflectedinappellatecourtdecisionsinvariousstates.TrendsandtrajectoriesinAmericanjudicialthoughtonthetopicareidentifiedanddiscussed.Thischapterfocusesonclaimsbasedonthefollowingtheories:leaseterminationlitigationbasedonhabendumendingactsoromissions;leaseterminationlitigationbasedonimpliedcovenantviolations;andleaseterminationlitigationbasedonfailuretopaydelayrentalsintheprimarytermorfailuretopayshut-inroyaltiesinthesecondaryterm.

§ 7.02 Theories of Lease Termination Reliant upon the Habendum Clause.

Thefirsthabenda encounteredinoilandgasleaseswereforspecificterms.Thehabendumhasevolved intoahybridconsistingofaprimary,fixedterminwhichrentissometimespaidfortheprivilegeofdeferringdrillingandasecondary,productionbasedterm.1Historically,partiesseek-

1 See generally,3HowardR.Williams&CharlesJ.Meyers,Oil and Gas Law § 603 (2013).


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ingtoterminateanoilandgasleaseonthebasisthattheleasehasexpiredbyitsowntermsinthehabendumclausehavewagedtheirattacksusingtwoseparatetheories.First,thattherehasbeennocommencementofop-erations,causingtheleasetoexpireattheconclusionoftheprimaryterm.Second,thatthewellisnotsufficientlyproducingsoastoextendtheleaseinto the secondary term.This sectionof thechapterwill focuson theseleaseterminationtheoriespursuanttothehabendumclauseandreviewle-galopinions fromselectappellatecourtsacross thenation thathavead-dressedeachtheory.

[1] — What Constitutes a “Commencement of Operations” Sufficient to Withstand an Attack Under the

Habendum Clause? Thehabendumclausetypicallyrequiresthatoperationsbecommenced

withinaspecifiedperiodoftime,theprimaryterm,orelsetheleasewillexpireattheendoftheprimaryterm.Manymodernleasesnowhavetermsthat specifically define “commencement of operations” for purposes ofholdingtheleasepasttheprimaryterm,however,therearenumerousexist-ingoilandgasleasesthatdonotdescribewhatconstitutesa“commence-ment of operations.” As such, numerous legal battles have been foughtconcerningwhatconstitutesa“commencementofoperations”sufficienttowithstandanattackseekingtoterminatethelease.

Thevastmajorityofjurisdictionsadheretoalongstandinggeneralrulethatactualdrillingisnotrequiredtocommenceoperations,solongassomeamountofpreliminaryactivities,necessary to thedrillingofawell, areundertakenpriortoexpirationoftheprimarytermandtheoperatorcontin-uestooperateingoodfaithtowardthecompletionofawellandultimateproduction.Althoughearlycasesfocusedprimarilyonpreliminarysurfaceactivitiesontheleasehold,moremoderncasesalsolooktounitizationandpoolingefforts.

[a] — Actual Drilling Not Required.Beginningearlyinthetwentiethcentury,jurisdictionsthataddresseda

“commencementofdrilling”or“commencementofoperations”provisioninthehabendum establishedthatactualdrillingisnotrequired.2Anearly

2 ThestateofKansasisonejurisdictionthatdoesnotdefinitivelyfollowthegeneralrule.Infact,intheabsenceofactualdrilling,theappellatecourtsofKansasmaynotfinda

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Texasdecisionisillustrativeofthevastmajorityofotherjurisdictionsthatsimilarlyfollowthegeneralrule.3

McCallister centered around a lessor’s attempt to terminate a leasebasedonthecommencementprovision.Thelessorallegedthelesseehadfailedtocomplywiththetermsandconditionsofthehabendumwhichpro-videdthatsolongasdrillingoperationswerebegunwithintheseven-yearperiodmentioned,andthereafterprosecutedwithdiligence,therecouldbenoforfeitureofthelease.Alittlemorethanonemonthpriortotheexpira-tionoftheseven-yearperiod,thelesseebeganoperationsforthedrillingofawellononeofthefourtractscoveredbythelease.Thoseoperationscon-sistedofselectionandlocationofthedrillingsite,haulingofderricktim-berstothesiteselected,andprovidingawatersupplyfordrillingpurposes.4

Theactualdrillingofthewelldidnotbeginuntilafterexpirationoftheseven-yearperiod.However,theoperationsthatwerecommencedonemonthpriortoexpirationoftherelevantperiodwerecontinuedwithdili-genceuntilthedrillingofthewellwasactuallybegunanduntilthewellwasfinished.Accordingly,theTexascourtheldthattheactsdoneandper-formedbythelesseewithintheseven-yearperiodfromthedateofthelease,

commencement of operations. See generally,Hallv.JFW,Inc.,893P.2d837(Kan.App.1995)(statingthat“[a]llowinganirrevocablecommitmenttoconductoperationstocompletiontosatisfyaleaserequiringthecommencementofdrilling,andnotmerelyoperationsfordrilling,toobroadlystatesthelawofKansas”);BunnellFarmsCo.v.SamuelGary,Jr.&Assocs.,47P.3d804(Kan.App.2002)(notingthat“thestandardinKansasafterHallisthatatleastsometypeofactualdrillingmustoccurbyalease’sexpirationdatetosatisfyarequirementofcommencementofdrilling,”butnotingthatHalldoesnotstatethatdrillingmustbedonewithanappropriaterigorthatthewellmustbecompletedpriortoexpirationoftheprimaryterm).3 See generally,FlemingOil&GasCo.v.S.PennOilCo.,17S.E.203(W.Va.1893);Duffieldv.Russell,63N.E.1127(Ohio1902);Gonzalesv.Cowerd,188P.1053,1054(Okla.1920);McCallisterv.TexasCo.,223S.W.859(Tex.Civ.App.1920);Wilcoxv.W.,114P.2d39,40(Cal.1941);Cryev.Giles,200So.155(La.Ct.App.1941);Haddockv.McClendon,266S.W.2d74(Ark.1954);TrueOilCo.v.Gibson,392P.2d795(Wyo.1964);LeonardCrudeOilCo.v.Walton,197N.W.2d503(Mich.App.1972);PemcoGas,Inc.v.Bernardi,5Pa.D.&C.3d85(Pa.Com.Pl.1977);Oelzev.KeyDrilling,481N.E.2d801(Il.App.1985);Bedorev.RanchOilCo.,805N.W.2d68(Neb.2011).4 McCallister,223S.W.at861.

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mentionedabove,constitutedabeginningof“operationsforthedrillingofawellforoil”withinthemeaningofthelease.5

[b] — There Must Be Preliminary Activities Necessary for Drilling.

Although actual drilling is not required to “commence operations”sometypeofpreparatoryworkmustbeundertakenbythelesseepriortotheexpirationoftheprimaryterm.6Inearlycases,thepreparatoryworkfocusedonpreliminaryphysicalsurfacepreparationsfordrilling,suchassitelocation,buildingofderricks,movingofequipmentandthelike.7Moremoderncasesalsotakeintoconsiderationpoolingandunitizationefforts.8 Theamountandtypeofpreparatoryworkrequiredtoconstitutea“com-mencementofoperations,”however,mayvarybyjurisdiction.

[c] — Preliminary Activities Must Be Done in Good Faith, with a Bona Fide Intent to Proceed, and Diligence Toward Completion and Production.

Anumberofjurisdictionslookbeyondthetypeandamountofprepara-toryworkperformed,towhetherthereisanyevidencethatthepreliminaryworkwasorwasnotdoneingoodfaith,withabonafideintenttoproceedwithdiligencetowardcompletionandproductionofthewell.9

5 See generally,Gonzales,188P.at1054(holdingworkdonepreliminary toactualdrillingconstitutedasufficientcompliancewiththecontractrequirementthatthelesseebeginoperationswithinthreemilesofthepremisescoveredbythelease,whereinfivedayspriortoexpirationofprimarytermlesseehadhauledlumberuponlandswithinthreemilesoftheleasedpropertyanderectedaderrickandplacedtoolsontheground).6 Id.(holdingworkdonepreliminarytoactualdrillingconstitutedasufficientcompliancewiththecontractrequirementthatthelesseebeginoperationswithinthreemilesofthepremisescoveredbythelease,whereinfivedayspriortoexpirationofprimarytermlesseehadhauledlumberuponlandswithinthreemilesoftheleasedpropertyanderectedaderrickandplacedtoolsontheground).7 Id. 8 Henryv.ChesapeakeAppalachia,L.L.C.,739F.3d909(6thCir.2014)(reversingtrialcourtinfavorofLesseewhereLesseehadfiledaDeclarationofNoticeandPooledUnitencompassingLessor’spropertypriortoexpirationofprimaryterm).9 See generally,Duffield,63N.E. at1127 (affirmingwithout comment trial court’sdeterminationthatcommencementofoperationsuponthelandforthedevelopmentofoilorgas,ifdonehonestlyandbonafide,withtheintentionofdeveloping,mayconsistofa

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Thesejurisdictionshavedeterminedthatthe“goodfaith”ofthelesseeistobepresumed,solongasthelesseeperformspreliminaryactswithintheprimarytermandthereaftercontinueswithdiligenceuntilthewelliscompleted.10However,ifthelesseeisthereafterpreventedfromdrillingthewelltocompletion,orfailstocontinuewithduediligencetocompletethewell,thentheintentwithwhichthelesseeperformedthepreliminaryactsbecomesmaterialanditmustbeshownthatthelesseeactedingoodfaith.11

Forinstance, inButler v. Nepple,12 aCaliforniacourtacknowledgedthegeneralrulethatworkdonepreparatorytodrillingmaybesufficientto constitute a “commencement of operations,” but nonetheless the gen-eralruleisqualifiedbytherequirementthatsuchpreliminaryworkmustbesomethingmorethanapretense.13 ThelesseeinButlerduringthelasttwodaysoftheprimaryterm,stakedthewelllocation,movedaportabledrillingrigontotheproperty,set25feetofconductorpipe,filedanoticeofintenttodrillwiththestate,anddugandshoredacellar.Nonetheless,theCaliforniacourtfocusedonthelessee’ssubsequentactionofcausingplank-ingtobeplacedoverthecellarandnaileddown,alongwithnoadditionalworkbeingperformedforaperiodofalmostsixmonths,andthelessee’sapparentinabilitytoobtainfinancingtodrillthewell.TheCaliforniacourtconcludedthatthelessee’sactionsimpliedlyindicatedalackofgoodfaithonthepartofthelessee,suchthatthelessee’spreparatoryactivitiesdidnotconstitutea“commencementofoperations”sufficienttoextendthelease.14

[2] — Defenses to Timely Commencement of Operations/Doctrine of Equitable Extension.

Lesseeswhohaveencounteredinterferencebythesurfaceowner,havebeenpermittedanequitableextensionoftheprimaryterm,equivalenttotheperiodofinterferenceorforsuchadditionalreasonabletimethatjus-

trivialandcomparativelyinsignificantmatter,whenwetakeintoconsiderationwhatistobedoneandanyact,theperformanceofwhichhasatendencytoproducethedesiredresult,is a commencement of operations). 10 Waltonv.Zatkoff,127N.W.2d365(Mich.1964).11 Id.12 Butlerv.Nepple,354P.2d239(Cal.1960).13 Id. at 242.14 Id.at243-44.

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ticemayrequire.15OneoftheclearestexamplesisaveryearlycaseoutofPennsylvania,16whereinthelesseehadwaiteduntilthelastdayoftheprimarytermtobeginanypreparatoryactivities,includingthedrivingofasinglestakeintothegroundandattemptstodepositandunloadlumberontotheleasehold.Becausethelandownerlessorinsistedtheleasewasalreadyexpiredandevicted the lessee’s employees from theproperty, thePenn-sylvaniacourtfoundthatacommencementofoperationshadnonethelessoccurredsufficienttoextendthelease.17

Similarly,anOklahomacourt18equitablyextendedtheprimarytermofaleasewhereinthelesseeattemptedtomoveequipmentontotheleasedpremisestwodaysbeforeexpirationoftheprimaryterm,butwasbarredfromentrybythesurface(andnon-mineral)ownerwiththreatsofbodilyharm.Thelesseeimmediatelyfiledsuittoenjointhesurfaceowner’sinter-ference,however,theprimarytermexpiredwhileitwasstillpending.Thelessor(mineralowner)tookthepositionthattheleasewasterminatedbyvirtueofthelessee’sfailuretocommenceoperations,arguingthesurfaceowner’sconductcouldnotbeimpungedtothelessors.TheOklahomacourtnonethelessstillpermittedequitableextensionunderthelease,reasoningthatthelesseecouldnothaveanticipatedtheinterferenceandthatthereisnoprohibitionagainstwaitinguntilthelastdayoftheprimarytermtocom-mence operations.19

Whilesurfaceownerinterferencehasbeendeemedanacceptablede-fenseworthyofequitableextensionoftheprimaryterm,badweather,20and

15 SeeWilsonv.Xander,387S.E.2d809(W.Va.1989)(“Inrarecases,...lessormayhimselfhinderthelessee’sperformance,precipitatingthespeciallimitationanddefeasanceofthelessee’sestate...giv[ing]thelesseeacontinuinglegalexcusefornotperforming...[suchthat]thedoctrineofequitableestoppeleffectivelyextendstheleaseforthereasonabletimethatjusticemayrequireforthelesseetobeginproductionunhinderedandavoidthespeciallimitation.”)16 Hendersonv.Ferrell,38A.1018(Pa.1898).17 Id. at 1019.18 Burgerv.Wood,575P.2d977(Okla.Civ.App.1978).19 Id. at 980.20 Allisonv.Berry,44N.E.2d929(Ill.App.Ct.1942)(findingthatwinterweatherisnotanexcuseinequityforfailuretocommenceordrillawellinthemonthofDecemberinaccordancewithalease).

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governmentalaction21havebeendeterminedunacceptabledefenses,onthebasisthatthelesseeisnecessarilyrequiredtotakenoticeofclimaticcon-ditions,topographyofthecountryandthepowersofthegovernmentoverthecoalandironindustriesindeterminingwhenandhowtocommenceoperations.

[3] — Terminology — The Language Used in the Lease Is Critical.

Asinanycontract,thelanguageoftheleasewillcontrol.Theliteralprovisionsoftheclauseinquestiongovernwhattypeofoperationmustbecommenced.22Therefore,whenaprovisionreferstocommencingtodrillawell,itisnotnecessarytoactuallypenetratethegroundduringthespeci-fiedtimeperiod,however,thepreparatoryactivitymustbeingoodfaithandofthetypeassociatedwithorthatcanbeexpectedtoimmediatelyprecedetheprocessofdrillingahole.Undersuchaclause,operationsarenotcom-mencedbysimplyremovingplugsfromanoldwell.23

In the absence of amodern lease that defines terms such as “com-menceoperations”or“commencedrilling,”whenfacedwithleaselitiga-tion,courtsmustdeterminewhetherthelesseehastakensufficientactiontocomplywithcommencementprovisions.Insomejurisdictions,thesetermshavebeengivendistinctmeanings.OneMontanacourthasdistinguishedtheterm“commenceoperations”fromtheterm“commencedrilling,”find-ingthat theformerrequirespreliminaryworknecessaryforactualdrill-ing,whereasthelatterconnotesthefirstmovementofadrilltopenetrateground.24Bycontrast,aWyomingcourt25 hasdeclinedtodrawanyrea-sonabledistinctionbetweentheterm“commencingoperations”and“com-mencingdrillingoperations.”TheWyomingcourtconcludedthatbothre-

21 Baldwinv.BlueStemOilCo.,189P.920(Kan.1920) (refusing toacceptLessee’sdefensesthattherewasasignificantrainfall,followedbyablizzard,sickemployeesandgovernmentalactionthathadmadeitimpossiblefortheLesseetoobtaincoal).22 Bedore,805N.W.2d68(Neb.2011).23 Id. at 76.24 Solbergv.SunburstOil&GasCo.,235P.761,762(Mont.1925).25 Fastv.Whitney,187P.192,198(Wyo.1920)(refusingtodrawanyreasonabledistinctionbetweencommencing“operations”orcommencing“drillingoperations”underaprovisioninaleaseandnotingthatactsoflesseeifdoneingoodfaithandintendingdiligentlytoprosecuteworktocompletionamountstocommencementofoperations).

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fertodrillingoperationswhichcanbecommencedbycompletedactsthatarepartofthenecessaryworkindrillingorsinkingawellorboringforoil,ifdoneingoodfaithandintendingdiligentlytoprosecutetheworktocompletion.26

Onoccasion,oilandgasleasescontainlanguageotherthanthetypical“commenceoperations”or“commencedrilling”provision.For instance,onePennsylvaniaoilandgas leasewasdraftedwithaprovision that re-quiredthewellbe“completed,”ratherthansimplycommencedduringtheprimaryterm.27 Undersuchaprovision,thePennsylvaniacourtinterpretingtheleasefoundthatdespitethelessee’spreliminaryactofplacingtimbersonthepremisesforcompletionofacarpenter’srigandthelessee’sdiligentandgoodfaitheffortstosecureworkmentoerecttherigsothatthewellmightbecompletedontime,thelesseehadnotcompliedwiththeprovisionsoftheoilandgaslease.28

[4] — Common Threads in Case Law on Commencement.Sincenearlyalljurisdictionshaverecognizedthatactualdrillingisnot

requiredinordertocommenceoperationsordrillingunderthehabendumclauseofanoilandgaslease,theslightnuancesamongcourtshavetendedtofocusonthetypeandamountofactivitynecessarytoconstituteacom-mencementofoperations,whentheactivitywasundertakenincomparisontoexpirationoftheprimaryterm,andwhetherthelessee’soperationswereingoodfaithandcontinuedwithduediligencetowardcompletionandpro-ductionofthewell.

[a] — Types of Preparatory Activity Sufficient to Constitute Commencement.

Across jurisdictions, courtshave founda “commencement”ofoper-ationsordrilling throughavarietyofactivities.For instance, inLouisi-ana,29 alesseefailedtoobtainadrillingpermitpriortotheexpirationoftheprimaryterm.However,thelesseehadengagedinanumberofotherpreliminaryactivities, includingsurveying,procuringaunitizationorder,

26 Id.27 Cryanv.Ridelsperger,7Pa.C.C.473(1887).28 Id.29 Casonv.ChesapeakeOperating,Inc.,92So.3d436,438,reh’g denied(May10,2012),writ denied,2012-1290(La.9/28/12),98So.3d840.

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stakingthesite,andbuildinganaccessroad.TheLouisianacourtofap-pealsdeterminedthatthepreliminaryactivitiesweresufficienttoconstituteacommencementofoperationsunderthelease.30Bycontrast,inIndiana,31 wherealesseehadmerelystakedthewellwithonestakeandhaddugaslushpit330 feetwestof the lessor’s farm, the Indianacourtofappealsfoundthatthelessee’sactivitieswerenotperformedingoodfaith,butre-flectedinsteadmerelyanefforttoholdtheleaseonatechnicalbasis,suchthattheleasewasfoundterminated.

Belowaresomeoftheactivitiesthathavebeentakenintoconsiderationbythecourtsofvariousjurisdictionsinfindingacommencementofopera-tions.Itshouldbenoted,however,thatinmostcases,thelesseehasper-formedmorethananisolatedpreliminaryact,butratherhasperformedacombinationofpreliminaryacts.Assuch,itappearsthatjurisdictionstakeintoaccountboththequalityofthepreliminaryactsperformedaswellasthequantityoftheactsonacase-by-casebasis.

[i] — Site Selection.Siteselection,intermsofselectingthewellsite,stakingthewellloca-

tion,surveyingthesiteandgatheringtopographicdata,istypicallyapre-liminaryactivitysufficienttocommenceoperationsunderanoilandgaslease.32

[ii] — Official Paperwork.Courtswillalsotakeintoconsiderationanyeffortsbythelesseetoob-

tainandcompleteofficialpaperworkrequiredpriortothedrillingofawell,suchasobtaininga license,bond,ordrillingpermit.33Courtshavealso

30 Id. at 442.31 IllinoisMid-ContinentCo.v.Tennis,102N.E.2d390(Ind.App.1951).32 Pemco Gas, Inc.,5Pa.D.&C.3d85(findingacommencementofoperationswhereinpriortoexpirationoftheprimarytermlesseehadundertakensurveying,negotiationsforlocationofsite,contractingwithadrillerandexcavatorandobtainingdrillingpermit);Cason, 92So.3dat438,reh’g(findinglesseehadcommenceddrillingoperationsundertheleasedespitethefactthatnodrillingpermithadbeenobtainedwithinprimarytermwherefactsshowedlesseehadobtainedaunitizationorder,completedpreliminarysurveying,gatheredtopographicdata,stakedthesiteandaccessroad,andlogged12hoursoffellingtreesandclearingthesiteonthedaytheprimarytermexpired).33 Pemco Gas, Inc.,5Pa.D.&C.3d85(findingacommencementofoperationswhereinpriortoexpirationoftheprimarytermLesseehadundertakensurveying,negotiationsforlocationofsite,contractingwithadrillerandexcavatorandobtainingdrillingpermit).

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foundthatalessee’sactofobtaininganabstractoftitleoratitleopinionconstitutedacommencementofoperations.34 Morerecently,courtshavetakenintoaccountthelessee’sfilingadeclarationofpooledunit,oraunit-izationorder.35

[iii] — Site Preparation. Multiplejurisdictionshaveheldthatpreparatoryphysicalsurfaceac-

tivities such as clearing brush, grading thewell site, digging slush pits,buildingaccessroads,etc.aresufficienttoconstitutea“commencement”ofoperationsunderthelease.36Incasesinvolvinghorizontaldrilling,thephysicalactivityneednotnecessarilytakeplaceontheLessor’sproperty,rather,preliminaryactivityonadjoiningpropertyissufficient.37

34 TrueOilCo.v.Gibson,392P.2d795(Wyo.1969)(findingpreliminaryactivitiessuchasorderingabstractoftitle,obtainingtitleopinion,surveyinglocation,partiallygradinglocation,purchasingdrillingwaterandcommencingmovementofdrillingrigfromanotherstatearetobeconsideredtimelycommencementofdrillingoperationsonlywhentherewaspresentatthetimeofthepreliminaryactivitiesagood-faithintentiontocompletetheperformance). 35 Henryv.ChesapeakeAppalachia,L.L.C.,739F.3d909(6thCir.2014)(reversingtrialcourtinfavorofLesseewhereLesseehadfiledaDeclarationofNoticeandPooledUnitencompassingLessor’spropertypriortoexpirationofprimaryterm).36 See generally,Oelzev.KeyDrilling,481N.E.2d801(IllApp.1985)(determininglesseehadcommencedoperations inobtainingdrillingpermit,clearingbrush, levelingwellsite,anddiggingslushpits);Cryev.Giles,200So.155(La.Ct.App.1941)(findinga“commencementofoperations”hadoccurredwherelesseeerectedaderrick,dugaslushpit,placedthreeorfourhundredfeetofdrillstemontheground,hadonemanpatchingtheroadleadingtothelease,andhadonemantodigareservepit);Breauxv.ApacheOilCorporation,240So.2d589(La.App.1970)(reiteratingthegeneralrulethatactualdrillingisunnecessaryto‘commence’awellandnotingthatsubstantialsurfacepreparationstodrillaresufficienttobeconsidered‘commencement’ofdrillingoperations,inthiscase,buildingaboardroadandturn-aroundtothewelllocationbeforetheexpirationoftheprimarydate,followedbycontinuousoperationsuntilthewellproduced).37 A&MOil, Inc. v.Miller, 715P.2d1295 (Kan.App.1986) (holding lesseehadcommencedoperationsunderthetermsoftheleasewhichdidnotrequirephysicalentrywhereinalthough the lessor’sproperty linewasnotpenetrateduntilafterexpirationoftheprimary term,beforeexpiration the lesseehadobtainedauthorization to slantdrillfromadrillingunitadjacenttolessors’drillingunit,erectedarigontheadjacentunitandcommenceddrilling).

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[iv] — Moving Equipment and Supplies.Preliminaryactivitiesintermsofmovingequipmentandsuppliesonto

theintendedwellsitealsohavebeenfoundsufficienttocommenceopera-tions.Forinstance,obtainingadrillingrig(evenifsmallerthanneeded)hasbeenfoundtobeanoteworthypreliminaryactivitybyaKansascourt38 for thepurposeofcommencementofoperations.Movinglumber,sand,gravel,toolsandmachineryontotheproperty,hasbeenfoundtoconstitutecom-mencementinmultiplejurisdictions.39Theactofstartingtomoveadrill-ingrigontothesitehasalsobeengivenconsiderationbycourts,eveniftherighasnotyetbeenplacedon-site.40Eventhelessee’sactofcontractingwithathird-partyvendorforthehaulingofequipmentandmachinerytothewellsitehasbeentakenintoconsideration.41

38 BunnellFarmsCo.v.SamuelGaryJr.&Assocs.47P.3d804(Kan.App.2002)(holdingthatlessee’suseofasmallrigfordrillingondateoflease’sexpirationwascommencementofdrillingwithinprimarytermoflease).See also,Haddockv.McClendon,266S.W.2d74(Ark.1954)(holdinglessee’sactivitiescompliedwithleaseprovisionrequiringlesseeto“commencedrillingoperations”priortoexpirationofprimarytermwherelesseeretainedexperiencedoilman fromOklahoma tocome toArkansas todrill,drillingpermitwassecured,asmallerdrillingrigwassecuredtodrillthefirst200feetforsoilpipeeventhoughalargerrigwouldbenecessarytodrilldowntothedesireddepth,accessroadwasbuilteventhoughitwasinsufficienttohandlelargerdrillerrigthatwouldultimatelybeneeded).39 Gonzalesv.Cowerd,188P.1053,1054(Okla.1920)(holdingworkdonepreliminarytoactualdrillingconstitutedasufficientcompliancewiththecontractrequirementthatthelesseebeginoperationswithinthreemilesofthepremisescoveredbythelease,whereinfivedayspriortoexpirationofprimarytermlesseehadhauledlumberuponlandswithinthreemilesoftheleasedpropertyanderectedaderrickandplacedtoolsontheground);Terryv.TexasCo.,228S.W.1019(Tex.Civ.App.1920)(findinga“commencementofoperations”hadoccurreddespitenodrillingbeforeexpirationofprimarytermwherethelesseehadplacedontheH.O.Hogantracttimbersforerectingderrickandmachinery,includingboiler,onsitebeforedeadline,andwherelesseehadcommencedriggingupforthewellthedaybeforeexpirationoftheprimaryterm).40 Allenv.ContinentalOilCo.,255So.2d842(La.1971)(findinglesseehad“commenceddrillingoperations”whereitobtaineddrillingpermit,builtaccessroad,dugslushpits,gradedwellsiteandwasintheprocessofmovingthedrillingrigontoleasedpropertywhenheavyrainsdelayedactivitiesbywashingoutaportionoftheroadandmakingitnecessarytostackthedrillingrigbesidetheroadontheunitbutnotatthewellsite).41 FlemingOil&GasCo.v.S.PennOilCo.,17S.E.203(W.Va.1893)(findingthatpursuanttoprovisionrequiringlesseeto“commenceoperationsforatestwell”withinone

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[v] — Erecting Structures.Preliminaryactivityintheformofconcreteworkforthefoundation

ofaderrick,orerectingaderrickordrillingrighavebeenconsideredandfoundtoconstituteacommencementofoperations.42

[b] — Timing of the Preliminary Activities Vis-à-vis the Expiration Date of the Primary Term.

Becausethegeneralrulepermitspreliminaryactivityshortofactualdrilling,asecondaryissueishowclosetotheexpirationdateofthepri-marytermcanthelesseewaittostartpreparatoryworkandstillconstitutecommencingoperations?Again,courtshavelookedtothespecificcircum-stancespresented in eachcase.However, thereare avarietyof jurisdic-tionsthathavepermittedeleventhhourpreliminaryactivitiestoconstitutea commencement of operations.

AnOklahomacourt43foundacommencementofoperationswherethelesseewaiteduntilthelastsevendaysoftheprimarytermtoenterontothelandandstartpreparingthewellsite,andwaiteduntilthelasttwodaystocompleteaderrickanddrillawaterwell.Notably,however,theOklahomacourtdeterminedthatthelesseecontinuedtopursuetheactiveoperationspasttheexpirationdateuntilthewellwascompletedandproducing.44

yeartheprimarytermwasextendedbasedonthelessee’sactionsofhavingsurveyedtheleasedpremisesfortheoilbelt,havingtimbersforthederrickcutandhewnandcontractingwithonetohaulthenecessarymachineryfordrillingthetestwelltotheleasepremises).42 Gulekev.HumbleOil&Ref.Co.,126S.W.2d38,39(Tex.Civ.App.1939)(findingthateventhoughtherewasnomachineorrigfordrillinganoilwellonsite,a“commencementofoperations”hadnonethelessoccurredwhereseveralmenwereonsitehavingerectedthefirstsectionofsteelderrickandworkingonthesecond,waterwellwasbeingbuilt,andonejointofthecasinghadbeensetforanoilandgastestwell,eventhoughtherewasnomachineorrigfordrillinganoilwellonsite);LeonardCrudeOilCo.v.Walton,197N.W.2d503(Mich.App.1972)(holdingthatunderleaseprovisionrequiring“commencedoperationsfordrillingofawell”thegeneralruleisthatactualdrillingisunnecessary,butthatthelocationofwells,haulinglumberonthepremises,erectionofderricks,providingawatersupply,movingmachineryonthepremisesandsimilaractspreliminarytothebeginningoftheactualworkofdrilling,whenperformedwiththebonafideintentiontoproceedthereafterwithdiligencetowardthecompletionofthewell,constituteacommencementorbeginningofawellordrillingoperationswithinthemeaningofthisclauseofthelease).43 Smithv.GypsyOilCo.,265P.647(Okla.1928).44 See id.

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Likewise, aTexas court opinion found a “commencement of opera-tions”wherethelesseewaiteduntilseveraldaysbeforeexpirationoftheprimarytermtoenter intoacontractwithadriller;waiteduntil thedaybeforeexpirationtosurveythesite;andwaiteduntiltheexpirationdatetostakeandlevelthesite.45Bycontrast,however,anearlierTexascourtopin-ionrefusedtofindacommencementofoperationswherethelesseewaiteduntilthe daybeforeexpirationoftheprimarytermtohaullumbertothesitetoconstructaderrick,andtherewasnoevidenceofanypriorpreparatorywork.46

[c] — Preliminary Activity Undertaken in Good Faith, and Operations Continued with Due Diligence to Completion and Production.

Courtshavedistinguishedbetweenbonafideefforts tocommenceandcontinueoperations,versusmereeffortsattechnicalcompliancetoavoidleasetermination.InaCaliforniacase,47thelesseewaiteduntilthelasttwodaysoftheprimaryterm,atwhichtimeitstakedthewelllocation,movedaportablerigtotheproperty,dugandshoredacellar,set25feetofconduc-torpipe,andfiledanoticeofintenttodrillwiththestateofCalifornia.Theappellatecourtfoundthatthecircumstancesimpliedalackofgoodfaith onthepartofthelesseebecausethelesseehadnaileddownplankingoverthecellar,andhadperformednofurtherworkinsixmonths.48Similarly,inaKansascase,49thelesseehadcompletedpreparatoryactivities(suchasbuildinganaccessroad,stakingthelocation,anddeliveringcasingpipetothesite),butdidnottakeactionstolocateadrillerwitharig.Thecourtheldthattheleaseterminatedbecausethelesseehadmadenoadditionaleffortsafteroriginalcommencement.50

45 Petersenv.RobinsonOil&GasCo.,356S.W.2d217(Tex.Civ.App.1962).46 Forneyv.Ward,62S.W.108(Tex.Civ.App.1901).47 Wilcox,114P.2d39,40(Cal.Ct.App1991).48 Id at 41.49 Herlv.Legleiter,668P.2d200(Kan.App.1983)(failingtoaddresswhetheractualdrillingwasrequired).50 Id.KansascourtsgenerallyappeartozeroinmoreonthegoodfaithintentoftheLesseetoperformcontinuedoperationswithduediligencetocompletionandproductionofthe

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[5] — Summary.Overwhelmingly, intheabsenceofanexpressleasedefinitiontothe

contrary,mostjurisdictionsadheretothelongstandingrulethatcommence-mentofoperationsdoesnotrequireactualdrilling,solongasthereissomepreliminaryactivityundertaken.Boththequalityandquantityofthepre-liminaryactivitiesundertakenbythelesseearegivenconsiderationbythecourtsindeterminingwhethertherehasbeenacommencementsufficienttoextendtheprimaryterm.Ifthereisanydoubtastothesufficiencyofthepreliminaryactivities,somejurisdictionswillfocusonwhethertheactivi-tieswereundertakeningoodfaithbythelessee.Innearlyeveryjurisdiction,ifthepreliminaryactivitiesarenotcontinuedwithduediligencebeyondtheexpirationoftheprimarytermuntilthereiscompletionandproductionofawell,a“commencement”isunlikelytobefound,regardlessofthetypeandamountofinitialpreparatoryactivity.

This is true for the Southwestern andmid-continent states such asTexasandOklahoma,aswellasthosestateswithintheAppalachianbasinthathavehadanopportunitytoaddresstheissue.Giventhelongstandingadherence to thegeneral rule, it isbelieved that thosestateswhichhavenot yet had anopportunity to address the issue at the appellate level orabovewilllikewisefollowthegeneralrulethatpreliminaryactivitiesinthepreparationtodrillawell,undertakeningoodfaithandwithadiligencetocontinuecompletionofthewellthroughproductionconstitutesacom-mencement of operations.

wellwhenconsideringwhethera“commencement”hasoccurred.See generally,Phillipsv.Berg,243P.1054(Kan.1926)(quietingtitleinfavoroflessorupondeterminationthatlesseehadnotproperlycommencedoperationswithinprimarytermswhereinpriortoexpirationofprimarytermtwoloadsofsandwerehauledtosite,aloadofcementandcementstaveswerehauledtositeanddrillingofwaterwellwascommenced,andwhereworkcontinuedanddrillingofgaswellwasactuallycommencedsomesevenmonthsaftertheprimarytermexpired,however,thereweremultiplecessationsindrillingduetoequipmentfailuresandthelikeand“bonafidedrillingoperations”werenotactuallycommenceduntilfouryearsaftertheprimarytermexpired);Shoupv.FirstNat’lBank,67P.2d569(Kan.1937)(opiningthatitmaybedoubtedthatthedumpingofsomeusableandusefulequipmentonalocationbyonewhohasnointentionofdrillingawellhimself,butexpectsittobeusedbysomeonewithwhomhemaycontractthereafterfordrillingofawellconstitutesacommencementofoperations,andthatevenifitdid,thelackofanyactivitythereafterforaperiodofnearlythreemonthsfailsutterlytoshowthatthe“operations”socommencedwerecontinuedwithduediligencetocompletionsuchthatleaseexpiredbyitsownterms).

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§ 7.03. Production Sufficient to Prevent Termination.Inadditiontorequiringsomesortofcommencementofoperations,the

typicalhabendumclausefurtherrequiresthatinorderfortheprimarytermoftheleasetobeextended,thewellmustcontinuouslyproduceoilorgas.Habendumclausesinmostolderleasesallowtheleasetocontinuebeyonditsprimarytermfor“solongthereafterasoilorgasis‘produced,’or‘pro-ducedinpayingquantities,’or‘found,’or‘foundinpayingquantities,’ordiscovered,’or‘discoveredinpayingquantities,’or‘canbeproduced,’or‘canbeproducedinpayingquantities.’”51 Thesehabendumclauses“havecometobewordsofartinmanyjurisdictions,andsuchwordsarenotnec-essarilygiventheirliteralmeaning.”52

[1] — Production in Paying Quantities.Mostcourtsconstruetheword“produced”ina“thereafter”clauseto

mean“produced inpayingquantities to the lessee”evenwhen the leasedoesn’texpresslyrequireit.53Eventhoughmostcourtsagreethat“produc-tion”means“production inpayingquantities,” jurisdictions implementasomewhatvaryingapproachwhendeterminingwhetherproduction is inpayingquantities.

[a] — Actual Production and Marketing Versus Capability.

Inanalyzingwhetherawellisbeingproducedinpayingquantities,mostjurisdictionsrequireeitheractualproductionandmarketingoftheproduct,orjustacapabilityofproduction.54Theactualproductionapproachnar-

51 SeeKuntz,Law of Oil and Gas § 26.5 (2011).52 Id.53 See3Williams&Meyers,supra,§note1.54 TherewasathirdapproachadoptedinearlyopinionsemanatingoutofWestVirginia,KentuckyandIllinois,knownasthe“merediscoveryapproach.”Underthemerediscoveryapproach,leaseswereextendeduponthelessee’smerediscoveryofoilorgasduringtheprimaryterms.See e.g.,Gillespiev.OhioOilCo.,102N.E.1043,1044(Ill.1913)(findingthatwelldrilledlessthanoneweekbeforeexpirationofprimarytermandwhichproduced12barrelsofoilperdayforthefirsttwodaysandinsignificantamountsthereafter,nonethelesswasincontinuousproduction—albeit“sosmallastomaketheventureunprofitable”—soastoholdtheleaseintoasecondaryterm);SouthPennOilCo.v.Snodgrass,76S.E.961,964(W.Va.1912)(interpretingprovision“aslongthereafterasoilorgasoreitherofthem

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rowlyconstrues the secondary term languageofanoil andgas leaseasrequiringactual,physicalproductionandmarketingofoilandgas.55Bycontrast,thecapabilityapproachdoesnotrequirethelesseetoactuallyselloilandgasduringtheprimaryterminordertoholdthelease.56

Texas is one jurisdiction that has adopted the actual production ap-proach.Inoneoftheseminalcasesaddressing“productioninpayingquan-tities,”theTexassupremecourtexplainedinKing v. Garcia,that“[t]heterm‘payingquantities’involvesnotonlytheamountofproduction,butalsotheabilitytomarkettheproductataprofit.”57Therefore,ininstanceswhereinawellisclearlycapableofproduction,butforsomereasonoranotheris

isproducedtherefrom”aspermittinglesseetoextendleasebeyondprimarytermbaseduponlessee’sdiscoveryofoil,wherelesseediscoveredoilonthepropertyintraceamountsaweekbeforeexpirationoftheprimaryterm,shotawellthelastdayoftheprimarytermandbeganpumpingthewellthereafter);Reynoldsv.WhitePlainsOil&GasCo.,250S.W.975,976(Ky.1923)(interpretingphrase“solongthereafterasoilandgasareproducedoroperationsarecontinuedthereon”asgrantinglesseetheexclusiverighttodeterminewhenawellisproducingoilorgasorbothinpayingquantities,andinthecasebeforeitfindingthattheprimarytermwasextendedwherethreewellsproducedonlyonebarrelofoileveryotherday). Thisapproachisantiquated,andsubsequentopinionsinthesestatesreflectmoreofacapabilityapproach.See e.g.,Pieszchalskiv.Oslager,470N.E.2d1083(Ill.App.1984)(clarifyingthatearlierGillespiedecisiondoesnotstandforthepropositionthatproduction,howevermeager,issufficientinanyeventtoextendanoilandgasleasebeyondtheprimarytermofahabendumclausenotrequiringproductioninpayingquantities);Goodwinv.Wright,163W.Va.264,255S.E.2d924(W.Va.1979)(reiteratingthegeneralrulethat“produced”means“producedinpayingquantities”andcancelingtheleaseinquestionbecausedespitethefactthatthelesseereceivedfreegas,theproductionrequiredundertheleasewassuchthatitwouldnotresultinroyaltypaymentstothelessee);HirocPrograms,Inc.v.Robertson,40S.W.3d373,378(Ky.Ct.App.2000)(reiteratingthat“consummationofasaleisnotnecessarilythedeterminingfactorofwhetherthelesseehasmarketedthegas...[andacourtmustconsider]“allofthecircumstances,suchastheabsenceofamarketandthediligenceofalesseeinseekingamarket,thefailureofthelessortomakeademand,theacceptancebyalessorofotherbenefitsunderthelease,whetheritwasnecessarytomakeabnormalexpenditurestomarkettheproduct,andwhetherthedelaywastogainbettermarketingterms.”). 55 AshleighL.Boggs,Note:“AnadarkoPetroleumCorp.v.Thompson:InterpretationofOilandGasLeaseHabendumClausesinTexasandWhyOklahomaShouldMaintainItsDivergentApproachtoKeepLeasesAlive,”61Okla. L. Rev.341,342(2008).56 Id. at 343.57 Kingv.Garcia,164S.W.2d509,511-12(Tex.1942).

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notbeingproducedbytheoperator,courtsrequiringactualproductionandmarketingwill determine that the lease has failed to produce in payingquantities.58

Bycontrast,Oklahomaisajurisdictionthathasdevelopedthe“capa-bilityrule”bydecliningtoimplyadutytomarketoilandgasduringtheprimarytermsolingasthewellcouldclearlyproduce.59Underthecapabil-ityrule,ithasbeenheldthatwhereawellis“completedandcapableofpro-ducinginpayingquantitieswithintheprimaryterm,theleasecontinued,sofarasthehabendumclausewasconcerned,aslongasthewellremained

58 See, e.g.,GulfOilCorp.v.Reid,337S.W.2d267(Mo.1960)(concludingtherewasafailuretoproduceinpayingquantitieswherethewellwascapableofproductionbutoperatorhadcappedthewellduetoalackofmarketingfacilitiesdespitecontinuednegotiationsbytheoperatortofindamarketforitsproduct);see alsoTedrowv.Shaffer,155N.E.510(OhioApp.1926)(holdingleaseexpiredwherelesseedrilledawellnotlongaftertakingtheleaseandpumpedasmallamountofoilfromitandforthenextsevenyears,paiddelayrentalstothelessorbutfailedtofurtherdeveloptheoilandgasuntilonemonthpriortotheexpirationoftheprimarytermwhenthelesseeassignedtheleasetoadeveloperwhopromptlyenteredthepremises,builtroads,andbeganpumpingoilfromthewellontheverydaytheprimarytermexpired.Thecourtnotedthatthelesseecannotsimplyproduceoilinpayingquantitiesonthelastdayoftheterm;“hemusthavebeenproducingitinpayingquantitiesforsomesubstantialorreasonabletimepriortothefinaldayofsuchterm,sothatitclearlyappears,whentheendofsuchtermcomes,thatheisingoodfaithactuallyfindingoilinpayingquantities.”);La.Rev.Stat.§31:124(2012)(enactedin1975,codifyingthecommonlawandstatinginpertinentpart:Whenamineralleaseisbeingmaintainedbyproductionofoilorgas,theproductionmustbeinpayingquantities.Itisconsideredtobeinpayingquantitieswhenproductionallocabletothetotaloriginalrightofthelesseetoshareinproductionundertheleaseissufficienttoinduceareasonablyprudentoperatortocontinueproductioninanefforttosecureareturnonhisinvestmentortominimizeanyloss).59 SeeMcVickerv.Horn,Robinson&Nathan,322P.2d410,412(Okla.1958);see also Christianv.A.A.OilCorp.,506P.2d1369,1372(Mont.1973)(notingthat“thetestfordeterminingwhethertherewassufficientproductionorwhetherthelesseewasactingwithreasonablediligenceinproducingandmarketingthegasfromtheleasedlandsisthediligencewhichwouldbeexercisedbytheordinaryprudentoperatorhavingregardtotheinterestsofbothlessorandlessee”andfurthercommentingthatthemerediscoveryofoilandgasisnotsufficient,butthediscoveryofgasincommercialquantitiesduringtheprimarytermwillextendtheleaseintothesecondarytermuponwhichthelesseeisrequiredtousereasonablediligenceinoperatingthewellandmarketingtheproductwithinareasonabletimesoastoproduceinpayingquantitieswhichthecourtdefinedasaprofitoveroperatingexpenses);see generallydiscussionatfootnote51,supra.

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capableofproducinginpayingquantities,regardlessofanymarketingoftheproduct.”60

[2] — Standards Utilized for Determining Production in Paying Quantities.

Thereisaspectrumofstandardsimplementedbyjurisdictionsforde-terminingwhetherawellisproducinginpayingquantities.Atoneendofthespectrumarethosejurisdictionsthatemployastraightmathematicalap-proach,attheotherendofthespectrumarethejurisdictionsthatgivegreatdeferencetothelessee’sjudgment.Somewhereinthemiddlearethoseju-risdictionsthateitherhavenotdefinitelyadoptedeitherapproach,orinsteademployahybridapproachthatconsistsofbothanobjectivemathematicalstandardandareasonablyprudentoperatorstandard.

[a] — Objective Mathematical Test.Somejurisdictionsfocusprimarilyonanobjectivemathematicalcom-

putationtodeterminewhetherawellisprofitable,andthusproducinginpayingquantities.Forinstance,inthecaseofReese v. Enterprises v. Law-son, theKansasSupremeCourt specifically rejected apayingquantitiesanalysisthatwasbasedentirelyonthelessees’goodfaithjudgment.61Therationale is that apurely subjective testdoesnotprotect the lessor fromlesseeswhomaywanttosimplypreservetheirinterestintheleaseholdinthehopesofanupturninthemarketorfuturediscoveriesofotherforma-tions.62Undertheobjectiveprofitabilityanalysis,itappearsnottomatterhowmuchprofitthelesseemade,butonlythathemadeaprofitoverhisoperatingexpenses,howeversmall.63InReese,theKansascourtconcludedthat the lessee’soperatingexpensesof$300.00 farexceeded the lessee’sgrossincomewhich,afterdeductingroyaltypaymentsfromthegrosspro-ceeds,wasonly$268.42.64

60 Packv.SantaFeMinerals,869P.2d323,326(Okla.1994).61 ReeseEnterprises,Inc.v.Lawson,553P.2d885,891,896-897(Kan.1976)(“Inouropinionthebetterapproachistofollowtheinnumerablecaseswhichapplyanobjectivetest,wherethedeterminationof‘payingquantities’turnsuponamathematicalcomputation.”)62 Id. at 897.63 See id.64 See id. at 899.

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[b] — Subjective Test.Somejurisdictionsemployamoresubjectivetestfordeterminingifa

well isproducing inpayingquantities.Agoodexample isPennsylvania,whichattheendofthe19thCentury,adopteda“goodfaith”test,givinggreatdeferenceto thelessee’ judgment,65 in the case of Young v. Forest Oil Co.66InYoung,thePennsylvaniacourtdeclaredthatawellproducesinpayingquantitiesifit“paysaprofit,evenasmallone,overtheoperatingexpenses...[eventhoughit]...mayneverrepayitscost,andtheoperationasawholemayresultinaloss.”67TheYoungcourtwentontoholdthat“thephrase‘payingquantities,’thereforeistobeconstruedwithreferencetotheoperator,andbyhisjudgmentwhenexercisedingoodfaith.”68TheearlyanalysisannunciatedinYoung,isstillgoodlawandmorerecentcaseshaveexplainedthatinassessingwhetheranoperatorhasexercisedhisjudgmentin good faith (in continuing to operationmarginal or sporadicwells) “acourtmustconsiderthereasonablenessofthetimeperiodduringwhichtheoperatorhascontinuedhisoperationofthewellinanefforttoreestablishthewell’sprofitability.”69

65 See alsoSwissOilCorp.v.Riggsby,67S.W.2d30,31(Ky.1934)(rejectinglessor’sclaimthatleaserequiredlesseetopayarentalordrillwherelesseehaddetermineditwouldbeunprofitabletodrillgiventhelocationofexistingpipelinesincomparisonwithlessor’slandandnotingthat“thejudgmentofanexperiencedoperatororlessee,ifexercisedingoodfaith,willprevailasagainstthatofalessorwithoutexperience”);Littonv.Geisler,76N.E.2d741(Ohio1945)(characterizingtheamountofproductionrequiredtoextendaleasebeyonditsprimarytermas“thatquantitywhichwillbringareasonablepecuniaryreturninexcessofthecostofproduction,regardlessofanyparticularamountofprofitderivablefromtheoperationofthewell”andfurtherexplainingthatthelesseemaydeterminewhatquantitysatisfiesthisstandard,solongasheexerciseshisjudgmentingoodfaith);ManhattanOilCo.v.Carrell,73N.E.1084,1085(Ind.1905)(holdinginsuitbylessoragainstlesseeforfailuretodrilladditionalwellsafterdiscoveringoilinfirstwell,thatthephrase“payingquantities”meanssuchquantitiesasordinarilyprudentpersonscould“expectareasonableprofitonthefullsumrequiredtobeexpendedintheprosecutionoftheenterprise”whichdeterminationmustbelefttothelesseeandmadeingoodfaithbaseduponsoundbusinessprinciples).66 Youngv.ForestOilCo.,45A.121(Pa.1899).67 Id.at122-23.68 Id. at 123.69 T.W.PhillipsGas&OilCo.v.Jedlicka,42A.3d261(Pa.2012).

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[c] — Combination of Approaches.Otherjurisdictionsfallsomewhereinthemiddleofthetwotests.For

example,somehaveadoptedastandardthathasbothsubjectiveandobjec-tive components.This two-step approach is succinctly illustrated by theTexasappellateopinionofClifton v. Koontz.70Underthetwo-stepapproachthecourtisrequiredto(1)calculateprofitsandlossesoverareasonablepe-riodoftime,todetermineifthewellpaysaprofitoveroperatingexpenses.Ifthewellisprofitable,theanalysisends;however,ifthewellprovesun-profitable,thenthecourtmust(2)applythereasonableandprudentoperatorstandardtodeterminethateveniftherewasanetloss,thereasonableandprudentoperatorwouldcontinuetooperatethewell.71

PursuanttothecaseofClifton v. Koontz,thefollowingfactorsshouldbeconsideredbythecourtsindeterminingwhatareasonableandprudentoperatorwoulddo:depletionof the reservoir,price forwhich lesseecansellhisproduct,relativeprofitabilityofotherwellsinthearea,operatingandmarketingcostsofthelease,lessee’snetprofit,eachoftheforegoingcalculatedoverareasonableperiodoftime,andwhetherornotthelesseeisholdingtheleasemerelyforspeculativepurposes.72

[3] — Considerations in the Profitability Analysis.Notonlydoes the legal test fordeterminingpayingquantitiesdiffer

byjurisdiction,therearealsoamyriadoffactorsthatmayormaynotbetaken intoconsiderationbyvarious jurisdictionswhencalculatingprofit-ability.The“directcosts”appropriatelyconsideredbythecourtasattribut-abletotheoperationofthewellvariesbyjurisdiction.Forinstance,somecourtsconstruedirectcostsattributable tooperationof thewellbroadly,soastoincludeallpotentiallytraceableexpensessuchaslabor;trucking;transportationexpense;replacementandrepairofequipment;taxes;licenseandpermit fees;operator’s timeon the lease;maintenanceandrepairofroads,entrancesandgates;andexpensesencounteredincomplyingwithstatelawswhichrequirethepluggingofabandonedwells.73

70 Cliftonv.Koontz,325S.W.2d684,691(Tex.1959).71 See also,3Williams&Meyers,§604.5supra.72 Clifton,325S.W.2d684,691.73 ReeseEnters,Inc.v.Lawson,553P.2d885,898(1976).

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Other courts construe “direct costs”more narrowly, excluding over-headorcostsofdrillingandequippingthewell.74Likewise,somecourtshavepermittedasanincludedexpensethecostofequipmentusedtocleanthewellcase,andanyotheroperationsthatmerelyservetoimprovepro-ductivityofawellbuthaveexcludedequipmentcostsrelatedtonewdrillingormajor equipment.75Other jurisdictionshave excluded a lessee’s laborcostsfromthetotaloperatingexpensesinthecalculationofprofitsversusoperatingcosts.76

Whenmorethanonewellisoperatedbyalesseeinthesamegeneralvicinity,courtshaveundertakentoapportionthecoststoeachwellforthepurposeofcompletingaprofitabilityanalysis.For instance, inTurner v. Reynolds Metals Co.,77thelesseeoperated10wellsintheareawherethewellinquestionwaslocated.Inundertakingaprofitabilityanalysisonthesinglewellinquestion,theArkansascourtapportionedmonthlycoststo

74 RossExplorations, Inc. v.FreedomEnergy, Inc., 8S.W.3d511, 514 (Ark. 2000)(determiningthatonlydirectexpensesattributabletooperationwererelevanttodeterminationofprofitability,excludingcostssuchasoverheadandthoseofdrillingandequippingthewell);see alsoMasonv.LaddPet.Corp.,630P.2d1283(Okla.1981)(notingthatoverheadexpensesarenottobeconsideredintheanalysisofproductioninpayingquantities);Ovav.LaddPetroleum,630P.2d1283,1284(Okla.1981)(notingpayingquantitiesmeansthelesseemustproduceinquantitiessufficienttoyieldareturn,howeversmall,inexcessof‘liftingexpenses,’eventhoughwelldrillingandcompletioncostsmightneverberepaid.).75 Lough v.CoalOil, Inc. 217Cal.App. 3d 1518 (1990) (upholding lower court’sterminationofleaseforfailuretoproduceinpayingquantitiesuponevidencethatlesseesufferedseriousfinanciallossduringan18-monthperiodaroundthetimethatthequiettitleactionwasfiledandduringasubsequent51-monthperiodwhilesuitwaspending).76 Blauseyv.Stein,400N.E.2d408,410(Ohio1980)(holdingthat‘payingquantities’means‘quantitiesofoilorgassufficient toyieldaprofit,evensmall, to the lesseeoveroperatingexpenses,eventhoughthedrillingcosts,orequippingcosts,arenotrecovered,andeventhoughtheundertakingasawholemaythusresultinaloss”andforthepurposesofcalculatingexpensesinthematterbeforeit,excludedlessee’slaborcostsfromtotaloperatingexpensesinthecalculationofprofitsversuscosts,whichlefthimwithasmallprofit).77 Turnerv.ReynoldsMetalsCo.,721S.W.2d626(Ark.1986)(holdinglessorwasentitledtocancelleasefornon-productionaftercourtconsideredtheexpensethelesseepaideachmonthtoservicethe10wellsinthefieldareawherethesubjectwellwaslocated,allocatedashareofthatexpensetoeachwell,anddeterminedthatthelesseelostmoneyonthewellatissueeveryyearduringthesecondaryterm).

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eachwell,andfoundthatthelesseelostmoneyonthewellatissueineveryyearofthesecondaryterm,resultinginthecourtcancelingthelease.

Anotherissuethatarisesundertheobjectivearithmeticapproachistherelevanttimeperiodoverwhichthecourtshouldconducttheprofitabilityanalysis.TheTexascourtinClifton v. Koonznotedthatthereisnoarbitraryfixedperiodthatacourtmustconsider,fordeterminingwhetheraleasehasterminatedfornon-productionbecause“therearevariouscausesforslow-ingofproduction,oratemporarycessationofproduction,whichthecourtshaveheldtobejustifiable.”78Similarly,Pennsylvaniahasdeterminedthatwhatisa“reasonableperiodoftime”isbasedontheindividualcircum-stancesofeachcase,andmay“bedrivenbyconsiderationofthegoodfaithjudgmentoftheoperator.”79Forthemostpart,courtshaverefusedtoadoptafixedtimeperiod,insteadconcludingthata“reasonableperiodoftimemustbeemployed”whenanalyzingwhethertheleaseisproducinginpay-ingquantities.80

[4] — Summary.Whilenearlyeveryjurisdictionhasinterpreted“production”asmean-

ing“productioninpayingquantities,”thereisavariationinthestandardsutilizedacrossthejurisdictionsforanalyzingwhetherproductionisinpay-ingquantities.Jurisdictionsinthemid-continentareas,suchasOklahomaandTexasappearmorefocusedontheobjectivemathematicalcomputationofprofitability,althoughevensomeofthosejurisdictionshavefashionedatwo-parttestthataddsasubjectivereasonablyprudentoperatorcomponentwhenfacedwithamarginalwell.StatesintheEastsuchasPennsylvania,aswellasthoseintheAppalachianbasin, includingKentuckyandOhiogivegreaterdeferencetothegoodfaithjudgmentofthelessee.Amongstallofthesejurisdictions,itiscriticaltoknowwhatfactorsareappropriatelyconsideredbythecourtwhenundertakingaprofitabilityanalysisinorder

78 Clifton,325S.W.2dat690.79 T.W.PhillipsGas&OilCo.v.Jedlicka,42A.3d261(Pa.2012)(rejectinglandowner’scontentionthataone-yearperiodoflossconstitutesnon-productionandholdingthatprofitsmustbemeasuredovera“reasonableperiodoftime”whichperiodisbasedontheindividualcircumstancesofeachcase,andmay“bedrivenbyconsiderationofthegoodfaithjudgmentof the operator.”).80 3Williams&Meyers,supra,§604.6(c)supra note 1.

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tomaximizetheprofitabilityofthewellinordertothwartattacksbasedonallegednon-productionofthelease.

§ 7.04. Equitable Remedies for Breach of Implied Covenants in Oil And Gas Leases.

[1] — Genesis of Covenants Implied in Oil and Gas Leases.Impliedcovenantsinoilandgasleaseshavetheiroriginsintheprin-

cipleofcooperationapplicablegenerallytocontracts.Thatstandsforthepropositionthatpartiestoanagreementareboundtocooperatetoreachthegoalorpurposeoftheagreement.81Withrespecttooilandgasleases,themutualgoal—extractionofmineralsfromland—typicallyinvolvesanumberofunknownfactors,makingthespiritofcooperationmorecriti-cal.82 “Andbecause this is the situationof theparties toanoil andgaslease,theimplicationofpromisesthereindoesnotrequireacourttochoosebetweenconflictinggoals-thegoalofstabilityinthewrittenwordandthegoalofachievingequityevenattheexpenseofthewriting.”83

Asearlyas the late1800s,courts recognized thatcertainconditionspertainingtotheleasingofoilandgasrightsaresowellacceptedthat,intheabsenceofanexpresswaiverofsaidconditions,theywouldbedeemedtobepartoftheleasebyimplication.Theimpliedcovenantsmostwidelyrecognizedinthemoderneraare:1)Covenanttoprotecttheleaseholdfromdrainage;2)Covenanttoreasonablydevelopthepremises;3)Covenanttoexplorefurther;and4)Covenanttomarkettheproduct.84

[2] — Remedies for Breach of Implied Covenants.Leasesarefundamentallycontracts,andthereforemostcourtswillfol-

lowthegeneralrulethatalegalremedyintheformofmonetarydamageswillbeawarded,ifadequatetocompensateforthebreach.Notsurprisinglyhowever,giventheequitablefoundationofimpliedcovenants,itistypicalforcourtstofindmoneydamagestobeinadequatewhendeterminingtheappropriateremedyforbreachofanimpliedcovenant.Theequitablerem-

81 5Williams&Meyers,§802.1supra note 1. 82 Id. 83 Id.84 5Williams&Meyers,supra,§804.

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edytypicallyawardedforbreachofanimpliedcovenantisadecreeororderfor cancellationof the lease,partially (theaffectedpartof the leaseholdcouldbedefinedbysurfaceacreageoritmightbedefinedbyundevelopedstrata)orinitsentirety,eitherofwhichmaybeabsoluteorconditional.

Various terms are used in discussing equitable remedies pertainingtoleases,including: cancellation (nullifyingofaleasebycourtorder);85 forfeiture(oftenusedtomeananyformofleasetermination,butstrictlyspeaking, “forfeiture is a remedygivenby the lease expresslyor by thecourts toextinguish the lifeofa leaseotherwise in force”);86 rescission (“unmaking or undoing a contract from its beginning”);87 termination (“expiration,cancellationorforfeitureofalessee’sinterestinleasedprem-ises”);88 and conditional decree of cancellation (order directing perfor-manceofcertainobligationsbylesseewithincertaintimeframeelseleasewillbecancelled).89Breachesofanyoftherecognizedimpliedcovenants,dependentupontheparticularfactsofthecase,canserveasthebasisforanawardofequitablerelief.Becausetheremedyistypicallyoneinequity,the particular facts of the case willalmostalwaysdrivetheultimateresult,regardlessofthejurisdiction.

[3] — A Brief Discussion on Legal or Money Damages.Somejurisdictionsmorestronglyfavortheremedyofmoneydamages

thanothers,andasthetechnologyandaccuracyassociatedwithascertain-mentofremainingundergroundmineralreservesimproves,thesupportforthisremedyisstrengthened.90ThejurisdictionswhichtendmorestronglytofavormoneydamagesforbreachofimpliedcovenantsincludePennsyl-vania,Kansas,Texas,MississippiandOhio;buteventhesestatesrecognizethatattimes,legaldamagesareinsufficient.91,92,93,94,95

85 8Williams&Meyers,supra, Manual of Terms.86 Id.87 Id.88 Id.89 Id.90 5Williams&Meyers,supra note 1. 91 Colganv.ForestOilCo.,1(Pa.1899).See also,T.W.PhillipsGas&OilCo.v.Jedlicka,42A.3d261,273(Pa.2012).“Withrespecttoabreachofimplieddutiesunderalease,equitywillnotdeclareaforfeitureunlesstherehasbeenfraud,mistake,orthelike,theonlyremedyisanactionatlawfordamages.”

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AlsorecognizedbyMississippicourts(aswellasothers)isthatbreachoftheimplieddutytoprotectagainstdrainageismoreoftenthannotsus-ceptibleofalegalremedy.96

92 Asageneralrule,forfeitureofoilandgasleasesforbreachofanimpliedcovenantisdisfavored.Christiansenv.VirginiaDrillingCo.,170Pac.1005(Kan.1918).Forfeitureshouldbegrantedonlyifaremedyofdamagesisinadequate.Howertonv.GasCo.,81Kan.at561.Also,Kansasfavorsatimebeaffordedtothelessortocurethedefect.Robbinsv.ChevronU.S.A.,Inc.,785P.2d1010(Kan.1990).93 “Variouscourtshaverecognizedthreeseparateremediesforbreachofthecovenantofreasonabledevelopment:(1)Outrightcancellation,exceptforasmallareasurroundingexisting,producingwells;(2)themoremoderateconditionaldecreeofcancellation,unlessaspecifiednumberofwellsaredrilledwithinafixedperiodoftime;and(3)damages.Wethinkthatdamagesaretheappropriateremedyintheinstantcase.ThisistheviewtakenbytheTexasCourts.Christe,Mitchell&MitchellCo.v.Howell,359S.W.2d658(Tex.Civ.App.1962);5Williams&Meyers,Oil and Gas Law,s834,at240-241(1964)supra note 1. TheTexasruleisinaccordwithwhatwethinkisthebetterauthority,unlesstheremedyofdamagesiswhollyinadequate,andthatdoesnotappearhere.Further,itisconsistentwiththetraditionaldecisionsofthiscourtnotfavoringforfeitures.”SouthwestGasProducingCo.v.Seale,191So.2d115,122(Miss.1966)(lesseeheldtohavebreachedimpliedcovenantofgoodfaithwithrespecttopoolingclausebutlesseenotentitledtoforfeiture;legaldamagesheldtobesufficientasamatteroflaw).94 Inregardstotheremedyofforfeitureorcancellationofanoilandgaslease,it isanequitableremedythatrestswithin thediscretionof the trialcourt.Ohiocourtshaverecognizedthatforfeitureisanappropriateremedywhenlegaldamagesresultingfromacontractualbreachareinadequate;uponabreachofimpliedcovenants;uponaclaimofabandonment;orwhennecessarytodojustice.See,Beerv.Griffith,399N.E.2d1227(Ohio1980),atsyllabus4(wherelegalremediesareinadequate,forfeitureorcancellationofanoilandgaslease,inwholeorinpart,isanappropriateremedyforalessee’sviolationofanimpliedcovenant);Wohnhasv.Shepherd,119N.E.2d861(Ohio1954)(abandonment—orevasionofdutytodevelop—isrecognizedinOhioasagroundforcancellationofoilandgaslease).95 Thus,theBeerdecisiondoesnotstandforthepropositionthatforfeiturecanneverbeimposedwherethereisabreachofanimpliedcovenant.Suchreliefwillbegrantedwhennecessarytodojusticetotheparties,eventhoughspecificgroundsforforfeiturearesetforthinthelease.See Beer, supra.However,inasmuchasforfeitureisanequitableremedy,astrongshowingofaviolationofaclearrightisrequiredbeforeacourtwillresorttosuchanextrememeasure.Moorev.Adams,2008-Ohio-5953,P47,2008OhioApp.LEXIS4998,16,2008WL4907590(OhioCt.App.,TuscarawasCountyNov.17,2008).96 Theremedyforbreachof the impliedcovenantofdevelopmentof thepremises isforfeiture(afterreasonablenoticeandtimetocureisafforded),andotherimpliedcovenants,

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[4] — In Some Jurisdictions, Equitable Remedies Are Preferred.Somejurisdictionstendtopresumethenecessityofanequitablerem-

edywhenbreachofanimpliedcovenantoccurs,includingColorado,NewMexico,MontanaandArkansas.97,98,99,100,101,102

suchastheimpliedcovenanttocompensatefordrainage,allowonlyforrecoveryofdamages,notforfeiture.MonsantoChem.Co.v.Andreae,147So.2d116(Miss.1962).97 Cancellationofanoilandgasleaseisanequitableremedyandisappropriatewhenabreachoftheimpliedcovenantofreasonabledevelopmentisshown.RobersonEnterps.Inc.v.MillerLand&LumberCo.,700S.W.2d57(Ark.1985);Blairv.ClearCreekOil&GasCo.,230S.W.286(Ark.1921).Cancellationofinstrumentsisoneofthewell-recognizedgroundsofequityjurisdiction.AmericanIns.Co.v.MountainHomeSch.Dist.No.9,780S.W.2d557(Ark.1989).SunbeltExplorationCo.v.StephensProd.Co.,896S.W.2d867(Ark. 1995).98 InNewMexico,“cancellation[forfeiture]willbedecreedforbreachofanimpliedcovenantinoilandgasleases.3Summers,Oil and Gas,§§453through468(Perm.Ed.);Merrill,Covenants Implied in Oil and Gas Leases,p.362(2dEd.1940).Thisistherulethathasbeenestablishedinthisjurisdiction.Libbyv.DeBaca,179P.2d263(N.M.1947).Asheretoforepointedout,theleaseinquestionshouldbegovernedbytheprinciplesapplicabletooilandgasleasesincludingthedoctrinethatsuchaleasewillbecancelledforfailuretoexercisereasonablediligenceinmarketingtheproduct.Andsuchcancellationwillbedecreedagainstanassigneeofthelease.”Merrill,CovenantsImpliedinOilandGasLeases,p.392,(2dEd.1940);HumphreysOilCo.v.Tatum,26F.2d882(5thCir.1928);PhillipsPetroleumCo.v.Taylor,116F.2d994(5thCir.1941),ConocoPhillipsCo.v.Lyons,299P.3d844(N.M.2012).99 “Thestatutoryremedyapplieswhenevertheoilandgasleaseis‘forfeited’(sec.6902,Rev.Codes1921),and,ifaleaseis terminatedbythebreachofimpliedcovenants, it isforfeited.”Berthelotev.LoyOilCo.,28P.2d187,190(Mont.1933)(inconnectionwithoilandgasleases,forfeituresarefavoredbythelaw).100 PinnacleGasRes., Inc.v.DiamondCrossProperties,LLC,201P.3d160,166-167(Mont.2009).101 ItisrecognizedinColoradothatabreachoftheimpliedcovenantsinanoilandgasleasegenerallyleavesnoadequateremedyatlaw.Gillettev.PepperTankCo.,694P.2d369(Colo.App.1984)(overruledonothergroundsinDavisv.Cramer,infra).102 “Ifalesseefailstomarkettheproductforanextendedperiodwithoutexplanation,thelessorhasmadeaprimafaciecaseforcancellation.Townsendv.Creekmore-RooneyCo.,358P.2d1103(Okla.1960).”Davis837P.2dat225(Colo.Ct.App.1992).

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[5] — Most Jurisdictions Acknowledge a More Open Approach.

Thosejurisdictionsmoreopenlyacknowledgingthefact-drivennatureof a remedy includeWestVirginia103 andNorthDakota.104But as onecomestorealizeuponareviewofthetopic,regardlessofthejurisdiction,remedies are almost always completely fact-driven.

[6] — Conditional Cancellation Is the Most “Equitable” Remedy.

A decree of “conditional cancellation” gives courts (and parties tothelease)theflexibilitytoissueanaward(ornegotiateasettlement)withmaximumflexibility,andthusisthemost“equitable”approachtoremedybreachofanimpliedcovenantwhenlegaldamagesareinadequate.“Con-ditionalcancellation”canrunthegamutfrompartialleaserescissionastoparticularformation/strataand/orcertaintractswithinalease,tototalleasecancellationunlessparticulartermsandobligationsarefulfilledwithinaspecifiedtimeframe.

TheseminalcaseonconditionalcancellationofanoilandgasleasewasissuedbytheUnitedStatesSupremeCourt in1934andbearssomediscussion here. In Sauder v. Mid-Continent Petroleum Corp.,105 “[t]he

103 [T]he equitable remedyofpartial cancellationorpartial rescissionhas longbeenrecognizedas aviablemeansof resolvingvariousoil andgas leasedisputes.See, e.g.,Adkins,,168S.E.at369;Jennings,80S.E.at372.Todispelanylingeringconfusionontheremedialuseofpartialrescission,weholdthatatrialcourtmayconsidertheequitableremedyofpartialrescissioninfashioningtherelieftobeawardeduponproofsufficienttoestablishabreachoftheimpliedcovenantofdevelopmentinconnectionwithanoilandgasleasedispute.St.Luke’sUnitedMethodistChurchv.CNGDev.Co.,663S.E.2d639,647(W.Va.2008). 104 Eachleasedoes,however,carryanimpliedcovenantofreasonabledevelopment,abreachofwhichisgroundforapplyingtoacourtofequityforaforfeitureofthelease.Beforealessorisentitledtothatrelief,hemustshowthathehasmadedemandofthelesseetocomplywiththeimpliedcovenantandhasallowedareasonabletimeforsuchcompliance.Thisisnottosaythatthelessoristhearbiterofreasonabledevelopment.Whetherornotthelesseehasdevelopedthepropertyasthereasonablyprudentoperatorwouldisaquestiontobedeterminedbythecourtinlightofallsurroundingcircumstances.Olsonv.Schwartz,345N.W.2d33,40-41(N.D.1984).105 Sauderv.Mid-ContinentPetroleumCorp.,292U.S.272(1934).

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questionfordecision[was]whethertherespondentfailedtocomplywithanimpliedcovenanttodevelopthetractwithreasonablediligence.”106 Inthatcase,thedistrictcourthadconcludedthatsuchbreachhadoccurred,withadecreeofpartialcancellationentered,exceptingfromcancellation thatportionoftheleaseonwhichwellshadbeendrilledandwereproducing.107

Thecircuitcourtfoundnobreachandoverruledthedistrictcourt.108

In reviewing theapplicable law, theSupremeCourtquoted liberallyfrom Brewster v. Lanyon Zinc Co.,109 the landmarkdecisionon impliedcovenantsinoilandgasleases.ThecourtnotedtheBrewstercourt’sac-knowledgmentthatthestandardofthereasonableoperatormustbeappliedto the facts todeterminewhether the leasehasbeenoperatedwithdili-gence.110 “Whatever,inthecircumstances,wouldbereasonablyexpectedofoperatorsofordinaryprudence,havingregard to the interestsofbothlessorandlessee,iswhatisrequired.”111

Uponreviewofthepertinentfacts,thecourtagreedwiththedistrictcourt,findingabreach.Althoughitsreasoninginreachingtheremedyisnotdiscussed,thecourtnotedboththedistrictcourt’sdecreeofabsolute partial cancellation aswell as the dissenting appellate judge’s proposedremedyofconditionalpartialcancellation,statingsimplythat,astothelat-ter,“[w]eareoftheopinionthatsuchadecreewouldrecognizeandprotecttheequitiesofbothparties.”112InhisdissentinMid-Continent Petroleum Corp. v. Sauder,113 JudgeMcDermottthoughtfullyandplainlynotedthelogicbehindhissuggestedremedy:“Thedefendant,incommonfairness,oughttogivetheselessorsawellorgetoffandletsomeoneelsedrillit.”

Takingthis‘middleground’approachmakesthemostsense.Theper-tinent factsmustbe reviewed indetail inorder foracourt todeterminewhetherthesubjectleaseincludesanyimpliedcovenantsandifso,whetherit/theyhavebeenbreached. Ifabreachhasoccurred, thesamefactsare

106 Id. at 278.107 Id.at277-78.108 Id. at 278.109 Brewsterv.LanyonZincCo.,140F.801(8thCir.1905).110 Sauder,292U.S.275-280.111 Id.at280,quoting Brewster,140F.at814.112 Id. at 282.113 Mid-ContinentPetroleumCorp.v.Sauder,67F.2d9(10thCir.1933).

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criticaltoadeterminationofwhethermoneydamagescanmakethelesseewhole. If legal damages are inadequate, again, the unique andpertinentfactsofthecasethenbeforethecourtwilldrivethemostequitableremedy.

Casesseekingcancellationofaleasetypicallyariseinthesecondaryterm. In the standardscenario, the lease is“heldbyproduction”but thelesseeclaims thatproduction is inadequateor insufficient—moreacre-ageshouldbedrilled,ordifferentformationsshouldbeexplored,oroffsetwellsshouldbedrilledtoprotectthelessee’soilorgasfromproductiononneighboringtracts.Orthelessormayclaimthatfailuretodrilloffsetwellshasresultedindrainage.Therewillalmostalwaysbeacolorfulhistoryofpre-suitinteractionsbetweenthelesseeandlessorontheissue,andthosefactswillbekeyincraftingtheappropriateremedyifabreachisfound.

Becausetheremedyofabsolutecancellationissodrastic,ifthelessorisfightingtheclaim,therebymanifestingitsdesiretocontinueasapartytothelease,shouldnotthelessorbegivenanopportunitytotakereason-ablestepsto“putitsmoneywhereitsmouthis”andabatetheshortcomingsfoundbythecourt?ThiswasrecognizedbyJudgeMcDermottinhisdis-sent in Mid-Continent Petroleum Corp., whenheacknowledgedthat,“he[Defendant’s representative] isnotwilling to relinquish thishalfsection.Hefranklysaysthathewantstoholditbecausetheremaybeoilunderit.Ofcoursethisistrue,orhewouldnotgototheexpenseofdefendingthissuitunlesshethoughtenoughofthepossibilitiestowarranttheexpense.”114

Wouldthatremedynotbemoreequitabletobothpartiestothelease,sincethelesseewantsdevelopment,andthecurrentlessoristheproverbial‘birdinthehand?’

[7] — A Spectrum of Equitable Remedies.Asdiscussed,whenfashioning theappropriateremedyforbreachof

animpliedcovenantinanoilandgaslease,mostcourtstendtofollowthegeneralruleofissuinganequitableremedyonlywhenalegalonewillnotsuffice.Somecourtstendtoleanmoretowardforfeiturewhileotherstendtotaketheoppositeapproach,withmostfallingsomewhereinthemiddle.

In1966,theMississippiSupremeCourtcategorizedtheavailablerem-ediesasfollows:115

114 Id. at 16.115 SouthwestGasProducingCo.v.Seale,191So.2d115,122(Miss.1966).

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Variouscourtshaverecognizedthreeseparateremediesforbreachofthecovenantofreasonabledevelopment:(1)Outrightcancella-tion,exceptforasmallareasurroundingexisting,producingwells;(2)themoremoderateconditionaldecreeofcancellation,unlessaspecifiednumberofwellsaredrilledwithinafixedperiodoftime;and(3)damages.Wethinkthatdamagesaretheappropriaterem-edyintheinstantcase.ThisistheviewtakenbytheTexasCourts.Christe,Mitchell & Mitchell Co. v. Howell,359S.W.2d658(Tex.Civ.App.1962);5Williams&Meyers,OilandGasLaw,s834,at240-241(1964).TheTexasruleisinaccordwithwhatwethinkisthebetterauthority,unless theremedyofdamages iswholly in-adequate,and thatdoesnotappearhere.Further, it isconsistentwiththetraditionaldecisionsofthisCourtnotfavoringforfeitures.[Internalcitationsomitted.]Equityabhorsaforfeitureandisdis-posedtoseizeonslightcircumstancestoavoidone.Monsanto Co. v. Cochran,254Miss.399,180So.2d624(1965).Nearly20yearslater,theAlabamaSupremeCourtaddressedasamat-

teroffirstimpression“[t]heappropriateremedyforbreachoftheseimpliedcovenants[toreasonablydevelop,toprotectfromdrainage,toproduceandmarketminerals].”116Followinga slightlydifferent categorizationof thepotentialremediesthanhadbeenframedbytheMississippiCourtafewdecadesearlier,theyadoptedwhattheyviewedasthemajorityapproach:

Threeviewsexistthroughouttheoilandgasproducingjurisdic-tions.SeegenerallyR.Hemingway,Law of Oil & Gas §§ 8.10—8.11(1983).Aminorityofjurisdictionsholdthattheexclusiverem-edyforbreachofimpliedcovenantsisdamages.Seee.g., Geary v. Adams Oil & Gas Co.,31F.Supp.830(E.D.Ill.1940);Beer v. Griffith,61OhioSt.2d119,399N.E.2d1227(1980);McCutcheon v. Enon Oil & Gas Co.,102W.Va.345,135S.E.238(1926).Inthemajorityofjurisdictions,cancellationmaybesoughtasaremedyforbreachofimpliedcovenantsonlyuponashowingthatdam-agesarewholly inadequate.Seee.g., Southwest Gas Producing

116 Meaherv.GettyOilCo.,450So.2d443,447(1984).

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Co. v. Seale,191So.2d115(Miss.1966);W.T. Waggoner Estate v. Sigler Oil Co.,118Tex.509,19S.W.2d27(1929);Alford v. Dennis, 102Kan.403,170P.1005(1918).Finally,afewjurisdictionsallowcancellationasaremedywithoutfirstprovingtheinadequacyofdamages.Seee.g., Sapp v. Massey,358S.W.2d490(Ky.1962).

[8] — Notice and Demand.Referencetoconditionalcancellation,inthecontextofthischapterand

generally,meansthegivingofnoticeofallegedbreachtothelesseealongwithademandthatthebreachbecuredbythelessorpriortoinstitutionofanactionforbreach,orpriortoentryoftheequitableremedyofcancella-tion.TheEighthCircuitCourtofAppealsdescribedthisinthefollowingdiscussionfroma1979decisionconcerningadisputedNebraskalease.Ofnote,consistentwiththeobservationthatremediesarefact-drivenregard-lessofthejurisdiction,thecourtcitedprinciplesfromvariousjurisdictions,withoutdistinction:117

Anoilandgasleaseisarecognizedandprotectedpropertyinter-est.Acancellationofanoilandgasleaseeffectsaforfeitureofthatinterest.Thelawabhorsaforfeiture.George v. Jones, 168Neb.149,95N.W.2d609,616(1959).Therefore,anoilandgas leasewillnotbecancelledforbreachofanimpliedcovenantwithoutthelessorhavingfirstgiventhelesseenoticeofthebreachandde-mandingthatthetermsoftheimpliedcovenantbecompliedwithwithina reasonable time.Robinson v. Continental Oil Co.,255F.Supp.61,64(D.Kan.1966);Howerton v. Kansas Natural Gas Co.,81Kan.553,106P.47,51(1910),Rev’donothergrounds,82Kan.367,108P.813(1910);Sapp v. Massey,358S.W.2d490,492-93(Ky.1962);Cameron v. Lebow,338S.W.2d399,402(Ky.1960);Hermon Hanson Oil Syndicate v. Bentz,77N.D.20,40N.W.2d304,308-09(1949);Doss Oil Royalty Co. v. Texas Co.,192Okl.359,137P.2d934,938-39(1943);Hudspeth v. Schmelzer,182Okl.416,77P.2d1123,1125(1938).The rationale underlying the requirements of notice and demand is

clear.Alessee,eventhoughhemaybeinbreachoftheimpliedcovenant,

117 SuperiorOilCo.v.DevonCorp.,604F.2d1063,1070(8thCir.1979).

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shouldbeinformedofthatbreach,andshouldbegivenanopportunitytoredeemhimselfbycommencingfurtherdevelopmentwithinareasonabletime.The lessee is ineffectgivenachoiceofdevelopmentor forfeiture.Sucharuleisconsistentwithdueprocessandwiththelaw’sabhorrenceofforfeitures.Ittakesnothingawayfromthelessorbecauseheretainshisrighttobringanactionforforfeiture.

Arelatedconceptisthatofjudicialascertainmentclauses.

[9] — Judicial Ascertainment Clauses.Judicialascertainmentclausesaresometimes referred toas ‘right to

cure’clauses.Theymaybeincludedinaleaseasasafeguardagainstabso-lutecancellationinthefaceofabreachofanimpliedduty.Inessence,theclauses typicallyprovide that failureby the lessee toconductoperationsin compliancewith the leasewill notbegrounds for forfeitureunless ajudgeascertainsthatthelesseefailedtoconductoperationsincompliancewiththelease,wasgivenanopportunitybythecourttodoso,butfailedtocomply.

TheproprietyofjudicialascertainmentclauseswasrecentlyupheldbytheSecondCircuitAppellateCourtofLouisianainB.A. Kelly Land Co. v. Questar Exploration and Production Co.118However,otherjurisdictionshavestrickensuchleaseprovisionsasvoidasagainstpublicpolicy.119

[10] — Identification by Jurisdiction as to Favored Remedy for Breach of Implied Covenants.

Whileit is tempting(andgenerallypossible) todeterminewhetherastatefavorsaparticularremedyforbreachesofimpliedleasecovenants,inpractice,cautionshouldbeusedbeforeplacingtoomuchrelianceonsuchgeneralities.This isbecausethecircumstancesofeachimpliedcovenantbreachsituationaresodifferent,andtheseareremediesin equity.Incasesofequity,theremedyISresultoriented.

118 B.A.KellyLandCo.v.QuestarExplorationandProd.Co.,106So.3d181(La.Ct.App. 2012).119 E.g.,Wellmanv.EnergyRes.,Inc.,557S.E.2d54(W.Va.2001);ConnyFarmsLtd.v.BallRes.,Inc.,2011-Ohio-5472(OhioCt.App.7th2001).

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§ 7.05. Non-Payment of Delay Rentals and Shut-In-Royalties As Grounds for

Terminating Oil And Gas Leases in the Primary and Secondary Terms.

[1] — Introduction.Courts oftenmust determine if anoil andgas lease has terminated

duetofailuretopaydelayrentalsduringtheprimaryterm.Thecasesaredivided into twocategories: (1)“unless” leases,which terminate ifdrill-ingisnotcommencedwithinacertainperiodoftimeunless delayrentalpaymentsaremade;and(2)“or”leases,whichprovidethatthelesseemayproduceoilandgasfromthepropertyor paydelayrentalstothelessor.Im-portantly,leasescontainingan“unless”delayrentalclausegenerallyhavebeenheldtoterminateautomaticallyifthedelayrentalpaymentsarenotmade,whereasleasescontaining“or”delayrentalclausesarenotforfeitedunlessthelessortakessomeaffirmativesteptoenforcethefailuretopaydelayrentals.However, therearesomeexceptions to thesegeneral rules.Eachleasecategoryisdiscussedbelow,alongwithasamplingofdefensesraisedtocounterleaseterminationincertainjurisdictions.

[2] — Failure to Pay Delay Rentals in the Primary Term.[a] — Difference Between “Unless” and “Or” Delay Rental Clauses.

Delayrentalclausesapplytoterminatinganoilandgasleasepriortoexpirationoftheprimaryterm.120“Unless”and“or”delayrentalclausesaredistinguishedonanumberoflevels.First,theseclausesaffectwhetherthe lease terminates automatically.121 “In an ‘unless’ lease, if the lesseefailstobeginorcompletedrillingwithinthespecifiedtimetheleaseter-minatesunlessastipulatedrentalispaidtothelessor.”122However,“[i]n

120 McCulloughOil,Inc.v.Rezek,346S.E.2d788,796n.6(W.Va.1986)(“thedistinctionsbetween‘unless’and‘or’leasesrelateonlytothemannerinwhichtheleaseisterminatedbeforetheexpirationoftheprimaryterm.”).121 See, e.g.,Salingv.Flesch,277P.612,614(Mont.1929)(an“unless”leaseautomaticallyexpiresifthelesseedefaultsinpayingdelayrentals);Duerv.Hoover&BrackenEnergies,Inc.,753P.2d395,398(Okla.Civ.App.1986)(“InOklahomaitissettledthat,absentthirdpartyerror,aleasewillautomaticallyterminatebyitsowntermsduetolessee’sfailuretopaydelayrentalpaymentsinatimelymannerattheaddressdesignatedinthelease.”).122 Hoodv.Adams,614S.W.2d574,577(Tenn.Ct.App.1981).

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an‘or’lease,thelesseemustdrillorpayrent.Thereisnoprovisionforanautomatic termination.”123Nonpaymentofdelayrentalswillautomaticallyterminatean“unless”lease,asopposedtoviolatingacovenantandallow-ingforcancellationofan“or”lease.124

Second,thelessee’sliabilityfornonpaymentofrentalsdiffersbetweeneachtypeofdelayrentalclause.Whereawellisnotdrilledwithinthepre-scribedtime,alesseemaybeheldliableforrentalsunderan“or”lease,butnotunderan“unless”lease.125

Third, “unless” and “or” delay rental clauses are contrasted by themannerinwhichtheleasemaybesurrenderedpursuanttosuchclauses:

Inthecaseofthe“or”lease,thelesseesurrendersbythepaymentoftheconsideration,usuallynominal,forhisprivilegeofsurrender,andbytheexecutionanddeliveryofarelease,anduponfailuresotosurrenderbythisexclusivemethodthelesseebecomesboundforthepaymentoftherentalforanotherterm.Inordertoavoidthisadditional labor in terminating the lease, the “unless” leasewasprovided,whereinthelesseemaysurrendermerelybyhisfailureorrefusaltopaytherental.Theleasetherebyautomaticallytermi-nates.Inthecaseofthe“or”lease,thelesseeabandonshisleasebytheformalactandinthemannerdescribedinthelease;andinthe“unless”lease,thelesseeabandonshisleasemerelybyfailingtopaytherental,bythepaymentofwhichhecouldextendthetimefordevelopmentanotherterm.Resultingfromthesedifferentmethodsofsurrender,thelessorcannotholdthelesseeforrentalindefaultinthecaseofan“unless”lease,butcanholdthelesseeforrentalindefaultinthecaseofan“or”lease.126

Fourth,theleasestreatdifferentlyalessee’sobligationtotakecertainactions.127“Inan‘or’lease,thelesseecovenantstodosomealternativeact,

123 Id.124 Ricev.Hillenburg,766P.2d182,paragraph4ofsyllabus(Kan.App.1988).125 Fordv.KentuckyW.Va.GasCo.,185S.W.2d953,954,(Ky.App.1945).126 GarfieldOilCo.v.Champlin,189P.514,518-19(Okla.1920).127 Ricev.Hillenburg,766P.2d182,paragraph1ofsyllabus(Kan.App.1988)(“Underthenormal‘unless’drilling/delayrentalclauseinanoilandgaslease,thereisnolegalobligationenforceablebythelessoragainstthelesseeforthepaymentofthedelayrental;but,ifthepaymentisnotproperlymadewhendue,theleaseterminatesautomatically.”).

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usuallytodrillawellortopayperiodicrentals,tomaintaintheleasedur-ingitsprimaryterm.Simplyput,thelesseemust‘drillorpay’.Conversely,thelesseeinan‘unless’leasedoesnotcovenanttodrillawellorpayrent-als.However,ifthelesseedoesneitherwithinthetimeintervalsspecifiedtherein,theleaseautomaticallyexpiresbyitsownterms.Intypicalform,‘if’nowellisdrilled,theleaseterminates‘unless’rentalsarepaid.”128

Finally,themannerinwhichaleasemayterminatediffersasbetweenthesetwotypesofdelayrentalclauses.Underan“or”delayrentalclause,theleasemayterminate“bymutualconsentofthepartiesduringthepri-maryterm,failuretopaydelayrentalsoranactionbythelessortodeclaretheleaseforfeited.”129Underan“unless”delayrentalclause,“thelesseehastheoptiontoproduce,paydelayrentals,ordoneither,allwithoutincur-ringobligation.Butfailuretoactisautomaticterminationinfavorofthelessor.”130

[b] — “Unless” Delay Rental Clauses.Thepurposeofadelayrentalclauseistopromotedevelopmentofthe

lessor’sproperty,or,ifdevelopmentdoesnotoccur,tocompensatetheles-sor for the delay.131 “Unless” delay rental clauses are strictly construedagainst the lessee.132Under an “unless” delay rental clause, the oil andgasleasewillterminateautomaticallyifdrillingisnotcommencedwithinaspecified time,unless the lesseepaysdelayrentals.133Forexample, in

128 Warnerv.Haught,Inc.,329S.E.2d88,(W.Va.1985)(footnoteomitted).129 Carrollv.Eaton,541P.2d64,65-66,168(Mont.1975)(mininglease)(citationsomitted).130 Id.131 OklahomaNaturalGasCo.v.Long,406P.2d499,paragraph1ofsyllabus(Okla.1965)(“Thepurposeofthe‘unlessclause’ofanoilandgasleaseistoinsuretothelessoreitherthatthelessor’spropertywillbedevelopedforoilorgasorthatinlieuthereofthelessorshallreceiveanagreedamountdesignated‘delayrental.’”)132 ValentineOilCo.v.Powers,59N.W.2d150,paragraph12ofsyllabus(Neb.1953)(“Anoilandgaslease,providingthat,unlessawelliscommencedbyacertaintime,orunlessthelesseetimelypaysastatedrentaltorenewthelease,itshallterminate,confersanoptionalrightuponthelesseeandshouldbestrictlyconstruedinfavorofthelessorandagainstthelessee.”).133 However,notalljurisdictionsconcludethat“unless”delayrentalclauseswillresultinautomatic termination. See, e.g.,Engelv.E.OilCo.,130S.E.491,paragraph1ofsyllabus

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NorthDakota,theleaseterminates,ipso facto,withoutnoticeordemandonthepartofthelessor.134The“unless”delayrentalclauseisviewedasaspeciallimitationresultinginautomatictermination,asopposedtoacondi-tionsubsequentwhichcouldcompelforfeiture.135Whenan“unless”delayrentalclauseispresentinthelease,automaticterminationresultswhenthelesseefailstocommencedrilling,and,inaddition,failstopaytherequireddelayrental,intheprimaryterm.136

(W.Va.1925)(“Equitywillnotenforcetheforfeitureofavestedestateforafailuretopayrent.Thelessormustresorttohislegalremedy.”);ReserveGasCo.v.CarbonBlackMfg.Co.,79S.E.1002,paragraph3ofsyllabus(W.Va.1913)(“Anoilandgasleasebindingthelesseetodrillawellontheleasedpremiseswithinacertainperiod,or,inlieuthereof,makeperiodicalpaymentsofrentalordelaymoney,andcontainingnoclauseofforfeiture,isnotforfeitablemerelybynonpaymentoftherental.Itcanbeterminatedonlybysurrender,abandonment,orexpirationoftheterm.”);CastleBrookCarbonBlackCo.v.Ferrell,85S.E.544,paragraph2ofsyllabus(W.Va.1915)(“Aclauseinanoilandgaslease,stipulating‘thatthefailuretocompleteawelluponthesaidpremiseswithinthetimehereinspecifiedortopaytherentalsatthetimeandinthemannerhereinprovidedshallipsofactoworkaforfeitureofthisleasewithoutnotice,’heldtorelateonlytorentalsprovidedtobepaidfordelayindrilling,andnottorentalsorroyaltiestobepaidforaproducinggaswell.”).134 Schwartzenbergerv.HuntTrustEstate, 244N.W.2d711,paragraph3of syllabus(N.D.1976)(“Thegenerallyacceptedconstructionoftheprovisionsfortheterminationofan‘unless’leaseisthatthe‘unless’clausedoesnotstateaconditionsubsequentuponwhichtheleasemaybeforfeitedbutstatesacommon-laworspeciallimitationuponwhichtheinterestofthelesseeterminatesimmediately.Uponfailureofthelesseetocommencedrillingoperationswithinthelimitedtime,suchleaseterminatesipsofactowithoutanynoticeordemanduponthepartofthelessorunlessdelayrentalsarepaidasprovidedbythelease.”);Schankv.NorthAm.Royalties,Inc.,201N.W.2d419,paragraph1ofsyllabus(N.D.1972).See alsoEllisonv.SkellyOilCo.,244P.2d832,206Okla.496,paragraph1ofsyllabus(Okla.1951)(“Whenthelesseefailstocommencedrillingoperationsormakepaymentofrentalinlieuofsaiddrillingonorbeforethedatespecifiedinthelease,thelease,ipsofacto,asperitsexpressterms,comestoanend….”).135 Schwartzenberger,244N.W.2dat711,paragraph3ofsyllabus;Schank,201N.W.2d419,paragraph1ofsyllabus.136 Griggsv.ParsonsLeasing,Inc.,776So.2d766,769(Ala.2000)(failuretocommencedrillingor tender timelypaymentofdelay rentalsprior to expirationofprimary termresultedinautomaticterminationofthelease);Vaughanv.Doss,245S.W.2d826,(Ark.1952)(“unless”lease)(“theholding,thattheleaseterminateduponfailureofthelesseetomakepromptpaymentofdelayrental,hasbecomearuleofproperty in thisstate”);AtlanticRefiningCo.v.ShellOilCo.,46So.2d907,911,(La.1950)(“unless”lease)(leaseterminatedbyitsowntermswherelesseefailedtocommenceoperationswithinprimary

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However,theruleofautomaticterminationisnotalwaysenforcedasanabsolutebartocontinuationoftheoilandgaslease.Forexample,someTexascourtshaverelaxedtheotherwisestrictruleoftermination,whereequitable considerationswould render itmanifestlyunjust todeclare theleaseterminated.137

An“unless”clausedoesnotobligatethelesseetodoanyact.138Rather,the lesseehas the right, option, orprivilege to allow the lease to termi-nate.139Therefore,asoneOklahomacourtput it, thelessee“musteitherbuymoretime(throughpaymentofsomethinglikeadelayrental)orlosetheleasewhenthetermhasexpired.”140

Thelesseedoesnotincuranobligationifitdoesnotpaydelayrentals.Rather,theleasejustterminatesbyitsownterms.Inaddition,thelessee’sgoodfaithintentiontopaydelayrentalswillnotrelievehimofconsequenc-esoffailuretopay(particularlywherethelessorisnotatfaultwithrespecttocausingthefailuretopaythedelayrentals).141

termandextendedperiods,andfailedtopaydelayrentals);Doornbosv.Warwick,177P.527(Kan.1919)(wherealesseefailstopayrentorcommencedrillingbyacertaindate,theleaseisnullandvoidandsubjecttoforfeiture);SuperiorOilCo.v.Jackson,250P.2d23,syllabus(Okla.1952)(“Whereoilandgasleaseprovidesthatitshallterminateattheendofoneyearifnowelliscommencedwithinthattimeunlessthelesseeshallpayortendertolessor,ortohiscreditindepositorybanknamed,acertainsumasrentaltocoverprivilegeofdeferringcommencementofwellforadditionalyear,failuretocommencewellorpayrentalwithintimespecifiedterminateslease.***”).137 HumbleOil&RefiningCo.v.Harrison,205S.W.2d355,360-61(Tex.1947)(courtshavevariedhowtheruleisapplied(i.e.,strictcomplianceversusarelaxedapproach));Hamiltonv.Baker,214S.W.2d460,461(Tex.1948)(notingthatthestrictruleofleaseterminationhasbeenrelaxedincaseswhich“mainlyinvolvesituationswhereequitableconsiderationswouldrenderitmanifestlyunjusttodeclaretheleaseatanendinconsequenceofafailuretomaketimelypaymentofdelayrentalstechnicallyandexactlyasstipulatedintheleasecontract.”).138 Serhienkov.Kiker,392N.W.2d808,811-12(N.D.1986)(“An‘unless’clausedoesnotobligatethelesseetodoanactbutprovidesthattheleaseshallterminateunlessthelesseedoessomeact.”).139 NewEnglandOil&PipeLineCo.v.Rogers,7P.2d638(Okla.1931)paragraph2ofsyllabus(“lessee“isdeemedtohaveexercisedtheprivilegegivenhimtoallowtheleasetoterminatebynotcommencingawellorpayingtherentalwithinthetimespecified.”).140 Dannev.TexacoExplorationandProd.Inc.,883P.2d210,214(Okla.App.Div.21994).141 Ellisonv.SkellyOilCo.,244P.2d832(Okla.1951)paragraph1ofsyllabus(“...thegoodfaithintentionanddesireofthelesseetomaketimelypaymentofdelayrentalswill

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[c] — “Or” Delay Rental Clauses.Bycontrast,an“or”delayrentalclause permitsthelesseetoproduce

oilandgasfromtheproperty,orpaydelayrentals.Paymentofdelayrentalsisnotnecessarytokeeptheoilandgasleasealive.142Similarly,failuretopaydelayrentalsdoesnotresultinautomatictermination.143Ifthedelayrentalsarenotpaid, thelesseemaybeheldliablefor theunpaidrentals;alternatively,thelessormayseektohavetheleaseforfeited.144

[d] — Defenses to Lease Termination Due to Failure to Pay Delay Rentals.

Courtsinvariousjurisdictionsrecognizeavarietyofdefensestotermi-natingaleaseforfailuretopaydelayrentals.Thesedefensesareexceptionstootherwisestrictadherencetoleasetermination.

notrelievethelesseefromtheconsequenceofhisfailuretopaythedelayrentalonorbeforethetimespecifiedinthelease,whenthelessorisnotatfaultandthefaultischargeabletothelessee.”).142 Ricev.Hillenburg,766P.2d182(Kan.App.1988)(nonpaymentofdelayrentalswillautomaticallyterminatean“unless”lease,asopposedtoviolatingacovenantandallowingforcancellationofan“or”lease);HealdtonOil&GasCo.v.Smith,195P.756(Okla.1921)(“Underanoilandgasleaseknownasan‘orlease,’thepaymentofrentalsbythelesseeaccordingtothetermsoftheleaseisnotnecessarytokeepitalivefromtimetotime,nordoesfailuretopayautomaticallyterminatethecontract.Hemay,however,terminatetheleaseatanytimebyexercisingtherightcontainedinthesurrenderclauseandpayingtherentalsdue,andwhereitisprovidedintheleasethatrentalsshallbepaidinadvance,therentalsbecomedueattheexpirationoftheperiodwithinwhichawellshallbecompleted,andasurrenderthereafterwillnotrelievethelesseefrompaymentofsaidrentalsthendue.”).143 Ballv.Ball,137Misc.693,244N.Y.S.300(N.Y.Supr.Ct.1930)(underan“or”lease“thelesseeagreestodevelop(intheinstantcase,awell)orpayastipulatedrental...[and]failuretodevelopdoesnotauthorizetermination.”).144 Carrollv.Eaton,541P.2d64(Mont.1975)(mininglease)(“Hadthelesseedefaultedinthese[delayrental]payments,thelessorswouldcertainlyhavehadtheoptiontoinsistuponforfeitureorwaiveitandsuefortherentalsdue.”);HealdtonOil&GasCo.v.Smith,195P.756,756(Okla.1921)(“[W]henthelesseemakesdefaultinpaymentofrentalsthelessormaywaivetheforfeitureclauseandmaysueandrecoverrentalsaccordingtothetermsofthelease.”).

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[i] — Lack of Forfeiture Clause in the Oil and Gas Lease.

APennsylvaniacourtheldthatwherethereisnoprovisionforautomat-ictermination,orexpressreservationofforfeiture,intheoilandgaslease,thelessorhasanactionatlawfornon-paymentofrentals,orrescissiononlyuponclearproofofabandonment.145

[ii] — Late Acceptance of Delay Rentals.AnAlabamacourtheldthatlateacceptanceofdelayrentalsbytheles-

sorcanrevivetheoilandgasleasethatterminatedduetonon-payment.146

[iii] — Late Delivery of Delay Rentals Attributable to the Mail Service.

Failureofthemailservicetotimelydeliveradelayrentalcheckpriortothepaymentdeadlinemayserveasgroundstoavoidleasetermination.Forexample,aKansascourtfoundthatitwouldbe“inequitableandunjusttocancelthelease”where,amongothercircumstances,thelesseesentthedelayrentalpaymentbyregisteredletterfivedaysbeforethedeadline,andthemailservicedelayeddeliverytothelessor.147 Similarly,anotherKan-sascaseinvolvedthefailureofthemailservicetodeliveranannualdelayrentalcheck.Thelesseesentanotherchecktwomonthslateruponlearningofthemishap.Indeterminingthatleaseterminationwasnotwarranted,thecourtnotedthatthelesseehadexpendedconsiderablemoniesindevelopingneighboringleasedtracts.148

145 Girolamiv.PeoplesNaturalGasCo.,76A.2d375,377(Pa.1950)(“Theleaseinsuitcontainsnoprovisionforitsautomaticterminationintheeventofthefailureofthelesseetodrillortopaythedelayrental,noranyexpressreservationofthepowerofforfeiture.Itthereforeleavesthelessorstoanactionatlawfortherentalsandissubjecttorescissiononlyuponclearproofofitsabandonmentbythelessee[.]”)(citationsomitted).146 Griggsv.ParsonsLeasing,Inc.,776So.2d766,770n.2(“TerminationoftheleasewouldhavebeenavoidediftheDepartmenthadacceptedthedelinquentdelayrental;lateacceptanceoperatestorevivealeasepreviouslyterminatedbynonpayment.”).147 Kaysv.Little,175P.149(Kan.1918)(lesseesentthedelayrentalpaymentbyregisteredletterfivedaysbeforedeadline,butdelayinmailservice,andothercircumstances,madeit“inequitableandunjusttocancelthelease.”).148 Youngv.Moncrief,232P.871(Kan.1925)(citingtoKays)175P.at149.

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[iv] — Lessor Has Waived a Possible Default by the Lessee.

AKansascourtheldthatthelessor’sfailuretoassertrightofforfeiturepromptlyandunequivocallyresultedinawaiver,suchthatpaymentofrentatanyreasonabletimeavoidsforfeiture.149InanArkansascase,thelessorreceivedadelayrentalcheckfromthelessee,andheldontoit.Thelessorwastryingtodecidewhatwasmoreprofitable:todeclare,ornottodeclare,aforfeiture.Thecourtheldthatthelessorwaivedforfeiturebecauseheheldthelessee’scheckforanunreasonabletime.150

[v] — Unilateral or Mutual Mistake.ALouisianacourtdiscussedequitableconsiderationsthatcouldavoid

automaticforfeitureoftheoilandgaslease,specifically,mutualmistake,orapardonableunilateralmistake.Thecourtstatedthatwhenamistakeisevident,thelessorisrequiredtopromptlynotifythelesseeandgivehimanopportunitytocurebeforedemandingforfeiturefornon-payment:“Insuchcasesequityrequiresthatwhenthelessorlearnsofthemistakeheshouldpromptlyinformthelesseeofthemistakeandgivethelatteranopportunitytocorrectitimmediately,beforehe,thelessor,candemandaforfeiturefornonpaymentoftherentalwithinthetimestipulated.”151

149 Bowenv.Rugh,160P.1135(Kan.1916)(“unless”delayrentalclause)(“Held,thatthefailureoflessortoassertherrightofforfeiturepromptlyandunequivocallyonthefirstdefaultwaivedthatright,andthefirstleasewasnotvoidforuncertaintyastothetimewhenrentshouldbepaidifthewellwasnotcommencedinninetydays,andpaymentofrentatanyreasonabletimeondemandwouldbesufficienttoavoidtheforfeiture,followingSmithv.Steele,150P.519.”).150 Cordellv.Enis,257S.W.375(Ark.1924)(“Equityabhorsforfeituresandwillseizeuponslightcircumstancesindicatingawaiver,toavoidorpreventthem”;lessorreceivedandheldlessee’sdelayrentalcheckforaboutaweekbeforereturningit,andindoingsowaivedforfeiturebecause“[t]heywerenotwarranted inholding thecheck foranunreasonabletimesothattheymightspeculateuponwhetheritwouldbemoreprofitabletodeclareornotdeclareaforfeitureofthelease.Theretentionofthecheckforthisunreasonablelengthoftimeconstitutedawaiveroftheforfeiture.”).151 Jonesv.SouthernNaturalGasCo.,36So.2d34,38 (La.1948) (“There is ampleauthority for theproposition that considerationsofequitymayprevent a forfeitureofamineralleasewherethefailureofthelesseetopaythefullamountofthedelayrentals,orhisfailuretopayitwithinthetimestipulated,istheresultofamistakeonhispart,andwhere

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[vi] — Attack on Lessee’s Title.CourtsinKansas152andOklahoma153 heldthatalessor’sattackona

lessee’stitlewillrelievethelesseeofthedutytoproceedwithdrillingorpaymentofdelayrentalsduringthecontinuationofthatattack.“Iftheleaseissubsequentlyfoundvalidbyacourtoflaw,thelesseewillbepermittedtomakethepaymentswithinareasonabletimethereafter.”154

[3] — Failure to Pay Shut-In Royalties in the Secondary Term.

Unlikedelayrentals(whichareanalternativetocommencingtodrillawell),shut-inroyaltiesaredependentuponthewellactuallybeingshut-inbutotherwisecapableofproduction.Courtsinmanystatesviewthefail-uretopayshut-inroyaltiesascauseforautomaticterminationofthelease.Courts in somestateshaveheld that the lessee isobligated todiligentlymarkettheoilorgasnotwithstandingthepaymentofshut-inroyalties.Ex-ceptionsanddefensescanberaisedtocounterleasetermination.155

[a] — Prerequisites for a Well to Be Deemed Shut-In. Courtsinvariousjurisdictionshaveheldthatinorderforashut-inroy-

altyclausetobeineffect,thewellmusthavecertaincharacteristics,such

thecircumstancesaresuchthatthemistakeisapardonableone,andparticularlywherethemistakeisamutualmistakeonthepartofboththelessorandthelessee.”).152 Thurnerv.Kaufman,699P.2d435,237(Kan.1985)(“Wherealesseeunderan‘unless’oilandgasleaseisready,able,andwillingeithertodevelopthepremisesortopayrentals,anattackuponthelessee’stitlebythelessorwillrelievethelesseeofthedutyeithertoproceedwithdrillingoperationsorpaythedelayrentalspecifiedintheleaseduringthecontinuanceofthechallengetohistitle.”);Ricev.Hillenburg,766P.2d182(Kan.App.1988)(same).153 Hudspethv.Schmelzer,77P.2d1123(Okla.1938)(“Wherethelesseeofanoilandgasminingleaseisready,willing,andabletodevelopthepremisesandproceedwithduediligenceasrequiredbyimpliedcovenantsinthelease,anattackuponhistitlebythelessorwillrelievehimofthedutytofurtherproceedwithdrillingoperationsortopaythedelayrentalsspecifiedintheleaseduringthecontinuanceofsuchattack.”).154 Thurner,699P.2d435,paragraph4ofsyllabus.155 Foranoverviewofleaseterminationissuesinvolvingshut-inprovisions,seeR.NealPierce,KaterinaE.MilenkovskiandRyanS.Bundy,“TheQuickandtheDead:CessationofProductionandShut-insDuringtheSecondaryTermofanOilandGasLease,”88N.D.L. Rev. 728 (2012).

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ashavingbeenphysicallycompleted,156beingactuallyshut-in,157andbe-ingcapableofproducinginpayingquantities.158“Regardlessofwhetheraclause thatprovides forshut-in royaltyexpresslyprovides,awellmustbecapableofproducinginpayingquantitiesatthetimeitisshutin,ortheshut-inroyaltyclausewillnotextendthetermofthelease.”159 Therequire-ment that the shut-in royalty clause is contingent upon thewell actuallybeingshut-inisimportant,giventhenatureofshut-inwellsvis-à-visactualproduction.Shut-inroyaltiesareuniqueinthattheyrepresentconstructiveproduction,beyondtheprimaryterm,suchthatawellmaybeconsideredtobeproducingevenwhenthereisnomarketfortheproduct.160Courtsalso

156 Levinv.MawOil&GasLLC,234P.3d805,paragraph4ofsyllabus(Kan.2010)(“Generally,tobeshut-in,awellmustbephysicallycompletedandcapableofproducinginpayingquantities,evenifithasnotactuallyproducedinpayingquantitiesinthepast.”).157 Dotyv.KeyOil,Inc.,404N.E.2d346,(Ill.App.1980)(“Theinstantshut-inclauserequiredthatawellcapableofproducinggasinfactbeshut-inasaprerequisitetoextensionoftheleaseunderthetermsofthatclause.BecauseKeyOilfailedtoshut-inthewellpriortotheexpirationoftheleaseunderitsotherprovisions,theleaseterminated.”).158 MaralexRes.,Inc.v.Gilbreath,76P.3d626(N.M.2003)(wellmustbecapableofproductioninorderthatleasecanbepreservedbyshut-inroyalties);Fisherv.GracePetroleumCorp.,830P.2d1380(Okla.App.1991)(preservationofleasebyshut-inpaymentsrequireswell tobe capableof producing inpayingquantities);HydrocarbonMgmt. v.TrackerExploration,Inc.,861S.W.2d427(Tex.App.1993)(preservationofleasebyshut-inpaymentsrequireswelltobecapableofproducinginpayingquantitiesattimeofshut-in).159 VorttExplorationCo.v.EOGRes., Inc.,11-07-00159-CV,2009Tex.App.LEXIS4113,at*14(Tex.Ct.App.2009)(“Regardlessofwhetheraclausethatprovidesforshut-inroyaltyexpresslyprovides,awellmustbecapableofproducinginpayingquantitiesatthetimeitisshutin,ortheshut-inroyaltyclausewillnotextendthetermofthelease.”).160 Robbinsv.ChevronU.S.A.,Inc.,785P.2d1010,paragraph5ofsyllabus(Kan.1990)(“Ashut-in royalty clause in anoil andgas lease enables the lessee,under appropriatecircumstances,tokeepanonproducingleaseinforcebythepaymentofshut-inroyalties.Suchaclausebyagreementofthepartiescreatesconstructiveproduction.”);Welschv.TrivestcoEnergyCo.,221P.3d609(Kan.Ct.App.2009)(asaresultofconstructiveproduction,“the[shut-inroyalty]clausecanmodifyandbecomeanintegralpartofthehabendumclause,orextensionclause,ofthelease.”);Davisv.Laster,138So.2d558,565(La.1962)(“Theshut-inclauseisspecificallydesignedtoenablethelesseestoprotecttheirinvestmentinashut-inwellbeyondtheprimaryterm—for,attheexpirationoftheprimaryterm,theycannolongerpaydelayrentalstomaintaintheleaseandtheycannotproducethegasfromthewelltheyhavediscoveredwherenomarketisavailable.Therefore,ifitwerenotforthe

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emphasizethatpaymentofshut-inroyaltiesdoesnotexcusethelesseeofitsobligationtoexercisereasonablediligencetomarkettheproduct.161

[b] — Consequences of Failure to Pay Shut-In Royalties.

Somecourtshaveheldthatanoilandgasleasewillterminateauto-matically162wheretheshut-inroyaltiesarenotmadeinatimelymanner,163

shut-inclause,andtheconstructiveproductionresultingfromitsapplication,theleasewouldbeforfeitedforexpirationofitstermattheendoftheprimaryterm.”);W.BayExplorationCo.v.AmocoProd.Co.,384N.W.2d407(Mich.Ct.App.1986),vacatedandremandedonothergroundsbyAmocoProd.Co.v.Ct.App.,389N.W.2d865(Mich.1986)(constructiveproductionrequiresthatshut-inpaymentbemadeinatimelymannerinaccordancewithleaseprovisions);Mayersv.Sanchez-O’BrienMineralsCorp.,670S.W.2d704(Tex.Ct.App.1984)(shut-inroyaltiesviewedasconstructiveproduction).161 Davisv.Cramer,837P.2d218,223(Colo.App.1992)(“Inthissituation,ashut-inroyaltyclausecanbeinsertedtoprovideanadditionalspeciallimitation,whichrequirespaymentoftheshut-inroyaltyifgasisnotmarketed.Itmayalsobeinsertedtopreventforfeitureforfailureofthelesseetoexercisediligenceinmarketing,mayextendthereasonabletimewithinwhichthelesseeisrequiredtomarkettheproduct,ormayremovedoubtregardingthetimewithinwhichmarketingmustbeaccomplished,oritmayservetocompensatethelessorfordelaybypaymentoftheroyalty....Constructionoftheshut-inroyaltyclausemayaffecttheremedytowhichthelessorisentitledandmayalsoremovethequestionofdiligenceinseekingamarketforthepayment.”);Robbins,785P.2dat1010,paragraph6ofsyllabus(“Thefactaleaseisheldbypaymentofshut-inroyaltiesdoesnotexcusethelesseefromitsdutytodiligentlysearchforamarketandreasonablydeveloptheleasehold.”);Sandtana,Inc.v.WallinRanchCo.,80P.3d1224(Mont.2003)(shut-inroyaltiescanpreservetheleasewherethewelliscompletedandcapableofproducingandthelesseemakesdiligenteffortstomarket);BerryEnergyConsultantsandManagers,Inc.v.Bennett,331S.E.2d823,paragraph2ofsyllabus(W.Va.1985)(“Where,however,alessorandalesseehaveenteredintoaleaseforthepurposeof‘exploringandoperatingfor’and‘producingandmarketing’oilandgas,andawellhasbeendrilledbythelesseeandgasdiscovered,thepaymentortenderbythelesseeofdelayrentalfortheleasedpremisesdoesnotrelievethelesseefromanimpliedobligationtoexercisereasonablediligenceinmarketinggasfromtheleasedpremises.”).162 See, e.g.,LoneStarOil&Gas,Inc.v.Howard,No.E2009-0428-COA-R3-CV,2010Tenn.App.LEXIS111 (Tenn.Ct.App.,Feb.12,2010) (failure topay shut-in royaltiesresultsinautomaticleasetermination);Lamczykv.Allen,134N.E.2d753(Ill.1956)(leaseterminatesforfailuretopayshut-inroyalties,notwithstandingseparateprovisionallowingpreservationofleaseforwantofmarketforgas).163 W.BayExplorationCo.,384N.W.2d407(Mich.Ct.App.1986),vacatedandremandedonothergroundsbyAmocoProd.Co.,389N.W.2d865 (Mich.1986) (noconstructive

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oraremadeaftertheleasehadterminated,164oraremadeonlysporadi-cally,165 oraremadebelatedlytotrytomakeupformissedshut-inpay-ments.166AsoneTexascourtnoted:“Becausepaymentofashut-inroyaltyisasubstituteforproductionwhichkeepstheleaseineffect,failuretomakeatimelyshut-inpaymentistheequivalentofcessationofproduction,andthe lease automatically terminates. The rule is generally applied rigidlyagainstthelesseebecausetimeisoftheessenceinanoilandgaslease.”167

However,othercourtshaveheldthatanoilandgasleaseisnottermi-natedautomaticallybyfailuretopayshut-in-royalties.AnOklahomacourtstated that “shut-ingasprovisionsarenot tobeconstruedas limitationsorconditionswhichwouldaffect terminationoftheleases.”168InTexas,ashut-inroyaltyclausecreatesacovenant“enforcedbyasuitformoneydamages.”169

productionwherelesseefailedtomaketimelyshut-inpayments,therebyresultinginleasetermination);P.M.Drilling,Inc.v.Groce,792S.W.2d717,723(Tenn.App.1990)(whereactualproductionceasedduetolackofmarketforgas,leaseexpiredbecauselesseefailedtomakeatimelyshut-inroyaltypayment);GulfOilCorp.v.Reid,337S.W.2d267(Tex.1960)(failuretomakeshut-inpaymentsonorbeforedatewelliscapped,resultsinautomaticleasetermination);FainFamilyFirstLtd.P’ship.v.EOGRes.,Inc.,02-12-00081-CV,2013Tex.App.LEXIS4888,at*12(Tex.App.2dDist.Apr.18,2013)(“Thus,whentheshut-inroyaltyclausecouplesanoptionalpaymentwithaprovisionstatingthat‘itwillbeconsideredthatgasisbeingproduced’ifthepaymentismade,thelesseemustmaketimelypaymentortheleasewillterminate.”).164 L&LEnergyCo.v.ChesapeakeExploration,L.L.C.,379S.W.3d42(Ark.Ct.App.2010)(shut-inpaymentsdidnotpreserveleasewherethepaymentsweremadeafterleasehadterminated).165 PlymouthFertilizerCo. v.Balmer, 488N.E.2d1129 (Ind.Ct.App. 1986) (leaseterminatedwherelesseemadeonlysporadicshut-inpayments).166 Moorev.Adams,5thDist.App.No.2007AP090066,2008-Ohio-5953(OhioCt.App.2008)(leaseterminationwherelesseebelatedlytriedtomakeupmissedshut-inroyaltypayments).167 AmberOil&GasCo.v.Bratton,711S.W.2d741,743(Tex.Ct.App.1986)(citationomitted).168 Gardv.Keiser,582P.2d1311,1314-15(Okla.1978).169 Blackmonv.XTOEnergy,276S.W.3d600,607 (Tex.Ct.App.2008) (“Here, theconstructiveproductiondefinedbythehabendumclauseistheexistenceofawellonthepremisescapableofproductioninpayingquantities.…Theprovisionforpaymentofshut-inroyaltiesisacovenantbythelesseewhichmaybeenforcedbyasuitformoneydamages.

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Eveninstatesinwhichfailuretopayshut-inroyaltiesdoesnotresultinautomaticleasetermination,thelesseestillmustcomplywithitsotherleaseobligations.Forexample,aColoradocourtstatedthateventhoughfailuretopaydoesnotresultintermination,thelesseehasadutytofindamarketandoperateinareasonablyprudentmanner.170AnOklahomacourtstatedthatwhereasthefailuretopayshut-inroyaltieswillnotterminatealease,thefailuretocomplywiththeimpliedcovenanttomarkettheproductwill.171

[c] — Defenses to Lease Termination Due to Failure to Pay Shut-In Royalties.

Courtsinvariousjurisdictionsrecognizeavarietyofdefensestoter-minatinga leasefor failure topayshut-inroyalties.Thesearesimilar todefensesthatmayavoidleaseterminationforfailuretopaydelayrentalsintheprimaryterm.

[i] — Lack of Forfeiture Clause in the Oil and Gas Lease.

InanOklahomacase,thecourtheldthattheoilandgasleasedidnotterminate automaticallywhere the lessee tendered shut-in royalties fouryearsafterthewellwasshut-in.Thecourtnotedthattherewasnoprovisionin the leaseforforfeituredue tonon-payment.Therefore, the lessormayobtainreliefbyactiononthecontract.172

...Accordingly,theleasedidnotterminatebecauseofanyfailureonthepartofXTO’spredecessor-in-interesttomakeshut-inroyaltypayments.”).170 Davisv.Cramer,808P.2d358(Colo.1991)(failuretopayshut-inroyaltiesdidnotterminatelease;however,lesseehasadutytofindamarketandoperateinareasonablyprudentmanner).171 Packv.SantaFeMinerals,869P.2d323,330(Okla.1994)(“[T]hefailuretopayshut-inroyaltiesinandofitselfdoesnotoperatetocauseaterminationofthelease.Rather,itisthefailuretocomplywiththeimpliedcovenanttomarketwhichresultsinleasecancellation”).SeealsoGardv.Keiser,582P.2d1311,1314-15(Okla.1978)(“marketingwasnotnecessarytoextendtheeffectivenessoftheoilandgaslease.However,…inthiseventlesseemustshowadiligenteffortwasmadetomarketproductioninordertoextendthelease....[S]hut-ingasprovisionsarenottobeconstruedaslimitationsorconditionswhichwouldaffectterminationoftheleases.”);RoyeRealty&Developing,Inc.v.Watson,791P.2d821(Okla.Civ.App.1990)(failuretopayshut-inroyaltywillnotterminateleaseiflesseeactsasareasonablyprudentlesseeinsecuringproduction).172 Dannev.TexacoExp.&Prod.Inc.,883P.2d210,215(Okla.Ct.App.1994)(“Unlessa leaseclearlyprovides for forfeitureof the lessee’sestateupon failure tomake timely

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[ii] — Estoppel Due to Acceptance of Shut-In Royalties.

Thefailuretomarkettheproductmaybeexcusedbythelessor’sac-ceptanceofshut-inroyaltiespriortocommencingalawsuittocancelthelease.173Oklahoma courtsmake a distinction as towhen royaltieswereaccepted. If the leasealreadyautomaticallyexpired, thenacceptanceofroyaltieswillnotestopthelessorfromseekingcancellation.However,iftheleasehasnotautomaticallyexpired,thenestoppelispossible.174

[iii] — Unilateral Mistake.InTexas,thelessee’smistakeastopaymentofshut-inroyaltieswillre-

sultinautomatictermination,wherenofaultisattributabletothelessor.175

[iv] — Force Majeure.A force majeureclauseisonlymeanttoexcusenon-paymentwhenthe

underlyingeventiscausedbycircumstancesbeyondthelessee’scontrolorwasunforeseeableatthetimeofthecontract.176Forthatreason,aTexas

payment,thelessor’sgroundsforrelieflayonlyincontractlaw”;therefore,lessee’stenderofpaymentsfouryearsafterwellwasshut-indidnotresultinautomaticterminationofthelease).173 ConcordeRes.Corp.v.KepcoEnergy, Inc., 254P.3d734 (Okla.Civ.App.2011)(lessorisestoppedfromdenyinglessee’stitlewherelessoracceptedshut-inroyaltiespriortocommencinglawsuittocancellease;“paymentandacceptanceofshut-inroyaltymayexcusefailuretomarket”).174 Danne,883P.2dat215(“IthasbeenheldinOklahomathatacceptanceofroyaltiesdoesnotestopthelessorfromassertingleasecancellation,iftheleasehasalreadyautomaticallyexpired,byitsownterms,priortoacceptanceofroyalties....Whenaleasedoesnotexpireautomatically,however,thelessor’sacceptanceofbenefitsmayestopthelessorfromassertingleasetermination.Eveninacasewhereanexpresscovenanttodrillwellswasbreachedbythelessee,thelessorhasbeenestoppedfromassertingterminationoftheleaseongroundsofacceptanceofroyaltiesfromlessee.”)(Lessoracceptedbothshut-inroyaltiesandproductionroyalties).175 AmberOil&GasCo.v.Bratton,711S.W.2d741,743-44(Tex.Ct.App.1986)(mistakeonthepartoflesseewithrespecttopaymentofshut-inroyaltieswillresultinautomaticterminationofthelease,wherenofaultisattributabletolessor).176 AtkinsonGasCo.v.Albrecht,878S.W.2d236,241(Tex.Ct.App.1994)(“Thepurposeof a force majeure clause is toexcusenon-performanceof leaseobligationsonlywhen

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courtheldthattheforce majeureclausecontainedinthelease“isnottrig-geredwhentheTexasRailroadCommissionordersawellshut-induetothe lessee’s failure to complywith its regulations, at leastwhencompli-ancewiththeregulationiswithinthereasonablecontrolofthelessee.”178 AKansas court held that a force majeure clause is not triggeredwherefailuretopayshut-inroyaltieswasnotduetounavailabilityofpurchasingortransportingservices.178

[4] — Summary.Delayrentalclausescanbedivided into twocategories: (1)“unless”

clauses,which generally are held to cause automatic termination of theleaseifneitherdrillingnorpaymentofthedelayrentaloccursinthepri-maryterm;and(2)“or”clauses,whichpermitthelesseetodrillorpayde-layrentals,butgenerallydonotresultinautomaticterminationofthelease.Asasubstituteforactualproduction,shut-inroyaltiesarepaidtopreservetheleaseinthesecondaryterm.Failuretopayshut-inroyaltiescanresultinautomaticterminationofthelease,althoughcertainjurisdictionsholdthatnonpaymentdoesnotdirectlyaffectthevalidityoftheleasebutmayresultinasuitformoneydamages.Courtsinvariousjurisdictionshaveheldthatbothenforcementofdelayrentalclausesandshut-inroyaltyclausesmaybesubjecttocertaindefenses(suchaswaiver,estoppel,mistake,andothers)thatweighagainsttheharshresultofterminatingthelease.

causedbycircumstancesbeyondthereasonablecontrolofthelesseeorbyaneventwhichisunforeseeableatthetimethepartiesenteredintothecontract.”).177 Id.178 Welschv.TrivestcoEnergyCo.,221P.3d609,paragraph11ofsyllabus(Kan.Ct.App.2009)(“Underthefactsofthiscase,andgivenaforce majeureclausethatrequiredforitsapplicationthatsomedefaultwasduetoaforce majeureevent,thedefault(failuretopayshut-inroyalties)wasnotduetotheunavailabilityofpurchasingandtransportingservices.Therefore,theforce majeureclauseinthisleasewasnottriggered.”).

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