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Reworking Operations Held Not to Satisfy Continuous Development Clause – Oil and Gas Law Digest
19Feb

Reworking Operations Held Not to Satisfy Continuous Development Clause

HJSA No. 3, Ltd. P’ship v. Sundown Energy Ltd. P’ship, No. 08-18-00113-CV, 2019 Tex. App. LEXIS 7254 (Tex. App.—El Paso Aug. 16, 2019, no pet. h.)

This oil and gas lease termination dispute centered on a disagreement as to what type of “drilling operations” constituted “continuous drilling operations” under a continuous development clause. The court held that the lessee’s reworking of existing wells did not satisfy the continuous development clause, resulting in a partial termination of the lease. The court held that, while the lease contained a definition of “drilling operations” that expressly included “reworking,” that was a general definition that did not control over the more specific terms in the continuous development clause. In reaching its conclusion, the court analyzed the role of several lease provisions, including the continuous development clause, retained acreage provision, temporary cessation clause, and an agreed definition of “drilling operations.”

The continuous development clause at issue read, in part, as follows:

The obligation…to reassign tracts not held by production shall be delayed for so long as Lessee is engaged in a continuous drilling program on that part of the Leased Premises outside of the Producing Areas. The first such continuous development well shall be spudded-in on or before the sixth anniversary of the Effective Date, with no more than 120 days to elapse between completion or abandonment of operations on one well and commencement of drilling operations on the next ensuing well

Sundown Energy drilled fourteen development wells between February 2006 and March 2015. In January of 2016, HJSA sent Sundown a letter claiming that several portions of the lease had terminated because, between 2007 and 2013, Sundown had on five separate occasions allowed more than 120 days to elapse under the continuous development clause. HJSA contended that the continuous development provision required Sundown to spud-in and drill new wells outside of the producing areas, and that reworking on existing wells was insufficient.

Sundown countered that, while no new wells had been spudded-in during those periods, Sundown contended that it had satisfied the continuous development clause because the continuous develop provision only used the phrase “spudding in” for the first well, and Sundown only had to commence “drilling operations” for subsequent wells. Sundown pointed to paragraph 18 in the lease which defined “drilling operations” as including not only actual operations for drilling a well, but also expressly including “reworking” and “reconditioning” operations.

The court rejected Sundown’s argument that only the first well had to be “spudded-in.” The court began by construing the continuous development provision as requiring the lessee to be in a “continuous drilling program.” The court construed the lease as defining a “continuous drilling program” as “the spudding in of the first such continuous development well, and not more than 120 days elapsing between abandonment of one well and commencement of drilling operations on the next ensuing well” (emphasis supplied by court). The court rejected Sundown’s argument that only the first well must be spud in, explaining that the inclusion of the word “such” in the description meant that all of the continuous development wells are necessarily of the same type – i.e., a well that is spudded-in.

The court also rejected Sundown’s argument that the definition of “drilling operations” in paragraph 18 controls the interpretation of the continuous development clause, such that “drilling operations” on the “next ensuing wells” means Sundown could rework existing wells. The court explained that specific provisions control over general provisions, and in this case the definition of “drilling operations” in paragraph 18 was a general definition, and the continuous development provision was a specific provision. The court explained that several specific phrases in the continuous development clause modified the general definition in paragraph 18, including the phrases “continuous drilling program,” “continuous development well,” “spudded-in,” “such,” and “next ensuing well.” According to the court, these more specific phrases “all clarify that Sundown was required to spud-in a new well in a non-producing area within 120 days of completion or abandonment of a prior well to maintain the lease in the areas not held by production.”

The court explained that this interpretation did not render the custom definition of “drilling operations” meaningless because it is used in the temporary cessation provision, which specifically allowed the lessee to save the lease by conducting timely “drilling operations as defined herein.” The court also explained that the definition’s introductory phrase (reading “whenever used in this lease”) was not controlling and could not be interpreted as requiring that the general definition impose a greater duty than the specific obligations defined in the development paragraph.

Finally, the court affirmed the trial court’s orders striking portions of an affidavit of an attorney who had negotiated the lease, claiming it informed rather than varied or contradicted the contract. The court explained that, “[w]hile a reviewing court may consider the surrounding circumstances of the contract, we may only consider objective, not subjective, evidence.” The court also rejected the argument that HJSA’s acceptance of royalties for years was course-of-performance evidence that favors its reading of the contract. The court rejected that argument, explaining that course-of-performance evidence is not considered in construing an unambiguous lease.

Austin Brister
Austin represents oil and gas exploration and production companies and landowners in a wide variety of complex commercial litigation matters, including contract and property disputes, royalty disputes, breach of lease cases, lease termination/perpetuation disputes, and an array of other issues in the upstream oil and gas sector. Austin has prosecuted and defended claims in state courts and federal courts. Austin strives to find practical business solutions to complex issues, but if necessary, he works hard to implement effective strategies in the courthouse.
Austin Brister
Ana Navarrete
Ana specializes in Oil and Gas litigation. Her experience includes matters in South Texas and the Eagle Ford Shale Play in disputes involving title issues, drilling operations between operator and non-operators, royalty underpayment, offset and development, cessation of production and lease termination, among other issues in the upstream oil and gas sector. Ana is also knowledgeable in matters involving state and federal oil and gas regulatory authorities includes agency hearings, examining the scope and limits of regulatory authority and providing advice about how to comply with or seek exemptions to agency rules.
© Copyright 2012-2018, McGinnis Lochridge LLP. All Rights Reserved. DISCLAIMER: The information in this article is for general information purposes only. This article should not be substituted for legal advice and should not be taken as legal advice for any individual case or situation. This information is not intended to create, and receipt or reading this article does not constitute, an attorney-client relationship. You are encouraged to contact an attorney for legal advice concerning the information provided in this article.
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