The Texas Supreme Court clarifies the standard for lease termination in Texas
By Christopher M. Hogan, Trial Attorney & Founding Partner, Hogan Thompson LLP
01/06/2021 – Some of the most common disputes I see in the oil patch relate to lease provisions like continuous-drilling clauses, retained-acreage clauses, or Pugh clauses. These cases usually revolve around the question of whether a lease terminated—in whole or in part—when an operator failed to keep drilling or completing wells or failed to produce oil or gas from a particular part of a lease. These are often high-dollar cases, as leasehold acreage worth millions of dollars can be in dispute. Operators defending against these suits may have received a boost based on a recent Texas Supreme Court case.
Each of these kinds of cases involve a “special limitation” in an oil and gas lease. A special limitation is essentially a clause that provides a lease will terminate (in full or in part) when a particular event takes place. Last month, the Texas Supreme Court in Endeavor Energy Resources, L.P. v. Energen Resources Corp., 18-1187, 2020 WL 7413727 (Tex. Dec. 18, 2020) reiterated that these special limitation provisions are, indeed, special. The case centered on a continuous-drilling provision in the oil and gas lease at issue:
This lease shall terminate as to all non-dedicated acreage any time a subsequent well is not commenced within one hundred fifty (150) days from the completion of a preceding well. Each well herein provided to be drilled, once spudded, shall thereafter be drilled with reasonable and continuous diligence to a depth below three thousand five hundred one feet (3,501') below the surface and shall be deemed to be completed ten (10) days after the drilling rig moves off the hole or upon removal of the completion rig, whichever is sooner. Lessee shall have the right to accumulate unused days in any 150-day term during the continuous development program in order to extend the next allowed 150-day term between the completion of one well and the drilling of a subsequent well.
Id. at *1 (emphasis in original).
The operator—Endeavor—drilled twelve wells on the lease but waited 320 days after completing the twelfth well to start drilling the thirteenth well. It believed that it could accumulate unused days from multiple 150-day terms during its drilling of the first twelve wells. But Energen, which took a new lease on the property at issue, argued that Endeavor could utilize only the unused days left over from the most recently completed well. Using that reading, the special limitation would have been triggered based on a lack of drilling and much of the lease would have terminated.
The Texas Supreme Court began with a recitation of principles of oil and gas lease interpretation. Leases are contracts and thus the “plain, grammatical language” dictates the meaning of such agreements. Id. at *2. The Court emphasized that that a trial court can consider the “fact and circumstances surrounding the contract,” including the commercial setting in which it was negotiated, when interpreting a contract. Id. at *3 (brackets omitted). But if the court found that “even after applying all pertinent construction principles, a contract’s language remains susceptible to two or more reasonable interpretations, then the agreement is ambiguous as a matter of law.” Id. It is then up to the fact finder (usually a jury) to determine the contract’s meaning.
So far, this is all standard contract-interpretation jurisprudence. But the Court noted that the last step above does not apply to special limitations. Instead, if a special limitation in an oil and gas lease is “susceptible to two or more reasonable interpretations,” the interpretation of that provision does not go to the fact finder. Instead, “the ambiguity will be resolved against imposition of a special limitation.” Id.
And that is exactly what the Court proceeded to do. It noted that neither party advocated for the “strictly literal” reading of the clause, which would allow the unused days to apply to only terms of exactly 150 days. Id. at *5. The Court too declined to “interpret the contested sentence in this hyper-literal fashion.” Id. It considered both Endeavor’s and Energen’s readings of the continuous-drilling clause and suggested that both appeared reasonable. This remained the case even after considering the “extrinsic circumstances,” which consisted primarily of economic considerations. Id. at *7.
Because the continuous-drilling clause was “reasonably susceptible to more than one meaning,” the clause was ambiguous. But Endeavor and Energen will not be fighting this out in front of a Howard County jury. Instead, because Energen’s lease-cancellation argument relied on triggering a special limitation, this ambiguity was fatal to its case.
This special-limitation ruling is not unprecedented for the Texas Supreme Court. Rather, the Court discussed this topic only a few years ago in Endeavor Energy Resources, L.P. v. Discovery Operating, Inc., 554 S.W.3d 586 (Tex. 2018) and before that in Anadarko Petroleum Corp. v. Thompson, 94 S.W.3d 550 (Tex. 2002). But this case is a strong reminder from the Court that a party claiming that an oil and gas lease has terminated cannot hope to throw the case to a jury by claiming ambiguity. Rather, it needs to show that its reading—and only its reading—is the reasonable way to interpret the lease.
Christopher M. Hogan Trial Attorney & Founding Partner chogan@hoganthompson.com | 713.671.5642
Chris Hogan focuses his litigation practice on resolving complicated disputes for corporate and individual clients, particularly those in the energy industry. Chris has substantial first-chair experience in federal court, state court, and arbitration proceedings. is honored to represent as lead counsel major energy companies such as Apache, BPX, Chevron, ConocoPhillips, Devon, EOG, Marathon Oil, Mewbourne, and Ovintiv.