April 10, 2014

Potential Pitfalls of Continuous Drilling Provisions in HBP Fee Leases

Potential Pitfalls of Continuous Drilling Provisions in HBP Fee Leases

A common but often overlooked oil and gas lease provision is the "continuous drilling" or "continuous operations" provision. Generally, a continuous drilling provision allows a temporary cessation of production without automatically resulting in the termination of an oil and gas lease that has been extended by production. In order to qualify for the temporary cessation, certain operations (as defined in the lease or by case law) must be commenced on the leased premises or lands pooled or unitized therewith within a specified time period (typically from 30 to 120 days). Two examples are as follows:

If, at the expiration of the primary term of this lease, oil or gas is not being produced on the leased premises or on acreage pooled therewith but Lessee is then engaged in drilling or reworking operations thereon, then this lease shall continue in force so long as operations are being continually prosecuted on the leased premises or on acreage pooled therewith; and operations shall be considered to be continuously prosecuted if not more than ninety (90) days shall elapse between the completion or abandonment of one well and the beginning of operations for the drilling of a subsequent well.

If, at the expiration of the primary term, oil or gas is not being produced on said land, but lessee is then engaged in drilling or reworking operations thereon, the lease shall remain in force so long as operations are prosecuted with no cessation of more than 30 consecutive days.

Continuous drilling provisions are of particular importance when analyzing older, HBP leases. Specifically, a number of situations should be considered. Has your lease produced each and every month since the expiration of the primary term? Have you or your predecessor ceased production to rework the well or recomplete in a new formation? Have severe weather conditions caused a temporary cessation of production? Each of these situations could potentially lead to a finding that your lease has expired.

Oil and gas wells generally do not have perfect production histories. Williams & Meyers states: "Since repairs, breakdowns, and reworking operations are incidental to the normal operation of a lease, the parties must have contemplated that the temporary cessation of production caused by such events would not result in automatic termination of the lease."1 Based upon this implied understanding, if an oil and gas lease does not contain a continuous drilling provision, the lessee may extend the lease by exercising reasonable diligence in the continuance of its operations on the leased premises. In other words, courts have held that a temporary cessation of production is allowed where no specific deadline is provided.2 What is temporary? There is no hard and fast rule. An Arkansas court found a temporary cessation where a fire destroyed a producing well and production was not resumed for four years.3 However, whether a cessation of production is temporary is a question of fact that will depend on the individual circumstances.4 Although the individual facts may vary, courts typically weigh the following factors: failure of the lessor for a substantial period of time to claim forfeiture during which time the lessee was engaged in activities on the lease, absence of drainage, intent of lessee to hold the lease, and diligence of the lessee in seeking to find a market or to resume production.5 Due to the fact-intensive nature of the analysis, each circumstance must be carefully reviewed under the applicable case law in that state.

The continuous drilling provision was created in order to provide more certainty in the face of inconsistent court rulings. While providing the parties with a more reliable test, a continuous drilling provision could prove fatal to an HBP lease. According to Williams & Meyers: "Where there are express savings provisions in a lease that specify dates [i.e., 30-120 days] by which the lessee must take certain action or the lease will terminate, the temporary cessation of production doctrine will not apply so as to extend the lease beyond those specified time limits."6 Unlike the analysis above, the specific time periods by which a lessee must recommence operations are hard and fast.7 Absent some other lease provision, mechanical issues with the well, lack of a market, or any other delay in production could cause a lease to be deemed expired in as few as 30 days without production. Therefore, careful attention should be made to the production (and operations) history on the leased premises to ensure any continuous drilling provision has been strictly observed.

Despite a constant push for greater efficiencies in acquisition due diligence and title opinions, a thorough HBP analysis should not be forgotten. Such analysis may require obtaining well records back to the date of first production, reviewing the complete well file, and investigating the cause of any delays in production.

For More Information Contact:
David B. Hatch
Phone: 801-799-5834
Email: dbhatch@hollandhart.com


1Williams & Meyers, "Oil and Gas Law" § 604.4.
2Id.
3Saulsberry v. Siegel, 252 S.W.2d 834 (Ark. 1952).
4See Watson v. Rochmill, 155 S.W.2d 783 (Tex. 1941).
5Williams & Meyers, § 604.4 at fn. 11; see, e.g., Somont Oil Co. v. A & G Drilling, Inc., 49 P.3d 598 (Mont. 2002) (finding the intent and diligence of the operator in restoring production is a factor in determining with a cessation of production is temporary).
6Williams & Meyers, § 604.4.
7See, e.g., Greer v. Salmon, 479 P.2d 294 (N.M. 1970) (finding that where the lessee didn't strictly comply with the 90-day cessation clause the lease terminated).

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