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A recent case from the Waco Court of Appeals, Rippy Interests, LLC v. Nash, illustrates an important issue to consider when negotiating oil and gas leases. [Read full opinion here.]

Lease Background

Nash owned mineral rights for 1,888 acres in Leon County.  He entered into a lease with Range Production, who later assigned the lease to Rippy Interests, LLC. The lease was for a primary term of three years, with a two year option to extend that primary term, which was exercised.  The lease language provided that:

…this lease shall remain in force for a term of three (3) years from the date hereof, hereinafter called “primary term” and as long thereafter as operations, as herein defined, are conducted upon said land with no cessation for more than ninety (90) consecutive days.

The lease then goes on to define “operations” as operations for and any of the following:  drilling, testing, completing, reworking, recompleting, deepening, plugging back or repairing of a well in search of or in an endeavor to obtain production of oil, gas, sulphur, or other minerals, excavating a mine, production of oil, gas, sulphur or other mineral, whether or not in paying quantities.

Thus, the lease was signed on January 18, 2006 and the primary term (3 years plus the 2 year extension) ended on January 18, 2011.  The lease would continue beyond that date only if “operations” were being conducted.

In Septmeber 2010, Nash granted a top lease to US KingKing LLC.  A top lease is granted by an owner during the term of an already existing lease and becomes effective only if the original lease terminates.  Therefore, the top lease here was signed while Rippy’s lease was still in place, and the KingKing lease would be effective only if the Rippy lease terminated.

Facts

On January 1, 2011 (17 days before the end of the primary term), Rippy called Nash to inform him they were beginning work on the lease.  In the next 17 days, Rippy hired a general contractor to drill the well, received bids to prepare the well pad, and solicited bids for a drilling rig.  Rippy obtained a damage release and made payment to Nash for a drill pad and access road.  They began “general construction” of the will pad and road, including pad preparation and hauling clay.  The will pad was started and a conductor pipe placed in the ground before January 18, 2011.

On January 18, 2011, Nash place a lock on the gate entering the property.  He told Rippy that there was an issue about which lease was valid and that Rippy and KingKing needed to communicate.  When the Rippy workers cut the lot and entered the property, the police were called, but no arrests were made.

Rippy continued work on the lease through March 2011, including drilling the pilot hole.  In March, however, they ceased work on the lease, claiming the right to do so without causing the lease to terminate because Nash repudiated and unequivocally challenged Rippy’s title.

Lawsuit

At that point, Rippy filed suit against Nash and KingKing, seeking an injunction to keep them from preventing Rippy’s drilling activities.  Nash and KingKing filed a counterclaim against Rippy, seeking an injunction that the Rippy lease terminated on January 18, 2011 due to Rippy’s failure to conduct the “operations” as required in the lease.

The trial court sided with KingKing and Nash, holding that Rippy’s actions were insufficient to constitute “operations” and that the lease had terminated.  Rippy appealed.

Appellate Decision

The appellate court reversed the trial court’s decision.  Specifically, the court found that as a matter of law, Rippy’s actions met the contractual definition of “operations” to continue the lease term.

The court looked at numerous prior cases addressing this issue.  For example, in Ridge Oil Co. v. Guinn Investments, Inc., 148 S.W.3d 143 (Tex. 2004), the Texas Supreme Court found that the oil company did not engage in “operations” sufficient to continue the lease where they obtained a drilling permit, attempted to pay surface damages, and drove a wooden stake into the ground to mark the well site.  Conversely, in Whelan v. R. Lacy Inc., 251 S.W.2d 175 (Tex. App. Ct. 1952), the Texarkana Court of Appeals held that “operations” did occur where a lessee began working with a bulldozer for 9 days prior to the end of the primary term on the lease.

Because the facts showed that Rippy obtained a drilling permit and surface damage release, hired a drilling contractor, solicited a bid for a drilling rig, began construction of the drilling pad, and set the conductor pipe, it had conducted “operations” as defined by the lease.  Thus, the Rippy lease did not terminate on January 18, 2011 and, consequently, the KingKing lease did not become effective at that time.

There was, however, a second issue.  Nash and KingKing argued that because Rippy ceased operations in March 2011, the lease terminated 90 days later pursuant to the habendum clause.  Rippy argued it had the right to cease operations because Nash repudiated the lease claiming Rippy did not hold clear title.  The appellate court found this issue to be a question of fact that could not be decided on summary judgment and remanded to the trial court.

Now, the trial court will enter an order finding that the Rippy lease did not terminate on January 18, 2011 and will conduct a trial to determine whether the lease subsequently terminated due to Rippy’s 90 day cessation in operations.

What Can We Learn?

This case is a perfect illustration of the importance of language in an oil and gas lease.

First, mineral owners must understand how habendum clauses in oil and gas leases usually operate.  It is important to  understand that the lease will remain in place the length of the primary term, but that the lease then could last an undetermined amount of time based on the language included in the secondary term.

Second, mineral owners should ensure that all defined terms are clear and unambiguous. Here, the question of whether the lease continued after January 18, 2011 revolved solely around the definition of “operations” included in the lease agreement.  Mineral owners entering into oil and gas leases must be very careful to carefully read definitional terms like this, and to ensure they are clearly drafted.

Third, mineral owners may want to consider negotiating a narrowly defined requirement in determining the length of the secondary term.  In this case, the broad language defining “operations” allowed the Rippy lease to continue into the secondary term.  Had the language been written more narrowly–requiring production, for example–the lease would have terminated on January 18, 2011 and Nash would have had the benefit of the more desirable terms under the KingKing lease.

Finally, given the complex nature of oil and gas law and the importance of these leases, I always recommend seeking the advice of an experienced oil and gas attorney licensed in your jurisdiction.