Many oil and gas leases are approaching their 5 and 10 year primary terms, and landowners in Pennsylvania and Ohio[1] may find themselves confused about the duration of their lease once the primary term expires. The habendum clause of an oil and gas lease separates the duration of the lease into a primary term and a secondary term. Understanding the habendum clause, or the clause that bridges the primary and secondary terms, is crucial not only when negotiating a lease, but also in understanding whether an existing lease has expired after the primary term instead of entering the secondary term. The primary term is set for a certain number of years, typically 5 or 10. The duration of the secondary term is often indefinite, but usually requires some continued action on the part of the lessee[2] in order to keep the lease in effect.
It is important to note that there is no universal form for an oil and gas lease, and the terms of each lease can vary substantially. Generally, the question of whether the lease expires at the end of the primary term is going to be governed by the terms within the lease itself. Understanding how your lease can be held over into the secondary term is the first step in ensuring that your mineral rights are properly reverted back to you. Whether a lessee has met the requirements for the secondary term under the lease is usually going to be fact-specific, but there are some typical phrases used to holdover the lease into the secondary term that have been interpreted by the courts.
Common language triggering the secondary term
Nearly all habendum clauses provide for an extension of the lease beyond the primary term end date and into the secondary term if there is actual and ongoing production of oil or gas. An example of this type of clause provides that “the lease shall remain in force for five years or as long thereafter as oil and gas is produced in paying quantities.” There has been extensive litigation as to what is required for “in paying quantities.” Of course, in order to have production in paying quantities there must be actual production.[3] The more difficult question is how much production constitutes “in paying quantities?” The Ohio Supreme Court has defined the answer as “quantities sufficient to yield a profit, even small, to the lessee over operating expenses, even though the drilling costs, or equipping costs, are not recovered, and even though the undertaking as a whole may thus result in a loss.”[4] Similarly, the Pennsylvania Supreme Court has recently held that “if a well consistently pays a profit, however small, over operating expenses, it will be deemed to have produced in paying quantities.”[5] Thus, even a marginally productive well could be enough to hold over the lease into the secondary term.
The clause may also provide that the lease will continue so long as oil or gas is “capable of being produced.” Courts have required that in order for a lease to continue pursuant to this language there must be an established gas well capable of producing in paying quantities.[6] These wells are typically “shut in” while there is a lack of market for oil or gas.[7]
Some leases contain language allowing “operations in search of oil and gas” or “drilling operations” to continue the lease into the secondary term. If those terms are defined, the definition within the lease will generally control. However, these terms are often undefined, and parties may have different understandings of what “operations” mean. Typically, “good faith” commencement of drilling operations before the expiration of the primary term period will be enough to extend the lease into the secondary term.[8] Drilling operations might fall short of drilling an actual well, as a generally accepted definition of operations is taken as “work or actual operations undertaken or commenced in good faith for the purpose of carrying out rights, privileges, or duties of the lessee under a lease, followed diligently and in due course by the construction of a derrick or other necessary structures for the drilling of an oil or gas well, and by the actual operation of drilling in the ground.”[9] Thus, a lessee attempting to hold over a lease through “operations” will likely have to do so with “diligence” and in “good faith,” and such requirements are going to depend largely on the specific facts surrounding a lessee’s activities.
Removing uncertainty: ways to ensure the lease has terminated or expired
It is a common occurrence that a lease expires on its terms, but has never formally been released or surrendered by the lessee. Both Pennsylvania and Ohio have statutorily developed processes designed to provide assurances that a lease has been formally released or surrendered by the lessee.[10] The Pennsylvania statute, which was just signed into law last year, requires a lessee to issue a recordable surrender upon expiration, termination, or cancellation of the lease.[11] If the surrender document is not issued to the lessor, the lessor can then serve a 30-day notice on the lessee. If that notice is unchallenged, the landowner can then record an Affidavit of Termination, Expiration, or Cancellation.[12] However, the statute does not give any insight into what effect the Affidavit has on the mineral rights once it is recorded.
The Ohio statute similarly provides that a lessor may send notice requesting the lease to be released of record, and that the lessor intends to file an Affidavit of Forfeiture if the lease is not released.[13] The lessor then may file the Affidavit after 30 days.[14] The lessee then has 60 days to notify the lessor that the lease is still in effect, and record its own Affidavit stating that the lease has not been forfeited.[15] If the lessee fails to give such notice, the lessor can record a “notice of failure to file” with the recorder. Unlike the Pennsylvania statute, the effect of a properly recorded notice is described in the statute: the record of the oil and gas lease shall not be noticed to the public, and the record shall not be received in evidence in any court of the state on behalf the lessee or its assigns, or against the lessor or the lessor’s successors or assigns.[16] However, similar the to Pennsylvania statute, the process is not designed to resolve disputes between the lessor and the lessee, and the lease will not be barred from being introduced into evidence in any proceeding if there is a proper challenge or objection by the lessee.[17]
To resolve a dispute as to the expiration of a lease in either state, a landowner will likely need to file a declaratory judgment action in civil court. Declaratory judgment actions are designed to decide and end controversies or uncertainties between parties.[18] Thus, when the expiration of a lease is disputed, declaratory judgment actions can be used to state a claim that an oil and gas lease has expired by its terms.[19] However, because of the fact-specific nature of some of these issues, the outcomes of such a challenge in this area can be especially uncertain. Moreover, declaratory judgment actions relative to oil and gas lease disputes can take years to litigate, and costs and attorney’s fees can quickly pile up. Landowners should be encouraged to consult an attorney before making a decision to pursue a declaratory judgment action in order to resolve a dispute over mineral ownership.
By James Yskamp
[1] Landowners everywhere may find themselves confused about these issues, but this article is limited to the two aforementioned states for purposes of simplicity. Each state might have different common law and statutory interpretations of issues surrounding habendum clauses and lease expiration. There are also other ways that leases terminate or expire in both the primary and secondary terms, such as breaches of implied covenants, but this article is limited to expiration issues upon the end of the primary term.
[2] The “lessee” is typically the oil and gas company or operator, and the “lessor” is the mineral owner, or landowner who is leasing the mineral rights.
[3] Hanna v. Shorts, 163 Ohio St. 44, 49, 125 N.E.2d 338, 341 (1955).
[4] Blausey v. Stein, 61 Ohio St. 2d 264, 265, 400 N.E.2d 408, 410 (1980).
[5] T.W. Phillips Gas & Oil Co. v. Jedlicka, 615 Pa. 199, 224, 42 A.3d 261, 276 (2012).
[6] See Hupp v. Beck Energy Corp., 2014-Ohio-4255, ¶ 101, 20 N.E.3d 732, 752 appeal allowed, 2015-Ohio-239, ¶ 101, 141 Ohio St. 3d 1454, 23 N.E.3d 1196 (emphasis added).
[7] Summers Oil and Gas § 14:30 (3d ed. 2011).
[8] Henderson v, Ferrell, 38 A. 1018 (Pa. 1898).
[9] Williams & Meyers Manual of Oil and Gas Terms (11th ed. 2006)(emphasis added).
[10] See Ohio Rev. Code Ann. § 5301.332; 58 Pa. Cons. Stat. Ann. §§ 901 et seq.
[11] Pa. Cons. Stat. Ann. § 903.
[12] Id. at § 904(d).
[13] Ohio Rev. Code Ann. § 5301.332(B)
[14] Id.
[15] Id. at § 5301.332(C).
[16] Id. at § 5301.332(D)(4).
[17] See Blausey v. Steln, OT-78-3 (Ohio Ct. App. 1978).
[18] Ohio Rev. Code Ann. § 2721.02; 42 Pa. Cons. Stat. Ann. § 7541; See also Com., Pennsylvania Game Comm'n v. Seneca Res. Corp., 84 A.3d 1098, 1103 (Pa. Commw. Ct. 2014).
[19] See Stewart v. SWEPI, LP, 918 F. Supp. 2d 333 (M.D. Pa. 2013).
