Federal Court Determines Predrilling Activities Extend Term Of Lease

On August 13th, the United States District Court for the Middle District of Pennsylvania granted partial summary judgment in favor of Chief Exploration & Development and other defendants (Chief) in a consolidated case regarding the extension of three oil and gas leases in which the primary terms had expired.  Three landowners filed lawsuits in the Court of Common Pleas against Chief in order to terminate the oil and gas leases.  Chief then removed the suits to the federal district court based on diversity jurisdiction, and filed a motion for summary judgment arguing that it had extended the term of the leases pursuant to the habendum clause and unitization clause by performing various predrilling activities.
The habendum clause of the lease provided that “the lease shall remain in force for a primary term of five (5) years . . . for as long thereafter as operations are conducted on the Leasehold in search of production of oil, gas or their constituents . . .”  The court recognized this provision as a ‘commence clause’.  The plaintiffs argued that the habendum clause was ambiguous and that parol evidence was required to determine the intention of the parties.  The plaintiffs further argued that Chief failed to commence operations prior to the expiration of the primary term and failed to proceed to the completion of a well with due diligence.
The court first concluded that the habendum clause was not ambiguous.  It summarized the rules of contract interpretation and how they apply to oil and gas leases.  In doing so, it stated that while it is common for commence clauses to condition a lease extension explicitly on the commencement of operations, the failure to use the word commencement or commence does not render such a clause ambiguous.  It further provided that a reference to operations standing alone is generally sufficient to make the meaning of the clause distinct.  Therefore, the court found that it was the intent of the parties to condition the extension of the leases on the commencement of operations and that the habendum clause was unambiguous.
The court then held that Chief adequately commenced operations in order to extend the term of the lease.  It first stated that commencement of operations does not mean actual drilling of the well.  It noted that lessees must be given “great leeway” in manifesting their intent to drill.  The court held that the quantum or nature of the lessee’s preparatory activities do not in themselves matter much to the commencement inquiry.  The material issue is, rather, whether the activity – minimal or extensive – is undertaking “in good faith, and with a determination on the lessee’s part to prosecute with due diligence the work the lessee was authorized by the lease to do.”  The court held that Chief’s activities were sufficient to trigger the lease extensions.  Specifically, Chief established the location of the well on a neighboring tract, conducted field surveys, staked the well location, obtained a vertical drilling permit and Erosion and Sediment Control General Permit from the Department of Environmental Protection, and finalized several necessary regulatory submissions prior to unitizing the plaintiffs’ leaseholds.  After creating the unit, Chief surveyed the tract of land in which the well was to be located, placed a bulldozer on the property and began to clear lumber.