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Federal Court Holds Lease Extended By Shut-In Royalty Provision

On August 14th, the United States District Court for the Middle District of Pennsylvania adopted a magistrate judge’s report and recommendation that recommended granting SWEPI, LP’s (“SWEPI”) motion to dismiss a lawsuit regarding the extension of a lease by tendering shut-in royalties.  In a case titled Mesner v. Swepi, LP, a landowner filed a lawsuit in the Court of Common Pleas against SWEPI in order to terminate the oil and gas lease.  SWEPI then removed the suit to the federal district court based on diversity jurisdiction, and filed a motion to dismiss arguing that it had extended the term of the lease by tendering the shut-in royalty pursuant to the terms of the oil and gas lease.

The shut-in provision of the lease provided that “[i]f during or after the primary term of this lease, all wells on the leased premises or within a unit that includes all or a part of the leased premises, are  . . . otherwise not producing for any reason whatsoever for a period of twelve (12) consecutive months, . . . Lessee may maintain this lease in effect by tendering to Lessor a shut-in royalty equal to the delay rental as found elsewhere in this lease . . . Upon payment of the shut-in royalty as provided herein, this lease will continue in force during all of the time or times while such wells are shut in.”  The plaintiff argued that SWEPI did not extend the lease by tendering the shut-in royalty payments because shut-in royalty provision may only be applied to “wells capable of producing gas in paying quantities” and the two wells shut-in on the leased property were not capable of producing gas in paying quantities.  The plaintiff further argued that automatic termination rule should be found applicable to the lease and result in the denial of SWEPI’s motion to dismiss.

Based on the language of the shut-in provision, the court first concluded that SWEPI complied with the provision and extended the term of the lease.  The court began its analysis by summarizing the rules of contract interpretation and how they apply to oil and gas leases.  In doing so, the court said it must ascertain and give effect to the intent of the parties and that the lease should be given its accepted and plain meaning.  Accordingly, the court concluded that the shut-in provision permits SWEPI to tender the shut-in royalty payment to the lessor when all of the wells on the property or in the unit are (1) shut-in, (2) suspended, or (3) otherwise not producing for any reason whatsoever.  The court stated it was irrelevant whether the wells shut-in on the leased premises were or were not capable of production.  Therefore, it held that SWEPI extended the lease pursuant to the shut-in provision when it tendered the shut-in royalty payment to the lessor.  In making his argument, the plaintiff relied on case law from other jurisdictions.  The court found these cases to be inapplicable to this case.

The court then held that the automatic termination rule has no affect in this case.  Under the automatic termination rule, a lease will terminate if no hydrocarbons are produced in paying quantities, unless the lease contains a savings clause.  Since the lease permits SWEPI to extend the term of the lease by tendering a shut-in royalty, regardless of whether the wells are capable of producing gas in paying quantities, the court held that the automatic termination rule was not applicable.  Therefore, the court held that SWEPI extended the term of the lease by tendering the shut-in royalty payment.