In Fleck v. Missouri River Royalty Corp., the North Dakota Supreme Court outlined the test that should be used to determine whether a well is producing in paying quantities to satisfy the habendum clause. That test involves both an objective component, i.e., whether the well has yielded revenue in excess of operating costs over a reasonable period of time, and a subjective component, i.e., whether a reasonable and prudent operator would continue to operate a well in the manner in which the well was operated under all of the relevant facts and circumstances.
In this case, the George J. Fleck Trust (Fleck), owner of mineral interests in McKenzie County that were subject to an HBP lease executed in 1972, sued the lessees to quiet title alleging that the lease had expired due to a failure to produce oil or gas in paying quantities. The lease was beyond its primary term, and the habendum clause stated that the lease remained in effect for so long as "oil or gas, or either of them, is produced from said land by the lessee, its successors and assigns."
Lessees defended, claiming that production from the Fleck #1 well, which produced an average of a few barrels a day, maintained the lease in effect. The district court granted summary judgment to the lessees holding that production in paying quantities was not required, and that the continuous production of only a few barrels per day was enough to sustain the lease.
The Supreme Court reversed, finding that the term "production" as used in the habendum clause means "production in paying quantities." This is consistent with prior case law in North Dakota. (See Tank v. Citation Oil & Gas Corp. and Sorum v. Schwartz). The Court reasoned that this interpretation is consistent with the objective of the lease, which is to obtain production that is commercially profitable, i.e., beneficial, to both lessor and lessee, and because the parties to the lease did not intend the lessee to hold a lease after the expiration of the primary term for speculative purposes.
The Supreme Court went on to state, however, that "[t]his Court has not specifically addressed how production in paying quantities should be determined." Ultimately, the Court adopted a two-part test that involves both objective and subjective components. Both parts of that test must be satisfied.
The Two-Part Test
First, the Court said that the well must yield "a profit over operating costs over a reasonable period of time." Satisfying this test requires a mathematical calculation to determine if the lessee's gross income from the lease exceeds lease operating costs. Drilling costs, workover costs, taxes, depreciation and all expenses other than operating costs are not considered in that mathematical calculation. Moreover, there is apparently no minimum rate of return and the receipt of $1.00 more than operating costs will satisfy this test. The only variable in this mathematical computation is the period of time that is used for the calculation, and the Court failed to specify what accounting period should be used other than to say that it should be a "reasonable period of time."
Second, the Court said that it must also be shown that "a reasonable and prudent operator would continue to operate" the well. This subjective component of the test involves an examination of all the relevant facts and circumstances, and whether a prudent operator would continue to produce the well. Whether this prong of the test has been met will be based on expert testimony in light of the specific facts and circumstances of each individual case. The Court did not offer any guidance on the factors that should be examined in determining whether this test has been satisfied.
Ultimately, the Court remanded the case back to District Court for factual findings to determine whether the Fleck well produced in paying quantities under that two-part test.
