In Landover Production Company, LLC v. Endeavor Energy Resources, L.P., et al., the Texas Court of Appeals re-affirmed the application of the implied, “temporary cessation of production doctrine” to prevent an oil and gas lease from expiring during its secondary term when a lessee encounters mechanical issues that require a temporary break in continuous production.
Under the law of Texas and many other oil and gas producing jurisdictions, the general rule is that an oil and gas lease expires in its secondary term if a producing well stops producing. [1]
Leases sometimes account for this situation by expressly providing that a lease will not expire in its secondary term when an operator/lessee finds it necessary to take a well temporarily out of production. For example, some leases may address the stoppage of production during the secondary term by, for example, specifying the circumstances that justify a break in production and specifying a period of time in which production must resume before the lease expires.
When leases are silent on this point, many oil and gas producing jurisdictions, including Texas, have recognized an implied, “temporary cessation of production” doctrine. [2] Absent lease language to the contrary, a temporary cessation of production does not automatically terminate a lease. Courts evaluate several factors to determine whether the doctrine should apply to save the lease, including (1) the length of cessation of production; (2) the cause of the cessation; (3) the lessee’s efforts to restore production.
The rationale for the doctrine is that, during its life cycle, a well is bound to stop producing at some point for some reason – e.g., for reworking, stimulation, or repairing (to name a few). Courts in many oil and gas producing jurisdictions presume that the parties contemplated this situation when they entered the lease, so the courts read the temporary cessation of production doctrine into the lease as a practical way to avoid the harsh result of automatic termination for lack of production during the secondary term.
In Landover Production, the Texas Court of Appeals affirmed the application of this doctrine in a case involving a period of non-production in the secondary lease term due to equipment malfunction.
By way of background, Endeavor owned the working interest in an oil and gas lease covering 80 acres. Endeavor operated a well on the property during the secondary term of the lease. Landover held a “top lease” on the same 80 acres, which would take effect if Endeavor’s “base lease” expired. [3] The Endeavor lease included the following language (referred to as the “savings clause”):
If at the expiration of the primary term oil and gas is not being produced on said land but Lessee is then engaging in drilling or re-working operations thereon, the lease shall remain in force so long as operations are prosecuted with no cessation of more than thirty (30) consecutive days….
The Endeavor lease was in its secondary term when, in May of 2001, Endeavor discovered a hole in its “heater-treater” (a device that separates water from oil). As a result of that mechanical issue, the heater-treater leaked, such that Endeavor could not separate the water from the oil and the oil was rendered unmarketable. Endeavor made several attempts to repair the leak, requiring it to suspend well production while repairs were pursued. After several unsuccessful repair efforts, delayed by rainy weather, Endeavor successfully repaired the well equipment and resumed production in August of 2001.
Landover sued Endeavor, claiming that the Endeavor lease terminated due to the cessation of production. At trial, the jury found that the period of non-production was excused under the temporary cessation of production doctrine. Landover appealed the trial court’s entry of judgment for Endeavor, arguing that the jury’s finding was not supported by evidence.
On appeal, the appellate court concluded that Endeavor’s lease did not expire.
As a threshold matter, the court interpreted the Endeavor lease’s savings clause as applicable only to the primary term of the lease and found no other provision of the lease protecting the lessee’s interest during the secondary term.
The court, however, applied the temporary cessation of production doctrine under Texas law, requiring that the lessee demonstrate:
(i) that the “cessation of production after the primary term [was] temporary and [that it was] due to sudden stoppage of the well, some mechanical breakdown of the equipment used in connection therewith, ‘or the like,’” and
(ii) that the lessee acted with diligence and remedied the cause and resumed production in a reasonable time.
The court found “ample evidence” that Endeavor had proven to the trial court that the “cessation of production after the primary term was temporary and that the temporary cessation of production was the result of a sudden stoppage of the well” due to the mechanical failure of the heater-treater. The court rejected Landover’s argument that Endeavor had some burden to use reasonable production alternatives in order to keep the lease alive. Given that Landover’s appeal did not challenge Endeavor’s diligence in addressing the mechanical issue and resuming production, the court did not pass on the legal or factual sufficiency of the case on these grounds. [4]
The court’s application of the temporary cessation of production doctrine in Landover re-affirms the additional protection and certainty that lessees should enjoy under a lease without an express savings clause when operating wells that stop producing during the secondary term. As the court held, a lessee should not suffer the harsh result of having its lease expire when a legitimate mechanical issue causes a break in production and the lessee works diligently to re-establish production, even in the absence of an express provision in a lease that governs that situation.
Although the outcome in Landover favored the lessee, the decision serves as a reminder that operators should review their leases to identify and understand their obligations when production ceases in the secondary term and, in the absence of lease language, take steps to assure they are complying with the factors courts consider when deciding to apply the implied doctrine. In most cases, operators that experience mechanical issues with their wells or other related equipment should take appropriate and diligent action when production must be suspended during the secondary term in order to avoid lease expiration claims.
Notes:
[1] Watson v. Rochmill, 137 Tex. 565, 155 S.W.2d 783, 784 (Tex. 1941).
[2] Cole v. Phila. Co., 26 A.2d 920 (Pa. 1942); Wagner v. Smith, 456 N.E.2d 523, 525-528 (Ohio Ct. App. 1982); Bryan v. Big Two Mile Gas Co., 213 W. Va. 110, 118, 577 S.E.2d 258, 266 (2001).
[3] A “top lease” is a lease granted for property on which a lease already exists, whereby the “top lease” would become effective upon the termination or expiration of the existing “base” lease.
[4] The court further noted that even if it had held that there was an error of law regarding application of the temporary cessation of production doctrine, Endeavor still held title over the leasehold estate by adverse possession.
