To Spud Or Not To Spud? In Sundown Energy LP v. HJSA No. 3, The Texas Supreme Court Interprets What “Drilling Operations” Means Under A Lease’s Continuous Drilling Clause

Vinson & Elkins LLP

Vinson & Elkins LLP

“To spud or not to spud,” that was the question before the Texas Supreme Court in determining whether a lessee, Sundown Energy, maintained a lease on non-producing acreage under the lease’s continuous drilling provisions.1 Ultimately, the Court concluded Sundown Energy maintained the lease under the continuous drilling program, even though it did not drill new wells, because the definition of “Drilling Operations” included activities other than spudding-in new wells.

Defined Terms Can Impact Your Savings Clauses

Under the lease, Sundown Energy was required to reassign to the lessor non-producing acreage after the primary term unless it engaged in a continuous drilling program. The continuous drilling provision specified that:

The first such continuous development well shall be spudded-in on or before the sixth anniversary of the Effective Date, with no more than 120 days to elapse between completion or abandonment of operations on one well and commencement of drilling operations on the next ensuing well.2

“Drilling operations” was specifically defined as actual drilling or spudding-in a well, but also included other activities such as reworking, fracturing, and testing. The lease also made clear that the broad definition of “drilling operations” applied “whenever used in this lease.”3

The lessor, HJSA, claimed the lease terminated on non-producing acreage because Sundown Energy did not spud a new well every 120 days after completion or abandonment of operations on a prior well. According to HJSA, “drilling operations” was modified by the phrase “the next ensuing well” and other phrases such as “spudded in” and “continuous development well,” in the continuous drilling program clause. Sundown Energy argued that “next ensuing well” just meant the next well on which “drilling operations” occurred, which includes all of the activities set out in the lease’s definition of that phrase.

In a per curiam decision, the Texas Supreme Court sided with Sundown Energy because of the “drilling operations” definition’s directive that it applies “whenever” the phrase was used in the lease. Following black-letter contract law, the Court reasoned it cannot substitute “spudded-in” for “drilling operations” in the continuous drilling clause when the lease specifically defined “drilling operations” to include other activities.4

What Now?

Sundown Energy demonstrates that lessees can maintain non-producing acreage under a continuous drilling clause by doing other developmental activities that are not necessarily drilling a new well — if those operations are specifically defined as operations that qualify. Here, Sundown Energy pointed out that fracturing, reworking, and the other defined “drilling operations” can increase production and be more cost-effective than drilling new wells.5 This decision perhaps signals an understanding that with new and improving technology, drilling new wells is not always necessary — or even economically reasonable — to continue developing leased acreage.

Nevertheless, the Sundown Energy case underscores the need for careful and clear drafting when negotiating oil and gas leases. Even if a particular clause has a clear meaning when read in isolation, its meaning can be impacted by other provisions — like the definition of “drilling operations” in this case.

1 Sundown Energy LP v. HJSA No. 3, Ltd. P’ship, No. 19-1054, 2021 WL 1323406, at *1 (Tex. Apr. 9, 2021).

2 Id. (emphasis in original).

3 Id. at *2.

4 Id. at *3.

5 Id. at *4.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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