The Shut-In Clause: Keeping an Oil And Gas Lease In Effect
By Paul R. Yagelski, Esquire
Can Payment Under A Shut-In Clause Of an Oil And Gas Lease Maintain The Oil And Gas Lease In Effect Once The Primary Term Has Expired?
Virtually every oil and gas lease contains a shut-in clause. Sometimes these are quite lengthy and complex. Sometimes they are short and simple. Regardless, the shut-in clause normally provides that once the primary term has lapsed and the oil and gas lease is extended into the secondary term, the oil and gas lease may be maintained in effect if the shut-in is due to the reasons specified in the clause and if certain payments are made in accordance with the clause.
In Wheeland Family Ltd. Partnership LP v. Rockdale Marcellus LLC, No. 4:18-CV-01976, 2019 WL 2868937 (M.D. Pa. July 3, 2019), the Federal District Court dealt with the issue of whether a shut-in clause, if complied with, would extend the term of the oil and gas lease.
In Wheeland, plaintiffs owned various parcels of land in Tioga County, Pennsylvania and had executed seven separate oil and gas leases with Rockdale’s predecessor-in-interest. Rockdale eventually became the lessee under the leases. Five of the leases’ primary terms expired in 2011. Drilling operations also ceased in 2011 and the Pennsylvania Department of Environment Protection determined that the one well that was being constructed was inactive. As such, plaintiffs argued that because of the well’s non-production, the five leases expired in 2011.
Rockdale, however, explained that despite the well’s inactivity, the leases had been extended pursuant to Rockdale’s compliance with the “shut-in” clause within each lease. According to Rockdale, because the shut-in royalties had been tendered to each lessor, the leases did not expire.
In 2018, plaintiffs demanded that Rockdale surrender the leases. Rockdale refused, arguing that the leases remained valid and enforceable. Plaintiffs then filed a complaint in the Court of Common Pleas of Tioga County, Pennsylvania, seeking declaratory relief and quiet title, arguing that Rockdale’s interest in the seven leases was invalid or had expired. Rockdale filed an answer and alleged a counterclaim, seeking a declaration that the leases were held beyond their primary terms through the payment of shut-in royalties. Rockdale moved for partial summary judgment arguing that as a matter of law, it had successfully maintained the lease terms for the five leases by complying with the shut-in clause within each lease.
Plaintiffs argued that because a well can only be deemed shut-in if it was capable of producing hydrocarbons in paying quantities, a question of fact arose as to whether the wells productive capacity allowed Rockdale to invoke the shut-in clause and extend the leases beyond the primary term. Rockdale, however, contended that because the shut-in clause expressly allowed Rockdale to shut in a well when it was “otherwise not producing for any reason whatsoever,” the shut-in clause’s application was not predicated on whether the well is capable of production. The shut-in clause provided as follows:
If during or after the primary term of this lease, all wells on the leased premises are within a unit that includes all or part of the leased premises, are shut-in, suspended or otherwise not producing for any reason whatsoever for a period of twelve (12) consecutive months, and there is no current production of oil or operations on said leased premises sufficient to keep this lease in force and this lease is not otherwise kept in force by other provisions of this lease, 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. Said shut-in royalty shall be paid or tendered to Lessor within ninety (90) days after the next ensuing yearly anniversary of the Effective Date of this lease, and thereafter on or before each yearly anniversary of the Effective Date hereof while the wells are shut-in or production therefrom is not being marketed by Lessee. 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 but failure to properly pay shut-in royalties shall [r]ender Lessee liable only for the amount due and shall not operate to terminate this lease.
The Federal District Court looked at the language of the shut-in clause and held that Rockdale was authorized to invoke the expansive shut-in clause when, among other things, the well was “not producing for any reason whatsoever.” Therefore, plaintiffs could not point to the well’s production capacity as a fact barring judgment on the pleadings. The court noted that Rockdale complied with the shut-in clause. Rockdale tendered to each lessor an annual shut-in royalty. Rockdale “properly exercised its right to maintain the lease in effect by tendering the shut-in royalty payment after the wells that were drilled on the units were ‘not producing for any reason whatsoever.’”
Accordingly, if you, the lessor, are not receiving royalties, but receive a shut-in payment under a shut-in clause of your oil and gas lease, then you need to review the shut-in clause of the oil and gas lease to see under what circumstances the shut-in clause will extend the lease. Failure to comply with those provisions may mean that the lease has expired or been terminated. On the flip side, if the clause is applicable and has been complied with by the lessee, the lease may be kept in effect by the lessee’s compliance with the shut-in clause, which normally requires that a payment, usually a nominal payment, be made by the lessee to the lessor.
If you have questions about your Oil and Gas lease, contact us or call (412) 338-1124.