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Indiana Court of Appeals: Use or lose oil and gas lease

As drilling for petroleum products in the Midwest becomes more prevalent than it has been for decades, existing oil and gas leases will become more valuable to the holders of those leases.  Even though an owner’s property may appear to be burdened by an oil and gas lease, a recent Indiana case shows that such leases may terminate if the lessee fails to abide by all of the terms of the lease.

In L.C. Neely Drilling and Maverick Energy, Inc. v. Hoosier Energy Rural Electrical Cooperative, a predecessor of Maverick Energy had entered into an oil and gas lease with the owner of a large tract of land in Sullivan County.  The lease, as amended, provided that the lease would last for a period of five years and would continue after that period as long as gas was being produced and sold from the land.  However, if no gas production royalties were being paid at the expiration of thirty-six months after the commencement of the lease, the lease would continue from year to year upon payment by Maverick Energy of advance royalty payments equal to $5 per acre; such advance royalty payments were due within thirty days after expiration of the 36-month period and on each anniversary of the expiration of that 36-month period.

As of January 2012, no production royalties had been paid, and Maverick Energy did not pay the required advance royalty payment by the January 3 deadline that year.  In late January 2012, Maverick Energy sent a check to Hoosier Energy for the advance royalty payment.  Hoosier Energy returned the check and notified Maverick Energy that the gas and oil lease had terminated because the advance royalty payment was not timely.

The trial court granted Hoosier Energy’s motion for summary judgment, thereby ruling that Maverick Energy’s lease had expired.  In reviewing Maverick Energy’s appeal of the ruling, the court of appeals examined the differences between “drill or pay” provisions and “unless” provisions in oil and gas leases.  If a lease contains a “drill or pay” provision, the lessee must commence production or pay advance royalties, but the failure to do one or the other is only a breach of the lease and not a cause for automatic termination of the lease.  If a lease contains an “unless” provision, the lease will terminate automatically unless the lessee either commences production or pays the advance royalties by the prescribed date.

Since Maverick Energy’s lease stated that the lease would continue only if Maverick Energy paid the advance royalty payments by the date required, the court of appeals found the parties’ intention to be that the lease would terminate if Maverick Energy failed to comply with the requirements for continuation of the lease.  Maverick Energy’s failure to make the required payment by the prescribed date resulted in a termination of the lease–and not a default under the lease which Maverick Energy could have cured within thirty days after notice.

It is important for both the holders of oil and gas leases and the owners of property burdened by the leases to be aware of the specific provisions in such leases.  Depending on the circumstances, it is possible that an owner of a property burdened by an oil and lease may not have to honor that lease if the lessee has failed to abide by the terms of the lease.  Owners and lessees under oil and gas leases should also be aware of the provisions of Indiana Code §32-23-8, which permits the property owner to void  oil and gas leases after a period of one year has elapsed since the last payment of rentals or operation for oil or gas have ceased.

By: George Abel

 

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