North Dakota Supreme Court Concludes that a Pugh Clause Controls over the Habendum and Continuous Drilling Clauses

In Robert Post Johnson & A.V.M., Inc. v. Statoil Oil & Gas LP, 918 N.W.2d 58 (N.D. 2018), the North Dakota Supreme Court interpreted an oil and gas lease to resolve a conflict between the habendum and continuous drilling clauses and the Pugh clause.  The habendum and continuous development clauses were part of a form oil and gas lease and the parties separately negotiated a Pugh clause that was added to the lease.

At the expiration of the three-year primary term, production in paying quantities was occurring in only three of eight units that included lands covered by the disputed lease.  The Plaintiffs argued that the Pugh clause terminated the lease as to the lands within the five non-producing units upon expiration of the three-year primary term.  The Defendants asserted that the lease remained in force and effect as to the five non-producing units due to continuous drilling operations.

The Court explained that the general rule is that “an oil and gas lease is indivisible by its nature.”  Id., at 61.  However, a Pugh clause severs the oil and lease “from units where drilling operations or production are not occurring[, but] to make a lease divisible, the Pugh clause must be clear and explicit.”  Id., at 61-62.  In Johnson, the Pugh clause provided:

“Notwithstanding anything to the contrary, on expiration of the primary term of the lease, the lease shall terminate as to any part of the property not included within a well unit or units, as established by appropriate regulating authority, from which oil or gas is being produced in paying quantities and shall also terminate as to 100’ below geologic strata or formations from which production has not occurred during the primary term.”

Id., at 60-61.  The Defendants argued that the continuous drilling operations provision saved the portions of the lease included within the five units that were not producing in paying quantities based upon the North Dakota Supreme Court’s decision in Egeland v. Cont’l Res., Inc., 616 N.W.2d 861 (N.D. 2000) (concluding that “because the Pugh clause was silent to the method of extension, no conflict existed regarding the Pugh clause’s interaction with the habendum and continuous drilling operations clauses of the lease”).  The Court distinguished Egeland because the Pugh clause in Johnson specifically stated that “the lease will terminate at the expiration of the primary term for any part of the property not included within a well unit from which oil or gas is being produced in paying quantities.”  The absence of any language in the Pugh clause to incorporate or reference the habendum or continuous drilling clause was fatal to Defendants argument that the lease was maintained by continuous drilling operations.

Additionally, the Court relied upon Section 9-07-16, N.D.C.C., which provides:

“When a contract is partly written and partly printed, or when part of it is written or printed under the special directions of the parties and with a special view to their intention and the remainder is copied from a form originally prepared without special reference to the particular parties and particular contract in question, the written parts control the printed parts and the parts which are purely original control those which are copied from a form and if the two are absolutely repugnant the latter must be disregarded insofar as such repugnancy exists.”

As a result, because the Pugh clause was not part of the form lease, Section 9-07-16, N.D.C.C. required that the Pugh clause control over the habendum or continuous drilling clauses.  Johnson, 918 N.W.2d at 63.  Thus, the Pugh clauses terminated the lease as to all lands not included within the three units producing in paying quantities at the expiration of the three-year primary term.

The decision in Johnson underscores the importance of careful drafting and review of oil and gas leases and other instruments conveying interests in oil and gas rights.  Failure to carefully draft the Pugh clause in Johnson rendered the continuous drilling clause permitting the lessee to maintain an oil and gas lease beyond the primary term meaningless.  Parties to an oil and gas lease must consider how any additional terms or provisions added to a form oil and gas lease will interact with the remaining provisions in the lease.