Drilling Down on Termination Clauses in Oils and Gas Leases L.C. Neely Drilling, Inc. v. Hoosier Energy Rural Electrical Cooperative, Inc., 8 N.E.3d 251 (Ind. Ct. App. 2014)

The Indiana Court of Appeals recently issued an opinion explaining the difference between two common types of termination clauses in oils and gas leases. The first, known as a “drill or pay” clause, obliges the lessee to either commence production within a certain timeframe or pay advance royalties, but does not operate to automatically terminate the lease in the event of a breach. The second, called an “unless” clause, provides that the lease will automatically terminate if the conditions are not met.

In this case, an oil and gas lease was amended to include a provision requiring payment of advance royalties be made within a certain timeframe if neither actual production nor shut-in gas royalties were being paid (the “Advance Royalties Clause”). The operative effect of this provision was to permit the lessee to renew the lease from year-to-year by timely paying advance royalties in the proper amount. When that amendment was made, there was no change to the demand clause which stated that the lease would terminate upon the occurrence of certain conditions (“Demand Clause”). One of the conditions was the nonpayment of any amount due within ten days following a demand for payment. However, the Demand Clause made reference to “other termination provisions.”

The court explains that the lessor did not need to make a demand to the lessee because the Advance Royalty Clause was another termination provision within the lease and was one of the “other termination provisions” referenced in Demand Clause. When the lessee failed to timely pay the proper amount of advance royalties, the effect was an expiration of the lease by operation of its terms rather than by an action of the parties to the lease. The court determined that the terms of the contract were clear and there was no need to resort to extrinsic evidence. The outcome of this case reinforces that courts will give effect to the parties’ intent and will interpret oil and gas leases according to the plain meanings of their terms.

Jeremy Fetty is a partner in the law firm of Parr Richey Obremskey Frandsen & Patterson with offices in Lebanon and Indianapolis. He often advises businesses and utilities (for profit, non-profit and cooperative) on organizational, human resources, and transactional matters and drafts and reviews commercial contracts.

The statements contained herein are matters of opinion and general information only and are not to be considered legal advice and should not be construed to form an attorney-client relationship. If you have any questions regarding this article, please contact an attorney.