What’s the difference, and how do they apply to the Pugh clause?
Every petroleum landman should be very familiar with the Rubberband Clause and the Freestone Rider Clause and how they can affect the future development of the oil and gas lease for both vertical and horizontal well development. These two clauses are also referred to as a ‘Pugh Clause.’ In order to accomplish this, the landman must understand what a Pugh Clause is and how it is applied to depths and surface areas which are only associated in a Pooled or Spaced Unit or in a Unitized Lease.
What is the Pugh Clause?
A Pugh Clause generally provides that production from either a unitized or pooled area located on or including a portion of the leased lands will not be sufficient to extend the primary term for the entire leasehold. Further, if the lessee has not created operations to extend those portions of the lease outside of the pooled or unitized portion of the leased lands (such as continuous development, payment of delay rentals, etc.), the lease will expire as to these excluded lands.
Here are some comparisons that every petroleum landman must know:
- Surface Area Pugh Clauses or Vertical Pugh Clause
- Depth Pugh Clauses or Horizontal Pugh Clause
- Pairing the Pugh Clause with the Continuous Development Clause
- Comparing the Pugh Clause to the Wellbore Only Pugh Clause
- The Pugh Clause and the Express Development Clauses
- Pugh Clause vs. Retained Acreage Clause
A typical oil and gas lease allows the lessee to maintain the entire lease as being held by production beyond the primary term when only a portion of lease was included in a pooled or producing unit. In the absence of specific lease provisions to the contrary, production from any tract in a pooled unit or production unit is to be considered as production from the entire leased premises for the purpose of extending leases beyond their primary term on all the tracts involved. The typical oil and gas lease with a pooling clause provides that the entire lease tract will be considered held by production (HBP), regardless of whether that production is on the pooled area or on some area of the tract that has not been unitized.
In addition, the petroleum landmen must understand how the Pugh Clause operates in each lease and how it may impact other clauses contained in the lease, such as the shut-in royalty clause, the continuous drilling clause, and the retained acreage clause. When drilling schedules have been altered, postponed, or shifted, it is critical that you understand when Pugh Clauses will necessarily cause leasehold to expire (unless there is a ‘force majeure’ provision in the lease that provides for this type of alteration).
The Rubberband Clause
"If all or a part of the leased premises is included in a production unit or units (whether a pooled or unpooled), then, at the end of the primary term, only the land in the production unit or units shall continue to be held by the lease. In the event that the land is included in more than one production unit, then each production unit shall be view for purposes of the lease as individual and distinct leases and the lease provisions apply separately to each."
This clause provides for the creation of a production unit, whether it is pooled or not, with the applications of the vertical severance clause. And it makes each production unit a separate lease. Production or operation from one production unit cannot continue the lease on a production unit where production or operations have ceased. Each production unit will revert to the landowner as operations or production ceases. This also means that during the lease term, the horizontal severance clause applies on a unit-by-unit basis. Thus, a deep well drilled on one production unit will not hold any land below a shallow well drilled on another unit. Generally, you’ll see this clause used on larger tracts of land.
NOTE: If there is no notice or release of lands filed in the county records where the leases are located it could cause a cloud on the title to exist, especially if other leases with later dates are found in the chain of title.
The Freestone Rider Clause
This clause provides for the creation of the pooled unit or units a condition for the application of the Pugh Clause to the lease. If no pooled unit is created, there is no vertical severance. An alternative on much smaller tracts is "all or nothing." If any part of the leased premises is included in a unit, then all the land much be included.
"If a part of the leased premises is included in a pooled unit or units, then, at the end of the primary term, only the land that is included in the pooled unit or units shall continue to be held by the lease."
Although the Pugh Clause is a common provision found in many leases today, there is no “industry standard” Pugh Clause. However, in Oklahoma, North Dakota, Mississippi, and Arkansas there are “statutory” Pugh Clause rulings.
- In Oklahoma the statutory Pugh Clause went in effect on May 27, 1977 (Title 52 O.S. Section 87.1(b)) which provides that “in case of a spacing unit of one hundred sixty (160) acres or more, no oil and/or gas leasehold interest outside the spacing unit involved may be held by production from the spacing unit more than ninety (90) days beyond expiration of the primary term of the lease.”
- The North Dakota statutory Pugh Clause applies to leases that have been committed to a compulsory unit that has lands inside the unit boundary and lands outside the unit boundary. “After two years from the effective date of the order of the commission creating and approving the unit or the expiration of the primary term of the lease, whichever is the later date...lands outside the unit area may be maintained in force and effect only in accordance with the terms and provisions contained in the lease.”
- Mississippi Pugh Clause provides that if an oil and gas lease contains lands partially within and partly outside a compulsory field-wide unit, production from the unit shall not hold the lands outside the unit. The exception to the rule applies if the lessee commences drilling activities on the land outside the unit within one year from the date of the determination of the unit or before the end of the primary term of the lease, whichever is a longer period of time.
- The Arkansas Pugh Clause statute applies to oil and gas leases that were executed on or after July 4, 1983. Drilling operations or production from lands falling within a pooled unit shall maintain the lease only as to the lands where the production occurs. Those leased lands falling outside the sections or pooling unit will not be extended into the secondary term of the lease. There is an exception to this rule also. The rule does “not apply when drilling operations have commenced on any part or lands in sections or pooling units under the lease within one year after the expiration of the primary term, or within one year after the completion of a well on any part of lands in sections or pooling units under the lease.”
NOTE: Louisiana does not have a statutory Pugh Clause. However, they do require that all state leases, which have been executed after August 1, 1991, contain a type of Pugh Clause. The language in this clause permits the lessee to maintain lands outside a unit for two additional years past the primary term of the lease, if the lessee submits rental payments during that two-year term.
The first Pugh Clauses were Surface Area Pugh Clauses (vertical Pugh Clause), essentially created to cause the release of acreage based on surface area, stating that following the expiration of the primary term, or any extensions thereof as provided for under the lease, the lease would expire as to all acreage not included in a pooled unit or producing unit. That portion of the lease within the area included in the pooled unit or producing unit, from the surface to all depths, would be maintained HBP.
“Production from or operations on a pooled unit or units including a portion or portions of the leased premises will maintain this Lease in force only as to the acreage included in the unit or units. On acreage not included in a unit or units, the Lease may be maintained by any of its other provisions.”
Surface Area Pugh Clauses allow the lessee to maintain non-producing formations that might be productive but weren’t being developed. This led to the development of the Depth Pugh Clause, which typically provided for lease expiration either (a) below the deepest producing zone or (b) as to non-producing formations. With the advent of horizontal wells, these clauses also commonly act to release depths above and/or below the actively producing formation(s).
Two common examples of a Depth Pugh Clause
"At the expiration of the primary term of this lease or at the end of the extended period for continuous development provided below, whichever is later, this lease shall also terminate as to all rights, strata and horizons situated below one hundred feet (100’) below the stratigraphic equivalent of the deepest depth drilled in a well or wells drilled, producing and located on the leased premises or on lands pooled therewith.“
“The production of oil or gas from any formation, zone, or horizon in and under a pooled oil unit or a pooled gas unit formed pursuant to the printed provisions of this Lease will maintain this Lease only as to that portion of the lease premises located within the pooled unit and only as to the formation, zones, or horizons from which production is being obtained. This Lease may be perpetuated as to nonproductive formations, zones, and horizons, and that part of the lease premises located outside of the pooled unit under other provisions of this Lease.”
Is it a Vertical or Horizontal Pugh Clause – and how are these terms defined?
Some industry organizations, courts, and reference materials refer to a Surface Area Pugh Clause as a “Vertical Pugh Clause” (AAPL; NARO; Schlumberger Oilfield Glossary; Sandefer v. Duhon, 961, F 2nd 1207, Court of Appeals, 5th Cir., (1992)). This definition appears to have gained more traction in recent years.
However, others refer to a Surface Area Pugh Clause as a “Horizontal Pugh Clause” (see Roseberry v. LL&E, 470 So. 2d 178 (La. Ct. App. 1985)). In exactly opposite fashion, some industry organizations, courts, and reference materials refer to the Depth Pugh Clause as a “Horizontal Pugh Clause” (see Questar Exploration and Production Co. v. Woodard Villa, Inc. et al., Court of Appeals of Louisiana, Second Circuit, 123 So.3d 734 (2013)).
The Wellbore Only Pugh Clause releases all acreage outside the wellbore after the primary term and extensions expire. This type of Pugh Clause has been a more recent development, and it is typically coupled with a depth Pugh Clause. The wellbore only Pugh Clause is typically seen only on leases that reflect a large acreage position in a lucrative field which gave the landowner significant negotiation power in lease negotiations.
With the advent of horizontal wells, Pugh Clauses have been modified to accommodate the horizontal drilling and completion process. The landman must be cautious when writing a Pugh Clause that pertains to a horizontal well. For example, trying to adapt or customize a Pugh Clause written for vertical wells does not work well for horizontal wells.
Many mineral owners have attempted to obtain Pugh Clauses that release all acreage outside of the horizontal strip drained by the hydraulic fracturing process, conceptually akin to a wellbore only Pugh Clause for a vertical well. The actual language used for these clauses can vary greatly with some clauses creating complex formulas including length of the lateral line to determine acreage allocation for each horizontal well. Other clauses simply establish a stated number of acres to be allocated around each horizontal well's lateral line.
Depth Pugh Clauses may also be added to restrict acreage to the target zone or zones. Further, when a shale play acreage includes possible vertical well drill sites as well, the issue of Pugh Clauses becomes further complicated.
We determined that the Implied Covenant of Development alone was not adequate to solve our problems of less-than full development of leased acreage. Lawrence Pugh came up with the Pugh Clause, which has been modified and refined to suit our purposes, to include many variations on vertical, horizontal, wellbore, and horizontal well Pugh Clauses. Most leases now include “express development clauses” in conjunction with the Pugh Clause.
The express development clauses generally fall into two categories:
- Continuous Development Clauses.
- Retained Acreage Clauses.
Pugh Clause vs. Retained Acreage Clause
Generally speaking, the Retained Acreage Clause is a lease provision that authorizes the lessee to retain an agreed amount of acreage around a producing well or producing unit after the balance of the lease automatically terminates, which may occur at the end of the primary term or at the end of continuous development. This clause is closely related to the Pugh Clause. However, the Retained Acreage Clause does not require pooling in order to be effective. Pugh Clauses have sometimes been referred to as a type of Retained Acreage Clause. Retained acreage clauses are often paired with "Depth Pugh" clauses in order to limit the number of depths that a Lessee can maintain under lease after the expiration of the primary term.
Pairing the Pugh Clause with the Continuous Development Clause: Here is an example of a Pugh Clause triggered at the end of primary term as may be extended by continuous development:
“At the expiration of the Primary Term or the conclusion of the continuous development program, this Lease shall terminate as to all of the leased Oil and Gas rights in all formations below the depth of 100 feet below the stratigraphic equivalent of the base of the deepest formation from which the Lessee is then producing Oil and/or Gas in paying quantities from a well or wells located on such proration or producing unit.” Community Bank of Raymore v. Chesapeake Expl., L.L.C., 416 S.W. 750 (Tex. App.—El Paso 2013, no pet.)
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