Introduction
Last spring, with the pandemic in full force, through IL-2020-21, the Government of Alberta announced a one-year extension of tenures on Crown leases expiring between March 20, 2020 and March 31, 2021, in recognition of the “multiple challenges currently being faced by the [energy] sector”. The one-year extension implemented under section 8 of the Mines and Minerals Act means that any leases issued by the Government of Alberta and expired between the specified dates, were and are automatically extended for one year. In this time of pandemic-related challenges, this has given Crown lessees welcome breathing room in relation to steps required to maintain their leases in good standing and without penalty.
However, freehold lessees do not have the same breathing room. Rather, lessees holding non-Crown leases must carefully consider the specific provisions of their leases to determine whether they can be relieved of their obligations without triggering a default or termination under their leases.
As a starting point, lessees should be familiar with their obligations under the existing lease. All forms of oil and gas lease require drilling in the initial term in order to extend the lease past its primary term. In some cases, that drilling can be deferred by the payment of a deferred drilling payment, but that option is only available within the primary term. If no operations have been commenced to drill a well during the primary term, then the lease will expire at the end of that term.
Most leases also have some form of continuous production obligation. Where continuous production is not achieved, some leases provide for the ability of the lessee to make payments to extend the lease, but absent these provisions, the lease terminates.
Relief from continuous production: perform or pay
Shut-in/suspension clauses
While newer forms of leases allow the payment of a shut in well payment where production has ceased or been suspended for longer than the allowable period, some older forms of lease do not have that option.
For example, the August 31, 1990 PanCanadian Lease allows for the continuation of the lease through payment of a shut-in royalty in the case of shut in wells. Similarly, in effect, the Form of Natural Gas Lease deems shut in wells to be producing wells with royalties paid in the amount of stipulated delay rentals. The 1988 and 1991 CAPL leases in both Manitoba and Saskatchewan, among others, also provide for the continuation of the lease in the event of shut-in or suspended wells.
On the other hand though, older leases such as the CPR PNG Lease 4494 (October 1959), the CPR Lease Form 564-3-3M-3-58-AW (January 1958) and the CPR Lease Form 564-2-1M-8-55-AW (April 1956) and others, do not have shut-in well clauses and thus the lessee under these leases has decreased protection from forfeiture for non-production, particularly in the cases of shut-in wells.
Offset clauses
All oil and gas leases contain some form of offset drilling provision. That provision requires the lessee to commence drilling operations on the leased lands within a specified time frame following production being obtained on a well adjoining the leased lands. Generally, leases will require drilling to the horizon from which production is obtained on the offsetting lands, and production must be commenced within a specific number of days. Leases such as the 1999 Alberta CAPL Petroleum and Natural Gas Lease and Grant and the 1991 Alberta CAPL Natural Gas Lease contain provisions allowing for the payment of compensatory royalties in lieu of offset drilling obligations. That said, similarly to the case with shut-in well clauses, often older forms of leases do not offer this option to lessees. In these cases, where a lessee is unable or unwilling to drill and offset well, it must surrender the lease or relevant portion thereof.
Where performance is impossible
In light of the foregoing, what options are available to the lessee the options available to the lessee that is unable to meet these obligations and cannot avail themselves of the option to pay their way out of the problem under the terms of the lease?
Force majeure
While the rights and options of lessees are constrained to the terms of the lease, scrutiny of some may offer other remedies. It is critical that a careful review of the language of the lease be undertaken. Alternatives to or relief from performance may be found, for example, in any force majeure clause, which are common in newer forms of leases. These clauses, where present in the lease, provide relief for lessees in the event of circumstances or events beyond the lessee’s control.
That said, the concept of force majeure is purely contractual. There is no inherent right to avoid one’s obligations under a lease where not expressly provided for in a lease. Even where a force majeure clause is present, its application is highly fact-specific – that is, it is dependent on the interplay between the language of the clause and the factual circumstances giving rise to the lessee’s intention to rely on same. Central to determining whether a force majeure clause will apply is the question of whether the claimed “supervening event” can be said to have caused the lapse in performance by the lessee. If this causal link cannot be conclusively established, the lessee may not be able to avail itself of the relief afforded by the force majeure clause.
After careful scrutiny courts have shown a willingness to provide some force majeure-type relief in the event of a lack of an economic or profitable market, or in the case of low commodity pricing, however this is not to be read as a blessing for lessees to suspend production for speculative purposes, in the hopes of achieving higher profits later. In these instances, courts have not hesitated to deem the lease terminated.
It should also be noted that the common law standard for whether force majeure relief should be granted is whether the supervening event has rendered performance impossible. Lessees who claim that they cannot perform under the lease because of increased costs, will generally not find adjudicators to be sympathetic to these cries. Courts have also recognized an obligation on the lessee to diligently recovery from the temporary supervening event. Failure to take adequate steps to recover will not prevent a lease from terminating on its own terms. That is, even if protection is afforded to a lessee on account of any force majeure clause, this relief must be seen as a fleeting assist and not a permanent deferral of its obligations under the lease.
Default
It is worth nothing that where there is a legitimate claim in respect of default, commencing a litigation action to determine the fact of default is an option available to lessees. While it is not advisable to use the court process as a delay tactic (frivolous or vexatious actions can have adverse costs and other consequences), the practical reality is that in the current judicial climate, actions are taking several years to proceed through to completion
Takeaway
The current global and economic crisis has presented unique challenges for all industries. For freehold oil and gas lessees, the challenges are particularly unique. The lessees, who are not keenly aware of their obligations under leases governing their lessor-lessee relationships, are particularly at risk of losing those leases, particularly if they have been forced or chosen to interrupt production, or shut in or suspend wells. Lessees must not assume that their leases are continued by virtue of continued payments to lessors, or that force majeure-type relief is available to them or automatic. It would be prudent for all freehold lessees, especially those facing a slow-down in operations and production, to undertake a comprehensive review of their leases and consider whether they are taking sufficient action to preserve their rights under the leases, in order to avoid unintended and costly termination of same.
