Extension of the Primary and Secondary Terms

The primary and sometimes the secondary terms of the lease may be extended contractually via shut-in provisions, dry-hole provisions or cessation-of-production provisions. Most leases will contain all three.

Shut-in provisions allow the lease to remain in effect (sometimes during both the primary and secondary terms) whenever gas from a producing well is not, for some reason, being sold or used by the lessee. In other words, a well that is shut-in is still classified as a producing well under the lease provisions and the lease will not terminate. However, a shut-in royalty (or some other stipulated sum generally approximating the value of the delay rental payment) must be paid annually to keep the lease in effect.

Dry-hole provisions, on the other hand, can only extend the primary term of the lease. Basically the lease will provide that if oil or gas has not discovered when a dry hole is struck, the lease will not terminate even though the primary term has expired in the interim if the lessee renews drilling or re-working operations within 60 days (or some other specified period) thereafter. In the event the primary term has not expired and more than fourteen months still remain, the lessee has two other options available. He can either pay the next delay rental payment which comes due more than 60 days after the dry hole was discovered or commence drilling or re-working operations on or before the same date. If less than fourteen months remain in the primary term when the dry hole is discovered, the lease will continue in force to the end of the primary term even though the lessee operations remain idle and no delay rentals are paid.

Cessation-of-production provisions correspond quite closely to the dry-hole provisions, but apply only after oil or gas has been discovered. If oil and gas production should cease for any reason, the lease will not terminate if the lessee again follows one of the three options described in the dry-hole provisions. In this instance, though, there are no exceptions accorded under the fourteen-month rule.

It is quite possible for the primary term to be extended indefinitely via the dry-hole provisions. If the lessee has not discovered oil or gas and is in the process of drilling or re-working operations when the primary term expires, the lease will continue in force for so long as the lessee faithfully renews drilling or re-working operations within 60 days after striking each dry hole. However, if a producing well should subsequently be discovered and its production later ceases, the lessee must strike another producing well stemming from operations commencing within 60 days thereafter or the lease will expire. The discovery of a subsequent dry hole will terminate the lease according to its terms.

Most landowners have little quarrel with dry-hole and cessation-of-production provisions since in both cases oil and gas are being diligently sought. However, landowners may question the shut-in provisions, especially where no apparent reason for the harboring of gas (or possibly oil) exists.

While shut-in provisions may not be used as extensively as in the past, landowners should be aware of the following alternatives that clarify its possible usage.

1. Make sure shut-in royalties are required during both the primary and secondary terms of the lease.
2. Place a time limit on the shut-in clause--no more than three years or three years beyond the primary term.
3. Escalate the shut-in royalty for each year the gas or oil is shut in.
4. As an alternative, permit the shut-in clause to continue after a stated period but only for a given number of acres immediately surrounding the well—e.g., 40 acres. The rest of the leased area will revert back to the lessor-landowner. (This provision may be qualified depending on the reasons for the shut-in).
5. Always phrase the necessity of making the payments under the shut-in provisions in optional terms (may or can) and not in obligatory terms (shall or will). In some states a breach of the former terminates the lease whereas a breach of the latter does not. The only recourse left to the landowner in the latter case is to sue the producer for breach of contract.
6. Specify the circumstances when the shut-in clause may be invoked—e.g., for lack of market, available pipeline, or government restrictions, or permit the shut-in only when, in the lessee's good faith judgment, it is economically inadvisable to produce and sell for the time being.
7. Automatically terminate the shut-in provision whenever a well located on adjacent land, situated within a certain number of feet of the leased premises, and completed within the same producing reservoir, begins producing and selling gas in marketable quantities.