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On April 9, 2021, the Supreme Court of Texas concluded that a contractual provision defining “drilling operations” applied to a lessee’s operational activities, rendering them sufficient to comply with the lease’s continual drilling program. Contrary to requiring the spudding of new wells to hold the relevant portions of the lease, the Court opined that the lease’s definition of “drilling operations” applied to the entirety of the lease, and allowed the lessee to hold non-producing tracts based on operations other than spudding wells. This case provides further precedent for the application of the principles of contract interpretation in oil and gas leases, and demonstrates that lease language – in this case, a definition – can apply throughout a contract to control the parties’ agreements absent clear expression to the contrary.

Authors: Lucas Liben Nicole Soussan Caplan Gina M. Kantos

Summary

Sundown Energy LP, et al. v. HJSA No. 3, LP arises from a dispute regarding the definition of “drilling operations” sufficient to maintain non-producing portions of an oil and gas lease. The parties’ lease contained a “continuous drilling program” provision, which required “drilling operations” to maintain the non-producing lease tracts. “Drilling operations” was not a defined term in that provision, but was defined elsewhere in the lease. HJSA filed suit against Sundown, arguing that pursuant to the continuous drilling program, Sundown was required to spud-in new wells prior to the expiration of certain time periods, and that Sundown had failed to do so. Sundown counterclaimed, asserting that its interests in non-producing tracts were maintained so long as it engaged in “drilling operations,” defined to include additional operational activities – not merely spudding-in new wells.

The trial court granted partial summary judgment for Sundown, finding that the contractual definition of “drilling operations” applied throughout the lease, and as a result, Sundown maintained its lease on the non-producing tracts by engaging in operational activities despite not having spudded-in a new well. A divided court of appeals partially reversed the decision of the trial court, concluding that the provision at issue “assigns a more specific definition of ‘drilling operations’ that controls over the general definition” provided elsewhere in the lease. The dissent observed that the parties had agreed on the definition of “drilling operations,” and determined that this definition applied “whenever” the term was used in the contract.

A unanimous Supreme Court affirmed the trial court’s grant of partial summary judgment, holding that the definition of “drilling operations” contained in the contract applied to the continuous drilling program provision. The Court reasoned that the contract specified this definition applied “whenever” the term “drilling operations” was used in the lease. Further, the clause at issue clearly used the term “spud[ding]-in” to discuss the first continuous development well and the term “drilling operations” thereafter, demonstrating the parties’ intent for the two terms to have different meanings.