In Wagner & Brown, Ltd. v. Sheppard, 282 S.W.3d 419 (Tex. 2008), the Texas Supreme Court held that the termination of Sheppard’s lease (Sheppard was the Lessor) did not terminate her participation in a unit into which her lease had been pooled, finding that the unit agreement pooled certain “premises” and “lands,” not just the leased interests. This made Sheppard a working interest owner after the lease expired, liable for a share of all unit expenses – not at all what Sheppard expected when signing the lease.

Harkening to Sheppard’s result, on February 12, 2015, the Eastland Court of Appeals obviated a horizontal Pugh clause, in part because of the leased tract’s inclusion in a pooled unit. The case is pending as: David Albert d/b/a David Albert Oil & Gas and ABX Oil & Gas, Inc. v. Dunlap Exploration, Case No. 11-12-00064-CV.

Some background facts are needed to understand the Eastland Court’s decision. In 1995, certain trusts and individuals signed a lease for the larger of two contiguous tracts that contained a horizontal Pugh clause. The Pugh clause declared that, at the end of the primary term, the lease “also shall expire as to all depths below the deepest depth drilled theretofore established in a well located on lands covered by this lease.”

After drilling commenced, but before the expiration of the primary term, the lessees and the lessorsexecuted a pooling declaration which pooled the production from gas wells on the contiguous tracts “as to all depths covered by the leases.” The deepest well on the larger tract (with the Pugh clause) was 4,135 feet. Pursuant to a farm out agreement, other wells in the pooled unit had a production interval of 4,164 to 4,167 feet. Albert/ABX argued that Dunlap was not owed production payments from these wells because of the Pugh clause. Thus, the crux of the dispute was whether the Pugh clause effectively terminated the lease as to depths below the deepest depth drilled.1ABX/Albert said it did; Dunlap said it did not. The court found that the parties “executed the pooling agreement during the primary term … when all depths continued to be covered by the lease,” and “[w]e agree with Dunlap that the depth limitations of the horizontal Pugh clause were never triggered because the first production from the unit occurred before the primary term … ended. In this regard, the lessors agreed to the terms of the pooling agreement and its resulting modification of the … lease by their execution of the pooling agreement.”

The pooling declaration did not include a clause making it subject to the terms of the lease. (The only “subject to” clause related to the lease covering the smaller contiguous tract in the pooled unit.) This leaves open the possibility that an appropriately placed “subject to” clause could lead to a different outcome, but that is not entirely clear from the Court’s reasoning. Alternatively, a lessor might decide not to sign a pooling declaration. Presumably, the lessors in this case joined in executing the pooling declaration because the lease contained a provision “that the lands covered by such lease shall not be pooled without the written consent of lessor.”

There is one other facet of the case that may help explain its result. The putative lessees, one with the deep rights and outside acreage, and one with the shallow rights and 160 acres out of the 251 acre lease had previously entered into a ratification agreement. In an exhibit to that ratification agreement, they provided that the agreement modified the lease terms (it’s not clear that the ratification agreement was signed by the lessors) and included a provision setting out the acreage to be assigned to wells according to formation and depth. That same provision set out acreage for formations well below the deepest depth previously drilled. The court concluded that the ratification agreement supersedes “any conflicting terms in the two leases … [and] negates the horizontal Pugh clause contained in the … lease (on the larger tract).”

The lesson of Albert may be that Texas courts are leaning in favor of preserving pooled units over lease termination clauses and the careful drafter must be more explicit in drafting the pooling provision in the lease and limiting the reach of the pooling declaration.