In 2005, Chesapeake Exploration, L.L.C. (Chesapeake) and Anadarko Petroleum Corp. (Anadarko) entered into an oil and gas lease with Community Bank of Raymore (CBR) covering approximately 16,000 acres in Texas, which was divided into four separately identified blocks. During the lease's primary term, Chesapeake drilled thirteen producing wells on Block Two, and when the primary term expired, the base of the deepest producing formation was located 5,672 feet below the surface of Block Two. After expiration of the primary term, CBR requested that Chesapeake release the mineral rights to all formations on Block Two found at depths greater than 5,672 feet below the surface. However, when Chesapeake refused to release the mineral rights, CBR sued for a declaratory judgment and breach of contract.
The issue before the court was whether the right to extract minerals found deeper than the stratum or level from which production had been secured terminated when the lease's primary term expired. The Court of Appeals of Texas concluded it did not.
CBR asserted that the horizontal Pugh clause had terminated the mineral rights to the undeveloped, deeper formations because there was no production in paying quantities from these formations when the primary term expired. The Pugh clause states: "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." However, the Court of Appeals agreed with the defendants' argument that the termination clause "never sprang into life" because they had maintained the lease beyond the primary term by securing production in paying quantities from Block Two's existing wells and by developing Block Two in accordance with the lease's continuous development clause.
CBR's second argument was that the defendants had triggered the lease's severance clause, which effected a partial termination of the deep drilling rights as to the areas of the lease in which defendants had already achieved production at the expiration of the primary term. Thus, CBR contended that because Chesapeake was not engaged in continuous development of every producing stratum within Block Two, the Pugh clause terminated the lease rights to the undeveloped formations below those producing units. The court concluded, however, that because there had been no cessation of continuous development, the severance clause had not been triggered.
This case provides support for lessees attempting to hold on to the entire mineral estate in the lease, and serves as a warning to lessors that, if they want to lease only certain strata, their lease must express that intent.