In two recent decisions, judges of the Alberta Court of Queen’s Bench have made rulings that freehold petroleum and natural gas leases had terminated. The two cases arose out of different factual circumstances and related to different lease provisions – the default clause and the habendum, respectively. A common theme is that both decisions resulted from applications for summary judgment, showing that a full trial is not always required to obtain a court ruling in lease termination cases.

Sword Energy Inc.: Failure to Respond to a Default Notice Has Dire Consequences

In 1301905 Alberta Ltd. v. Sword Energy Inc., [2013] A.J. No. 190 (Lee, J., February 19, 2013), Sword Energy Inc. (“Sword”) was held to have lost its P&NG lease because it failed to make an effective response to a default notice.

The lessor’s default notice alleged that Sword was in breach of the offset well clause of the lease. That clause places an onus on the lessee to take steps to prevent the lessor’s reserves from being drained by an offset well – a well drilled on a spacing unit laterally adjoining the leased lands – or else to compensate the lessor by paying an offset royalty.

The default clause in this case required Sword to do one of two things with 30 days. It could either:

  1. remedy the alleged breach; or
  2. “commence and diligently pursue proceedings for a judicial determination as to whether the alleged acts or omissions constitute a breach or breaches on the part of the Lessee”.

Sword did neither of these things. Instead, it sent a letter to the lessor denying that it had breached the offset well clause.

The judge did not quote the entire default clause. However, it is apparent that the clause follows a standard Canadian Association of Petroleum Landmen (CAPL) form which provides that the lease shall terminate if the lessee fails to take either of the steps specified in the default clause.

Justice Lee reasoned that the 30-day time limit operated in the same way as a statutory limitation. He held that Sword’s rights under the lease had been “extinguished” or “cancelled” as a result of its failure either to do anything to “remedy the breach” or else to commence legal proceedings, within 30 days of receiving the notice. The only issue left for trial was the quantum of damages payable by Sword for its (assumed) breach of the offset well clause.

The loss of Sword’s lease was a harsh consequence for its failure to make the right kind of response within 30 days of receiving a default notice. In view of the approach the court took, it made no difference whether or not Sword was actually in breach of the offset well clause. The damages for which a quantum assessment was ordered were therefore for a breach of contract which had not even been proven.

In his book, The Oil and Gas Lease in Canada (4th ed., 2008), the late John Ballem reflected as follows: “It is easy to visualize circumstances where the alleged breach would be out of proportion to the loss of an oil and gas lease, which could lead a court to relieve against forfeiture.” (page 279) In an appropriate future case, it would be interesting to see if a court would be prepared to exercise its power to relieve from forfeiture as a result of the operation of this type of default clause.

Locke, Stock & Barrel Company Ltd.: No Production and No Working Operations

In P. Burns Resources Limited v. Locke Stock & Barrel Company Limited, 2013 ABQB 129 (Bensler, J., March 18, 2013), the lessee, Locke Stock & Barrel Company Limited (“LSB”), lost its lease because of two gaps in production exceeding 90 days.

Like the lease considered in the Sword case, the lease in the LSB case followed a form that is in common use in the industry. After the primary term, any cessation in the production of leased substances would result in termination of the lease, subject to certain saving provisions.

Specifically, a proviso to the habendum stated that the lease would continue in force during the period of non-production if drilling or working operations were commenced and prosecuted with no cessation of more than 90 days. Furthermore, time would not count against LSB in either of two further circumstances:

  1. If drilling or working operations were interrupted as a result of any cause beyond LSB’s reasonable control; or
  2. If a well was shut in or suspended or otherwise not produced for any cause whatsoever which was in accordance with good oil field practice.

On the basis of the affidavit evidence before her, Justice Bensler found that there had been no production at all for two periods exceeding 90 days. That left the question of whether LSB had engaged in “working operations” within those 90-day periods. Previous case law establishes that “working operations” must be “activities which are directed to the production of oil”, and that the lessee must expend more than a minimal effort.

Affidavit evidence from LSB’s field operator (as summarized by Bensler, J.) was to the effect that he did no more than attend at the site and turn the pump on and off during those two 90-day periods. She held that these efforts were “minimal and not directed at the production of oil”, and therefore did not qualify as “working operations”.

Finally, she held, on the affidavit evidence, that the failure to produce was not the result of “any cause outside the lessee’s control” or any cause which was in accordance with good oil field practice. She rejected arguments by LSB that the non-production was due to malfunctions in the pump and elevated concentrations of wax and acetate.

The lease was therefore held to have terminated.

Summary; Implications

As these two decisions show, in cases where the continued validity of an oil and gas lease has been called into question a full trial will not always be necessary. Nonetheless, resort to the summary judgment option will not simplify proceedings in all cases. In Desoto Resources Ltd. v. EnCana Corp., [2011] A.J. No. 355, a master granted summary judgment in favour of the lessor, holding that a P&NG lease had terminated. A judge upheld the master’s decision. The Court of Appeal took a different view, holding that there were unresolved issues of fact that required a trial. In that case, therefore, the lessor’s application summary judgment ended up taking additional court time, with greater expense to both parties, than if the matter had proceeded directly to trial.

As discussed in a previous energy@gowlings article (ERCB Rulings on Validity of Freehold Oil and Gas Leases, Ballem and Edwards; Dec./09), other procedural avenues exist in Alberta which can result in binding decisions on the validity of freehold leases. In more than one case, the Energy Resources Conservation Board has suspended a well licence after being convinced that the licence-holder no longer held a valid lease. The Court of Appeal has accepted that the Board has jurisdiction to make such rulings (Desoto Resource Limited v. ERCB, [2008] A.J. No. 1156) and has upheld such decisions on appeal: OMERS Energy Inc. v. Alberta (ERCB), [2011] A.J. No. 954.

The facts of each case involving a problematic freehold lease will dictate which type of procedure is the most appropriate.