In Stewart Estate v. TAQA North Ltd.[1], Justice Romaine of the Alberta Court of Queen’s Bench dealt with several important issues relating to freehold oil and gas lessees.  Aside from the issues which always arise in such cases (lease termination and remedies), this decision also dealt with time limitations and the “leave and licence” defence that may be available in some cases, as well as the question of whether a toplessee, as promoter of the litigation, can be liable for the tort of maintenance.  This case comment will focus on the court’s decision regarding the continued validity of the leases and the appropriate remedies to be given to mineral owners if (contrary to the court’s decision) the lease had been found to have terminated. 

The Defendant lessees had drilled a gas well on the leased lands. The well was subsequently shut in, and production suspended, for a period of over five years following a downturn in the gas market.  After the period of shut-in, gas prices improved and production resumed.

Each lease was for a primary term of ten years, continuing thereafter so long as there was production.  An ‘ameliorative subclause’ (the third proviso to the habendum in most Canadian oil and gas leases) was to the effect that, if production from the lands was suspended due to “a lack of or an intermittent market” or “any cause whatsoever beyond the Lessee’s reasonable control”, the period of non-production would not be counted against the lessees.[2]

The main issue before the Court was whether the cessation of production from the well fell within the scope of the third proviso.  Justice Romaine held that it did.  The leases were therefore valid.

Interpretation of “Lack of or an Intermittent Market”

The evidence at trial indicated that, although there was a market for gas during the five-year shut-in period, the lessees would have operated this particular well at a loss if, during the shut-in period, they had pursued the gas contracts that were then available.   Justice Romaine found that the phrase “a lack of or intermittent market”, read in its proper context, should be interpreted to mean lack of or an intermittent economical or profitable market.  This issue had arisen in previous cases but had never been determined definitively.  In Justice Romaine’s view, freehold oil and gas leases should be interpreted having regard to their commercial purpose, which is to allow both parties to profit from the agreement: the lessor by obtaining royalty payments and the lessee by selling its product assuming a successful well.

The mineral owners had argued that interpreting “a lack of or intermittent market” to include an economical or profitable market was unreasonable because a lessor would never agree to tie its land to a lessee beyond the primary lease term for a speculative purpose only.  Justice Romaine rejected that argument emphasizing that, in the present case, the well had produced for a number of years before  being shut in and had earned revenues that resulted in royalties being paid to the mineral owners.

Interpretation of “Any Cause Whatsoever”

As a further reason for upholding the leases, the Court found that the drop in natural gas prices was not foreseeable and therefore fell within the ambit of the phrase “any cause whatsoever beyond the Lessee’s reasonable control”.  These words were not limited to “acts of God” or “supervening” type events that make performance impossible.

The Court distinguished Canada-Cities Service Petroleum Corp v. Kinimonth[3], in which the Alberta appellate court had held that municipal road bans, which had prevented the lessee from getting its supplies to the wellsite, could not be regarded as a cause beyond the lessee’s reasonable control.  In Justice Romaine’s view, a downturn in the price of gas is not inevitable or foreseeable in the same way as the seasonal road bans that were at issue in Kinimonth.

Remedies

Justice Romaine went on to consider the appropriate remedy should the appellate court approve an appeal and find the leases to have been terminated.

The remedy that is selected can make an enormous difference in dollar terms.  The possibilities include: restitution for all revenues the lessee has earned from the well for the entire period of production up to the date of trial, less only transportation costs; restitution from the date the Statement of Claim was issued;[4] and damages equal only to the bonus consideration and the royalties the mineral owners could have earned if (free of the defendants’ leases) they had been able to lease their lands to another oil company.[5]

Given the lack of any persuasive evidence of bad faith or cynical over-holding on the part of the defendant oil companies, Justice Romaine concluded that the appropriate measure of damages would be the royalty-plus-bonus approach adopted by the Saskatchewan Court of Appeal in Williston Wildcatters and Justice Kent in Freyberg.[6]

Despite some evidence that the issue of lease validity had been raised with the defendants before the  litigation was started, the Court found that (assuming they had been producing under invalid leases) the defendants should be regarded as innocent tortfeasors.  The defendants had consistently maintained the validity of the leases, and the issue of lease validity was not clear-cut.  According to the Court, that finding precludes the harsh remedy of disgorgement of profits.

Justice Romaine also felt that the royalty plus-bonus-approach was appropriate in this case because the evidence suggested that the Plaintiff mineral owners lacked any intention to exploit the property themselves.  Williston Wildcatters stands for the proposition that where the plaintiffs are persons who could not (or would not) extract the resources themselves, but would have procured a third party to do so, the damages awarded should be limited to the royalty the plaintiffs would have received from the third party.

Justice Romaine recognized that the royalty approach to damages will leave a defendant with the profit it would have received had it acted lawfully.  However, she preferred that result to an outcome which would give the plaintiffs a windfall.  It is possible she was influenced by the fact that, in the case before her, the windfall would not all have gone to the freeholder landowners but would have been shared with the top-lessees, the instigators and promoters of the litigation.

Summary

This case serves as a reminder that the exact wording of an oil and gas lease – and in particular the third proviso to the habendum – will always be crucial in lease termination cases.  Equally crucial will be the details of the evidence, including the oil company’s explanation of the exact reasons the lease was shut-in, the economics that would have applied throughout any periods of non-production, and whether the decisions made by the lessee-operator can be justified as conforming with good oilfield practice.   The detailed reasons of Justice Romaine also provide a useful review of the basic principles involved in determining the appropriate remedy.   Mineral owners – and toplessees who in many of these cases are the real litigants – should not assume that that the courts will be eager to provide them with a windfall should the lease be struck down.