Courts in Alberta have wrestled with the issue of under what circumstances a cessation in production will bring a freehold lease to an end. The latest instance was by the Alberta Court of Appeal in Bearspaw Petroleum Ltd . v EnCana Corporation , [2011] ABCA 7. In light of the wording of the lease and the facts, the Court of Appeal agreed with the trial judge that the lease did not terminate.

Bearspaw was the successor to the lessee and Encana the successor to the lessor under a 1960 freehold lease. The lease had a primary term of ten years and continued after that term "so long thereafter as the leased substances or any of them are producible".

Three wells were drilled on the leased quarter section. They produced over various periods of time with the last year of production being 2005. It was conceded by the lessor on appeal that the wells on the subject lands were capable of economic production. As at the date of the trial, there was no pipeline to which the wells could be tied in.

The evidence at trial, which was accepted on appeal, was that the lessee had a plan to build a pipeline to tie these wells in at some point in the future. EnCana argued that because the wells were not currently tied in, and thus were not immediately capable of production, the lease could not be continued.

The decision turned on the meaning of the word "producible" contained in the habendum clause. The trial judge, in finding that the lease had not terminated, found that the word "producible" contemplated a future occurrence, which negated a need for an immediate ability to produce.

The Court of Appeal noted that there was no Canadian decision in which the meaning of the word "producible" was considered in the context of a freehold lease. The lessor urged the Court to follow an American decision which used the terms "produced or producible". In the American case the court held that there was a requirement for an immediate ability to produce, which was not met.

The Alberta Court of Appeal distinguished this decision on the basis that in the lease before them, the word "produced" (which was found to have a present rather than future connotation) was not present.

The Court of Appeal stated that it was obligated to construe the lease in a manner that did not defeat the objectives of the parties in entering the lease. The lessor had argued that this was the result of the trial decision, as it would permit a lease to continue indefinitely with only a modest payment to the lessor. This position was rejected by the Court of Appeal, in part due to the language of Clause 4 of the lease (which was determined to be an express requirement to market leased substances) which permitted the lessee to develop the lands "in the manner best suited to the recovery of the greatest quantity of the leased substances at the least cost…". It was held that the intention of the parties was to provide the lessee with the flexibility to develop the lands in the commercial manner it saw fit, which did not include an immediate requirement to tie in the wells.

The policy considerations dictating a strict construction of habendum clauses which were set out in its earlier decision of Freyberg v Fletcher Challenge Oil and Gas Inc. , [2005] ABCA 46, were referred to by the Court of Appeal. However, it was noted that no evidence had been tendered which suggested that the lessor's interest was being eroded in any manner by drainage from other wells.

The lessor advanced a further argument to the effect that the lease contained an implied covenant to market the leased substances which was breached by the lessee's failure to tie-in and produce the wells. This position was supported by a number of American authorities put forward by the lessor. This issue then turned on whether Clause 4 of the lease (discussed above) was an express requirement to market - which would then necessarily negate any implied obligation.

The Court concluded that Clause 4 was an express marketing provision which had not been breached by the lessee. It was important to the Court of Appeal that there was evidence that the lessee had a plan to develop the lands, as opposed to vague statements of future intention. The fact that the lessee made the decision to first build pipelines on other lands was not held to be an indication that there was no intention to develop the lessor's lands.

In upholding the lease, the trial judge had relied on a finding that the lessor's predecessor had never sought to terminate the lease. On appeal, the lessor argued that this was an error. The Court of Appeal agreed with the lessor on this point; however, it was held that the absence of this error would not have resulted in a different decision as to the validity of the lease.

This decision reflects the recognition by the Court of Appeal of the business realities of oil and gas lessees. Not all producers wish to develop a number of properties simultaneously. Where the habendum clause in a freehold lease contains wording which contains a future rather than a present requirement to produce, and a party can demonstrate a plan to develop the lands, this decision suggests that the lease should be continued.