Lease Option

FORT WORTH–The virtual shutdown of the American economy on account of the novel coronavirus has led to re-examination of an often-overlooked oil and gas lease provision: the force majeure clause. Frequently an afterthought and relic of law school exams, the force majeure clause generally operates to excuse lessee performance during unforeseen extraordinary circumstances that inhibit lessee compliance with terms of the lease.

There are a number of general rules for interpreting force majeure clauses. Like many oil and gas lease provisions, there are countless variations of force majeure clauses in use, each with significant differences. Whether a specific force majeure clause excuses lessee obligations ultimately depends on a number of circumstances:

• The exact language used by the parties;
• The circumstances creating the lessee’s inability to perform under the lease;
• Whether the lessee effectively invokes the force majeure clause; and
• The law of the jurisdiction where the oil and gas lease is located.

Force Majeure Effects

Most oil and gas leases contain a primary term, such as “for five years,” and then continue so long as the habendum clause is satisfied, with language such as “for so long as oil and gas are produced in paying quantities.” The habendum clause contains the termination condition to which the parties agreed, and once that condition occurs, the oil and gas rights conveyed to the lessee return to the lessor. In general, and in the absence of other language in the lease, courts tend to strictly enforce the habendum clause irrespective of a lessee’s mitigating circumstances.

In some leases, the parties agree to various savings clauses–each of which prevent the otherwise automatic termination of the lessee’s mineral interest once the habendum clause is no longer satisfied. Common examples of savings clauses include shut-in provisions, continuous operations clauses and temporary cessation clauses. Each addresses premeditated circumstances which, although resulting in nonsatisfaction of the habendum clause, are exempt from the rule of automatic termination.

Depending on the specific language, the force majeure clause also may act as a savings clause. Specifically, the force majeure clause may prevent termination of the lease even though the habendum clause is not satisfied because of certain extraordinary circumstances beyond the lessee’s control. While not always necessary to use the exact words, force majeure clauses most clearly act in a saving capacity when the clauses specify that the lease extends during the force majeure period.

Depending on its scope, a force majeure clause also may excuse noncompliance with express contractual obligations (such as the timely payment of royalty) or implied covenants (such as the implied covenants of further development and further exploration). In such clauses, the force majeure provision prevents lessee liability for damages such as interest applied to late royalty payments or lost royalties in the event of breach of an implied covenant to develop. Significantly, if the lease contains a forfeiture provision that ends the lease in the event of breach by the lessee, the force majeure clause may prevent forfeiture and therefore the end of the lease.

The Force Majeure Event

In deciding whether a force majeure clause applies, the parties should review the words in the lease carefully to determine whether the events inhibiting lessee compliance are included within the scope of a force majeure event.

Some force majeure clauses appear quite broad. For example, the Williams and Meyers treatise on oil and gas law quotes one force majeure clause as excusing performance for “any cause whatsoever beyond the lessee’s control” and another as excusing performance for “lack of market reasonably satisfactory to lessee for production from the premises.” Such broad-form force majeure clauses certainly could apply if a severe pandemic significantly impacted a lessee’s operations, particularly when coupled with historically low commodity prices.

Another, potentially broad, force majeure stipulation is the “act of God” provision. However, jurisdictions differ on what exactly constitutes an act of God. For example, while some courts have interpreted the term narrowly to include only acts occasioned by the “force of elements,” other sources, such as the U.S. Code, define the term more broadly as including certain natural phenomena.

In contrast, other force majeure provisions appear more targeted, applying to an enumerated set of events. For example, some versions of force majeure clauses excuse lessee compliance if such compliance was prevented by “law, order, rule or regulation.”

In an effort to slow the spread of COVID-19, several states and jurisdictions have issued shelter-in-place or other stay-home orders to employees of nonessential businesses, which (depending on the definition of essential) may include certain employees of oil and gas production companies and associated contractors. Defining force majeure events as including government orders can make an executive order limiting the number of workers on a well site a force majeure event. Another example (particularly in a low commodity price environment) of a law, order, rule or regulation that may trigger the force majeure clause in certain instances is bankruptcy.

A minority of force majeure clauses specifically define force majeure events as “epidemics or quarantine regulations”–which almost certainly apply if lease performance was made impossible by the coronavirus or a quarantine order. Given the geographic breadth of quarantine orders and regulations issued concerning COVID-19, lessees may re-examine the scope of their standard force majeure provision to ensure the scope is broad enough to encompass future widespread illnesses that disrupt field activities and office work. In the future, the oil and gas industry may see more form leases with language specifically enumerating pandemics, epidemics, quarantine regulations or other widespread illnesses as force majeure events.

Not Always Impossible

A force majeure clause does not always apply simply because a circumstance constitutes a force majeure event. For example, a tornado generally constitutes a force majeure event, but it may not inhibit lease operations if there is no direct impact to the well pad.

Again, the specific words used in the clause are important. While some force majeure clauses require that the force majeure event make lease compliance “impossible,” others only require that the force majeure event make compliance “unreasonable.”

The distinction between impossible and unreasonable may play a significant factor in the instance of a limited workforce (such as when a significant proportion of workers are sick). At least one state appellate court decision has suggested that where a lessee chooses to allocate resources limited by a force majeure event to other leases, compliance with the lease provisions is not impossible.

Invoking Force Majeure

Many force majeure clauses require affirmative action on the lessee’s part to invoke the clause’s protections. For example, some variations of clauses that excuse lease performance when prevented by executive order or other law require the lessee to challenge the law in the appropriate forum. Other clauses do not require a challenge if the challenge is likely to fail.

Some force majeure clauses require a payment in order to invoke the clause (often in place of a delay rental, production-based royalty or minimum royalty). If the lease does not classify the payment as either a rental or royalty, and if the executive rights and right to receive royalty are owned by different people, it may be difficult for the lessee to determine which owner to pay.

Like other oil and gas lease provisions, the force majeure clause does not operate in isolation. Thanks to some inherent subjectivity concerning what constitutes a force majeure event, a lessee may elect to proceed under more than one savings clause at a time. For example, a lessee may seek to invoke both the continuous operations clause and the force majeure clause in a belt-and-suspenders approach.

Once invoked, the force majeure clause excuses lessee performance for a period. Some clauses specify the duration to one month or year, while other clauses excuse performance so long as the force majeure event inhibits performance. Lessees should be particularly diligent with force majeure provisions that only continue so long as performance is impossible, since the force majeure savings provisions may no longer apply once the circumstance changes.

Ultimately, the applicability of a force majeure provision depends on a host of factors, including the specific language used in the lease and the law of the jurisdiction in which the lease is located. Parties should carefully review the specific language used by the lease in determining what events trigger the force majeure clause:

• Whether the force majeure clause requires impossibility or a lesser standard;
• What specific obligations the force majeure events excuses;
• What (if anything) must be done to invoke the force majeure clause; and
• How long the force majeure period will last.

If applicable, the force majeure clause is a powerful tool to prevent breach or termination of a lease even where compliance with the lease terms, including the habendum clause, is impossible.

This article is for general information purposes only and is not legal advice.