682 Mzyk v. Murphy Exploration & Production Company-USA, No. 04-15-00677-CV, 2017 WL 2797479 (Tex. App.—San Antonio June 28, 2017, no pet.)

Tuesday, August 7th, 2018

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.

Mzyk v. Murphy Exploration & Production Company-USA, No. 04-15-00677-CV, 2017 WL 2797479 (Tex. App.—San Antonio June 28, 2017, no pet.)(mem. op.) held that the reasonably prudent operator standard in an offset well clause applied to the obligation to drill an offset well and was not limited to how the well was drilled. Lessor and Lessee entered into an oil and gas lease containing an offset well clause that was triggered if a well was drilled on other lands within 467 feet of the lease. The lease was silent as to whether such well must be draining or would be presumed to be draining the leased premises. During the primary term, two or three wells were drilled on an adjacent landowner’s property, which were located within 467 feet of the lease. However, the new wells’ laterals ran directionally away from the lease, caused no drainage, and Lessee determined that drilling on the lease would be unprofitable. Lessee allowed the lease to expire at the end of the primary term. The next month, Lessor sued Lessee for $11 million in compensatory royalty.

The offset well clause provided that if a well was drilled within 467’ of the lease:
Lessee agrees to drill such offset well or wells on said lands (or attempt to complete for production any existing offset well or wells drilled by Lessee on said lands) as a reasonably prudent operator would drill under the same or similar circumstances . . . .

Lessee was then given the option, in lieu of drilling the offset, of (a) paying compensatory royalty, or (b) delivering a partial release of lease. Lessee was required to drill or release within six months from date of first production, or Lessee was deemed to have elected to pay compensatory royalty.

The principal issue was whether the reasonably prudent operator standard operated as a trigger that, once met, obligated Lessee to drill on the land; or, whether the reasonably prudent operator standard did not apply to the determination of whether to drill an offset well, but merely described how Lessee was to conduct such drilling. Lessor contended the offset well clause effectively presumed drainage, and Lessor was not obligated to prove and presented no evidence on, drainage, profitability of an offset well, or what a reasonably prudent operator would or would not do.

The court held that the reasonably prudent operator standard applies to a lessee’s determination of whether to drill an offset well. The court further held that the applicable legal standard was expressly adopted in the offset well clause in this particular lease; accordingly, Lessee was obligated to drill an offset well “only if a reasonably prudent operator would have drilled an offset well under the same or similar circumstances.”

The court disagreed with Lessor’s argument that the lease clause presumes drainage will occur by the drilling of a producing well on an adjacent lot. The Court pointed out that the offset well clause did not contain language suggesting a presumption of actual or substantial drainage. Moreover, the evidence did not demonstrate that “the parties intended the omission of the drainage requirement to constitute an agreement to presume any triggering well was causing drainage. . . .”

Finally, the court determined that the plain language of the “compensatory royalties” provision in lease paragraph 6 referred back to the “offset well” provision in lease paragraph 6 incorporating the reasonably prudent operator standard. Compensatory royalty was payable in “a sum equal to the royalties which would be payable under this lease on the production from such well had same been drilled and produced under this lease.” Therefore, Lessee was required to pay compensatory royalties only if it “failed to drill an offset well when a reasonably prudent operator would have done so.”

This is a lease construction case that follows existing precedents and refuses to expand the offset well obligation to include a presumption of drainage by a nearby well or to create an obligation to drill a well which would produce nothing or be unprofitable. If there is no obligation to drill, there is no obligation to pay compensatory royalties in lieu of drilling.