One consequence of falling oil prices is leases that cease to produce in paying quantities. The producer’s question: How soon must the well return to profitability? The answer in BP American Production Company v. Laddex, Ltd. is, a “reasonable” period, to be determined by the jury and not the judge.
The Magic Well
The facts aren’t unique: The well on a 40 year old lease produced steadily until August 2005, when production slowed “significantly”. In November 2006 the well “inexplicably” resumed producing in quantities comparable to prior to the slowdown (usually it’s because of higher prices or a workover). In 2007 Laddex took a top lease which would begin when the old lease was terminated, either by BP’s written release or by judgment terminating the old lease.
Laddex sued for termination of the old lease and possession of the mineral estate.
The Test For Paying Quantities
The jury must go through a two-step process to determine whether a lease should be terminated for failure to produce in paying quantities:
(1) Viewed over a reasonable period of time did the lease cease to pay a profit after deducting operating and marketing expenses; and
(2) would a reasonably prudent operator continue to operate under the lease for a profit and not merely for speculation?
The Problem with the Question
The question to the jury focused on a specific fifteen month period. The jury found that the well failed to produce in paying quantities and that a reasonably prudent operator would not continue to operate the well for profit. On the basis of that verdict the trial court entered judgment terminating the old lease and finding that the mineral estate reverted back to the lessor, at which time the top lease began.
What is a “Reasonable” Period?
By the time the top lease was executed the old lease had resumed production in paying quantities. On appeal BP argued that limiting the inquiry to a specific fifteen months was not a reasonable period. The court of appeal agreed, and concluded that the trial court arrogated to itself the decision that the relevant period was that particular fifteen months. Thus, it limited the jury’s consideration to a period of time that was not reasonable.
Evidence that a lease has returned to profitable production is material to the determination of whether the period of time is reasonable under the circumstances. The jury was deprived of the opportunity to consider that evidence.
At Gray Reed we urge producers to treat their lessors with respect. Aside from being “the right thing to do” it could help in unexpected ways. Human nature being what it is, juries will want to punish the black-hat. Being reminded that your fate in a paying quantities case could be left to a jury, why give them a reason to punish you?
Invoking lagniappe calls for an extra dose of musical interlude.