Co-author Gunner West
In In re Pearl Resources LLC, a Houston bankruptcy court rejected the Texas General Land Office’s attempt to partially terminate state oil and gas leases in Pecos County, despite finding the operator had breached offset well obligations.
The court describes the difference between “drilling operations” and “drilling”, explains when failure to comply with an offset well obligation was not a material breach, and upholds the viability of the State’s sovereign immunity.
Overview
Pearl Resources operated 35 leases issued under the Relinquishment Act. The GLO asserted that 27 of these leases had partially terminated as to all but 320 acres around the Garnet State #3 — the only producing well on the acreage — for failure to conduct continuous drilling operations. The GLO demanded partial releases under the retained acreage clauses; Pearl refused; the GLO filed a Designation of Terminated Acreages and Depths; Pearl filed for Chapter 11 bankruptcy.
No “Rolling Termination”
The retained acreage clause stated that leases “in force and effect two (2) years after the expiration date of the primary or extended term” would terminate except for 320 acres around each producing gas well, “or a well upon which lessee is engaged in continuous drilling or reworking operations, … .” The court found this created two distinct termination points: (1) at the conclusion of the secondary term, and (2) two years after the expiration of the secondary term.
The court rejected the GLO’s “rolling termination” theory, explaining that “under Texas law, unless a lease specifically calls for a rolling termination, a retained acreage provision only operates once.” The GLO lease form lacked the clear language needed for rolling termination.
“Drilling Operations” Extend Beyond Actual Drilling
The GLO argued Pearl’s failure to actually drill a well was insufficient to maintain the leases.The court disagreed. Texas Administrative Code broadly includes all “activities designed and conducted in an effort to obtain initial production.” According to Ridge Oil Co. v. Guinn Invs., Inc. “drilling or reworking operations” encompasses more than just drilling.
Pearl’s operations included spudding three horizontal wells, conducting facilities work, engaging contractors, building roads, and performing environmental studies. Each activity was “designed to, and being conducted for the purpose of obtaining, initial production from a well.”
Offset Well Breach was Immaterial
The court found that Pearl breached the lease by failing to timely drill an offset well after a nearby well began producing. But the breach was immaterial for purposes of the GLO’s prior‑material‑breach defense, so it did not excuse the GLO’s performance or support forfeiture or partial termination. The court emphasized that the GLO:
- had specific statutory remedies available but never pursued the proper forfeiture process under the Texas Natural Resource Code §52.174;
- could be and was adequately compensated with money damages for drainage; and
- sought damages rather than forfeiture, demonstrating that Pearl’s breaches could be cured.
The court granted Pearl’s quiet‑title claim, declared the DTAD “invalid and of no force or effect,” and confirmed Pearl’s superior title to all 955.22 acres in dispute.
Damages Barred by Sovereign Immunity
Pearl proved $43,155,664 in damages from the GLO’s improper DTAD filing. The GLO proved $2,578,633 in damages from drainage due to Pearl’s failure to drill an offset well. Te court barred Pearl’s recovery; the GLO had not waived sovereign immunity. Even though the GLO initiated the lawsuit, it “retains its ability to assert whatever rights, immunities or defenses are provided for by its own sovereign immunity law.”