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Doty v. Key Oil





APPEAL from the Circuit Court of Fayette County; the Hon. WILLIAM H. SPITLER, JR., Judge, presiding.


Defendant Key Oil, Inc., appeals from a judgment of the Circuit Court of Fayette County declaring terminated an oil and gas lease and ordering it cancelled as a cloud upon the title of the plaintiff-lessors, Eldo and Rosa Doty. Contrary to the trial court's conclusion that the lease expired by its own terms, defendant contends that the lease remained in force under the extension provision of the "shut-in" clause. The lease in question was executed on February 12, 1976. Key Oil, Inc., acquired the lessee's interest by assignment on February 7, 1977.

The habendum clause of the lease provided that "subject to other provisions herein contained, this lease shall remain in force for a term of 1 year from this date (called the `primary term'), and as long thereafter as oil, liquid hydrocarbons, gas or their respective constituent products, or any of them is produced from said land * * *." Other paragraphs provided for payment of one-eighth royalties on oil and gas produced and sold.

Paragraph 3(c) provided:

"If at any time while there is a gas well or wells on the above land (for purposes of this clause (c) the term `gas well' shall include wells capable of producing natural gas, condensate, distillate or any gaseous substance and wells classified as gas wells by any governmental authority) such well or wells are shut in, and if this lease is not continued in force by some other provision hereof, then it shall nevertheless continue in force for a period of ninety (90) days from the date such well or wells are shut in, and before the expiration of any such ninety day (90-day) period, lessee or any assignee hereunder may pay or tender an advance annual royalty payment of Fifty Dollars ($50.00) for each such well, and if such payment or tender is made, this lease shall continue in force and it shall be considered that gas is being produced from the leased premises in paying quantities within the meaning of paragraph 2 hereof for one (1) year from the date such payment is made, and in like manner subsequent advance royalty payments may be made or tendered * * *."

Paragraph 5 provided that if oil or gas was not being produced at the end of the primary term "but lessee is then engaged in operations for drilling, mining, or reworking" of any well, the lease would remain in force for so long as these operations were conducted without cessation for more than 60 days and for so long thereafter as oil and gas were produced.

The undisputed evidence was that Key Oil conducted drilling operations from February 12, 1977, to March 26, 1977. Well completion was begun about two months later, and on July 26, 1977, gas was discovered, apparently in significant quantities. During September of 1977 the well was fitted with equipment for production of oil (e.g., gas separator, flow lines, oil tank). From October 11, 1977, to October 10, 1978, the gas was flared, and an employee of Key Oil checked the tank daily for oil; no oil was produced.

After the lessors demanded release of the lease, Key Oil conducted further unsuccessful oil production operations on October 10, 1978. Lessors filed their complaint on October 24, 1978. Key Oil "shut in" the well with a temporary, drillable plug on November 2, 1978. Lessors refused Key Oil's tender of $50 on November 18, 1978.

James Gray, secretary of Key Oil, testified that gas from the well could not be profitably marketed on July 27, 1977, when it was discovered, because the nearest pipeline was five miles from the well. At the time of trial, the pipeline had been extended to a leasehold about 1 1/2 miles from the instant well.

After closing arguments, the trial court commented that the flaring of the well appeared to be inconsistent with an intention to produce gas at some later date. After taking the matter under advisement, the court found that the lease had expired by its own terms. The court entered judgment declaring the lease terminated and ordering it cancelled.

At issue here is the so-called shut-in provision of the lease. The term "shut in" refers to the plugging of a well capable of producing gas. Professor Summers discusses the practical considerations involved:

"Oil is of such a nature that it need not be transported to market through a pipe line, but may be taken from the ground and stored in tanks to await shipment by rail or truck to an ever-ready market. But the only storage for gas is the stratum in which it is found." (2 Summers, Oil and Gas § 299, at 222-23 (1959).)

By complying with the terms of the shut-in clause, the lessee may procure extension of the lease beyond the primary term even though actual production of gas under the habendum clause is impossible for lack of a pipeline:

"The shut-in-royalty clause, found in most oil and gas leases, expressly qualifies the rule of construction that a lease terminates at the end of the primary term unless there is production and permits a lessee who has discovered gas in paying quantities during the primary term for which there is no market to keep the lease alive by ...

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