By Paul B. Westbrook and Shawna R. Rinehart
Cessation of Production:
A cessation of production savings clause is primarily intended to prevent termination of the lease immediately upon the cessation of production, whether during the primary term, secondary term, or both. Certainly, the most significant impact of a cessation of production clause occurs in the secondary term of a lease because the habendum clause of a paid-up lease would generally hold the lease through the end of the primary term regardless of a cessation occurring during the primary term.
A few things to note about a cessation of production clause:
A cessation of production clause is often combined with other lease provisions, such as a dry hole clause and/or continuous operations or reworking clause.
A number of courts have held that a cessation of production savings clause is not applicable where production in paying quantities has never been achieved. Two Texas Supreme Court cases discussing this concept are Gulf Oil Corp. v. Reid, 337 S.W.2d 267, 271 (Tex. 1960) and Rogers v. Osborn, 261 S.W.2d 311, 313 (Tex. 1953).
A cessation of production savings clause can be triggered by a complete cessation of production as well as circumstances under which there is still production, but it is no longer in paying quantities, presumably whether due to a decline in production, reduction in commodity prices, or other factors relevant to a paying quantities determination. In the absence of an express cessation of production clause, one Texas Supreme Court dissenting opinion has advocated applying the temporary cessation of production doctrine to market-induced interruptions, rather than only mechanical breakdowns or similar traditional triggers. In the opinion, Justice Jefferson reasoned that deferred marketing of oil could potentially benefit the lessor under certain circumstances, which accomplishes the lease’s primary function to develop minerals for the mutual benefit of the lessor and the lessee.
Although a cessation of production clause is generally considered a savings clause, it may in fact be less favorable to a lessee seeking to perpetuate a lease than the common law temporary cessation of production doctrine. Texas courts have generally held that an express cessation of production clause controls, and the temporary cessation of production doctrine may not be used to extend the lease past the terms of a cessation of production clause.
Here is a basic example of a cessation of production clause:
If after the discovery of oil or gas the production thereof should cease from any cause, this lease shall not be terminated thereby if lessee commences drilling or reworking operations within sixty (60) days thereafter or (if it be within the primary term) commences or resumes the payment or tender of rentals on or before the rental paying date (if any) next ensuing after thirty (30) days following the cessation of production.
Whether there is a total cessation of production or severe curtailment in production resulting in the lack of production in paying quantities, it is important that lessees are familiar with the express cessation of production clauses within their leases. In the event that a lease does not contain an express clause, lessees should be aware of the temporary cessation of production doctrine and determine whether it will apply to their particular situation given the reason for and duration of the cessation.