When it comes to agreements and lease documents in the oil and gas industry, it’s essential to know the terms and their meanings to avoid loss of land. A lease may have many clauses, one of which is the Pugh Clause.
Understanding Pugh Clause, its history, and its implications are especially important for both lessors and lessees. If you aren’t aware of what it is, you can find yourself in trouble at times.
So before you have your lawyer explain to you what it is, read this article for everything you should know about it.
What is Pugh Clause?
To understand what Pugh Clause in oil and gas lease is, you have to learn its history. It’s actually named after a lawyer who represented a lessor in a lawsuit against Shell, one of the biggest oil companies in the world.
Lawrence Pugh represented a lessor from Louisiana in 1947 who eventually lost the case to Shell. To avoid the same problem as the lessor, the lawyer created a clause so it could be included in future leases to protect the lessors.
So what does Pugh Clause state? Well, it’s not an exact clause per se, rather a guideline. The clause basically protects the lessors unleased part of the land or its depth from going to the oil company with a working interest at the end of the lease.
It ensures that the lease properly defines which parts of the surface and depth of the land the company has the right for and the access to. Otherwise, the lessors are at risk for ending up leasing more land and even all of it to the company and that too without necessary compensation.
A properly drafted Pugh Clause fixes the area of land or the depth underneath it that the lessee can utilize after the expiration of the lease.
There’s no standard for this kind of clause, and it differs case by case.
Types of Pugh Clause
Typically, Pugh Clause has two types: horizontal and vertical.
The horizontal clause covers the surface of the land and its acreage, unified or divided. The vertical clause covers the depth rights, that is, to which depth in a specific portion of the land that lessor has rights for extracting minerals.
In many agreements, both of these types of clauses are present. This way, it’s clear which areas, horizontally or vertically, the lessee can use.
Why You Need Pugh Clause?
Any land or mineral owner would want the best deal when leasing their land. You wouldn’t want to end up leasing more land or depth than you originally planned. However, without this clause in the lease, the oil or gas company may end up taking over more land and demand that their lease renewal include those portions as well as they are necessary for their mineral extraction and process.
This prevents the landowner from leasing those previously unleased parts of the surface. Many oil companies may want to incorporate more surfaces for their drilling and production purposes or to prevent other companies or parties from operating there.
This usually happens when the lease defines production requirements but not the limit of the land or depth necessary for it. This loophole allows companies to claim that more surface area can help reach those production levels or to maintain current production levels.
As a result, the lessor, even after contesting the claim, may have to include more surface or depth in the new lease. Consequently, they lose the opportunity to get revenue from that land.
Pugh Clause Examples
It’s important to understand that there’s no specific clause format or method you can use. Each Pugh Clause depends on the unique circumstances of the lessor and the land they own. So the clause must be for that specific lease only.
Moreover, the wording of the Pugh Clause has to be accurate and literal because courts usually take clauses in the oil and gas leases very literally. You don’t want to leave any room for speculation.
Therefore, it’s necessary to hire a competitive lawyer or law firm to help draft the lease, especially this clause. Make sure that you read it carefully, along with all the other clauses, before signing the lease.
For educational purposes, here are some sample Pugh clauses from Law Insider:
- “Subject to Paragraph 24 below, Drilling or reworking operations on or production of oil and/or gas from a pooled unit established under the provisions of Paragraph 17 of the lease above shall maintain this Lease in effect only as to that portion of the leased premises (also referred to as said land in the lease) which is included in such pooled unit. This Lease may be maintained in effect as to the remainder of the leased premises in accordance with the other provisions of this Lease; provided, however, that if such maintenance is by the payment of delay rentals during the primary term of this Lease, then the delay rentals shall be proportionately reduced and payable on a pro-rata acreage basis on only that portion of the leased premises not included in such pooled unit.”
- “Production from, or operations conducted on, one unit will only maintain this Lease in force as to any parcel or parcels of land, all or a portion of which is included in the unit. Except as provided in Paragraph 4 below, upon expiration of the Primary Term or any extension thereof, in the event a part or parts of the Leased Premises is pooled or unitized with other land so as to form a unit or units; operations on, completion of a well upon, or production from such pooled unit(s) will not maintain this Lease in force as to the land not included in such unit or units. However, this Lease may be maintained in force as to any land covered hereby and not included in such unit or units as defined in Paragraph 4 below, or in any other manner that complies with this Lease’s terms.”
Pugh Clause is crucial for lessors to clearly define exactly how much land surface and depth the lessee can use for production. Without this, they are in for a surprise at the renewal of the lease. Also, careful wording of the clause is extremely important.
Before signing the lease, both parties should review the lease and ask questions wherever there’s confusion. This is also relevant for royalty calculation.