A recent case in Saskatchewan which meandered through various court levels for years (leave to appeal to the Supreme Court of Canada was refused) should send shivers of fear through freehold lessors and their counsel who feel some compunction to litigate disputes involving freehold oil and gas lease continuation issues.
The case is Montreal Trust Co. v. Williston Wildcatters Corp. (sub. nom. … requiem to freehold lease litigation?). This case involved a 1952 freehold oil and gas lease (with apparently no shut‑in well clause) having a primary term of 10 years, the habendum clause providing:
TO HAVE AND ENJOY the same for the term of Ten (10) years from the date hereof and so long thereafter as the leased substances or any of them are produced from the said lands, subject to the sooner termination of the said term as hereinafter provided.
AND FURTHER ALWAYS PROVIDED that if at any time after the expiration of the said Ten (10) year term the leased substances are not being produced on the said lands and the Lessee is then engaged in drilling or working operations thereon, this lease shall remain in force so long as such operations are prosecuted and, if they result in the production of the leased substances or any of them, so long thereafter as the leased substances or any of them are produced from the said lands; provided that if drilling, working or production operations are interrupted or suspended as the result of any cause whatsoever beyond the Lessee's control, the time of such interruption or suspension shall not be counted against the Lessee, anything hereinbefore contained or implied to the contrary notwithstanding.
The lease was continued by actual production until January 2, 1990 at which time the initial lease continuation well (the "initial well") was shut‑in. Production started again from the initial well in August, 1990 and in May, 1991 the initial well was permanently shut‑in. A second lease continuation well was completed on May 28, 1991.
The parties agreed the trial would proceed in two stages: stage one, a trial to determine whether the petroleum and natural gas lease lapsed pursuant to its terms by reason of non‑production; and if the lease had lapsed, stage two, to determine the damages (if any) suffered by the lessor.
At trial1 and as stated by Gerein C.J.Q.B.:
There can be no uncertainty about whether there was production during the stated period in 1990. There clearly was no production after January 2, 1990. Accordingly, the term of the lease was not extended by production. It then becomes necessary to determine whether it was extended by drilling or working operations…,
and to make a very long story short, Chief Justice Gerein went on to find that the lease lapsed pursuant to its terms on January 3, 1990 by reason of non‑production. That decision was upheld by the Saskatchewan Court of Appeal2 and leave to appeal to the Supreme Court of Canada was denied.3
Stage two was held to determine the amount of damages suffered as a result of the continued production of leased substances after the lapse of the lease.4 The lessor claimed it was entitled to 100% of the profits generated from the sale of the leased substances less the costs of production by reason of the lessee's trespass on its lands (approx. $1,500,000). The lessee's argued that the lessor was not entitled to any damages because they occupied the land and produced the leased substances with the consent, express or implied, of the lessor. Alternatively the lessees argued that if they were trespassers, they suggested that the measure of damage was limited to the best royalty and bonus that was available at the time the lease lapsed (approx. $183,000).
Again, to make a very long story short, Chief Justice Gerein found that the lessees did not occupy the land with the consent or leave and licence of the lessor and were trespassers after the lapse of the lease. He awarded the lessor damages based upon a lessor's royalty of 18% plus a bonus of $6,400.00 which in his opinion was the best the lessor could have negotiated in the marketplace at that time. Gerein C.J.Q.B. states:
I return to the assessment of damages in this case. It is my conclusion that the plaintiff should receive as damages the sum of $6,400.00 plus an amount equal to 5.5% of the gross revenue from the oil produced from the subject lands. This means that the plaintiff, having already received 12.5% by way of royalty, will receive an additional 5.5% for a total of 18% of the gross revenue.
In adopting this approach I have taken several things into account. I have sought to restore the plaintiff not only to its original position, for it never lost that; but rather to the best position it could have attained were the lands not occupied by the defendants. The undisputed evidence was that there was a strong likelihood that the plaintiff could have obtained a lease paying a royalty of 18% with a bonus of $6,400.00. The plaintiff had already done so in respect of nearby lands. This clearly demonstrates what the plaintiff would have done and what would "have been obtained by way of revenue".
The lessor appealed contending the Chief Justice erred in failing to award damages based on 100% of production less the costs of production and marketing. The lessee cross‑appealed contending the trial judge erred in failing to find it occupied the land and produced the leased substances with the consent of the lessor.
In denying the appeal of the lessor and allowing the cross‑appeal of the lessee5, Vancise J.A. considered three critical time‑frames:
- January, 1990 to March, 1992: being the lease termination date to the date the lessor wrote to the lessee questioning the validity of the lease;
- March, 1992 to February, 1993: being the date the lessor wrote to the lessee questioning the validity of the lease to the date of the statement of claim; and
- February, 1993 to November, 2001: being the date of the statement of claim to the date the parties entered into a consent order permitting the lessees to continue producing the leased substances with the net proceeds being paid into court.
Without dealing with the court's lengthy analysis of the doctrine of leave and licence, as to period one, Vancise J.A., concludes:
There was no knowledge that the lease had terminated and that a trespass had or was taking place. Therefore, there could not be any question of granting consent to occupy the land during this period of time the [lessee] was in possession. The [lessee] was a trespasser during this time-frame.
As to period two and contrary to the findings of the Chief Justice, Vancise J.A. determines:
This is the most critical time-frame. The [lessor] was aware that the lease with T.D.L. had probably lapsed. It wrote to the [lessee] on March 11, 1992, questioning the validity of the lease but significantly did not request that the [lessee] get off the property. More importantly the [lessor] did not demand that [the lessee] cease production of the oil from the 11-8 well.
On April 11, 1992, the [lessor] sent a second letter to [the lessee] in which it offered to grant the [lessee] a new lease (implying that the 1952 lease was at an end) but again significantly advised that it was "not yet requiring the operator vacate the property." The letter requested that no further work be done on the 11-8 well. It is common ground that that was a reference to the permission [the lessee] was seeking to drill a horizontal well.
A statement of claim was issued in February of 1993 in which the [lessor] claimed an accounting but did not plead trespass. The [lessor] amended the statement of claim in 2000 to add some of the [lessees] to the action and to claim damages for trespass. The [lessor] continued to receive royalties based on the royalty rate of 12.5% as provided for in the 1952 lease during this time.
In my opinion, the [lessees] were on the land with the consent and leave and licence of the [lessor]. At no time did the [lessor] demand that the [lessees] give up possession of the property even though it claimed that the lease had terminated. Further, the letter and conduct of the [lessor] set out the limits of the licence which were narrower than the existing lease.
"No further work" was to be undertaken until the resolution of the dispute between the parties. Notwithstanding this statement, the [lessor] made it clear that it wanted the 11-8 well to continue producing. The [lessor] had more than a suspicion that the lease had terminated pursuant to its terms and indeed they were confirmed in this by Chief Justice Gerein. Despite that finding the [lessor] required the [lessee] to remain in possession and produce the oil and pay the royalty.
In my opinion, there was express leave and licence from the [lessor] to the [lessees]. The letters clearly outline that the [lessor] took the position that the lease was terminated pursuant to its terms, but despite this, the [lessee] could stay on the land. The [lessor] specifically required that the [lessees] stay on the land and continue to produce oil (and thereby royalty revenue). It advised however that if the [lessees] drilled the horizontal well as previously planned, they ran the risk of being outside of the lease and/or the licence. That drilling program did not occur.
The [lessees'] conduct vis-à-vis the working of the oilwell in this period cannot be questioned. Although they resisted the suggestion that the 1952 lease had terminated, they faithfully discharged their duties to the [lessor] and at no time entertained harsh or malicious conduct. The permission from the [lessor] to stay on the land and continue producing oil from the 11-8 well was never revoked…
With respect to period three, Vancise J.A. concludes:
Whether the filing of a claim in trespass can be said to be a revocation of licence given by a plaintiff depends on the facts and the circumstances of each case. The starting point for deciding whether the leave and licence was revoked is the filing and service of the claim for an accounting. This first claim did not plead trespass, and though trespass may be inferred through the claim for accounting, it is my opinion that something more is required to terminate the leave and licence in the circumstances. This is especially so when one examines the post-claim conduct of the [lessor] and the [lessees]. Post-claim conduct is clearly relevant and in this case no request was made by the [lessor] for the [lessee] to stop production or vacate the lease. In fact, the facts as found by Gerein C.J. were completely to the contrary. Thus, on the facts of this case a revocation of the leave and licence did not occur in February 1993 when the [lessor] issued the statement of claim.
And as a result and although the lease was dead, the lessor was entitled to damages only for the period January, 1990 to March, 1992 and calculated on the basis assessed by the Chief Justice (in essence and in this context, nominal damages), Vancise J.A. concluding no error in the original manner of assessing damages.6
On a related issue and of general interest to freehold lease continuation combatants, and deserving of a lengthy quote from the Court of Appeals reasons:
This leaves one issue to be resolved: the ownership of the wellbore, downhole and surface equipment on L.S.D. 11-8. Chief Justice Gerein declined to decide the issue because "he was not apprised of all the facts"…
The [lessor] contends that it is entitled to the ownership of the equipment because the wellbore and downhole equipment are an integral part of the oil well which was annexed or affixed to the surface for the sole purpose of permitting extraction of the petroleum and natural gas. It contends the equipment is a fixture which, in the absence of an agreement to the contrary, it owns.
The [lessees] on the other hand contend that the equipment is annexed to the surface and as such is a fixture owned by the holder of the surface lease. Any transfer of ownership of the equipment to the [lessor] would, the [lessees] contend, result in a forfeiture of their interest which could only be justified if they were guilty of misconduct in relation to the interests of the [lessor]. The trial judge expressly found as a fact they were not guilty of misconduct.
The ownership of the equipment is dealt with in both the petroleum and natural gas lease and the surface lease. Clause 17 of the petroleum and natural gas lease which was in effect between the parties prior to its termination for lack of production states as follows:
17. -- Removal of Equipment: --
The Lessee shall at all times during the currency of this Lease and for a period of Six (6) months from the termination thereof, have the right to remove all or any of his machinery, equipment, structures, pipe lines, casing and materials from the said lands.
The surface lease in effect at all relevant times deals with the right to remove the equipment and ownership in the following terms:
16. -- Surrender and Removal of Equipment
Provided that the Operator is not in default in respect of any of the covenants and conditions contained in this lease it may at any time, upon three months' notice to that effect to the Owner, cease the use and occupation of the demised premises or any part thereof and shall restore the same as provided in the next succeeding paragraphs whereupon this lease shall terminate at the next anniversary date and the Operator may, within the balance of the rental year, remove or cause to be removed from the demised premises all structures, materials and equipment of whatsoever nature or kind which the Operator may have placed on or in the demised premises.
17. -- Abandonment and Restoration
Upon the abandonment, in whole or in part, of the well on the demised premises, cause the same to be plugged and all excavations in connection therewith to be filled in...and upon the discontinuance of the use of any portion or portions of the demised premises, to restore such portion or portions to the same condition as that existing immediately prior to entry thereon and the use thereof by the Operator and/or to pay a monetary sum of money in lieu thereof or on account of the inability of the Operator to restore the same to the condition existing at the time of entry thereon. The Operator upon giving the notice of intention to abandon shall be responsible, without further proof, to carry out the restoration regardless of fault of its predecessors in interest, if any. The obligation to pay annual rental hereunder shall continue until proper restoration has been completed as required by said regulations. …
The standard petroleum and natural gas lease in use in the oil industry in Canada is the Canadian Association of Petroleum Landmen ("CAPL") lease. Ballem, in The Oil and Gas Lease in Canada, discusses the prevalence of the standard CAPL lease in these terms:
The CAPL leases have met with almost universal acceptance in the industry... Informal surveys indicate that more than 95 per cent of the leases currently being negotiated follow the CAPL form or, in some instances, computer-generated forms based on the CAPL lease.
The current equipment removal provision in the standard CAPL, 91, lease is almost identical to Clause 17 of the subject lease, which provides that the operators of the well are able to remove the equipment at anytime up to six months after the termination of the lease. The clause in the 91 CAPL is to the same effect as Clause 17 and differs only in that it contains a specific reference to "whether placed upon, within or under the said lands by or for the lessee."
The [lessor] contends the [lessees] cannot rely on Clause 17 in the lease because it has terminated and as result it (the [lessor]) owns the equipment. That contention in my opinion is too simplistic. It ignores the standard practice in the industry and the fact the [lessees] were on the land and operating the well with the [lessor]'s consent and that [the lessor's] took advantage of the equipment to have the leased substances produced and as a result receive their royalty.
The prevalence of the use of Clause 17 in the industry does more than just set out the terms of an agreement between the parties, it defines the standard practice or practices in the industry regarding the ownership of the equipment and the right to remove it when production ceases. The terminology used clearly in the leases indicates that the ownership of the equipment remains with the operator of the well and not the owner of the mines and minerals.
That conclusion is consistent with the obligations assumed by the operator in Clauses 16 and 17 of the surface lease. The operator agrees in the surface lease to be subject to the strict liability concerning any damage caused by the presence of the well. Such obligations would work a hardship on the operator if it lost control of the equipment and lost the capacity to use and remove the equipment.
The evidence of the parties themselves confirms the standard practice that ownership remains with the operator. The [lessor] did not intend to assume ownership of the equipment or to be responsible for its operation. Similarly, Mr. Stan Devaleriola testified that the operators always considered that they were the owners of the equipment and conducted themselves accordingly.
Recent developments in the oil industry reinforce the industry practice regarding the ownership and the right to remove the equipment from the land. The latest CAPL lease, released in 1999, does not have an equipment removal clause. The CAPL surface lease grants the lessee the right to remove all equipment, fixtures, casings in wells, pipelines and anything else placed on the land. The deletion of the equipment removal clause in the petroleum and natural gas lease is based on the assumption that the right to remove the equipment is dealt with in the surface lease. If the owner of the minerals owned the equipment the operator and the owner of the surface would be relying on a clause in the surface lease which is meaningless. The change in the CAPL lease cannot have been made to cause such a situation. The change is however, consistent with the position that the equipment is annexed to the surface and subject to the terms of the surface lease.
In my opinion, the current standard practice confirms that the surface lease is determinative of the rights and obligations of the parties and the past standard practice of the parties confirms that the equipment belongs to the operator. The standard practice in the industry overrides the arguments advanced by the [lessor] regarding annexation of the equipment to the mines and minerals. The operators are the owners of the equipment.
The finding that the operator owns the downhole and wellbore is consistent with case law that has come from the very early development of the oil industry in Canada which held that a lessee who has drilled a well under an invalid lease or one that has been terminated, is entitled to be compensated for its costs. In Maple City Oil & Gas Co. v. Charlton, the well was drilled by the holder of a top lease which was taken despite the existence of a prime lease. The prime lease was upheld, but the Ontario High Court ruled that if the successful lessee (the plaintiff) took "the benefit of the work done and improvements made by the defendant company on the lands, it must be on terms of compensating that company therefor[.]"
That decision followed McIntosh v. Leckie where the successful party was ordered to compensate the lessee who drilled a well under an invalid lease if it took the benefits of the work.
This concept was followed in Weyburn Security where the party seeking the benefit of past production or who takes the benefit of the improvement made under a mistaken view of its interests should be compensated.
That conclusion is also consistent with the determination of the rights and obligations of the parties throughout this action, that is, that the [lessor] is entitled to all that it would have received under the lease and the [lessees] should be compensated in the normal way for their services.
Thus, the question of the ownership of the downhole, wellbore and surface equipment is resolved in favour of the [lessee] operator.
So and in the end for the lessor, although having won the battle on lease continuation arguably loses the war being entitled only to nominal damages and no ownership interests in and to the equipment, this after many years of litigation.
[1]2001 CarswellSask 729 (Sask. Q.B.)
2 2002 CarswellSask 476 (Sask. C.A. )
3 2003 CarswellSask 151 (S.C.C.)
4 2003 CarswellSask 534 (Sask. Q.B.)
5 2004 CarswellSask 583 (Sask. C.A. )
6 Leave to appeal to the Supreme Court of Canada refused: April 21, 2005 CarswellSask 254 (S.C.C.)