Last week I discussed Wagner & Brown v. Sheppard, a recent Texas Supreme Court case that involved a lease termination clause. Sheppard’s lease in that case provided that, if royalties were not paid to her within 120 days after first production, the lease would automatically terminate. That is exactly what happened.
Landowners are usually surpriesed to learn that, under a “standard form” oil and gas lease, the lessee’s failure to pay royalties does not give the lessor the right to terminate the lease. The lease remains in effect, and the lessor’s only remedy is to sue for the unpaid royalties. Landowners often seek to negotiate a clause like Sheppard’s that gives the lessor the right to terminate the lease for failure to pay royalties. Exploration companies of course do not like such a provision. It puts them at risk that, if royalties are not timely paid for some inadvertent reason, they can lose the lease even though they are willing and able to pay the royalties.
First, I think it is not a good idea to include a provision that a lease terminates automatically if royalties are not paid within a specified time. Depending on the circumstances, it may not be in the lessor’s best interest to terminate the lease, even though royalties have been delayed. A better provision is that, if royalties are not paid by a specified date, the lessor has the option to terminate the lease.
Second, I think that the lessee has a good point as well. The lessor should not be able to terminate a lease because of inadvertence, or an innocent mistake, in paying royalties. A well-drafted termination clause should provide that, if royalties are late, the lessor must give written notice to the lessee and an opportunity to cure the problem. Only if the late payment is not rectified should the lessor have the right to terminate the lease.