For Bakken mineral owners, the Pugh Clause is one of the most critical components of any oil and gas lease. Failing to inject this small but critical clause into an oil and gas lease may leave you with a lifetime of regret.
The Situation
In order to define a Pugh Clause, we must first explain a pooled production unit.
When an operator amasses enough leased acreage to put together a oil and gas production unit, they will piece together different landowner properties and request a drilling permit from the state. As a part of this process, the operator creates a Declaration of Pooling and Unitization which lists all the landowners to be made a part of the unit. Let’s start with an example
Example:
Operator A leases two 160 acre tracts of land:
- Landowner A owns 160 Acres.
- Landowner B owns 160 Acres.
Together the operator has leased 320 acres and creates a unit. The Declaration of Pooling and Unitization will show each of these owners having half of the mineral interest.
However, what would happen if we injected a third landowner?
Operator A leases three 160 acre tracts of land:
- Landowner A owns 160 Acres.
- Landowner B owns 160 Acres.
- Landowner C owns 160 Acres.
Together the operator has leased 480 acres but still creates a 320 acre unit. What if you received a Declaration of Pooling and Unitization showing the following interests?
- Landowner A is credited with 160 acres in the unit.
- Landowner B is credited with 155 acres in the unit
But you, Landowner C is only credited with 5 acres in the unit.
Obviously as Landowner C, you would be terribly disappointed having only 5 of your 160 acres included in the unit. The reduction in royalty income alone would be significant. But what most landowners do not realize is without a Pugh Clause their situation is much worse.
The Results without a Pugh Clause
What is a Pugh Clause?
So you have just learned that only 5 acres of your 160 was included in the unit. While this is not good news, without a Pugh Clause it gets worse. The Pugh Clause is usually an addendum to the original lease. In short, it states that at the end of the primary term (typically 3 years), the lease will terminate and any acreage not currently held in a producing unit will be released back to the landowner to sign a new lease.
In our example above, if you had leased 160 acres with a Pugh Clause and only 5 acres were included in the unit, you will be able to sign a new lease for the 155 acres not included in the unit at the end of the three year term.
However, if you failed to negotiate a Pugh Clause, the remaining 155 acres will be forever held by production, unless it later becomes included in a new unit. Meaning, the cash bonus you received for signing the original lease will be the only compensation you will ever receive on the 155 acres outside the unit. The only exception to this is if at some point in the future, the original lease no longer produces. At that point, all 160 acres may be released.
IMPORTANT NOTE: Oil and gas companies will rarely offer this clause. It is not in their best interest to do so.
Solution?
Make sure you have a proper Pugh Clause inserted into your lease.
If you have not already signed a lease and have more question, please contact us using the form below.
If you have already signed a lease and are not sure if you have a Pugh Clause or not, please contact us using the form below.
If you have already signed a lease and are confident you do not have a Pugh Clause, all is not lost. Again, with the action in the Bakken today, it is very likely your remaining acreage will be put into another unit.
Still have Questions?
If you have questions about leasing in general, please read the topic Leasing Mineral Rights in North Dakota or contact us using the form below.
