Canada-Cities Service Petroleum Corporation v. Kininmonth et al., [1964] SCR 439

Supreme Court of Canada

Canada-Cities Service Petroleum Corporation v. Kininmonth et al., [1964] S.C.R. 439

Date: 1964-04-28

Canada-Cities Service Petroleum Corporation (Plaintiff) Appellant;

and

Orvilla Gertrude Kininmonth, Leonard Wickson Kininmonth and Prudential Trust Company Limited (Defendants) Respondents.

1964: February 12, 13 14; 1964: April 28.

Present: Cartwright, Martland, Judson, Ritchie and Spence JJ.

ON APPEAL FROM THE SUPREME COURT OF ALBERTA, APPELLATE DIVISION.

Mines and minerals—Petroleum and natural gas lease—Provision for extension of primary term if production obtained—Well drilled and made ready for fracturing treatment prior to expiry of term—Operations delayed beyond expiry date due to municipal road ban—Whether lease continued in force or terminated at end of primary term.

The habendum clause of a petroleum and natural gas lease, dated May 11, 1951, defined the term of the lease as "10 years from the date hereof, and so long thereafter as the said substances or any of them are being produced from the said lands." During the tenth year of the lease the appellant (the assignee of the lessee) obtained a licence from the Alberta Oil and Gas Conservation Board to drill a well to produce oil from the Jumping Pound Sand formation. The drilling of a well was commenced on March 21, 1961, and the formation in question was reached on March 27. The Jumping Pound Sand was dry, but crude oil had been encountered at a lesser depth in the Cardium Sand formation. On March 29, 1961, the appellant applied to the Board to obtain permission to plug back the well to complete it for the taking of production from the Cardium Sand. This application was approved on

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March 30, subject to a condition with respect to a spacing unit requirement.

On April 1, 1961, the well was ready for fracturing treatment designed to open up the producing formation so that the well would be in a position to produce commercial quantities of oil. The appellant did not, at that time, bring to the well location the necessary heavy equipment required for that purpose because, on March 17, a road ban had been imposed by the municipality in which the well was located, which ban continued until May 11. After the termination of the road ban, the equipment was brought to the well site and, in the result, production of oil from the well was obtained from the Cardium Sand between June 26, 1961, and July 6, 1961. The appellant was compelled to cease production by order of the Board because the taking of such production was in breach of the condition which had been imposed when approval had been given for the plugging back of the well.

In an action in which the appellant sought a declaration that the lease was valid and subsisting, the trial judge held that the lease was still subsisting. This decision was reversed on appeal by the Appellate Division of the Supreme Court of Alberta, one member of the Court dissenting. From that judgment an appeal was brought to this Court.

Held: The appeal should be dismissed.

The habendum clause granted a primary term of 10 years, which was to be extended if production of any of the substances had been obtained during that period, for so long as such production continued beyond the 10-year term. However, no production had been obtained prior to the expiration of the 10-year primary term. At the end of that period it could not be said that any of the substances "are being produced." Under those circumstances, the lease expired on May 10, 1961, and there was nothing in the provisions of the lease which enabled it to be revived after it had terminated. It was, therefore, unnecessary to consider whether the interruption of the operations which were in fact being carried on by the appellant was or was not the result of causes beyond its control.

The paragraph of the lease imposing a drilling commitment did not modify in any way the terms of the habendum clause. That clause specifically defined the period during which the lessee was entitled to exercise its rights respecting the land, including the right to drill. The drilling commitment did not create any overriding right to drill and to continue drilling operations after the 10-year term. On the contrary, it imposed a duty to drill within the specified period. The lessee deferred the performance of its drilling obligation to the last months of the 10-year term at its own risk. If it failed to be in production before that term expired, then the habendum clause came into play and the lease automatically terminated at the end of the primary term.

Shell Oil Co. v. Gunderson, [1960] S.C.R. 424, applied.

APPEAL from a judgment of the Appellate Division of the Supreme Court of Alberta1, reversing a judgment of McLaurin C.J.T.D. Appeal dismissed.

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J. M. Robertson, Q.C., for the plaintiff, appellant.

W. B. Gill, for the defendants, respondents, O. G. Kininmonth and L. W. Kininmonth.

The judgment of the Court was delivered by

Martland J.:—The matter in issue in this appeal is the interpretation of a petroleum and natural gas lease, dated May 11, 1951, made by James Kininmonth, as lessor, and Douglas M. Machon, as lessee, in respect of the south half of Section 26, Township 27, Range 2, West of the 5th Meridian, in the Province of Alberta, which will be hereinafter referred to as "the land." The respondents Orvilla Gertrude Kininmonth and Leonard Wickson Kininmonth are the successors in title of the lessor. The respondent company claims an interest in the land under a royalty trust agreement made by it with the lessor. The appellant is the assignee of the lessee's interest under the lease.

After describing the land, the lease went on to provide that the lessor:

Doth Hereby Grant and Lease unto the Lessee the said Petroleum, Natural Gas and Related Hydrocarbons with the exclusive right and privilege to prospect and drill for, remove, store and dispose of, the said substances, and for the said purposes, so far as the Lessor has the right so to grant, to enter upon the said lands and use and occupy so much thereof as may be necessary or convenient for any or all of the said purposes or operations incidental thereto, or associated therewith, including drilling for producing, treating, processing and transporting the said substances.

To Have and Enjoy the same for the term of ..10.. years from the date hereof, and so long thereafter as the said substances or any of them are being produced from the said lands, subject to the sooner termination of the said term as hereinafter provided.

Provided that if operations for the drilling of a well are not commenced on the said lands within One (1) year from the date hereof, this lease shall thereupon terminate and be at an end, unless the Lessee shall have paid or tendered to the Lessor the sum of …Three hundred twenty —00/100— ($..320.00..) Dollars, as rental, which payment shall confer the privilege of deferring the commencement of drilling operations for a period of One (1) year, and that, in like manner and upon like payments or tenders, the commencement of drilling operations shall be further deferred for like periods successively;

Provided Further that if at any time during the said … 10… year term and prior to the discovery of production on the said lands, the Lessee shall drill a dry well or wells thereon, or if at any time during such term and after the discovery of production on the said lands such production shall cease, then this lease shall terminate on the next ensuing anniversary date hereof unless further operations for the recovery of the said substances from the said lands shall have been commenced or unless the Lessee shall have paid or tendered the said rental, in which latter event the immediately preceding proviso hereof governing the payment of the said rental and effect thereof, shall be deemed to have continued in force;

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And Further Always Provided that if at any time after the expiration of the said …10… year term the said 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 said substances or any of them, so long thereafter as the said 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, other than the Lessee's lack of funds, the time of such interruption or suspension shall not be counted against the Lessee, anything hereinbefore contained or implied to the contrary notwithstanding.

The appellant availed itself of the right to postpone from year to year its drilling commitment by the payment of the stipulated delay rentals. During the tenth year of the lease, on February 24, 1961, the appellant applied to the Alberta Oil and Gas Conservation Board for a licence to drill a well on legal subdivision 8 of the land to produce oil from the Jumping Pound Sandstone. A licence was granted by the Board on February 27. The spacing unit prescribed by the Drilling & Production Regulations under The Oil and Gas Conservation Act, 1957 (Alta.), c. 63, for the geological formation in question, was 80 acres.

The appellant commenced to drill a well on March 21, 1961, and reached the formation in question on March 27. The Jumping Pound Sand was dry, but crude oil had been encountered at a lesser depth in the Cardium Sand formation. The evidence indicates that the finding of oil in that formation was a reasonable probability in the light of development which had occurred in the area in which the land is located. The discovery of oil in the Jumping Pound Sand was much more uncertain.

The Alberta Oil and Gas Conservation Board had, on April 27, 1960, by Order SU 172, prescribed a spacing unit for a well drilled in a defined area, in which the land was situated, to obtain oil production from the Cardium Sand, of one half section of land comprising the east half or the west half of a section. As the land consisted of the south half of a section it did not constitute a spacing unit within that Order for the drilling of a well to the Cardium Sand, or for the production of oil therefrom.

On March 29, 1961, the appellant applied to the Board to obtain permission to plug back the well to complete it for the taking of production from the Cardium Sand. This application was approved by the Board on March 30, but

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subject to the express condition that "This well shall not be produced as a Cardium Oil well until the licensee has indicated to the Board that he has the right to produce from the entire spacing unit."

On April 1, 1961, the well was ready for fracturing treatment designed to open up the producing formation so that the well would be in a position to produce commercial quantities of oil from the Cardium Sand. The appellant did not, at that time, bring to the well location the necessary heavy equipment required for that purpose because, on March 17, a road ban had been imposed by the municipality in which the well was located, which ban continued until May 11.

After the termination of the road ban, the equipment was brought to the well site and, in the result, production of oil from the well was obtained from the Cardium Sand between June 26, 1961, and July 6, 1961. The appellant was compelled to cease production by order of the Board because the taking of such production was in breach of the condition which had been imposed when approval had been given for the plugging back of the well.

On June 1, 1961, Order No. SU 172 was superseded by Order No. SU 185, but the provision as to required spacing units was similar to that which had been contained in the earlier Order.

Various efforts were made by the appellant, which it is unnecessary to describe in detail, to put itself into a position whereby it could lawfully produce oil from the well from the Cardium Sand, but, up to the time of the trial of this action, which commenced on September 24, 1962, these had been unsuccessful.

A caveat had been filed by the appellant, under the provisions of The Land Titles Act, R.S.A. 1955, c. 170, to protect its interest under the lease. The respondents gave the form of notice prescribed in that Act, whereby the caveat ceases to have effect after the expiration of 60 days next ensuing the date of the notice, unless proceedings are commenced by the caveator on the caveat. Following receipt of this notice and prior to the expiration of the 60 day period, the appellant commenced this action, seeking a declaration that the lease was valid and subsisting.

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The question in issue was as to whether the petroleum and natural gas lease still subsists, or whether it terminated at the end of the 10-year primary term.

The learned trial judge held that the lease was still subsisting. This decision was reversed, on appeal, by the Appellate Division of the Supreme Court of Alberta, Macdonald J.A. dissenting2. From that judgment the present appeal has been brought.

I construe the five paragraphs which were cited earlier to provide as follows:

The first paragraph defines the rights granted by the lease in respect of the land. In particular, it gives to the lessee the right to drill for petroleum, natural gas and related hydrocarbons, which will be referred to hereafter, as they were in the lease, as "the substances."

The second paragraph is the habendum clause. It defines the term during which the lessee may enjoy the rights which had been granted to it in the first paragraph. The term is "10 years from the date hereof, and so long thereafter as the said substances or any of them are being produced from the said lands." I interpret this paragraph as granting a primary term of 10 years, which is to be extended if production of any of the substances has been obtained during that period, for so long as such production continues beyond the 10-year term. At the end of the 10-year term the lease is extended if any of the substances "are being produced."

The third paragraph obligates the lessee to commence drilling a well within one year from the date of the lease. This obligation may, however, be postponed from year to year by payment of delay rentals. Failure to commence drilling as required, unless the stipulated payments to postpone drilling are made, results in the termination of the lease within the 10-year period.

The fourth paragraph deals with the situation which occurs if the lessee, during the primary term, before production has been discovered, drills a dry well; or if, during the primary term, production has been discovered, but ceases.

The fifth paragraph commences with the words "if at any time after the expiration of the said 10 year term the said substances are not being produced on the said lands." The habendum clause spoke of a 10-year term "and so long there-

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after as the said substances or any of them are being produced." When the two expressions "are being produced" and "are not being produced" are read together, it is my opinion that this fifth paragraph is obviously designed to deal with the situation which occurs if the primary term has been extended by production from the land and then such production ceases. Without the fifth paragraph, the lease would automatically terminate upon the cessation of production. This paragraph, however, prevents that termination occurring if, when such production ceases, the lessee is then engaged in drilling or working operations on the land, or so long as such operations are prosecuted. If such operations result in further production, the lease continues during such production.

I cannot construe the paragraph as meaning that, even though no production has been obtained within the 10-year primary term, the lessee may thereafter carry on drilling operations on the land which, if successful, will then serve to extend the lease for a further period during the continuance of such production.

The latter part of the fifth paragraph covers the situation which may occur if drilling, working or production operations are interrupted or suspended by causes beyond the lessee's control. In my opinion this portion of the paragraph only comes into play if the lease has already been extended beyond the 10-year primary term, as a result of production, and then such production ceases.

In the present case no production had been obtained prior to the expiration of the 10-year primary term. At the end of that period it could not be said that any of the substances "are being produced." Under those circumstances, in my opinion, the lease expired on May 10, 1961, and there is nothing in the provisions of the lease which enabled it to be revived after it had terminated. It is, therefore, unnecessary to consider whether the interruption of the operations which were in fact being carried on by the appellant was or was not the result of causes beyond its control.

The views which I have expressed regarding the meaning and effect of the provisions of the lease under consideration are in accordance with what was stated in relation to similar provisions contained in the petroleum and natural gas lease

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which was under consideration in this Court in the case of Shell Oil Company v. Gunderson3. At p. 429 it was said:

Drilling operations, in order to be effective to continue the lease in force beyond the five-year term, would have to be of the kind defined in the proviso to the habendum clause, which has been previously quoted. That proviso refers to drilling operations "after the expiration of the five-year term". The proviso takes effect only if the lease has been extended as a result of production and if, when production ceases, the lessee is then engaged in drilling operations.

The contention of the appellant is that it had the right to commence drilling at any time within the final year of the 10-year term and that it must be inferred that the lease contemplated that, if it did commence drilling within such time, it would then have the right to complete its drilling operations and to take production from the well drilled after the end of the 10-year period. The appellant further contends that it did commence drilling operations within the 10-year period and was only precluded from continuing them by reason of their interruption by causes beyond the appellant's control.

The appellant's argument involves the proposition that the drilling obligation imposed upon the lessee, coupled with the lessee's right to postpone the commencement of drilling by payment of delay rentals, has the effect of modifying the habendum clause to the extent that the lease is extended beyond the 10-year term if drilling of a well is commenced within that period and thereafter continued and completed.

I do not construe the paragraph which imposes the drilling commitment as modifying in any way the terms of the habendum clause. That clause specifically defined the period during which the lessee was entitled to exercise its rights respecting the land, including the right to drill. The drilling commitment did not create any overriding right to drill and to continue drilling operations after the 10-year term. On the contrary, it imposed a duty to drill within the specified period. The fact that the lessee was under a contractual obligation to commence the drilling of a well, in this case, in the tenth year of the term of the lease did not have the effect of enabling him to defer the commencement of drilling until practically the end of the 10-year term and then to claim, as a right, an extension of the term during such time as it might take to complete the drilling of the well. In my

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view the lessee deferred the performance of its drilling obligation to the last months of the 10-year term at its own risk. If it failed to be in production before that term expired, then the habendum clause came into play and the lease automatically terminated at the end of the primary term.

The appellant cited American authorities, some of which were the basis for the reasons for the dissenting opinion of Macdonald J.A. in the Appellate Division. He cited a summary of the effect of the cases on which he relied, which is contained in certain "Discussion Notes" found in 17 Oil & Gas Reporter at p. 785:

Where a lease contains an habendum clause providing that the lease shall be for a fixed term and so long thereafter as oil or gas is produced, and such lease also contains a drilling clause which provides that the lease will terminate unless a well is commenced on or before a certain date or payment made of delay rentals, there is division of authority as to the effect of a well commenced prior to the termination of the primary term and completed as a producing well after the primary term. A series of cases in Oklahoma makes it clear that Oklahoma follows the view that the lessee under such a lease has the right to complete such well and that the lease will remain effective during drilling operations in good faith after the primary term.

In particular he cited a portion of the judgment of Lewis J., delivering the judgment of the Court, in Moncrief v. Pasotex Petroleum Company4:

The right to commence a well during the primary term carries with it, by necessary legal implication, the right to complete the well after expiration of the primary term unless negatived by contract terms or loss by abandonment. Simons v. McDaniel [7 P.2d 419].

It may be noted that in Summers' "The Law of Oil & Gas", Permanent ed., vol. 2, the learned author deals with the interpretation of the habendum clause in a petroleum and natural gas lease in c. 10. In particular, in ss. 292 to 301 in that chapter, he refers, on various occasions, to the general rule that production within the definite term is a condition precedent to the extension of the lease beyond that term. He refers, with apparent disapproval, to the fact that courts in some states have created exceptions to the general rule and refers in this regard, among other cases, to the case of Simons v. McDaniel, the case which was relied upon by Lewis J. in the passage from his judgment previously quoted.

However, irrespective of what construction may have been placed by courts upon other leases, the essential task in the

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present case is to construe the terms of the lease which is in question. For the reasons already given, it is my view that there is no provision in it to enable the extension of its term beyond 10 years, save only by the production of one of the substances from the land within and continuing beyond that period. Such production did not occur in the present case and, accordingly, in my opinion, the lease terminated at the end of its primary term.

For these reasons, in my opinion, the appeal should be dismissed with costs.

Appeal dismissed with costs.

Solicitors for the plaintiff, appellant: Fenerty, Fenerty, McGillivray, Robertson, Prowse, Brennan & Fraser, Calgary.

Solicitor for the defendants, respondents, O. G. Kininmonth and L. W. Kininmonth: W. B. Gill, Calgary.