What Is A Pugh Clause?

For most Pennsylvania landowners who have signed an oil and gas lease, the possibility of receiving royalties sounds exciting. As landowners see drilling development approaching their property, the potential royalties seem ever more real. When a landowner receives notification that her land has been included in a pooled production unit, these life-changing royalties seem just around the corner.

Imagine the landowner’s dismay when she reads the Declaration of Pooling and Unitization and realizes that her property has been “clipped” and that and only a small portion of her land has been included in the production unit. Unfortunately, this is the reality for many Pennsylvania property owners.

The gas leases used by the companies drilling in Pennsylvania allow the gas company to combine multiple properties into a pooled production unit. The landowners in the unit will share in the royalties from wells drilled based on their proportional ownership of the unit. While some production units may follow property boundaries, in most cases the unit is in the form of a rectangle with the boundaries of the unit not following property lines. Although the landowner will only receive royalties for the portion of the land included in the unit, the entire property is extended into the secondary term of the lease and held by production. For a landowner with only a small portion of her land in a production unit this is not a good outcome.

The solution to this problem is a Pugh Clause. Usually added to the lease as an addendum, the pugh clause provides that at the end of the primary term (typically five years) the lease will terminate as to any acreage outside of a production unit. This allows the landowner to sign a new lease for the property not included in the unit at the end of the five year primary term. The cash bonus received for signing the new lease provides compensation to the landowner for the property not included in the unit.

Naturally, the gas companies don’t want to lose leased acreage and won’t offer a pugh clause to landowners signing a gas lease. However, this is an important provision that should always be requested in gas lease negotiations.

Landowners who have signed a lease without a pugh clause and find that their property has been “clipped” can take comfort from the accelerating pace of development in the Marcellus shale. Over time it is likely that additional production units will be formed including the acreage left out initially. However, landowners who have not signed a lease should understand the importance of working with an experienced oil and gas attorney who can draft an effective pugh clause and assist in negotiating with the gas company to include this important provision in their gas lease.

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