NO. 86-430 

IN THE SUPREME COURT OF THE STATE OF MONTANA 

19 9 0 

THE FEDERAL LAND BANK OF SPOKANE, a corporation, 

Plaintiff and Petitioner, 

-vsTEXACO, INC., a corporation, 

Defendant and Respondent. * 

ORIGINAL PROCEEDING: 

COUNSEL OF RECORD: 

For Petitioner: 

W. H. Bellingham argued; Moulton, Bellingham, Longo 

& Mather, Billings, Montana. 

For Respondent: 

Raymond K. Peete argued, Attorney at Law, Billings, 

Montana. 

Filed: 

Submitted: September 18, 1991 

Decided: November 14, 1991 
Justice R. C. McDonough delivered the Opinion of the Court. 

This matter is before us on certification from the United 

States District Court for the District of Montana, Billings 

Division. We accepted certification pursuant to Rule 44 of the 

M.R.App.P. 

Plaintiff-petitioners, Federal Land Bank (FLB), are lessors 

and defendant-respondent, Texaco, is lessee under an oil and gas 

lease. FLB brought. suit in the United States District Court of 

Mont'ana to terminate the lease as to all land not producing oil and 

gas upon expiration of the 5-year primary term under the lease. 

Texaco maintains the lease is in effect for all the lands under the 

lease due to the production of FLB No. 1 oil and gas well. The 

parties disagree as to the effect of the Pugh clause, paragraph 23, 

on the Habendum clause, paragraph 5, in the lease. We conclude the 

Habendum clause is modified by the Pugh clause. 

On December 18, 1973, FLB leased the land to Ray Kemmis for 

the purpose of drilling for oil and gas. Kemmis assigned the lease 

to Texaco. The lease, which contained a five-year primary term, 

expired on December .l8, 1978. 

Texaco completed FLB well No.1 on February 4, 1978. The well 

is located at the NE+SE$ of Section 7-T22N-R60E. 

The Oil and Gas Conservation Board of the Department of 

Natural Resources and Conservation for the State of Montana (the 

Board) is the agency charged with regulating matters pertaining to 

drilling of oil and gas for the State of Montana. Section 82-11- 

111, MCA. The Board named all of the leased lands in question the 

2 
Mon Dak West Field' (The Field). The Field contains several 

sections of land totalling 1,580 acres. In attempting to determine 

how wells should be spaced on this acreage, the Board initially 

determined 320 acre spacing per well. 

Section 82-11-201, MCA, provides in part: "To prevent or 

assist in preventing waste of oil or gas prohibited by this 

chapter, the board, upon its own motion or upon application of an 

interested person, after hearing, may by order establish well 

spacing units for a pool as to oil wells or as to gas wells or 

both.. ." The Board issued its spacing requirements for a period of 

one year, after which permanent spacing of the producing well was 

to be sought by the operator of the well. Texaco never applied for 

a permanent spacing order. On May 26, 1977, August 18, 1977, and 

May 12, 1978 the Board issued orders spacing the units in question. 

On June 7, 1978 the Board conducted a hearing and issued an 

Advisory Opinion. Certain members of the Board made a motion for 

spacing to be changed to one well per 160 acres, but the motion 

fail'ed. The spacing of wells, upon failure of the motion, reverted 

to "state-widet1 spacing; one well per 320 acres. Administrative 

Rules of Montana 36.22.701, et sec. 

The spacing per 320 acre drilling unit of the field is 

important here because it is pivotal to the understanding of the 

disputed clauses included in the lease. The Habendurn clause reads 

as follows: 

It is agreed that this lease shall remain in force 

for a term of 5 years from this date, and as long 

thereafter as oil, gas, casinghead gas, casinghead 

gasoline or any of them is produced from said leased 
premises, or drilling operations are continued as 

hereinafter provided. If, at the expiration of the 

primary term of this lease, oil or gas is not being 

produced on the leased premises but lessee is then 

engaged in drilling operations, then this lease shall 

continue in force so long as drilling operations are 

being continuously prosecuted on the leased premises; and 

drilling operations shall be considered to be 

continuously prosecuted if not more than sixty days shall 

elapse between the completion or abandonment of one well 

and the beginning of operations for the drilling of a 

subsequent well. If oil or gas shall be discovered and 

produced from any such well or wells drilled or being 

drilled at or after the expiration of the primary term of 

this lease, this lease shall continue in force so long as 

oil or gas shall be produced from the leased premises. 

The Habendum clause sets the term of the lease. The Habendum 

clause in the FLB lease provides the lessee can extend the five 

year term by producing oil and gas from said leased premises and in 

addition can be extended past the five year term by the continuous 

drilling clause. Also, the lease could be extended during the five 

year term by payment of yearly delay rental. Texaco paid FLB the 

delay rental fee on -December 18, 1977, to continue the lease for 

another year. FLB No. 1 well has been producing since February 4, 

Paragraph 23 of the FLB lease known as the Pugh clause reads 

as follows: 

23. Should any of the lands hereunder be included 

in a unit or units, during the primary term, either by 

written consent of the lessor or as the result of action 

by any duly authorized authority having jurisdiction 

thereof, then operations on or production from a well 

situated on lands embraced in such unit, shall serve to 

maintain this lease in force as to that portion of the 

leased premises embraced in such a unit, but shall not so 

maintain the lease on the remainder of the leased 

premises not embraced in such a unit and not otherwise 

maintained under the terms hereof beyond the next rental 

paying date, unless on or before such rental date lessee 

shall pay or te.nder to lessor, or to lessor's credit in 
the manner provided in this lease, the amount of rental 

provided herein to be paid upon the area then covered 

hereby, reduced in the proportion that the acreage 

covered by this lease and contained in such unit or units 

bears to the total acreage then covered by this lease and 

further reduced by the amount of any shut-in gas well 

royalty payments made by lessee during the rental period 

or portion thereof immediately preceding such rental 

payment date on that portion of the leased premises not 

embraced in such a unit. By similar tender or payments 

on each succeeding annual rental date this lease may be 

so maintained in force during the remainder of the 

primary term as to the portion thereof not included in 

such unit or units. 

The main purpose of a Pugh clause is to "segregate the lands 

under the lease outside the unit from lands included in the unit 

for purposes of payment of delay rentals or perpetration by unit 

production or both." Hemingway, Oil and Gas, 464-465 3rd edition 

(1991). The Pugh clause may therefore, modify a Habendum (or term) 

clause to the extent that the lease terminates as to all of the 

lands included therein with the exception of a unit containing a 

producing well. In construing an oil and gas lease courts will 

app1.y the rules of contract interpretation. We have previously 

stated: 

[Tlhe intention of the parties is to be pursued if 

possible. This intention is to be gathered from the 

entire agreement, not from particular words or phrases or 

disjointed or particular parts of it . . . The contract 

must be viewed from beginning to end, and all its terms 

must pass in review; for one clause may modify, limit or 

illuminate the other. 

Lee v. Lee Gold Mining Co., et al. (1924), 71 Mont. 592, 599, 230 

P. 1091, 1093. Further we stated: 

[I]t is well established that a court, in interpreting a 

written instrument, will not isolate certain phrases of 

that instrument in order to garner the intent of the 

parties, but will grasp the instrument by its four 

corners and in light of the entire instrument, ascertain 
the paramount and guiding intention of the parties. 

Steen v. Rustad (1957), 132 Mont. 96, 102, 313 P.2d 1014, 1018. 

In Riis v. Day (1980), 188 Mont. 253, 257, 613 P.2d 696, 698, we 

said.: 

A contract is to be construed so as to make 

provisions effective, if possible. Repugnant provisions 

should be interpreted in such a way as will give them 

some effect, subordinate to the general intent and 

purpose of the entire contract. Sections 28-3-201, 28-3- 

202, and 28-3-204, MCA. Followed in St. Paul Fire & 

Marine Ins. Co. v. Cumiskey (1983), 204 Mont. 350, 363, 

665 P.2d 223, 229. See also Daniels v. Thomas, Dean & 

Hoskins (1990), 246 Mont. 125, 145, 804 P.2d 359, 371. 

For our purposes the pertinent part of the Habendum clause 

provides : 

It is agreed that this lease shall remain in force for a 

term of five years from this date, and as long thereafter 

as oil, gas, casinghead gas, casinghead gasoline or any 

of them is produced from said leased premises, or 

drilling operations are continued as hereinafter 

provided. 

Without more, inasmuch as FLB No. 1 well began producing 

during the five-year primary period, the lease would remain in 

effect as to the entire leased premises. However, the pertinent 

part of the Pugh clause provides: 

Should any of the lands hereunder be included in a unit 

or units, during the primary term, either by written 

consent of the lessor or as a result of action by any 

duly authorized authority having jurisdiction thereof, 

then operations on or production from a well situated on 

lands embraced in such unit, shall serve to maintain this 

lease in force as to that portion of the leased premises 

embraced in such a unit, but shall not so maintain the 

lease or the remainder of the leased premises not 

embraced in such a unit . . . (Emphasis added.) 

Here the Pugh clause modifies the Habendum clause. Therefore, 

the two clauses are not in conflict with one another. Reading both 
paragraphs together, and the lease as a whole, their meaning is 

clear. The Pugh clause does just what it provides; it terminates 

the lease as to lands not embraced in a producing oil and gas unit. 

The ~nain purpose of the Habendum clause is to: 

. . . describe the duration of the interest granted, 

subject to other provisions contained in the lease 

(emphasis added) which may provide for an earlier or 

later termination under prescribed circumstances or upon 

the happening of certain events. 2 Kuntz, Law of Oil and 

Gas, 88 26.1, p. 318, (1989). 

The Pugh clause here is another provision contained in the lease. 

Texaco maintains that the S% of Section 7 where the well is 

located has not been established as a unit and therefore the Pugh 

clause does not apply. We disagree. To determine whether the Pugh 

clause applies in this instance, it is necessary to set forth some 

factual background. The producing well Texaco completed in 

February of 1978 extracts oil and gas from the Red River, Stony 

Mountain, Mission Canyon and Radcliff formations. The Red River 

and Stony Mountain formations are part of the Ordovician geological 

time period and the Mission Canyon and Radcliff formations are part 

of what has been termed the Madison group, which is part of the 

Mississippian geological time period. Texaco argues that the 

result of the June 7, 1978 hearing before the Board reverting the 

Mon Dak West Field to statewide spacing, did not have an effect on 

the Red River Formation. It did have an effect, however, because 

prior thereto, on May 15, 1978, Texaco requested and was given 

perrr~ission to comingle the production from these two zones. The 

Advisory Notice from the June 1978 hearing, refers to the Madison 

and Devonian Formations. 
On May 26, 1977, the Board spaced the Madison and Devonian 

formations (which include Mission Canyon and Radcliff) for a period 

of one year upon 320 acre drilling and spacing units. On May 12, 

1978, the Board continued this order until July 1, 1979. 

On August 18, 1977, the Board spaced the Silurian and 

Ordovician formations (which include Red River and Stony Mountain) 

upon 320 acre drilling and spacing units. 

FLB maintains that even though the Board used different 

nomenclature than the specific four formations from which 

production was eventually obtained, that the four producing 

formations are included in terms used in the various Board orders. 

Further, FLB argues that Texaco in filing a Notice of 

Intention to Drill with the Board, indicated that the land was 

located in the Mon Dak West Field. And, Texaco specifically 

designated the S$ Sec. 7 as a 320 acre spacing unit. The Board 

approved the application. FLB further argues that both Texacols 

and FLB1s division orders covered the S+ of Section 7-22N-60E only 

and Texaco paid royalties under the division order, which further 

indicates the tract was a properly spaced unit. 

We agree that the Board's orders established well spacing 

units for the field in question. We also hold that the lands 

covered in the lease were included in a unit. Based on the above 

discussion, we answer the certified questions separately. 

The following questions were certified: 

1. Is the term provision of the basic lease as set 

forth verbatim in paragraph 5 in conflict with paragraph 

23 of the basic lease, and if so, what is the legal 

effect of such conflict? No, as stated above, the Pugh 
clause modifies the Habendurn clause. 

2. Are paragraphs 5 and 23 of the basic lease 

referred to in the foregoing paragraph so indefinite, 

uncertain and ambiguous that they are incapable of being 

interpreted? No. 

3. Under the facts of this case, have any of the 

lands covered by the basic lease been I1included in a unit 

or unitsu as set forth in paragraph 23 of the basic lease 

and if so, what is the legal effect of such inclusion? 

Yes, as stated above, the inclusion of the land in a unit 

triggered the Pugh clause. 

4. Under the facts of this case, do the provisions 

of paragraph 23 of the basic lease operate to terminate 

and cancel the lease as to all of the lands included 

therein with the exception of those lands located in 

Section 7-22N-60E? Yes. 

5. Have any formations in the Mon Dak West Field 

been spaced under the applicable Montana statutes, rules 

and regulations by Orders numbered 23-77, 42-77, 33-78 

and 51-79 and Advisory Notice dated June 8, 1979, of the 

Montana Board of Oil and Gas Conservation? Yes. 

We Concur: