On February 17, 2015, the Pennsylvania Supreme Court decided Harrison v. Cabot Oil & Gas Corp., No. 75 MAP 2014, 2015 Pa. LEXIS 355 (Pa. Feb. 17, 2015) , holding that a declaratory judgment action by a landowner/lessor challenging the validity of an oil and gas lease does not constitute repudiation of the lease. While the ruling is the minority view in the decisional body of oil and gas law, it is a victory for Pennsylvania landowners – particularly those whose property is presently subject to an oil and gas lease.
Ultimately, the Pennsylvania Supreme Court permitted the express terms of the oil and gas lease to control. However, the Court specifically advised, “oil-and-gas producing companies are free to proceed according to their own devices to negotiate express tolling provisions for inclusion in their leases.” Id. at *20. This instructive language exemplifies the importance of seeking legal representation prior to entering into an oil and gas lease.
In 2007, Harrison entered into a lease with Cabot Oil to explore oil and gas resources on his property. Id. at *1. The lease called for a primary term of five years. Id. Halfway into the term, Harrison filed an action in federal court seeking a declaration that the lease was invalid based on the premise that Cabot Oil fraudulently induced him to enter into the lease. Id. at *2.
Cabot Oil denied the allegation and filed a counterclaim seeking a declaratory judgment that, in the event Harrison’s claim failed, the primary term of the lease would be equitably tolled (suspended) during the pendency of the litigation and thereby extended for an equivalent period after the litigation concluded. Id. at *2-3. As a primary reason in support of its equity argument, Cabot Oil asserted that the cost of drilling a Marcellus Shale well in Pennsylvania ranges from $4 million to $7 million dollars and, therefore, it is “particularly impractical for an oil-and-gas producer to invest in drilling, completing a well when there is an ongoing lawsuit regarding the validity of the oil-and-gas lease.” Id. at *3.
As to the lease’s validity, the district court ruled in favor of Cabot Oil and against Harrison, but the court concluded that Pennsylvania law does not provide for equitable extensions of oil and gas leases under these circumstances. Harrison v. Cabot Oil & Gas Corp., 887 F. Supp. 2d 588, 596-98 (M.D. Pa. 2012). The district court relied on Derrickheim Co. v. Brown, 451 A.2d 477 (Pa.Super. 1982) and Lauchle v. Keeton Group LLC, 768 F. Supp. 2d 757 (M.D. Pa. 2011) in support of its position.
In Derrickheim, an oil and gas company entered into a lease with a landowner for a primary term of four years, with a right of first refusal to purchase the property during the primary term. Derrickheim, 451 A.2d at 175. After the oil and gas company learned of a possible title defect regarding the property, it suspended operations. Id. at 176. Following the expiration of the primary term, the landowner informed the oil and gas company that the lease was terminated. Id. The landowner then entered into an agreement to sell the property to a third party, which prompted the oil and gas company to file a complaint seeking a determination as to the validity of the lease – namely its right of first refusal. Id.
The trial court agreed with the oil and gas company’s contention that it was “prudent and proper” to suspend operations until the cloud was removed and therefore the lease term was equitably suspended until such time as the cloud was removed. Id. at 177. On appeal, the Superior Court reversed, stating:
[W]e cannot agree that the cloud on the title stopped the running of the lease term. The lease specifically stated that it would run for a term of four years “and as much longer as oil and gas is produced in paying quantities.” Since oil and gas was not being produced in paying quantities, the lease did not continue to run past the primary term of four years. The fact that it was “prudent” for Derrickheim to suspend operations upon learning of the cloud on the title does not justify disregarding the express language of the lease.
Id. at 177-178.
Lauchle involved a class of landowners who entered into substantially identical oil and gas leases with oil and gas companies in which each lease had a primary term of five years. Lauchle, 768 F. Supp. 2d at 760. During the term, the landowners filed a declaratory judgment action to determine whether their leases were valid under Pennsylvania’s Guaranteed Minimum Royalty Act, 58 Pa.C.S. § 33. Id. at 759. After the district court granted the oil and gas companies’ motion to dismiss, the oil and gas companies requested that the district court “equitably extend the leases to account for the period of time during which the [landowners] contested the leases.” Id.
The district court in Lauchle found “it extremely persuasive that the Derrickheim Court declined to equitably extend an oil and gas lease term after the conclusion of litigation that impacted the lease.” Id. at 761. “[M]indful of the fact that oil companies  wield significant, if not exclusive, power in the drafting of oil and gas leases,” the Lauchle Court declared that “deeming these leases to have been repudiated under the circumstances of this case is both bad law and even worse public policy.” Id. at 762.
Derrickheim was a Superior Court decision. Lauchle was a coordinate district court ruling. Thus, in Harrison, Cabot Oil appealed the district court’s decision to the Third Circuit Court of Appeals, contending that the Pennsylvania Supreme Court “‘would recognize the rule that, where a lessor repudiates a lease by initiating litigation seeking to invalidate the lease, the lessee is entitled to an equitable extension of the lease term if the lessor’s claim is denied.’” Harrison, 2015 Pa. LEXIS 355 at *7. The Third Circuit applied for certification to the Pennsylvania Supreme Court, which accepted, “recognizing that the issue was one of first impression and of significant public importance, given that its resolution may affect a large number of oil-and-gas leases in Pennsylvania.” Id. at *8.
The Pennsylvania Supreme Court observed that similar decisions on this issue by other jurisdictions have been in favor of oil and gas companies. Id. at *4, n.1, citing e.g. Greer v. Carter Oil Co., 25 N.E.2d 805, 810 (Ill. 1940)(“The great weight of authority in other States holds that where the lessor brings suit to avoid an oil and gas lease and the litigation ends after the grant has expired, that the lessors are estopped to claim the lease is invalid because the term has expired, and that an additional period of time may be fixed by a court of equity in which to commence drilling operations”). The Court also acknowledged that treating meritless lease challenges as a repudiation warranting equitable remedies “has become essentially one of black-letter law.” Id. at *11; Id. at *11, n.2, citing 3 Patrick H. Martin & Bruce M. Kramer, Williams & Meyers, Oil and Gas Law § 604.7 (2009)(“[C]ourts have almost universally held that when the lessor has brought a suit during the primary term claiming the termination of the lessee’s interest, the lessee, should he prevail in such action, will be entitled to a period of time extending beyond the expiration of the primary term to gain production”).
Notwithstanding the apparent majority view and black-letter law, the Court declined to modify longstanding Pennsylvania jurisprudence. “Under Pennsylvania law, anticipatory repudiation or breach requires an absolute an unequivocal refusal to perform or a distinct and positive statement of an inability to do so.” Harrison, 2015 Pa. LEXIS 355 at *17. Under the Restatement (Second) of Contracts:
“Generally, a party acts at his peril if, insisting on what he mistakenly believes to be his rights, he refuses to perform his [contractual duties]. His statement is a repudiation if the threatened breach would, without more, have given the injured party a claim for damages for total breach. Modern procedural devices, such as the declaratory judgment, may be used to mitigate the harsh results that might otherwise result from this rule. Restatement (Second) of Contracts § 250 cmt. d (1981).”
Id. at *18 (emphasis in original).
The Court observed, “it would disserve the legislative objectives [of the Declaratory Judgment Act] to treat recourse to such procedure, alone, as a basis for altering material provisions of the agreement in controversy (i.e., the lease term).” Id. at *20. With these principles in mind, the Court refused to “adopt a special approach to repudiation pertaining to oil-and-gas leases, as a substantial number other [sic] jurisdictions would appear to have done.” Id. at 18.
At Sebring & Associates, our attorneys can advise on the following matters:
- Review of existing oil and gas lease
- Review and negotiation of proposed oil and gas lease
- Formation of legal entity to hold oil and gas rights in sale or lease
- Review and negotiation of agreement of sale for oil and gas rights
- Drafting of hydrocarbon deed and conveyance of oil and gas rights
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