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Energy & the Law

Is Your Well Producing in Paying Quantities? – The Jury Will Decide

Posted in Lease Disputes

genieOne consequence of falling oil prices is leases that cease to produce in paying quantities. The producer’s question: How soon must the well return to profitability? The answer in BP American Production Company v. Laddex, Ltd. is, a “reasonable” period, to be determined by the jury and not the judge.

The Magic Well

The facts aren’t unique: The well on a 40 year old lease produced steadily until August 2005, when production slowed “significantly”. In November 2006 the well “inexplicably” resumed producing in quantities comparable to prior to the slowdown (usually it’s because of higher prices or a workover). In 2007 Laddex took a top lease which would begin when the old lease was terminated, either by BP’s written release or by judgment terminating the old lease.

Laddex sued for termination of the old lease and possession of the mineral estate.

The Test For Paying Quantities

The jury must go through a two-step process to determine whether a lease should be terminated for failure to produce in paying quantities:

(1) Viewed over a reasonable period of time did the lease cease to pay a profit after deducting operating and marketing expenses; and

(2) would a reasonably prudent operator continue to operate under the lease for a profit and not merely for speculation?

The Problem with the Question

The question to the jury focused on a specific fifteen month period. The jury found that the well failed to produce in paying quantities and that a reasonably prudent operator would not continue to operate the well for profit. On the basis of that verdict the trial court entered judgment terminating the old lease and finding that the mineral estate reverted back to the lessor, at which time the top lease began.

What is a “Reasonable” Period?

By the time the top lease was executed the old lease had resumed production in paying quantities.  On appeal BP argued that limiting the inquiry to a specific fifteen months was not a reasonable period.  The court of appeal agreed, and concluded that the trial court arrogated to itself the decision that the relevant period was that particular fifteen months.  Thus, it limited the jury’s consideration to a period of time that was not reasonable.

Evidence that a lease has returned to profitable production is material to the determination of whether the period of time is reasonable under the circumstances. The jury was deprived of the opportunity to consider that evidence.

Lagniappe 

At Gray Reed we urge producers to treat their lessors with respect. Aside from being “the right thing to do” it could help in unexpected ways. Human nature being what it is, juries will want to punish the black-hat. Being reminded that your fate in a paying quantities case could be left to a jury, why give them a reason to punish you?

Invoking lagniappe calls for an extra dose of musical interlude.

Defendants Saved by Louisiana Subsequent Purchaser Rule

Posted in Pollution

james carvilleCo-author Brooke Sizer

Another Louisiana court has ruled that the Subsequent Purchaser Rule applies to damages following a mineral lease. In Bundrick v. Anadarko Petroleum Corp. it is the 3rd Circuit.

The Rule:

An owner of property had no right or actual interest in recovering from a third party for damage which was inflicted on the property before his purchase, in the absence of an assignment or subrogation of the rights belonging to the owner of the property when the damage was inflicted.

The Case

The plaintiffs bought seven tracts in St. Martin Parish that had been previously leased and subject to oil and gas production. They acquired the property after the expiration of the mineral leases and without obtaining an assignment of their predecessor-in-interest’s right to proceed against responsible parties. Oops!

Plaintiffs argued that the 12 defendants were negligent and strictly liable for the damage and that their conduct created a continuing and damaging nuisance and continuing trespass on the property.

They were denied recovery because they had not been assigned the rights of the prior owners to sue for damages. That right is a personal right and is not transferred to a subsequent owner without a clear stipulation to that effect.

Why is This Case Different from Eagle Pipe?

The plaintiffs wanted it to be, but the court said it isn’t. In Eagle Pipe and Supply, Inc. v. Amerada Hess Corp. the Louisiana Supreme Court relied upon the Subsequent Purchaser Rule to deny recovery to plaintiffs for contamination.

In Eagle Pipe the defendants operated under a surface lease and the Supreme Court specifically declined to rule on whether the doctrine applied to mineral leases. A different 3rd Circuit panel had ruled that the Rule did not apply to operations under a mineral lease. But the Supreme Court later told the 1st Circuit that they should apply Eagle Pipe to facts involving mineral leases. In Bundrick the 3rd Circuit did just that.

The plaintiffs also argued a cause of action for remediation of the contaminated property pursuant to Louisiana Mineral Code Art.11, because mineral rights are real rights that pass with the property to the subsequent purchaser without the need for a specific assignment. According to the court, Eagle Pipe clearly stated that leases convey personal rights only and these rights must be expressly assigned.

Why is That Man in This Blog?

Visit here often enough and you won’t usually find agreement with LSU grad James Carville. But then there was his address to the 2015 graduating class of LSU’s Manship School of Communication. Always entertaining, he decried the looming destruction of Louisiana higher education by Gov. Bobby Jindal and asked what the grads – and proud parents – are going to do about it.

Here’s something to do about it: Think of Bobby Jindal as you would an unprincipled, ambitious college football coach.  He cheats, achieves fame and success, and is off to a bigger contract before sanctions hit the fan. Or see him as an abscess. Tea Party tax relief metastacizes, and breaks catastrophically bad for those around him. He is Grover Norquist’s “girlfriend”. His lust for the power of higher office could leave Louisiana healthcare and higher education impoverished for years.

Mr. Carville and the crowd closed with this sing-along.

Can the Tax Man Come After Your Stored Gas?

Posted in Taxation

Co-author Matthew Wheatley

The owner of 33 BCF of gas cant’ just stuff it in his pocket and move it county-to-county to avoid taxes. So, the question: Is gas in storage subject to ad valorem tax on personal property?  taxThe Harris County Appraisal District thought so. The taxman prevailed in ETC Marketing v. Harris County Appraisal District.

The gas was stored in a depleted oil reservoir. The storage agreement between ETC – owner of the gas – and affiliate Houston Pipeline – transporter – enabled ETC to hold the gas for delivery to other states when demand is higher. ETC contended the gas was exempt from taxation because it is in interstate commerce.

When is Personal Property Taxable?

Tangible personal property is appropriate for taxation if it is located in the jurisdiction “for longer than a temporary period.” Property is immune from taxation if the owner can prove the tax:

  • applies to activity lacking a substantial nexus to the taxing state,
  • is not fairly apportioned,
  • discriminates against interstate commerce, or
  • is not fairly related to services provided by the state.

(Notice who has the burden of proof.)

Why Was the Stored Gas Taxable?

There was a substantial nexus between the activity and Texas. The gas was purchased, transported, and stored in Texas, and ETC had facilities and employees in Texas. Houston Pipeline’s facilities are also located entirely within the state.

The tax is fairly apportioned because it is “internally and externally consistent.” It is internally consistent because it is “structured so that if every state were to impose an identical tax, no multiple taxation would result.” The gas was stored in Texas “for longer than a temporary period” and ETC did not attempt to store the gas in any other state at the same time.

The tax is externally consistent because “the state has taxed only that portion of the revenues from the interstate activity which reasonably reflects the in-state component of the activity being taxed” … the entire volume of gas.

The tax did not discriminate against interstate commerce because it “places no greater burden upon interstate commerce than the state places upon competing intrastate commerce of like character.”  Even if the gas was in interstate commerce, it could be taxed when stored for the business purpose of selling at a later time of the owner’s choosing.  HCAD taxed only that quantity stored in Harris County on the date of taxation and as to which ETC acknowledged ownership.

The tax was fairly related to services provided by the state. ETC enjoys the benefit of police and fire protection and other public services which facilitate gas storage.

Not Everyone Agreed

A dissent made these points:

  • The tax imposes a burden on working gas in interstate trade that is “clearly excessive in relation to the… local benefits.”It threatens the free movement of commerce by placing a financial barrier by imposing a tax not levied by taxing authorities in other jurisdictions.
  • Local law enforcement, fire, and other public services serve the facility itself, which ETC pays substantial property taxes on, in addition to the taxes paid on cushion gas it permanently stores at the facility. The tax is thus not fairly related to state-provided services.

What is it about Kern County?

Two things: It produces 75 percent of all California onshore oil. And it’s home of the “Bakersfield Sound”. Examples:

Buck Owens

Buck disciple Dwight Yoakum

Flatterers

 

How to Manage Credit and Collect Unpaid Bills in Today’s Oil Patch

Posted in Contract Disputes, Litigation

chasing moneyCo-authors Preston Kamin and Joe Virene

Everybody from the well site to the board room has an opinion about when oil prices will “rebound”. Rather than an opinion, we have a question:  How do I collect my money while we’re waiting?

This post is a refresher for service companies and suppliers looking for money from operators, and for operators looking to non-operators.  There are many steps you can take to minimize credit risk and maximize leverage in the event extra efforts become necessary to collect.

Getting to Know You:  Dot the I’s and Cross the T’s at the Beginning

Vendors: Larger operators typically require master service agreements prior to the vendor doing work. Many of those agreements contain lien releases precluding the vendor’s ability to file a lien, or impose stringent limitations on the customer’s liability. When not negotiated, such agreements can leave the vendor vulnerable to liability. For example, indemnities and warranties can be one-sided, and warrant careful review to ensure they are fair and equitable.

Operators: Do you insist on a memorandum of operating agreement to be executed and filed in the public record so that your JOA-imposed operator’s lien can be given priority?

Of equal importance, especially with smaller customers, is investigating a potential customer’s credit.

What to Do When Things go Wrong

If the customer/non-op fails to pay, there are options prior to filing suit. For example:

  • Whatever you do, do it now. The longer you delay, the more likely the debtor will run out of money or someone will get to him first;
  • File a lien. There are time limits, and he is likely to ask you not to so that he can continue to do business unencumbered by questions of solvency.
  • Propose a payout agreement secured by an agreed judgment.
  • If the customer needs additional goods or services and you are willing to provide them, require payment before delivery;
  • If you have the leverage, negotiate for an overriding royalty.

This summary is from a longer article presented in this month’s TIPRO Target.

BB King RIP (music starts at 1:35).

 

 

Lipsky Revisited – Details and Debate

Posted in Hydraulic Fracturing, Litigation, Pollution

dunceI often wonder if anybody actually reads our modest, quasi-weekly offerings. They do! And they respond! To criticize!  I earn my keep being “critiqued” by impatient judges, aggressive opposing counsel and, occasionally, less-than-happy clients, so – challenge accepted.

“Critique” One:

Lipsky was not Range’s lessor, therefor I know nothing about the case. Surely, this person lives in my house, where I enjoy a long history of knowing nothing about anything. (Memo to self: check progress on subpoena for kids’ “sent” box). And the inquisitor is as adept as my beloved family in drawing expansive and incorrect conclusions from meager evidence.

As for Mr. Lipsky, he was a nearby landowner and not a lessor.  But the point – and the lesson – remain the same: His big mouth spread accusations that Range says are untrue. Range wanted to put a stop to it and was partially rebuked. Whether against a lessor or a stranger, it will be more difficult than in the past for anyone to use litigation as a tool to quash criticism.

“Critique” Two:

The EPA did not find Lipsky’s claims to be false, says our inquisitor. To evaluate this one, let’s use the time-honored, citizen-friendly, and court-validated process invoked by the TCPA: Can the reader draw rational inferences from circumstantial evidence in determining what the EPA believed about Mr. Lipsky’s claims?

What Really Happened?

The Railroad Commission ordered Range to test its gas, launched an investigation, and held a formal hearing – in which Mr. Lipsky and the EPA were invited to participate (they declined). The RRC considered scientific testimony on “geology, hydrogeology, microseismic analysis, hydraulic fracturing, geochemical gas fingerprinting, and petroleum engineering” and determined that gas in Mr. Lipsky’s water well was most likely from the Strawn formation, found at 200 to 400 feet, and not the Barnett Shale, from which the Range wells produced at 7,000+/- feet, and that Range’s wells did not contribute to the contamination. Shortly thereafter, the EPA – declining to explain why – withdrew its earlier finding that Range’s wells were an imminent and substantial endangerment to a public drinking water aquifer. The inquisitor blames “political pressure”.

A Quiz:

Who had the motive and stroke to apply “political pressure” on the EPA to withdraw its report?

A.  EPA BFF then-Gov. Rick Perry

B. Sen. Ted “Hands Across the Aisle” Cruz

B. Al Armendariz

C. The ghost of George Mitchell

Who is it?

Who is our nemesis, the avenger of truth, the harbinger of a world purified by its abstinence from hydrocarbons? The inquisitor claimed to be “Sharon Wilson”. Given the anger revealed in the communications and on a certain Website, I assume it is “Texas Sharon”. Those running for high office adhere to a cardinal rule: Never name your adversary. However, this is a public service. When you hear a story, consider the source. Get to know Texas Sharon as a source. Then draw your own inferences, rational or otherwise.

Answer to the Quiz:

Nobody. It was a trick question. My “inference”: The EPA realized they were wrong and, wisely, drug the report off into a gloomy corner of the bureaucratic netherworld where it died, alone and abandoned, shorn of its misshapen graphs, charts and footnotes.

In the name of “debate”, we have this musical interlude.

Invasion Update:

The dog barked last night; thought I heard the rumble of tanks from the invasion. Turned out it was just thunder.

How Are the Texas Anti-SLAPP Statute and Jade Helm 15 Alike?

Posted in Hydraulic Fracturing, Litigation, Pollution
Here The Come

Here They Come

May a court “draw rational inferences from circumstantial evidence” when determining if a plaintiff  has met its burden in a suit in which the defendant has invoked the Texas Citizens Participation Act . That was the question in In re Lipsky.

What is The Anti-SLAPP Statute?

The purpose of the TCPA (the “Anti-SLAPP” statute) is to protect citizens from retaliatory lawsuits seeking to intimidate or silence them on matters of public concern. The procedure for expedited dismissal of such suits involve a two-step process: First, a defendant-movant must show by a preponderance of the evidence that the plaintiff’s claim “is based on, relates to or is in response to the movant’s exercise of (1) the right of free speech; (2) the right to petition; or (3) the right of association.” If the movant demonstrates that the plaintiff’s claim implicates one of those rights, the burden shifts to the plaintiff to establish by “clear and specific evidence” a prima facia case for each essential element of the claim.

Applied to Lipsky and Range

Mr. and Mrs. Lipsky sued Range Resources for polluting their water well by Range’s gas wells in the area. You will remember the infamous video of Mr. Lipsky lighting the garden hose on fire. (Ultimately the Lipsky’s claims were determined by the Railroad Commission and the EPA to be false.) Range counterclaimed, alleging defamation, business disparagement and civil conspiracy. The Lipskys moved to dismiss the counterclaim under the TCPA.

The court focused on the second prong. Lipsky said “clear and specific” means “evidence unaided by presumptions, inferences or intendments”.  No, said the Supreme Court. In TCPA cases, like in others – fraud for example – “clear and specific evidence” can include drawing of inferences from circumstantial evidence. That’s the way people make decisions about a lot of things.

The court decided that Range’s evidence would support a claim for defamation but not business disparagement, and there was no clear and specific evidence to support a case against Mrs. Lipsky or consultant Alisa Rich. Range’s only remaining claim is against Mr. Lipsky for defamation.

What Does This Mean To Me?

Operator: You can’t intimidate your loud-mouthed lessor as easily as your predecessors once could.  Lessor: You are still on the hook for crushing legal fees and potential big-money liability if you persist in wildly exaggerated or untruthful accusations to anyone who will listen.  The anti-frackers aren’t your friends. They will repeat it, truth-be-damned, to anyone who will listen, causing you more grief and despair than you bargained for.

One if By Land, Two if By Sea 

While we’re here, let’s apply Lipsky to the real world. What “rational inferences from circumstantial evidence” can our elected officials draw so as to conclude there is a risk that the U. S. Government, in conducting its Jade Helm 15 military exercise, intends to invade the state, convert vacant west-Texas Walmarts to detention facilities, and incarcerate the true patriots? You could ask it this way: How irrational is it to believe that home-grown SEALS and Green Berets are going to storm the Rio Grande, pillage and plunder their way north to Dallas, and turn their wives, mothers, sisters, fathers and brothers over to the CIA? Prove to me they won’t, I guess.

Two musical interludes – one “subversive”, one not:   RIP Jack Ely and Ben E. King.

Your Texas Legislature at Work, Part 2

Posted in Legislation

tx capitolThe Texas legislature is still busy on energy issues. Is that good or bad? It depends on your situation; oil patch thieves won’t like it.

Wind Energy

Senate Bill 931 would blow away the Renewable Portfolio Standard, established in 1999 to set renewable energy goals for Texas. The bill would also halt construction of transmission lines in Competitive Renewable Energy Zones, through which miles of transmission lines connect West Texas wind energy with cities in the eastern part of the state.

The rationale is that wind energy targets in the original act have attained their goal and thus should be terminated. Here is a discussion of the bill.

Wind energy proponents are unhappy. See, for example, this editorial in the Dallas Morning News by Jim Marston of the Environmental Defense Fund. Among other complaints, he cites a double standard:

Oil and gas subsidies = good

Alternative energy subsidies = bad.

They seem to have a point.  Texas gives tax incentives for certain oil and gas production. What’s the difference?

Allocation Wells

House Bill 1552 would add a provision to the Natural Resources Code to address allocation wells. The high points are:

  • The statute would apply unless expressly prohibited by a lease, deed or other contract.
  •  An operator may obtain a RRC permit allowing it to drill, operate and produce from a well that traverses multiple tracts in order to prevent waste, promote conservation, or protect correlative rights.
  • Absent an agreement among affected owners of royalty or mineral interests regarding how to allocate production among the tracts, production will be allocated to each tract on in the proportion “that the operator or lessee reasonably determines or reflects the amount produced from each tract.”
  • The operator must send written notice to affected royalty and mineral owners.
  • If there is an agreement with a royalty or mineral owner allocating production, the agreement will prevail.
  • An affected owner unhappy with the allocation assigned by the lessee may request a RRC hearing on whether the production will harm the correlative rights of working interest and mineral owners, is necessary to prevent waste, and accurately attributes to each affected owner its fair share of the aggregated production.

If the bill passes I will discuss what its effect might be.

Oil Field Theft

House Bill 3291 establishes the crime of selling oil, gas or condensate without a Railroad Commission permit. The bill specifically includes oil and gas equipment or pipeline equipment. If the value exceeds $10,000 it’s a felony.

How do they do it?

In case you are looking for a new line of work: According to proponents of the bill, one way to steal production is to purchase a well that has ceased to produce for lack of production and claim that it is producing and selling oil stolen from another well.  Then you acquire a vacuum truck and help yourself to what’s not yours.

A Religious Experience, Part 2

As promised last week, here are the other artists “discovered” by Sam Phillips and recorded for the first time at Sun Studio:

Johnny Cash 1955

Carl Perkins 1956

Roy Orbison 1958. This one can’t be beat for its intellectual content.

What is Your Texas Legislature Doing for You Today?

Posted in Energy Policy, Local Ordinances

million dollar quartetThe Texas legislature has been busy on energy.

House Bill 40, similar to House Bills 539 and 540, steamrolled through the House of Representatives last week by a vote of 122 to 18. Reminds us of A L pitchers not rookies and the Rangers’ betting order.

The bill would preempt local control of oil and gas operations. If the bill becomes law political subdivisions could not enact or enforce ordinances that ban, limit or otherwise regulate an oil and gas operation within its boundaries.

Exceptions would be:

  • Above ground activity that governs fire and emergency response traffic, lights, or noise, or “reasonable” setback requirements;
  • That is commercially reasonable;
  • Does not effectively prohibit an oil and gas operation conducted by a reasonably prudent operator (hello Dallas and Denton); and
  • Is not otherwise preempted by state or federal law.

A regulation is prima facie commercially reasonable if it has been in place for at least five years and has allowed oil and gas operations to continue during that period.

See the House Research Organization’s analysis of who’s for and who’s against. You won’t be surprised at the lineups.

What Supporters Say:

  • To satisfy concerns that Railroad Commission surface regulations are insufficient and not enforced, the Legislature should fully fund the Railroad Commission and focus on improving state policies and regulations instead of off-loading that task to municipalities (good luck on the “fully fund” part);
  • The law would affirm the preemptive nature of state oil and gas regulations and reduce litigation (a cause dear to the heart of our legislature, regardless of the side effects);
  • Municipal regulations that effectively ban attempts to exploit natural resources deprive mineral rights owners of their property.
  • The law would affirm the dominance of the mineral estate (as has been the law of Texas since minerals were discovered).
  • The impact of operations are only temporary and can be mitigated by above-ground regulations such as setbacks, fencing, etc.
  • Establishes regulatory certainty.

What Opponents Say:

  • Even basic ordinances intended to insure public health and safety would be prohibited;
  • Effects of operations are felt most acutely at the local level, and municipalities are better equipped than state agencies to understand the effects of operations in their communities.
  • State agencies may not have the political will to enforce regulations to protect public health and the environment.
  • Gaps in state subsurface rules and regulations are filled by local ordinances, which would be preempted.
  • State regulations on oil and gas operations are notoriously weak.
  • Municipalities might have statutory obligations that cannot be performed without limiting subsurface activity.
  • Current law is sufficient to protect property rights. Regulatory takings are not inherently bad; property owners are compensated for a regulatory taking facilitated by municipal regulation.
  • Erosion of property rights is worthwhile if local regulations are necessary to protect neighborhoods from environmental degradation and public health consequences.
  • Oil and gas operations infringe on property rights of surface owners.

What Sam Phillips Did For You Yesterday

After watching Rhodes Baseball take three out of three from Millsaps, we had a holy experience Sunday in Memphis. The 8:00 a.m. Rite I service at Calvary Episcopal Church downtown was one, but I’m really talking about Sun Studio – “The birthplace of Rock and Roll”. Today’s musical interludes are the first studio recordings ever by these artists. What’s so new and different? Nothing, until you consider the best-selling tune of 1952 for perspective. Imagine the world before Rock and Roll and then listen:

Howling Wolf 1952 (not R&R of course, but it set the stage).

Elvis 1953

The Killer 1956

Three more next time, including two gents in the picture.

The Danger of “Too Much Information”?

Posted in Land Titles, Title Issues

bombI know contract writers who like to state terms, such as property descriptions, several different ways. If you just have to over-describe, at least be careful, and at least be sure the descriptions are consistent.

The McGregors and Millican were adjacent landowners fighting over a 34.28 acre wooded tract in Brazos County, Texas. The question:  Was the acreage in Millican’s chain of title. The answer: “No”. A 1945 deed in Millican’s chain conveyed 202 acres described by metes and bounds. It undisputedly included the 34.28 acres.

The Time Bomb Waiting to Explode 

A 1973 deed listed, as the “First Tract”, nine smaller parcels. Added together they totaled 1145.95 acres, though the deed did not mention that sum. One of the parcels was the 202 acre tract, and the previous deed was cited. So far, so good. A metes and bounds description was added, to “more fully describe” the First Tract, but that description did not contain the 34.28 acres. That tract was contiguous to the tract described in the metes and bounds. There were two inconsistencies: The general description purported to convey the 34.28 acres, but the metes and bounds did not. Second, the acreages for the nine parcels totaled only 1145.95, but the deed itself stated the total acreage was 1167.203.

The Rule – Kaboom

In case of conflict between two provisions in a deed, the more specific provision will control over general expressions that apply to the same land. This rule is not arbitrary, but is a means of discerning the parties’ true intent. Because the 1973 deed contained an unambiguous description – metes and bounds which did not include the 32.28 acres – reference to any other deed – such as the one that included he 34.28 acres – was not necessary to locate the tract. A metes and bounds description is more specific and better-indicates the parties’ intent.

Some Exceptions Apply, But Not Here

The court did allow that a metes and bounds description would not be given controlling effect if it is apparent from the language of the deed, read in light of the surrounding circumstances, that the parties intended that the general description should control, or when the grantor’s intention clearly and unmistakably appears from the language of the entire instrument. The clear intent for the general description to control in the face of a directly contrary metes and bounds description did not exist in this case. The court said it has never found a clear intent for a general description to control when directly contrary to metes and bounds that clearly defines an area. The general description can help when the specific description is “defective or doubtful.”  Mere inconsistency between the two does not itself render metes and bounds doubtful.

The Court of Appeals Rationale – Rejected

The court disagreed with the court of appeals on three points:

  • Lower court: The deed should be construed to convey the greatest estate its terms permit. Supreme court:  The preference for the greater estate does cannot overcome the clear and unambiguous specific description.
  • Lower court: The 1973 deed incorporated the 1945 deed by reference. Supreme court: The cases cited for that point did not focus on conflicts between general and specific descriptions. There were general statute of frauds discussions or general and specific provisions that could be reconciled.
  • The effect of the lower court opinion presented difficulties. The deed stated that the First Tract was composed of 1167.203 acres, but the description referred to nine parcels when added to together total only 1145.95. The metes and bounds description excluded the 34.28 acres but conveyed a larger area that the general description. To rule as the lower court did would create guesswork for future title examinations.

Percy Sledge RIP

No Equitable Extension of a Pennsylvania Oil and Gas Lease

Posted in Lease Disputes

Boss dismissing an employeeWhoa! I didn’t see this one coming. Pennsylvania lessees are not entitled to an equitable extension of the primary term of an oil and gas lease in the face of a legal challenge to the validity of the lease.

Half way during the primary term of a five-year lease, lessors the Harrisons sued Cabot in federal court seeking a declaration that the lease was invalid.  The Harrisons claimed to have been fraudulently induced to enter into the lease. Cabot sought its own judgment that if the suit failed the primary term of the lease would be equitably tolled during pendency of the suit.

Cabot’s claim – Do it like everybody else does it

  • The lawsuit created a cloud on title that prevented Cabot from prudently taking any steps to develop or commence operations on the leasehold as allowed by the lease.
  • Cases from Louisiana, Arkansas, Illinois, Texas and Montana, and Williams and Meyers establish, equitable extension as almost black letter law.
  • A party to a contract is entitled to the benefit of the bargain, of which the Harrisons were depriving Cabot by their suit.

The Harrisons’ claim – Hitch up your big-boy pants   

For their part, the Harrisons relied on these propositions:

  • The mere filing of a declaratory judgment action challenging a lease is not, in and of itself, refutation of the lease such that would “implicate judicial redress”.  In other words, the court expected Cabot to drill a well (which would have cost $4 – 7 million).
  • Big companies such as Cabot are capable of negotiating tolling provisions to account for a delay occasioned by a challenge to the validity of the lease.
  • The equitable extension principle is nothing more than a “judicial affirmative action program” for oil and gas companies which “abuses land owners who have done nothing other than exercise their legal rights”.
  • Don’t forget disparate bargaining power.
  • There is the “chilling effect” that an extension rule would have on landowners’ willingness to bring meritorious challenges. (Another way to see it: If the lessor loses he still ends up with what he bargained for – an oil and gas lease for a term during which the validity of the lease was not in question.)
  • Lease litigation is merely one of a number of risks encountered by oil and gas companies.

Winning the battle but losing the war

The federal district court awarded summary judgment to Cabot on the suit to invalidate the lease, but denied the counterclaim.  The case was sent to the Pennsylvania Supreme Court by the federal 3rd Circuit.  It was a case of first impression.

The court has historically required more than a mere judicial challenge to the validity of an agreement to demonstrate repudiation. In cases outside of oil and gas context the filing of a declaratory judgment action contesting the validity or scope of an agreement does not entail such an unequivocal refusal to perform.  The court declined to carve out an exception in oil and gas lease cases.

In Pennsylvania, a party repudiates a contract and thus effectuates an essential breach when it makes an unequivocal statement that he will not perform in accordance with the agreement. The Harrisons’ suit was not such a statement.

The court considered it a disservice to the legislative objectives of the declaratory judgment act to treat recourse to that procedure alone as a basis for altering material provisions of the agreement in controversy.

What does it mean?

  • A Pennsylvania court will require an affirmative repudiation of a lease, which a suit to declare a lease invalid is not.
  • What about a letter to the lessee that walks like repudiation and quacks like repudiation but stops just short of outright repudiation?  It depends. Is it “unequivocal”?
  • Landmen – get out your tolling agreement forms ready for every new lease in Pennsylvania.
  • Mineral owners – you now have a nifty but shifty new way to run off that lessee you don’t like.
  • It also works if you just want more bonus money.

Pennsylvania’s message to the oil business.