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.