The Oil and Gas Addendum

Your family owns a 87 acre farm in Tioga County. Back in 1979, your grandfather signed a lease with ABC Oil Co with a customary primary term of five years. In that 1979 lease, ABC Oil Co. promised to pay 12.5% on all oil and gas produced. One shallow vertical well was drilled in 1983, which produced modest royalties until the mid-1990’s. No other wells were ever drilled. In 2002, ABC Oil Co. sold the lease to Shale Gas Inc. In the years immediately after the sale, Shale Gas Inc. came out to the farm once or twice a year to inspect the well and perform general maintenance. Those visits stopped ten years ago. Around the same the time the inspections ceased, your family began to receive a “delay rental” check from Shale Gas Inc. in the amount of $870.00 each October. Your family never cashes the checks as it was assumed that the 1979 Lease had long expired due to non-production. Now, Shale Gas Inc. wants to build a well pad on your farm and drill several deep horizontal wells. Is the 1979 Lease still valid? Can Shale Gas Inc. build a well pad and drill new wells even though no royalties have been paid in over 25 years? Did the mere payment of “delay rentals” somehow revive and maintain the 1979 Lease? A recent decision by the Pennsylvania Superior Court strongly suggests that the 1979 Lease expired because the payment of “delay rentals” cannot maintain an oil and gas lease beyond its primary term.

At issue in Barton v. Graham ( 1704 WDA 2018, March 26, 2020) was an oil and gas lease signed in September 1964 ( the “1964 Lease” ). The 1964 Lease covered 100 acres in Armstrong County and had an unusually long primary term of fifteen (15) years. The habendum clause stated that the 1964 Lease would remain in effect beyond 1979 “so long thereafter as oil and gas can be produced in paying quantities.” The 1964 Lease also contained a “delay rental” clause whereby the lessee agreed to pay “a rental of $54.00 yearly until drilling operations are begun.”

The original lessee drilled a single shallow gas well on the leasehold which ceased producing in or around June 1993. No other wells were ever drilled. The Bartons purchased the 100 acre parcel in 1999. In the mid-2000’s, the Bartons began to receive annual “delay rental” checks from the driller. The Bartons rejected these payments and demanded that the driller surrender the 1964 Lease. The driller refused and the Bartons filed suit in May 2017. In their complaint, the Bartons sought a declaration from the court that the 1964 Lease had expired due to non-production. The Bartons further argued that although the driller had recently tendered annual “delay rentals”, these payments alone were legally insufficient to maintain the 1964 Lease beyond expiration of its primary term.

In June 2018, the Bartons moved for summary judgment. The trial court agreed with the Bartons and held that the payment of “delay rentals” could not maintain 1964 Lease since the primary term had expired years ago. The trial court cited Hite v. Falcon Partners, 13 A.3d 942 ( Pa. Super. 2011) as controlling authority and entered judgment favor of the Bartons. The driller then filed an appeal to the Pennsylvania Superior Court.

Before we examine the decision of the Superior Court, a brief discussion about “delay rentals” is warranted. Many older oil and gas leases required the operator to either drill a well or tender a “rental” payment in lieu of actual drilling. This obligation to drill or pay was triggered each year during the primary term. The failure to satisfy this annual obligation (i.e. drill a well or pay a rental) would typically terminate the lease, even if the primary term had not yet expired. Given this harsh outcome, many operators, especially in the Marcellus region, moved away from the delay rental concept and instead adopted a policy of offering “paid up” leases. Under this approach, the delay rentals and in years one (1) through five (5) of the primary term are bundled together and paid in one lump sum amount at execution of the lease. This eliminates the risk of possibly losing the lease due to the inadvertent non-payment of a delay rental. As such, delay rentals have become nearly obsolete and are now relatively uncommon here in Pennsylvania.

But, there are a number of older, pre-Marcellus leases that still have a delay rental mechanism. These older leases are generally subject to the well-established delay rental rule: the payment of delay rentals can only maintain a lease during its primary term. See, State ex rel. Claugus Family Farm LP v. Seventh Dis. Court of Appeals, 145 Ohio St. 3d 180 (Ohio 2016) (“[D]elay rental provisions have been interpreted to apply only during the primary term of a lease”); Vaughn v. Hearrell, 347 S.W.2d 542 (Ky. 1961) (“. . . delay rental clauses of the standard oil and gas contract are intended to keep it in force only within the primary term”); Morriss v. First National Bank of Mission, 249 S.W. 2d 269, 279 (Tex. Civ. App. 1952) (“. . . option to pay rentals ordinarily will delay operations as long as the rentals are paid, but not beyond the primary term”). Pennsylvania has long followed this general rule and reaffirmed this principle as recently as 2011 in Hite v. Falcon Partners.

In Hite, the Pennsylvania Superior Court concluded that the mere payment of delay rentals after the expiration of the primary term could not maintain the parties’ oil/gas lease. The panel opined that such an arrangement would be “inconsistent with the established rulings in public policy” that lessees should not be able to “postpone development indefinitely by the payment of delay rentals.” Hite, 13 A.3d at 948. Although the underlying lease in Hite arguably contained language that authorized the payment of delay rentals after the primary term expired, the Superior Court refused to give effect to such language. The court further opined that even if a party were to accept “delay rental” payments after expiration of the primary term as implied extensions of the lease, such extensions cease when a party refuses to accept further “delay rental” payments. Following Hite, it was generally understood and acknowledged that Pennsylvania adhered to the general rule that “delay rentals” are only effective during the primary term of an oil/gas lease.

The scope and legal effect of “delay rentals” under Pennsylvania law was somewhat muddled by the Pennsylvania Superior Court’s January 2020 decision in Wilson v. Synder Brothers, et al ( 734 WDA 2019, January 3, 2020). In Wilson, the driller tendered “delay rentals” after the primary term expired as a means to maintain the underlying lease. The landowner also executed a lease ratification agreement six years after the primary expired in which the landowner acknowledged and agreed that the lease was in “full force and effect”. The landowner filed suit in 2018 arguing that the underlying lease had expired due to non-production in 2004 and that the payment of “delay rentals” between 2004 and 2010 could not revive the expired lease. The trial court rejected this theory and the landowner appealed. On appeal, the Wilson panel held that the fact that the landowner executed the ratification in 2010 took the case outside the scope of Hite and therefore the purported “delay rentals” paid between 2004 and 2010 were sufficient to maintain the lease. The Wilson decision represents a dubious outlier and the rationale espoused by the court remains questionable.

The author submits that the recent decision in Barton restores some clarity to the legal effect of “delay rentals” under Pennsylvania oil/gas law. The Barton panel soundly rejected the drillers’ argument that the 1964 Lease could be revived and maintained after expiration of the primary term by the mere payment of “delay rentals”. Moreover, the Barton panel re-affirmed the clear “delay rental” rule adopted by the Hite court nine years ago:

“Based on our review of the record, we find that the trial court neither abused its discretion nor erred as a matter of law when it granted the Bartons’ motion for summary judgment. Indeed, pursuant to the Lease terms and this court’s holding in Hite, the primary term in the Lease ended when production ceased and the Bartons refused the [drillers’] delay rental payments”

Although the Barton opinion is technically non-precedential under Internal Operating Rule 65.37, it does shed some light on the direction the Pennsylvania Superior Court may be going with “delay rentals”. As such, it appears that the application and legal effect of “delay rentals” will continue to be governed by the rule set forth in Hite. This is good news as the bright-line rule provides much-needed clarity and certainty for landowners and drillers alike.