The Oil and Gas Addendum

In a recent non-precedential decision, the Pennsylvania Superior Court ruled that a driller did not breach the implied covenant of reasonable development by failing to drill a Marcellus Shale well. While Pennsylvania law generally recognizes an implied covenant of reasonable development in every oil/gas lease, the Superior Court in Caldwell v. Kriebel Resources Co., LLC, et al., 1305 WDA 2012 (June 21, 2013) concluded that the covenant can be negated and superceded by the express terms of the parties’ lease. Although the Caldwell opinion is non-precedential, it does illustrate the importance of reviewing and understanding each and every lease paragraph before actually signing the lease. An express lease term disclaiming the applicability of implied covenants may be enforceable under Pennsylvania law in light of the Caldwell decision.

On January 19, 2001 the Caldwells entered into an oil/gas lease with Kriebel Resources Co., LLC (“Kriebel”) concerning their 105 acre parcel in Clearfield County, Pennsylvania. The lease contained a twenty-four (24) month primary term. Pursuant to the habendum clause, the lease would continue beyond the primary term “so long as” oil and gas were produced from the leased premises. Buried in the middle of the lease was Paragraph 11. Paragraph 11 is what lawyers often refer to as a “boiler-plate” clause and provided that “no inference or covenant shall be implied as to either party hereto since the full contractual obligations and covenants of each party [are] herein fully and expressed set forth.” Although probably given little attention during the lease negotiation, this boiler-plate language would prove significant. Prior to expiration of the primary term, Kriebel drilled a series of shallow wells on the property which produced natural gas.

Several years later the Caldwells approached Kriebel about drilling a Marcellus Shale well. Kriebel refused. Eventually the Caldwells filed suit seeking judicial termination of the lease. In their suit, the Caldwells alleged that Kriebel had breached the implied covenant of reasonable development by failing to drill a Marcellus Shale well. In support of this theory, the Caldwells contended that Kriebel had an implied duty to develop all “economically exploitable” strata, not simply the shallow hydrocarbon formations. By drilling only shallow wells and ignoring the profitable Marcellus Shale formation, the Caldwells’ argued that Kriebel had breached this implied duty. Since it was undisputed that the shallow gas wells were, in fact, producing hydrocarbons, the Caldwells’ suit only sought termination of the “deep rights” under the lease. The trial court, however, disagreed with the Caldwells’ theory and dismissed the Caldwells’ suit based, in large part, on Paragraph 11 of the lease.

On appeal, the Caldwells argued that the trial court had erred in dismissing their suit and again asserted that Kriebel had a “duty to develop all economically exploitable strata of natural gas.” This duty, according to the Caldwells, existed regardless of the apparent limitation set forth in Paragraph 11. The Superior Court disagreed and held that the Paragraph 11 disclaimer negated any implied duties:

“…we are not authorized to impose an implied duty on the lessee to develop various strata in light of the language contained in their contract…”

The Superior Court noted that while Pennsylvania law does recognize the implied covenant of reasonable development, the parties’ specific agreement “may preclude application of the doctrine.” Given the language of Paragraph 11, the Superior Court concluded that the parties had agreed to disclaim all implied duties, including the implied covenant of reasonable development. Since Kriebel had no implied duty to develop the entire premises, let alone each and every hydrocarbon strata, the Superior Court opined that Kriebel’s shallow well operations were enough to maintain the lease as to all strata, including the deeper Marcellus Shale formation.

The important lesson from the Caldwell decision is that the implied covenant of reasonable development can be superceded by the express terms of your lease. The significance of this should not be overlooked. Upon the discovery of hydrocarbons, the operator generally has an implied obligation to drill as many additional wells as may be reasonably necessary to fully “develop” the underlying hydrocarbon formation. Without this implied covenant, a gas operator has no obligation or duty to drill additional wells. In other words, a 400 acre parcel could be maintained indefinitely with a single, shallow well. If the implied covenant has been expressly disclaimed in the lease, the landowner has no basis to challenge the operator’s failure or refusal to drill additional wells and develop the entire parcel. As such, landowners should carefully review any lease proposal that seeks to limit or disclaim this implied covenant.