The Oil and Gas Addendum

In an October 10, 2023, the United States District Court for the Middle District of Pennsylvania dismissed a gas driller’s declaratory judgment lawsuit involving an oil and gas lease in the SWN Production Company, LLC v. Blue Beck, Ltd. Civil Action No. 22-cv-91 (M.D.Pa. October 10, 2023) case. This decision addresses an interesting question about when oil and gas claims are properly before courts for adjudication.

The SWN Production Company case has a fairly common foundation - an oil and gas lease royalty dispute. SWN Production Company (“SWN”) was the lessee under an oil and gas lease (the “Subject Lease”) with Blue Beck Ltd. (“Blue Beck”) concerning a leasehold property in Susquehanna County, Pennsylvania. Believing that its royalties were being underpaid, Blue Beck sent several default notices to SWN. The parties met to attempt to resolve the issues, and some matters were resolved, but Blue Beck nonetheless continued to claim that SWN failed to make certain royalty payments due under the Subject Lease. Apparently of concern to SWN was Blue Beck’s lack of a specific identification of why it believed that SWN was still underpaying royalties.

The Subject Lease contained a notice and dispute resolution procedure, allowing the lessee the opportunity to cure any alleged breaches. But, if the lessee did not cure a default in the time allowed under the Subject Lease, the lessor had the right to terminate the Subject Lease after providing 10 days notice to the lessee (if the default was not cured in that period).

With this backdrop, SWN filed a lawsuit seeking a declaratory judgment about the Subject Lease from the federal trial court. More specifically, SWN requested a declaration that:

(i) none of the purported Events of default exist or have not been cured; and (ii) the Lease’s Section 26(b) & (c) cure period (30 days + 10 days) for an Event of Default requires disclosure of sufficient detail, including the alleged amount of underpayment, that would allow SWN Production the opportunity [to] cure; (iii) once the Lessor engaged in the Dispute Resolution process under the Lease, it was required to allow the 60-day period for resolution of disputes to run before it could send a Notice of an Event of Default; (iv) there is no ‘occurrence’ of an ‘Event of Default’ that would allow for forfeiture of the Lease until (a) the Lessor and Lessee agree that an Event of Default has occurred or (b) there has been a final judicial determination that an event of Default has occurred; and (v) the Lease’s cure period does not begin to run until after the ‘occurrence’ of an ‘Event of Default’ has been (a) agreed to by the Lessor and Lessee or (b) determined to exist by a final judicial order.

Essentially, SWN asked the court for declarations of certain points under the Subject Lease in an apparent attempt to gain certainty regarding the dispute resolution process. The District Court declined and dismissed the case, concluding that it lacked jurisdiction to consider the issues that SWN presented.

The foundation of the District Court’s decision was theory that federal courts have limited jurisdiction. There must be a “case” and “controversy” before the court, and it cannot issue advisory opinions. U.S. Cons. art. III Sec. 2; Lewis v. Continental Bank Corp., 494 U.S. 472, 477 (1990). The SWN Production Court observed that “[t]o satisfy Article III’s case or controversy requirement, an action must present (1) a legal controversy that is real and not hypothetical, (2) a legal controversy that affects an individual in a concrete manner so as to provide the factual predicate for a reasoned adjudication, and (3) a legal controversy so as to sharpen the issues for judicial resolution.” quoting Rhone-Poulenc Surfactants & Specialists, L.P. v. C.I.R., 249 F. 3d 175, 182 (3d. Cir. 2001).

The District Court concluded that SWN did not present a “ripe” case or controversy in its request for a declaration under the Subject Lease. The court seemed to focus on the fact that, while Blue Beck asserted a breach of the Subject Lease, Blue Beck had not actually threatened to terminate the Subject Lease. While the court noted that SWN took action in court to avoid lease termination, the District Court reasoned that there was no ripe dispute that would implicate the court’s jurisdiction. The District Court reasoned:

“The parties here do not dispute that Plaintiff must pay Defendant royalties under the Lease; they only disagree on whether Plaintiff has done so correctly. Plaintiff is not faced with termination, for Defendant has not attempted to terminate or expressed an intention to do so.

Rather, the potential harm here remains contingent. It requires that Defendant choose to terminate, and that termination take effect after the ten-day cure period. Defendant has only given a notice of default, and termination is not the inevitable result of a notice of default. The parties may yet reach an understanding about the royalty payments, or Defendant may abandon this course. The facts here are simply not enough to demonstrate the likelihood of harm is sufficiently real and immediate to warrant a declaratory judgment. And, at this point, it cannot be said that the parties’ interests are adverse, for they share the goal of profiting on the Lease.”

[SWN Production at pp. 14-15]. This conclusion seems overly broad and raises interesting questions for both lessors and lessees under oil and gas leases.

In any lawsuit, parties may reach an understanding about its subject matter, so that, in and of itself, seems to be an insufficient explanation for why SWN’s claim was dismissed. Likewise, in an oil and gas royalty dispute, a lessor and lessee share a goal of profiting on the lease - but that does not eliminate the existence of a bona fide legal dispute regarding royalty underpayments. Therefore, it seems that the thrust of the District Court’s basis for dismissing the case was that SWN’s requested relief was geared toward obtaining a declaration of rights involving termination of the Subject Lease - a point which Blue Beck apparently had not yet raised. This is even though Blue Beck was unclear as to the root of its claims that SWN breached the Subject Lease and SWN was apparently concerned about Blue Beck claiming termination of the Subject Lease under this uncertain backdrop.

The SWN Production decision shines a light on oil and gas lease dispute resolution provisions. Drillers often use "notice" and "opportunity to cure" lease provisions to slow down litigation by landowners. But, such clauses do not always work to drillers' benefit, because, as in SWN Production, they can thwart an attempt to gain certainty about the status of an ongoing dispute and its impact on the validity of a lease. Moreover, it is important to recognize that not every disagreement under a lease or desire for clarity in parties' relationships implicates courts' jurisdiction. SWN Production gives both drillers and landowners something to consider when framing disputes, seeking the intervention of courts to resolve those disputes, and even in crafting dispute resolution clauses during lease negotiations.

If you have a lease dispute or disagreement with an oil and gas driller, SWN Production highlights important considerations that guide how to obtain a resolution. Contact Houston Harbaugh oil and gas attorney Brendan A. O'Donnell at 412-288-2226 or odonnellba@hh-law.com.