The Oil and Gas Addendum

There are thousands of older vertical wells scattered across Pennsylvania. Many of these wells have not produced oil or gas in years and have fallen into disrepair. Despite this non-production, drillers often contend that these idle wells can and do maintain the underlying oil and gas lease. These drillers often tell the frustrated landowner that they will operate the lease again “when the market rebounds” or “when the wells can be repaired.” In the meantime, the landowner is trapped in marketing limbo: he cannot enter into a new lease with a Marcellus operator because the old, shallow lease remains “in effect,” yet he is receiving no royalties or income from that non-productive lease. In a recent opinion, the Pennsylvania Superior Court recognized this dilemma and perhaps breathed new life into the venerable doctrine of abandonment.

At issue in Montgomery v. R. Oil & Gas Enterprises, Inc. was an oil and gas lease executed in 1975 concerning 240 acres in Venango County, Pennsylvania. The 1975 Lease contained a ten-year primary term and would continue beyond 1985 only if oil and gas was “produced from said land in paying quantities…” Shortly thereafter, several shallow vertical wells were drilled on the leasehold.

In 1991, the original lessee, Quaker State Oil Refining Corporation (“Quaker State”), assigned the shallow rights under the 1975 Lease to Pennsylvania General Energy (“PGE”). Quaker State retained the deep rights. In 2009, PGE’s successor, Harmony Oil & Gas (“Harmony”), assigned those same shallow rights under the 1975 Lease (along with the shallow vertical wells) to R. Oil & Gas Enterprises (“OGE”). The following year the Montgomerys purchased 32.21 acres of the original 240-acre leasehold. In 2014, having received no royalties from any of the older, shallow wells located on the 240-acre leasehold, the Montgomerys filed suit seeking partial termination of the 1975 Lease. Interestingly, the Montgomery complaint did not name Quaker State as a defendant and only sought termination of the 1975 Lease as to their 32.2 acres.

In response to the Montgomerys’ complaint, OGE defended the suit primarily on two grounds: i) that the trial court lacked jurisdiction because Quaker State and the owner of the other 208 acres were not part of the suit, and ii) that the 1975 Lease remained in effect because the leasehold itself could still produce hydrocarbons in the future. The trial court rejected OGE’s defenses and entered judgment in favor of the Montgomerys.

Critical to the trial court’s ruling was the undisputed fact that the shallow wells stopped producing prior to 2001. The trial court correctly noted that, under Pennsylvania law, the 1975 Lease would remain in effect after 1985 “only so long as production continued” and that when production ceased “the lease became an at-will tenancy, subject to termination by the lessor at any time.” Since production ceased sometime prior to 2001, the 1975 Lease had “terminated upon its own, unambiguous terms” long before OGE acquired its interest in 2009.

The trial court’s holding correctly applied what is commonly known as the “automatic termination rule.” This rule provides that the property interest acquired by the driller upon execution of an oil and gas lease will automatically terminate if the driller fails or ceases to produce hydrocarbons any time after expiration of the primary term. See, Brown v. Haight, 255 A.2d 508 (Pa. 1969) (“[T]herefore, in 1947 when oil and gas were not produced in paying quantities, the grantee’s fee interest terminated automatically and the property reverted to the grantor”); Cassell v. Crothers, 44 A. 446 (Pa. 1899) (“[W]here oil was no longer being produced in paying quantities, the lease was liable to be terminated”); Hite v. Falcon Partners, 13 A.3d 942 (Pa. Super. 2011) (“…when that primary term ended and Falcon failed to commence production, the agreement expired.”); Heasley v. KSM Energy, 52 A.3d 341 (Pa. Super. 2012) (“[W]hen production ceased, the lease became an at-will tenancy, subject to termination by the lessor at any time”). The hallmark of the “automatic termination rule” is that it is automatic: cessation of production, unless excused by a savings mechanism in the parties’ lease, terminates the driller’s property interest by operation of law.

The trial court, however, did not stop there. In a rather perplexing move, the trial court also opined that the exploration and developmental rights under the 1975 Lease were “abandoned” by OGE’s predecessor, Harmony. The trial court noted that the term “abandoned well” is specifically defined by statute as a well that has “not been used to produce, extract or inject any gas, petroleum or other liquid within the preceding twelve months…” See, 58 Pa.C.S.A. §3203. Since the shallow wells had not produced any hydrocarbons since 2001 (i.e., more than 12 months) and since the Pennsylvania Department of Environmental Protection had expressly declared these same wells “abandoned” in 2009, the trial court inexplicably concluded that Harmony had also “abandoned” the 1975 Lease. The trial court opined that:

“We are left with the conclusion that the subject MacDonald Oil and Gas Lease was abandoned by the prior owner Harmony Oil and Gas Company, Inc. That wells on that property have not been producing at any time after the year 2001. The aforementioned case law makes clear that neither oil nor gas was produced from the MacDonald Oil and Gas Lease in paying quantities, and that Harmony Oil and Gas had breached its implied obligation to explore and develop the property ‘with reasonable diligence.’ The failure to do so amounted in an abandonment of the Lease.”

It is respectfully submitted that given the trial court’s correct application of the “automatic termination rule,” discussion of the doctrine of abandonment was unnecessary and unwise.

Under Pennsylvania law, to successfully establish a claim for abandonment, a party must demonstrate an “intentional relinquishment” of rights. See, MacCurdy v. Lindey, 37 A.2d 514 (Pa. 1944) (“[M]ere nonuse does not constitute abandonment; there must be an intention to abandon together with external acts”). Oil and gas leases can be abandoned if there is evidence that the lessee intended to abandon the lease and commits some positive act of abandonment. Unlike the “automatic termination rule,” an abandonment claim requires the lessor to proffer evidence demonstrating or proving the lessee’s intent to abandon the lease. See, Hummel v. McFadden, 150 A.2d 856 (Pa. 1959) (noting that abandonment “differs from a forfeiture in that it is based on an intentional relinquishment of rights by the lessee, and not upon a breach of obligation”). No such evidence is required under the “automatic termination rule”. As such, it is generally recognized that the concepts are mutually exclusive: if a lease terminates due to non-production it is unnecessary to examine or assess the lessee’s intent to abandon. The trial court in Montgomery overlooked this distinction and apparently conflated the two theories.

On appeal, the Pennsylvania Superior Court affirmed the trial court’s entry of judgment in favor of the Montgomerys. Unfortunately, the Superior Court did not clarify the trial court’s erroneous reliance on the doctrine of abandonment. This is troubling. What is even more alarming is that the Superior Court went on to say that “…we adopt the trial court’s opinion, at pages 7 through 14, filed on June 30, 2015, as our own.” It is unclear if this statement represents a subtle change in the Superior Court’s view of the “automatic termination rule” and a signal that, in the future, an examination of the lessee’s intent may always be warranted. Such a change, in the author’s view, would bring unnecessary confusion and ambiguity to Pennsylvania law.