The Oil and Gas Addendum

In its May 22, 2024 non-precedential memorandum decision in Frye v. Penn View Exploration, Inc., 919 WDA 2023 (Pa. Super. Ct. May 22, 2024), the Pennsylvania Superior Court found that an oil and gas lease’s shut-in royalty provision had no connection to the duration of that lease.  The Frye court concluded that a gas company’s failure to pay a shut-in royalty did not result in the termination of that oil and gas lease. With its focus on the text of the shut-in royalty provision, the Frye decision confirms the importance of oil and gas lease language, but also raises broader questions about whether shut-in royalty payments have any bearing on the duration of oil and gas leases absent express language.

The Frye case was an oil and gas lease termination dispute arising from a 69 acre parcel in Westmoreland County, Pennsylvania. The Fryes leased that property in 2008 (the “Frye Lease”). In 2012, Chevron, the successor lessee, formed the “Frye Unit”, included the Frye Lease in it, and drilled 3 wells from a well pad on the Fryes’ property. Those wells produced gas from late 2012 until July 1, 2018. At that time, the wells stopped producing because Equitrans abandoned a pipeline connecting those wells to market. In early 2019, Penn View, the defendant in the lawsuit, acquired rights to the Frye Unit and raised capital to construct a new gas gathering line to get gas to market. None of the Frye Unit wells produced gas after July 1, 2018.

In late May 2021, the Fryes sent Penn View a letter identifying that the Fryes intended to terminate the Frye Lease. In response, Penn View sent the Fryes a series of shut-in royalty checks for prior years, which the Fryes did not cash. In early June 2021, the Fryes sued Penn View in the Court of Common Pleas of Westmoreland County, seeking a declaratory judgment and injunctive relief that the Frye Lease terminated. A little over a month later, the Fryes filed an amended complaint, to which Penn View filed a Counterclaim, asserting that the Fryes breached the lease and damaged Penn View.

The Fryes moved for summary judgment on their lease termination claims. The trial court denied that request. Penn View moved for summary judgment on its breach of contract Counterclaim, which the trial court granted. The Fryes appealed to the Pennsylvania Superior Court, which reversed the lower court in part, but did not deliver the victory that the Fryes wanted.

The Fryes argued that the trial court errantly dismissed their request for summary judgment on the lease termination claim because all the wells in the Frye Unit stopped producing gas and Penn View did not maintain the Frye Lease in effect by paying a shut-in royalty. The habendum clause of the Frye Lease, setting its duration, stated that:

This lease shall continue in full force and the rights granted hereunder will be quietly enjoyed by the Lessee for a term of Five (5) year(s) and so much longer thereafter as oil or gas or their constituents are produced or are capable of being produced on the premises in paying quantities, in the judgment of Lessee, or as the premises shall be operated by Lessee in the search for oil or gas and as provided in Paragraph Seven (7) following.

The referenced “Paragraph 7” addressed what would happen when a well was a dry hole and plugged. The wells in the Frye Unit produced gas; they were not “dry holes” and were never plugged. So, Paragraph 7 was not implicated.

Importantly, the Frye Lease had a shut-in royalty clause. That provision contemplated a number of potential situations where wells were not producing oil or gas:

8. In the event a well drilled hereunder is a producing well and the Lessee is unable to market the production therefrom, or should production cease from a producing well drilled on the premises, or should the Lessee desire to shut in producing wells, the Lessee agrees to pay the Lessor, commencing on the date one year from the completion of such producing well or the cessation of production, or the shutting in of producing wells, an advance royalty in the amount and under the terms herein above provided for delay rental until production is marketed and sold off the premises or such well is plugged and abandoned according to law. In the event no delay rentals are stated, the advance royalty payable hereunder shall be made on the basis of one dollar ($1.00) per acre per year.

The Superior Court found this provision to be dispositive of the Fryes’ request for summary judgment on the lease termination issue. The appellate court determined that the shut-in royalty clause of the Frye Lease was implicated but rejected what it claimed to be the Fryes’ request to read a lease termination clause into the shut-in royalty provision. Instead, the Superior Court wrote of the shut-in royalty provision that “[u]nlike Paragraphs 3 and 7 of the Lease, this clause does not contain any direction that the Lease becomes null and void unless such payments are made. Indeed, this clause does not contemplate that a situation involving a shut in would affect the term of the Lease.” The Superior Court concluded that “. . . under Paragraph 8, the shutting-in of a well by a Lessee has no bearing on the habendum clause in Paragraph 2.”

Finding that Penn View’s non-payment of shut-in royalties had no bearing on the duration of the Frye Lease, the Superior Court agreed with the trial court that questions remained about whether Penn View satisfied the habendum clause of the Frye Lease after the wells stopped producing gas. The Superior Court noted Penn View’s efforts to return the wells to productive status by obtaining financing for a gathering pipeline raised a good faith question about whether the wells were capable of being produced in paying quantities under the Frye Lease habendum clause. That required further development in the trial court.

Additionally, the Superior Court reversed and vacated the lower court’s entry of judgment in Penn View’s favor on its Counterclaim. Penn View had argued, and the lower court agreed, that the Fryes breached a provision in the Frye Lease which allowed the lessee 30 days to “cure” any breaches of the lease before filing a lawsuit. The Fryes wrote to Penn View on May 20, 2021 identifying that the Frye Lease had terminated. They filed their lawsuit on June 9, 2021, less than 30 days later. Penn View claimed that it was damaged by this breach, though the details of that claim were not substantively developed.

The appellate court recognized that the Fryes had filed their complaint less than 30 days after their May 20, 2021 notice letter, but also noted that the Fryes amended their complaint on July 21, 2021. Since amended complaints moot prior pleadings, the Superior Court concluded that the Fryes did not breach the Frye Lease, since the Fryes’ operative pleading, their amended complaint, was filed over 30 days after their May 20, 2021 notice letter to Penn View. The Superior Court also found that the trial court had not addressed the substantive merits of Penn View’s breach of contract claim. So, the Superior Court remanded the case back to the Westmoreland County Court of Common Pleas for further development of all claims.

The Superior Court’s conclusions about lease termination and the lessee’s opportunity to “cure” both flow from the premise that the Frye Lease shut-in royalty provision had no impact on the duration of that lease. It is true that the Frye Lease shut-in royalty provision does not say anything about the payment of shut-in royalties having any bearing the duration of the lease. If the shut-in royalty clause had no role in the duration of the Frye Lease, then the lease would not have automatically terminated, so there would have been something that the lessee could have “cured” after the Fryes’ May 20, 2021 “notice”.

But, there is another side to this logic which the Superior Court did not address. The shut-in royalty provision’s disconnect from the duration of the Frye Lease would have to work both ways. If the lessee timely paid shut-in royalties during the period of non-production from the Frye wells after July 1, 2018, that conduct should not have had any bearing on whether the Frye Lease remained operative.

Consider the scenario where Penn View paid the annual shut-in royalty but did nothing to obtain a marketing outlet for the gas. Would that have been sufficient to maintain the Frye Lease in effect? The Frye Lease habendum states that it remains operative beyond its primary term for as long as wells are “capable of being produced on the premises in paying quantities, in the judgment of Lessee.”  Would making shut-in payments (and nothing more) be sufficient evidence of a lessee’s belief that the wells were capable of producing in paying quantities even though paying shut-in royalties had no bearing on the continued effectiveness of the Frye Lease? The Frye decision does not delve into those issues.

The takeaway for oil and gas owners from Frye is that the words of an oil and gas lease matter. The Superior Court’s Frye decision is non-precedential. It does not bind any court in Pennsylvania. But, it has persuasive value and provides insight into how appellate court judges may interpret oil and gas lease terms. The Frye court determined the effect of the shut-in royalty (or absence thereof) based on the specific language of the Frye Lease, not the general understanding that a shut-in royalty clause is a “savings” provision that can operate to maintain a lease in effect. That elevates the importance of contractual language over general concepts of how provisions usually function in oil and gas leases. But, it also compels examination of every oil and gas lease to determine if payment of a shut-in royalty is explicitly tied to the duration of the oil and gas lease.

Houston Harbaugh’s Oil and Gas Law practice assists oil and gas owners with all aspects of oil and gas matters. If you have an oil and gas related question, contact Brendan A. O’Donnell at odonnellba@hh-law.com or 412-288-2226.