The Oil and Gas Addendum

The modern producing gas well is a sophisticated and complex piece of equipment. The basic well head itself consists of several meters, valves and other components, each of which is under constant stress and pressure. In addition to the well head, the producing gas well will be connected to an active network of gathering and transmission pipelines. Proper maintenance is a necessary and ongoing activity at any well site. Such maintenance, however, often requires the producer to take the well temporarily out of production. Moreover, unexpected breakdowns can and do occur over the life of a well. These breakdowns inevitably also take the well out of production.

In the absence of a specific clause in the applicable lease, it is unclear under Pennsylvania law exactly how much “time” a producer has to repair or rework the well before the entire lease will be declared terminated due to non-production. Pennsylvania has historically applied the “automatic termination rule” during the secondary term of a gas lease. Under this harsh rule, the secondary term of a lease will automatically expire unless there is a well producing gas “in paying quantities.” See, Cassell v. Crothers, 44 A. 446 (Pa. 1899) (“the moment she failed to produce oil in paying quantities, that moment the tenancy became a tenancy at will…”); Brown v. Haight, 255 A.2d 508 (Pa. 1969) (“…when oil and gas were not produced in paying quantities, the grantee’s fee interest terminated automatically…”); White v. Young, 156 A.2d 919 (Pa. 1963) (failure to produce gas in paying quantities results in termination of lease after primary term expired).

As such, any cessation of production during the secondary term, even one for routine maintenance or repair, will theoretically trigger the “automatic termination rule” and terminate the lease. Most oil/gas jurisdictions, however, have recognized the inflexibility of this rule and have adopted what is commonly known as the “temporary cessation of production” (“TCOP”) doctrine. Pennsylvania has not. Given the number of new Marcellus wells being drilled every day throughout this Commonwealth, it is time for Pennsylvania to formally recognize and adopt the TCOP doctrine and provide clarity and predictability to the industry.

What is the TCOP doctrine? In essence, the doctrine recognizes that it is nearly impossible for a producer to operate a lease continuously without any interruption. “[T]he TCOP doctrine presumes that the parties understood that mechanical problems, reworking operations or other similar events would inevitably interrupt production from time to time.” Natural Gas Pipeline Co. v. Pool, 124 S.W.3d 188, 204 (Texas 2003). The doctrine further assumes that the parties “did not intend such occurrences, which are incidental to normal oil and gas operations, to terminate the lease.” Midwest Oil Corp. v Winsauer, 323 S.W.2d 944, 946 (Texas 1959); See also McCullough Oil Inc. v Rezek, 346 S.E.2d 788, 794 (W.Va. 1986) (“…mere temporary cessation of production during secondary term for equipment repairs or technical problems, reworking operations … does not result in automatic termination of the lease…”). The doctrine gives the producer a “reasonable period” of time which to remedy the defect and resume production. Winsauer, 323 S.W.2d at 946.

The modern TCOP doctrine can be traced to the Texas Supreme Court’s decision in Watson v. Rockmill, 155 S.W.2d 783 (Texas 1941). In Watson, the well had been in production for approximately eight (8) years before it became clogged with salt deposits. Watson, 155 S.W. 2d at 784. The well produced about one barrel of oil to ten barrels of salt water per day. Id. Though the producer could have continued production, he concluded that the “lack of market” for low gravity oil did not justify operation of the well. Id. The cessation lasted over two (2) years before the salt deposits were removed. Id. The landowner filed suit for a judgment declaring the lease terminated due to non-production. Id. The producer defended the suit on the grounds that the cessation was temporary and should not automatically terminate the lease. Id. The Watson court concluded that to prevent termination pursuant to the TCOP doctrine, the cessation must be “due to a sudden stoppage of the well or such mechanical breakdown of the equipment used in connection therewith, or the like.” Watson, 155 S.W.2d at 784. Because the cessation was unrelated to actual repairs or reworking operations, the court held that the lease was not saved by the TCOP doctrine and terminated the lease. Id.

The doctrine set forth in Watson has evolved over the years but essentially consists of a two-part test. The first prong focuses solely on the cause of the cessation. Under this prong, the producer must demonstrate that the cessation was due to the factors outlined in Watson: a sudden stoppage or some mechanical breakdown of the equipment. See Somont Oil Company v. A&G Drilling, 49 P.3d 598 (Mon. 2002); See also, Bryan v. Big Two Mile Gas Company, 577 S.E.2d 258, 266 (W.Va. 2001) (the doctrine applies if the cessation is required to “accomplish necessary maintenance, repairs or replacements or to deal with the unexpected loss of market…”).

Courts have slowly expanded, however, application of the doctrine beyond the “mechanical breakdowns” envisioned by the Watson court. See, Ridge Oil Company Inc. v. Guinn Investments Inc., 148 S.W.3d 143 (Texas 2004). Voluntary cessations based on maintenance, reworking or even litigation have been found to satisfy the first prong of the test. See Midwest Oil Corp. v. Winsauer, supra (two successive lawsuits and an obstructed pipeline held sufficient to trigger TCOP); Stuart v. Pundt, 338 S.W.2d 167 (Tex.Civ.App. 1960) (voluntary plugging of well due to casing collapse and subsequent drilling of new well held sufficient to trigger TCOP); Amoco Production Company v. Braslau, 561 S.W. 2d 805 (Texas 1978) (casing collapse in old well and drilling of new well held sufficient to trigger TCOP). Thus, typical maintenance or reworking operations which require a brief interruption of production clearly fall within this prong of the test.

Production interruptions caused by the conduct of third-parties have also been found to satisfy the first prong of the test. The TCOP doctrine has been expanded further to even include mechanical breakdowns or other physical causes “beyond the well head” and outside of the producer’s control. See, Krabbe v. Anadarko Petroleum, 46 S.W.3d 308 (Tex. App. 2001) (shutdown of third-party buyer’s processing plant which necessitated cessation of production held sufficient); Casey v. Western Oil & Gas, Inc., 611 S.W.2d 676 (Tex. App. 1980) (applying TCOP doctrine to excuse cessation were well was disconnected by third-party gas purchaser). Purely economic motivated cessations, however, generally do not satisfy this prong of the test and will not excuse non-production. See, Bachler v. Rosenthal, 798 S.W.2d 646, 650 (Tex. App. 1990).

The second prong focuses on whether, under the circumstances, the producer exercised “diligence to remedy the defect and resumed production in a reasonable time.” Cobb v. Natural Gas Pipeline Co., 897 F.2d 1307, 1309 (5th Cir. 1990). The pivotal issue is often whether the period of non-production was truly “temporary” or of a permanent nature. See Wagner v. Smith, 456 N.E.2d 523 (Ohio Ct. App. 1982); See also, Wilson v. Holm, 188 P.2d 899, 907 (Kansas 1948) (the producer is “required to move promptly and by [its] efforts actually establish that such cessation, regardless of its cause, is temporary, not permanent”). The producer must act “diligently” to restore production or the TCOP doctrine will not save the lease. Somont Oil Company v. A&G Drilling, supra (“[T]he diligent lessee who takes immediate steps to rectify a sudden halt in production will not lose his or her investment”).

As can be imagined, there is no fixed formula on what is or is not a reasonable time to restore production. Courts have held that a cessation of three months was excused (Cobb v. Natural Gas Pipeline, supra) but a cessation of four to five months (Bryan v. Big Two Mile Gas Co., supra) was not. Such determinations must be made on a case-by-case basis and turn heavily on the diligence of the producer. In short, most courts have generally applied the TCOP doctrine and excused the non-production when the producer acted with reasonable diligence in restoring actual production.

Remarkably, the Pennsylvania Supreme Court has never formally adopted the TCOP doctrine. In fact, the issue of “temporary cessation” has apparently only been referenced once by the Pennsylvania Supreme Court. In Cole v. Philadelphia Co., 26 A.2d 920 (Pa. 1942), the Pennsylvania Supreme Court rejected the producer’s argument that “temporary cessation” constituted “abandonment” of the lease. Cole, 26 A.2d at 923. The landowner in Cole had brought suit to recover unpaid royalties. Id. at 921. The producer defended the suit on the grounds that he had “abandoned” the lease prior to that time by temporarily disconnecting the well. Id. The Cole panel opined that “[a] cessation of operations for a short time does not signify the same intention of abandonment…” Id.

Since 1942, no Pennsylvania appellate court has addressed the issue of “temporary cessation” or the TCOP doctrine itself. Pennsylvania can no longer ignore this issue. Given the dramatic increase in drilling operations being conducted across this Commonwealth, litigation arising out of “temporary cessation” is inevitable. Producers and landowners alike can only hope that the Pennsylvania appellate courts will adopt the TCOP doctrine and provide much needed guidance and clarity in this area.