The Oil and Gas Addendum

Suppose you purchase a 100-acre farm in Armstrong County. You are told that the property is subject to an old gas lease but that the farmhouse receives “free gas” from the lone shallow well on the property. Several months after moving into the farmhouse, you receive a notice from the gas company advising you that the supply of free gas will be terminated in thirty (30) days. There is no indication, however, that the existing well will be plugged or shut-in. The gas company tells you that the free gas was a benefit only afforded to the original landowner who signed the lease. Can the gas company now unilaterally terminate the free gas but still maintain the old lease?

Many oil and gas leases contain what is commonly known as a “free gas” clause. Such clauses typically entitle the landowner to “use” 250,000 to 400,000 cubic feet of gas per year from any wells developed on their property. Whether the gas company can unilaterally terminate the free gas supply will most likely depend on whether the free gas clause is characterized as a “covenant running with the land.”

Under Pennsylvania law, and the law of many other states, a covenant that runs with the land is one that is legally binding not only on the current owner, but also any future owners of the property. Treasure Lake Prop. Owners Ass’n v. Meyer, 832 A.2d 477, 482 (Pa. Super. 2003). For example, some homes carry a covenant that any owner of the home must join and pay dues to a homeowners’ association. That covenant will affect and bind subsequent purchasers of the home, even though they never agreed to or signed the original deed covenant. In contrast, personal covenants bind only the persons who sign them. They cannot bind future owners.

A recent decision of the Ohio Court of Appeals suggests that a free-gas clause is a covenant running with the land and that subsequent owners are entitled to free gas. In Kramer v. PAC Drilling Oil & Gas, LLC, 2011 WL 6917588 (Ohio Ct. App., 9th District, December 29, 2011), Joseph and Helen Kocsis signed a gas lease in 1978 (“1978 Lease”) that entitled them to take an unlimited amount of gas for domestic purposes from any wells drilled on their 149 acre property. At the time they entered into the 1978 Lease, the Kocsises lived in a farmhouse located on the north end of the property. In the mid-2000s, the Kocsises sold 14 acres of the property, including the farmhouse, to Kramers. As part of the sale, the Kramers, Kocsises, and the gas company all agreed to modify the gas lease to allow the Kramers to use up to 250,000 cubic feet of gas on the 14 acre tract. Several years later the Kramers experienced problems with the line supplying gas to the farmhouse and they connected a new line directly to the nearest well. According to the gas company, the extra connection caused the pressure in the well to drop and made it more difficult to operate the well. When negotiations with the Kramers failed, the gas company closed the well, cutting off the Kramers’ access to free gas. Shortly thereafter, the gas company sent the Kramers a “notice of cancellation” seeking to surrender the 1978 Lease but only with respect to the 14 acre tract.

The Kramers’ then filed suit seeking a declaratory judgment that they were entitled to 250,000 cubic feet of free gas per year. They also asserted that the gas company had breached the 1978 Lease by unilaterally terminating the gas supply. The gas company defended the suit on the grounds that its voluntary surrender of the 1978 Lease with respect to the Kramers’ 14 acres terminated their right to receive any free gas. The trial court agreed with the gas company and dismissed the Kramers’ suit.

On appeal, Court of Appeals reversed. First, the court noted that “Under Ohio law, a free gas clause is construed as a covenant running with the surface ownership of the leasehold tract unless a contrary intention appears in the wording of the instrument.” Kramer, 2011 WL 6917588 at 4. Next, the court observed that the express language of the 1978 Lease, which stated that “the occupants of the [farmhouse] shall be entitled to 250,000 cubic feet per annum of free gas for domestic use….”, was compelling. Id. The Kramer court then concluded that the free-gas clause was intended to benefit the present occupier of the farmhouse:

“[B]ecause the right to free gas benefits the occupants of the farmhouse regardless of who they are, we conclude that the free-gas clause created a covenant that runs with the surface estate of the land…”

See, Kramer, 2011 WL 6917588 at 4. Consequently, the gas company could not terminate the free-gas clause by only surrendering the 14 acre tract. The court observed that the gas company’s surrender of the 14 acre tract was effective but only as to the underlying oil and gas estate. In other words, the gas company only surrendered its right to extract and remove the oil and gas beneath the 14 acre tract. Because the entitlement to free gas was a covenant running with the land, it was not affected by the surrender of the underlying oil and gas estate. As such, the Kramers were still entitled to free gas as long as the 1978 Lease remained active.

The Kramer decision is consistent with a majority of oil and gas jurisdictions that have addressed this issue. See, Jackson v. Farmer, 594 P.2d 177, 181 (Kan. 1979)(the right to use free gas is a covenant running with the land); Warfield Natural Gas Co. v. Small, 138 S.W. 2d 488, 489 (Ky. 1940)(“…the free gas covenant is a covenant running with the land, it runs with the surface of the land and not with the oil, gas and mineral estate…”); Universal Resources Corporation v. Ledford, 961 P.2d 593, 595 (Col. Ct. App. 1998)(“…the rights arising from a free gas clause are generally characterized as a covenant which runs with the surface estate…”); Sinclair Oil & Gas v. Huftman, 376 P.2d 599 (Okl. 1962)(free gas clause runs with the surface estate).

Unlike Ohio, Pennsylvania has not yet ruled on this issue. As such, there is no presumption under Pennsylvania law that a free-gas clause is a covenant running with the surface land. While there is no reported decision on this exact issue, it is plausible that Pennsylvania would likely characterize a free gas clause as a covenant running with the land. In Akin v. Marshall Oil Co., 41 A. 748 (Pa. 1898), the Pennsylvania Supreme Court observed that when a covenant in an oil and gas lease is for the performance of “some duty in connection with the possession of land,” it can be a covenant running with the land. The court in Akin enforced a lease clause requiring the gas operator to give the owner a portion of all oil produced from the premises as a covenant running with the land. Akin, 41 A. at 751.

Returning to our Armstrong County farm, whether the gas company can terminate the supply of free gas will largely depend on the language of the original gas lease. In Pennsylvania, the test for determining whether a promise runs with the land is whether it was so “intended” by its creators. Caplan v. City of Pittsburgh, 100 A.2d 380, 383 (Pa. 1953) (“…a covenant which is to run with the land ordinarily must affect the land and be intended to pass with it”); See also, Hartzfeld v. Green Glen Corp., 552 A.2d 306 (Pa. Super. 1989). As such, the specific language in the underlying oil and gas lease is critical. For example, if the lease states that the gas company’s successors and assigns are bound by the free gas covenant, then the covenant will be held to be one running with the land. Likewise, language which indicates that the “benefit” of the free gas clause inures to anyone who occupies the leasehold will strongly suggest an intention to “run” with the land. Many leases, however, contain express language which limits the free gas clause to the initial landowner. In such circumstances, the intent to run with the surface land is absent and it is unlikely a Pennsylvania court would permit a subsequent owner to enforce the free gas clause.

When confronted with a free gas question, it is imperative that both the gas operator and the landowner review the original lease language. If the clause contains no express restrictions or limitations, it is plausible that a Pennsylvania court will characterize the clause as a covenant running with the land and will allow subsequent landowners to enforce the free gas clause. Alternatively, if the clause limits the supply of free gas to the initial landowner, the clause may not be enforceable by subsequent owners.