The Oil and Gas Addendum

Continuing a trend that puts Pennsylvania at odds with most oil/gas jurisdictions, the federal court in Scranton recently ruled that an unsuccessful suit filed by a landowner challenging the validity of the underlying oil/gas lease did not warrant equitable extension of the lease’s primary term. In Harrison v. Cabot Oil & Gas Corp., 2012 WL 3542382 (M.D. Pa. August 14, 2012), the gas producer argued that its lease should be equitably extended for a period of time equal to the length of the litigation. Due to uncertainty caused by the landowner’s lease challenge, the gas producer had voluntarily ceased all development on the subject property. The gas producer requested that the federal court apply the “doctrine of repudiation” and extend the primary term so as to avoid expiration of the lease. The District Court rejected this request and ruled that the doctrine is not recognized in Pennsylvania.

On February 11, 2010, the landowner filed suit against Cabot Oil & Gas (“Cabot”) seeking to invalidate the parties’ August 18, 2007 oil/gas lease (the “Lease”) on the basis of fraud. Specifically, the landowner alleged that he was fraudulently induced into signing the Lease and that Cabot’s representative misrepresented what competitors were offering to other landowners. After discovery closed, Cabot sought dismissal of suit and filed a motion for summary judgment. The District Court granted Cabot’s motion and dismissed the landowner’s fraudulent inducement claim.

Before the motion for summary judgment was granted, however, Cabot filed a counterclaim seeking equitable extension of the Lease under the doctrine of repudiation. Essentially, Cabot argued that the five-year primary term should be “extended” to account for the period of time which the landowner had contested the Lease. Cabot contended that since it had suspended all operations while the litigation was pending, it “had been deprived of its expectation interest” under the Lease, namely a five-year primary term.

The doctrine of repudiation is well-established in most oil/gas jurisdictions. The doctrine is an “equitable doctrine” created by the courts to prevent a landowner who wrongfully repudiates a lease from profiting from the wrong. See, NRG Exploration, Inc. v. Rauch, 671 S.W. 2d 649 (Tex. App 1984). Generally, a landowner’s challenge to the validity of a lease “suspends the lessee’s obligation to perform under the lease until that challenge is resolved.” French v. Tenneco Oil Co., 724 P.2d 275, 276 (Okla. 1986); see also, Cheyenne Res. Inc. v. Criswell, 714 S.W.2d 103, 105 (Tex. App. 1986) (the doctrine “relieves the lessee from any obligation to conduct any operations on the land in order to maintain the lease in force”); Duerson v. Mills, 648 P.2d 1276, 1278 (Ok. Ct. App. 1982) (“[T]he lessee should not be required to invest in drilling a well when his legal right to drill is in serious legal jeopardy”). In other words, the landowner cannot argue that the lease has “terminated as a result of the leasee’s nonperformance” when the landowner directly contributed or caused that nonperformance. See, Mitchel Energy Corp. v. Samson Res. Co., 80 F.3d 976, 982 (5th Cir. 1996).

Texas and Oklahoma courts have long recognized the doctrine and have held that the proper remedy is to declare the lease should remain “in full force and effect for a period (after termination of the lawsuit) that allows the lessee to perform the conditions required to extend/maintain the lease…” See, Tar Heel Energy Corp. v. Menking, 621 S.W. 2d 450, 451 (Tex. App 1981). Litigation commenced by the landowner asserting “cancellation” of a lease is widely regarded as a challenge triggering the doctrine and will generally result in the suspension of the gas producer’s duties under that lease. Hoyt v. Continental Oil Co., 606 P.2d 560, 562 (Okla. 1980). The suspension of duties, including the duty to drill and develop the property, continues throughout the course of the litigation, until the challenge is finally resolved. Elsey v. Wagner, 183 P.2d 829, 830 (Okla. 1946.

In rejecting Cabot’s request to extend the primary term, the District Court relied upon the Pennsylvania Superior Court’s 1982 decision in Derrickheim Co. v. Brown, 451 A.2d 477 (Pa. Super. 1982). In Derrickheim, the Superior Court refused to apply the repudiation doctrine to a lease challenge filed by the gas producer. The court observed that:

[S]ince oil and gas was not being produced in paying quantities, the lease did not continue to run past the primary term of four years. The fact that it was prudent for Derrickheim to suspend operations upon learning of the cloud on the title does not justify disregarding the express language of the lease.

& 451 A.2d at 480. The lease in Derrickheim had a primary term of four (4) years, which had long expired by the time the producer filed suit in 1978. Although the lease challenge in Derrickheim was filed by the gas producer, as opposed to the landowner, the Harrison court nonetheless concluded that Derrickheim was controlling Pennsylvania authority. The District Court explained that:

[U]ntil Pennsylvania courts say otherwise, this Court will not find that a party’s filing of a lawsuit in federal court amounts to a repudiation of a lease between the parties, despite what courts in other jurisdictions have held.”

Harrison, 2012 WL 3542382 at 8. The District Court’s ruling was issued on August 14, 2012. In its opinion, the District Court acknowledged that although the Lease’s primary term was set to expire the very next day, it was unmoved by Cabot’s equitable arguments and was compelled to apply the Derrickheim rule.[1] As such, the court’s refusal to apply the doctrine most likely resulted in the expiration of the Lease on August 15, 2012

The Harrison decision could delay and frustrate Marcellus Shale development here in Pennsylvania. Lease challenges are not uncommon. Litigation can and does create uncertainty. When faced with such uncertainty, it is unreasonable to expect a gas producer to invest resources developing property that is the subject of a” lawsuit seeking to invalidate the underlying lease. The doctrine of repudiation seeks to balance the rights and interests of both the landowner and the gas producer. Both the Harrison decision and Lauchle decision fail to take into account this delicate balance.

[1] The Harrison decision is consistent with ruling issued last year in Lauchle v. The Keeton Group, LLC, 768 F.Supp.2d 757 (M.D. Pa. 2011) which also refused to apply the doctrine of repudiation to an unsuccessful landowner suit.