The Oil and Gas Addendum

If you have an abandoned oil and gas well on your property, it may no longer be just an ugly eye-sore. As a result of controversial legislation recently enacted by the General Assembly, that old well may now be used by drillers to revive and resurrect leases that expired decades ago. This troubling piece of legislation was enacted without any debate or hearings and represents a radical departure from existing Pennsylvania oil and gas law. Landowners must now carefully monitor those old, abandoned wells as drillers may suddenly show up and commence re-working operations under the auspices of the expired lease.

On October 30, 2017, Pennsylvania Governor Tom Wolf signed a number of bills into law that ended the Commonwealth’s months-long budget impasse. One of these bills, House Bill 674, included amendments to the Pennsylvania Fiscal Code. In general, the amendments to the Fiscal Code set forth language to implement the budget. Buried within the amendments to the Fiscal Code was Section 1610-E. Subsection (a) of Section 1610-E provides as follows:

“An oil and gas lessor shall be deemed to acknowledge that a period of nonproduction under an oil and gas lease is a temporary cessation insufficient to terminate the lease and the lessor waives his right to seek lease termination upon those grounds if:

Production is recommenced and the lessor accepts royalty payments for the production. Any first royalty payment following recommencement of production after a period of more than one year of inactivity shall be accompanied by an explanation, in plain terms, that acceptance of the royalty payment shall constitute acknowledgement of an existing lease with the operator; or

The operator, after notifying the lessor of its intent to drill a new well and giving the lessor 90 days within which to object, drills a new well under the lease.”

Under this new law, the mere acceptance of a royalty payment or the failure to object to a new well may automatically ratify and revive an expired lease and foreclose the landowner’s ability to bring a lease expiration claim based on prior non-production. Section 1610-E represents a troubling and unwarranted change to Pennsylvania oil and gas law.

Pennsylvania has historically applied the “automatic termination rule” during the secondary term of an oil and gas lease. Under this rule, an oil and gas lease will automatically expire and terminate 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…”); McKnight v. Manufacturers Natural Gas Co., 23 A. 164, 166 (Pa. 1892) (“[T]he defendant cannot hold the premises and refuse to operate them”); Brown v. Haight, 255 A.2d 508, 511 (Pa. 1969) (“. . . in 1947 when oil and gas were not produced in paying quantities, the grantee’s fee interest terminated automatically. . .”; Jacobs v. CNG Transmission Corp., 772 A.2d 445 (Pa. 2001) (” . . . the lessee has an affirmative obligation to enter to develop and to produce the oil and gas or terminate the landowner’s contractual royalty…”); 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”). This basically means that any cessation of production during the secondary term of a lease, even one of short duration, will theoretically trigger the “automatic termination rule” and terminate the lease. Prior to the enactment of Section 1610-E, it was generally recognized that an expired lease could not be revived by merely resuming production from an abandoned and idle well. That may no longer be the case.

Here’s how Section 1610-E will change things. Assume that your grandfather signed an oil and gas lease with XYZ Oil in 1927. One shallow well was drilled in 1935 which produced gas until 1997. No oil or gas has been produced since then and XYZ Oil has not been out to the farm in years. The old well remains on the farm but has not been plugged or decommissioned and is in a state of disrepair. Under existing Pennsylvania law, a colorable argument could be made that the 1927 Lease expired due to non-production. But let’s assume that XYZ Oil “assigned” the 1927 Lease (and the old well) to Big Driller Inc. in 2012. Under Section 1610-E, Big Driller Inc. can now go on the farm, re-work the old well and try to resume production. If Big Driller Inc. gets the old well producing again, even if the well only produces 1 or 2 Mcf per month, your grandmother’s acceptance of the small royalty payment will operate as a waiver of her right to challenge the validity of the 1927 Lease. In other words, the twenty years of non-production is automatically forgiven and the 1927 Lease is again in full force and effect. Moreover, Big Driller Inc. can now attempt to drill a new Marcellus Shale well under the revived 1927 Lease. In short, drillers will use Section 1610-E to circumvent negotiating new leases with landowners by reviving these older, expired leases. What is particularly alarming is that any production, however slight, will be sufficient to revive the expired lease. So, even if your grandmother “accepts” the royalty check in the amount of $1.43, the 1927 Lease is instantly revived and resurrected. This is both unfair and bad policy.

So, what does the future look like under the new Section 1610-E? There are a few options.

The inclusion of Section 1610-E into the amendments to the Fiscal Code may have violated the Pennsylvania Constitution. Article III, Section 3 of the Pennsylvania Constitution contains what is known as the “single subject rule” and provides that “[n]o bill shall be passed containing more than one subject, which shall be clearly expressed in its title, except a general appropriation bill or a bill codifying or compiling the law or a part thereof.” The purpose of this “single subject rule” was both to prevent the inclusion of independent legislative subjects into a bill to hide the real purpose of the bill and to eliminate the practice of “logrolling”, where a number of different matters are included in one bill, where they would not have passed on their own. See, City of Philadelphia v. Commonwealth, 838 A.2d 566 (Pa. 2003); Pennsylvanians Against Gambling Expansion Fund, Inc. v. Commonwealth, 877 A.2d 383 (Pa. 2005).

The Pennsylvania Supreme Court has set forth two criteria to determine if a bill complies with Article III, Section 3. “First the title of the bill must clearly express the substance of the proposed law . . . Second, the differing topics within the bill must be ‘germane’ to one another.” Commonwealth v. Neiman, 84 A.3d 603, 612 (Pa. 2013) (citing Pennsylvania State Association of Jury Commissioners v. Commonwealth, 64 A.3d 611, 616 (Pa. 2013)). Although there does not appear to be a “bright line” rule regarding the ‘germaneness’ test, the Pennsylvania Supreme Court has stated that ” . . . our task is to ascertain whether the various components of the enactment are part of ‘a unifying scheme to accomplish a single purpose.'” Commonwealth v. Neiman, 84 A.3d 603, 612 (Pa. 2013) (citing City of Philadelphia v. Commonwealth, 838 A.2d at 589). It is submitted that the purpose of House Bill 674 was to amend the Fiscal Code to address revenue issues and to essentially fund the budget. Changing well-established oil and gas law with respect to expired leases has nothing to do with the budget or the Fiscal Code. It appears that the clandestine inclusion of Section 1610-E into House Bill 674 is exactly what Article III, Section 3 of the Pennsylvania Constitution was designed to prevent.

Beyond this constitutional question, landowners should consider changing their royalty payment method from “direct deposit” to physical checks. While receiving royalty checks via direct deposit is easier than going to the bank or ATM to deposit a check, the direct deposit process does not allow an opportunity to refuse or reject a royalty payment. Under Section 1610-E, it is likely that the electronic deposit of these funds will constitute an “acceptance” which would automatically waive your right to challenge the validity of the underlying expired lease. If you receive an unsolicited notice from a driller asking you to enroll in their direct deposit program, decline the invitation and demand physical checks.

Section 1610-E also serves as a reminder to landowners that before depositing any “royalty” check, research should be undertaken to verify and confirm that oil and gas was, in fact, produced and that the habendum clause of the lease was satisfied. Particularly for older oil and gas leases which contain “flat rate” royalties, drillers may attempt to “pay open” an expired lease by transmitting a royalty check, regardless of whether production has actually occurred. Carefully review the royalty statement to verify production volumes for each well and cross-reference this data with reported production on the Department of Environmental Production website.

If you believe that a lease has terminated due to non-production, immediately inform the driller in writing that the lease has terminated. The writing should expressly state that any effort by the driller to revive the expired lease under Section 1610-E will be disputed and contested and that no royalty checks will be accepted or acknowledged as valid. It is unclear how Pennsylvania courts will apply this new law. As a precaution, we urge all landowners to be proactive and send a letter putting the driller on notice that royalty checks issued under the auspices of Section 1610-E will be rejected and will not revive any expired lease. Otherwise, we suspect that drillers across Pennsylvania may view Section 1016-E as an open invitation to enter upon your property to re-work and repair abandoned and dormant wells which have not produced in decades.