The Oil and Gas Addendum

In a recent decision, the Pennsylvania Superior Court gave diligent landowners powerful protection against unwanted subsurface activity. In Sabella v. Appalachian Development, 2014 Pa. Super. 237 (2014), the Superior Court held that a landowner who had duly recorded his oil and gas interests could recover damages for a bad-faith trespass against a driller who had drilled several gas wells on the property without ever securing a lease with the landowner. This case illustrates the practical and legal significance of recording deeds, gas leases and other conveyances with the appropriate recorder of deeds office. Such recording provides constructive notice of the landowner’s oil and gas interest. Drillers who ignore such recorded instruments will be considered bad-faith trespassers under Pennsylvania law.

The Facts of the Case

In 1997, Dennis Sabella acquired the oil and gas rights underlying 66 acres in Warren County. Sabella properly recorded a deed in the Warren County Recorder of Deeds Office. After viewing the property from a nearby road and seeing no signs of development, Sabella assumed that there were no oil and gas operations being conducted.

Sabella did not own the surface rights. The surface, which consisted of a 104-acre parcel, was owned by Mark and Virginia Harvey. In 2001, the Harveys entered into an oil and gas lease with Appalachian Development Corp. regarding the 104-acre parcel, which, unbeknownst to the Harveys and Appalachian, included Sabella’s 66 acres. Appalachian recorded its lease and then, in 2003, sold its holdings to an unincorporated business association known as Pine Ridge, which was operated by Brian and Lisa Haner. The Haners, after discussing with counsel the merits, risks and costs of various title search options, elected to forgo a full title search, conducting instead only a “bring down” search, consisting of a review of documents recorded only from the time when Appalachian recorded its lease in 2001.

When the Haners took possession in 2003, there were two existing oil and gas wells. Between 2004 and 2008, the Haners drilled seven more wells on the 104-acre parcel. Around that time, the Haners were considering expanding their operations and were attempting to get in touch with potential business contacts. In a coincidence that only the law can appreciate, the Haners recalled that one such contact worked for somebody named Sabella, and so the Haners began calling each Sabella listed in the phone book, eventually reaching the previously mentioned Dennis Sabella.

In 2008, Sabella and the Haners arranged a meeting, each still unaware of the other’s interest in the property. During the meeting, the Haners discussed many topics, including their drilling operations, which prompted Sabella to mention that he owned subsurface rights in the area. Sabella produced a map and the Haners recognized the area where their wells were producing, but Sabella was not explicitly told that the Haners were drilling on the 104-acre parcel. Moreover, based on comments during the meeting, Sabella was led to believe that he need not worry about the 104-acre parcel being developed. After the meeting, the Haners did not consult with counsel or obtain a title search, but rather reached out to Appalachian, which assured the Haners that they had good title. Following the meeting, the Haners drilled three additional wells on the 104-acre parcel, bringing the total number of wells drilled to nine. The Haners did not pay any royalties to Sabella, despite the fact that all nine wells were extracting hydrocarbons from his underlying oil and gas estate.

On Appeal

Eventually, in 2010, Sabella filed suit against the Haners and Appalachian, bringing claims for ejectment, trespass and conversion. Following a bench trial, the trial court found the Haners liable for both good-faith trespass and bad-faith trespass as a result of their unauthorized extraction of Sabella’s hydrocarbons. The trial court awarded Sabella $250,000 in compensatory damages. The Haners and Sabella appealed.

Good-Faith and Bad-Faith Trespass

The key issue for the court was the distinction between good-faith and bad-faith trespass. Under Pennsylvania law, when improvements made to land are made by a good-faith trespasser, the aggrieved party is essentially entitled to the trespasser’s net profits—the revenue generated, less the money expended in facilitating the profitable activity. But when a party trespasses in bad faith, the aggrieved party is entitled to all income derived from the trespass, without any offset for the cost of generating that profit.

The trial court found that the Haners were good-faith trespassers from the time they commenced drilling operations in 2003 until the time of the 2008 meeting, during which time the Haners learned or should have learned that they might be trespassing upon Sabella’s oil and gas interests. As such, the trial court deducted, as an offset, the Haners’ developmental and production costs associated with the six wells drilled between 2003 and 2008. No offset was given for the wells drilled after the 2008 meeting.

Sabella appealed this finding. He argued that because he had duly recorded his subsurface interest years before the Haners’ first well, the Haners had constructive notice of his interest. Given this notice, all of the Haners’ subsequent drilling operations constituted a bad-faith trespass. Sabella argued on appeal that none of the developmental or production costs should be offset.

The Superior Court agreed with Sabella, finding that the Haners acted in bad faith from the time they commenced drilling operations in 2003. The court noted that Pennsylvania’s constructive notice statute requires that all agreements relating to real property must be recorded in the office of the county in which the property is located. By recording his deed in 1997, Sabella gave constructive notice of his ownership of the underlying oil and gas rights. As in 21 P.S. Section 357, “the legal effect of the recording of such agreements shall be to give constructive notice to subsequent purchasers.” Although the Haners elected not to conduct a full title search, the court opined that this notice was “imputed to them by statute as though they had joined in the execution of the agreement.” As a result, the Haners’ drilling operations were done with constructive knowledge of Sabella’s oil and gas interest. Based on the foregoing, the Superior Court vacated the trial court’s holding and remanded for a recalculation of Sabella’s damages with no offset.

The Sabella decision confirms the value of recording oil and gas interests pursuant to 21 P.S. Sections 356 and 357. Prior to Sabella there was a question whether the constructive notice provision of Section 357 could be imputed to oil and gas lessees. The text of Section 357 only references “subsequent purchasers, mortgagees and/or judgment creditors” as being bound by the constructive notice afforded by a recorded instrument. The Sabella decision has now clarified that oil and gas lessees fall within the protective reach of Section 357. As such, oil and gas lessees will be deemed to have constructive notice of prior recorded oil and gas interests, regardless of the scope of their title search. This is good news for Pennsylvania landowners.

In light of Sabella, landowners should carefully review the status of their oil and gas holdings. If any such interests are unrecorded, a landowner would be well advised to consult an attorney to properly record the oil and gas interests.