Pennsylvania Superior Court Interprets Forfeiture Clause in Oil and Gas Lease

In McCausland v. Wagner, the Pennsylvania Superior Court was confronted with the question of whether the lessor under an oil and gas lease was entitled to terminate the lease due to the lessee’s failure to pay royalties under the lease. 2013 PA Super 256 (Pa. Super. Sept. 20, 2013). The lessor argued that the forfeiture clause in the lease entitled him to terminate the lease, even though he had accepted payments for the belated royalties under a separate settlement reached with the lessee. The Superior Court disagreed.

The court began its analysis by noting that oil and gas leases are unique in that they implicate both contract and property interests. Specifically, the court explained that an oil and gas lease works by vesting title to the minerals in the lessee if oil and gas is discovered on the property. Upon the vesting of title, the lessee must operate the leasehold for the mutual benefit of him/herself and the lessor, particularly if the lease is royalty-based. Moreover, where a forfeiture clause is contained in the lease, the clause is to be construed narrowly because the law disfavors forfeiture.

Applying these general principles, as well as the principles of contract law, the court concluded that the forfeiture clause at issue did not permit the lessor to terminate the lease after it had accepted payment for the belated royalties that were owed under the lease. The court also noted that, even had the lessor not accepted the payments, the forfeiture clause in any event applied only to the failure to make rental, not royalty, payments. The court held that this was consistent with industry practice, which originally employed forfeiture clauses as a means of incentivizing lease development before a well was drilled on the property. In other words, the court found that it would be inconsistent with the purpose of forfeiture clauses to construe them broadly as allowing termination of the lease for failure to pay a royalty after a well was already drilled on the property.

This decision highlights the importance of electing remedies, especially where the contract contains a forfeiture clause. In addition, although the court did not state as much, Pennsylvania law generally construes forfeiture clauses as independent covenants. McHenry v. Mitchell, 68 A. 729 (Pa. 1908). This possibly explains why the court did not find that the lessor was entitled to forfeit the lease (particularly after recovering damages) due to the lessee’s nonpayment except as provided by the lease. On this point, it is also interesting to note that one of the primary authorities that the court relied upon in support of its interpretation of the forfeiture clause expressly noted that an oil and gas lease theoretically could give the right to recover accrued payments after forfeiture, even though the lease at issue in that case did not contain such a provision. The Superior Court did not address this issue, however, making it unclear what effect, if any, such a provision in the lease would have had on the court’s decision.

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