Arbitration/Class Waiver Clauses in Oil and Gas Leases: The Applicability of Concepcion and Italian Colors Restaurant to the Natural Gas Industry

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Class action lawsuits filed against natural gas producers have become increasingly common. For example, in Pennsylvania over the last several years, royalty owners have filed a number of royalty and bonus-payment class action lawsuits in state and federal court, which have caused producers to incur significant time and expense to defend. In light of the costs and risks involved in class action litigation, producers have begun contemplating the use of arbitration clauses in their oil and gas leases, which would require all disputes to be resolved in a private and confidential arbitration setting and would prevent a royalty owner from combining his claim with hundreds or thousands of other similar claims by pursuing a class action lawsuit or class arbitration. While such arbitration/class waiver clauses had been declared by certain courts to be unenforceable in the past, two recent decisions from the Supreme Court have endorsed the use of arbitration/class waiver clauses.

In AT & T Mobility, LLC v. Concepcion[1] and American Express Co. v. Italian Colors Restaurant,[2] the Supreme Court recently issued two decisions holding that arbitration/class waiver clauses in consumer contracts can effectively prevent plaintiffs from bringing class actions. As a result of these decisions, parties to oil and gas leases in Pennsylvania have begun considering what effect, if any, arbitration/class waiver provisions would have in their oil and gas leases, and whether, for example, Concepcion and Italian Colors Restaurant would prevent royalty owners from bringing the increasingly common royalty and bonus-payment class actions being filed in Pennsylvania.
In short and as discussed below, it appears likely that Concepcion and Italian Colors Restaurant will apply to oil and gas leases, and thus, in light of these decisions, a well-drafted arbitration clause in an oil and gas lease may potentially be used to preclude class-wide dispute resolution arising out of lease disputes.

How does an arbitration clause preclude the right to pursue a class-wide dispute resolution?
An arbitration clause can be used to essentially “contract out” of class action litigation. Indeed, by their very nature, most arbitration clauses preclude litigation entirely, including class action litigation, arising out of disputes covered by the arbitration clause. Instead, most typical arbitration clauses mandate that defined disputes between the parties will proceed through private arbitration, where the parties select one or more privately retained arbitrators to resolve their disputes in a confidential and less formal setting. What is less clear, however, is whether class arbitration is permitted when the parties include an arbitration clause in the contract.

Class arbitration is a relatively new phenomenon in the United States, and is neither addressed in the Federal Arbitration Act (“FAA”),[3] nor was contemplated by the FAA’s drafters. Class arbitration operates similarly to class action litigation. Thus, if class arbitration is permitted in a contract or lease that has an arbitration clause, the efficiency of bilateral arbitration is typically lost.  For example, class arbitration, similar to class action litigation, can require class member notices, application of formal rules of evidence, including unwieldy class-wide discovery, and formal approval and notice of any class settlement.

Few, if any, arbitration clauses expressly provide for class arbitration. Thus, the key question becomes: In the absence of a class arbitration provision, does the arbitration clause alone open the door to a class arbitration procedure? Courts are somewhat divided on this issue, but most have held that where an arbitration clause is silent as to the permissibility of class arbitration, class arbitration is not permitted.

Nevertheless, to avoid any doubt as to whether an arbitration provision in an oil and gas lease authorizes class arbitration, a carefully crafted arbitration clause should expressly preclude or waive class arbitration.

How have Concepcion and Italian Colors Restaurant affected the limitations on class waivers?
Under the FAA, an arbitration clause is presumed to be valid and enforceable, “save upon such grounds as exist at law or in equity for the revocation of any contract.”[4] Therefore, to be enforceable, an arbitration provision that waives class arbitrations and class actions cannot be considered “unconscionable” under the relevant state contract law.

In the past, courts would oftentimes hold that arbitration provisions that waived the right to class arbitration or class action litigation were unconscionable because the parties had unequal bargaining power, the arbitration provision was in buried boilerplate, or the absence of a class remedy would effectively prevent the plaintiff from pursuing relief (i.e., the amount at issue was too small to pursue except on a class-wide basis).  Concepcion and Italian Colors Restaurant, however, eviscerated this line of reasoning.

In Concepcion, at issue was a judicially crafted rule in California that class arbitration waivers in contracts of adhesion governing disputes over small amounts of money were unconscionable and could not be enforced.  The Supreme Court held that the California state law interfered with the core attributes of arbitration and created a scheme that is inconsistent with the FAA—i.e., in other words, that the FAA’s presumption in favor of enforcing arbitration clauses preempted California state law.

In Italian Colors Restaurant, the Supreme Court considered American Express’s arbitration agreement with merchants that contained a class arbitration waiver. The merchants brought an antitrust class action and opposed American Express’s motion to compel arbitration, arguing that the class arbitration waiver was unconscionable because the cost of arbitrating a single claim far exceeded the potential recovery. Following its decision in Concepcion, the Supreme Court rejected this argument, refused to create such an exception to the FAA’s presumption in favor of enforcing arbitration clauses, and held that contractual waivers of class arbitration are enforceable even if the cost of proving an individual claim in arbitration exceeds the potential recovery of the plaintiff.

Concepcion and Italian Colors Restaurant make clear that arbitration clauses/class waivers governed by the FAA will be strictly enforced, and that contentions that such clauses are unconscionable or otherwise unenforceable are unlikely to prevail.[5]

Do Concepcion and Italian Colors Restaurant apply to oil and gas leases?
In light of Concepcion and Italian Colors Restaurant, the question remains whether those decisions—which concerned consumer contracts—apply to oil and gas leases that have arbitration/class waiver provisions. While there have yet to be any reported decisions to consider the applicability of Concepcion and Italian Colors Restaurant to the oil and gas lease context, it appears likely that those decisions will apply for at least two reasons.

First, the more supported view is that most, if not all, oil and gas leases containing arbitration clauses are governed by the FAA. This is important because the Court’s decisions in Concepcion and Italian Colors Restaurant were predicated on the FAA and the fact that the FAA essentially preempted state unconscionability laws. Thus, if a contract is not governed by the FAA, those decisions may arguably not apply.  Oil and gas leases should be considered to be covered by the FAA because the FAA applies to any contract involving interstate commerce.[6] Like the Supreme Court’s interstate commerce jurisprudence, the interstate commerce nexus that governs the applicability of the FAA is extraordinarily broad. Thus, where the parties to the oil and gas lease are located in multiple states, or the contemplated scope of development under the oil and gas lease is through interstate channels (even where development has not yet occurred), courts have held that the interstate commerce nexus will likely be deemed to be sufficient for the FAA to apply.[7] If the FAA applies, Concepcion and Italian Colors Restaurant apply as well.[8]

Second, Concepcion’s holding has already been extended to the non-consumer contract context. For instance, the Supreme Court relied on Concepcion in Italian Colors Restaurant in an antitrust context. The holding in Concepcion has also been extended to real property,[9] employment discrimination,[10] and employment contract[11] cases by various courts. Thus, it appears that there is no reason why Concepcion and Italian Colors Restaurant would be considered limited to consumer contracts and would not apply to any contract, including oil and gas leases.

Conclusion
After Concepcion and Italian Colors Restaurant, the use of carefully crafted arbitration clauses in oil and gas leases may be an effective way to preclude class arbitrations and class action litigation. As courts continue to apply Concepcion and Italian Colors Restaurant, parties to oil and gas leases may consider reviewing or redrafting their arbitration clauses in such a way as to immunize them from further challenge.

Notes:

[1]       131 S. Ct. 1740 (2011).

[2]       133 S. Ct. 2304 (2013).

[3]       9 U.S.C. § 1 et seq.

[4]       9 U.S.C. § 2.

[5]       Since Concepcion and Italian Colors Restaurant, the Third Circuit has similarly upheld the enforceability of an arbitration/class waiver clause.  See Homa v. Am. Express Co., 494 F. App’x 191 (3d Cir. 2012).

[6]       Allied-Bruce Terminex Cos., Inc. v. Dobson, 513 U.S. 265 (1995).

[7]       See Alexander v. Chesapeake Appalachia, LLC, 839 F. Supp. 2d 544, 550 (N.D.N.Y. 2012) (holding that FAA applies because “[a]lthough the oil and gas leases at issue involve real property only in New York, the plaintiff landowners in New York negotiated the subject leases with CAP, an Ohio company and CNR, a Delaware limited liability company. Those leases have since been acquired by Chesapeake, an Oklahoma limited liability company, and Statoil, a Delaware corporation”); accord In re Chevron, --S.W.3d--, 2010 WL 299149, at *5 (Tex. Ct. App. 2010) (finding that FAA applied because “[i]t is a matter of common knowledge that the oil industry involves interstate commerce”).

[8]       There is limited authority from the U.S. District Court for the Middle District of Pennsylvania concluding that an oil and gas lease covering only property in a single state renders state law, not the FAA, applicable. This line of authority, however, is based on one largely unsupported slip opinion. See Ulmer v. Chesapeake Appalachia, LLC, No: 4:08–cv–2062, slip op. at 2 (M.D. Pa. Jan. 16, 2009) (citing no authority, but finding that “[t]he oil and gas lease at issue in this case involved property only in Pennsylvania, and therefore, the FAA does not apply”); Eisenberger v. Chesapeake Appalachia, LLC, No. 3:09-cv-1415, 2010 WL 1816646, at *2 (M.D. Pa. May 5, 2009) (citing only Ulmer for the finding that “this Court will apply Pennsylvania law in this case, as it involves a gas and oil lease for a property located entirely in Pennsylvania”); Roman v. Chesapeake Appalachia, LLC, No. 11-1614, 2012 WL 2076846, at *3 n.1 (M.D. Pa. June 7, 2012) (citing Ulmer, but not deciding whether state law or FAA applied); Vosburg v. Chesapeake Appalachia, LLC, No. 11-1615, 2011 U.S. Dist. LEXIS 155364, at *6-7 n.2 (M.D. Pa. Nov. 16, 2011) (citing Ulmer, but not deciding whether state law or FAA applied).

[9]       A-1 A-Lectrician, Inc. v. Commonwealth Reit, No. 12-00607 ACK-BMK, 2013 WL 1817688 (D. Haw. Apr. 26, 2013).

[10]     Wallace v. Red Bull Distribution Co., No. 5:12-CV-02431, 2013 WL 3823130 (N.D. Ohio July 23, 2013).

[11]     D’Antuono v. Service Road Corp., 789 F. Supp. 2d 308 (D. Conn. 2011).

 

Topics:  American Express v Italian Colors Restaurant, Arbitration, AT&T Mobility v Concepcion, Class Action, Class Action Arbitration Waivers, Federal Arbitration Act, Natural Gas, Oil & Gas, Royalties, SCOTUS

Published In: Alternative Dispute Resolution (ADR) Updates, Civil Procedure Updates, General Business Updates, Energy & Utilities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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