Earth Matters - April 2013: Fracking Moratorium Leads to Termination of Oil and Gas Leases

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In 2008, then-Governor David A. Paterson directed the New York State Department of Environmental Conservation (DEC) to supplement its environmental impact review of oil and gas exploration in New York to consider the potential environmental effects from increased use of horizontal drilling and high-volume hydraulic fracturing (or “fracking”) to develop gas reservoirs located in deep underground shale formations that extend through Ohio, West Virginia, and Pennsylvania into the southern tier of New York. Pending that still-uncompleted environmental review, DEC refuses to issue any drilling permits that would use fracking technology in New York. A federal court in New York recently decided that this permit moratorium did not constitute a “force majeure” and, as a result, a number of oil and gas leases had expired at the end of their primary terms.

The lawsuit, Aukema v. Chesapeake Appalachia LLC, No. 3:11– CV–00489, 2012 WL 5522832 (N.D.N.Y. Nov. 15, 2012), involved challenges by landowners who entered into 31 oil and gas leases that eventually were acquired by defendant Chesapeake Appalachia LLC.

Each of the leases had a fixed “primary term” and a clause, known as an “habendum clause,” that provided that the leases would continue to operate following the end of the primary term for so long thereafter as gas exploration and production or certain other specified activities continued.

The leases also contained force majeure clauses or their equivalent that provided the leases would not terminate so long as the lessee had been prevented by law from complying with the leases’ obligations (such as the gas exploration and production). The leases also contained delay rental clauses that required the lessee to make delay rental payments until such time as production commenced.

The parties did not dispute that, due to the 2008 Governor’s Directive, DEC refused to issue fracking permits, there had occurred no operations, drilling, storage, or production of gas on the subject properties, and the lessees had not paid any royalties to the landowners. Instead, Chesapeake made delay rental payments to the landowners throughout the primary term and following its expiration.

When the landowners filed suit in Federal Court seeking a declaration that the oil and gas leases had expired at the conclusion of the primary terms, Chesapeake argued that the leases had been extended because its failure to conduct operations was due to the 2008 Directive to DEC, and the agency’s subsequent refusal to issue permits to allow drilling with fracking technology.

The Court concluded that the landowners had established that their oil and gas leases had terminated because there had occurred no operations during the primary term. The Court held that the Governor’s 2008 Directive did not constitute a force majeure that excused compliance by Chesapeake. The purpose of a force majeure clause, according to the Court, was to relieve a party of contractual duties when performance was prevented by circumstances outside its control. Mere impracticability or unanticipated difficulty, however, was not enough in the Court’s view to excuse performance. In the Court's view, the 2008 Directive did not prevent Chesapeake’s performance because Chesapeake was still able to explore, drill, and produce gas reserves using traditional drilling technologies. In addition, as the drafter of the leases, Chesapeake (or its predecessors-ininterest) could have specified the specific technology to be used in developing the gas fields (such as fracking), but failed to do so.

Finally, the Court concluded that the delay rental payments negated an implied covenant that the lessee immediately begin to develop the gas reserves under the properties at the outset of the primary term, but Chesapeake could not use those delay rental payments to extend the primary term of the leases.

DEC’s refusal to issue permits to allow the use of high-volume hydraulic fracturing technology for oil and gas drilling, until the Agency completes its overdue supplemental environmental review, likely will mean that more oil and gas leases like those involved in Aukema will expire before exploration or production can begin.

Those seeking more information about the fracking moratorium can contact Kevin M. Hogan, Partner and Team Leader of the Phillips Lytle Environment Practice at (716) 847-8331 or khogan@phillipslytle.com.

Published In: Civil Procedure Updates, General Business Updates, Energy & Utilities Updates, Environmental Updates, Zoning, Planning & Land Use 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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