Pennsylvania Appeals Court Issues Decision Curtailing Oil and Gas Owners’ Ability to Terminate Their Leases

by K&L Gates LLP
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Introduction
Forfeiture clauses are common in many legacy oil and gas leases in Pennsylvania and are often relied upon by oil and gas owners/lessors seeking to terminate their leases in order to seek more financially lucrative arrangements. Recently, in McCausland v. Wagner, et al., [1] the Pennsylvania Superior Court issued a decision that provided a comprehensive explanation of forfeiture law, and made clear that leases should rarely, if ever, be terminated on the basis of leases’ forfeiture provisions. As discussed below, after McCausland, an oil and gas owner who accepts royalties or has a lease in its secondary term will likely be unable to terminate the lease in the event of a breach of the lease. The only remedy for such a breach would be monetary damages, to the extent that they can be proven with certainty.

What Happened in McCausland?
McCausland involved a 1964 oil and gas lease. Three wells were drilled on the property, and at least one well was still producing in paying quantities. One of the oil and gas owners/lessors filed a complaint in 2009 alleging that he had not received any royalties due under the lease since 2005. The complaint sought money damages for past royalties and a declaration that the lease was null and void pursuant to a forfeiture clause in the lease.

It was undisputed that the oil and gas owner did not receive the appropriate royalty payments due under the lease.  However, after the case was initiated, the oil and gas owner received all royalty payments that were due under the lease as part of a partial settlement of the claims. The settlement agreement specifically reserved to the lessor “the right and ability to seek a judicial declaration that the [. . .] lease is null and void.” 

The oil and gas owner moved for summary judgment, asking the court to find, as a matter of law, that the lease is null and void because he did not receive the appropriate royalty payments. The trial court denied the motion, finding that, under the “doctrine of inconsistent remedies,” the lessor could not simultaneously recover money damages for breach of the lease and also seek a declaration that the lease is null and void.

On appeal, the oil and gas owner argued that the trial court erred by essentially prohibiting him from seeking a declaration that the lease was null and void due to the acceptance of the disputed royalties.

What Did the Superior Court Decide?
A. Inconsistent remedies: An oil and gas owner may not both terminate a lease and seek to enforce its terms.
The Superior Court affirmed the trial court decision finding that a lessor cannot seek inconsistent remedies.  In doing so, it summarized the doctrine of inconsistent remedies, stating that it is well-settled under Pennsylvania law that:

In a breach of contract suit, the plaintiff either may rescind the contract and seek restitution or enforce the contract and recover damages. . . In such a case, the inconsistent nature of those actions is obvious—one cannot attempt to terminate his contractual obligations and, at the same time, seek to enforce the contract and enjoy its full benefits in an action for breach.      

The Court noted that it was undisputed that the oil and gas owner did not receive the appropriate royalty payments due under the lease. However, the oil and gas owner subsequently received all royalty payments that were due under the lease. “[I]n accepting the royalty payments, the [oil and gas owner] essentially deprived himself of the right to declare a forfeiture of the [. . .] lease.”

B. Forfeiture provisions customarily will not terminate oil and gas leases in the secondary term.
In reaching its decision that forfeiture clauses customarily will not apply to leases in the secondary term, the Court first summarized Pennsylvania’s historical approach to forfeiture provisions in oil and gas leases, specifically noting that (i) “it is an oft-stated maxim that the law abhors a forfeiture” of oil and gas leases, (ii) “it is well established that the party seeking to terminate an oil and gas lease bears the burden of proof,” and (iii) in order for a forfeiture provision to be enforceable, it must be “expressed with clearness and certainty.” 

The Court then discussed its 1899 decision in Wheeling v. Phillips [2] as instructional in the application of forfeiture clauses to oil and gas leases. According to Wheeling, where there has been a breach of the lease, a lessor has two options: (i) demand and compel payment, which is an election to continue the lease; or (ii) notify the lessee that there has been a forfeiture. The acceptance of payment after the right to forfeiture accrues operates as a waiver of the right to declare forfeiture.

Based principally on Wheeling, the structure of the lease at issue, and the discerned purpose of forfeiture clauses, the Court held that the forfeiture provision did not apply, for at least two reasons.

First, more broadly, the Court explained that the purpose of forfeiture provisions in oil and gas leases “was to guarantee that the lessee would develop the property and, if the lessee failed to do so, the lessor could declare a forfeiture.” Accordingly, consistent with this view of the purpose of forfeiture clauses, the Court found that a lease that has been developed such that it is properly held by production beyond its primary term would not be subject to a forfeiture provision.

Second, as a matter of construction of the particular lease at issue, the Court found that the structure of the lease was such that the forfeiture clause, if it were applicable, only applied to failure to pay delay rentals (or complete one well on the premises), not failure to pay royalties. [3]

What Is the Impact of McCausland?
McCausland serves as strong, recent Pennsylvania authority that essentially forecloses an oil and gas owner/lessor from being able to terminate his lease due to a purported breach by the natural gas producer so long as the lease is being properly held by production. Based on the Superior Court’s interpretation of the customary purpose of a forfeiture provision, lessors may have difficulty seeking to terminate a lease in the secondary term based on a forfeiture provision. Therefore, given the frequency in which lessors attempt to rely on forfeiture provisions, oil and gas companies involved in lease litigation should: (i) be cognizant that forfeiture clauses will generally only be applicable during the primary term of an oil and gas lease, and (ii) beware of lessors’ requests/actions that may preclude termination of the lease under the doctrine of inconsistent remedies.

Notes:
[1] ---A.3d---, No. 1186 WDA 2012, 2013 WL 5296824 (Pa. Super. Ct. Sept. 20, 2013).

[2] 10 Pa. Super. 634 (Pa. Super. Ct. 1899).

[3] The lease at issue contained a royalty provision providing for a fractional royalty payable annually. Two paragraphs after the royalty provision, the lease contained a delay rental and drilling commitment. Immediately after this provision, the lease contained a forfeiture provision, which provided for forfeiture for “failure to make any one of such payments, or to complete one well on the premises.” As a matter of construction of the lease, the Court found that the forfeiture provision only applied to the failure to make delay rental payments (not royalty payments) because the placement of the forfeiture provision immediately followed the delay rental provision, and the clause “such payments” was meant to refer to the delay rentals in the immediately preceding paragraph.

 

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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