Pa. Litigation Update

by Spilman Thomas & Battle, PLLC

This summer was anything but a sleepy period for decisions from Pennsylvania courts on issues important to the oil and gas industry. Here are summaries of four cases issued in July and August - one from the Third Circuit Court of Appeals, one from a federal trial court, and two from the Pennsylvania Superior Court - that will impact operations in the oil and gas industry throughout the Commonwealth.

Vodenichar v. Halcon Energy Properties, Inc., 2013 WL 4268840 (3d Cir. Aug. 16, 2013)

In a precedential opinion, the Court of Appeals for the Third Circuit issued a ruling on the "home state" and "local controversy" exceptions to federal subject matter jurisdiction under the Class Action Fairness Act (CAFA). This case presented a situation familiar to the industry – Pennsylvania residents entering into leases with companies based out of state and litigation ensuing relating to the formation of the leases. Plaintiffs, landowners in Mercer County, Pennsylvania, engaged defendants Morascyzk & Polochak and Co-eXprise, dba CX-Energy (the “Agent Defendants”) to act as their agents in negotiating oil and gas leases with defendant Halcon Energy Properties, Inc. Under the leases negotiated by the Agent Defendants, Halcon was permitted to reject any lease pursuant to certain identified conditions. Subsequently, Halcon rejected many of the leases on a basis – the geology – that was not set forth in the leases, claiming that the operative language was fraudulently omitted from the leases by the Agent Defendants.
Initially, the Plaintiffs sued only Halcon in federal court, asserting diversity jurisdiction as Halcon was a Delaware corporation headquartered in Texas (the “First Action”). After Halcon indicated that it intended to join the Agent Defendants as “necessary parties,” the plaintiffs moved to dismiss the First Action to file a new complaint against both Halcon and the Agent Defendants in state court (the “Second Action”). In response to the filing of the Second Action in state court, Halcon removed it to federal court pursuant to CAFA, 28 U.S.C. § 1332(d).

After removal, the Halcon plaintiffs filed a Motion for Remand, arguing that jurisdiction was lacking under both the home state and local controversy exceptions to CAFA. Plaintiffs successfully argued before the trial court that the Home State Exception applied as the resident Agent Defendants were the “primary defendants” and all other elements of the exception had been met. Plaintiffs were less successful in the trial court with their argument that the Local Controversy Exception applied, as the district court found that the existence of the First Action precluded its application. On appeal, the Third Circuit affirmed the remand, but flipped on the basis, holding that Halcon was a primary defendant and the Home State Exception did not apply, but as the Second Action was in essence a continuation of the First Action, the Local Controversy Exception mandated the remand.

With respect to the Home State Exception, the Third Circuit clearly rejected the district court’s finding that, because Halcon denied all liability, it was not a “primary defendant.” Rather, the Court provided the following guidance for future cases:

"In short, courts tasked with determining whether a defendant is a “primary defendant” under CAFA should assume liability will be found and determine whether the defendant is the “real target” of the plaintiffs’’ accusations. In doing so, they should also determine if the plaintiffs seek to hold the defendant responsible for its own actions, as opposed to seeking to have it pay for the actions of others. Also, courts should ask whether, given the claims asserted against the defendant, it has potential exposure to a significant portion of the class and would sustain a substantial loss as compared to other defendants if found liable."

Moreover, the Court stated that remand under the Home State Exception will be required “only if all primary defendants” are citizens of the forum state. As Halcon met all of the requirements of a “primary defendant” but was not a citizen of Pennsylvania, remand under the Home State Exception was in error.

Regarding the Local Controversy Exception, the Third Circuit rejected the notion that the First Action was a disqualifying class action asserting similar factual allegations against Halcon. Deciding that the “no other class action” factor should “not be read too narrowly” to preclude remand, the Court explained that the statutory language was intended to protect defendants from facing a multiplicity of copycat lawsuits in different fora brought by different representative plaintiffs and different class counsel. As the Second Action did not fall within that category of lawsuits, the Third Circuit held that the Local Controversy Exception “mandate[d] this truly local case involving Pennsylvania landowners and their land remain in state court”.

Roe v. Chief Exploration & Development, LLC, 2013 WL 4083326 (M.D. Pa., Aug. 13, 2013)

On August 13, 2013, the U.S. District Court for the Middle District of Pennsylvania held that certain oil and gas leases held by Chief Exploration & Development LLC had been properly extended by Chief’s predrilling activities on property that had been pooled with the challenged leases.

The plaintiffs were all lessors of oil and gas leases executed with Chief in October 2005 for five-year terms. Each of the leases provided Chief with the exclusive right to “all the oil, gas, and coalbed methane and their constituents … underlying the [land leased by the plaintiffs], together with such exclusive rights as may be necessary or convenient for [Chief] … to explore for, develop, produce, measure, and market production from [the land leased by plaintiffs].” The leases also included a unitization clause which granted Chief the right to pool or combine the leased properties with other lands to create a drilling unit as well as a habendum clause that provided for lease extension beyond the primary term by operations “conducted … in search of oil, gas, or their constituents.”

Prior to the expiration of the leases’ primary term, Chief pooled plaintiffs’ properties into a unit and began to conduct various predrilling activities on property, including establishing the location of the well, conducting field surveys, obtaining the required permits to drill and withdraw water for use in completing the well, delivering a bulldozer to the site and starting the process of clearing timber. The well was ultimately drilled and completed on the pooled property in March 2011, approximately five months after expiration of the leases’ primary term.

Plaintiffs’ lawsuits, which were originally brought in the Sullivan County Court of Common Pleas in March and April 2011, concerned whether their leases expired or had been extended. After removing the cases to federal court, Chief moved for summary judgment. Chief argued that its predrilling activities on the pooled parcel prior to the expiration of plaintiffs’ leases, combined with the prompt completion of a well on that property, constituted “operations … in search of production of oil, gas, or their constituents” sufficient to extend the leases beyond their primary terms.

In granting chief’s motion for partial summary judgment, the Court concluded that Chief’s clearing and staking activities on another property that was part of the pooled unit was sufficient to extend the leases and rejected the plaintiffs’ argument that “only actual drilling” during the primary term was required to extend the leases.

Referencing the Pennsylvania Supreme Court decision in Henderson v. Ferrell, 183 Pa. 547, 38 A. 1018 (1898), the Court held that the “material issue [was] … whether the activity — minimal or extensive — is undertaken ‘in good faith, and with a determination on [the lessee’s] part to prosecute with due diligence the work [the lessee was] authorized by the lease to do.’” Then, looking at all of Chief’s efforts and activities on the pooled property, as well as its continued work to develop a well that was operational a few months later, the Court found that the company had demonstrated sufficient good faith to extend plaintiffs’ leases.

Caldwell v. Kriebel Resources, LLC, 2013 PA Super 188 (Jul. 12, 2013)

In Caldwell, the Pennsylvania Superior Court affirmed a lower court’s ruling that the defendants did not have a duty to drill for gas in the Marcellus Shale. The case involved an oil and gas lease which had been entered into on January 19, 2001 with a two-year term that would be extended so long as oil or gas was being produced. Although it was undisputed that gas was being produced from a shallow formation, the plaintiffs claimed that the defendants breached an implied duty to produce gas in paying quantities and develop gas from the Marcellus Shale.

More specifically, relying on precedent from outside Pennsylvania, the plaintiffs argued that there is an implied duty to develop all strata and not simply to extract gas from a shallow formation and pay minimum royalties. The Court completely rejected plaintiffs’ arguments and found that the disputed oil and gas lease remained in full force and effect for all strata. The Court also looked to Pennsylvania precedent holding that some profit over operating expenses, even if small, is sufficient production in paying quantities and found sufficient production despite plaintiffs’ desire for greater production and royalties through development of the Marcellus Shale.

Humberston v. Chevron U.S.A., Inc., 2013 PA. Super 238 (Aug. 20, 2013)

Here, the Superior Court of Pennsylvania affirmed a lower court’s ruling which found that Chevron’s oil and gas lease with the landowner allowed it to construct an 11-acre freshwater impoundment as part of its exclusive rights to develop minerals from the property’s subsurface. The three-judge panel held that Chevron’s rights under the lease included the right to use the surface area of the leasehold as reasonably necessary to develop natural gas from the Marcellus Shale.

In Humberston v. Chevron et al, the plaintiffs leased 133 acres of land in Fayette County, Pennsylvania to Chevron, and the oil and gas lease gave Chevron the right to explore for oil and natural gas “together with such exclusive rights as may be necessary or convenient for Lessee … to explore for, develop, produce, measure, and market production from the Leasehold.” Chevron hired a contractor, its co-defendant Keystone Vacuum, to construct an 11-acre freshwater impoundment on the Humberstons’ property.

The Humberstons then filed an action to quiet title and in trespass, alleging that (1) Chevron’s freshwater impoundment was not contemplated at the time their lease was executed, (2) the lease did not grant Chevron the right to construct the freshwater impoundment, and (3) Chevron improperly intended to use the impoundment to serve potential wells on other parcels. The Humberstons’ complaint sought declaratory relief as well as actual and punitive damages.

In addition to the parties’ lease, the Humberstons relied on a surface damage release they entered into with the prior lessee, Chief Exploration & Development LLC, which paid them $10,000 in advance for damages to seven acres of their property stemming from the initial drilling operations. The Humberstons maintained that the absence of any mention of the freshwater impoundment in the surface damage release was significant in that the release defined the type of activities that could occur on the leasehold.

In response to the Complaint, Chevron and Keystone filed preliminary objections in which they asserted that the Humberstons had failed to state a claim for relief, which were granted/ sustained by the trial court.

On appeal, the Pennsylvania Superior Court affirmed the trial court’s ruling and dismissed the complaint with prejudice. The Court rejected the Humberstons’ attempt to use parole evidence and found that the lease allowed for surface use “as is reasonably necessary or convenient to develop the natural gas under the Humberstons’ property and that of property constituting the Humberston Unit.” The Court also rejected the Humberstons’ reliance on the surface damage release, finding that “[t]he Release does not incorporate the Lease and therefore cannot limit in any way the use of the surface as contemplated in the Lease.”

Of further note, the Humberstons argued that at the time the lease was executed (April 6, 2006), hydraulic fracturing (and the corresponding need for freshwater impoundments) had not been used in Fayette County and, thus, could not have been a foreseeable or contemplated method for extracting gas from the leasehold. The Court rejected this as a basis to narrowly construe Chevron’s lease rights finding that “the express language of the Lease provides for the use of “methods and techniques … not restricted to current technology[.]” The Superior Court noted the trial court conclusion that:

“we do not find hydrofracking to be a new and novel method for the recovery of natural gas. Hydraulic fracturing of the strata to stimulate recovery of natural gas has been utilized in the drilling industry for many years. As noted by our Supreme Court in United States Steel Corporation v. Hoge, 503 Pa. 140, 468 A.2d 1380 (1983), the use of hydrofracking to stimulate gas recovery was developed by the drilling industry in the late 1940’s.”

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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