Pennsylvania Superior Court: Separate Consideration for Operated and Unoperated Acres Does Not Render an Oil and Gas Lease Severable

by McGuireWoods LLP
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The recent boom in natural gas production in the Appalachian Basin has led to a concomitant boom in litigation, as landowners who are lessors in long-standing oil and gas leases seek declarations that the leases are no longer operative so that they may attempt to negotiate new leases with production companies. One particular ground for landowner challenges is the contention that a lease is “severable,” such that it can be held to have partially lapsed (thus freeing up the “severed” estate or portion thereof for re-leasing). To date, those efforts have been largely unsuccessful. The Pennsylvania Superior Court’s decision in Seneca Resources Corporation v. S&T Bank, No. 2057 WDA 2014 (Pa. Superior Ct. Aug. 31, 2015), is the latest in a string of Pennsylvania cases in which courts apply these leases’ express terms and refuse to hold that the operative lease is severable, such that the landowner may enter into a new lease conveying production rights.

At issue in Seneca Resources was a 1962 lease involving storage and production rights over leased premises totaling 25,000 acres. At the inception of the lease, approximately 15,000 acres of the leased premises were developed, and the remaining 10,000 acres were undeveloped. The lease outlined separate consideration for the developed and undeveloped acreage, with the lessee paying royalties for any oil or gas produced from the operated acreage and a rental payment for the unoperated acreage. The landowners argued that, as a result of this language, the lease was severable and they had the right to terminate the lease with respect to the unoperated acreage after the 40-year primary term of the lease expired.

Following summary judgment in favor of Seneca Resources at the trial court, the Superior Court considered two questions. First, the Court addressed the landowners’ contention that the lease was severable as to the operated and unoperated acreage. Following the Pennsylvania Supreme Court’s holding in Jacobs v. CNG Transmission Corporation, 772 A.2d 445 (Pa. 2001), the Court reasoned that determination of whether a lease is severable depends upon examination of the language of the lease, the character of the consideration, the circumstances surrounding the lease’s execution, the conduct of the parties, and any discernible intent of the original contracting parties that could be derived from the lease. In considering the language of the lease, the Court noted that the lease clearly and unambiguously defined the leased premises to encompass 25,000 acres for a primary term of 40 years and a secondary term that would continue indefinitely as long as oil or gas was produced or withdrawn from any portion of the leased premises. The Court also noted that neither the leasing clause nor the habendum clause made any distinction between operated and unoperated acreage and thus “the clear and unambiguous language of the Lease grants Seneca a fee simple determinable of the entire leasehold so long as the lessee stores, produces, or withdraws oil or gas from any portion of the 25,000 acres.” As to the landowners’ argument that the separate consideration provisions rendered the lease severable, the Court concluded that “the fact that consideration provisions include royalties, delay rentals, and storage rentals, and that unoperated acreage may be converted to operated acreage at any time, reflect an intent by the parties to enter an agreement to achieve the fullest development of the entire 25,000 acres of the leased premises.” Accordingly, the Court concluded that the lease was entire and that the operable and unoperable acreages were not severable from each other.

The Court also rejected the landowners’ argument that Seneca Resources had violated the implied covenant to develop by failing to develop approximately 3,000 acres of commercially viable land. The trial court held that because a portion of the leased premises was already developed at the time Seneca acquired the rights to the lease, the implied covenant to develop was inapplicable to the property as a whole. The Superior Court, following Jacobs, disagreed, reasoning that “the fact that the leased premises are under production at the time of the entry of the Lease does not, in itself, invalidate the implied covenant to develop.” However, the Court noted that the express terms of the habendum clause provided that the lease would be extended if oil or gas were stored in, produced or withdrawn from “all or any portion of said leased premises.” Because it was “undisputed that Seneca continues to drill and withdraw gas from a portion of the leased premises,” the Court held that “the Lease between the Appellants and Seneca forecloses a finding of a breach of the implied covenant to develop and produce oil and gas on the unoperated acreage.”

The Superior Court’s decision in Seneca Resources provides further support for the proposition that courts will be reluctant to sever oil and gas leases, and will instead construe them according to their express terms.

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