Harrison Decision: Cabot Oil Denied Equitable Extension of Oil and Gas Lease

On February 17, the Pennsylvania Supreme Court (the Court) unanimously ruled that state law does not recognize equitable extensions of leases in the absence of an absolute and unequivocal repudiation of the agreement and expressly refused to create an exception for the oil and gas industry when there is a declaratory judgment action that seeks to invalidate a lease without an actual repudiation of that lease.

Background

In August 2007, Wayne Harrison (Harrison) entered into a five-year oil and gas lease (the Lease) with Cabot Oil & Gas Corporation (Cabot). Halfway through the Lease’s term, Harrison sought to invalidate the Lease, which he claimed was fraudulently procured. His complaint, filed in the U.S. District Court for the Middle District of Pennsylvania (District Court), alleged that Cabot had represented that it would pay no more than $100 per acre. but, as he subsequently learned, his neighbors were receiving substantially larger amounts, some as much as $3,000 per acre. As a result of the lawsuit, Cabot did not operate on the leased property, and therefore sought an equitable extension of the Lease’s primary term equivalent to the lawsuit’s duration.

Although the District Court granted Cabot’s motion for summary judgment on Harrison’s fraud claim, it also granted summary judgment for Harrison against Cabot’s counterclaim for equitable extension of the Lease.[1] While the District Court acknowledged that Cabot had “advance[d] persuasive arguments” and that several other jurisdictions recognized the relief Cabot sought, the District Court expressed doubt that a declaratory judgment action was a repudiation of the Lease under Pennsylvania law and declined to create state law when there was little precedent to do so.[2] The decision was the second from the Middle District of Pennsylvania to reach this conclusion.[3]

In addition to its appeal, Cabot sought certification to the Pennsylvania Supreme Court on the question of whether a lessee is entitled to an equitable extension of the lease if a lessor unsuccessfully challenges its validity. The U.S. Court of Appeals for the Third Circuit certified the question to the Supreme Court of Pennsylvania, which accepted the question. The Court affirmed the District Court’s rejection of an equitable extension due to the filing of a declaratory judgment action.

Analysis

In its opinion, the Court declared, “[W]e view the controlling determination in this case as devolving to whether this Court will adopt a special approach to repudiation pertaining to oil-and-gas leases, as a substantial number of other jurisdictions would appear to have done. We decline to do so, however.”[4] By its decision, the Court deviated from courts in other traditional oil and gas–producing states, such as Texas, Montana, Oklahoma, Louisiana, Michigan, Arkansas, Illinois, and Ohio, which recognize equitable extensions of leases in similar circumstances.

In its analysis, the Court noted that oil and gas companies frequently possess superior bargaining power over landowners and could, therefore, easily draft contracts to include tolling provisions that account for the possibility of lease validity challenges. Relying on such reasoning, the Court brushed aside Cabot’s arguments that it had been denied the benefit of its bargain and that pursuing drilling operations while the lawsuit was pending would have been both an unnecessary risk and economically unwise.

The Court concluded that Harrison had not absolutely and unequivocally refused to perform his obligations under the Lease by filing a declaratory judgment lawsuit, and, accordingly, Cabot was not entitled to an equitable extension of the Lease. In so deciding, the Court was careful to limit its ruling to the particular facts of this case: “We do not foreclose that equitable relief may be available to oil-and-gas-producing companies—subject to applicable requirements governing recourse to equity—where there is an affirmative repudiation of a lease.”[5]

Impact

The Harrison decision represents another example of the Court’s willingness to break from other oil and gas jurisdictions, as demonstrated by its 2013 affirmation of the historic “Dunham Rule,” under which natural gas is presumptively not a “mineral” under oil and gas leases. More significantly, the ruling can be viewed as yet another missed opportunity for the Court to provide a measure of predictability and security to the oil and gas industry in Pennsylvania. Only 14 months ago, we reported in our December 2013 LawFlash on the Court’s landmark Robinson Township decision that invalidated major components of the Commonwealth’s modernized Oil and Gas Act, known as Act 13. The ruling dismantled the legislature’s attempt to establish a uniform set of rules that governs the responsible development and operation of natural gas resources.

On the surface, the Harrison decision can be viewed narrowly as a simple warning to the oil and gas industry to draft leases more carefully. But more importantly, this ruling represents another significant development in the ongoing evolution of the judicial, regulatory, and political regime that oversees oil and gas operations in Pennsylvania. As this landscape continues to change, operators should keep a close eye on emerging developments in Pennsylvania, as its common law does not necessarily track that of other oil and gas–producing states.

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