Articles, Newsletters and Advisories
(by Nicholas J. Habursky)
On October 30, Governor Tom Wolf signed House Bill 74, which amended the Pennsylvania Fiscal Code. The 90-page bill included Section 1610-E, entitled “Temporary Cessation of Oil and Gas Wells,” which codified certain rights of oil and gas lessors and lessees to extend leases during periods of temporary cessation of production. This article explores how traditional savings clauses found in leases and existing legal precedent may be impacted by Section 1610-E, and provides an analysis of potential challenges arising out of the application of this new law.
The new law provides:
Section 1610-E: Temporary Cessation of Oil and Gas Wells
“(a) General rule.–An oil and gas lessor shall be deemed to acknowledge that a period of nonproduction under an oil and gas lease is a temporary cessation insufficient to terminate the lease and the lessor waives his right to seek lease termination upon those grounds if, prior to claiming the lease has terminated:
(1) production is recommenced and the lessor accepts royalty payments for the production. Any first royalty payment following recommencement of production after a period of more than one year of inactivity shall be accompanied by an explanation, in plain terms, that acceptance of the royalty payment shall constitute acknowledgment of an existing lease with the operator; or (2) the operator, after notifying the lessor of its intent to drill a new well and giving the lessor 90 days within which to object, drills a new well under the lease.
(b) Lease provisions.–Nothing in this section is intended to waive lease requirements related to commencement of operations during a lease’s primary term or affect a lease provision expressly providing for lease termination following a fixed period of nonproduction.”
Savings clauses preventing lease termination
Traditional Pennsylvania oil and gas leases typically terminate upon the: i) expiration of the primary term unless the lease entered its secondary term; or ii) cessation of production and/or other operations provided for in the lease, once the lease has entered its secondary term. However, more modern leases include savings clauses, such as shut-in clauses, cessation of production clauses and continuous drilling operations clauses, which can prevent lease termination during a stoppage in production.
A shut-in clause allows a lessee to maintain a lease without actual production when and if a well has been drilled which is capable of producing gas in paying quantities but which is temporarily shut-in. 8-S Williams & Myers, Oil and Gas Law Scope. Similar to Section 1610-E, a shut-in clause is designed to prevent automatic termination of a lease due to non-production. Additionally, a cessation of production clause provides a lessee the right to preserve a lease during periods of non-production under certain circumstances, such as during well maintenance or an elapsed time between completion or abandonment of one well and the beginning of operations for the drilling of a subsequent well. 8-C Williams & Meyers, Oil and Gas Law Scope. Furthermore, aside from modern lease form language, courts have held that “a temporary cessation of production is not sufficient to terminate a lease.” Cole v. Philadelphia Co., 345 Pa. 315 (Pa. 1942).
In certain circumstances, Pennsylvania courts have upheld a lessee’s usage of these savings clauses to continue the lease’s enforceability. Many modern lease forms include savings clauses, which Section 1610-E(b) acknowledges. Therefore, it is possible that the Legislature intended Section 1610-E to apply where a savings clause is not present or applicable, as opposed to limiting the application of contractual savings clauses.
Legal precedent for lease termination due to nonproduction
The Pennsylvania Supreme Court has admitted that “the traditional oil and gas ‘lease’ is far from the simplest of property concepts.” Brown v. Haight, 255 A.2d 508 (Pa. 1969). As evidenced by the above savings clauses and the case law described below, non-production of an oil and gas lease is not necessarily the end of the life for the lease or the existing relationship between the lessee and lessor in Pennsylvania. In this way, Section 1610-E may not differ significantly from existing case law. Pennsylvania courts and the Legislature have established the relationship between a lessor and lessee and have dictated how termination of a lease can be formalized.
Early Pennsylvania cases defined the relationship between a lessor and lessee after production ceases as a tenancy at will. A tenancy at will is a tenancy for an uncertain period of time that can be terminated by either party. 30 P.L.E. Landlord and Tenant § 74. If a lessor did not “enter and repossess himself of the premises demised” after a period of non-production, a tenancy at will was created. Cassell v. Crothers, 44 A. 446 (Pa. 1899); See also Brown v. Haight, 255 A.2d 508 (Pa. 1969). Unless a lessor or lessee exhibited an action evidencing intent to terminate the lease and the tenancy at will, a non-producing lease could be continued under Pennsylvania law. However, it is unclear whether the tenancy at will and right to recommence production would exist in perpetuity or just for a reasonable amount of time after a period of non-production begins.
More recent Pennsylvania cases hold that if oil and gas is produced “a fee simple determinable is created in the lessee, and the lessee’s right to extract the oil or gas becomes vested.” T. W. Phillips Gas & Oil Co. v. Jedlicka, 42 A.3d 261 (Pa. 2009). Upon the occurrence of a specific event, the fee simple determinable estate automatically reverts back to the lessor. Id. at 267. See also Seneca Res. Corp. v. S & T Bank, 122 A.3d 374 (Pa. Super. Ct. 2015). The specific event would be determined by the lease terms.
Pennsylvania also provides a statutory framework for the formal release or forfeiture of a lease. Within 30 days of termination, expiration or cancellation, the lessee is required to deliver to the lessor a surrender document in recordable form. 58 P.S. § 903(a). Similarly the lessor can provide notice of termination to the lessee, and if no challenge is received within 30 days, the lessor can record an affidavit of termination. 58 P.S. §§ 901- 905.
Impact and scope of Section 1610-E
Based upon Section 1610-E, non-production alone is insufficient to definitively terminate an oil and gas lease.
Despite the parameters set forth in Section 1610-E preventing the automatic termination of an oil and gas lease, the law explicitly defers to the terms of the oil and gas lease that deal with termination after a specific period of non-production. Thus, the practical scope of the law may be limited to older oil and gas leases whose secondary term is commonly defined as “…and so long thereafter as oil and gas is producing in paying quantities…” and which do not contain numerous savings clauses. Many modern oil and gas leases contain language that more broadly defines a secondary term, such as a period when a well located on the leased land is capable of production. Additionally, modern leases are more likely to include savings clauses such as cessation of production clauses or continuous drilling operations clauses whereby Section 1610-E would likely be inapplicable. Therefore, Section 1610-E likely will have a greater impact on older held-by-production leases requiring production in paying quantities for the lease to remain in effect.
Potential issues with the application of Section 1610-E
In the event a temporary cessation of production occurs, and if the lease does not contain terms regarding rights or obligations of the lessee and lessor as to the force and effect of the lease, then Section 1610-E may provide curative rights. These curative rights are available only if neither the lessor nor the lessee has terminated the lease. Section 1610-E may be utilized if one of two criteria exists: (1) lessee must recommence production and lessor must accept a royalty payment for this production; or (2) if after providing 90 days’ notice of its intent to drill a new well, and absent objection, the lessee drills a new well. Both steps require either an affirmative action by the lessor and lessee or acquiescence to drilling on the part of a notified lessor. The new law does not provide an affirmative right of the lessee to continue operations without first either confirming the lessor will not object to new drilling or risk recommencing production dependent upon the lessor accepting future royalty payments.
As a result, the new law does not provide any greater certainty or clarity as to the effectiveness of leases with historical production. This is especially true if the lessor or lessee do not provide record notice that the lease has expired or terminated. Section 1610-E does not define what is meant by its usage of the phrase “prior to claiming the lease has terminated.” Unless a lease is terminated pursuant to statutory provisions, it is not always clear what action is required to claim lease termination. Therefore, a lessor may disagree as to whether Section 1610-E is even applicable. This can lead to further litigation between lessors and lessees in the event of a temporary cessation of production.
It is also unclear whether the “period of non-production” discussed in the statute has any limit. The law acknowledges the period can be more than a year, but does not definitively state a limit to the application of the law to revive a lease for non-production, beyond the use of the term “temporary” cessation. Additionally, there could be a conflict between a lease and the application of the new law if a lease contains a shut-in limitation regulating the length of time a well can be shut-in.
As Section 1610-E is utilized in the future, it is likely that these issues will be addressed by lessors, lessees and the courts.
For more information, contact Nicholas Habursky at 412- 253-8859 or firstname.lastname@example.org.