Pennsylvania Supreme Court Accepts Appeal in Case Involving Lease Abandonment by Operator

The Pennsylvania Supreme Court recently accepted the appeal of Mitch-Well Energy, Inc. (“Mitch-Well”) in SLT Holdings, LLC v. Mitch-Well Energy, Inc. on the issue of whether Mitch-Well effectively abandoned its leases by failing either to produce oil or gas or pay required minimum rental payments to the landowners.  In 2019, the Pennsylvania Superior Court affirmed the trial court’s determination that Mitch-Well abandoned its leases due to the lack of production and payments.

The leases, executed in 1985, cover two tracts in Warren County, Pennsylvania, and contain provisions requiring Mitch-Well to drill a certain number of wells on the parcels and make yearly minimum payments to the lessors.  The leases also contain a provision stating that the leases will continue for so long as Mitch-Well determines that oil and gas can be produced in paying quantities.  From 1996 through 2013, wells drilled under the leases failed to produce in paying quantities and Mitch-Well neglected to make the minimum payments are required by the leases, prompting the landowners to seek judicial determination that Mitch-Well abandoned the leases.

On appeal, the Supreme Court will consider Mitch-Well’s argument that in its good faith determination, the wells were productive even though the trial court failed to take testimony on this issue. The Supreme Court asked Mitch-Well and the landowners to address Aye v. Philadelphia Co. and Jacobs v. CNG Transmission Corp., indicating that the Court may consider whether the leases survive both the automatic termination due to the non-payment of royalties and whether Mitch-Well abandoned the leases during the 16 years of non-production.  This is an opportunity for the Court to provide additional clarity on Pennsylvania law relating to cessation of production and lease abandonment and termination.

Ohio’s Statutory Unitization Amended to Clarify Inclusion of Partially Leased Tracts

Ohio recently passed HB 166, effective October 17, 2019, amending Section §1509.28 of Ohio’s statutory unitization statute.  The prior version of Section §1509.28 did not specify whether all mineral owners in a tract must be leased to be included in the accounting for the minimum 65% operator ownership interest, which is the threshold required in order to apply for statutory unitization.  The Section also did not address whether an operator could count partial net-acreage interests in a tract.  For example, under the prior version of Section §1509.28, if a 10 acre tract was owned jointly by five owners, two of which had leased their oil and gas interests, it was unclear whether the operator was required to represent the leased interest as only four net acres or whether the operator was required to represent the tract as wholly unleased until all owners in the tract had entered into oil and gas leases.  The new amendment added the following clarification to the Code: “In calculating the sixty-five per cent, an owner’s entire interest in each tract in the proposed unit area, including any divided, undivided, partial, fee, or other interest in the tract, shall be included to the fullest extent of that interest.”  The amendment makes clear that for tracts with multiple owners, any type of interest held by the applicant-operator in a unitized tract counts towards the minimum 65% threshold required to apply for an order permitting forced unitization from the chief of the division of oil and gas resources management.

Federal Court Upholds Constitutionality of Ohio’s Unitization Statute

A federal district court in Ohio recently upheld the constitutionality of Ohio’s forced pooling statute (R.C. § 1509.28) in Kerns v. Chesapeake Exploration, LLC, et al., N.D. Ohio No. 5:18 CV 389 (June 13, 2018). R.C. § 1509.28 establishes the procedure for owners to combine contiguous acreage and interests to efficiently and effectively develop the oil and gas resources underlying that land. Additionally, the statute grants the chief of the division of oil and gas resources management the authority to compel landowners unwilling to lease their land to join in drilling operations. The constitutional challenge in Kerns involved the same group of landowners whose writ of mandamus was rejected by the Ohio Supreme Court in January. Following their unsuccessful challenge at the Ohio Supreme Court, the landowners alleged that R.C. § 1509.28 violated their constitutional rights under the Fifth and Fourteenth Amendments by authorizing an impermissible taking of their property. In rejecting the constitutional challenge, the federal district court relied on previous decisions from the United States Supreme Court holding that the statute was a legitimate exercise of Ohio’s police powers to protect correlative rights and reduce waste. In deeming R.C. § 1509.28 constitutional, Ohio courts join the well-settled national consensus that unitization procedures do not constitute an impermissible taking of property.

Challenge to Constitutionality of Ohio’s Forced Pooling Statute Rejected on Procedural Grounds

The Ohio Supreme Court recently rejected a constitutional challenge to Ohio’s forced pooling statute in State ex rel. Kerns v. Simmers, Slip Opinion No. 2018-Ohio-256. A group of landowners (the “Landowners”) sought a writ of mandamus compelling the Chief of the Ohio Department of Natural Resources (ODNR) to commence appropriation proceedings to compensate landowners with interests included in an oil and gas drilling unit through a unitization order. The Landowners alleged that the Chief’s order issued pursuant to R.C. 1509.28 was “unlawful or unreasonable” and constituted an unconstitutional taking of their property without compensation. Under R.C. 1509.36, the Landowners appealed the Chief’s order to the Ohio Oil and Gas Commission (the “Commission”). The Commission, concluding that it lacked jurisdiction to determine the constitutionality of the order, dismissed the appeal. Instead of appealing the Commission’s decision to the Franklin County Court of Common Pleas within 30 days as permitted by R.C. 1509.37, the Landowners filed a petition for a writ of mandamus to the Ohio Supreme Court.

The Ohio Supreme Court denied the writ and dismissed the Landowners’ case, reasoning that the Landowners failed to utilize the adequate legal remedy available. To be entitled to a writ of mandamus, the Landowners needed to show (1) that they had a clear legal right to appropriation proceedings, (2) that the ODNR had a clear legal duty to commence the proceedings, and (3) that the Landowners had no plain and adequate legal remedy. Under R.C. 1509.37, the Landowners could have appealed the Commission’s decision to the Franklin County Court of Common Pleas to determine the constitutionality of the unitization statute. In denying the writ, the court determined that the Landowners had a complete, beneficial and speedy remedy at law by way of an appeal to the Franklin County Court of Common Pleas as provided in R.C. Chapter 1509 and should have pursued their appeal there. While dismissing this challenge on procedural grounds, it appears inevitable that the Ohio Supreme Court will ultimately have to determine the constitutionality of Ohio’s forced pooling statute.

Ohio Supreme Court does not Recognize Implied Covenant to Further Explore

The Supreme Court of Ohio recently ruled in Alford v. Collins-McGregor Operating Company, Slip Opinion No. 2018-Ohio-8, that Ohio does not recognize an implied covenant to further explore, separate and apart from the implied covenant of reasonable development. Under Ohio law, the implied covenant of reasonable development requires a lessee to drill and operate such number of wells as would be reasonably necessary to develop the leasehold premises in a proven formation. While other jurisdictions recognize a separate implied covenant of further exploration, which requires a lessee to additionally explore potentially productive formations that are yet to be proven, the Supreme Court of Ohio refused to impose such requirement on lessees.

The Alford oil and gas lease was held by production and did not disclaim the application of any implied covenants. The lessee drilled one shallow well pursuant to the lease, which had produced in paying quantities ever since. The lessee never drilled any additional wells or sought production from any additional depths. Because the lessee declined to explore deeper depths, the Plaintiff landowners alleged that the lessee breached the implied covenant of reasonable development and the implied covenant to explore further, and sought a partial forfeiture of the lease as to deeper formations.

Affirming the Fourth Appellate District’s decision, the Ohio Supreme Court held that the implied covenant of reasonable development sufficiently protects the landowner’s interest in the exploration of deep formations. The court discussed that the implied covenant of reasonable development requires the lessee to act as a reasonably prudent operator would in developing an oil and gas lease. It requires the lessee to take into account the interests of both the lessor and lessee and to consider all of the circumstances relevant to the exploration and development of the land, including the associated risks, costs and profit. Conversely, the court observed that the implied covenant of further exploration only focuses on a small subset of factors relevant to the overall development of a lease, namely the lessor’s interest in obtaining additional compensation, and ignores the profit motive of a reasonably prudent operator.

The court held that the comprehensive scope of the implied covenant of reasonable development subsumes the implied covenant to further explore. The implied covenant of reasonable development is well suited to address the landowner’s interests in the further exploration of deeper formations because it takes into consideration all of the factors relevant to the exploration and development of a leased property. The court noted that it would be “unhelpful at best” to recognize a separate implied covenant to explore further, but expressed no opinion whether a prudent operator has a duty to develop deep rights under the implied covenant of reasonable development.

SB 576: Revised Co-Tenancy and Lease Integration Legislation Introduced in West Virginia

On March 10, 2017, Senate Bill 576 (SB 576) was introduced in the West Virginia Senate to take the place of SB 244, which addressed the oil and natural gas industry’s effort to efficiently develop production of natural resources. Similar to SB 244, SB 576’s stated purpose is “to encourage the efficient and economic development of oil and gas resources[;]” however, it contains a number of provisions that differ from SB 244.

If signed into law, SB 576 would create a new code section, W. Va. Code §37B-1-1, et seq., titled the “Cotenancy and Lease Integration Act,” which, like SB 244, contains both “co-tenancy” and “lease integration” provisions.

SB 576 declares in proposed §37B-1-2 that West Virginia public policy includes both “the maximum recovery of oil and gas” and the “protect[ion] and enforce[ment of] the clear provision of contracts lawfully made.” This section also states that West Virginia public policy is to “safeguard, protect and enforce” both “the rights of surface owners” and “the correlative rights of operators and royalty owners in a pool of oil and gas to the end that each such operator and royalty owner may obtain his or her just and equitable share of production from that pool of oil and gas[.]”

Proposed section §37B-1-4 allows oil and gas production on a piece of property when “two thirds of the ownership interest in the oil and gas mineral property consent to a lawful use [i.e., production] of the mineral property[.]” By contrast, SB 244 only required that a “majority” of ownership interests agree to a “lawful use.”

In addition, SB 576 (like SB 244) states that payment of royalties will be on a pro rata basis, with payments for a mineral owner who cannot be located reserved by the producer.  Unlike SB 244, however, SB 576 would specifically allow surface owners to use W. Va. § 55-12A-1, et seq. (the unknown and missing landowners statute), to lay claim to the interests of the absent or missing owners.  Finally, and importantly, SB 576 would require that a mineral interest owner who opposes oil or natural gas development be paid royalties (1) “free of post-production expenses” and (2) “equal to his or her fractional share of the average royalty of his or her consenting cotenants[,]” but “in no event may the royalty be less than his or her fractional share of one-eight [12.5%].”

SB 576 adds proposed sections §37B-1-5 and -6, which would take the place of the “Joint Development” provision in SB 244. Under proposed §37B-1-5, “[w]here an operator or operators have the right to develop multiple contiguous oil and gas leases, the operator may develop these leases jointly by horizontal drilling unless the development is expressly prohibited by the terms of a lease or agreement.”  Importantly, an operator may only disturb the surface of property subject to this provision if it “has a surface use agreement” with the owner(s) of the property that will be disturbed.  As with SB 244, under proposed §37B-1-6, royalty payments are based upon “production [that] shall be allocated to each lease in the proportion that the net acreage of each lease bears to the total net acreage of the jointly developed tracts.”  As with dissenting owners under proposed §37B-1-4, however, “[i]n the absence of specific agreement to the contrary or where deductions are authorized by statute, the royalty for all royalty owners of the jointly developed acreage who do not have leases containing express pooling and unitization clauses shall not be reduced for post-production expenses incurred by the operator.”  This provision, however, is not “intended to impact royalties due for wells drilled prior to the effective date of this chapter.”

While SB 576 keeps the basic goals of SB 244 – development without the approval of all mineral interest owners and development of contiguous property through horizontal drilling – it contains a number of provisions designed to mollify the concerns of surface owner organizations and other property rights groups. The “co-tenancy” provision now requires a 2/3 majority of mineral ownership interests to permit development, and royalty payments to dissenting owners must not take post-production costs into account.  The “lease integration” provisions explicitly allow horizontal drilling of contiguous tracts that are each subject to production leases (provided horizontal drilling is not expressly prohibited), but if a production lease does not explicitly permit pooling or unitization, then royalty payments to the owners under that lease cannot be deducted for post-production costs.  Important to surface owners is the requirement that a surface use agreement be in place before the surface of any property is disturbed by joint development.

Babst Calland will follow SB 576 during West Virginia’s Legislative Session, which is scheduled to end on April 8, 2017.

U.S. Supreme Court Rejects Appeal of Ohio Dormant Mineral Act Case

On Tuesday, the Supreme Court of the United States denied certiorari in Walker v. Shondrick-Nau, Exr. (Slip Opinion No. 2016-Ohio-5793). As more fully explained in our Blog post discussing Walker, in September the Ohio Supreme Court held that, if a surface owner failed to quiet title under the 1989 version of the Ohio Dormant Mineral Act (the “ODMA”) prior to the enactment of the 2006 version of the ODMA, then the 1989 version is unavailable and the surface owner can only pursue a claim to abandon mineral interests under the 2006 version of the ODMA. Walker subsequently appealed this decision to the Supreme Court of the United States. In denying certiorari, the U. S. Supreme Court refused to hear the case meaning that the decision of the Ohio Supreme Court will stand as the law in Ohio.

Court Upholds Zoning Ordinance Permitting Oil and Gas Well Development In Agricultural/Residential Zoning District

On October 21, 2015, Judge Richard McCormick, President Judge of the Westmoreland County Court of Common Pleas, issued a decision and order upholding the validity of Allegheny Township’s zoning ordinance, which permits oil and gas well development in the Township’s R2 Agricultural/Residential Zoning District. The decision in Frederick v. Allegheny Township Zoning Hearing Board, No. 1898 of 2015 (Com. Pl. Westmoreland Co. Oct. 21, 2015), affirms a previous decision of the Township’s Zoning Hearing Board. Babst Calland represented CNX Gas Company LLC (CNX), an intervenor in the case, before both the Common Pleas Court and the Zoning Hearing Board.

CNX applied for and received a zoning compliance permit to develop an unconventional gas well pad in the Township’s R2 District, in which oil and gas well development is permitted as a use by right. Neighboring property owners Dolores Frederick, Beverly Taylor, and Patricia Hagaman appealed to the Zoning Hearing Board, challenging both the issuance of the permit and the validity of the Township’s zoning ordinance, alleging that permitting oil and gas well development in the R2 District violated the Pennsylvania Supreme Court’s plurality decision in Robinson Township v. Commonwealth of Pennsylvania. Following several nights of hearings and oral argument, the Zoning Hearing Board ruled that the zoning ordinance was valid and upheld the issuance of the zoning compliance permit. Objectors then appealed to Common Pleas Court.

Since the Robinson decision, zoning ordinances authorizing oil and gas development have been challenged in several municipalities, with objectors essentially arguing that those ordinances are invalid because they are not strict enough. In most of these cases, the objectors have asserted that the zoning ordinance violated the Pennsylvania Environmental Rights Amendment (as interpreted by the Robinson plurality) because it permitted oil and gas development, a use they characterize as “industrial”, in agricultural, residential and other non-industrial districts. To date, all of those challenges have been rejected by local zoning hearing boards, although several of those decisions have been appealed to Common Pleas Court. Frederick is significant in that it is the first case in which a Court has addressed a Robinson based ordinance validity challenge. This case is precedential in Westmoreland County and is instructive to Courts in the other counties of the Commonwealth.

In Frederick, Judge McCormick first observed that Robinson was not binding precedent because it was only a plurality decision. The Court also pointed out that that Robinson did not address the constitutionality of a local ordinance, but instead involved a statute of statewide application (Act 13) that was invalidated because it interfered with the right of municipalities to make local zoning determinations. In any event, the Court went on to conclude that the Allegheny Township zoning ordinance was consistent with the Robinson plurality. Significantly, citing the extensive record developed before the Zoning Hearing Board, Judge McCormick expressly rejected the objectors’ contention that the zoning ordinance’s authorization of oil and gas uses “is inconsistent with the agricultural and residential character of the Township.” That record established that (1) there was a long history of oil and gas development in the Township, including a number of wells and a pipeline in close proximity of the objectors’ properties, (2) in the R2 District approximately 75% of the land mass is leased to oil and gas operators, (3) having the well pad on his property enabled the surface owner to continue actively farming his property instead of developing it for a residential subdivision, and (4) permitting oil and gas operations in the R2 District enhances the Township’s ability to maintain its rural character. The Court also cited to expert testimony which concluded that oil and gas operations have safely coexisted within rural communities throughout the Commonwealth.

Judge McCormick also rejected several of the objectors’ related arguments. Specifically, the Court ruled that the Township zoning ordinance did not constitute illegal “spot” zoning and did not violate sections 604 and 605 of the Pennsylvania Municipalities Planning Code. In so concluding, the Court stated that the Township’s “legislative body sought to further the general welfare of its citizens by permitting them to benefit economically from oil and gas resources and royalites, and enabling them to retain the agricultural use and rural setting of their land.”   Finally, the Court found that the authorization of oil and gas development did not violate the community development objectives of the Township zoning ordinance.

Federal Court Invalidates Portions of a Local Ordinance, Which Banned the Use of Underground Injection Wells

On October 14, 2015, the United States District Court for the Western District of Pennsylvania invalidated several provisions of a Grant Township, Indiana County, Pennsylvania local ordinance that was intended to prevent an oil and gas operator from operating an injection well that had been permitted by the U.S. Environmental Protection Agency.  In Pennsylvania General Energy Company, L.L.C. v. Grant Township, C.A. No. 14-209, 2015 U.S. Dist. LEXIS 139921 (W.D. Pa. Oct. 14, 2015), Pennsylvania General Energy Company, L.L.C. challenged the constitutionality, validity and enforceability of the Grant Township ordinance that sought to establish a self-described Community Bill of Rights Ordinance.  For additional information, read our recent Administrative Watch.

Pennsylvania DEP Releases Latest Revisions Of Oil And Gas Rulemaking

The Pennsylvania Department of Environmental Protection (DEP) recently announced the draft final revisions to the “Environmental Protection Performance Standards at Oil and Gas Well Sites” rulemaking (Chapters 78 and 78a).  Following the most recent round of public comment, DEP decided not to include the provisions for noise mitigation and centralized storage tanks for wastewater in the final regulations.  DEP indicated that a separate process is more appropriate for noise mitigation due to the complex nature of noise mitigation.  With regard to centralized storage tanks, DEP decided it would continue to regulate these facilities under the residual waste regulations.  The amendments will be discussed at the upcoming meetings of the Conventional Oil and Gas Advisory Committee and, Oil and Gas Technical Advisory Board in late August and early September, respectively.