Equitable Extension of Oil and Gas Lease Rejected During Pendency of Lessor’s Declaratory Judgment Action to Declare Lease Invalid: Pennsylvania

On February 17, 2015, in a decision that is contrary to the principle that is nearly universally applied in other oil and gas producing jurisdictions, the Pennsylvania Supreme Court held that an oil and gas lessee is not entitled to an equitable extension of the primary term of a lease when the lessee is forced to spend years litigating the question of the lease’s validity. This decision represents a material departure from the general rule followed in other jurisdictions that, when a suit by a lessor challenging the validity of an oil and gas lease is unsuccessful, equitable principles apply to ensure that the lessee is not deprived of the agreed-upon time within which it must perform to maintain the lease.

In Harrison v. Cabot Oil & Gas Corp., No. 75 MAP 2014, Harrison, the owner of real property leased for oil and gas production to Cabot, sued Cabot seeking a declaration that the lease was invalid. Harrison argued that the lease was invalid because he signed the lease after Cabot represented that Harrison would not receive more than $100 per acre as a lease bonus. Cabot filed a counterclaim requesting that the primary term of the lease be extended for the period of time during which the lawsuit was pending in the event that the courts confirmed the validity of the lease.

The U.S. District Judge granted summary judgment in favor of Cabot on Harrison’s claim, finding that the lease was valid and enforceable. However, the court ruled against Cabot on the counterclaim, declining to extend the primary term of the lease. The court reasoned that equitable extension of the lease was not proper because the filing of a declaratory judgment action by a lessor seeking invalidation of an oil and gas lease is not a “repudiation of the contract,” which would justify an equitable extension under Pennsylvania law.

On appeal to the Third Circuit, the Third Circuit certified a question of law to the Pennsylvania Supreme Court, asking the state court to determine “whether the primary term of an oil-and-gas lease should be equitably extended by the courts, where the lessor has pursued an unsuccessful lawsuit challenging the validity of the lease.”

The Pennsylvania Supreme Court agreed with the U.S. District Court’s refusal to equitably extend the lease, concluding that commencement of an action seeking judicial declaration of an oil and gas lease’s invalidity is not a “repudiation of the lease” because, under Pennsylvania law, repudiation requires an “absolute and unequivocal refusal to perform” the contract. Rather than an outright refusal to perform the lease, the Pennsylvania Supreme Court found that Harrison was only trying to “settle and to afford relief from uncertainty and insecurity with respect to rights, status, and other legal relations,” as set out in Pennsylvania’s Declaratory Judgment Act.

The Court concluded that to hold otherwise would be to adopt a special repudiation rule for oil and gas leases. The Court also emphasized lessor’s observation “that oil-and-gas-producing companies are free to proceed according to their own devices to negotiate express tolling provisions for inclusion in their leases.” (Emphasis added.) The Court concluded that the result might be different where evidence of “affirmative repudiation of a lease” is present: “Our determination is only that, consistent with the prevailing substantive law of this Commonwealth, the mere pursuit of declaratory relief challenging the validity of a lease does not amount to such.”

Therefore, even though Cabot was forced to standby and do nothing to develop the leasehold while the litigation was occurring, all while the primary term of the lease ticked-by, the court concluded that Cabot was without a remedy to recoup the time lost during the litigation.

This outcome is contrary to the decision of almost every other court to consider the issue. As explained by Patrick H. Martin & Bruce M. Kramer, “courts have almost universally held that when the lessor has brought a suit during the primary term claiming the termination of the lessee’s interest, the lessee, should he prevail in such action, will be entitled to a period of time extending beyond the expiration of the primary term to gain production.” 3 Patrick H. Martin & Bruce M. Kramer, Williams & Meyers, Oil and Gas Law § 604.7 (2009). For example, in Southwestern Energy Production, Inc. v. Elkins, 374 S.W.3d 678 (Ark. 2010), the Arkansas Supreme Court applied the repudiation doctrine to toll lease performance from the date the suit was filed, finding that not tolling lessee’s “obligation to drill as of that date would create an impossible dilemma” for lessee to “either use the contested lands and potentially expose itself to more liability or refrain from using the lands and lose its investment….” Other courts have reached similar conclusions. See, e.g., Snowden v. JRE Investments, Inc., 2010 Ark. 276, 370 S.W.3d 215, 221-22; Barby v. Cabot Petroleum, Inc., 944 F.3d 798, 799 (10th Cir. 1991), citing Duerson v. Mills, 648 P.2d 1276, 1277 (Ok. 1982), overruled on other grounds, Baytide Petroleum, Inc. v. Continental Resources, Inc., 231 P.3d 1144 (Okla. 2010).

Oil and gas lessees should be concerned that other courts may adopt this precedent because it could allow a lessor or other interested party to challenge the validity of an oil and gas lease and force the lessee to decide between continuing to develop the lease in the face of the risk that the lease will be invalidated (and, arguably, that lessee’s actions are a trespass on lessor’s land) and losing the lease for failure to develop during the primary term. It appears that this issue has yet to be decided by the Colorado Supreme Court. As such, it would be prudent for Colorado lessees to include express tolling provisions in their leases.