Oil & Gas Leases; Cessation of Production; Lease Abandonment and Termination

SLT Holdings, LLC v. Mitch-Well Energy, Inc., 217 A.3d 1258 (Pa. Super. 2019), allocatur granted Apr. 14, 2020, appeal docket 6 WAP 2020

This case involves two parcels of land in Warren Count subject to leases granting oil, gas, and mineral (OGM) rights. Following SLT Holdings, LLC’s acquisition of the ownership of the mineral estate beneath the two tracts, Mitch-Well Energy, LLC was assigned the leases. Each of the leases contained a habendum clause providing that the lease “shall be in force for a primary term of five (5) years from the effective date of this lease, and for as long thereafter as oil or gas or other substances covered hereby are or can be produced in paying quantities….” Slip op. at 8. The leases also contained the following relevant provisions:

5) Rental Payment – This Lease is made on the condition that it will become null and void and all rights hereunder shall cease and terminate unless work for the drilling of a well is commenced … within ninety (90) days and prosecuted with due and reasonable diligence, or unless the Lessee shall pay to the Lessor, in advance, every twelve (12) months until work for the drilling of a well is commenced, the sum of Twelve Dollars ($12.00) per acre, that is Thirty-Six Hundred Dollars ($3,600.00) for each twelve (12) months during which the commencing of such work is delayed.

6) Continuing Operations – If, at the end of the primary term or any time thereafter, this lease is not being kept in force … but [Mitch-Well] is then engaged in drilling, reworking or any other operation calculated to obtain production on the leased premises or lands pooled therewith, this lease shall remain in force as long as … such operations are conducted in a reasonable, prudent manner and, if such operations result in production of oil or gas or other substance covered thereby, as long thereafter as production continues in paying quantities.

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8) Shut-In Gas Royalty – Notwithstanding anything herein to the contrary, if all wells on the leased premises are capable of producing gas in paying quantities but the wells are shut-in, such wells shall nevertheless be considered as though the wells are producing gas in paying quantities for the purpose of maintaining this lease in effect by Lessee on or before the end of each calendar year in which the wells are shut-in, pay Lessor a shut-in gas royalty equal to the delay rental provided for herein prorated by the number of days the wells were shut in.

Slip op. at 8-9 (footnote omitted). For roughly sixteen years, the wells did not produce OGM in marketable quantities, and as such, Mitch-Well did not make royalties payments or any required minimum lease payments. Although Mitch-Well did visit the wells in question during this period, it did so to ensure that the wells remained safe and in compliance with applicable law. During this time, Mitch-Well did not attempt to achieve marketable levels of OGM production as prevailing OGM prices made production uneconomical for Mitch-Well. In 2013, Mitch-Well, allegedly pursuant to the leases, pumped and sold oil from the wells. SLT filed suit against Mitch-Well for conversion and sought injunctive relief, arguing that because Mitch-Well defaulted on the leases, the leases terminated or else were abandoned. Additionally, SLT sought declaratory judgment that Mitch-Well has no rights to either lot as a result of Mitch-Well’s failure to maintain its drilling commitment and/or otherwise remit delay rental payments.

The trial court concluded that Mitch-Well abandoned the leases and thus granted summary judgment in favor of SLT on its claims for conversion, declaratory judgment, and permanent injunctive relief. In support of its finding of abandonment, the trial court noted that SLT’s case “is analogous in all relevant aspects to the seminal case of” Jacobs v. CNG Transmission Corp., 332 F.Supp.2d 759  (W.D. Pa. 2004), reasoning that:

Jacobs also involved a lawsuit over an oil and gas lease brought by plaintiffs/lessors against defendant/lessee. Id. Plaintiffs sought relief in the form of a judicial determination that the lease was terminated. Id. As in the instant case, the lease in Jacobs was a “drill or pay” lease, meaning that the lessee/defendant was required to pay a specified rental fee if it did not produce oil or gas and make royalty payments. The term of the lease in Jacobs was also divided between a primary term and an indefinite period thereafter, similar to the provisions in paragraph 2 of the leases under consideration in the instant case. Id. The Jacobs defendant had not produced oil or gas on the property in almost forty-eight years. Id. at [] 793. Plaintiffs asked the Jacobs court to find that the lease had terminated notwithstanding the rental payments in lieu of production, and the court did so for the reasons discussed below. Id. at [] 783-96. The instant case differs only insofar as neither [Appellant] paid [Appellees] the minimum annual payment required by ¶ 18 of both leases during the period of no production.

The Jacobs court offered multiple, independent rationales for its decision. One rationale offered by the court was based on an analysis of the lease and a concomitant finding that the term of the lease had expired. Id. at [] 783-96. A second, independent rationale given by the Jacobs court was that the defendant had abandoned the lease. The proposition that an oil and gas lease. may be abandoned arises from the implied covenant to produce that is read into oil and gas leases. Id. The court found that “the clear purpose of an oil and gas lease providing for production royalties … is to develop the property for the mutual benefit of both parties, regardless of whether the lease contains an expressed provision obligating the lessee to do so.” Id. at 789 (citing Ray v. Western Pennsylvania Nat’l Gas Co., 138 Pa. 576, 20 A. 1065 (Pa. 1891)). An obligation to make payments in lieu of production royalties is only intended to spur the lessee toward development and compensate the lessor for the delay. Id. The Jacobs court expressly rejected the proposition that the defendant could indefinitely postpone development of the property by paying rental fees in place of royalties. Id. at 790. This proposition would render the lease “a mere option[.”] Id.

Slip op. at 12-13. The trial court further addressed the Pennsylvania Supreme Court’s decision in Aye v. Philadelphia Co., 44 A. 555 (Pa. 1899) in which the doctrine of abandonment was first applied to an oil and gas lease, noting that:

The Aye court found that the lessee in an oil and gas lease has an obligation to diligently develop the leased property and a failure to do so constitutes abandonment. Id. The question of whether or not abandonment has occurred is one of fact and the [c]ourt must analyze the acts and intentions of the parties to the lease. Id. The Aye court specifically found that four years of inaction by a lessee gives rise to a presumption of abandonment. Id. If the lessee fails to present a valid explanation for the inaction then judgment as a matter of law is appropriate. Id.

In the instant case, there was a prolonged period of inactivity by [Appellants] concerning production at the relevant wells. This period was approximately sixteen years long, which is far longer than the four year period contemplated by the Aye court. Mr. Mitchell’s deposition testimony suggests that his explanation for this inactivity is that the price of OGM had fallen so dramatically that [Appellants] could not make money by producing at the wells in question. Transcript of Deposition of William Mitchell[, 5/19/17,] at [] 75-76, 84. The [c]ourt does not find this to be a valid explanation that will defeat the presumption of abandonment. If the [c]ourt found otherwise, then the leases would be reduced to mere options and the implied covenant to produce would be practically insignificant.

Slip op. at 12 (emphasis in original). Mitch-Well appealed to Superior Court, arguing that several issues of material fact, including whether Mitch-Well’s production decision was in good faith, prevented the entry of summary judgment. In support, Mitch-Well relied on the Pennsylvania Supreme Court’s decision in T.W. Phillips Gas and Oil Co. v. Jedlicka in which the Court held that, where production on a well has been marginal or sporadic, such that for some period profits did not exceed operating costs, the phrase “in paying quantities” in an oil and gas lease must be construed with reference to an operator’s good faith judgment. 42 A.3d 261, 267 (Pa. 2012).

Superior Court affirmed the trial court’s grant of summary judgment based on its determination that Mitch-Well abandoned its leases due to the lack of production and payments. Superior Court found the trial court’s reliance on Jacobs, rather than Jedlicka, was proper, explaining that:

… the facts in Jacobs are analogous to the instant case and the Jacobs Court applied relevant Pennsylvania law. Jedlicka, on the other hand, is distinguishable because, unlike in the present matter, the crux of the dispute in Jedlicka was the meaning of the term “in paying quantities” under the lease and the focus of the Court was on determining the proper test for evaluating whether oil or gas has been produced “in paying quantities.” See Jedlicka, 42 A.3d at 267-68.

Slip op. at n. 12. Thus, having determined no genuine issue of material fact existed to preclude summary judgment, Superior Court found the trial court’s finding of abandonment was supported by the record.

The Supreme Court granted alloctur to examine:

Did the Superior Court err in the grant of summary judgement against Petitioner on Counts I, II, and V of its amended complaint in equity on a “drill or pay oil and gas lease” where a well on each parcel was drilled by Petitioner and pursuant to each lease the wells were productive, and no testimony was taken as to the Petitioner’s good faith production decision pursuant to the Supreme Court decision in the case of T. W. Phillips Gas and Oil Co. v Jedlicka, 42 A.3d 261 (2012)?

In its grant of allocatur, Supreme Court directed the parties to address Jacobs v. CNG Transmission Corp., 332 F. Supp. 2d 759 (W.D. Pa. 2004), Aye v. Philadelphia Co., 193 Pa. 451 (Pa. 1899), and the doctrine of abandonment.

For more information, contact Kevin McKeon or Dennis Whitaker.