February 24, 2015
Last week, the Pennsylvania Supreme Court, on certification from the United States Court of Appeals for the Third Circuit, ruled that the primary term of an oil and gas lease would not be equitably tolled during the pendency of a landowner’s declaratory judgment action challenging the lease’s validity. This decision, one of first impression in the Commonwealth, places Pennsylvania squarely in the minority of natural-gas-producing jurisdictions on this issue. Looking to established Pennsylvania legal principles rather than the laws of other states (as the Court has proven it is apt to do in these circumstances), the Court held that the mere filing of a declaratory judgment action is not a repudiation of a lease. The Court’s analysis focused on the fact that the lessee was free (but failed) to bargain for an express tolling provision in the lease. As a result, the ruling puts producers on notice that the insertion of such language is a must going forward, and will necessarily inform defense strategies in future lease disputes.
What we learned from the Pennsylvania Supreme Court’s decision in Harrison:
Harrison v. Cabot Oil & Gas Corp. , No. J-95-2014 (Pa. Feb. 17, 2015), springs from a case filed in the United States District Court for the Middle District of Pennsylvania, in which the landowners sought a declaration that their lease was invalid. The claim was based on alleged fraudulent inducement related to the amount of per-acre bonus payments other oil and gas producers would be willing to pay for the right to develop the property. The landowner-plaintiffs allegedly learned, after leasing their property to Cabot, that much larger sums were later paid to their neighbors. Cabot counterclaimed, asking the District Court to declare that, should the Harrisons’ suit fail, the lease’s primary term would be equitably extended a period of time equivalent to the pendency of the litigation (as is the rule in a vast majority of other oil-and-gas-producing jurisdictions that have addressed the issue).
Cabot moved for summary judgment as to all claims, including its equitable tolling counterclaim, arguing that the suit created a cloud on the lease which prevented Cabot from developing the property as it had bargained. In support, Cabot cited cases from other gas-producing jurisdictions. Those cases recognize the lessee’s predicament, in holding that lease disputes constitute an effective repudiation, thereby extending the lease’s primary term when such suits were unsuccessful. The District Court awarded Cabot summary judgment as to the underlying lawsuit, but not on its counterclaim, concluding that Pennsylvania law does not allow for equitable tolling under the circumstances. The District Court predicted that the Pennsylvania Supreme Court would adopt and extend Derrickheim Co. v. Brown, 305 Pa. Super. 173, 451 A.2d 477 (1982) (prioritizing lease terms over equitable considerations where a producer forewent operation of a well until a defect in the lessor’s title was resolved), and agreed with the policy expressed in Lauchle v. Keeton Group LLC, 768 F. Supp. 2d 757 (M.D. Pa. 2011), which posited that deeming challenged leases to have been repudiated “is both bad law and even worse public policy,” given a lessee’s superior bargaining power and the potential chill on meritorious landowner actions which might result. Cabot appealed and requested certification to the Pennsylvania Supreme Court, which the Third Circuit granted and the Pennsylvania Supreme Court accepted.
Before the Pennsylvania Supreme Court, Cabot argued that it was entitled to the benefit of its contractual bargain, and that Pennsylvania should join the vast majority of gas-producing states in correcting the deprivation of its bargain wrought by the lawsuit. Cabot also pointed to the difficulties posed by the recent myriad (and often meritless) lease challenges resulting from competition amongst producers and other factors at play in the burgeoning industry, drawing specific parallels in the oil and gas context with basic contractual principles. Cabot also attempted to distinguish or discount Derrickheim and Lauchle.
However, in concluding that the commencement of a declaratory judgment action does not constitute a lease repudiation, and thus a lease’s primary term would not be equitably tolled during the pendency of such disputes, the Pennsylvania Supreme Court agreed with the Harrisons that the risk factors associated with oil and gas development did not justify a diminution of existing legal principles or a curtailment landowner rights. The Court specifically invoked the liberal construction given to Pennsylvania’s Declaratory Judgment Act, as a valued mechanism for settling contractual uncertainty. In so doing, the Supreme Court honored its usual practice of looking primarily to analogies from existing Pennsylvania jurisprudence in declining to create exceptions to basic legal principles, even if that means bucking national trends in oil and gas law or otherwise falling within the minority.
Notably, the Court added that its decision was bolstered by the fact that producers are free to negotiate express tolling provisions in their leases, pointing to the number of landowner challenges as clear evidence of the need for such language. The Court clarified, however, that while the mere challenge to a lease’s validity via a declaratory judgment action did not amount to a repudiation under Pennsylvania law, it was not entirely foreclosing the availability of equitable relief where a landowner takes affirmative acts to repudiate a lease (pointing, by way of example, to cases cited by Cabot in which landowners refused to surrender possession of leasehold premises). The case was returned to the Third Circuit, where it currently awaits final determination in light of this ruling.
Although the Harrison decision is an unfortunate one from an industry standpoint, producers now know that Pennsylvania leases must include an express tolling provision, and/or a covenant that the lessor will not cause or create any encumbrance or cloud on title. The fact that the lessee here could have bargained for this protection was an important factor in the decision. Producers should continue to take cues from previous lease disputes in crafting language to preemptively address potential areas of dispute.
Also, because the Supreme Court limited its holding and focused on the particular nature of and purpose for declaratory judgment actions, the potential for a contrary result may lie in a different cause of action, such as a claim for rescission. However, whether or not this is true will need to be resolved in a subsequent case.
Moreover, the decision is interestingly devoid of any discussion about a demand for adequate assurances by Cabot after the lawsuit was filed. It is therefore unclear whether a consideration of the related doctrines of adequate assurance and anticipatory breach would have changed the result here. (These doctrines generally give a contracting party with reasonable grounds for insecurity the right to demand adequate assurance of future performance. The failure of the other party to provide the demanded assurance is then deemed to establish an anticipatory breach and a right for the insecure party to suspend performance. See generally Jonnet Dev. Corp. v. Dietrich Indus., Inc., 316 Pa. Super. 533, 463 A.2d 1026 (1983)).
Ultimately, while Harrison may or may not lead to increased litigation, it could incentivize landowners to bring and prolong lawsuits in an effort to “wait out” primary lease terms. Consequently, when faced with lease disputes in Pennsylvania, lessees should endeavor to expedite the litigation, whether by formally seeking to expedite proceedings or by otherwise employing aggressive tactics to actively move the case along. The fact that the clock continues to tick on the primary term, in addition to the risks attendant with developing a contested property, should be compelling evidence of the potential irreparable harm that may justify expedited consideration by the trial court. Lessees should also consider early dispositive motions (e.g., motions to dismiss or preliminary objections, if appropriate, and early motions for summary judgment), particularly because resolution by motion is generally fit for disputes involving the construction and interpretation of written instruments. In some cases, producers may further want to consider taking steps to begin operations for exploring or producing oil and gas during the litigation (to the extent required to bring the lease into its secondary term), commensurate with the risk involved in a given instance.