Superior Court of Pennsylvania strikes down unlimited oil and gas lease delay rental terms - by Ross Bruch, Esq., Saul Ewing LLP
Posted by George on 02 Feb 2011 | Tagged as: General
On January 4, 2011 the Superior Court of Pennsylvania ruled in Hite v. Falcon Partners that an oil and gas exploration lease’s indefinite delay rental provision was void.
In 2007 Falcon Partners acquired the rights to several oil and gas leases dating to 2002 and 2003. The leases contained the following clause:
“Lessee has the right to enter upon the Property to drill for oil and gas at any time [within one] year from the date hereof and as long thereafter as oil or gas or either of them is produced from the Property, or as operations continue for the production of oil or gas, or as Lessee shall continue to pay Lessors two ($2.00) dollars per acre as delay rentals, or until all oil and gas has been removed from the Property, whichever shall last occur.”
Exploration and production never started, but the lessee paid the delay rental. Impatient with the lack of production, and lack of royalties, and pressed by the interest of other potential exploration and production companies, the land owners attempted to terminate the lease and demanded that Falcon record a release. Falcon refused and the owners filed suit in the Court of Common Pleas of Cambria County. The lower court granted summary judgment in favor of the owners, terminating the lease. The Superior Court affirmed on appeal.
The disputed issue between Plaintiffs and Falcon was whether Plaintiffs were permitted to terminate the leases, despite a provision in the leases that allowed Falcon to continue to pay $2 per acre, per year as delayed rental. Delay rental is often used to extend an oil and gas lease where no production is occurring and therefore no royalties are being paid.
Early oil and gas lease forms generally contained an expressed or implied obligation on the part of the lessee to immediately develop the property or terminate the lease. Lessees who wished to avoid termination for non-development incorporate delay rental clauses into leases, which relieve them of their obligations to immediately begin production. However, courts often interpreted delay rentals to be limited to initial lease terms. Jacobs v. CNG Transmission Corp., 332 F.Supp.2d 759, 785 (W.D.Pa.2004) and not indefinitely.
The court determined that it was the parties’ original intention to accomplish certain drilling operations on the landowners’ properties within the first year of the lease — not for the properties to sit idle for six to seven years. The court reasoned that if the parties originally intended for a lease to extend indefinitely for $2 per acre per year, there would be little need for the parties to agree to the initial one-year lease term in addition to the delay rental. Furthermore, the Superior Court stated that since the intention of a delay rental is to “spur the lessee toward development,” it would be contradictory to the opinion of the courts of Pennsylvania to allow Falcon to pay delay rental indefinitely.
Hite v. Falcon Partners may have a significant impact on present and future oil and gas leases for Marcellus Shale drillers and landowners alike. Lessees who have not initiated exploratory or drilling operations, and who are beyond an initial lease term, may be in jeopardy of losing their property rights if owners are successful in terminating leases before production commences. Lessors and lessees that intend to use a delay rental provision to extend their lease term must take this ruling into account when drafting their new agreements, explaining clearly their intentions, to avoid an unintended termination. Lessees may also consider drilling sooner, rather than later, to preserve their gas rights. The case may be subject to appeal to the Pennsylvania Supreme Court.
