Pennsylvania Superior Court Rejects Claim for Indefinite Oil and Gas Lease for Nonproductive Property

January 10, 2011
by SUZANNE ILENE SCHILLER
MGKF News Flash

On January 4, 2011, the Pennsylvania Superior Court issued its opinion in Hite v. Falcon Partners, No. 197 WDA 2010, 2011 PA Super 2, holding that productive activities at premises leased for oil and gas activity were essential for the lessee to retain control of the property after the primary lease period, even though the oil and gas lease provided for an indefinite extension of the lease upon the payment of small delay rental payments. Relying on long-standing case law, the Court determined that despite the "unusual" wording of the lease at issue, the equitable principles that require such leases to be interpreted to promote development of the land and resources for the benefit of both the lessor and the lessee remained paramount. Importantly, though, both the lower court and the Superior Court left a slight opening for lessees. The trial court opined that an indefinite period for exploration was not completely foreclosed to lessees, but that the lease language must be "clear and unequivocal." Similarly, the Superior Court noted that a lessee who wished to preserve exploration rights could enter into a lease with a significantly longer primary term.

The written opinion provides a primer on oil and gas leasing law in Pennsylvania, tracing the development of oil and gas lease forms since the nineteenth century as both drilling companies and landowners seek to maximize their rights and their financial returns. As the Court explained, early oil and gas leases required the lessee to immediately develop the property in order to generate royalties for the lessor. However, such lease terms pressured oil companies to begin activities sooner than was feasible, and thus lessees sought more time to begin exploration and/or drilling. As a result, these leases began to include clauses allowing companies to postpone exploration and drilling upon the payment of modest amounts as "delayed rental." At the same time, to ensure that lessees would profit from their activities even if production began late in the primary term, language that extended the lessee's rights beyond the primary term so long as drilling occurred and royalties paid to the landowner found its way into the leases. But, almost from their inception and no matter how worded, courts interpreted the delayed rental provisions to apply only during the primary lease term and not to the extended production term, finding that any other reading would be unfair to the lessor, who was precluded from making productive use of the property without receiving royalties as compensation.

The Superior Court's ruling in Hite is a reminder that lease language matters, and reinforces the importance of negotiation and precise drafting of leases relating to oil and gas exploration and similar types of energy development land uses such as wind energy. Thus, it is important that landowners and project developers consult with experienced legal counsel before entering into oil and gas, mineral and wind turbine leases, to ensure that rights are properly protected and the intent of the parties is properly documented and secured.