Pennsylvania Appeals Court Affirms Trial Court’s Order To Terminate A Portion Of An Oil And Gas Lease And Eject Operator

On March 17, 2017, the Superior Court of Pennsylvania affirmed a trial court’s 2015 order that severed and terminated a portion of an oil and gas lease.  The subject lease covered 240 acres located in Venango County, Pennsylvania, which was subsequently subdivided.  Additionally, the leasehold interest was divided into depths that lie above and below the Onondaga formation and were held by different operators.  On appeal, the appellant operator argued that the trial court lacked jurisdiction over the controversy because the plaintiffs failed to join all the indispensable parties.  This action was originally brought by property owners who acquired 32 acres of the 240 acre tract.

In part of affirming the trial court’s order, the Superior Court indicated that one of the major factors involved in a determination of whether a party is indispensable in a lease context is whether the lease is severable.  In this case, the court held the lease was severable based on the intent of the parties to the lease, which was determined by the language of the lease and the subsequent conduct of the successors in interest to the original lessee.  The lease specifically provided the lessee the “right to subdivide and release the premises.”  Additionally, successors in interest to the original lessee divided the leasehold interest into depths that lie above and below the Onondaga formation, which supports that the lease was severable.  The Superior Court distinguished this case from precedent set forth in Seneca Res. Corp. v. S & T Bank, 122 A.3d 374., that an operator was not required to be actively drilling undeveloped portions in order to maintain the leasehold on the bases that: (1) the leased acreage in this case consisted of a number of distinct parcels rather than one tract; (ii) the language of the subject lease provided the lessee the right to “subdivide and release” the property; and (iii) the successors in interest to the original lessee of the subject lease subdivided the leasehold into two or more formations rather than operating under the lease as a whole.  Based on these factors, the court held that the lease was severable.  Additionally, the Superior Court affirmed the trial court’s finding that the lease had expired as to the subject property because the predecessors in interest to the appellant operator failed to produce oil and gas in paying quantities on the subject property and had breached the implied obligation to explore and develop the property “with reasonable diligence.”  Accordingly, the court held that the lease was null, void, and of no force and effect pertaining to the subject property.

SB 576: Revised Co-Tenancy and Lease Integration Legislation Introduced in West Virginia

On March 10, 2017, Senate Bill 576 (SB 576) was introduced in the West Virginia Senate to take the place of SB 244, which addressed the oil and natural gas industry’s effort to efficiently develop production of natural resources. Similar to SB 244, SB 576’s stated purpose is “to encourage the efficient and economic development of oil and gas
resources[;]” however, it contains a number of provisions that differ from SB 244.

If signed into law, SB 576 would create a new code section, W. Va. Code §37B-1-1, et seq., titled the “Cotenancy and Lease Integration Act,” which, like SB 244, contains both “co-tenancy” and “lease integration” provisions.

SB 576 declares in proposed §37B-1-2 that West Virginia public policy includes both “the maximum recovery of oil and gas” and the “protect[ion] and enforce[ment of] the clear provision of contracts lawfully made.” This section also states that West Virginia public policy is to “safeguard, protect and enforce” both “the rights of surface owners” and “the correlative rights of operators and royalty owners in a pool of oil and gas to the end that each such operator and royalty owner may obtain his or her just and equitable share of production from that pool of oil and gas[.]”

Proposed section §37B-1-4 allows oil and gas production on a piece of property when “two thirds of the ownership interest in the oil and gas mineral property consent to a lawful use [i.e., production] of the mineral property[.]” By contrast, SB 244 only required that a “majority” of ownership interests agree to a “lawful use.”

In addition, SB 576 (like SB 244) states that payment of royalties will be on a pro rata basis, with payments for a mineral owner who cannot be located reserved by the producer.  Unlike SB 244, however, SB 576 would specifically allow surface owners to use W. Va. § 55-12A-1, et seq. (the unknown and missing landowners statute), to lay claim to the interests of the absent or missing owners.  Finally, and importantly, SB 576 would require that a mineral interest owner who opposes oil or natural gas development be paid royalties (1) “free of post-production expenses” and (2) “equal to his or her fractional share of the average royalty of his or her consenting cotenants[,]” but “in no event may the royalty be less than his or her fractional share of one-eight [12.5%].”

SB 576 adds proposed sections §37B-1-5 and -6, which would take the place of the “Joint Development” provision in SB 244. Under proposed §37B-1-5, “[w]here an operator or operators have the right to develop multiple contiguous oil and gas leases, the operator may develop these leases jointly by horizontal drilling unless the development is expressly prohibited by the terms of a lease or agreement.”  Importantly, an operator may only disturb the surface of property subject to this provision if it “has a surface use agreement” with the owner(s) of the property that will be disturbed.  As with SB 244, under proposed §37B-1-6, royalty payments are based upon “production [that] shall be allocated to each lease in the proportion that the net acreage of each lease bears to the total net acreage of the jointly developed tracts.”  As with dissenting owners under proposed §37B-1-4, however, “[i]n the absence of specific agreement to the contrary or where deductions are authorized by statute, the royalty for all royalty owners of the jointly developed acreage who do not have leases containing express pooling and unitization clauses shall not be reduced for post-production expenses incurred by the operator.”  This provision, however, is not “intended to impact royalties due for wells drilled prior to the effective date of this chapter.”

While SB 576 keeps the basic goals of SB 244 – development without the approval of all mineral interest owners and development of contiguous property through horizontal drilling – it contains a number of provisions designed to mollify the concerns of surface owner organizations and other property rights groups. The “co-tenancy” provision now requires a 2/3 majority of mineral ownership interests to permit development, and royalty payments to dissenting owners must not take post-production costs into account.  The “lease integration” provisions explicitly allow horizontal drilling of contiguous tracts that are each subject to production leases (provided horizontal drilling is not expressly prohibited), but if a production lease does not explicitly permit pooling or unitization, then royalty payments to the owners under that lease cannot be deducted for post-production costs.  Important to surface owners is the requirement that a surface use agreement be in place before the surface of any property is disturbed by joint development.

Babst Calland will follow SB 576 during West Virginia’s Legislative Session, which is scheduled to end on April 8, 2017.

EPA Withdraws Controversial Methane Information Collection Request

Effective March 2, 2017, the U.S. Environmental Protection Agency (EPA) has withdrawn the information collection request (ICR) entitled, “Information Collection Effort for Oil and Gas Facilities.”  EPA issued the final ICR in November 2016, requiring more than 15,000 owners and operators in the oil and natural gas industry to submit information that would support a future EPA rulemaking to reduce methane emissions from existing sources.  The ICR required companies to provide a significant amount of information in two phases, known as the Part 1 Operator Survey and Part 2 Facility Survey.  EPA has withdrawn both parts of the ICR, which means that owners and operators who received a letter directing them to complete an ICR survey are no longer required to respond.

According to an official withdrawal notice that is expected to be published in the Federal Register on March 7, 2017, “[t]he withdrawal is occurring because EPA would like to assess the need for the information that the agency was collecting through these requests, and reduce burdens on businesses while the Agency assesses such need.”  The notice also indicates that EPA acted in response to a letter from a group of states expressing concern for burdens on businesses.

PADEP Extends Public Comment Deadline for Draft Air Permits, Revised Exemption List

On February 23, 2017, the Pennsylvania Department of Environmental Protection (PADEP) announced an extension of the public comment period regarding recently proposed draft general air permits for the oil and natural gas industry.  Comments are now due by June 5, 2017.  PADEP has proposed to issue a new general permit known as GP-5A for unconventional natural gas well site operations and remote pigging stations, as well as revise the existing general permit known as GP-5 for natural gas compression and/or processing facilities.  PADEP’s proposal would also revise the Air Quality Permit Exemptions list.  Refer to our Administrative Watch for more information.  A formal notice regarding the comment deadline extension was also published in the Pennsylvania Bulletin dated February 25, 2017.

SB 244: Co-Tenancy and Joint Development Legislation Introduced in West Virginia

On February 10, 2017, Senate Bill 244 (SB 244) was introduced in the West Virginia Senate to address the oil and natural gas industry’s effort to efficiently develop production of natural resources.  Sponsored by, among others, Senate President Mitch Carmichael, SB 244’s stated purpose is “encouraging and facilitating the efficient and economic development of oil and gas resources” by addressing two situations common in West Virginia: (1) fractured ownership of mineral interests where less than 100% of the mineral owners can be located, and (2) development through horizontal drilling of contiguous parcels of property that are already under production leases.

SB 244 amends W. Va. Code §37-7-7 by adding subsection (b), the “Co-Tenancy” provision, which states that “a majority of the ownership interest in the mineral property” may “consent to a lawful use of the mineral property[.]”  If the majority of the ownership interest agrees to the use, then the use is “permissible” and the non-agreeing ownership interest cannot claim “waste” or “trespass” on the mineral property.  In addition, payment of royalties to all ownership interests will be on a pro rata basis to all owners of the mineral property, with payments for an owner who cannot be located reserved by the producer.  While intended to address West Virginia’s requirement that 100% of the mineral owners agree on the terms for development of the mineral property, there is no requirement in SB 244 that the minority owners be absent or otherwise not found.

SB 244 also adds subsection (c), the “Joint Development” provision, to §37-7-7.  Under this subsection, “[w]here an operator or operators have the right to develop multiple contiguous oil and gas leases separately, the operator may develop these leases jointly by horizontal drilling unless the development is expressly prohibited by the terms of a lease.”  Under this language, an operator may development contiguous parcels of property using horizontal drilling unless a lease expressly prohibits such joint development activity. Notably, under this proposed subsection, the “operator’s use of any surface tract overlying the jointly developed leases shall be permissible for that joint development.”  Finally, absent an agreement by all affected royalty owners, production shall be allocated to each lease “in the net proportion that the net acreage of each lease bears to the total net acreage of the jointly developed tracts.”

While Legislative leadership and Governor Justice have each articulated strong support for the oil and natural gas industry, SB 244 faces significant resistance from surface owner organizations, which dislike the simple “majority rules” aspect of the Co-Tenancy provision.  Likewise, those groups also object to the Joint Development provision as it opens the surface of an affected parcel to development using horizontal drilling, even if the lease for that property was entered long before horizontal drilling became a popular technology in oil and natural gas production.

Babst Calland will follow SB 244 during West Virginia’s Legislative Session, which is scheduled to end on April 8, 2017.

West Virginia Supreme Court Ruling Potentially Impacts Use of Partition Statute

The Supreme Court of Appeals of West Virginia recently emphasized that a party seeking a partition of property by allotment or by sale under W. Va. Code §37-4-3 must strictly follow the prerequisites in the statute — but only those prerequisites.

In Bowyer v. Wyckoff, 2017 W. Va. LEXIS 27 (Jan. 26, 2017) (Link to PDF of the case here), the Court addressed an effort by Wyckoff to partition the surface of property in kind or by sale. Bowyer, however, counterclaimed and sought to partition both the surface and the mineral interests either though by allotment or by sale, allegedly because he wanted to develop the shallow natural gas under the property. The circuit court granted judgment to Wyckoff, and Bowyer appealed.

The Court initially confirmed that, under W. Va. Code §37-4-3, “a party desiring to compel partition through sale is required to demonstrate that the property cannot be conveniently partitioned in kind, that the interests of one or more of the parties will be promoted by the sale, and that the interests of the other parties will not be prejudiced by the sale.” Bowyer at *8. The circuit court, however, added another, general requirement for any partition: “It is predicate to the partition of an oil and gas mineral interest that there be an inability of the mineral owners to agree on how to develop the mineral estate.” Bowyer at *6.

The Court rejected the circuit court’s attempt to add a requirement that mineral owners not agree on how to develop a mineral estate before allowing partition; however, the Court affirmed the circuit court’s decision that rejected partition by sale of the surface and mineral interests because Bowyer had not otherwise proven his entitlement to partition by sale under §37-4-3. (The Court did not address Bowyer’s attempt to partition by allotment because Bowyers failed to preserve that issue for appeal.)

Perhaps most important for parties seeking partition by either sale or allotment, however, was the circuit court’s rationale for rejecting sale by partition — a rationale affirmed by the Court:

The forced sale of oil and gas minerals precludes the owner of the benefit of lease consideration and the prospect of production proceeds, which represent the primary and perhaps the exclusive value which such ownership vests. Therefore, the public interest will not be promoted by sale.

Bowyer at *9. Under this rationale, any partition for sale or by allotment under §37-4-3 can be forestalled by a single interest holder who does not wish to sell his or her interest. In fact, this rationale undercuts the entire purpose of the partition statute, which necessarily results in a “forced” sale of a person’s property interest, whether the partition be by sale or by allotment.

For oil and natural gas producers that seek partition in order to develop mineral interests, the Court’s implicit acceptance of the notion that any “forced sale of oil and gas interests” precludes partition could significantly hamper efforts to use the partition statute to develop minerals. For questions about West Virginia’s partition statute, contact Mychal Schulz (mschulz@babstcalland.com) or Matt Casto (mcasto@babstcalland.com).

Pennsylvania Appeals Court Vacates Denial of Class Certification of Lessors to Oil and Gas Leases in Clearfield County

On January 17, 2017, the Superior Court of Pennsylvania vacated a trial court’s order denying class certification of two classes of lessors to oil and gas leases covering property in Clearfield County, Pennsylvania in Cardinale v. R.E. Gas Dev., 2017 PA Super 13.  The case involved two classes of plaintiffs because two similar class action complaints were consolidated.   These cases involved whether the lessees were required to tender paid-up bonuses when the lessee untimely rejected an oil and gas lease based upon title, surface or geology within a specified due diligence period.  The trial court previously rejected the class certification that would have combined these two classes because common questions of law or fact did not predominate over individual questions with respect to the breach of contract claim, stating “[t]o fully resolve the case, the finder of fact would have to analyze each individual property and the circumstances surrounding the Defendants’ refusal to pay the bonus to determine if the Defendants breached each contract, or if the Defendants simply did not approve of the surface, title or geology of each parcel of land.”

On appeal, the Superior Court indicated that the critical inquiry for the certifying court is whether the material facts and issues of law are substantially the same for all class members.  The court further provided that the existence of distinguishing individual acts is not fatal to class certification and that it is Pennsylvania’s policy to favor certification of class actions.  Because the court identified six fundamental questions that are common to all class members, it found that the trial court erroneously denied class certification.  Accordingly, the court vacated the trial court’s order and remanded so that the trial court may utilize its discretion and determine whether class certification is proper in this case, including whether the class definition is overly broad insofar as it may include individuals whose leases were rejected in a timely fashion.

U.S. Supreme Court Rejects Appeal of Ohio Dormant Mineral Act Case

On Tuesday, the Supreme Court of the United States denied certiorari in Walker v. Shondrick-Nau, Exr. (Slip Opinion No. 2016-Ohio-5793). As more fully explained in our Blog post discussing Walker, in September the Ohio Supreme Court held that, if a surface owner failed to quiet title under the 1989 version of the Ohio Dormant Mineral Act (the “ODMA”) prior to the enactment of the 2006 version of the ODMA, then the 1989 version is unavailable and the surface owner can only pursue a claim to abandon mineral interests under the 2006 version of the ODMA. Walker subsequently appealed this decision to the Supreme Court of the United States. In denying certiorari, the U. S. Supreme Court refused to hear the case meaning that the decision of the Ohio Supreme Court will stand as the law in Ohio.

Court Declares Pennsylvania DEP’s Calculation of Continuing Penalties for “Seemingly Endless” Violations Unlawful under the Clean Streams Law

On January 11, 2017, the Pennsylvania Commonwealth Court held Section 301 of the Clean Streams Law “is a provision that prohibits acts or omissions resulting in the initial active discharge or entry of industrial waste into waters of the Commonwealth and is not a provision that authorizes the imposition of ongoing penalties for the continuing presence of an industrial waste in a waterway of the Commonwealth following its initial entry into the waterways of the Commonwealth.” EQT Production Co. v. Com., Dep’t of Envtl. Prot., 485 MD 2014, slip op. at *24 (Jan. 11, 2017).

This case arose out of a release from an impoundment at a Marcellus Shale well pad site in Tioga County, Pennsylvania. It is undisputed that EQT stopped the source of the release within twelve days of reporting it on May 30, 2012 and thereafter entered the Act 2 program to achieve cleanup standards for soil and groundwater. In May 2014, the Department sought a non-negotiable penalty of $1.2 million for the release. EQT filed a complaint in Commonwealth Court in September 2014 challenging the Department’s use of a “continuing violation” theory to support this penalty calculation. Subsequently, in October 2014, the Department filed a Complaint for Civil Penalties with the Pennsylvania Environmental Hearing Board, seeking a penalty of $4.5 million for the same release. The Department’s post-hearing brief in the EHB proceeding states that a penalty of nearly $470 million is supported by the Clean Streams Law.

The Department argued in the Commonwealth Court that “the illegal activity continues so long as the leaked industrial waste exists in any water of the Commonwealth” and that “the natural flow of waste from that water into another water of the Commonwealth” constitutes a new violation. Id. at *17-18. The Court noted that adopting the Department’s theory “would result in potentially limitless continuing violations for a single unpermitted release” and “would be tantamount to punishing a polluter indefinitely.” Id. at *20-21. The Court stated that the Department’s theory was “not supported by the statutory provisions and framework or the rules of statutory construction.” Id. at *20.

By clarifying the limits of the Department’s penalty authority to the days a waste or pollutant actually enters into groundwater or surface water, this precedential decision prevents the Department from threatening unauthorized civil penalties under the Clean Streams Law to leverage settlements in any context involving the Clean Streams Law, not just in the oil and gas industry.

Pipelines are safe. They already are the safest way to transport energy – and getting safer.

In a recent op-ed published in the Post-Gazette, “Gas Pipelines Represent Prosperity” (Sept. 5 Perspectives), David Spigelmyer and James Kunz of the Marcellus Shale Coalition described the many benefits that Pennsylvanians could see from the expansion of natural-gas pipelines and related energy infrastructure in the commonwealth. That op-ed prompted a response from Art Wegweiser (Oct. 3) adding an important cautionary note about pipeline safety. The good news, according to a 2015 report from the American Gas Foundation, “Natural Gas Pipeline Safety and Reliability: An Assessment of Progress,” is that pipelines are safe — and getting safer.  Read my full article describing the AGF report and industry’s efforts to improve pipeline safety.