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Can a landowner obtain a new oil and gas lease by severing production rights from storage rights?

Recently, Pennsylvania’s Superior Court rendered a decision that may have a significant impact on whether production rights may be severed from storage rights in a dual purpose oil and gas lease.

By Paul R. Yagelski, Esq.

 

In Pennsylvania, it is not unusual to find an oil and gas lease that provides for both production and storage of gas.  These leases are known as dual purpose leases.  Many of these leases do not pay bonuses to the landowner and do not pay royalties in excess of the state minimum of 12 ½%.  In fact, many of these dual purpose leases pay only small amounts for production and storage, usually a few hundred dollars per production well and a few hundred dollars per storage well. 

Under many dual purpose leases, gas is being stored but no production of gas is taking place, and it is not unusual to find that no production of gas has ever taken place.  Under such circumstances and where landowners are being offered bonuses that can run into thousands, if not hundreds of thousands, of dollars with royalty percentages in excess, if not well in excess, of 12.5%, the issue arises as to whether production rights in a dual purpose lease can be severed from storage rights.  For the landowner with a dual purpose lease, the situation becomes very practical, very fast:  “Everyone else is receiving thousands of dollars in bonus money with a great royalty and I’m only getting a few hundred dollars a year.  Why can’t I get the same?  My oil and gas company has never produced any gas, and there is another oil and gas company that wants to lease my rights.  Why can’t I get a new lease?”

One of the arguments that is invariably made in favor of a new lease is that the production rights can be severed from the storage rights.  One of the main arguments employed to support this argument is the use of the disjunctive “or” in the durational clause, a/k/a habendum clause, of the dual purpose oil and gas lease.  The durational provision provides that either the production of gas or the storage of gas will maintain the lease in effect.  Accordingly, as the disjunctive “or” is used, it is argued that the production rights are severable from the storage rights.  As such, and where the oil and gas company has not produced any gas, the landowner also argues that the oil and gas lease is no longer in effect as to the production rights.  Accordingly, the landowner should be able to re-lease the production rights.  Is, however, the use of the disjunctive “or” in a dual purpose oil and gas lease an indicator of severability?  Based upon Loughman v. Equitable Gas Co., 134 A.3d 470 (Pa. Super. 2016), the answer is “no.”

On August 11, 1966, Dorothy Loughman entered into a lease of the oil and gas under her tract of approximately 250 acres in Morris Township, Greene County, with Equitable Gas Co., LLC, (“Equitable”).  By the terms of this lease (“Loughman Lease”), Equitable acquired the right to produce oil and gas and “to inject gas for storage or repressuring in the substrata and to remove same therefrom by pumping or otherwise.”  The Loughman Lease provided for a flat rent for each producing well, delay rent of $250 per year, and storage rent of $500 per year, or $2.00 per acre per year.

Dorothy Loughman’s succesors-in-interest (the “Loughmans”) filed an action in Greene County seeking to have the Loughman Lease declared terminated because of the failure of Equitable or its assigns to produce any oil or gas since the lease was signed.

The Loughmans filed a motion for summary judgment asking the court to declare that all production-related rights under the Loughman Lease were terminated. They contended that a 2011 Sublease Agreement between Equitrans, L.P. (“Equitrans”), who had received the Loughman Lease from Equitable, and EQT Production Company (“EQT”) treated production rights and storage rights as severable and that the production rights were terminated because no oil or gas well was ever drilled on the property.  Equitable, Equitrans, and EQT, countered by arguing that the Sublease Agreement did not sever production and storage rights and that the production rights are not severable from the storage rights under the terms of the Loughman Lease. 

The trial court denied the Loughmans’ motion and issued a memorandum in which it concluded that “the lease was not severable and had been held by the Lessee, or its assigns, by paying the storage rents provided for in the lease.”  The trial court also determined that the 2011 Sublease Agreement did not alter the outcome because it was simply a sublease and was of little use in determining the intent of the parties to the Loughman Lease, executed in 1966.

In deciding whether production rights were severable from storage rights, the Superior Court relied on Jacobs v. CNG Transmission Corp., 565 Pa. 228, 772 A.2d 445 (2001), wherein the issue of the severability was examined.  In so doing, the Supreme Court held that:

[A]bsent express language that a contract is entire, a court may look to the contract as a whole, including the character of the consideration, to determine the intent of the parties as to severability and may also consider the circumstances surrounding the execution of the contract, the conduct of the parties, and any other factor pertinent to ascertaining the parties’ intent.  The court need not make a specific predicate finding of ambiguity before undertaking the inquiry – indeed, if the contract were crystal clear as to the parties’ intent, severability likely would not be a contested issue.

Id. at 452.

In accordance with Jacobs, the Superior Court in Loughman went first to the language of the Loughman Lease to determine whether it clearly addressed the issue of severability and concluded that it did not.  The Superior Court then looked at the contract as a whole and concluded that it was clear that the Loughman Lease did include disjunctive language addressing the duration of the contract, specifying that the lease was to remain in effect as long as the “land is operated for the exploration or production of gas or oil, or as gas or oil is found in paying quantities thereon, or stored thereunder or as long as said land is used for the storage of gas or the protection of gas storage on lands in the general vicinity of said land.”  (emphasis in original).  Loughman, 134 A.3d at 475.

The Loughmans argued that the use of the term “or” confirmed that the production rights and the storage rights are separate and divisible rights that can be, as the parties have treated them, severable.  The Superior Court disagreed, holding the exact opposite. 

Based upon its review of the record, including the Loughman lease, the assignment, and the Sublease Agreement, the Superior Court found that the durational provisions of the Loughman Lease were clearly and unambiguously written in the disjunctive and provide that the Loughman Lease shall continue during either production or storage.  Further, the 2011 Sublease Agreement specifically expressed Equitran’s intent not to sever production and storage rights.  In the event, EQT, as the sublessee, elected to surrender its rights, the non-severed production rights associated with the Loughman Lease would automatically revert to Equitrans.  Recognizing that its goal is to ascertain and effectuate the intention of the parties, its examination of the contracts led the Superior Court to conclude that the parties intended the Loughman Lease to be nonseverable.

Based upon Loughman then the use of the disjunctive “or” in a durational clause is not an indication of severability.  On the contrary, it would be an indication that a dual purpose lease is an entire contract.

Does Loughman, however, preclude any argument by the landowner that the production rights in a dual purpose lease can be severed from storage rights where the disjunctive “or” is used in the durational clause?  In light of Jacobs and Loughman itself, the answer should be “no.”  Use of the disjunctive “or” may be an indication that the dual purpose lease is entire, but that should not end the inquiry.

Under Jacobs, if there is no express language in the contract that the contract is entire, the entire contract, or in this case, an oil and gas lease, must be looked at as a whole.  This may include a review of the character of the consideration.  The court may also consider the circumstances surrounding the execution of the contract, the conduct of the parties, and any other factor pertinent to ascertaining the parties’ intent.  This is what the Superior Court did in Loughman.  It did not only rely on the use of the disjunctive “or” in arriving at its decision.  It also reviewed the other contracts between Equitable and Equitrans and Equitrans and EQT.

In examining these contracts, it is important to note that the conveyance of the Loughman Lease by Equitable to Equitrans was done by assignment in 1988 and the Sublease Agreement between Equitrans and EQT was in 2011.  These contracts were entered into subsequent to the 1966 Loughman Lease with parties; i.e., Equitrans and EQT, who were not the original contracting parties to the Loughman Lease; i.e., Dorothy Loughman and Equitable.  Loughman reviewed these contracts despite the trial court’s determination that the 2011 Sublease Agreement was of little use in determining the intent of the parties to the 1966 Loughman Lease.  Recognizing that its goal was to effectuate the intention of the parties; i.e., the intent of the original contracting parties, the Superior Court did so by examining subsequent contracts with different contracting parties, which led it to the conclusion that the original parties to the Loughman Lease intended the lease to be nonseverable.

The Superior Court’s approach to deciding the severability issue is important as in addition to the trial court in Loughman, at least one other court has indicated that the assignment of production rights subsequent to the original oil and gas lease by a subsequent party to the lease was irrelevant in determining whether the production rights can be severed from the storage rights in a dual purpose lease.  See Penneco Pipeline Corp. v. Dominion Transmission, Inc., No. 05-537, 2007 WL 1847391 at *6 (W.D. Pa. June 235, 2007). 

In light of Loughman, subsequent conduct by subsequent parties can also be examined to determine whether production rights are severable form storage rights and can be examined even if the disjunctive “or” is used in the durational clause.  See also Sun Co. v. Pennsylvania Turnpike Comm., 708 A.2d 875, 880 (Pa. Commw. Ct. 1998), (the Commonwealth Court, in acknowledging that the course of conduct of a party is always relevant in interpreting a contract and may be the strongest indication of the intention of the parties to the contract, considered the conduct of a subsequent assignee to a lease in interpreting the contract); Pathmark Stores, Inc. v. Gator Monument Partners, LLP No. 08-3082, 2009 WL 5184483, at *7 (E.D. Pa. Dec. 21, 2009) (specifically rejecting the contention that only the conduct of the original contracting parties is relevant in interpreting the meaning of a contract; i.e., a lease; most courts disagree with such a view); Getty Petroleum Mkgt., Inc. v. Shipley Fuels Mkgt., LLC, No. 07-340, 2007 WL 2844872, at *20 (E.D. Pa. Sept. 27, 2007) (“This construction is reinforced by the parties’ course of performance.  Every assignee of the Agreement, prior to Getty provided Defendant Shipley with both Mobile brand petroleum products and Mobile trademarks.”); Lafitte Co. v. United Fuel Gas Co., 177 F. Supp. 52, 60 (E.D. Ky. 1959) (“Not only is the conduct of the parties with respect to the matter of accepting the monthly royalty payments over a period of more than twenty-five years significant, but it must be born in mind that the lease was transferred on three different occasions.  It is proper to assume that on each of these occasions the [provisions at issue] were taken into careful consideration by both the seller and the purchaser . . . “); Warner-Lambert Pharm. Co. v. John J. Reynolds, Inc., 178 F. Supp. 655, 688 (S.D.N.Y. 1969) (“The continued periodic payments and the affirmance of the obligation by Plaintiff’s predecessor, long after the event upon which Plaintiff relies occurred, is strong evidence that the obligation to pay still continues in force and effect . . . “). 

Bottom Line: Under Loughman, the use of the disjunctive “or” in the durational clause of a dual purpose oil and gas lease is not an indication of the severability of production rights from storage rights.  It is an indication that the contract is entire; however, this does not end the inquiry. 

In accordance with Jacobs, the contract as a whole, including the character of the consideration, the circumstances surrounding the execution of the contract, the conduct of the parties, and any other facts pertinent to ascertaining the parties’ intent may still be looked at to determine whether production rights can be severed from storage rights in a dual purpose lease.  In reviewing the conduct of the parties, it is not only the conduct of the original contracting parties that may be examined, but in addition, subsequent conduct, including contracts; e.g., an assignment, may also be looked at to determine the original contracting parties’ intent as to severability.

In light of Loughman, the task of a landowner in endeavoring to sever production rights from storage rights in a dual purpose lease may be more problematic, but it is not impossible.  Loughman does not foreclose such an attempt.

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