Judge deals setback to drilling companies in shale case
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In a setback for oil and gas companies drilling in the Marcellus Shale, a federal judge in Harrisburg ruled that landowners who agreed to lease drilling rights -- and later sued, unsuccessfully, to have the leases declared void -- can't be deemed to have "repudiated" the leases.
As a result, U.S. District Judge John E. Jones III rejected counterclaims by the oil and gas companies asking that the five-year leases be extended by two years in order to restore the time lost during the litigation.
In his 11-page opinion in Lauchle vs. Keeton Group, Jones predicted that the Pennsylvania Supreme Court would not apply the doctrine of repudiation to hold that lessors who unsuccessfully challenge a lease in court must be ordered to extend the lease for its limbo period.
"Deeming these leases to have been repudiated under the circumstances of this case is both bad law and even worse public policy," Judge Jones wrote.
The ruling comes in three consolidated suits in which landowners claimed their leases were invalid under the state's Guaranteed Minimum Royalty Act.
Judge Jones delayed the three cases in 2009 to await a state Supreme Court ruling in Kilmer v. Elexco Land Service Inc.
Last March, the justices held in Kilmer that the valuation point under the GMRA was the wellhead and that a lease could calculate the wellhead using the "net back" method.
The Kilmer decision ultimately proved fatal to the claims of the three federal plaintiffs when Judge Jones granted a motion to dismiss all three cases on the grounds that the leases properly utilized the net-back method to calculate the lessor's royalty as one-eighth of the wellhead value of the natural gas. (It's the "net back" method of calculating royalty value because the value of the gas is tallied only after first deducting the costs of getting the natural gas from the wellhead to market.)
The October 2010 dismissal didn't end the case because the oil and gas defendants had filed counterclaims demanding the leases be extended to account for time lost during the litigation.
Attorneys David R. Fine, George A. Bibikos and Amy L. Groff of K&L Gates in Harrisburg, arguing on behalf of a coalition of oil and gas defendants, urged Judge Jones to follow rulings from Louisiana, Oklahoma and Texas that have adopted the doctrine of repudiation and upheld court-ordered extensions of drilling leases.
The defense team argued that "it would be unreasonable to expect an oil-and-gas producer to invest millions of dollars to drill on property that is the subject of a lawsuit seeking a declaration that the producer has no proper lease."
As a result, they argued, "the law presumes that, for as long as the leasehold was under the cloud of such a lawsuit, the lessee is not getting the benefit of its bargain."
The only proper remedy, they said, is "to restore the lessee to the position it would have been in but for the repudiation."
Although Pennsylvania's jurisprudence on oil and gas drilling is in its infancy, the defense team argued that "there is every reason for this court to conclude that the Pennsylvania Supreme Court would join the courts of Texas and the other jurisdictions with respect to the repudiation doctrine."
Pennsylvania courts have followed Section 344 of the Restatement (Second) of Contracts, the defense said, in holding judicial remedies should be available to vindicate the "expectation interest" of a lessor.
But plaintiffs attorney Michael A. Dinges of Elion Wayne Grieco Carlucci Shipman Dinges & Dinges, in Williamsport, said Pennsylvania did not recognize the doctrine of equitable lease extension.
"The defense is requesting this court disregard the express language of the lease by rewriting the lease to extend the primary term. This is something that Pennsylvania courts will not do," Mr. Dinges wrote.
He cited the 1982 decision in Derrickheim Co. v. Brown in which the Pennsylvania Superior Court reversed a lower court's decision to extend the term of an oil-and-gas lease because the lessee had stopped drilling to await the outcome of litigation over title to the land.
Mr. Dinges argued that "the Derrickheim case makes it clear that the primary term of an oil and gas lease would not be extended by the courts in Pennsylvania as an equitable remedy to lessees who didn't develop the leasehold during the primary term of the lease."
Judge Jones agreed, saying: "We find it extremely persuasive that the Derrickheim court declined to equitably extend an oil and gas lease term after the conclusion of litigation that impacted the lease."
Defense lawyers argued that Derrickheim should not apply because the lessees had started the litigation in that case, while the cases before Judge Jones were brought by the lessors.
Judge Jones disagreed, saying: "This distinction puts too fine a point ... by placing undue emphasis on the party initiating the legal action."
Such a bright-line rule, Judge Jones said, "would discourage lessors from bringing actions to determine the validity of their leases, since they would risk a finding that they had thus repudiated those agreements even in the event the underlying actions proved unsuccessful."
The judge found the oil and gas firms "wield significant, if not exclusive, power in the drafting of oil and gas leases."
As a result, he said, a finding that the plaintiffs had repudiated their leases by filing lawsuits to challenge them would "further tip the balance in favor of the oil companies."
First Published March 14, 2011 12:00 am