Pennsylvania Oil & Gas Lease Cancellations – CASE TRACKER SERIES (Part 2)

On October 22, 2020, the Pennsylvania Supreme Court heard oral arguments for SLT Holdings, LLC v. Mitch-Well Energy, Inc., No. 542 WDA 2018 (Pa. Super. Ct. 2019), an interesting and potentially significant case for the Oil and Gas Industry in Pennsylvania.  You can read our first post for a more detailed discussion of the facts and significance of this case here. 

The Case

The case involves two oil and gas leases executed in the 1980’s by and between SLT Holdings, LLC et al, as the Lessors, and Mitch-Well Energy, LLC, as Lessee.  Both leases included “drill or pay” clauses, requiring a minimum number of wells to be drilled on the leased premises, as well as specified a minimum annual payment (delay and shut-in) threshold, such that if royalties did not exceed the minimum payment threshold, the operators under the leases were to pay the difference.  Each lease also contained secondary term clauses that granted Mitch-Well sole discretion to determine whether a well was capable of producing in paying quantities.  Additionally, both leases set forth the procedure in the event of a breach, whereby the aggrieved party was to provide notice to the party in breach and provide an opportunity to cure, and that the remedy for failure to cure was to terminate the lease.  Both leases had one shallow vertical well drilled during their primary terms and, between 1996 and 2013, neither of these wells produced oil and gas in marketable quantities and Mitch-Well did not make the required minimum payments under the leases.  

The trial court granted summary judgment in favor of SLT, et al and the Superior Court affirmed, declaring the leases abandoned, an action in equity, under the implied covenant to produce, rather than merely terminated.  This distinction is important in this case as the leases in question granted Mitch-Well particular rights for a certain number of acres surrounding the wells, with no time restriction or requirement to make any further payments.  With the lease having been declared abandoned, no ongoing rights continue for Mitch-Well, up to and possibly including the right to remove any remaining infrastructure or equipment.

There are a couple of interesting questions arising from this case.  The first of which is, are oil and gas leases unique as a contract, requiring a different framework or standard of analysis from an ordinary contract?  The Court seemed to struggle for a justification to allow an action in equity opposed to an action in law for breach of contract.  In this case, the leases provided that the exclusive remedy in the event of a breach was termination, which provided for some ongoing rights as to a certain number of acres.  The central case discussed during oral argument was Aye v. Philadelphia, 193 Pa. 451, 44 A. 555 (1899).  In Aye, the Court set a rebuttable presumption of abandonment, as a violation of an implied covenant to produce oil and gas, after four years of inactivity.  The leases in Aye set forth the remedy for a breach as forfeiture of the lease and the Supreme Court declared the leases abandoned. 

The Oral Arguments

Counsel for Mitch-Well drew a distinction from Aye because, in the present case, the interest ripened into a fee simple determinable as wells were drilled and produced, whereas Aye involved dry holes.  Counsel for SLT, et al argued that the breach provisions in the lease were a benefit of the contract and, as such, given the length of the period of nonperformance (at least 16 years) by Mitch-Well, an action in equity is warranted, as under Aye. 

It is yet to be determined how narrow the Court will tailor its decision.  When and under what circumstances is it proper for a court to look beyond the four corners of the lease?  Does the Aye test apply where a lease provides for an exclusive remedy for breach of contract?  How much can the express terms of the lease limit, or eliminate, the implied covenant to produce oil and gas?  Martin Legal Group will continue to track the status of this case and will post an update on this once the Pennsylvania Supreme Court has issued its Opinion.