Look Before Assigning that Lease

Federal Court Rules That Assignment of Oil/Gas Lease
May Not Leave Original Gas Operator Off the Hook

Landowners are often alarmed and angered when they receive word that the oil/gas lease they executed several years ago, after months of intense and personal negotiations, has been assigned to an unknown, unfamiliar gas operator.  This anxiety is amplified when the landowner’s phone calls or letters go unanswered, the royalty checks are late or are not made at all and the once well-maintained well pad site is now overgrown and in a state of disrepair.  Can the landowner seek redress against the original gas operator?

A federal court in Pittsburgh recently addressed this issue and suggested that the assignment of an oil/gas lease may not relieve the original gas operator from liability.

This decision could impact thousands of leases throughout the Commonwealth of Pennsylvania.  Given the potential impact of this decision, landowners and gas operators alike should carefully review the assignment clauses in their leases and re-evaluate liability risks in light of the federal court’s opinion in Rice v. Chesapeake Energy Corp., et al.

The case was originally filed in state court on March 2012 by the landowners, James and Veronica Rice, who signed an oil/gas lease with Dale Property Services Penn, LP (DPS Penn) in November 2009.  Since DPS Penn had subsequently assigned the lease to Chesapeake Energy Corp., the Rices also named Chesapeake as a defendant.  The Rices’ complaint alleged various claims against both DPS Penn and Chesapeake, including trespass, unauthorized access roads, crop damage and failure to pay the well pad drilling fees.

The defendants argued to “remove” the case to federal court from state court on the basis that while the Rices are Pennsylvania citizens, Chesapeake was not.  And since DPS Penn had assigned the lease to Chesapeake, there could be no liability against DPS Penn.

The Rices opposed removal on the grounds that, under Pennsylvania law, the mere assignment of the lease did not automatically extinguish DPS Penn’s liability and, therefore, the claims against DPS Penn remained viable.  The federal court agreed with the Rices and sent the State Court Action back to Pennsylvania’s Greene County.

This decision illustrates the complex and unique nature of oil/gas leases.  DPS Penn argued that the lease should be treated solely as a property conveyance.  If viewed solely as a conveyance, the promises and covenants set forth in the lease “run with the land” and can only be enforced against the party in possession of the property at the time of the alleged breach.

Under this analytical framework, DPS Penn maintained that since the lease was assigned to Chesapeake, the covenants could only be enforced against Chesapeake.

The Rices contended, however, that under Pennsylvania law, when it comes to the effect of an assignment, oil and gas leases are treated the same as any other contract.  According to the Rices, oil/gas leases contain both “land use and contractual attributes” and that absent consent and release by the lessor, a lessee retains liability even after an assignment.  Since the Rices never formally released DPS Penn from the original lease covenants, the Rices contended that the lease covenants could still be enforced against DPS Penn despite the purported assignment.

In remanding the State Court Action back to Greene County, the federal court decided that according to legal precedent, the lease covenants could still be enforced against DPS Penn despite the assignment to Chesapeake.  In light of this ruling, the litigation against DPS Penn and Chesapeake will now proceed in Greene County as opposed to federal court.

Although the Rice court did not rule on the actual merits of the Rices’ claims against DPS Penn, the decision is nonetheless significant because it recognizes those claims as being viable against the original lessee.  What can we take away from the Rice decision?  Unless the lessor specifically “releases” the original lessee, the mere assignment of the lease to another gas operator may not automatically extinguish the liability of the original lessee.  Landowners who may have claims for unpaid rentals, incorrect royalties or surface damage should carefully review the assignment clauses in their respective leases.  In the event of an assignment, such claims may be advanced against the original lessee.