A fairly recent case decided by the Supreme Court of Pennsylvania lays
out the rule to follow when questioning whether an oil and gas lease has
produced “in paying quantities.” In the recent case of T.W. Phillips Gas and Oil Co. and PC Exploration, Inc., v. Ann Jedlicka, 42 A.3d 261, the Supreme Court held that, “where production on a well has been marginal or sporadic, such that for some period profits did not exceed operating costs, the phrase ‘in paying quantities’ must be construed with reference to an operator’s good faith judgment.”
In T.W. Phillips v. Jedlicka, Appellant Ms. Jedlicka is the owner of a parcel of land consisting of approximately 70 acres located in North Mahoning Township.
The original oil and gas lease contained an habendum clause which
provided, “to have and to hold the above-described premises for the sole and
only purpose of drilling and operating for oil and gas with the exclusive right
to operate for same for the term of two years, and as long thereafter as oil or gas is produced in paying quantities, or operations for oil or gas are being conducted thereon, including the right to drill other wells.” The habendum
containing the above language can commonly be seen in oil and gas leases, and
has caused some concern for landowners when wells are not producing high
royalties and they wish to terminate the lease. The term “in paying quantities” was not defined in the above lease.
T.W. Phillips drilled four gas wells on the Jedlicka property. One well was abandoned back in 1955, and another was temporarily abandoned back in 1953.
All four wells were fractured and eventually assigned to PC Exploration, Inc. in 2004. PC Exploration drilled four additional wells upon their assignment of the lease and Ms. Jedlicka had received royalties and free gas throughout the life of her
lease. PC Exploration then made plans to drill four more wells on the Jedlicka property and Ms. Jedlicka objected to the construction claiming that T.W. Phillips failed to maintain production “in paying quantities” under the habendum clause, and as a result, the lease had lapsed and been terminated.
Appellees, T.W. Phillips, argued that the lease remained valid since the
wells on the property have produced gas in paying quantities and continued to
pay a profit over operating expenses, and additionally, that they have operated
the wells in good faith to make a profit. The Indiana County Court of Common Pleas determined that T.W. Phillips had produced gas on their leasehold in paying quantities, and therefore the lease remained in effect. The Trial Court relied on the Supreme Court’s 1899 decision in Young v. Forest Oil,, 45 A. 122, where the Court held that, “consideration should be given to a lessee’s good faith judgment when determining whether oil was produced in paying quantities.” The Superior Court then affirmed the Trial Court’s decision and reiterated that although the decision in Young was more than a century old, it still remained good law. The Superior Court held that the Appellant, Ms. Jedlicka, failed to carry her burden that the Appellee’s acted in bad faith.
The Supreme Court reviewed both decisions and again reiterated important
aspects of oil and gas leases. The Supreme Court noted that “a lease is in the nature of a contract and is controlled by principles of contract law.” Further, as the Supreme Court earlier recognized in Brown v. Haight, “the traditional oil and gas ‘lease’ is far from the simplest of property concepts. In the case law oil and gas ‘leases’ have been described as anything from licenses to grants in fee,” 255 A.2d 508. Generally though, the title conveyed in an oil and gas lease is inchoate, and is initially for the
purpose of exploration and development, Calhoon v. Neely, 50 A. 967. If development is unsuccessful during the agreed upon primary term, then no estate will vest in the lessee; however, if oil or gas is produced during that primary term, then a fee simple determinable is created in the lessee, and their right to extract oil becomes
vested. The interest held by the grantor/lessee is termed a “possibility of reverter.”
In the instant case, the Appellant, Ms. Jedlicka, was arguing that the oil and gas did not produce “in paying quantities” during the primary term. The Supreme Court found that, “the phrase ‘found or produced in paying quantities’ means paying quantities to the lessee or operator.” Further, “so long as the lessee is acting in good faith on business judgment, he is not bound to take any other party’s, but may stand on his own. No court has any power to impose a different judgment on him, however
erroneous it may deem his to be. Its right to interfere does not arise until it has been shown clearly that he is not acting in good faith on his business judgment, but fraudulently, with intent to obtain a dishonest advantage over the other party to the
contract. The Supreme Court wrote that,
“if a well consistently pays a profit, however small, over
operating expenses, it will be deemed to have produced in paying
quantities. Where, however, production on a well has been marginal or sporadic, such that, over some period, the well’s profits do not exceed its operating expenses, a determination of whether the well had produced in paying quantities requires consideration of the operator’s good faith judgment in maintaining operation of the well. In assessing whether an operator has exercised his judgment in good faith in this regard, a court must consider the reasonableness of the time period during which the operator has continued his operation of the well in an effort to reestablish the well’s profitability.”
In reiterating the holding in the century old Young, the Supreme Court in T.W. Phillips
had molded together century old law and gave an unambiguous standard for courts
to follow when assessing whether oil and gas has been produced “in paying
quantities” giving much credence to the lessee’s business judgment.