Oil and gas and the Empire State

Does a state's years-long ban on the fracking of oil and gas wells extend the "primary" term of a lease until the ban ends, allowing the frackers who couldn't frack more time to come back and frack?

This week, the highest court of an important commercial state that seldom speaks on oil and gas industry matters took up the question. Although in 1882 New York became "the number one oil-producing state in the nation", New York courts have long since ceded authoritativeness in oil and gas matters to "out-of-state 'oil' jurisdictions". Beardslee v. Inflection Energy, LLC, No. 44 (N.Y. Mar. 31, 2015). But the Court of Appeals' thumping answer — in favor of landowners and against what it called "energy companies" — may open cracks in the fracking legal landscape across the U.S.

The leases

The dispute pitted owners of land in upstate New York (Tioga County) against those "energy companies", which had entered into oil and gas leases. Each of the leases contained "an identical term clause, also known as an habendum clause, which establishes the primary and definite period during which the energy companies may exercise the drilling rights granted by the leases." Beardslee, slip op. at 3 (footnote omitted).

The primary term ran out, per the lease language, after "FIVE (5) years from the date hereof". Id. A "secondary term" would kick in if, but only if, "said land is operated by Lessee in the production of oil or gas." Id. (emphasis added).

As the energy companies had drilled no wells on the landowners' property, the leases would have expired at the end of the primary term — unless something somehow extended them.

Here comes the ban

Possible rescue arrived in the guise of the Governor of New York. As alarm about fracking rose, Governor Paterson put a state-wide hold on new permits for the fracking of wells pending a study of environmental and other effects. The lessees responded by sending the landowners notice that "New York's government action constituted a force majeure event under the leases, which purportedly extended the leases' terms." Id. at 5. They cited a clause that stated as follows:

If and when drilling . . . [is] delayed or interrupted . . . as a result of some order, rule, regulation, requisition or necessity of the government, or as the result of any other cause whatsoever beyond the control of the Lessee, the time of such delay or interruption shall not be counted against Lessee, anything in this lease to the contrary notwithstanding.

Id. at 6 (emphasis added).

The landowners sued the lessees in the Northern District of New York. They sought a judgment declaring that the leases "had expired by their own terms" when the primary terms ended with no drilling or production.  The district court granted summary judgment on the ground that the force majeure clause had "no effect on the habendum clause and the lease terms because the energy companies did not have an obligation to drill" during the primary term. Id. at 7. Citing gaps in the spotty fabric of oil and gas law in New York, the Second Circuit certified questions to the Court of Appeals for a definitive ruling. The Court accepted.

The decision

The outcome of the case depended on whether the force majeure clause did, or did not, apply to the "primary term" part of the habendum clause. The Court concluded that it did not, holding both that "the habendum clause is not expressly modified or enlarged by the force majeure clause" and that "the language in the force majeure provision does not supersede all other clauses in the leases, only those with which it is in conflict." Id. at 10 & 11.

The Court went on:

Moreover, the second sentence in the force majeure clause, which deals exclusively with governmental regulations, pertains only to the energy companies' express or implied covenants — the lessee's obligations. As the energy companies made no express or implied covenants applicable to the primary term (other than to pay delay rentals, which are not at issue here), the force majeure clause must relate to only continuous drilling/production operations during the secondary term of the leases . . . . Furthermore, this latter sentence in the force majeure clause expressly indicates that the subject clause deals with lease termination, not lease expiration. The corresponding habendum clause provision is its secondary term, which also addresses the conditions under which the leases would terminate, whereas the primary term deals with lease expiration.

Id. at 11-12 (citation omitted). The force majeure clause, in other words, (a) did not apply to the lessee's obligations during the primary term (mainly to make bonus and rent payments but not to drill) and (b) did apply to the lessee's duties in the secondary term (after the commencement of drilling operations) but did not affect the outcome of the case because the leases never got beyond the primary term.

Upshot

The outcome generally spells bad news for oil and gas companies/lessees and good news for mineral owners/lessors. The former would like to hold onto potentially valuable leases, at little or no cost, until a fracking ban goes away and market prices go back up (having dropped by more than half in the case of oil since mid-2014 and 40 percent in the case of gas). The latter (landowners/lessors) would also prefer that prices rise again, but in the meantime they do not want the deadweight of a lease that produces no income or even any prospect of income while the lessees wait out the moratorium and the recession in market prices.

The tougher question will have to do with the effect of the fracking ban on leases in the secondary term, which does not start until production begins. The Court noted that the force majeure clause does address "the conditions under which the leases would terminate" – the principal one involving failure to produce oil or gas in paying quantities. See "Hottest Oil & Gas Claims, Part 1: Busting Leases"; "Hottest Oil & Gas Claims, Part 2: New Drilling Technology".

Will the moratorium on fracking extend the secondary term of a lease in New York (and elsewhere)? In a time of sub-$50 a barrel of oil and $2.65 an Mcf for gas, is it worth fighting over? Under what circumstances?

What do you think?