Federal Court Upholds Pennsylvania Act 85, Says Cross-Unit Well Didn’t Breach Lease Agreement

February 21, 2024

The Pennsylvania Act 85 of 2019 amended the Pennsylvania Oil and Gas Lease Act to add a section permitting cross-unit drilling. On Jan. 24, 2023, the U.S. District Court for the Middle District of Pennsylvania upheld Act 85 as constitutional, and held that SWN Production Co. LLC and Repsol Oil & Gas USA, LLC did not breach their 2006 lease agreement with Warner Valley Farm LLC by drilling a cross-unit well.

Lessor Warner Valley sued lessees SWN and Repsol, claiming they breached the terms of a 2006 lease agreement that permitted them to drill for oil and gas on Warner Valley’s land. Warner Valley alleged that SWN and Repsol breached the lease agreement by drilling a well that crossed the boundary of Warner Valley’s unit and extracted gas from properties contained in an adjacent drilling unit. Warner Valley also sought a declaration that Act 85 was unconstitutional under the contract clause of the U.S. and Pennsylvania constitutions. But in Warner Valley Farm, LLC v. SWN Production Co., LLC, the court rejected Warner Valley’s claims and granted SWN and Repsol’s motion for summary judgment.

The court held that Act 85 was constitutional. The court held that, because Act 85 did not substantially impair the 2006 lease, Act 85 was valid under the contract clause. According to the court, the plain language of Act 85 did not affect leases that already expressly forbade cross-unit drilling. Act 85 did replace a restriction that prevented cross-unit drilling in the past — the 330-foot setback limit. But it replaced that restriction with less-burdensome restrictions, only requiring a lessee to have the right to drill on both units and reasonably allocate the royalties among the respective lessors. Indeed, although Act 85 eased the regulatory barrier to cross-unit drilling, it left the issue of whether cross-unit drilling is permissible to the parties in negotiating their lease. For this reason, the court concluded that Act 85 did not insert new terms in or impair the 2006 lease.

The court also held that Act 85 did not substantially impair or expand the 2006 lease because, under that agreement, SWN and Repsol held a fee simple interest. That interest is the most expensive property right, subjecting them only to a duty to avoid waste and to any other restrictions imposed by the grantor. Because SWN and Repsol already had the most expensive property interest in the leasehold, the court concluded that Act 85 could not (and did not) expand their rights under the lease.

Continuing its constitutionality analysis, the court discussed Act 85’s allocation provision, which required a lease operator to “reasonably allocate[] production from the well to or among each unit the operator reasonably determines to be attributable to each unit.” Warner Valley claimed this provision inserted a new allocation method for cross-unit wells that the 2006 lease did not have and, accordingly, substantially impaired and expanded the 2006 lease. The court once again rejected Warner Valley’s argument, holding that Act 85 left allocation of royalties to the parties; it just required them to use reasonable terms. Thus, the court rejected the argument that Act 85’s royalty provision substantially impaired the 2006 lease.

Finally, the court held that even if Act 85 impaired the 2006 lease, that impairment would be justified (and thus, constitutional). The court found that — as with Act 85 — where the law affects only contracts between private parties, deference to legislative judgment is appropriate.

SWN and Repsol did not breach the 2006 lease. The court held that the 2006 lease permitted SWN and Repsol to drill cross-unit wells, so they did not breach that lease. The court focused on the 2006 lease’s broad granting clause, which allowed SWN and Repsol to use “methods and techniques which are not restricted to current technology” to drill for oil and gas. The 2006 lease also allowed SWN and Repsol “to pool, unitize, or combine all or any portion of the Leasehold with any other land or lands, whether contiguous or not contiguous … so as to create one (1) or more drilling or production units” and “to change the size, shape and conditions of any unit created.” It then specified that “[a]ny [o]perations conducted on the drilling or production unit … shall have the same effect in continuing [the] [2006 Lease] … as if such [o]perations were conducted upon the Leasehold.”

According to the court, Warner Valley chose to permit the inclusion of the term “combine” in the 2006 lease. If the pooling clause did not use the term “combine” (in addition to unitize and pool) or did not include noncontiguous lands, then the clause might be susceptible to an interpretation that bars cross-unit drilling. The court concluded, however, that the language the parties utilized in the 2006 lease did not contain such a prohibition.