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September 24, 2013

Failure to Pay Royalties Does Not Void Oil and Gas Lease

On September 20, 2013, the Pennsylvania Superior Court upheld a lower court’s ruling that the failure to pay royalty payments did not void an oil and gas lease.  The three judge panel rejected the argument that the forfeiture clause in the operative oil and gas lease applied to the payment of royalty payments and ruled, to the contrary, that such clauses exist only to guarantee that a lessee will develop the leasehold.

In McCausland v. Wagner (No. 1186 WDA 2012), the challenged lease included a forfeiture clause:

“It is further understood and agreed by and between the parties hereto that a failure to make any one of such payments, or to complete one well on the premises, shall render this lease null and void, and the same shall be fully ended and determined by and between the parties, and the party of the first part [McCausland] shall have no right, nor right of action in law and equity against the party of the second part [the Wagners], the recovery of any rent, damages or otherwise thereafter.” (emphasis added).

The undisputed record established that royalty payments had not been made initially but that since, the lessor had received all the royalty payments due under the lease.

The court began with a number of well-established legal principles including that a party seeking to void an oil and gas lease bears the burden of proof and that the law abhors a forfeiture.  Moreover, the Court reiterated long-standing Pennsylvania law that “[r]oyalty-based leases are to be construed in a manner designed to promote the full and diligent development of the leasehold for the mutual benefit of both parties.”  (citing Jacobs v. CNG Transmission Corp., 332 F. Supp. 2d 759 [W.D. Pa. 2004]).

Ultimately, the Court concluded that the lessor’s acceptance of royalty payments deprived him of the right to declare a forfeiture.  The Court then went on to hold that the placement of the forfeiture clause, immediately following the delay rental clause, rendered the lease void only for failure to make rental payments or the failure to complete a well on the premises.  According to the Court,

the oil and gas industry practice of including a forfeiture clause was to guarantee that the lessee would develop the property and, if the lessee failed to do so, the lessor could declare a forfeiture. Hence, it impedes logic to ascertain that the industry would develop a lease that allows a lessor to declare a forfeiture for failure to make a royalty payment after a well has been completed and oil or gas is being produced. Thus, it is our determination that forfeiture clauses in oil and gas leases customarily applied to the failure to complete a well or to pay delay rentals during the initial term of the lease, as is clearly expressed in the McCausland Lease.

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