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Federal Court Rules Marcellus Leases not Extended by New York’s Delay in Issuing GEIS for Fracking

By: Ed Roggenkamp

On November 15, 2012, in Aukema v. Chesapeake Appalachia, a judge in the U.S. District Court for the Northern District of New York ruled that several leases to drill for gas in the Marcellus Shale had expired, despite the gas companies’ claim that the delay in permitting associated with  New York’s environmental review process constituted a force majeure extending the lease.  The court also ruled that “delay rental” payments by the companies did not extend the leases beyond their primary term.  This decision could have significant repercussions for gas leases in New York State.

All of the leases considered in Aukema were originally signed between 2000 and 2006, and ran for a primary term of five to ten years.  During that term, the lessees paid the landowners a “delay rental” payment. If the gas companies began producing gas from the land during the primary term, the lease would extend into a secondary term for as long as production continued, and the landowners would receive a percentage of the revenue from the gas as a royalty instead of receiving continued delay rental payments.

In 2008, Governor Patterson directed the Department of Environmental Conservation (“DEC”) not to issue any permits for gas wells that would involve high-volume horizontal  fracturing (“HVHF”) until DEC had studied the environmental impacts of HVHF and issued a new Generic Environmental Impact Statement (“GEIS”). Although the primary term of the leases at issue had expired, the gas companies argued that the delay in permitting, and the de facto moratorium on permit issuance, triggered the leases’  “force majeure” clause. 

The court ruled, however, that the “force majeure” clause did not apply because the gas companies could have used conventional drilling techniques – which had been analyzed in a 1992 GEIS and can be permitted under existing regulations – to explore for gas and thus did not need to await the new GEIS to begin producing gas from the leased property.  Hence, the court concluded, performance under the contract was not impossible  and the force majeure clauses did not come into effect.

The court also held that payment by the gas companies of delay rental payments pursuant to the lease terms could not extend the primary term of the leases.  The gas companies contended that the continuing payment of delay rentals, by itself, extended the primary term of the leases.  The court disagreed, noting that delay rental payments originally arose when courts began to infer that lessees had an obligation to begin production immediately. Delay rental payments serve only to defeat that assumption, by taking the place of the royalty payments that would be made if production began.  Since delay rental payments therefore serve only to negate the implication that production will begin immediately, the Aukema court held that they do not extend the primary lease term.  

This decision has important implications for gas leases in New York because many have nearly identical force majeure and delay rental payment provisions to the ones at issue in Aukema.  The Aukema decision, if upheld on appeal, could mean that many gas leases in New York have expired.  The continuing delays in DEC’s rule making process – including DEC’s recent request for a 90-day extension of its rule-making process on natural gas, the public comment period necessitated by that request, and the pending Department of Health review – could lead to the expiration of additional gas leases. This could open the door to new leases being negotiated at terms likely to be more favorable to lease owners.

For more information, contact Chris Amato or Steven Barshov.

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