Steptoe & Johnson PLLC: Pennsylvania Supreme Court Affirms Good Faith Test of Production in Paying Quantities

Steptoe & Johnson PLLC: Pennsylvania Supreme Court Affirms Good Faith Test of Production in Paying Quantities

By Russell L. Schetroma, Nathaniel I. Holland

On Monday, March 26, 2012, in T.W. Phillips Gas & Oil Co. v. Jedlicka, No. 19 WAP 2009, 2012 Pa. LEXIS 627 (Pa. Mar. 26, 2012) [enhanced version available to lexis.com subscribers], the Pennsylvania Supreme Court reaffirmed and expanded its rule in Young v. Forest Oil, 194 Pa. 243, 45 A. 121 (Pa. 1899) [enhanced version available to lexis.com subscribers], that whether an oil and gas lease is producing in paying quantities is to be determined by the subjective good faith judgment of the lessee.

The Supreme Court noted Young and surveyed cases in other major oil and gas producing states to determine the extent that modern courts consider the good faith of the operator, even when purportedly applying only an objective test, in defining "paying quantities" for the purposes of continuing a lease in its secondary term. The Court concluded that deference to the lessee's good faith decisions concerning production is required to properly resolve production-based challenges to the continuance of oil and gas lease secondary terms. The decisions of the lower courts were affirmed because the Plaintiff had not demonstrated any facts upon which a conclusion of bad faith by the lessee could be based.

This opinion is notable for a number of reasons:

1) it reaffirms the longstanding rule that the lessee is in the best position to make business decisions regarding its leases, which should not be second guessed absent evidence of an illicit intent;

2) it reaffirms the conceptual nature of an oil and gas lease as an inchoate interest that vests in fee simple determinable upon achieving paying production; and

3) it continues the Court's laudatory trend exemplified in Kilmer v. Elexco Land Services, Inc., 605 Pa. 413, 990 A.2d 1147 (Pa. 2010) [enhanced version available to lexis.com subscribers], of looking to leading oil and gas treatises and expanding the scope of analysis to look to the case law of other oil and gas jurisdictions to expand and update, but also respect the venerable and long-established oil and gas law of Pennsylvania.

Four justices joined in Justice Todd's majority opinion (available here). In a separate opinion (available here) Justice Eakin concurred, noting that he would have affirmed without the need to reach the issue of whether the lessee acted in good faith. Justice Saylor's dissent challenged the majority's expanded consideration of Young. The dissent is available here.

Click here to read an expanded analysis of the case.

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