Oil Pumps

By Daniel Stratton

Today, the Fourth Circuit issued a published opinion in the civil case K & D Holdings, LLC v. Equitrans, L.P. In K & D Holdings, the court held that an oil and gas lease granted to defendants, Equitrans and EQT, by plaintiff, K & D Holdings, was not divisible into separate components. In reaching that conclusion, the court reversed and remanded the case to the district court with instructions to enter judgment in favor of Equitrans and EQT.

The Terms of the Original Lease

In December 1989, Henry Wallace and Sylvia Wallace signed a lease granting Equitrans the oil and gas rights to an area of land covering 180 acres in Tyler County, West Virginia. Currently, K & D is the successor in interest to the Wallaces. Additionally, Equitrans L.P., the successor-in-interest to Equitrans Corp., subleased the rights to produce and store gas on the land to EQT Corp. Essentially, the terms of the lease now govern a relationship between K & D and EQT.

The terms of the lease grant EQT the right to use the land to explore and produce oil and gas, store gas, and protect stored gas. The lease’s initial term ran for five years and would continue on for as long as a portion of the land was used for “exploration or production of gas or oil, or as gas or oil is found in paying quantities thereon or stored thereunder, or as long as said land is used for the storage of gas or the protection of gas storage on lands in the general vicinity.” After taking control of the land, EQT never engaged in exploration, production, or gas storage, but has engaged in gas storage protection.  Equitrans owns the nearby Shirley Storage Field, a natural gas storage facility. The Federal Energy Regulatory Commission established a buffer zone of 2000 feet around the storage area for protection of the storage facility. The leased land falls within that buffer zone.

Due to EQT and Equitrans not using the leased land for gas or oil production, K & D sought to end the arrangement and enter into a more lucrative contract with another company. On September 20, 2013, K & D filed a lawsuit in state court against EQT, arguing that it was entitled to a rebuttable presumption under West Virginia state law that EQT had abandoned the land after not producing or selling gas or oil from the property for more than twenty-four months. EQT removed to the United States District Court for the Northern District of West Virginia. EQT and K & D filed cross motions for summary judgment.

On September 30, 2014, the court denied both cross motions. Acting sua sponte, the district court found as a matter of law that the lease was divisible. The court argued that because the lease had two primary purposes, (1) exploration and production and (2) storage and protection, the lease could be divided into two separate leases. The lease for exploration and production of oil and gas had expired in the district court’s view, because the initial five-year term had elapsed without EQT exploring for or producing oil or gas. The court held however, that the second lease, for storage and protection, was still in force because EQT had used the land for that purpose.

On January 21, 2015, the district court issued its final order, stating that K & D was entitled to drill exploration and production wells in areas that were not within the buffer zone of the Shirley Storage Field. EQT appealed.

West Virginia is for Lessors

Because this case was heard under diversity jurisdiction, West Virginia state law applies. Under West Virginia law, contract law principles apply equally to the interpretation of leases. The primary criterion for determining if a contract is severable is whether such an intention was reflected by the parties in the terms of the contract itself, the subject matter of the contract, and the circumstances giving rise the question.  A contract is not severable when it has material provisions and considerations that are interdependent and common to each other. Additionally, under West Virginia state law, there is a presumption against divisibility unless the contract explicitly states that it is divisible or the parties intent of divisibility is clearly manifested. As a general matter, West Virginia law regarding oil and gas leases are liberally construed in favor of the lessor, but only when there is ambiguity as to the lease terms.

A Lease Divisible Cannot Stand

On appeal, EQT made two arguments. First, it argued that the district court erred as a matter of law in holding the lease divisible. Second, EQT contended that the district court was wrong in determining that the exploration portion of the lease had terminated after its initial five-year term. Reviewing the district court’s findings of fact for clear error and its conclusions of law de novo, the Fourth Circuit agreed with both of EQT’s arguments.

Starting with its first argument, EQT pointed to the language of the lease itself. The lease’s use of the word “or” between each act required of EQT in order to continue the lease indicated that the acts were alternatives, and that only one would be required to keep the entire lease in effect. Applying West Virginia’s test for determining if a contract is severable, the Fourth Circuit concluded that the lease was intended to be entire and not divisible.  The Fourth Circuit applied the plain, ordinary meaning of the word “or,” holding that in this case it was a disjunctive and could not be considered to have the same meaning as the word “and.”

K & D argued that because EQT paid different rents depending on what activities it was engaging in, the lease was divisible. The court found this argument to not be persuasive, noting that the activities EQT could engage in under the lease were interrelated. Additionally, because the Fourth Circuit found no ambiguity in the lease, it did not need to liberally interpret in favor of the lessor.

Having decided that the lease was not divisible, the court then turned to the question of whether EQT had continuing rights under the lease. The terms of the lease dealing with renewal stated that the lease would continue beyond the initial five-year term if “(1) the lessee explores for or produces gas or oil; (2) ‘gas or oil is found in paying quantities thereon or stored thereunder’; or (3) the ‘land is used for the storage of gas or the protection of gas storage on lands in the general vicinity.” Again noting the use of the disjunctive “or,” the court found that because it was undisputed that part of the land was being used for protection, EQT continued to hold all rights under the original lease.

The Fourth Circuit Hold the Lease is Not Divisible and Valid; Reverses and Remands 

Having determined that the lease was not divisible and that EQT still held all rights under the original lease, the Fourth Circuit reversed and remanded the lower court’s decision, instructing that court to enter judgement in favor of EQT and Equitrans.

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