Liability After Assignment Now Applies To Surface Rights

January 8, 2016Articles Law360

The practice of assigning rights and obligations in the oil and gas industry has become an integral process and a routine occurrence. In Pennaco Energy Inc. v. KD Company LLC, 2015 WY 152 (Wyo. 2015), the Wyoming Supreme Court affirmed the application of fundamental principles of contract law concerning assignments in the context of agreements with surface landowners.

In underscoring the well-settled contract principle that “obligations based on a contract relationship continue to bind the original obligor even after the obligor assigns its interest in a contract,” the court determined that Pennaco remained liable for its obligations under certain agreements with landowners, despite assignments to third parties. In essence, the court found that Pennaco bore continued responsibility, even though it had assigned its interests, because the original agreements did not contain express language eliminating said liability on the part of Pennaco.

The Pennaco decision stems from two separate actions involving Pennaco Energy Inc., one in Sheridan County, Wyoming, and the other in Johnson County, Wyoming, consolidated for purposes of argument and decision. Because there is no intermediate appellate court in the state of Wyoming, the case was appealed directly to the Wyoming Supreme Court from decisions in favor of the landowners at the district court level.

The case arose after Pennaco, a subsidiary of Marathon Oil Co., obtained oil and gas leases in northeastern Wyoming’s Powder River Basin and entered into contracts with the surface landowners for access and use of the land during exploration and production. The contracts, specifically, surface use agreements and agreements concerning water produced during drilling operations, were granted by the surface owners in exchange for Pennaco’s agreement to make annual payments for the use of the lands, to reclaim the lands and to provide compensation for damages caused by operations.

After developing a coalbed methane operation and reportedly drilling and producing gas, Pennaco assigned its interests in the operations and the agreements to CEP-M Purchase LLC, who then subsequently assigned to High Plains Gas Inc. The case was sparked when payments to the surface landowners were not properly made and reclamation activities were not completed following Pennaco’s assignment.

At issue was whether Pennaco remained liable for performing obligations under the agreements after assigning its interests to a third party.

Pennaco’s argument focused on covenants running with the land, such that when an agreement affecting the use of the land is assigned and privity of estate ceases, the assignor would be relieved from liability. The court rejected this argument, emphasizing the contractual nature of the relationship and focusing on the point that the agreements contained obligations based on Pennaco’s promises and the benefits it received, rather than on any privity of estate.

Central to the Pennaco decision, and providing the basis for the landowners’ arguments, were core contract law principles, including the proposition that although rights may be assigned and duties delegated, the delegating party continues to remain liable for its obligations.

Of critical importance to the court in making its determination was the absence of language eliminating Pennaco’s contractual liability upon assignment; there was no express clause contained in the underlying agreements terminating Pennaco’s obligations upon assignment. On the contrary, the court determined that the contracts indicated “an intent that Pennaco remain responsible for its promises to make damage payments and to perform reclamation.”

Declining to rewrite the agreements to include language the parties themselves did not include, the Wyoming Supreme Court affirmed the trial court and concluded that Pennaco remained liable to perform its obligations, including the obligations to make annual payments, plug and abandon wells upon cessation of operations and to reclaim the land.

The court reiterated the following long-standing policy: “contracting parties should not be permitted to avoid contractual obligations simply by assigning them.” The court also recognized “that contracting parties expect each other to perform the contract unless they specify otherwise.”

Pennaco does not represent a departure from the common application of this well-settled contract principle. Rather, the principle had long been applied to oil and gas leases, and the Pennaco decision went one step further by applying it to other agreements with surface owners.

The principle that, “[t]he original lessee continues liable to the lessor for a breach of an express covenant of the lease occurring after his assignment of the lease unless the lease contains a clause excusing him from further liability after assignment” is well-settled.

Indeed, the United States District Court for the District of North Dakota addressed a comparable issue concerning oil and gas leases in Wold v. Diamond Resources Inc., No. 4:11-CV-046, a case the Wyoming Supreme Court relied upon in its decision in the Pennaco case:

North Dakota follows the “well-established principle in the law of contracts that a contracting party cannot escape its liability on the contract by merely assigning its duties and rights under the contract to a third party.” Rosenberg v. Son. Inc., 491 N.W.2d 71, 74 (ND 1992); see also Estate of Murphy v. Murphy, 554 N.W.2d at 437 (“Even where there is an effective assignment of a contractual obligation, the assignor's ‘duty remains absolutely unchanged.’ ”) (quoting 4 Corbin on Contracts § 866). Under North Dakota law, this principle applies to all categories of contracts, including the oil and gas leases at issue here. Cf. Holman v. State, 438 N.W.2d 534, 537 (ND 1989) (“[D]ocuments conveying oil and gas interests are subject to the same general rules that govern interpretation of contractual agreements.”); see generally 5–64 E. Kuntz, A Treatise on the Law of Oil and Gas § 64.7 (Matthew Bender rev. ed. 2011) [“Kuntz”]; 2–4 P. Martin & B. Kramer, Williams & Meyers, Oil and Gas Law § 403.1 (Matthew Bender 2010) (“Williams & Meyers”).

Thus, while the application of this core contract principle to agreements with surface landowners, other than oil and gas leases, should come as no surprise, it does highlight a source of potential ongoing liability when interests are assigned, which is significant in the lesson it provides. The court’s emphasis on the need for explicit contract language detailing the intended consequences of the transaction is unequivocal.

The takeaway is that parties must use caution to avoid ongoing obligations. Fortunately, this issue can be easily resolved by considering including express clauses in the original contract addressing the cessation of liability upon assignment.

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