Wednesday, December 15, 2010

Arkansas Supreme Court Revisits Law on Pipeline Gathering System Condemnation and "Statutory Pugh Clause"

The Arkansas Supreme Court ruled against landowners who challenged to the authority of a gas gathering system to use the power of eminent domain to acquire rights of way.  In Ralph Loyd Martin Revocable Trust v. Arkansas Midstream Gas Services Corp., a landowner challenged whether a gas gathering system's condemnation was for a public use pursuant to Ark. Code Ann. 23-15-101. (2010 Ark. 480). The court ruled that the gas gathering system is for public use because the system was available to multiple royalty owners and working interest owners from many different drilling units with equal access for all at a fixed rate.  In industry language, the gathering system was a "common carrier." 

A gathering system provides a conduit for gas from a wellhead to reach larger interstate pipelines.  Without the power of eminent domain, it would be difficult for the public to have access to natural gas.  Landowners should be aware--as this case illustrates--that challenges to eminent domain cases for reasons other than the amount of compensation are seldom successful.  It takes a truly egregious abuse of eminent domain to mount a successful challenge on the merits.  Just 5 years ago, the United States Supreme Court upheld a taking of property for purely economic reasons. See Kelo v. City of New London, 545 U.S. 469 (2005).

The Court also re-examined the Statutory Pugh Clause codified at Ark. Code Ann. 15-73-201. Southwestern Energy Production Co. v. Elkins, 2010 Ark. 481.  A bit of background is necessary for those readers who do not understand the basics of oil and gas leases.  When a well begins to produce, an oil and gas lease enters its secondary term.  The secondary term continues until there is no longer a commercially viable oil or gas well.  A lease holder may drill wells perpetually to extend the secondary term. 

But suppose all of the drilling takes place on one tract, but the lease also covers tracts several miles away. A standard oil and gas lease always has some language to the effect that operations on one part of the lands extend to the whole of the leasehold.  Therefore, a well on one part of the leasehold holds all lands covered by the lease into the secondary term.  This idea is also incorporated into Ark. Code Ann. 15-73-201.  If one area of the leasehold is very attractive and easy to develop, it may be decades before the operator gets around to developing the less attractive areas.  This is a source of frustration for many landowners.  Enter a Lousiana lawyer named Pugh.  Lawyer Pugh drafted a simple clause to remedy the problem:

If at the end of the primary term, a part but not all of the land covered by this lease, on a surface acreage basis, is not included within a unit or units in accordance with the other provisions hereof, this lease shall terminate as to such part, or parts, of the land lying outside such unit or units, unless this lease is perpetuated as to such land outside such unit or units by operations conducted thereon or by the production of oil, gas or other minerals, or by such operations and such production in accordance with the provisions hereof.

Put simply, when operator finishes the drilling started in the primary term, the lease becomes severable, freeing up the lands the operator failed to develop. 

In response to outrage by mineral owners who did not see all of their lands developed in a timely manner, the General Assembly enacted the following as Ark. Code Ann. 15-73-201:

Lease extended by production -- Scope

(a) The term of an oil and gas, or oil or gas, lease extended by production in quantities in lands in one (1) section or pooling unit in which there is production shall not be extended in lands in sections or pooling units under the lease where there has been no production or exploration.

(b) This section shall not apply when drilling operations have commenced on any part of lands in sections or pooling units under the lease within one (1) year after the expiration of the primary term, or within one (1) year after the completion of a well on any part of lands in sections or pooling units under the lease.

(c) The provisions of this section shall apply to all oil and gas, or oil or gas, leases entered into on and after July 4, 1983.

The plain reading of this statute is that an operator must continue drilling, or lose the lease.  This is not quite a Pugh clause, but it is close.  In the latest case examining this statute, the landowner plaintiffs attempted to re-argue the correct interpretation of the statute.  The court did not see fit to alter the interpretation it adopted in Snowden v. JRE Investments, 2010 Ark. 276.  That is, the plain reading of the statute prevailed, and in this case, the operator complied with what the statute required.  Like the Snowden case, this case drew some dissenting opinions.  The gist of those dissents is that the General Assembly meant to write a true Pugh clause, but as the dissenters note, it is up to the General Assembly to change its statutes, not the courts.

Landowners should not rely on the so-called statutory Pugh as true Pugh clause because it isn't one.  When writing this law, the General Assembly compromised between the operator and landowner viewpoints.  The statute ended the days landowners languishing over the operator sitting on a single well to hold a leasehold spread over a large area, but it also allowed the operator a reasonable cushion of time for development.  Like all other aspects of an oil and gas lease, a landowner can negotiate for true Pugh clause.

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The above represents the opinion of the author and not of any organization or group to which the author may belong. This material is general information, and it is not intended to create any lawyer-client relationship. Neither the transmission nor receipt of this information is an offer to extend representation by the author. Any information, opinion, and comment provided herein should not be taken as legal advice or relied upon by the reader for any purpose. The author is licensed in the state of Arkansas. Commentary on cases and law from jurisdictions where the author does not hold license to practice are for demonstrative or scholarly purposes
and do not represent the author is licensed or accepts cases in the applicable jurisdiction. If you are need of legal services, you should contact a licensed attorney in your jurisdiction.

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