Caselaw Update: Liability of Former Operators under Surface Use Agreements in Wyoming

Recent caselaw and the application of Wyoming’s Split Estate Act has significantly increased risk for operators in Wyoming, who may be held liable for the conduct of their assignees (and their assignees) if such conduct breaches a surface use and damages agreement.    

In 2015 and 2016, the Wyoming Supreme Court issued rulings in what have come to be known as the Pennaco Cases (Pennaco Energy, Inc. v. KD Co. Ltd. Liab. Co.and Pennaco Energy, Inc. v. Sorenson).  Both cases involved Pennaco Energy, Inc. (“Pennaco”), a Wyoming oil and gas operator which had taken several leases for the production of coalbed methane. As required by state law, Pennaco executed a surface use and damages agreement under which Pennaco agreed to pay the surface owners for the use of the surface and any damages thereto, and at completion of operations, to restore the land as nearly as possible to its original condition.  Pennaco later assigned its interest in the gas leases to a different operator, who in turn assigned it to another.  Pennaco’s successors-in-interest failed to abide by the land use agreements, and the landowners sued all three operators for failure to pay land use fees and damages. 

The operators who succeeded to Pennaco’s interest in the leases filed for bankruptcy, leaving Pennaco as the only party against whom the surface owners could seek monetary compensation.  From the onset, Pennaco argued that it no longer held interest in the leases– it had transferred its interest, and therefore any liability under the surface use agreement, to its assignee.  The court disagreed and held Pennaco liable to the landowners under the surface use agreement.  The court reasoned that absent a reference in the land use and damages agreement to the gas lease, a novation at the time of lease assignment signed by the landowner, or evidence that Pennaco had negotiated for an exculpatory clause in the agreement, Pennaco remained liable to the surface owners for damages under the surface use agreement. 

Pennaco’s defense was privity of estate, which creates rights and duties that run with the land—successors-in-interest are bound by the duties in place of the original holder.  The Wyoming courts agreed with this principle but held that privity of contract supersedes privity of estate. A party who assigns or delegates a contractual duty remains responsible for performance of that duty absent an express contractual discharge therefrom. On this reasoning, the court found that Pennaco must be held liable for its assignees’ breach of the surface use agreement between Pennaco and the surface owners. 

A former operator must be diligent in responding to a demand for payment based on the breach of a surface use agreement by their successor-in-interest. The risk of liability for operators who divest their interest in Wyoming leases has increased significantly with Wyoming courts’ recent application of a provision of Wyoming Split Estate Act to disputes between surface owners and operators. The law allows surface owners to collect double the amount of unpaid annual surface use payments required by a surface use agreement, and applies when an operator has failed to remedy non-payment after 60-days’ notice from the surface owner.  Under this statute and the Pennaco holdings, past operators are subject to liability for the defaults of their assignees, and significant monetary damages that most operators would never expect to pay once they have parted with their interest.  

To shield themselves from liability for the conduct of their successors-in-interest, Wyoming operators should be sure to include exculpatory clauses in their leases, incorporated by refence into surface use and damages agreements, or alternatively, include an express exculpatory clause in the surface use and damages agreement itself. Additionally, operators should have landowners sign a novation upon assignment of the operator’s interest, which expressly transfers all duties under surface damages agreements to the assignee. 

Kuiper Law Firm, PLLC specializes in oil and gas; if you have any questions about how the information in this article may apply to your business or operations, do not hesitate to contact us.