Legal Updates

Don’t Risk Litigation Over the Arbitration Clause in Your Oil and Gas Lease

The arbitration clause in an oil and gas lease is likely not the most hotly negotiated term or even one that the parties think twice about. However, recent litigation in Pennsylvania should serve as a reminder to lessors and lessees to be aware that a poorly drafted arbitration clause may lead to unwanted litigation.

Recently, the United States Supreme Court denied a petition to review Chesapeake Appalachia, LLC v. Scout Petroleum, LLC, 809 F.3d 746 (3d. Cir. 2016) cert. denied (Oct. 3, 2016), a case addressing whether an arbitration clause used in numerous oil and gas leases covering lands in the Marcellus Shale region of Pennsylvania permitted class arbitration and whether the issue of class arbitrability is one for the courts or for the arbitrators to decide. The leases contained identical gas royalty clauses (except for some differing royalty percentages). The clauses provided that Chesapeake shall pay the lessor-royalty owners a certain percentage of the proceeds Chesapeake received from the sale of gas less four specific charges: transportation, treatment, processing and volume deduction to the point of measurement. All of the leases also included the following identical arbitration provision, which was silent as to both the availability of classwide arbitration and whether the question of classwide arbitrability should be submitted to the arbitrators or the court:

ARBITRATION. In the event of a disagreement between Lessor and Lessee concerning this Lease, performance thereunder, or damages caused by Lessee’s operations, the resolution of all such disputes shall be determined by arbitration in accordance with the rules of American Arbitration Association. All fees and costs associated with the arbitration shall be borne equally by Lessor and Lessee.

Without clear language on classwide arbitration the clause resulted in opposing interpretations. Scout sought to commence class arbitration on behalf of itself and a putative class of thousands of similarly situated lessor-landowners, claiming that Chesapeake breached the leases by deducting charges for compression, gathering, and other charges not authorized by the leases, resulting in the underpayment of royalties to itself and the other class members. Chesapeake disagreed that class arbitrability was available under the leases and initiated the litigation in the Middle District of Pennsylvania, arguing that the issue was one for the courts. The District Court agreed with Chesapeake and held that the issue of arbitrability was one for the courts, and not the arbitrators, to decide. Scout appealed the District Court decision.

On appeal, the Third Circuit reiterated that there is a presumption that courts (not arbitrators) must decide questions of arbitrability, including whether a contract contemplates class arbitrability. The court stated that the burden of overcoming the presumption that the issue of arbitrability is for judicial determination is “onerous [and] requires express contractual language unambiguously delegating the question of arbitrability to the arbitrator.” Ultimately, although the court was highly critical of Chesapeake, stating that “[a]s a sophisticated business, it could have, and, at least in retrospect, should have, drafted a clearer arbitration agreement,” it held in favor of Chesapeake that the leases “do not clearly and unmistakably assign to an arbitrator the question whether the agreement permits classwide arbitration.” Scout appealed to the United States Supreme Court, which denied the petition to hear the case.