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Pennaco Energy, Inc. v. KD Co. LLC

Supreme Court of Wyoming

December 2, 2015

PENNACO ENERGY, INC., Appellant (Defendant),
KD COMPANY LLC, a Wyoming close limited liability company, Appellee (Plaintiff). PENNACO ENERGY, INC., Appellant (Defendant),

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Appeals from the District Courts of Sheridan and Johnson Counties. The Honorable William J. Edelman, Judge.

Representing Appellant: Marie R. Yeates and Michael A. Heidler of Vinson & Elkins, L.L.P., Houston, Texas; Mark R. Ruppert and Isaac N. Sutphin of Holland & Hart, LLP, Cheyenne, Wyoming. Argument by Ms. Yeates.

Representing Appellees: Kendal R. Hoopes of Yonkee & Toner, LLP, Sheridan, Wyoming.

Representing Petroleum Association of Wyoming, Amicus Curiae in Support of Pennaco Energy Inc.: Thomas F. Reese, Ryan J. Schwartz, William E. Reese, and Kyle A. Ridgeway of Williams, Porter, Day & Neville, P.C., Casper, Wyoming.

Representing Texas Oil & Gas Association, Amicus Curiae in Support of Pennaco Energy Inc.: Timothy M. Stubson of Crowley Fleck PLLP, Casper, Wyoming.

Before BURKE, C.J., and HILL, DAVIS, FOX, and KAUTZ, JJ.


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KAUTZ, Justice.

[¶1] Pennaco Energy, Inc. (Pennaco) obtained oil and gas leases in northeastern Wyoming. Pennaco then made contracts with the surface landowners, who were predecessors of Appellees. These agreements granted Pennaco access to and use of the landowners' land during exploration and production under the mineral leases. In the agreements, Pennaco committed to pay for damages and for use of the land and, when operations ceased, to restore the land as nearly as possible to its prior condition. Pennaco developed its coalbed methane operation, drilling for and producing gas, and made the required payments for several years. It then assigned its interest in the operations and agreements to CEP-M Purchase, LLC (CEP-M), which re-assigned those interests to High Plains Gas, Inc. (High Plains Gas). Since Pennaco's assignment, neither Pennaco nor the assignees have made any of the payments required under the agreements, nor have they reclaimed any of the land.

[¶2] Appellees (referred to as landowners jointly, and individually as KD or Hollcroft) sued Pennaco, CEP-M and High Plains Gas for breach of the agreements. CEP-M and High Plains Gas defaulted. The district court granted summary judgment in favor of the landowners, concluding that Pennaco remained liable under the agreements even after assignment.

[¶3] Pennaco appeals, claiming the district court erred in applying contract law to find that it remained liable under the agreements. Pennaco contends the agreements created covenants running with the land, which can only be enforced against someone in privity of estate with the landowners. Upon assigning the agreements and leases to CEP-M, Pennaco asserts, it ceased to have privity of estate with the landowners and cannot be held liable under the agreements. We conclude the district court correctly ruled Pennaco remains liable under the agreements, and affirm the judgments.


[¶4] The issues for our determination are:

1. Whether the district court correctly ruled that Pennaco remains liable for performing the obligations under the agreements after assigning a portion of its interest under those agreements to a third party.

2. Whether the district court properly awarded costs and attorney fees to the landowners.


[¶5] The ranch lands at issue in these cases are located in the Powder River Basin in Sheridan County and Johnson County,

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Wyoming. During the 1990s, Pennaco acquired interests in oil and gas leases for the mineral estate underlying the ranch lands. Pennaco then made contracts with the surface owners, who were predecessors of KD and Hollcroft. In those contracts, the surface owners granted Pennaco the right to enter the lands for purposes of drilling, completing and producing gas wells, constructing and maintaining access roads and power lines, and installing pipelines to transport gas and water produced from gas wells drilled on the lands. In exchange, Pennaco agreed to make annual payments to the surface owners for use of the land and to compensate them for damages caused by its operations. Pennaco agreed to restore all impacted land when the use ended.

[¶6] In addition to the surface use agreements, Pennaco and the landowners entered into agreements concerning the disposal of water produced during the operations. Those agreements required Pennaco to make annual payments and, when operations ceased, either restore the land or make the areas suitable for the landowners' use as water wells or reservoirs.

[¶7] After signing the agreements, Pennaco began coalbed methane operations on the lands drilling numerous wells, constructing roads, building reservoirs for storing water produced from the wells, and installing underground pipelines and other infrastructure. As required by the agreements, Pennaco made the annual surface damage and reservoir payments through 2010. In 2009, Pennaco and Hollcroft signed agreements which required Pennaco to replace two of Hollcrofts' water wells and to pay for electricity to operate those wells.

[¶8] In July 2010, Pennaco sold a portion of its oil and gas interests in the Powder River Basin to CEP-M. The sale included part of Pennaco's interest in the leases underlying the ranch lands at issue and its rights under the surface agreements. However, the sale expressly reserved Pennaco's interest in the " deep rights" covered by the leases and the rights of access to and use of the ranch property in order to explore and develop the deep rights.[1] Pennaco also excluded monitoring wells and wells subject to a 2010 plugging and abandonment program along with surface access and other rights necessary to complete plugging and abandoning those wells. Finally, Pennaco retained a right to complete, plug and abandon wells and restore the sites at CEP-M's expense if CEP-M failed to do so.

[¶9] CEP-M then assigned its interests to High Plains Gas. High Plains Gas began operating the wells, producing gas and discharging water into the reservoirs on the ranch lands. No one, however, made any payments required under the contracts after Pennaco's assignments.

[¶10] By the time of the assignments, Pennaco had reclaimed a number of the wells it drilled on the ranch lands and reclaimed some of the roads it constructed. No one has reclaimed any wells, roads or reservoirs since the assignments. Annual payments required under the surface and damage agreements were not made after 2010. The annual payments required under the water storage agreements were not made after 2011. No one made electricity payments to the Hollcrofts as required by the water well replacement agreements after mid 2012.

[¶11] In 2012 and 2013, the landowners gave Pennaco, CEP-M and High Plains Gas notice that they were in default under the surface, damage and water storage agreements. When they did not cure the default, the landowners filed complaints against them in district court in Sheridan County[2] and in Johnson County[3] for breach of the agreements. Landowners sought judgment for all amounts due under the agreements. High Plains and CEP-M failed to answer the complaints and the district court entered default against them in both cases. The landowners

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and Pennaco then filed motions for summary judgment.

[¶12] Relying on well established principles of contract law, the landowners asserted that Pennaco remained liable under the contracts even after the assignments. Pennaco argued the landowners' analysis was not applicable because the parties to the agreements intended to create covenants running with the land, which could only be enforced against someone in privity of estate with the landowners. Pennaco claimed that upon assigning the agreements, it ceased to have privity of estate with the landowners. The district court determined that Pennaco remained liable under the contracts and granted judgments against Pennaco for past due payments of $63,864.90, plus interest, in the case filed in Sheridan County and $71,508.60, plus interest, in the Johnson County case. The district court also awarded the landowners attorney fees and costs. Pennaco timely appealed from the district court's judgments.

[¶13] Pennaco then filed a motion in this Court to consolidate the appeals involving KD and the Hollcrofts. KD and the Hollcrofts opposed consolidation for briefing purposes but agreed the cases should be consolidated for purposes of oral argument and this Court's decision. We entered an order granting the motion to consolidate for purposes of argument and decision. There are some differences between the KD contracts and the Hollcroft contracts, listed below, but much of the analysis of those contracts is the same. Consequently, this decision primarily addresses the agreements together. The Petroleum Association of Wyoming (PAW) and Texas Oil and Gas Association (TOGA) filed motions requesting an order allowing them to file amicus briefs. We granted the motions.


[¶14] Pennaco appeals from district court orders granting summary judgment to KD and the Hollcrofts. Summary judgment is governed by W.R.C.P. 56(c), which states:

The judgment sought shall be rendered forthwith if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.

We review a summary judgment de novo, using the same materials and following the same standards as the district court and examining the record from the vantage point most favorable to the party opposing the motion, giving that party the benefit of all favorable inferences which may fairly be drawn from the record. Baker v. Speaks, 2014 WY 117, ¶ 9, 334 P.3d 1215, 1219 (Wyo. 2014). The parties agree that there is no genuine issue as to any material fact. Each side asserts that it is entitled to a judgment as a matter of law based on the undisputed facts.

[¶15] Pennaco also appeals the district court judgments awarding KD and the Hollcrofts attorney fees and costs.

The question of whether there is legal authority to award attorney fees is one of law, which we review de novo. See, Thorkildsen v. Belden, 2011 WY 26, ¶ 8, 247 P.3d 60, 62 (Wyo. 2011); Ultra Resources, Inc. v. Hartman, 2010 WY 36, ¶ 149, 226 P.3d 889, 935 (Wyo. 2010); Breitenstine v. Breitenstine, 2006 WY 48, ¶ 12, 132 P.3d 189, 193 (Wyo. 2006). The final attorney fee award is, however, reviewed for abuse of discretion. Mueller v. Zimmer, 2007 WY 195, ¶ 11, 173 P.3d 361, 364 (Wyo.2007).

Evans v. Moyer, 2012 WY 111, ¶ 37, 282 P.3d 1203, 1214 (Wyo. 2012).


1. The Law of Contract Assignment Delegation, and of Covenants Running With the Land

[¶16] The key issue in this case is whether the relationship between Pennaco and the landowners, as established by their written agreements, is primarily a contractual relationship or one based on privity of estate involving covenants running with the land. As we begin our analysis, it is appropriate to provide a brief review of the law about the effect of assignments of contractual obligations and of covenants which run with the land.

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[¶17] Well established principles of contract law dictate that a party who assigns/delegates a contractual duty remains responsible for performance of that duty.

Rights are assigned; duties are delegated. When a right is assigned, the assignor ordinarily no longer has any interest in the claim. When a duty is delegated, however, the delegating party (delegant) continues to remain liable. If this was not so, every solvent person could obtain freedom from debts by delegating them to an insolvent. Delegation involves the appointment by the obligor-delegant of another to render performance on the obligor's behalf. It does not free the obligor-delegant from the duty to see to it that performance is rendered, unless there is a novation.

Joseph M. Perillo, Contracts, § 18.25, 665-666 (7th ed. 2014). See also Arthur L. Corbin, Corbin on Contracts, § 49.6, 206 (revised ed. 2007) (" If a party assigns his right and delegates his duty under a contract, he no longer has any right, but he remains liable as a surety for the performance of the duty." ); E. Allan Farnsworth, Farnsworth on Contracts, § 11.10, 127 (3rd ed. 2004) (" a delegation of a performance does not relieve the delegating party of 'any duty to perform' or of any 'liability for breach.'" ); Samuel Williston, Williston on Contracts, § 74.27, 412-413 (4th ed. 2003) (" one who owes money or is bound to any performance whatsoever cannot by its own act, or by any act in agreement with anyone else ... divest itself of the duty and substitute the duty of another." ); Restatement (Second) Contracts, § 318(3), 319 (" Unless the obligee agrees otherwise, neither delegation of performance nor a contract to assume the duty made with the obligor by the person delegated discharges any duty or liability of the delegating obligor." ).

[¶18] The same principle applies to oil and gas leases.

Another important area of concern for a lessee is whether the assignment of its rights and obligations under a lease to another party absolves it of all responsibility under the lease, or whether there are ongoing duties for which it may bear continued responsibility. It is broadly understood that when an oil and gas lease is assigned, the assignee becomes responsible for all of the covenants in the lease (although, as seen below, this does not automatically extinguish all obligations owed to the original lessor by the original lessee). The responsibility for the observance of covenants in the lease passes through to an assignee under the doctrine of privity of estate because they are covenants that run with the land. Consequently, if an assignee in turn assigns the lease to yet another party, privity of estate is destroyed as to the prior assignee and it is no longer responsible to the original lessor for those covenants.
Absent an express clause that terminates its obligations, the original lessee-assignor will continue to be responsible to the lessor for covenants in the lease under the doctrine of privity of contract. Many oil and gas leases contain clauses eliminating contractual liability of this nature, but some do not. Where they do not, the courts are nearly universal in their finding that the original lessee-assignor retains obligations to the lessor with respect to at least some of the covenants under the lease.

62-4 CAIL Annual Institute on Oil and Gas Law § 4.03 (Institute for Energy Law of the Center for American and International Law's 56th Annual Institute on Oil & Gas, 2015) (emphasis added). See also 6-49 Thompson on Real Property, Thomas Editions § 49-62 (" Neither an assignment nor sublease will release the lessee from liability on the express covenants of the lease because the lessee is in privity of contract with the lessor." ); Williams& Meyers Oil & Gas Law § 403.1 (" The original lessee continues [to be] 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." ); 5-64 Eugene O. Kuntz, Law of Oil and Gas § 64.6 (" Under traditional landlord-tenant law, a landlord can hold both the original tenant and the tenant's assignee liable for breach of a lease covenant that runs with the estate. The original tenant is liable under the initial contractual agreement (privity of contract) with

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the lessor, and the assignee is liable because it has accepted the benefit of the leasehold estate and must accept its attached burdens as well." ).

[¶19] Among the covenants the original lessee-assignor retains after assignment of its interest are those requiring payments of rentals and/or royalties and restoration of the surface to its original condition once production activities have ceased.

[1] Delay Rentals
In many leases there is an express covenant that the lessee either must drill a well within a specified time period or pay delay rentals to the lessor. If the lessee fails to do so the lease is not terminated but the lessee is liable for the lessor for the unpaid rentals. As noted above, once the lease is assigned, this duty to drill or pay rentals primarily falls on the assignee. Nevertheless, courts have held that if the assignee fails to pay rentals, the lessor may bring an action directly against the original lessee-assignor for the collection of rentals. Of course, the original lessee-assignor, being in privity of contract with the offending assignee, may bring a suit against the assignee to recover these rentals or for other damages is may have suffered because of the failure to pay rentals.

[2] Royalties

There is an express covenant in oil and gas leases requiring the payment of royalties to the lessor out of production under the lease. If the assignee fails to pay such royalties the lessor may sue the original lessee for them.

[3] Restoration of Surface

Another obligation that may remain with the original lessee is the responsibility to restore the surface to its original condition once the production activities have ceased. Many leases contain such a requirement. In these cases, as with rentals and royalties due under the lease, the lessee may be held responsibile for restoration of the surface even if it did not conduct the operations at issue.

62-4 CAIL Annual Institute on Oil and Gas Law § 4.03.

[¶20] However, when the relationship between the parties is based on privity of estate, such as adjoining landowners where one has an access easement across his neighbor, the standard contract rule that one who delegates a duty remains responsible for performance may not apply. Duties requiring or prohibiting certain activity on the land, may " run with the land" and only obligate the party who is " in privity of estate," or connected to that land (unless the parties specify otherwise). In such a circumstance, the transfer of the land connected with the duty carries that duty to the assignee, and relieves the assignor of future responsibility. An example of such a circumstance is found in the Restatement (First) of Property § 538, cmt. c:

A conveys Blackacre to B. B promises in behalf of himself, his executors, heirs and assigns that he will maintain a dam upon the premises conveyed which dam will have the effect of maintaining a pond or lake on land retained by A at a specified level. Upon these facts it is proper to hold that upon conveyance of Blackacre by B his liability for future maintenance of the dam will cease.

An example more closely resembling the arguments of Pennaco follows: The owner of tract A obtains an access easement across tract B for the benefit of tract A, and promises to annually maintain the access easement for the benefit of both tract A and tract B. When the owner then transfers tract A to a third party, the easement and the maintenance obligation transfer with tract A. Then the original owner of tract A is no longer responsible for the annual maintenance of the easement.

[¶21] Obligations and rights which run with the land are known as servitudes. Restatement (Third) of Property (Servitudes) § 1.1. The principle that an original obligor on a servitude may not have continued responsibility for performance after transferring the related land is stated in the Restatement (Third) of Property (Servitudes) as follows:

§ 4.4. Duration of Original Parties' and Successors' Obligations and Enjoyment of Rights

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If no duration is stated and the servitude has not terminated under Chapter 7, the duration of a party's obligation under, or right to enjoy the benefit of, a servitude, is as follows:
(1) An original party or successor to a servitude burden that runs with an interest in property incurs liability on account of the servitude burden only for obligations that accrue during the time the ...

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