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Pennsylvania Environmental Defense Foundation v. Commonwealth

Commonwealth Court of Pennsylvania

July 29, 2019

Pennsylvania Environmental Defense Foundation, Petitioner
Commonwealth of Pennsylvania, and Governor of Pennsylvania, Thomas W. Corbett, Jr., in his official Capacity as Governor, Respondents

          Argued: December 12, 2018




         This case returns to us following the Pennsylvania Supreme Court's remand in Pennsylvania Environmental Defense Foundation v. Commonwealth, 161 A.3d 911 (Pa. 2017) (PEDF II). Before this Court for disposition are the parties' cross-applications for summary relief in this declaratory judgment action filed in our original jurisdiction.[1] Petitioner Pennsylvania Environmental Defense Foundation (the Foundation)[2] and Respondents Commonwealth of Pennsylvania and Tom Wolf in his official capacity as Governor of Pennsylvania (collectively, Commonwealth) seek declaratory relief under the Declaratory Judgment Act[3] as to whether money received from payments due under leases for the extraction and sale of oil and gas on State forest lands, including bonuses and annual rental payments, are part of the corpus of the environmental public trust established by Article I, Section 27 of the Pennsylvania Constitution (Environmental Rights Amendment), and if so, whether various fiscal enactments appropriating those funds for non-trust purposes are unconstitutional under Section 27. The Foundation argues that bonuses and rental payments are part of the corpus trust; the Commonwealth argues that they are not. For the reasons that follow, we grant the Commonwealth's application upon determining that one third of the proceeds constituting bonuses and rental payments are not part of the corpus trust, and thus, the challenged fiscal enactments are not facially unconstitutional. We deny the Foundation's application.


         We begin by summarizing the Supreme Court's opinion in PEDF II and its directives to this Court on remand.[4] In PEDF II, the Supreme Court examined the constitutionality of legislative enactments to The Fiscal Code[5]relating to funds generated from the leasing of State forest and park lands for oil and gas exploration and extraction. The Supreme Court began its analysis by closely examining the contours of the Environmental Rights Amendment, which provides:

The people have a right to clean air, pure water, and to the preservation of the natural, scenic, historic and esthetic values of the environment. Pennsylvania's public natural resources are the common property of all the people, including generations yet to come. As trustee of these resources, the Commonwealth shall conserve and maintain them for the benefit of all the people.

Pa. Const. art. I, §27. The Supreme Court determined that Section 27 "establishes a public trust, pursuant to which the natural resources are the corpus of the trust, the Commonwealth is the trustee, and the people are the named beneficiaries." PEDF II, 161 A.3d at 931-32.

         The Supreme Court continued that the "public natural resources" referenced in Section 27 "include the [S]tate forest and park lands leased for oil and gas exploration and . . . the oil and gas themselves." PEDF II, 161 A.3d at 931. "[S]tate parks and forests, including the oil and gas minerals therein, are part of the corpus of Pennsylvania's environmental public trust." Id. at 916.

         The Commonwealth is the trustee and not the proprietor of public natural resources. PEDF II, 161 A.3d at 932. As trustee of the public natural resources, the Commonwealth has the duty to act toward the corpus of the trust with loyalty, impartiality and prudence. Id. at 932 (citing Robinson Township v. Commonwealth, 83 A.3d 901, 956-57 (Pa. 2013) (plurality)). This includes the "duty to prohibit the degradation, diminution, and depletion of our public natural resources." Id. at 933. In addition, the Commonwealth "must act affirmatively via legislative actions to protect the environment." Id. at 933 (citing Robinson Township, 83 A.3d at 957-58).

         The Supreme Court also reviewed the history of the laws relative to oil and gas funds and the recent legislative transfers. Briefly, in 1955, the General Assembly enacted the Oil and Gas Lease Fund Act ("Lease Fund Act"), [6] which has since been repealed, [7] requiring "[a]ll rents and royalties from oil and gas leases" of Commonwealth land to be deposited in the "Oil and Gas Lease Fund" ("Lease Fund") to be "exclusively used for conservation, recreation, dams, or flood control or to match any Federal grants which may be made for any of the aforementioned purposes." Former Section 1 of the Lease Fund Act, formerly 71 P.S. §1331. Neither rents nor royalties were defined therein. The Lease Fund Act specifically appropriated all money in the Lease Fund to the Department of Forests and Waters to carry out the purposes of the act and provided the Secretary of Forests and Waters with the discretion to determine the need and the location for projects. PEDF II, 161 A.3d at 919-20; former Sections 2 and 3 of the Lease Fund Act, formerly 71 P.S. §§1332, 1333.

         With the enactment of the Conservation and Natural Resources Act ("CNRA"), [8] the Department of Conservation and Natural Resources ("DCNR"), replaced the Department of Forests and Waters as the relevant entity for purposes of the Lease Fund. Section 101 of the CNRA(b)(1), 71 P.S. §1340.101(b)(1); Section 301 of the CNRA, 71 P.S. §1340.301; Section 304 of the CNRA 71 P.S. §1340.304; see former 71 P.S. §1333. The CNRA altered the Lease Fund Act "to provide that 'all moneys' paid in to the Lease Fund were 'specifically appropriated to' the DCNR." PEDF II, 161 A.3d at 920 (quoting former 71 P.S. §1333). The CNRA empowered DCNR "to make and execute contracts or leases in the name of the Commonwealth for the mining or removal of any valuable minerals that may be found in State forests" if the DCNR determines that it "would be for the best interests of this Commonwealth." 71 P.S. § 1340.302(a)(6).

         Pursuant to this authority, DCNR entered into oil and gas leases for natural gas extraction. Of significance here, in 2008, DCNR began lease sales of State forest land in the Marcellus Shale region of northcentral Pennsylvania. "The Marcellus Shale leases dramatically increased the money flowing into the Lease Fund." PEDF II , 161 A.3d at 920.

         The oil and gas leases generated funds in the form of royalties, rents and bonuses. PEDF II , 161 A.3d at 920. Per the lease terms, royalties are paid when gas is extracted, with the payment based upon the amount of marketable gas extracted. Id. at 921. The rents are comprised of annual rental fees, an example of which ranged from $20-35 per acre, in addition to large initial "bonus payments" ranging in the millions of dollars. Id.

         In determining whether those payments constituted part of the trust corpus, the Supreme Court opined that, "pursuant to Pennsylvania law in effect at the time of enactment, proceeds from the sale of trust assets are part of the corpus of the trust." PEDF II , 161 A.3d at 933 (citing In re McKeown`s Estate, 106 A. 189, 190 (Pa. 1919) ("Being a sale of assets in the corpus of the trust, presumptively all the proceeds are principal. . . .")). "Pennsylvania trust law dictates that proceeds from the sale of trust assets are trust principal and remain part of the corpus of the trust." PEDF II, 161 A.3d at 935 (citing McKeown's Estate, 106 A. at 190) (emphasis added). "When a trust asset is removed from the trust, all revenue received in exchange for the trust asset is returned to the trust as part of its corpus." PEDF II, 161 A.3d at 935 (citing Bolton v. Stillwagon, 190 A.2d 105, 109 (Pa. 1963)) (emphasis added).

         Ultimately, the Supreme Court determined that "all proceeds from the sale of our public natural resources are part of the corpus of our environmental public trust and that the Commonwealth must manage the entire corpus according to its fiduciary obligations as trustee." PEDF II, 161 A.3d at 939. The Supreme Court held that "royalties - monthly payments based on the gross production of oil and gas at each well - are unequivocally proceeds from the sale of oil and gas resources." Id. at 935. As such, funds generated from royalties are part of the corpus and must be committed to furthering the purposes, rights and protections afforded under Section 27, i.e., to conserve and maintain our natural resources. Id. at 935. "They are part of the corpus of the trust and the Commonwealth must manage them pursuant to its duties as trustee." Id. Consequently, the Supreme Court ruled that legislative enactments relating to the use of royalties in the Lease Fund were facially unconstitutional because they diverted proceeds from the sale of oil and gas, i.e., royalties, to non-trust purposes in violation of Section 27.[9] Id. at 938-39.

         However, the Supreme Court was less clear on how to categorize other revenue streams from State forest oil and gas leases, i.e., rents and bonuses, stating that "the record on appeal is undeveloped regarding the purpose of up-front bonus payments, and thus no factual basis exists on which to determine how to categorize this revenue." PEDF II, 161 A.3d at 935. The Supreme Court recognized that the leases designate bonuses and other annual payments as "rental payments," but stated that "such a classification does not shed any light on the true purpose of the payment, e.g., rental of a leasehold interest in the land, payment for the natural gas extracted, or some other purpose." Id. Thus, the Supreme Court remanded the matter to this Court for further proceedings. Id.

         In this remand, the question before us is whether the proceeds generated from rents and bonuses under the oil and gas leases must be devoted to the conservation and maintenance of our public natural resources, or may be used for other purposes without violating the Environmental Rights Amendment. More particularly, we are tasked with determining the constitutionality of Sections 1604-E and 1605-E of The Fiscal Code, [10] and Section 1912 of the Supplemental General Appropriations Act of 2009, [11] which directed that certain money deposited into the Lease Fund be transferred to the General Fund to pay for government operations in 2009 and 2010. None of these enactments indicate on their face whether the funds transferred related to royalties, rents, or bonus bid payments, or some combination of the three. See PEDF II, 161 A.3d at 923 n.11.

         As the Supreme Court instructed, the constitutionality of these acts "depends on whether they result from the Commonwealth's faithful exercise of its fiduciary duties vis a vis our public natural resources and any proceeds derived from the sale thereof." PEDF II, 161 A.3d at 939. The Supreme Court opined that "the legislature's diversion of funds from the Lease Fund (and from the DCNR's exclusive control) does not, in and of itself, constitute a violation of Section 27." Id. Rather, "the legislature violates Section 27 when it diverts proceeds from oil and gas development to a non-trust purpose without exercising its fiduciary duties as trustee." Id.

         The Supreme Court directed:

In construing Sections 1604-E and 1605-E, to the extent that the lease agreements reflect the generation of revenue streams for amounts other than for the purchase of the oil and gas extracted, it is up to the Commonwealth Court, in the first instance and in strict accordance and fidelity to Pennsylvania trust principles, to determine whether these funds belong in the corpus of the Section 27 trust.

PEDF II, 161 A.3d at 935-36 (emphasis added). More particularly, we must adhere to private trust principles. Id. at 933 n.26.

         The Supreme Court elaborated that, although Section 27 creates a public trust, the "'public trust doctrine' does not set forth universally applicable black letter law and that Pennsylvania has no established public trust principles applicable to Section 27." Id. "At most, the public trust doctrine provides a framework for states to draft their own public trust provisions, which (like many trust instruments) will ultimately be interpreted by the state courts." Id. The Supreme Court instructed that Pennsylvania's "private trust principles provide . . . the necessary tools to properly interpret the trust created by Section 27." Id.

         Further, the Supreme Court directed:

On remand, the parties should be given the opportunity to develop arguments concerning the proper classification, pursuant to trust law, of any payments called 'rental payments' under the lease terms. To the extent such payments are consideration for the oil and gas that is extracted, they are proceeds from the sale of trust principal and remain in the corpus. These proceeds remain in the trust and must be devoted to the conservation and maintenance of our public natural resources, consistent with the plain language of Section 27.

Id. at 936 (emphasis added).

         Finally, the Supreme Court emphasized that "the proper standard of judicial review lies in the text of Article I, Section 27 itself as well as the underlying principles of Pennsylvania trust law in effect at the time of its enactment." PEDF II , 161 A.3d at 930 (emphasis added). In accordance with these remand instructions, we review the matter before us.

         II. ISSUE

         On remand, the parties developed the record and now present their cross-applications for summary relief.[12] The crux of the matter is whether bonuses and rental payments set forth in the Commonwealth's oil and gas leases are compensation for the sale of natural resources and, thus, part of the corpus trust that must be used to conserve and maintain those natural resources, or income that may be used for General Fund purposes under the Environmental Rights Amendment.[13]


         A. Contentions

         1. The Foundation's Position

         The Foundation contends that bonus and rental payments from the Commonwealth's oil and gas leases are part of the corpus of the Section 27 environmental trust. The leases make no distinction between bonuses and rental payments and royalty payments. These payments are all consideration for the purchase of oil and gas. Under trust principles in effect when Section 27 was adopted, when a lease authorized the complete removal of oil and gas from the leased premises, all of the proceeds were considered payments for the sale of oil and gas and remained part of the corpus or principal. See Petitioner's Amended Application for Relief at 12-13 (citing In re Bruner's Will, 70 A.2d 222 (Pa. 1950) and Blakley v. Marshall, 334 A. 564 (Pa. 1896)). The trust established by Section 27 does not authorize the trustee to allocate proceeds from the sale of Pennsylvania's public natural resources for purposes other than the conservation and maintenance of those resources. Thus, the Commonwealth's fiscal enactments authorizing the transfer of corpus funds for non-trust purposes are facially unconstitutional under Section 27.

         2. Commonwealth's Position

         The Commonwealth contends that up-front bonus bid payments and rental payments do not constitute compensation for sale of the trust principal. The bonus payment is money paid by the highest bidder to obtain the lease in a formal bid process. Rental payments are due on an annual basis and secure the lessee's right to explore for oil and gas. Neither payment is consideration for the severance of natural resources from the land. Rather, under common law, they are consideration for an inchoate title for the right to explore for oil and gas. This is supported by the fact that DCNR retains any bonus bid payments and rentals received even when no oil or gas is produced. If the exploration for oil and gas is unsuccessful, no estate vests in the lessee and the lease terminates at the end of the lease's primary term.

         Royalty payments, on the other hand, are directly related to the extraction of oil and gas, and only become due and owing if oil or gas is extracted. Royalty payments represent proceeds from the extracted oil and gas and are consideration to DCNR for those public natural resources.

         Under current statutory law, rent is to be allocated as trust income, not as trust principal. See Section 8145(a) of the Pennsylvania Uniform Principal and Income Act (2002 Act), 20 Pa. C.S. §8145(a). Only refundable deposits for rent shall be applied to principal. See Section 8145(b)(1) of the 2002 Act, 20 Pa. C.S. §8145(b)(1). Neither bonuses nor rent payments are refundable at the termination of DCNR's leases. Thus, they are income, not trust principal.

         Thus, the Commonwealth avers that, because bonus-bid and rent payments are not compensation for the sale of trust assets, they are not corpus of the trust and the appropriation of those funds does not violate Article I, Section 27 of the Pennsylvania Constitution.

         B. Fundamentals of Oil and Gas Leases

         We begin our discussion with an examination of oil and gas leases and the interests conveyed therein. America's foray into oil and gas extraction began in Pennsylvania in the early 1850s. The first oil well in the United States was established on Oil Creek (present-day Oil Creek State Park), Cherrytree Township, Venango County, Pennsylvania, and the first gas well was bored in Erie, Pennsylvania. Eugene Kuntz, A Treatise on the Law of Oil and Gas §1.6 (1987). The basic instrument of the petroleum industry is the oil and gas lease. Robert E. Sullivan, Handbook of Oil and Gas Law 69 (1955). The first oil lease entered in America occurred in 1853 in Pennsylvania. Kuntz §1.32. "[T]he Commonwealth has a history of leasing its land to private parties for oil and gas exploration dating back to 1947." PEDF II, 161 A.3d at 919.

         1. A Lease is a Contract

         Since then, the area of law dealing with oil and gas leases has burgeoned. "[T]here have been many and radical developments in the industry with corresponding changes in the contracts employed to define the respective rights of land owners and operators and the laws and decisions have kept pace with these advances." Appeal of Baird, 6 A.2d 306, 310 (Pa. 1939). As our Supreme Court has recognized, the traditional oil and gas 'lease' is unique and "far from the simplest of property concepts." Brown v. Haight, 255 A.2d 508, 510 (Pa. 1969). At its core, "a lease is in the nature of a contract and is controlled by principles of contract law." T.W. Phillips Gas & Oil Co. v. Jedlicka, 42 A.3d 261, 267 (Pa. 2012). Accordingly, it must be construed "in accordance with the terms of the agreement as manifestly expressed, and '[t]he accepted and plain meaning of the language used, rather than the silent intentions of the contracting parties, determines the construction to be given the agreement.'" Id. (citation omitted).

         2. Interests Conveyed

         Typically, the landowner, as the oil and gas lessor, has three distinct interests in the land and the minerals contained therein: (1) a possessory interest in the surface except insofar as it may interfere with drilling operations; (2) a right to receive bonus, rentals and royalties under the lease; and (3) the possibility of reverter in the minerals in place. Sullivan at 69.

         The tenant, or oil and gas lessee, acquires a possessory interest in the minerals. Id. The tenant is able to use only so much of the surface as may be necessary for drilling operations. Id. His possession of the mineral estate is contingent upon discovery and production. Id. Many cases have considered the interests of lessees under oil and gas leases in various contexts. Baird's Appeal, 6 A.2d at 310. It is helpful in this context in determining the nature of the payments exchanged for that interest.

         "In the case law[, ] oil and gas Teases' have been described as anything from licenses to grants in fee." Brown, 255 A.2d at 510. Initially, Pennsylvania classified the lessee's interest as an incorporeal hereditament, not a conveyance of title. Funk v. Haldeman, 53 Pa. 229, 241 (1866) (a grant of the right to search for or "experiment for oil" and take all the minerals in the land of another, yielding a royalty to the grantor, is an incorporeal hereditament). Later cases consistently held that the title conveyed in an oil and gas lease is inchoate, and is initially for the purpose of exploration and development. Burgan v. South Penn Oil Co., 89 A. 823, 826 (Pa. 1914); Calhoon v. Neely, 50 A. 967, 968 (Pa. 1902); Venture Oil Co. v. Fretts, 25 A. 732 (Pa. 1893); see also Sabella v. Appalachian Development Corp., 103 A.3d 83, 101 (Pa. Super. 2014); Hite v. Falcon Partners, 13 A.3d 942, 945 (Pa. Super. 2011); Jacobs v. CNG Transmission Corp., 332 F.Supp.2d 759, 772 (W.D. Pa. 2004).

         Regardless of how the interests are classified, the general purpose of an oil and gas lease is to secure the right to explore and develop the property with the expectation of receiving large returns from the royalties payable on production. Sullivan at 72. Once oil or gas is discovered, captured, and removed, it becomes the property of the lessee. Brown, 255 A.2d at 512; Venture Oil Co. v. Fretts, 25 A. at 735. The lessee obtains a fee simple determinable estate. Brown, 255 A.2d at 512; Venture Oil, 25 A. at 735. The lessee's right to extract oil or gas becomes vested. Venture Oil, 25 A. at 735. If no oil or gas is produced, no estate vests. Id.

         3. Consideration

         In order for the contract to be valid, there must be consideration conveyed. Shedden v. Anadarko E. & P. Co., L.P., 136 A.3d 485, 490 (Pa. 2016) (citing T.W. Phillips Gas, 42 A.3d at 267). The same holds true with oil and gas leases. Id. There are various forms of consideration paid by a lessee for the privilege of exploring for and producing oil and gas such as royalties, rentals, bonuses, and interest. Our focus on remand is on rentals and bonuses.

         a. Rentals

         "The term 'rental' as used in standard oil and gas leases, refers to the consideration paid to the lessor for the privilege of delaying drilling operations." Sullivan at 126 n.9. Sometimes, this is referred to as a "delayed rental." The term "rent" has also been used to describe a flat sum to be paid for each producing well. George G. Bogert, The Law of Trusts and Trustees §827 (rev. 2019). Typically, rents do not depend on the discovery or production of oil and gas, but rather represent compensation for the time to explore. Sullivan at 125 n.4.

         Standard oil and gas leases provide for rents for a set number of years until oil and gas is discovered. Sullivan at 104. This affords the lessee time to explore and develop the property. Id. at 104. If oil or gas is not found within that set time, the lease automatically terminates. Id. Therefore, it is incumbent for the tenant to secure the testing, development and operation of the leased premises for oil and gas purposes during the set term. Id. The purpose of the rent is to compensate the landowner for this exploration time because he is not receiving royalties. Id. Typically, once oil or gas is discovered in paying quantities, payments from rentals convert to royalties.

         b. Bonuses

         As oil and gas leases became more lucrative, it became common practice to pay a bonus, i.e., "a substantial sum initially as an inducement to the landowner to grant the lease." Sullivan at 108. The amount varies depending upon the prospective value of the land for oil and gas purposes. Id.

         "The word 'bonus' has a definite meaning in the oil and gas industry. It is defined . . . as a premium paid to a grantor or vendor, and strictly in the cash consideration or down payment paid or agreed to be paid for the execution of an oil and gas lease." Sullivan at 126 n.9. A bonus is a sum paid for the execution of the lease, representing its market value, or to be paid later out of the lessee's share of the production of a well. Bogert §827.

         In Pennsylvania, bonus provisions in mineral leases have served different purposes. In some cases, the bonuses were due and owing based upon actual production. See Burgan (the lease required lessee to pay a bonus if the first well drilled produced 50 barrels of oil per day for 60 days); Akin v. Marshall Oil Co., 41 A. 748 (Pa.), aff'd sub nom. Stone v. Washington Oil Co., 41 A. 1119 (Pa. 1898) (bonus payable if gas discovered and produced in paying quantities); Nelson v. Eachel, 27 A. 1103 (Pa. 1893) (a bonus in the form of a judgment note was payable only upon production); Brushwood Developing Co. v. Hickey, 16 A. 70 (Pa. 1888) (bonuses were based on the amount of oil extracted); see also Wilson v. Philadelphia Co., 60 A. 149, 150 (Pa. 1904) (bonus due upon the completion of the first well).

         In other cases, the bonuses were given for the right to explore or enter the lease, but were not based on the actual production of oil and gas. See Brandon v. McKinney, 82 A. 764 (Pa. 1912) (a bonus was paid for the lease); Glasgow v. Chartiers Oil Co., 25 A. 232 (Pa. 1892) (bonus paid for the right to explore and develop the land); see also Carnegie National Gas Co. v. Philadelphia Co., 27 A. 951 (Pa. 1893) (the lessee forfeited an existing lease and entered a new lease by paying a bonus).

         In some cases, the bonus payment was split for a dual purpose. See McMillin v. Titus, 72 A. 240, 243 (Pa. 1909) (one bonus was given as consideration for the initial right to occupy the premises and explore for oil; the other bonus was payable only if oil or gas was found in paying quantities); Smiley v. Gallagher, 30 A. 713 (Pa. 1894) (part of the bonus was to be paid when the lease was delivered, part of the bonus was to be paid out of the first oil produced).

         Bonuses have also been used as part of a competitive bidding process in securing oil and gas leases. See Parry v. Miller, 93 A. 30, 32 (Pa. 1915); Lenau v. Co-eXprise, Inc., 102 A.3d 423, 425 (Pa. Super. 2014).

         4. Duty to Explore and Drill

         In addition to paying consideration, early cases imposed a duty upon the lessee to explore during the lease term or risk loss by abandonment. See Baird's Appeal, 6 A.2d at 311; Venture Oil, 25 A. at 735. Later cases backed away from this premise, particularly where the lease provided for rentals and bonuses as compensation for a set term. See Hite, 13 A.3d at 946 (delay rental payment relieved the company of any obligation to develop the leasehold during the primary term, but not beyond). Such payments ensured that the lessor would be compensated for the lessee's delay or default in exploring and developing the property. Ray v. Western Pennsylvania Natural Gas Co., 20 A. 1065, 1066 (Pa. 1891) (the payments "were intended not only to spur the operator, but to compensate [the lessor] for the operator's delay or default").

         Next, we examine whether rents and bonuses in the Commonwealth's oil and gas leases constitute income or principal pursuant to Pennsylvania trust principles in effect at the time of Section 27's enactment. PEDF II, 161 A.3d at 930.

         C. Pennsylvania Trust Law

         Under trust law, the question of the relative rights between present and future interests, particularly with regard to rents or bonuses under oil and gas leases, is a complex one.[14] As our Supreme Court instructed, we must adhere to Pennsylvania trust law principles at the time of Section 27's enactment. To understand trust law as it stood in ...

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