Recently, I’ve been receiving a number of calls from prospective clients who are looking for ways to extract themselves from an old lease that covers their property. Various scenarios exist: (1) an old lease was signed years ago, but no well was ever drilled; (2) a well was drilled, but has sat idle for some time, with no royalties being paid; (3) a well was drilled and royalties have been paid, but they are sporadic or of a very small amount. With the recent increase in leasing in Ohio, and considering the large sums being offered, these clients want to know if they can cancel the old lease to allow them to sign a new lease for large dollars.
Old Lease – No Well Ever Drilled
This situation is the simplest to deal with. An oil and gas lease will normally have a fixed primary term (for example, 5 years) and a loose ended, secondary term (for example, so long as oil or gas are produced). If a well is not drilled within the primary term, the secondary term never kicks in and the lease terminates automatically – it is not necessary for a landowner to go to Court to void the lease. A landowner should be free to sign a new lease with another company after the lease term expires. The new company will sometimes request that the landowner sign an affidavit indicating that no well was ever drilled under the old lease and that no royalties ever paid, just to have some peace of mind.
Old Lease – Well Drilled, But No Royalties Being Paid
This is a much trickier situation, and will really depend upon the particular facts. Recall, as discussed above, that the lease has a secondary term. Leases use various language to define the secondary term. Oil companies will frequently use some very broad, and sometimes vague, language to define the secondary term of the lease. For example, the lease will continue if “oil or gas are capable of being produced from a well on the subject premises in the judgment of the lessee.” That’s not a good clause for a landowner. I prefer to define the secondary term as “so long as oil and gas are being produced in paying quantities.” This means that there is significant production coming out of the well and the landowner is being sent a royalty check. I believe this is fair to both parties. After all, when the lease was signed, the parties likely were not agreeing or anticipating that the lease would continue for years after the point where was no profit being generated from the well.
If the lease is favorably drafted for the landowner, and if production has stopped for an extended period (particularly if for no good reason), a landowner can successfully argue that the term of the lease has expired. “Extended period,” as used in the preceding sentence likely means years, rather than months. There have been several Ohio court decisions that have so found under these circumstances. See, for example, American Energy v. Lekan, 75 Ohio App.3d 205 (1992) and Moore v. Adams, Ohio App. 5 Dist.,2008, 2007AP090066.
Old Lease – Well Drilled, Minimum Royalties Being Paid
One monkey wrench that an oil and gas company can throw into the above situation is the payment of a shut-in royalty. Most leases provide for a shut-in royalty that can extend the secondary term of the lease, even though a well is shut in. In the Moore case, cited above, the lease did have a provision permitting the lease to continue if shut-in payment were made. However, the gas company failed to pay shut-in payments (or any other royalties) for a period of 6 years. Then, as the landowner was about to file suit, the oil company sent a check equal to 6 years’ worth of shut in payments. The landowner (smartly) refused to cash the check and the court determined that tendering this late check did not keep the lease alive. When representing landowners, I will typically permit a shut in clause because sometimes things happen that legitimately cause an oil company to shut things down for a time. However, I like to fine tune that clause so that a producer does not have a right to pay a modest shut in fee indefinitely and for no good reason.
The discussion above really concerns the expiration of a lease based upon the written terms thereof. An alternative method of cancelling a lease would be through a forfeiture. Ohio courts generally disfavor forfeitures, so these are tough cases. If the facts and lease language are a favorable, a landowner will generally want to argue that his lease expired by its terms, rather than argue that the lessee forfeited its interests in a lease. Sometimes, however, you don’t have favorable lease terms or facts. For instance, maybe there is an old well and you are still getting small royalties. At the same time, all your neighbors are getting great wells drilled and the company operating your well appears to be in no hurry to do any additional drilling. You have a large farm which has ample room for more wells – or perhaps deeper formations could be drilled on your property (e.g. to the Marcellus or Utica formation.) What can you do about that?
Again, these are difficult cases, but you could argue that, by failing to drill additional wells on your land, the lessee forfeited such right. In 1897, the Ohio Supreme Court, in Harris v. Ohio Oil Co., 48 NE 502, held that an oil and gas companies have a duty to operate prudently, under the surrounding circumstances, and to reasonably develop the lands under lease. It affirmed similar decisions in other states that implied these concepts into an oil and gas lease. It recognized that where wells were drilled on neighboring properties, it was negligent for an oil and gas company to permit that to continue where gas or oil might be drained from the leased property. However, the court stressed that if the landowner could be compensated by money, rather than a by forfeiture of the lease, that was the preferred method of compensation. There have not been a lot of cases decided in Ohio on this issue, but I anticipate that there will be more activity in the courts in the near term.