Oil and Gas Lease Ownership Challenges
Below are the materials the National Business Institute asked me to prepare for a seminar on Oil and Gas law.
LEASE / OWNERSHIP CHALLENGES, DISPUTES AND NEGOTIATIONS
A. Recent case law and litigation trends
Though Ohio was one of the earliest states to have commercial production of oil and gas, surprisingly, it has not developed much of a body of case law in the field of oil and gas. Frequently, the laws of other states must be reviewed to find cases on point – Texas, Oklahoma and Louisiana seem to have the most published opinions concerning oil and gas.
The advent of the Utica shale has changed things. Numerous oil and gas cases have been filed in Ohio over the last several years and they are making their way through various levels of appeals. Within the next 10 years or so, it can be expected that Ohio’s case law in the field of oil and gas will have expanded considerably. Some of the recent cases in the pipeline are discussed below.
1. Dormant minerals cases
In many oil and gas producing states (e.g., Texas), when a mineral severance is made, it is permanent. If rancher Jones reserves the oil and gas rights on 1,000 acres, that interest remains in his name unless he assigns it of record. It is not unusual, particularly where a mineral interest is inactive (i.e., not generating any income), that the executor of party who dies owning mineral rights is unaware of the asset. When this occurs, things can get a bit complicated.
Assume rancher Jones reserves the oil and gas rights on 1,000 acres in 1900 and dies in 1920. No mention of the asset is made in his probate estate. Rancher Jones is survived by his wife and five children. By 1999, when drilling interest has heated back up in the area, there are several generations of Jones’ who have a claim to the oil and gas rights that are still titled in rancher Jones. An oil and gas company interested in drilling on that 1,000 acres must (an often will) go to great lengths to establish the family history, and review probate estates and wills so that the proper parties can identified to sign an oil and gas lease. Only then can drilling occur.
In an effort to somewhat streamline the process of dealing with severed mineral interests, Ohio and some other states have enacted what are referred to as dormant mineral laws. The general idea behind these laws is that where a severed mineral interest has remained ‘dormant’ or unused for a period of time, a process is used to allow the surface owner to acquire title to the minerals. When that occurs, an oil and gas company need not worry about determining and tracking down the heirs to the record owner of the minerals and may simply deal with the current landowner in lease negotiations. This would tend to make development of minerals throughout the State more likely.
Under the present version of the statute (the 2006 DMA), an inquiry is made into whether a ‘savings event’ occurred within the twenty years preceding the landowner’s required notice to the mineral owner of their intent to recapture the minerals. In situations where a savings event had clearly occurred within such time frame, a landowner would be out of luck under the new statute – thus a creative argument was made by such landowners that they could, nevertheless, use the older version of the statute (the 1989 DMA) to acquire their minerals. Proponents of this theory say that the prior version of the statute “deemed” the mineral to be abandoned in the absence of a savings event; thus, if a 20 year dormant period is shown to have occurred prior to the passage of the new statute, the minerals “automatically” reverted to the surface owner under the old statute. Opponents of this theory argue that a quiet title suit filed presently should use the current statute (not the old one) to determine the rights of the parties.
These cases are, by far, the most prevalent of oil and gas cases having been filed in Ohio over the last 5 years – many dozens have been filed with a few now pending in the Ohio Supreme Court. It would appear that this court recognizes the impact that oil and gas has upon our state and that it is willing to accept discretionary appeals in an attempt to bring clarity to the field.
Dodd v. Croskey, 2013-Ohio-4257, was the first dormant minerals case to reach a court of appeals in Ohio. This case was filed in Harrison County (CVH 2011-0019) and then appealed to the Seventh District. The first issue was whether a deed in the chain of title that was recorded within the last 20 years could be deemed a savings event (“title transaction”) because it restated the existence of a prior mineral reservation. The Court of Appeals overruled the trial court’s decision holding that such a deed was a title transaction. It based such holding on the fact that the definition of a title transaction is one that “affects” the interest. Here, the grantor of the recent deed did not own the mineral interest; thus he could not affect it. Reference to a prior mineral reservation in a new deed, therefore, did not qualify as a title transaction.
Another issue in Dodd was whether sufficient notice had been given by the landowner to the mineral owner claimants. Here, the evidence indicated that the record owners of the mineral interest were long deceased and a title search showed no transfer of record. There was also a contention made that a search showed that the record owners did not have probate estates opened in the subject county. No certified mail was sent by the landowner – only notice by publication was made. The mineral owners claimed that this did not meet the requirements of the statute, and the trial court agreed. The Court of Appeals avoided the issue of whether the landowner satisfied the notice requirements and instead found that, because some of the mineral owners did receive actual notice of the claim via the newspaper notice, lack of service by certified mail was “harmless error.”
The most significant holding in Dodd concerned the ramifications of a mineral owner timely responding to a landowner’s notice of intent to recapture minerals. Here, certain heirs of the record mineral holder did file “claims to preserve” their interests under 5301.56(C). This was done within the 60 day window set out in 5301.56(H). Via a lengthy analysis of the various provisions of the statute, the Court held that such a filing does qualify as a savings event under the statute, notwithstanding the fact that it was recorded outside of the 20 year window defined in 5301.56(B)(3). This case is presently pending in the Ohio Supreme Court.
Walker v. Shondrick-Nau, 2014-Ohio-1499, was the first case to reach a court of appeals (the Seventh District) that dealt with the issue of whether the 1989 DMA could be used in a suit filed after that statute was amended in 2006. The trial court and the Seventh District ruled that the statute could be used. In reaching this decision, the courts needed to tie the 20 year look back under the 1989 DMA to a particular event. Both courts decided to tie it to the effective date of the statute – March 23 of 1989. Thus, the focus is upon whether the minerals were dormant during the 20 years preceding the effective date, plus a 3 year grace period reference in the statute. In short, under this case, if there were no savings events between 3/23/69 and 3/23/92, the minerals automatically vested in the surface owner. This case has been accepted for review by the Ohio Supreme Court.
Following Walker, the Seventh District has issued several other decisions concerning the application of the 1989 DMA, which were consistent with Walker. In some of those decisions, Judge DeGenaro issued separate strong opinions disagreeing with the idea that the 1989 DMA should be used after it was amended in 2006 (see, e.g., Eisenbarth v. Reusser, 2014-Ohio-3792). Judge DeGenaro cited Judge Markus’ opinion in Dahlgren v. Brown Farms (Carroll Co. 13 CVH 27445 – presently pending in the Supreme Court) as supporting authority.
Wendt v. Dickerson, 2014-Ohio-4615, this opinion was issued by the Fifth District and primarily involved the issue of whether the 1989 DMA could be used in presently filed cases. This was a short opinion and cited to and agreed with the Seventh District’s decisions on this issue.
2. Lease cancelation actions
Hupp v. Beck Energy, 2014-Ohio-4255, was a case that sent shivers down the backs of the oil and gas industry. The case was filed as a class action and requested the court to certify a class of hundreds of landowners who had signed a particular form lease used by Beck Energy. The trial court did certify the class. It also found, upon a motion for summary judgment, that such leases were void and against public policy, because the terms therein appeared to create a lease that was “perpetual.” On appeal, the court of appeals held that the lease terms were similar to those used throughout the industry, though the particular language was aggressively favorable to the lessee. The appellate court ruled that the leases needed to be read in accord with industry practice and settled Ohio law, and with such an interpretation, they were not perpetual and remained in effect. The appellate court did uphold the trial court’s certification of the class, though it would appear there is no reason for Plaintiffs to continue the litigation in light of the relief prayed for (cancellation of the leases).
Hupp is also interesting as it relates to the issue of “tolling” leases during a period of litigation. At the trial level, an order was put on that tolled the running of the leases until such time as the matter was finally adjudicated. The concept here is that it is not fair for a landowner to file suit, arguing the lease is invalid, when there are only a few months left to run on the lease term; this puts the lessee in an untenable position – do I drill a well while litigation is pending and then get charged with a trespass?
Claugus v. Seventh Dist. Ct. of Appeals, Supreme Court # 2014-0423 directly resulted from the Hupp case. There, Claugus had an old lease that was getting ready to expire. He had worked out a deal with another company to execute a new lease with significant money to be paid by the lessee. In the course of investigating the title, the new lessee stumbled upon the Hupp case (recall that it was a class action, and recall that a tolling order had been issued which suspended the term of the old lease from running out). Though Claugus was unaware of the Hupp case and had never received any notice from that court, and though Claugus had no interest in participating as a class member, he was still considered a class member by the Seventh District. Thus, he could not proceed with his new lease (i.e. get paid big bucks). Claugus was filed as a mandamus action and the Supreme Court has accepted it for review.
Because Ohio recognizes the concept that “the law abhors forfeitures,” convincing a judge to terminate a lease where there are producing or producible wells located upon the property is often a tough task. Situations involving late payment of production royalties, or damage to farm fields can be solved with an award of money and do not require cancellation of the underlying lease. Your only real shot is trying to avoid the concept of forfeiture and argue that the lease has expired by its own terms – see Harris v. Ohio Oil Co., 57 Ohio St. 118, 130-31, 48 N.E. 502, 506 (1897):
While the period of five years that the lease was to run has expired, the lease is still in full force, because it provides that it shall continue as much longer as oil and gas are found in paying quantities. This provision extends and limits the period of the lease to such time in the future as oil and gas shall cease to be produced in paying quantities on said lands. When that period shall arrive, whether caused by the exhausting of the oil and gas, or by the permanent abandonment of production, the lease will cease, and the whole estate in the premises will become the property of the owner of the fee, not by forfeiture, but by virtue of the terms of the lease.
The bottom line on most of these cases is whether, for a significant period of time (probably at least 2-3 years), the lessee has failed to operate the lease at a profit – even a very small profit. That is, after paying the landowner royalties and all costs of operating the well, did the lessee make money?
Tisdale v. Walla, Ohio App. 11 Dist.,1994, 1994 WL 738744 (Ohio App. 11 Dist.) This case involved a well that was drilled and commercially produced for a number of years. Later, the well was only used for free gas purposes by several landowners who owned land in the drilling unit. Mr. Walla owned the property where the well was actually located and later disconnected the other neighbors from the well. He was sued by those neighbors. The lessee was not a party to the lawsuit. Mr. Walla argued that he owned the well; that he had no legal duty to supply gas to the neighbors; and that the lease had expired, since the well had not been produced for many years. The trial court held that the lease had not expired automatically and that Mr. Walla should have used ORC 5301.332 to obtain a cancellation of the lease. The court of appeals overruled, holding that the lease expired automatically when commercial production ceased for such a long period, particularly where shut in fees had not been paid by the lessee.
Wuenschel v. Northwood Energy Corp. Ohio App. 11 Dist.,2008, 2008 WL 5389710 (Ohio App. 11 Dist.), 2008 -Ohio- 6879 This complicated case involved the use of ORC 5301.332 by a lessor in a very aggressive manner. The well in question was transferred from Northwood Energy to another producer (Barr). Upon acquiring the well, Barr invested money to replace the old, leaky pipeline that had caused the well to be shut in for 1-2 years. Barr placed the wells into production soon after and sent a royalty check to the original lessor (who had sold the property to Wuenschel). Wuenschel had failed to notify Northwood or Barr of his ownership of the premises. When the royalty check came back as undeliverable, Barr began to escrow the landowner royalties, expecting that the rightful owner would make a claim. This situation continued for 4-5 years, at which point Wuenschel filed a notice of forfeiture under ORC 5301.332. Instead of sending the notice to Barr, who Wuenschel knew to own the well, notice was sent to the old owner, Northwood. Barr promptly tendered all back royalties to Wuenschel when he learned of the change in ownership, but did not timely file an affidavit contra to Wuenschel’s and the county recorder voided the lease. Under those facts, the trial court and appellate court found the landowner’s actions to be “disingenuous,” and it re-instated the lease in favor of Barr.
Morrison v. Petro Evalauation Serv., Inc., Ohio App. 5 Dist.,2005, 2005 WL 2715578 (Ohio App. 5 Dist.), 169 Oil & Gas Rep. 575, 2005 -Ohio- 5640 An interesting case where the lessee is making the argument that a lease has expired due to non-production. Briefly, a well was drilled which encountered sour gas that needed to be treated before it could be sold into a utility line. Over a period of several years, the lessee explored various ways in which it could market the gas. Ultimately the ODNR pressured the lessee to produce or plug the well and, in response, the lessee sent a letter to the ODNR indicating that the well was capable of producing oil and/or gas in commercial quantities. Sometime later the landowner sued the lessee for 11 years worth of shut in fees. The lessee claimed the fees were not due as the lease had expired. The landowner claimed that the lease language called for the lease to continue so long as “operations described above are being conducted on the premises, or oil or gas is produced or is capable of being produced from the premises.” The trial court and court of appeals held in favor of the landowner and awarded the past due shut in fees.
Moore v. Adams, Ohio App. 5 Dist., 2008, No. 2007AP090066 This recent case found that a failure to pay royalties for a period of 6 years, after a sales line was damaged, caused the lease to be terminated. It should be noted that no shut in fees were paid, as well.
American Energy Services v. Lekan (1992) 75 Ohio App. 3d 205, has a similar holding to Moore, supra and involves a lease where a well was drilled and, although capable of commercial production, never produced for a period of 20 years.
Sometimes a lease has very clearly expired by its terms: no well was ever drilled within the primary term; a well was drilled but has since been plugged and abandoned; or no production or activity on the well for many years. In these circumstances, and where your client has a pending lease offer for big money from another company, and where the old lessee refuses to record a cancellation of the lease, there is a nice statute that may allow you to apply additional pressure:
5301.09 Recording lease of natural gas and petroleum.
All leases, licenses, and assignments thereof, or of any interest therein, given or made concerning lands or tenements in this state, by which any right is granted to operate or to sink or drill wells thereon for natural gas and petroleum or either, or pertaining thereto, shall be filed for record and recorded in such lease record without delay, and shall not be removed until recorded. No such lease or assignment thereof shall be accepted for record after September 24, 1963 unless it contains the mailing address of both the lessor and lessee or assignee. If the county in which the land subject to any such lease is located maintains permanent parcel numbers or sectional indexes pursuant to section 317.20 of the Revised Code, no such lease shall be accepted for record after December 31, 1984, unless it contains the applicable permanent parcel number and the information required by section 317.20 of the Revised Code to index such lease in the sectional indexes; and, in the event any such lease recorded after December 31, 1984, is subsequently assigned in whole or in part, and the county in which the land subject thereto is located maintains records by microfilm or other microphotographic process, the assignment shall contain the same descriptive information required to be included in the original lease by this sentence, but the omission of the information required by this section does not affect the validity of any lease. Whenever any such lease is forfeited for failure of the lessee, his successors or assigns to abide by specifically described covenants provided for in the lease, or because the term of the lease has expired, the lessee, his successors or assigns, shall have such lease released of record in the county where such land is situated without cost to the owner thereof.
No such lease or license is valid until it is filed for record, except as between the parties thereto, unless the person claiming thereunder is in actual and open possession.
Effective Date: 09-20-1984
A lessee who continues to refuse to record a cancellation of lease, notwithstanding the statute, would leave itself open to a slander of title claim.
3. Improper unitization
Although the terms “pooling” and “unitization are frequently used interchangeably, more properly “pooling” means the bringing together of small tracts sufficient for the granting of a well permit under applicable spacing rules whereas “unitization,” or, as it is sometimes described, “unit operation,” means the joint operation of all or some part of a producing reservoir. Williams & Meyers, Oil and Gas Law, Section 901.
Unitization can take one of two forms: voluntary unitization, by way of an agreement by multiple owners or lessees of the subject mineral rights, or via compulsory unitization that is regulated by a state agency according to statute.
Unitization statutes appear customarily to include some reference to a “common source of supply” which expressly or implicitly limits unitization to such a common source. Thus the Oklahoma statute provides that: “Each unit and unit area shall be limited to all or a portion of a single common source of supply. Only so much of a common source of supply as has been defined and determined to be productive of oil and gas by actual operations may be so included within the unit area.” Williams & Meyers, Oil and Gas Law, Section 913.4
The idea behind unitization is that it permits a party to efficiently operate “a producing reservoir” with a common supply source, determined by actual study and testing. “It appears generally assumed in some unitization statutes that only lands proved to be productive shall be included in a compulsory unit.” Williams & Meyers, Oil and Gas Law, Section 913.8.
To make matters more complicated, we also have to consider “minimum spacing” or “proration” rules imposed by various states. In some of the western states, the governing bodies establish unique drilling units that apply to specific geologic horizons and which are sometimes created after wells have been drilled.
Ohio’s rules are somewhat simpler. Ohio generally does not concern itself with drilling units or pools. Instead, it principally focuses upon wells. Before the ODNR issues a drilling permit, the producer must represent that it has obtained the necessary leases required to meet minimum spacing requirements for such well. For example, as to vertical wells drilled below 4,000’, the producer need only show: (1) that all landowners falling within 500’ of the well have been included in the unit; (2) that a minimum of 40 acres is included in the unit; and (3) that the well does not fall within 1,000’ feet of any well producing from the same formation.
When pooling or unitization come into play in Ohio are usually when the lessee, itself, decides to create a unit or pool – typically by recording a formal declaration of pooled unit (DPU). This right to combine multiple tracts is generally found within the lease itself (the pooling or unitization clause). It is generally held that, without such a clause, the lessee has no right to pool a leased tract. The typical unitization clause found in Ohio leases gives the lessee broad rights to: create one or more pools; using all or portions of the leased premises; amend pools previously created; and to pool specific geologic formations.
There is no significant case law in Ohio governing a lessee’s powers and responsibilities in creating drilling units or pools. Other states have some published cases in this regard, but not as many as one would think – most of these cases tend to involve situations where there was some manner of compulsory pooling imposed by the state (which has not occurred with any frequency in Ohio). Generally speaking, most courts have imposed a duty upon a lessee to act in good faith when creating a drilling unit or pool. See, for example Circle Dot Ranch, Inc. v. Sidwell Oil & Gas, Inc., 891 S.W.2d 342, 345 (Tex. App. 1995), writ denied (Aug. 1, 1995):
At the outset, we notice that the paragraph 6 consolidation provision is an express covenant, which is independent in nature because actual performance by the lessee is not dependent on any performance by the lessor. Black’s Law Dictionary 363 (6th ed. 1990). Historically, Texas courts, in considering the lessee’s exercise of a pooling option granted by such a covenant, have held the lessee to a standard of good faith in making a determination to pool. Vela v. Pennzoil Producing Co., 723 S.W.2d 199, 206 (Tex.App.—San Antonio 1986, writ ref’d n.r.e.); Elliott v. Davis, 553 S.W.2d at 226; McCarter v. Ransom, 473 S.W.2d 235, 239 (Tex.Civ.App.—Corpus Christi 1971, no writ); Banks v. Mecom, 410 S.W.2d 300, 303 (Tex.Civ.App.—Eastland 1966, writ ref’d n.r.e.); Tiller v. Fields, 301 S.W.2d 185, 190 (Tex.Civ.App.—Texarkana 1957, no writ). Accord Smith v. Killough, 461 S.W.2d 510, 513 (Tex.Civ.App.—Eastland 1970, writ ref’d n.r.e.) (holding that to cancel a unitization declaration, the lessor had to prove the lessee acted in bad faith). In holding the lessee to a standard of good faith, some of the authorities characterized the standard as an implied requirement, see, e.g., Elliott v. Davis, 553 S.W.2d at 226; Tiller v. Fields, 301 S.W.2d at 190, or an implied obligation, see, e.g., McCarter v. Ransom, 473 S.W.2d at 239, but none of them designated the good faith standard as an implied covenant.
Pooling and unitization clauses can permit an unscrupulous lessee to create units for its own benefit, rather than based upon the involved geology or the need to aggregate smaller parcels to satisfy Ohio’s minimum spacing requirements. As an example, where several large farms are pooled and thereafter only one well is drilled thereon which drains only a small portion of the pool, a lessee could be deemed to have been in bad faith for creating the unit. Similarly, including only one acre of a hundred acre farm into a pool created for a single well, on its face, seems designed to hold that farm by production without an intent to extract the minerals therefrom. There are likely to be cases decided in the future that will better flesh out a lessee’s obligations in regard to unitization and pooling in Ohio.
It should also be noted that, concerning compulsory unitization, Ohio does have a statute in this regard that was infrequently used, but which is being used much more frequently with the advent of Ohio’s new shale plays:
1509.28 Order providing for unit operation of a pool or part thereof.
(A) The chief of the division of oil and gas resources management, upon the chief’s own motion or upon application by the owners of sixty-five per cent of the land area overlying the pool, shall hold a hearing to consider the need for the operation as a unit of an entire pool or part thereof. An application by owners shall be accompanied by a nonrefundable fee of ten thousand dollars and by such information as the chief may request… (remainder of statute omitted)
4. Improper royalty calculation
Before considering an action regarding improper payment of royalties, a practitioner should be aware of a couple of Ohio statutes that apply. The first gives you a statutory right to receive information about past payment of royalties prior to the filing of any lawsuit.
1509.30 Reports to holder of royalty interest.
The holder of a royalty interest in any natural gas well may request the owner to report to him, no more frequently than the payment period in his contract with the owner:
(A) The volume of natural gas for which he was or is being paid for the most recent period in his contract with the owner, and for any other previous periods within two years of the date of production for which the owner has not already given him such a report;
(B) The price per thousand cubic feet paid to the holder for such gas;
(C) The volume of natural gas which was shown to have passed through the owner’s meter for the field containing the holder’s well.
The owner shall preserve records of such volume for at least two years after the date the record is made. Upon receipt by the owner or his agent of a request by the holder pursuant to this section, the owner shall supply the information to the holder within fifteen days, or the end of the current payment period in the contract, whichever is later.
If the holder’s well is metered, the owner shall in such report also inform the holder of the volume of natural gas which was shown to have passed through such meter during the period.
The volume of gas required to be reported by this section shall be indicated on the basis of a standard cubic foot of gas.
The second statute limits how far back a landowner can go in claiming improper payment of royalties (effectively, 4 years):
2305.041 Action for breach of oil or gas lease or license.
With respect to a lease or license by which a right is granted to operate or to sink or drill wells on land in this state for natural gas or petroleum and that is recorded in accordance with section 5301.09 of the Revised Code, an action alleging breach of any express or implied provision of the lease or license concerning the calculation or payment of royalties shall be brought within the time period that is specified in section 1302.98 of the Revised Code. An action alleging a breach with respect to any other issue that the lease or license involves shall be brought within the time period specified in section 2305.06 of the Revised Code.
Effective Date: 04-06-2007
This statute is relatively new and few cases have involved it. Lutz v. Chesapeake Appalachia, L.L.C., 717 F.3d 459 (6th Cir. 2013) recently weighed in on how it operates. Plaintiff in that case argued that the lessee began improperly calculating royalties in 1993 and continued that practice to the present. At the trial level, the court held that the statute required suit to be brought within 4 years from the date the improper calculation commenced. The Court of Appeals found, however, that each royalty payment represented a separate breach so the Plaintiff’s claims were not barred. The Court of Appeals also noted that a properly supported claim of fraudulent concealment, could toll the applicable statute. Thus, if a lessee is issuing royalty statements that fail to disclose improper deductions from, or that misrepresent material facts concerning, the landowner’s royalties, the statute may be tolled during such period.
Background: Lessors of royalty rights to natural gas brought putative class action against three interrelated energy companies with whom they entered into oil and gas leases, alleging defendants deliberately and fraudulently underpaid gas royalties over a time period spanning more than a decade. The United States District Court for the Northern District of Ohio, Sara E. Lioi, J., dismissed plaintiffs’ suit, 2010 WL 2541669, and, subsequently, denied plaintiffs’ motion to alter or amend the judgment or, in the alternative, for relief from judgment, 2010 WL 4823225. Plaintiffs appealed.
Holdings: The Court of Appeals, Griffin, Circuit Judge, held that:
1 actions of lessees in making monthly royalty underpayments constituted breaches of divisible contract obligations;
2 discovery rule was not applicable to toll the limitations period on lessees’ breach of contract claim; but
3 issue of whether lessors were entitled to equitable tolling could not be resolved at the motion to dismiss phase.
Affirmed in part, reversed in part, and remanded.
Class action potential. Hupp v. Beck, cited above, indicates a willingness by the Seventh District to allow lease disputes to proceed as class actions under state law. I have handled two prior class action cases involving improper calculation of royalties by oil and gas companies, both of which were settled after the class was certified. There are a few big obstacles to overcome in prevailing. The first is the commonality requirement. Almost certainly, the leases held by class members vary in describing how royalties are to be paid. Another obstacle, discussed below, is the existence of “notice/cure” clauses within modern leases. Last, is the 4 year statute of limitations discussed above. These cases are vigorously defended for obvious reasons, so do your homework.
5. Failure to reasonably develop the leased premises
Ohio, like most other oil and gas producing states, has developed a body of law that “implies” various duties upon a lessee under an oil and gas lease. These are typically referred to as “implied covenants.” One such implied covenant is that a lessee must reasonably develop the premises under lease. For example, where a lessee obtained a 200 acre lease and drilled a good well that drained only 40 acres of such lease and then let the lease sit idle for another 10 years, the landowner would have a good argument that the lessee was acting unreasonably by failing to drill additional wells, and that the non-drilled acreage should be removed from the lease. Conversely, had a second and third well been drilled which were dry holes, the lessee likely was within its rights not to drill thereafter.
This duty, can also apply to differing formations within the same lease. Say your lessee fully drilled up the prevalent shallow formation under a large lease but stands idly by while competing lessees are drilling horizontal Utica shale wells under the neighboring properties. This could open the door up for a court to void the lease as to such deeper formations.
There is not significant case law in Ohio dealing with these issues. Do keep in mind, however, that modern leases attempt to avoid the imposition of the implied covenant to reasonably develop. A sample clause:
The consideration, land rentals or royalties paid and to be paid, as herein provided, are and will be accepted by the Lessor as adequate and full consideration for all rights herein granted to the Lessee, and the further right of drilling or not drilling on the leased premises, whether to offset producing wells on adjacent or adjoining lands or otherwise, as Lessee may elect.
Another clause inserted into leases more directly addresses the issue of implied covenants:
It is mutually agreed that this instrument contains and expresses all of the agreements and understandings of the parties in regard to the subject matter hereof, and no implied covenant, agreement or obligation shall be read into this agreement or imposed upon the parties or either of them.
Ohio courts have recognized that such clauses do not violate public policy and are enforceable. See for example, Taylor v. MFC Drilling, Inc., 94CA14, 1995 WL 89710 (Ohio Ct. App. Feb. 27, 1995), Bilbaran Farm, Inc. v. Bakerwell, Inc., 2013-Ohio-2487, and Bushman v. MFC Drilling Inc., 2403-M, 1995 WL 434409 (Ohio Ct. App. July 19, 1995)
6. Improper assignment of a lease
The overwhelming majority of leases contain clauses permitting the lessee to assign same. If the instrument lacks any language in that regard, public policy and the law weigh in favor of the right to freely assign property and contract rights. Sometimes, however, a lease will contain a clause requiring that a lease may not be assigned without a landowner’s consent. Sometimes such clauses require that the landowner not unduly delay or withhold their consent.
Nationwide, there is a dearth of cases that deal with this issue. Typically, plaintiff landowners discover the assignment and then file suit requesting that the lease be cancelled due to the improper assignment. Rarely have courts accepted that argument. In Stanolind v. Guertzgen, 100 F.2d 299 (1938), a federal court in Montana allowed such a claim and voided the lease. No other such cases have been found. Most cases on this issue hold that, rather than the lease being void, the improper assignment is void. A recent case in Ohio, so held.
Harding v. Viking Internatl. Res. Co., 2013-Ohio-5236
Background: Successors in interest to oil and gas lessors brought declaratory judgment action against purported assignee of lessee, seeking declaration that lessee had assigned its rights under three oil and gas leases in violation of anti-assignment clauses, so as to render leases invalid, forfeited, and void. Defendant filed counterclaim requesting that the court quiet title in its favor and declare the leases to be valid and in full force and effect. The Court of Common Pleas, Washington County, granted partial summary judgment in favor of plaintiff, holding that assignments were void but that original lease agreements remained in effect. Defendant appealed.
Holding: The Court of Appeals, McFarland, P.J., held that plaintiffs were not estopped from challenging validity of lessee’s assignments of oil and gas leases to defendant on grounds that lessee violated anti-assignment clause in original leases, even though plaintiffs accepted and cashed monthly royalty checks for eight months before objecting to the assignments.
B. Rights of the surface owner vs. mineral owner (the Accommodation Doctrine)
The Accommodation Doctrine is a body of law developed outside of Ohio (no cases can be found in Ohio where same is referenced within the context of an oil and gas or mineral case) which recognizes that the surface and mineral estates in the same lands are sometimes owned by separate parties. In such instances, issues can arise as to the parties’ respective rights in usage of the land.
The typical oil and gas lease grants the lessee wide powers to explore, survey, test, drill wells, install pipelines, use water, and build roads. Ideally, if the type and location of the well facility is known at the time of leasing, these issues can be addressed with some specificity to alleviate problems down the road. More typically, however, things are left vague because further leasing and study in the area is required before the location of the well and related improvements becomes more clear.
In Ohio, producers have historically acted to keep landowners apprised of their plans and will gain their informal consent and cooperation in siting leasehold improvements. Because Ohio has had a practice of giving “free gas” to landowners upon which wells are drilled, landowners are often receptive to having a well located on their property as opposed to the neighbor’s.
Sometimes leases have provisions requiring that the landowner’s written consent be obtained on these matters. Often this is a “soft” consent, requiring that it not be unreasonably withheld. A landowner refusing to grant a “soft” consent would presumably be required to convince a judge that he had a reasonable basis for refusing to allow a well or equipment to be located in a location proposed by a lessee. Alternatively, it may be a “hard” consent, giving the landowner absolute discretion in granting same; this sort of provision essentially turns the lease into a non-drilling or “no surface” lease.
Frequently, leases are silent on the issue of where wells and other leasehold improvements can be located and have no consent clause. Vertical wells often pose a relatively small imposition upon the use and aesthetics of land – typically only comprising a wellhead, a gravel road, a small tank battery, and underground pipelines. Horizontal shale wells are another story – the well pad may take up 5 or more acres, water holding ponds may be constructed, heavy duty roads are built, multiple tanks are involved and multiple wells can be drilled from the same pad over a period of many years. The impact upon the land from these facilities is much greater than that from a vertical shallow well.
For the above reasons, shale producers routinely negotiate agreements with their leased landowners after the lease is taken and prior to the drilling of any wells. These are referred to as surface use agreements; they are very detailed and normally provide significant additional compensation to the landowner – typically based upon the amount of affected acreage.
When the agreements reached between lessor and lessee do lack clarity, courts are often requested to resolve things. The Accommodation Doctrine is an attempt to balance competing goals of the landowner and the producer. A recent case out of Texas …
Merriman v. XTO Energy, Inc., 407 S.W.3d 244, 247 (Tex. 2013)
Homer Merriman, a pharmacist by occupation, owns the surface estate of an approximately 40–acre tract (the tract) in Limestone County. His home and a barn are on the tract, and he has installed permanent fencing and corrals which he uses in a cattle operation. Merriman leases several other tracts of land that he also uses in his cattle operation. Once a year he brings his cattle to the 40–acre tract in a “roundup” to sort and work them. The sorting and working activities involve using temporary corrals and catch-pens in conjunction with the permanent fencing and structures.
XTO Energy, Inc., the lessee of the tract’s severed mineral estate, contacted Merriman in September 2007 about locating a gas well on the tract. Merriman claimed that the proposed location would interfere with his cattle operation, so he opposed it. Despite Merriman’s opposition, XTO proceeded to construct a well site and drill the well. When XTO began construction of the well site Merriman filed suit seeking temporary and permanent injunctions enjoining it from drilling the well. After the well was drilled he amended his pleadings and sought a permanent injunction requiring XTO to remove it. Merriman’s claim for injunctive relief was based on his assertion that XTO failed to accommodate his existing use of the surface for the annual sorting and working part of his cattle operation so XTO’s acts exceeded its rights in the mineral estate and constituted a trespass.
A party possessing the dominant mineral estate has the right to go *249 onto the surface of the land to extract the minerals, as well as those incidental rights reasonably necessary for the extraction. Tarrant Cnty. Water Control & Improvement Dist. No. One v. Haupt, Inc., 854 S.W.2d 909, 911 (Tex.1993); Getty Oil Co. v. Jones, 470 S.W.2d 618, 621 (Tex.1971). The incidental rights include the right to use as much of the surface as is reasonably necessary to extract and produce the minerals. If the mineral owner or lessee has only one method for developing and producing the minerals, that method may be used regardless of whether it precludes or substantially impairs an existing use of the servient surface estate. Haupt, 854 S.W.2d at 911; Getty Oil, 470 S.W.2d at 622. On the other hand,[i]f the mineral owner has reasonable alternative uses of the surface, one of which permits the surface owner to continue to use the surface in the manner intended … and one of which would preclude that use by the surface owner, the mineral owner must use the alternative that allows continued use of the surface by the surface owner.
Haupt, 854 S.W.2d at 911–12. To obtain relief on a claim that the mineral lessee has failed to accommodate an existing use of the surface, the surface owner has the burden to prove that (1) the lessee’s use completely precludes or substantially impairs the existing use, and (2) there is no reasonable alternative method available to the surface owner by which the existing use can be continued. See Getty Oil, 470 S.W.2d at 628 (op. on reh’g); see also Humble Oil & Refining Co. v. Williams, 420 S.W.2d 133, 135 (Tex.1967); Davis v. Devon Energy Prod. Co., L.P., 136 S.W.3d 419, 424 (Tex.App.–Amarillo 2004, no pet.). If the surface owner carries that burden, he must further prove that given the particular circumstances, there are alternative reasonable, customary, and industry-accepted methods available to the lessee which will allow recovery of the minerals and also allow the surface owner to continue the existing use. Haupt, 854 S.W.2d at 911–12.
Merriman’s affidavit and deposition testimony, even assuming they were not entirely *252 conclusory, are evidence only that XTO’s well precludes or substantially impairs the use of his existing corrals and pens, creates an inconvenience to him, and will result in some amount of additional expense and reduced profitability because to continue his cattle operation he will have to build new corrals or conduct his operations in more phases. Evidence that the mineral lessee’s operations result in inconvenience and some unquantified amount of additional expense to the surface owner does not rise to the level of evidence that the surface owner has no reasonable alternative method to maintain the existing use. See Getty Oil, 470 S.W.2d at 623; Williams, 420 S.W.2d at 135. Thus, Merriman did not produce evidence sufficient to raise a material fact issue as to part of the initial element on which he had the burden of proof: that he had no reasonable alternative means of maintaining his cattle operations on the 40–acre tract. See Wal–Mart Stores, Inc. v. Merrell, 313 S.W.3d 837, 839–40 (Tex.2010); King Ranch, 118 S.W.3d at 755.
C. Resolving Oil and Gas Title Issues
1. Drafting oil and gas title opinions
Oil and gas title opinions in Ohio are primarily used by oil and gas companies and can be conducted at various stages – before paying for a lease, before drilling of the well, and before disbursing royalties generated by a well. In the past, such opinions were often prepared by small law firms for small companies who were expending small amounts to acquire leases and to drill shallow wells that produced modest amounts of income. That game has changed. The stakes involved with $5,000/acre leases and $10,000,000 horizontal shale wells are much different.
This change of stakes has actually caused title insurers to change the way they do business in Ohio. Within the last several years, title policies have begun including exclusions as to the minerals underlying the insured land. While the policy may reference some of the more recent leases and other mineral transactions, coverage as to minerals is excluded.
For the most part, producers are now using larger firms to issue title opinions. Sometimes landowners seek to obtain an opinion concerning their mineral title. When the property is unleased and where active leasing is ongoing in the client’s area, it seems like good advice to simply have the client sign the lease, delete the warranty of title clause, and let the lessee perform its own due diligence, rather than having the client go through the expense of a title review. Otherwise, an attorney might be tempted do this sort of work and limit their liability by including appropriate language in the agreement with the client. Be aware of ORPC 1.8:
(h) A lawyer shall not do any of the following:
(1) make an agreement prospectively limiting the lawyer’s liability to a
client for malpractice or requiring arbitration of a claim against the lawyer unless
the client is independently represented in making the agreement;
2. Held by production issues / Curing Title Defects
As previously discussed, sometimes litigation is required to finally determine the validity of an oil and gas lease. There are some alternative, statutory procedures, however, that may get the job done. Keep in mind that if a new or prospective lessee is in the picture, waiting to pay your client for a new lease, it is often advisable to consult with it as to your plan of clearing title to determine whether your course of action is practical – remember the “golden rule” – he who holds the gold rules. If the prospective lessee disagrees with your approach to voiding the lease or resolving some other title issue, you have wasted your efforts and your client’s money.
One approach, the easiest, is to prepare and record an affidavit by your client citing the lack of any activity, production or royalties from the old lease for a long period of time. These are sometime referred to as Affidavits of Non-Performance or some similar name. There is no Ohio statute that specifically authorizes such document. There is a more general statute that supports the usage of such an affidavit:
5301.252 Recording affidavit relating to title.
(A) An affidavit stating facts relating to the matters set forth under division (B) of this section that may affect the title to real estate in this state, made by any person having knowledge of the facts or competent to testify concerning them in open court, may be recorded in the office of the county recorder in the county in which the real estate is situated. When so recorded, such affidavit, or a certified copy, shall be evidence of the facts stated, insofar as such facts affect title to real estate.
(B) The affidavits provided for under this section may relate to the following matters:
(1) Age, sex, birth, death, capacity, relationship, family history, heirship, names, identity of parties, marriage, residence, or service in the armed forces;
(3) The happening of any condition or event that may create or terminate an estate or interest;
(4) The existence and location of monuments and physical boundaries, such as fences, streams, roads, and rights of way;
(5) In an affidavit of a registered surveyor, facts reconciling conflicts and ambiguities in descriptions of land in recorded instruments.
(C) The county recorder for the county where such affidavit is offered for record shall receive and cause the affidavit to be recorded as deeds are recorded, and collect the same fees for recording such affidavit as for recording deeds.
(D) Every affidavit provided for under this section shall include a description of the land, title to which may be affected by facts stated in such affidavit, and a reference to an instrument of record containing such description, and shall state the name of the person appearing by the record to be the owner of such land at the time of the recording of the affidavit. The recorder shall index the affidavit in the name of such record owner.
(E) Any person who knowingly makes any false statement in any affidavit provided for in this section is guilty of falsification under division (A)(6) of section 2921.13 of the Revised Code.
Effective Date: 03-18-1997
In the past, producers frequently accepted such affidavits as a title clearing mechanism, particularly where no wells had ever been drilled on or near the premises, or where those which had been drilled were plugged. More recently, some companies insist upon a signed release of the original lease, no matter how old or undrilled it may be. Obtaining same can often be difficult, particularly when the lessee is defunct. Research via the Secretary of State is a good starting point.
Another statutory process is available for clearing oil and gas leases. O.R.C. 5301.332 – This is a statutory process that is very similar to O.R.C. 5301.56 (the dormant mineral statute), but instead of dealing with severed mineral interests, this statute deals with forfeiture of oil and gas leasehold interests.
i. Has same notice requirements (certified mail, to the lessee, his successors or assigns or, when not possible, service by publication).
ii. Same 30-60 window to file an affidavit.
iii. Same ability of oil and gas interest holder to record a countervailing claim that interest has not lapsed.
iv. Same ability to have recorder notate the lease as being void if no claim is filed by lease holder.
v. Statute not nearly as useful as O.R.C. 5301.56, as the lessee is likely to still be alive and in business – all it needs to do is record a countervailing claim to shut the process down. May work for a sloppy or unsophisticated lessee.
vi. No presumption of invalidity upon the showing of stated elements set out in the statute. In the event of a lawsuit, validity of lease will be determined by the terms of the lease, the facts, and prior case law.
Yet another statute is available to deal with your client’s mortgage, which is typically viewed as a title defect. Most producers will attempt (either before paying for the lease or before drilling any wells) to obtain a mortgage subordination from the bank. Most banks seem cooperative in that regard, understanding that the funds received from their borrower make it more likely that the mortgage gets paid. Others, however, either perceive that the well decreases the value of their collateral or that they might be exposed to some sort of liability with a well on the mortgaged property. Some producers are willing to overlook the mortgage due a statute enacted in 2000, which gives oil and gas leases a super-priority in the event of a foreclosure. O.R.C. 1509.31(D) provides:
(D) If a mortgaged property that is being foreclosed is subject to an oil or gas lease, pipeline agreement, or other instrument related to the production or sale of oil or natural gas and the lease, agreement, or other instrument was recorded subsequent to the mortgage, and if the lease, agreement, or other instrument is not in default, the oil or gas lease, pipeline agreement, or other instrument, as applicable, has priority over all other liens, claims, or encumbrances on the property so that the oil or gas lease, pipeline agreement, or other instrument is not terminated or extinguished upon the foreclosure sale of the mortgaged property. If the owner of the mortgaged property was entitled to oil and gas royalties before the foreclosure sale, the oil or gas royalties shall be paid to the purchaser of the foreclosed property.
Some have proposed that the statute might not pass constitutional muster. While that argument has some merit, as the statute appears to violate existing contracts, mortgages issued following the effective date of the statute would have been granted with notice thereof.
One issue that is encountered in recording documents discussed above that arises more than it should occurs at the courthouse – either at the Auditor’s office or the Recorder’s office. When confronted with a document a clerk is not used to seeing, sometimes a document will not be accepted for recording – this decision is often made in the presence of a sign on the wall indicating “We are not permitted to give legal advice.” This can be extremely frustrating. The better practice seems to be to take a deep breath, speak with Recorder or Auditor directly, and if that does not work, speak to the County Prosecutor (who acts as counsel to those officers). Also remember to take a copy of any statute that applies to the document you intend to record. If none of the above work, contact a local title attorney who can run interference for you.
D. Resolving Common Lease Disputes
Like any other field, oil and gas is a world unto itself. Terms and procedures used in the industry are unique. Potential clients are quickly gaining sophistication in this area. If you intend to represent them, you need to know the difference between a ‘doghouse’ and an outhouse – they probably do. If you lack experience, seek out experienced counsel in this area for consultation. Use good people in the industry as experts (these are not always easy to find). Read books on petroleum geology. We recently tried a case where the other side was so obviously uneducated in the area of dispute that it was frankly embarrassing for them.
Oil and gas terms, procedures, and practices are frequently foreign to juries and judges – you need a way to convey simple rules of the road that they can follow and base their decisions upon. As an example, I recently represented a small producer, who was charged with failing to “reasonably develop” the Utica shale underlying the plaintiff’s property. I was able to show that not a single such well had ever been drilled within the subject township. I argued that the rule being imposed upon my client was that he had to be the first producer to drill a well in that township and such well had to include the plaintiff’s 20 acres in the drilling unit.
It is noted that oil and gas litigation in Ohio very frequently involves, not disputed facts, but interpretation of documents and statutes – this is likely due to the limited body of case law in Ohio. For this reason, litigation often involves extensive motion practice. Plaintiffs can expect to routinely be met with: motions to dismiss for failure to state claims (which were, frankly, few and far between when I started my practice); motions for full or partial summary judgment; and motions involving discovery and protective orders. In many cases, a trial before a judge or jury is simply not necessary. Attorneys should seek, early on, to attempt to arrive at mutually stipulated facts that allow a court to make a prompt ruling on the merits.
Notice and cure clauses. Many modern leases contain clauses indicating that, prior to any litigation being commenced, the lessee must be given written notice and an opportunity to cure the problem. Such clauses are likely enforceable, however be aware that they often have no application to the claim being asserted. For example, a failure to timely pay a delay rental under a lease that gives the lessee an option to extend same by payment of delay rentals, clearly does not involve some sort of breach by the lessee. There is no need to comply with a notice/cure clause in such instance. Similarly, if your claim is that the lessee has failed for some period of time to produce in paying quantities, it is not in breach of the lease, they lease has simply expired by its terms.
Tolling of leases. Always keep in mind that if you file a suit challenging the validity of a lease, the doctrine of “tolling” (discussed above) may well come into play. Factor that into your analysis. If you lease is about to expire in a couple of months anyway with no indication that a well could be drilled within that timeframe, maybe the worst thing you could do is file a suit asking to have it cancelled.
Many modern leases now contain arbitration clauses. Read these carefully before commencing litigation or making a demand for arbitration. Is arbitration mandatory, or merely optional? Many of these clauses do not provide a clear process for implementing the arbitration. Because of that, an unscrupulous producer can use such ambiguity to unduly delay a resolution of the case. If you feel that is what is happening to you, you may be caused to file a declaratory judgment asking for clarity as to the arbitration process.
Do your homework in selecting one or more arbitrators. If three are to be used, the one you select is effectively going to be your advocate to convince the neutral. It would be wise to pick someone with experience in oil and gas matters, rather than someone who is merely an experienced attorney or arbitrator.
If the AAA is to be involved, last time I checked, it has no specified panel of oil and gas arbitrators, so you could well end up getting one or more arbitrators with little or no oil and gas experience – hopefully that will change.
E. Mineral rights bequests?
“Mineral rights” can take all manner of different forms. I view them as being on a sliding scale from 1 – 10. The most aggressive form of a mineral reservation would be that of “all minerals.” If you are helping a seller of real estate draft their deed and use this phrase in your deed, a savvy buyer is likely to balk, as this language would permit, not only drilling of gas wells, but mining of coal, sand, gravel, etc.
In drafting reservations you need to tailor the language to the agreement reached by the parties. If the seller is only interested in making sure that she continues to receive the royalties generated from existing wells during her lifetime, then that is all that need be expressed in the deed.
If your client desires to bequeath by will certain mineral interests, make sure you understand exactly what interests are owned by the client, before describing them in the will. Then clearly state which beneficiaries are to receive same. If don’t have the time or don’t want to spend the money to determine exactly what mineral rights your client has when you are drafting their will, make them understand that a grant of “all real estate” to a beneficiary is going to cover same; likely, if a client holds only a leasehold estate in oil and gas, such an interest may not be covered by such a clause and, instead, would pass via the will’s residuary clause.
The reason we have so many pending dormant mineral suits presently is because attorneys handling estates many years ago apparently failed to ask their clients about minerals they might own. Without such an inquiry, the minerals were never transferred as part of the probate process. Due to the huge increase in value of minerals in Ohio, it would be wise to make such inquiry in all cases.