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Oil and Gas Lease Did Not Terminate for Unpaid Royalties

A lease to drill for oil and gas in Washington County did not terminate when the energy companies failed to pay annual royalties it promised the landowners, the Ohio Supreme Court ruled today.

At issue was a form contract that was altered by striking out provisions, and adding an addendum that  caused the parties to dispute whether failure to pay a “delay rental” was a reason to terminate a contract. Writing for the Supreme Court majority, Justice Patrick F. Fischer ruled the energy companies complied with the provision that prevented the contract from terminating, and remanded the case to the trial court for further proceedings.

Company Drilled and Underpaid
Ronald and Barbara Bohlen own 12 parcels of land covering 500 acres in Lawrence Township, Washington County. In 2006, the Bohlens entered an oil and gas lease with Alliance Petroleum Corp., which granted the company exclusive rights to use the land for exploration. Alliance agreed to make a royalty payment to the Bohlens based on gas production and proceeds.

The lease contained an industry-standard “habendum clause” that required the company to drill a well within one year and allowed the company to lease the property as long as oil and gas were capable of being produced in paying quantities.

The lease contained a provision to pay a delay rental of $5,500 for each year it deferred from drilling a well. If it did not pay the delay rental, the lease terminated. Separately, the lease contained an addendum that provided that Alliance would make up the shortfall between the royalty payments and the “annual rental payments” when the royalty payments were less than $5,500.

The company completed two wells within a year, and neither produced oil. One well produced gas in 2007, but not since. The other has produced gas since its inception in 2007. Between 2007 and 2013, Alliance only paid the Bohlens $5,500 once, and every other year paid between $4,172 and $5,448. During that period, Alliance assigned part of its lease interest to Anadarko E&O Onshore LLC.

Bohlens Seek to Terminate Lease
In 2013, the Bohlens filed for a declaratory judgment in Washington County Common Pleas Court requesting an order that the lease be declared forfeited. They argued the lease violated public policy because it allowed the companies to tie up the land indefinitely by only paying the $5,500 annual rentals. They also suggested that the lease terminated when the companies failed to pay $5,500 and that it terminated because the wells failed to produce.

The trial court sided with the Bohlens accepting all three of their arguments. The companies appealed to the Fourth District Court of Appeals, which reversed the trial court’s decision. In late 2014 Artex Energy Group LLC became a successor to Anadarko, and the Bohlens appealed the decision in favor of the three energy companies to the Ohio Supreme Court, which agreed to hear the case.

Leases Are Enforceable Contracts
Justice Fischer explained that the Court had previously noted that while oil and gas leases deal with property interests, they are contracts and the principles of contract law apply. This prompted the Court to examine the terms of the contract and determine what the parties intended when they used the terms “delay rental” and “annual rental payments” in this specific contract.

Oil and gas leases generally have a habendum clause with two components: a “primary term” that requires a definitive action, and a “secondary term” that carries on for an unspecified duration as long as certain conditions are met, typically producing oil and gas in paying quantities. A delay rental clause permits an energy company to delay drilling as long as it pays the landowner for the right. Citing recent Ohio Supreme Court and appellate court decisions, the Court noted that the delay rental provision only applies to the primary term.

In this lease, Alliance was required to drill a well within one year of signing the agreement with the Bohlens, or pay a $5,500 delay rental fee. The Bohlens maintained that this lease was not typical in that the parties struck out some of the language dealing with delay rentals and added an addendum that provided that Alliance must pay the $5,500 annual rental.

The couple argued the two clauses must be read together to mean that if the energy companies paid less than $5,500 a year, the lease terminates.
The Court disagreed. It ruled that since the company drilled two wells in the first year, the delay rental clause was not triggered. The lease was in its secondary term when the companies failed to pay the full $5,500.

“Therefore, we conclude that the underpayment by the lessees of the minimum annual rental, as provided in the lease addendum, does not entitle the Bohlens to a forfeiture of the lease under the unrelated delay-rental clause,” the opinion stated.

The opinion noted that whether the companies owe the Bohlens for the underpayment was not an “issue before this Court.”

The Court also rejected the argument that the arrangement violated the public policy against perpetual leases. The Bohlens cited the Court’s 1983 Ionno v. Glen-Gery Corp. decision where a mining company was found to have breached the “implied duty to reasonably develop the land” because the lease did not contain a time when mining operations needed to start. That type of lease allowed the mining company to pay a minimal delay rental for as many years as it wanted without ever having to mine, which the Court found violated public policy and was void.

Recently, the Court explained in its 2016 State ex rel. Claugus Family Farm, L.P. v. Seventh Dist. Court of Appeals decision that oil and gas leases with habendum clauses do not allow for perpetual payments to avoid drilling. The Court ruled delay rental payments apply only to the definite primary term. In this case, that term was one year, and the companies met the obligation by drilling the wells. Delay rental payments do not apply to the indefinite secondary term, and the lease does not allow the companies to indefinitely stall drilling without paying.

Chief Justice Maureen O’Connor and Justices Terrence O’Donnell, Judith L. French, William M. O’Neill and R. Patrick DeWine joined Justice Fischer’s opinion.

Justice Sharon L. Kennedy concurred in judgment only.

2015-0187. Bohlen v. Anadarko E&P Onshore LLC, Slip Opinion No. 2017-Ohio-4025.

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