Ohio Appellate Court Holds That the Exercise of Storage Rights Maintains Production Rights Under “Dual-Purpose” Leases

July 3, 2013

In a key ruling on July 1, Ohio’s 7th District Court of Appeals affirmed the trial court’s summary judgment in favor of the lessees of oil and gas rights, upholding the validity of two oil and gas leases. See Conny Farms, Ltd. v. Ball Resources, Inc., No. 12 CO 18, 2013-Ohio-2874 (7th. App. Dist. 2013).[1] In so doing, the court held, significantly, that leases allowing both production of oil or gas and the storage of gas (so called “dual-purpose” leases) would remain in effect so long as either production or storage is taking place.

In Conny Farms, the landowners (who had purchased the properties subject to the leases) filed suit against the lessees, arguing that (1) the leases had expired by their own terms because lessees failed to store or produce gas on the subject properties; and (2) the lessees had forfeited the leases by failing to make rental or royalty payments under the leases.

The parties filed cross motions for summary judgment. The lessees argued: (1) that the lessees and their predecessors had been continuously storing gas under the properties, and thus the leases remained in effect for all purposes (including production); and (2) that the landowners had failed to provide notice of the change in ownership, as they were required to do under the terms of the leases, and thus that the lessees did not breach the lease by not making payments.

Relying on the express language of the leases, the Court of Common Pleas granted the lessees’ motion for summary judgment and dismissed the landowners’ complaint. The 7th District affirmed.

In determining the continuing validity of the leases, the court looked to the habendum clause of the dual-purpose leases, which provided that “this Lease shall remain in force for the term of ten years from the date hereof, and as long thereafter as the said land is operated by the Lessee in the search for or production of oil or gas or so long as gas is being stored, held in storage, or withdrawn from the premises by Lessee ” (emphasis added). Relying on the unchallenged testimony of the president of the lessee gas company, the court held as a matter of law that gas had been continuously stored under the subject parcels, and thus, that the leases remained in effect according to the plain terms of the leases.

The court also rejected the landowners’ argument that the lessees failed to preserve their production rights by failing to pay delay rentals under the leases. Pursuant to the terms of the lease, the lessees were required to pay royalties in connection with production, rentals for storage and delay payments to preserve drilling rights in the absence of either drilling or storage. Again, citing to the express language of the leases, the court held that “a second payment was not necessary to preserve the lessee’s future right to drill.” The court explained that “the language in the [payment] clause provides that a payment pursuant to that clause is sufficient to preserve the future right to drill insofar as it states: ‘such payments shall be in lieu of and not in addition to royalties or rentals otherwise provided for by this agreement,’ and further that ‘[i]t is agreed that the Lessee may drill or not drill on said land, … , as he may elect and rentals paid and to be paid constitute adequate compensation for such privilege’ ” (emphasis and alterations in original).

Finally, the court found that the landowners’ noncompliance with the notice provision of the leases was “fatal” to their claim for nonpayment. The leases contained a provision acknowledging that either party could assign its interests, in whole or in part, but expressly requiring the landowners to provide notice of any change in ownership, declaring that “no change in ownership of the land or assignment of rentals or royalties shall be binding on the lessee until after the lessee has been furnished with a written transfer or assignment or a true copy thereof.”

The court rejected the contention that anything short of compliance with that term would suffice. In particular, while the court noted that the landowners sent letters arguing that the leases had terminated, and threatening to sue unless the lessees executed a cancellation of the leases, the court found this letter did not provide actual or constructive notice of the change in ownership, and did not represent substantial compliance with the notice provision. The court further held that the lessees were under no obligation to make payments until properly noticed with the change in ownership, and that the lessees acted in good faith in suspending payments until they received proper notice of the change. Additionally, the court recognized that the lessees had no affirmative obligation to search internal or county records to determine the identity of new landowners (adopting a decision from the 4th District Court of Appeals) The court recognized that this would impose an unreasonable burden and expense on lessees.

This opinion — from the court with jurisdiction over some of the most promising parts of the Utica shale play (including Harrison, Carroll, Belmont and Columbiana Counties) — represents an important win for lessees in the continuing torrent of lease-challenge litigation sparked by Utica and other deep shale production. In addition to strictly construing and enforcing express lease provisions, the court recognized the affirmative duty on the lessor providing a change in ownership, and declined to impose a duty on the lessee to identify new owners. Most importantly, the court recognized that, where the habendum clause provides that the lease will remain in effect so long as either production or storage takes place, the lessor will retain both rights by exercising either of them.

1. This is the second time the 7th District has ruled on this case. Previously, the trial court granted summary judgment to the lessees on the basis that the landowners failed to comply with “judicial ascertainment” clauses in the leases (i.e., clauses providing that the lease would not be forfeited until after a court had ruled that there was in fact a breach, and until after the lessee had failed to cure the breach in a timely fashion). The 7th District reversed, concluding (as a matter of first impression in Ohio) that “judicial ascertainment” clauses were unenforceable against public policy, on the ground that they caused a multiplicity of litigation. See Conny Farms Ltd. v. Ball Resources, Inc., No. 09 CO 36, 2011-Ohio-5472 (7th. App. Dist. 2011). After remand, the trial court once again granted summary judgment in favor of lessees, which is the subject of the current appeal.