On January 14, 2014, the Sixth Circuit applied Ohio law and reversed a judgment on the pleadings by the District Court for the Southern District of Ohio in favor of an oil and gas lessor and remanded for entry of judgment in favor of the lessee. See Henry v. Chesapeake Appalachia, LLC, 739 F.3d 909, 2014 U.S. App. LEXIS 682 (6th Cir 2014).
This Sixth Circuit opinion may have some impact on several “lease-busting” appeals pending in the Ohio Court of Appeals for the Seventh District, including Hupp v. Beck Energy Corporation, Oxford Oil Company v. West, Bentley v. Beck Energy Corporation and Belmont Hills Country Club v. Beck Energy Corporation, each of which invalidated leases still in their primary term based on trial court determinations that the leases were perpetual and therefore void ab initio as a violation of public policy.
In Henry, the trial court’s judgment on the pleadings in favor of the lessor had determined that the recording of a Declaration and Notice of Pooled Unit (DPU) during the primary term that included the lessor’s property did not extend the lease because the lease required the filing of a drilling permit application pertaining to the leased property or a property unitized with the leased property before the expiration of the primary term. The Sixth Circuit did not reach the question whether a drilling permit application was necessary to commence operations, because it determined that the DPU filing itself constituted the commencement of operations.
The primary lease term expired on October 17, 2011. The DPU that included lessor’s property was filed on October 14, 2011, bearing an effective date of October 6. Prior to the filing of the DPU, a drilling permit application had been submitted for a well located on a property that was included in the listed properties in Exhibit A to the DPU. The Sixth Circuit determined that the filing of the DPU was an “act…in an endeavor to obtain, maintain or increase the production of oil and/or gas,” as contained in the definition of ”Operations” contained in the lease, and relied on the Ohio Circuit Court decision in Duffield v. Russell 10 Ohio C.D.472, 19 Ohio C.C. 266 (Ohio Cir. Ct. 1899): ”…[T]he commencement of operations upon the land for the development of oil or gas, if done honestly and bona fide, with the intention of developing, may consist of a trivial and insignificant matter…[a]ny act, the performance of which has a tendency to produce the desired result, is a commencement of operations.” (Id. at 474). This Circuit Court opinion was affirmed without comment by the Ohio Supreme Court at 65, Ohio St. 605, 63 N.E. 1127 (1902). The Sixth Circuit reasoned that:
“…[B]ecause operations had already commenced on the Asuncion unit, the filing of the DPU was an act in an endeavor to join Plaintiffs property in the production unit that Chesapeake was in the process of exploiting…[i]t was clearly an act similar to or incidental to acts “in search for or in an endeavor to obtain, maintain or increase the production of oil and/or gas” from the Plaintiffs’ property.”
(2014 U.S. App. LEXIS at*13-14). It is worthy of note that the lease at issue in Henry provided that “Lessee is hereby granted the right, in its sole discretion, at any time and from time to time during and after the Primary Term, to pool, unitize or combine all or any portion of the Leasehold with any other land or lands.”
It was the lessee’s sole discretion in determining whether the wells were capable of producing in paying quantities that led the trial court in Hupp v. Beck to determine that the lease there was perpetual and consequently offensive to public policy. The trial courts in the other cases pending on appeal in the Seventh District relied heavily on Hupp in reaching their decisions to forfeit the leases.
Because the Sixth Circuit held that lease in Henry was extended by the discretionary act of the lessee during the primary term to unitize the leased acreage with other property on which drilling activity was commenced, it may well be considered persuasive by the Seventh District Court of Appeals in its consideration of the pending appeals. Since each of the pending cases involved leases that were declared forfeited even though they were still in their primary terms, the reviewing court may well be persuaded that the trial courts were premature in anticipating what might be done by the lessees in the exercise of their discretion to extend their leases beyond the primary term.