In Eastern Ohio, before 2010, a customary signing bonus for an oil and gas lease was usually less than $25 per acre, as it had been for years. By the fall of 2011, after the shale boom hit, lease bonus prices had risen in leaps and bounds to their peak (so far) of about $6,000 per acre before pulling back significantly in the spring of 2012.
Naturally, everyone who did not have the foresight or nerve to hold out for $6,000 per acre was left feeling more than a little miffed. After all, a typical bonus check on a 100 acre parcel in 2009 or early 2010 would have been $2,500 but that bonus may have swelled to $600,000 in less than two years!
Courts Do Not Decide What is “Enough”
Fortunately for our economy and legal system, a party to a contract cannot later adjust the contract price when they finally realize the value of a transaction. In fact, it is the imbalance of information, risk tolerance, and vision among different people that is the driving force of business in the United States.
But even reasonable lessors were overwhelmed by the incredible disparity between lease bonuses paid during the shale boom. That disparity, combined with the belief that the oil and gas companies have bottomless bank accounts, spawned lawsuits by lessors to try to break leases with the hope of signing for more.
Of course, breaking contracts requires more than just a lot of hard feelings about not getting paid enough. “It is axiomatic that courts, as a general rule, will not inquire into the adequacy of consideration once consideration is said to exist.” Rogers v. Runfola & Assoc. Inc. (1991), 57 Ohio St.3d 5, 7. In other words, as long as some valuable consideration was paid for a lease, the amount of that consideration is not relevant to the validity of the lease.
Read on to see how Oil and Gas Leases are Different
Oil and Gas Leases are Different
Courts should be even more reluctant to pass judgment about the initial consideration given for oil and gas leases than the consideration given for conventional contracts.
Unlike conventional contracts for sale of an asset at a determinable price, an important part of the consideration given for an oil and gas lease is the lessee’s promise to pay future royalties on production. The bonus payment is only part – and possibly a small part – of the total consideration that will be realized from an oil and gas lease.
If the total consideration (including bonus and royalties) for an oil and gas lease is calculated, the average difference in value realized by different lessors over the life of their leases will be much less distinct than the disparity in bonus payments they may have received.
For example, our hypothetical landowner with a 100 acre parcel who signed a lease for $2,500 may have only received .42% of the maximum bonus that would have paid at the peak of the market. But taking royalties into account, the total value of that same lease is discounted merely 11.94%, assuming royalty income of $5,000,000 over the life of the lease.
Furthermore, even with a narrow focus on only the bonus payment, it is incredible for a lessor to allege that he or she would have received a much larger bonus if a landman or lessee had been more forthcoming. Market forces caused bonus payments to fluctuate wildly during the shale boom and no one could predict when the market would peak or when it would collapse.
Consequently, landowners and courts should not be tempted to judge oil and gas leases from a narrow and short sighted analysis of only the disparity in bonus payments. Likewise, no one should be convinced by the perfect perspective of hindsight that a landowner would have timed the market better if further information was known.