In Eastham v. Chesapeake Appalachia, L.L.C., 6th Cir. No. 13-4233, 2014 U.S. App. LEXIS 10531 (June 6, 2014), the Sixth Circuit court of appeals considered whether a provision in a 2007 oil and gas lease that granted Chesapeake the option to “extend or renew under similar terms a like lease” was ambiguous and whether it required Chesapeake to renegotiate the lease when it expired. The court held that the plain language of the lease allowed Chesapeake to “extend” the lease on the same terms. The decision contains insights about Ohio law and important lessons in contract drafting and interpretation.

Facts of the case

On April 9, 2007, William and Frostie Eastham signed an oil and gas lease with Great Lakes Energy Partners, LLC (“Great Lakes”) for their 49.066 acre parcel in Jefferson County, Ohio. The five-year primary term of the lease required Great Lakes to either drill a well or make delay rental payments to Mr. and Mrs. Eastham in the amount of $10.00 per acre per year until a well was drilled. The lease also provided that if the lease expired, Great Lakes would have the following option:

Upon the expiration of this lease and within sixty (60) days thereinafter, Lessor grants to Lessee an option to extend or renew under similar terms a like lease.

Sometime before the lease expired, Great Lakes assigned the lease to Chesapeake. There was apparently no dispute that the assignment was authorized by the lease and that all required delay rentals were timely paid throughout the primary term. Then, on March 14, 2012, about one month before the lease expired, Chesapeake recorded a notice of extension of the lease and sent a check for $490.66 (delay rentals for the first year of the extended five-year term) to Mr. and Mrs. Eastham along with a letter explaining that Chesapeake was exercising its option to extend the lease under the provision quoted above.

Mr. and Mrs. Eastham were obviously disappointed. Before they received the letter from Chesapeake they were expecting to renegotiate the lease for many times the amount of the check they received. So, they filed suit against Chesapeake seeking a declaration that the lease expired at the end of the five-year primary term and asking the court to quiet title to the mineral interest in their names, free and clear of the lease.

Position of the parties

After removing the case to federal court (based on diversity jurisdiction), Chesapeake argued that the plain language of the lease gave it the option to either extend the lease under identical terms or renew the lease under similar terms.

On the other hand, Mr. and Mrs. Eastham asserted that the plain language of the lease only gave Chesapeake one option — to take a “like lease” under “similar terms.” Consequently, Mr. and Mrs. Eastham argued that the parties should be required to renegotiate the lease at the current market rates and terms, just as they had done when the lease was executed in 2007. In the alternative, Mr. and Mrs. Eastham argued that the lease was ambiguous and the court should consider extrinsic evidence which favored Mr. and Mrs. Eastham. Finally, Mr. and Mrs. Eastham argued that the unilateral option in the lease was unconscionable and void against public policy. Mr. and Mrs. Eastham also asserted that the lease was an adhesion contract that should be construed by the court against Chesapeake as it considered each argument.

The trial court ruled in favor of Chesapeake and against Mr. and Mrs. Eastham on each argument, finding that the option provision was fair and that it unambiguously gave Chesapeake an option to extend or renew the lease as Chesapeake asserted. Mr. and Mrs. Eastham appealed.

What to take away from the appellate court’s decision

The Sixth Circuit affirmed the trial court’s decision in every respect, ruling in favor of Chesapeake and agreeing that the lease was unambiguous. The court’s decision contains important lessons about Ohio law and contract law, generally.

Takeaway #1: “Extending” and “renewing” a contract are legally distinct concepts in Ohio.

The Sixth Circuit observed, “the Easthams’ ambiguity argument turns on an assumption that options to ‘extend’ are synonymous with options to ‘renew.’ Under Ohio law, they are not.” Id. at *8.

The court declined to follow a recent Carroll County Common Pleas decision that found “no meaningful distinction” between the option to “renew or extend” in an identical provision of another lease. Rather, the Sixth Circuit followed precedent from the Ohio Supreme Court which held that, “a distinction must be made between contacts containing options to ‘renew’ for a given term or terms and those containing options to ‘extend’ for a given term.” Id. at *8-*9 quoting State ex rel. Preston v. Ferguson, 170 Ohio St. 450, 166 N.E.2d 365, 371 (Ohio 1960); contra Flannery, et al., v. Enervest Operating, LLC, et al., C.P. No. 12 CVH 27524 (Carroll Cnty. Common Pleas, April 14, 2014 ). The Sixth Circuit also found support for making a distinction between the terms “extend” and “renew” in the dictionary definitions of those terms.

Ultimately, the court held that the disputed provision of the lease gave Chesapeake, “two options: (1) to extend the lease on the same terms as the existing lease; or (2) to renegotiate for a ‘renew[ed]’ ‘like lease’ on ‘similar terms’.” Id. at *8. The court also observed that this interpretation is the only one that would ascribe meaning to each phrase in the contract without rendering any phrase redundant or surplusage, which would be contrary to Ohio law.

Takeaway #2: Carefully chosen punctuation and language are critical.

From the Court’s holding, several intriguing questions emerge. First, the decision contains almost no discussion about the letter and notice that Chesapeake used to extend the lease. Presumably Chesapeake was aware of the legal distinction between renewing and extending the lease and it was careful to avoid any mention of a “renewal.” But what if Chesapeake had not been so careful to make clear that it was only extending the lease? For example, if Chesapeake had imprecisely communicated its intention to “exercise its rights” under the option provision (but failed to specify which right), would this decision have been different? Maybe so. This case is an example where attention to detail and carefully drafted documents probably saved Chesapeake hundreds of thousands or even millions of dollars considering the market rates for bonuses and royalties if it was required to renegotiate the lease.

The language of the lease itself also holds a lesson in contract drafting. Here, the disputed provision was remarkably devoid of punctuation. A carefully (or errantly) placed comma could have made a big difference in this case. For example if the disputed provision said, “…Lessor grants to Lessee an option to extend, or renew under similar terms a like lease” would the lease have been clear enough to avoid litigation all together? On the other hand, if the disputed provision said, “…Lessor grants to Lessee an option to extend, or renew, under similar terms a like lease” would the outcome have been different? We may never know, but like any contract interpretation case, punctuation undoubtedly played a big role in the outcome of this case.

Takeaway #3: Changing market rates do not make a lease unconscionable.

This case also stands for the proposition that rising prices and royalty rates are not sufficient to invalidate a prior lease. The court seemed to easily reject Mr. and Mrs. Easthams’ argument that Chesapeake’s extension of the lease at prices and rates agreed to in 2007 was unconscionable. The Court observed, “the Easthams are clearly dissatisfied with the terms of the lease–they now feel they could have done better under prevailing market rates. However, they have failed to demonstrate that the contract was commercially unreasonable [when it was signed].” Id. at *23-*24.

Overall, decisions like Eastham are invaluable to the mounting body of case law interpreting Ohio oil and gas leases. A predictable and consistent legal environment that builds upon existing precedent is just as valuable to the Ohio oil and gas industry, and to mineral owners, as the oil and gas resources beneath our feet.