On Jan. 21, 2016 the Ohio Supreme Court announced State ex rel. Claugus Family Farm, L.P. v. Seventh Dist. Court of Appeals, Slip Opinion No. 2016-Ohio-178, a decision that finally laid to rest two important oil and gas cases that have been winding their way through the Ohio courts for more than four years – Hustack v. Beck Energy Corp., case No. 2014-1933 and State ex rel. Claugus Family Farm, L.P. v. Seventh Dist. Court of Appeals, case No. 2014-0423.

The opinion, which was authored by Justice French and joined by four other Justices, upheld oil and gas leases held by Beck Energy Corporation and which are said to directly affect almost 700 landowners located in southern and eastern Ohio. The Supreme Court decision addressed three issues; two from the Hustack case and one from the Claugus case. The Court, in a separate matter, also denied a request to toll the terms of the Beck leases involved in the cases.

Justice Paul E. Pfeifer, joined by Justice Terrence O’Donnell, concur in part and dissent in part.

Hustack v. Beck

1) Is the Form G&T (83) lease void as against public policy?

The leases at issue in this case were standard forms that were often used by Beck, known as a “Form G&T (83) lease.” The leases contained a provisions that allowed Beck to make delay rental payments if a well was not commenced within twelve months from the inception of each lease. The Lessors argued that this improperly allowed Beck to maintain the leases in perpetuity by making nominal delay rental payments, and with no obligation to drill. The Lessors argued that a contract that runs in perpetuity is void as against public policy in the state of Ohio.

The Court, citing precedent from Brown v. Fowler, 65 Ohio St. 507, 63 N.E. 76 (1902), disagreed with the Lessors, holding that Beck’s right to extend the leases by paying delay rentals, in lieu of drilling, only applied to the ten-year primary term of the lease.  Consequently, under the terms of the lease, if Beck failed to drill a well in the first twelve months it could extend the lease for up to ten years by making the required delay rental payments.  But, in order to extend the lease beyond the ten-year primary term, Beck would have to comply with the requirements stated in the leases to trigger the secondary term. In particular, to extend and maintain the leases into the secondary term, the form leases required proof that either oil and gas are being produced or are capable of being produced on the premises in paying quantities, or that the land is being operated in the search of oil and gas.

The Court discussed the definition of “capable of being produced,” as the Lessors also contended that this could extend the lease in perpetuity at Beck’s discretion. Again, the Court disagreed and held that Beck would not be able to determine if oil and gas were capable of being produced on the premises without first drilling a well.

The Court ultimately held that Beck’s form leases are not void as against public policy.

2) Is the Form G&T (83) lease subject to an implied covenant of reasonable development?

The second issue the Court addressed from the Hustack case was whether the form leases were subject to an implied covenant of reasonable development.

The Lessors claimed that Beck improperly failed to develop the leases, instead relying on payment of delay rentals to hold the leases. The Court ruled that Ohio law only imposes an implied covenant of reasonable development when a lease “fails to refer specifically to the timeliness of development.” The Form G&T (83) leases in these cases required Beck to commence development within ten years, and furthermore, expressly state that no implied covenant shall be read into the lease. For these reasons, the Court held that there was no implied covenant of reasonable development in these leases.

Claugus v. 7th District Court of Appeals

The Claugus case has its roots in the Hustack case.

In the early stages of the Hustack case, the trial court certified a class of Plaintiffs which included any Lessors who were subject to a Form G&T (83) lease.  Later, the Seventh District Court of Appeals entered various orders tolling the terms of all leases that were affected by the case. Claugus Family Farm was not a named party to the Hustack lawsuit and did not even receive notice of the lawsuit, but Claugus was a member of the certified class because their property was subject to a Form G&T (83) lease. Claugus discovered that they were affected by the Hustack lawsuit and tolling orders after another oil and gas company defected a new lease they had signed when due diligence revealed that their property was subject to a Form G&T (83) lease and tolling order.

Claugus sought a writ of prohibition from the Ohio Supreme Court to permanently enjoin the Seventh District Court of Appeals from enforcing its order tolling the Form G&T (83) leases on the Claugus property and a writ of mandamus directing the Seventh District to vacate its tolling order.

The Court laid out that in order to be entitled to a writ of prohibition, the moving party must establish “(1) the court of appeals is about to exercise or has exercised judicial power, (2) the exercise of that power is unauthorized by law, and (3) denying the writ would result in injury for which no other adequate remedy exists in the ordinary course of law.” The Court also noted that “Even if Claugus Family has an adequate remedy in the ordinary course of law, it may be entitled to a writ if the court of appeals ‘patently and unambiguously’ lacked jurisdiction.”

Similarly, for Claugus to be entitled to extraordinary relief in mandamus, it must “establish a clear legal right to the requested relief, a clear legal duty on the part of the court of appeals to provide it, and the lack of an adequate remedy in the ordinary course of law.”

The Court ultimately found that Claugus had an adequate remedy in the ordinary course of law because it had a chance to intervene during the Seventh District Appellate proceedings. Despite Claugus not receiving formal notice of the proceedings, Claugus’ counsel admitted to knowing about the September 26, 2013 tolling order sometime in October 2013. The decision rendered on the merits of the appeal did not occur until September 26, 2014. Thus, the Court found that Claugus should have moved to intervene during this eleven-month period.

The Court, in applying the part of the test requiring relators to demonstrate a lack of jurisdiction, ruled that the Seventh District had jurisdiction to issue an order to maintain the status quo during the course of appeal, and the tolling order did that. For these reasons, the Court denied Claugus’ writs of prohibition and mandamus, resulting in the validity of the original tolling orders

Beck’s motion for a tolling order

As Beck had done in each of the lower courts, it also asked the Ohio Supreme Court to toll the leases at issue in these cases during the pendency of the appeal to the Ohio Supreme Court. While Beck prevailed on every other issue in the case, it did not prevail on this point.  The Court, in a brief statement, denied Beck’s motion to toll the terms of the Form G&T (83) leases during the proceedings before the Ohio Supreme Court.

What to take away

Broadly, the Claugus decision seems to reaffirm the Court’s intention to apply traditional contract law concepts and analysis to oil and gas leases and to enforce leases as written, without allowing amorphous public policy arguments supplant traditional analysis to any greater extent with oil and gas lease disputes than with any other contract dispute.

More specifically, the Claugus decision (1) approves and refreshes old precedent which holds that under lease terms such as those at issue in these cases, delay rentals allow a lessee to extend a lease through only the primary term of the lease, and (2) holds that the phrase “capable of being produced,” when used in connection with the right to extend a lease into the secondary term, refers only to production from a well, not the possibility of production from undeveloped land, and (3) holds that Ohio law does not impose an implied covenant to develop when a lease requires development to commence within a certain period or when the lease specifies that no implied covenant shall be read into the agreement.