A recent decision by the Ohio Supreme Court (the “Court”) highlights once again the importance of clearly stating in your contract what you mean or a court will decide for you.
Bohlen v. Anadarko E&P Onshore L.L.C., Slip Opinion No. 2017-Ohio-4025, involves Ronald and Barbara Bohlen, owners of approximately 500 acres in Washington County, Ohio, who entered into a gas and oil lease (the “Lease”) as lessors with Alliance Petroleum Corporation (Alliance) as the lessee. (Alliance later assigned a portion of the Lease to Anadarko.)
The lease provided for a one year term and would continue after the initial one year term for so long as gas or oil or their constituents are produced or are capable of being produced on the Bohlen’s property in paying quantities, in the sole judgment of the lessees, or are the lessee is conducting operations to search for oil or gas. The Lease also provided that Alliance must pay the Bohlen’s a “delay rental” of $5,500 per year “for the privilege of deferring the commencement of a well”, otherwise the Lease became null and void and the parties’ rights under it would terminate. The Lease stated that a well is commenced “when drilling operations have commenced on the leased premises.”
The parties also entered into an addendum to the Lease (the “Addendum”) that provided for a minimum annual royalty payment. If the royalty payments made by Alliance to the Bohlen’s was less than $5,500 in any calendar year, the it must make up the shortfall between the royalty payments and the minimum royalty payment.
Alliance drilled two wells during the first year of the Lease. The second well drilled was successful and produced gas. The company paid the Bohlen’s $5,500 for the first year of the Lease. Thereafter, it paid royalty payments based on the gas produced each year from 2008 through and including 2013. The annual royalties paid in those years never reached nor exceeded $5,500.
The Bohlen’s filed a declaratory action against Alliance and Anadarko in the trial court requesting the court issue an order declaring the forfeiture of the Lease. Both sides of the case filed motions of summary judgment asking the court to issue a judgment in favor of their arguments. The Bohlen’s argued that (1) the Lease violated public policy and was void because it allowed Alliance and Anadarko to encumber their property indefinitely by paying delay rental payments, (2) the Lease should be terminated by its terms because Alliance and Anadarko did not pay the minimum annual rental of $5,500 as required by the delay rental clause, and (3) the Lease terminated under its own terms due to the lessees failure of oil and gas production.
The trial court agreed with the Bohlen’s arguments and ordered forfeiture of the Lease. Alliance and Anadarko appealed to the Fourth District Court of Appeals, who reversed the trial court on all three arguments. The Bohlen’s appealed to the Court, who upheld the appeals court.
Since it was the review of a summary judgment ruling, the Court conducted its own full review of the arguments made on both sides. The Court has long maintained that gas and oil leases are contracts to which contract law applies. One key principle of contract law provides that unless there is an ambiguity in the contract language, a court will not give the contract any meaning other than what the plain language of the contract states.
Using this point of review the Court looked at the delay rental language in the Lease. Leases often provide for a primary term and a secondary term when it comes to the duration of the lease. In the Bohlen’ lease, the primary term was one year. The second term provides for a continued duration for so long as gas or oil or their constituents are produced or are capable of being produced on the Bohlen’s property in paying quantities, in the sole judgment of the lessees, or are the lessee is conducting operations to search for oil or gas.
As noted earlier, the Lease provided that it would be void and all rights of the parties to the Lease would terminate if Alliance failed to pay a delay rental of $5,500 per year for the privilege of deferring the commencement of a well. Alliance drilled a well during the primary term which met the definition of a commencement of a well as defined in the Lease.
The Bohlen’s argued that the delay rental addressed in the Lease with respect to the primary term should be read in conjunction with the Addendum language regarding minimum annual rent and the termination provision in the delay rental clause should be extended beyond the primary term. However, the plain language doesn’t provide for the termination provision in question to apply beyond the application of the delay rental clause and the obligation for payment of delay rental ceased once drilling was commenced. The Court held that underpayments by the lessees under the minimum annual rental provision in the Addendum did not entitle the Bohlen’s to forfeiture of the Lease under the unrelated delay rental clause. If the parties wanted the termination provision of the delay rental clause to apply to the minimum rental provision they should have stated that clearly in the Lease.
A no-term, perpetual lease violates public policy. The Bohlen’s argued that the Lease allowed the lessees to delay drilling on the undrilled acreage indefinitely by paying the $5,500 minimum annual rent. The Court disagreed with the Bohlen’s interpretation of the Lease and Addendum, stating that the plain language of the Addendum does not modify the delay rental clause and therefore does not create a no-term, perpetual lease.
Whether the lessees owe the Bohlen’s money for their underpayment of the annual minimum rental is another issue that was not addressed by the Court since it was not raised by the parties in their appeals. The Court the case to the trial court for further proceedings.
As my colleague, Steve Richman, points out in his series of “Watch Your Language” articles for this Blog, “as a general rule, courts will uphold language in commercial agreements, unless it is contrary to statutory law or public policy. They traditionally presume that commercial parties are on more of an equal playing field and are more sophisticated concerning commercial real estate transactions, since both parties to a commercial transaction will usually have attorneys to review their documents. Because of this judicial deference to “commercial language”, you must say what you mean, precisely, or a judge will decide what you meant.”