In a recent case, Cameron v. Hess Corporation, Case No. 2:12-CV-00168 (September 24, 2013), the United States District Court for the Southern District of Ohio held that an eastern Ohio oil and gas lease entered into by Hess Ohio Resources, LLC ("Hess"), a Hess Corporation affiliate, expired before Hess commenced drilling, exemplifying the importance of carefully drafting and understanding the scope and term of rights granted under a lease, and demonstrating how costly an unfavorably crafted provision can be.
The plaintiff landowners, lessors of oil and gas rights on their 229-acre farm in Jefferson County, Ohio, commenced the action seeking a declaratory judgment, in part, that the lease had expired in 2012 at the end of its 5-year initial term. The landowners' case hinged on the interpretation of the habendum clause and the delay rental provision in the lease. The habendum clause, i.e. the provision that defines the scope and term of the rights granted, provided for a "primary term" and an "additional term," as is the case in many oil and gas leases. The primary term continued for five years, expiring on June 13, 2012. In exchange for an extension payment before expiration of the primary term, the lease provided Hess the option to extend the lease for an "additional term" of five years "or as long thereafter as oil or gas . . . is produced" on the property.
However, the lease also contained a "delay rental" provision, which required Hess to make annual payments to extend the lease for successive 12-month periods "during the primary term" to keep the lease in effect if it did not commence drilling activities within 12 months of the execution of the lease, or each subsequent 12-month period. Though Hess never began drilling, it made the delay rental payments in 2008 through 2011, as well as the extension payment in May of 2012.
Accordingly, Hess took the position that it timely paid all amounts necessary to extend the lease for the 5-year additional term. To the contrary, the landowners argued that due to the limiting language in the delay rental provision allowing Hess to delay drilling operations for 12-month periods "during the primary term," Hess could not make delay rental payments in lieu of drilling during the additional term, so the lease terminated under the delay rental provision on June 13, 2012. The court dismissed Hess's urges to interpret "primary term" in the delay rental provision to include both the primary term and the additional term because the lease defined "primary term" relative to, and as distinct from "additional term." Citing recent precedent in the Southern District of Ohio in which the parties explicitly defined the primary term to include extension periods, the court held that it "cannot infer that conditions that expressly apply to the 'primary term' also automatically apply to the 'additional term,'" as the parties could have contracted for that result if so intended. The court also excused Hess's argument that the court's interpretation of the delay rental provision left the "additional term" language in the habendum clause meaningless, countering that the agreement could be reasonably read to permit extension of the term only where drilling activities had commenced by the expiration of the primary term.
Unsurprisingly, given the significant prospective financial loss, Hess issued a statement that company representatives were "surprised by the court's decision and intend to challenge it vigorously . . . ." The landowners in Cameron received a mere $6,500 up-front payment in 2007 for the lease. At today's rates, that same property would likely draw a signing bonus up to $1.5 million. With approximately 300 leases in the Eastern Ohio shale plays containing provisions similar to that at issue in Cameron, Hess may face a tremendous financial outlay to avoid forfeiture of its rights.
Oil and gas operators negotiating leases, or assuming them from a third party (as did Hess), need to cautiously scrutinize the duration of the lease and the rights granted thereunder to ensure that final document reflects the intended result. As demonstrated by the Cameron case, severe, yet avoidable, unintended consequences can result from a misunderstanding of these fundamental lease provisions.
Additional media coverage of the case can be located here.
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