Statutes of Limita-ons and Equity: Emerging Defenses to Lease Bus-ng Claims Based on Ancient Gaps in Produc-on

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1 Statutes of Limita-ons and Equity: Emerging Defenses to Lease Bus-ng Claims Based on Ancient Gaps in Produc-on Presented By: Peter A. Lusenhop Ilya Ba4kov Jessica Knopp Cunning Vorys, Sater, Seymour and Pease LLP

2 Introduc4on Thousands of historically producing oil and gas wells across the Appalachian Basin - many holding valuable reserves; lessors highly incen4vized to bust leases. Is there really no limit on the look back? Why not equity? Why not a statute of limita4ons (SOL)?

3 When Does an Oil and Gas Lease Terminate? Oil and gas leases are hybrids possess both contractual and real property elements. Generally leases terminate in one of two ways: The lessee breaches a covenant, resul4ng in its forfeiture. By the triggering of a special limita<on, resul4ng in the expira<on of the lease, and reversion of the mineral estate.

4 Lease Expira4on and Forfeiture Forfeiture Equitable remedy. Discre4onary. Disfavored. Generally no forfeiture where an adequate remedy at law (for damages). No4ce and opportunity to cure may be required. But, where lease expressly contemplates forfeiture upon an event certain, termina4on is likely, even if inequitable.

5 Lease Expira4on and Forfeiture Expira-on Habendum Clause If awer the primary term, the condi4ons of the secondary term are not con4nuing to be met, the lease is said to terminate automa4cally (i.e., expire) and the leased premises revests in the lessor. Lessor generally not required to take any ac4on to confirm the lapse of the lease - generally, no no<ce is required.

6 Lease Execu4on and Forfeiture Expira-on Unless Drilling Clause Provides the lease shall terminate at some point unless the lessee has commenced drilling or pays rentals. If the lessee fails to commence drilling or tender delay rentals by the agreed-upon date, the lease is generally found to terminate automa4cally (i.e., expire) by opera4on of law.

7 Determining Whether a Lease Expired Paying Quan--es Typical habendum clause: and as long thereawer as oil or gas or either of them is produced from said lands [in paying quan44es]. Standards for paying quan44es include objec4ve and selec4ve elements. Analysis may be fact-intensive.

8 Determining Whether a Lease Expired Temporary Cessa-on Doctrine Courts in all producing jurisdic4ons recognize a temporary cessa4on of produc4on doctrine. Factors: (1) the length of 4me without produc4on; (2) the reason for the interrup4on in produc4on, and (3) whether the lessee exercised reasonable diligence in resuming produc4on. This analysis, too, is fact-specific.

9 Defending Against Claims Based on Ancient Produc4on Issues What Do You Say So Loudly That I Can t Hear You? Unique eviden4ary problems posed by termina4on claims based on ancient produc4on issues. PPQ and temporary cessa4on analyses require access to documents and witnesses that are not available. How the par4es (or their successors in interest) perceive a gap in produc4on may be different or change over 4me.

10 Can Equity Bar a Lease Expira4on Claim? Some courts, including the Ohio appellate decision, Schultheiss, suggest that equity can never apply to lease expira4on claims. Decisions in Texas and California agree. Supreme Court of Ohio accepted Schultheiss on one proposi4on of law: [a] landowner should be estopped from termina4ng an oil and gas lease by the acceptance of benefits. Argued and pending.

11 Courts Permit Equitable Defenses in Certain Circumstances Estoppel from Detrimental Reliance What kind of detrimental reliance is necessary? Is silent acquiescence enough? In Texas and Pennsylvania, no. Decisions from states including Kentucky, Louisiana, West Virginia, and Arkansas indicate that a lessor s acquiescence to development following lease expira4on will estop an expira4on claim.

12 Courts Permit Equitable Defenses in Certain Circumstances Doctrine of Obstruc-on/Repudia-on Some4mes referred to as equitable estoppel or equitable tolling. Predicated on the lessor s hindrance of the lessee s performance, preven4ng 4mely compliance. The effect: extends the lease for the reasonable 4me that jus4ce may require for the lessee to begin produc4on unhindered and avoid the special limita4on. Wilson v. Xander (W. Va. 1989).

13 Courts Permit Equitable Defenses in Certain Circumstances Acceptance of Delay Rentals: In many producing states, including Texas, Ohio, Alabama, Montana, and Kentucky, acceptance of delay rentals with an unless -style drilling clause has been held to estop the lessor from claiming that the lease expired for lack of drilling or 4mely payment. The late acceptance of delay rentals is said to be inconsistent with an expira4on claim.

14 Equity and The Acceptance of Royal4es The Majority View Most courts, including the recent Schultheiss decision, refuse to apply equitable defenses to the late acceptance of royal4es. Ra4onale: the royalty represents a frac4on of the produc4on that the lessor would otherwise be en4tled to receive if the lease had terminated. Receiving only a frac4on of that produc4on is no benefit to the lessor and is not inconsistent with the termina4on claim.

15 Equity and The Acceptance of Royal4es Responses to Majority View Too great an emphasis on the property components of the lease, ignoring the contract performance required to produce royal4es/house gas. Acceptance of royal4es could be inconsistent with an expira4on claim if royal4es were accepted during a period of noncommercial produc4on. Also, consider the characteriza4on of the royalty: is it only a share of produc4on, or is it a contractual payment for the right to produce oil and gas? See Scruggs v. Clark (Miss. 1952). Other courts suggest that although not alone disposi4ve, the late acceptance of royal4es could be a factor in a broader equitable analysis.

16 Can Statute of Limita4ons Bar a Lease Expira4on Claim? Few decisions addressing applica4on of an SOL to a lease expira4on claim. Most prominent is Natural Gas Co. of Am. v. Pool (Tex. 2003). More recently, Ohio courts have addressed SOLs with lease expira4on claims Cox, Schultheiss and PoIs.

17 Natural Gas Pipeline Co. of Am. v. Pool (Tex. 2003) Lessors claimed leases expired due to gaps in produc4on occurring between the 1940s to the early 1980s, ranging from days. The lessees defenses included the claim that the lessees obtained 4tle to the leases through adverse possession under Texas 3-, 5, and 10-year statutes of limita4ons rela4ng to the recovery of real property.

18 Natural Gas Pipeline Co. of Am. v. Pool (Tex. 2003) Court held that lessees had acquired through adverse possession the same leases they had enjoyed before any alleged expira4on - lease creates a determinable interest that could be adversely possessed under SOLs rela4ng to recovery of real property.

19 Natural Gas Pipeline Co. of Am. v. Pool (Tex. 2003) Lessees possession was adverse - holding over to remove minerals is hos4le to the lessor s mineral estate because the corpus of the estate is depleted over 4me. A no4ce of repudia4on could be inferred without any change in the use of the land, if there has been long-con4nued use.

20 Natural Gas Pipeline Co. of Am. v. Pool (Tex. 2003) Policy ra4onale for SOLs: Statutes of limita4ons are designed to compel the asser4on of claims within a reasonable period while the evidence is fresh in the minds of the par4es and witnesses and to prevent li4ga4on of stale or fraudulent claims. The claims before the court in Pool gaps in produc4on that occurred upward of 29 years before suit was filed are the types of claims that statutes of limita4ons were intended to foreclose.

21 Cox. v. Kimble (Ohio Ct. App. 2015) A lease from 1980 required the lessee to either drill a second well within one year of the first well, or release any acreage not dedicated to the first well. One well was drilled in 1981, which con4nued to produce un4l suit was filed in Lessee disputed that any por4on of the leasehold expired, including the undeveloped acreage, and asserted defenses including adverse possession and statute of limita4ons.

22 Cox. v. Kimble (Ohio Ct. App. 2015) Court rejected adverse possession When the original entry onto another's property is permissive or conferred by grant, then any use reasonably consistent with such a grant or permission is not adverse. Here, the lessees rights were conferred under a lease, and their ac4ons and use of the property since that 4me have been consistent with such grant and/or permission and is therefore not adverse.

23 Cox. v. Kimble (Ohio Ct. App. 2015) Court rejected statute of limita4ons Lessees argued the claims were barred under Ohio s 15- year SOL for breach of contract claims. Held: not barred because the breach did not accrue un4l 2011, when the lessors first requested that the lessees release the undeveloped acreage, and lessees refused. Court also rejected claim that 21-year SOL rela4ng to recovery of real property applied, finding that the lessees never engaged in any overt acts that would outwardly demonstrate occupa4on and ownership of the property un4l 2011 when they refused to release the remaining acreage.

24 Schultheiss v. Heinrich Enters., Inc. (Ohio Ct. App. 2016) Rejected applica4on of statute of limita4ons. Cited William and Meyers for the proposi4on that awer a lease terminates by opera4on of law, any delay by the lessor in asser4ng termina4on of the lease cannot give life to the affirma4ve defenses of laches or the statute of limita4ons[.] Also rejected SOL on the basis that the lessor s acceptance of gas (in lieu of royalty) was not inconsistent with the claim that her lease terminated.

25 PoIs v. Unglaciated Indus. (Ohio Ct. App. 2016) Lessors alleged that an oil and gas lease executed in 1896 expired due to lack of produc4on during some unspecified period of 4me. Lessee at summary judgment provided evidence of con4nuous produc4on since 1962 and con4nuous royal4es since at least It claimed the eviden4ary burden then shiwed back to lessors, who failed to respond to its MSJ.

26 PoIs v. Unglaciated Indus. (Ohio Ct. App. 2016) Lessors claimed that it is not enough for the lessee to show produc4on since 1991 to meet the lessee s eviden4ary burden, it must show produc4on in paying quan44es from the day awer the expira4on of the primary term in 1901 through the present day with no gaps in produc-on. Also claimed that a lifeless lease cannot be revived, and that no statute of limita4ons applied.

27 PoIs v. Unglaciated Indus. (Ohio Ct. App. 2016) Court of Appeals affirmed, finding the lessee was only obligated to establish produc4on in paying quan44es for the period covered by the applicable SOL Ohio s 15-year SOL for contract breaches. Court read the Ohio SOL for breach of contract broadly to include events leading to the expira4on of a lease. Court was moved by the policy ra4onale for SOLs, for which it found strong support in Ohio s expansive legisla4ve scheme for SOLs.

28 PoIs v. Unglaciated Indus. (Ohio Ct. App. 2016) How Far Does PoIs Go? Decided in context of burden at summary judgment. Determined that a lease expira4on event is included in the defini4on of breach of contract for purposes of Ohio s 15-year SOL. Is this just a case about statutory construc4on?

29 What Now? Ancient PPQ claims feel unfair. Schultheiss creates a donut hole. Cox may be limited to its facts. PoIs is a helpful response, but will PoIs travel? (consult SOLs in your state). Time to revisit the old rules/ they don t fit.