Chapter 9 Coal Lease Terminations: Minimizing the Pain of Untying the Knot

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1 CITE AS 25 Energy & Min. L. Inst. ch. 9 (2005) Chapter 9 Coal Lease Terminations: Minimizing the Pain of Untying the Knot By Richard J. Bolen Huddleston Bolen LLP Huntington, West Virginia Synopsis Introduction Consequences of a Failed Commercial Marriage [1] Termination-Related Claims [a] Minimum Royalty Claims [b] Claims for Failure to Diligently Mine [c] Claims for Failure to Mine All Mineable and Merchantable Coal [d] Lost Coal Claims [e] Waste Claims [f] Other Property Damage Claims [g] Holdover Claims [h] Claims for Miscellaneous Breaches [i] Punitive Damage Claims [j] Interest Claims [k] Third Party and Indemnity Claims [l] Breach of Warranty Claims [m] Claims of Interference by Lessor [2] The Cost of Failing to End a Disadvantageous Relationship [a] Lost Opportunity Costs for the Lessor [b] Bankruptcy of the Lessee [c] Permanent Impairment of the Leased Property and Damage to Others [d] Carrying Costs for the Lessee How and When Coal Leases End [1] Expiration [2] Automatic Termination by a Special or Conditional Limitation [3] Surrender by Agreement The Amicable Divorce [4] Surrender by Operation of Law Abandonment [5] Forfeiture [6] Equitable Rescission or Cancellation by a Court

2 SYNOPSIS ENERGY & MINERAL LAW INSTITUTE [7] Merger of Estates [8] Perpetual or Indefinite Leases Planning an Exit Strategy [1] Prenuptial Agreements the First and Best Opportunity to Avoid a Painful Separation [a] Negotiating Strategies for the Lessor [i] Negotiate for a Relatively Short Fixed Term and No Renewal Absent Full Compliance [ii] Consider Creating Special or Conditional Limitations [iii] Secure a Binding and Broad Forfeiture Clause [iv] Include a No-Waiver Provision [v] Obtain an Express Diligent Mining Provision [vi] Negotiate for an Unqualified Minimum Royalty Clause [vii] Negotiate for an Obligation to Mine All of the Mineable and Merchantable Coal [viii] Negotiate for the Broadest Possible Lost Coal Provision [ix] Secure a Broad Covenant of Indemnity [x] Obtain Liability and Fire Insurance Coverage [xi] Make No Express Warranties and Disclaim Implied Warranties [xii] Negotiate for a Punitive Interest Rate for Past Due Obligations [xiii] Include Recital that the Lease Was... Prepared by Both Parties and Will Not Be Construed Against Either Party [xiv] Carefully Consider Whether to Include an Arbitration Provision and/or Forum Selection Clause [b] Negotiating Strategies for the Lessee [i] Negotiate for the Right to Cancel at Lessee s Option and/or for Short Renewable Terms

3 COAL LEASE TERMINATIONS SYNOPSIS [ii] Negotiate for Full Recoupment of Minimums Against Future Production Royalties and Lost Coal Damages [iii] Seek to Reduce Minimum Royalties as the Coal Is Depleted [iv] Negotiate for the Right to Terminate Minimum Royalties Upon Exhaustion of the Mineable and Merchantable Coal [v] Limit the Remedy of Forfeiture in Whatever Way Possible [vi] Disclaim Any Duty of Due Diligence [vii] Avoid Agreeing to Mine All Mineable and Merchantable Coal [viii] Negotiate to Restrict Potential Lost Coal Claims [ix] Try to Shift Some of the Risks of Coal Recovery to the Lessor [x] Obtain the Right to Use the Leased Premises After Termination [xi] Negotiate to Limit the Lessor s Remedies and Fix Reasonable Interest Rates [xii] Negotiate to Restrict the Scope of Indemnity [xiii] Negotiate for Express Warranties and/or to Eliminate Disclaimers of Implied Warranties [xiv] Carefully Consider Whether to Include an Arbitration Provision and/or Forum Selection Clause [2] Postnuptial Agreements Second Best, But Better Late than Never [a] Finding or Creating an Opening to Renegotiate [b] Strategies for the Lessor [c] Strategies for the Lessee [3] Positioning for the End Game Third Best, But Better than No Planning at All [a] Strategies for the Lessor [i] Taking the Moral and Legal High Ground

4 9.01 ENERGY & MINERAL LAW INSTITUTE [ii] Enforcing Forfeiture [iii] Pre-emptive Strikes [b] Strategies for the Lessee [i] Taking the Moral and Legal High Ground [ii] Avoiding (or Possibly Allowing] Forfeiture [iii] Pre-emptive Strikes Conclusion Introduction. Those who contract are not clairvoyant. Commercial marriage, like all other, is laden with uncertainty. 1 The Fourth Circuit s use of commercial marriage as a metaphor for the relationship between coal lessor and lessee is particularly apt. Certainly, it is not uncommon for prospective coal lessors and lessees, like engaged couples, to become excited or even euphoric at the prospect of a relationship with significant hoped-for benefits. Like a marriage contract, a coal lease represents a voluntary exchange of binding legal commitments, commitments which often cannot be ended without sobering financial consequences. The parties to a commercial marriage, like those who have gone down the aisle, acquire a shared interest in valuable assets which can and frequently do become the focus of acrimony, as euphoria fades and expectations fail to materialize. Of course, all marriages, commercial and otherwise, eventually end. 2 Some expire naturally with relatively little adverse consequences. Others end prematurely, abruptly and painfully, with substantial economic and other consequences for the parties. Often lawyers are hired by the parties to attempt to minimize the financial pain of untying the knot. In the case of all marriages, the least painful terminations from an economic standpoint 1 Orlandi v. Goodell, 760 F.2d 78, 81 (4th Cir. 1985). 2 Perpetual leases, discussed below, may be an exception. 262

5 COAL LEASE TERMINATIONS 9.02 are those that are planned for well in advance. By far, the best opportunity to control the consequences of terminating a legal relationship is before the parties have made their initial legal commitments. Well-drawn antenuptial agreements are generally effective in controlling economic consequences of a failed marriage. And, yes, well-drawn coal leases do contain what, in effect, are antenuptial provisions. Postnuptial agreements are also effective, if the parties can reach agreement after their positions have become legally fixed and reality has set in. Even when the end of the relationship is in sight, end game planning may serve as effective damage control Consequences of a Failed Commercial Marriage. Before attempting to plan for or even manage the consequences of the breakdown of any relationship, it is necessary to understand what those consequences could be in the absence of planning or management. The end of any relationship, and particularly any business relationship, is often seen as the last opportunity for settling accounts. Typically, the parties use the occasion to review their commitments to each other and assess the extent of compliance with or violation of those commitments. In the case of modern coal leases, the parties, particularly the lessees, frequently make a wide variety of commitments, any or all of which may become the subject of claimed violations when the lease ends. When such claims cannot be amicably resolved and litigation or arbitration ensues, only rarely is a single claim asserted. More commonly, all-inclusive laundry lists of claims and counterclaims are made. Some of the claims typically made when coal leases end are identified below. [1] Termination-Related Claims. [a] Minimum Royalty Claims. As the case law reflects, lessors have frequently asserted, and lessees have just as frequently resisted, claims for unpaid minimum royalties accruing after the cessation of coal production and prior to the expiration dates of the leases. True to human nature, lessees have been quick to try to shift the blame for their lack of mining success to conditions beyond their control, such as (1) no profitably recoverable coal found within the 263

6 9.02 ENERGY & MINERAL LAW INSTITUTE leased premises; 3 (2) exhaustion of profitably recoverable coal; 4 or (3) market conditions deteriorated to the point where coal, though not exhausted, can no longer be profitably recovered. 5 The lessees making these contentions, which we will collectively call exhaustion defenses or claims, 6 frequently argue that both their minimum royalty obligations and the leases themselves have terminated upon cessation of production. The lessors, in responding to these exhaustion arguments typically contend that the leased coal is really not exhausted, or, even if it is, both the lease itself and the lessee s minimum royalty obligation survive exhaustion and remain in effect until the end of the agreed lease term or even later if the lessee retains possession of the leased premises after the agreed expiration date. The numerous reported exhaustion cases have gone both ways, i.e., some have upheld the continuing validity of the leases and/or the minimum royalty obligations notwithstanding exhaustion, and some have held that exhaustion terminated the leases and/or the minimums. The efforts of the courts over the years to harmonize these decisions and develop from them rules of general application have been less than successful. The inconsistency and confusion in the exhaustion cases got off to an early start in Pennsylvania, before the turn of the last century. In an 1893 case, Timlin v. Brown, 7 the Supreme Court of Pennsylvania held that exhaustion of the profitably recoverable coal did not relieve the lessee from paying the agreed minimum royalties. In so holding, the court noted that there 3 See, e.g., Bright v. Coastal Lumber Co., 962 F.2d 365 (4th Cir. 1992). 4 See, e.g., Auxier Coal Co. v. Big Sandy & Miller s Creek Coal Co., 238 S.W. 189 (Ky. 1922). 5 See, e.g., Laurence E. Tierney Land Co. v. Kingston-Pocahontas Coal Co., 43 S.W.2d 517 (Ky. 1933). 6 Efforts by lessees to avoid liability for minimums in the absence of claimed exhaustion, i.e., for time periods when there admittedly was mineable and merchantable coal available within the leased premises have generally failed. See, e.g., Berwind-White Coal Min. Co. v. Martin, 124 F. 313 (3d Cir. 1903)(rejecting the lessee s argument that it should be relived of liability for minimums as to coal still in the ground, which could be recovered by the lessor in the future). 7 Timlin v. Brown, 28 A. 236 (Pa. 1893). 264

7 COAL LEASE TERMINATIONS 9.02 was no express agreement that the lessee should be relieved from the obligation to pay minimums because of exhaustion, and the lessee, the court reasoned, had assumed the risk of quantity, i.e., that less coal might be profitably recoverable than the parties had originally assumed. 8 Three years later in Boyer v. Fulmer, 9 the same court took an entirely different and, arguably, inconsistent position on nearly identical facts. The Boyer court admitted that It must be conceded that there is a close similarity in the controlling terms of the contracts in the two cases, 10 but then went on to conclude that the contracts were actually radically different for reasons which are far from clear. Contrary to Timlin, in which the court had concluded that the lessee had assumed the risk of not enough coal to support the minimum royalty commitment for the full term of the lease, Boyer concluded that If the ore is not there he (the lessee) is under no duty to pay because he never could get it. The foundation of his liability to pay is the fact that the ore is there. If the ore is not there the fundamental condition of all liability is gone. 11 The Boyer court reversed the lower court s judgment for minimum royalties in favor of the lessor. Subsequent decisions in Pennsylvania, West Virginia, Kentucky, Virginia, and other states have continued to go both ways on the issue of the lessee s liability to pay minimums after exhaustion or claimed exhaustion of the mineral. The decisions which have concluded that the lease and/or the lessee s obligation to pay minimum royalties ceased with the exhaustion of the mineral have generally so held either because (1) by agreement of the parties in the lease, exhaustion of the mineral expressly limited the term of the lease, or (2) even in the absence of any such agreed special limitation 12 in the term clause of the lease, the existence of the 8 The court also concluded that the lease amounted to a sale of coal in place, but that fact did not seem to be the basis of the court s holding. 9 Boyer v. Fulmer, 35 A. 235 (Pa. 1896). 10 Id. at Id. at See discussion below of special or conditional limitations. 265

8 9.02 ENERGY & MINERAL LAW INSTITUTE mineral is such a fundamental assumption of every coal lease that without it the lease ends and the lessee s obligation to pay minimum royalties ends as well. 13 Numerous other cases have reached a contrary conclusion, i.e., that exhaustion of the mineral does not terminate the lease and/or the 13 See, e.g., Vandalia Coal Co. v. Underwood, 111 N.E. 329 (Ind. 1916)(holding that lease for 15 years, unless sooner exhausted, and the lessee s minimum royalty obligation terminated with non-existence or subsequent exhaustion of minerals); Virginia Iron, Coal & Coke Co. v. Graham, 98 S.E. 659 (Va. 1919)(holding that iron ore lease for 20 year term would be canceled and/or rescinded by the court on grounds of impossibility, mistake and lack of consideration when the iron ore was found to be exhausted after many years of mining); Auxier Coal Co. v. Big Sandy and Miller s Creek Coal Co., 238 S.W. 189 (Ky. 1922)(holding that the exhaustion of the mineable and merchantable coal terminated the lease and the lessee s obligations); Byrd v. Anderson, 269 S.W. 323 (Ky. 1925)(holding that the exhaustion of the gas had the effect of terminating the lease and the lessee s obligation to pay a minimum royalty); Swiss Oil Corp. v. Riggsby, 67 S.W.2d 30 (Ky. 1933)(holding that a gas lease for 10 years or as long as gas was found in paying quantities terminated upon exhaustion of the gas as did the lessee s royalty obligation). Even though the term of the lease was limited to only so long as gas was found in paying quantities, the court discussed at some length the doctrine of impossibility of performance and/or of futility); Winco Block Coal Co. v. Evans, 76 S.W.2d 241 (Ky. 1934)(holding that a coal lease for 50 years, but providing that the lease was to terminate upon exhaustion of all workable and merchantable coal, was terminated by exhaustion and the lessee s minimum royalty obligation with it); William C. Atwater & Co. v. Fall River Pocahontas Collieries Co., 195 S.E. 99 (W. Va. 1937)(holding that a coal lease for a term of 30 years with minimum rental of 5,000 terminated with exhaustion of the coal); Kentucky & West Virginia Coal & Mining Co. v. Blue Diamond Co., 106 F. Supp. 274 (E.D. Ky. 1952)(holding that a lease for the term of years necessary to mine the mineable and merchantable coal ended with exhaustion of the mineable and merchantable coal); Geier v. Eagle-Cherokee Coal Mining Co., 313 P.2d 731 (Kan. 1957)(holding that a lease for 5 years or until exhaustion ended when the coal was exhausted); Windber Construction Co. v. Coleman, 139 A.2d 675 (Pa. Super. Ct. 1958)(holding that where coal was to be mined to exhaustion, when the economically recoverable coal was exhausted, the lease ended and the lessee s obligation to pay minimum royalties as well); Browning v. Mountain States Coal Corp., 338 S.W.2d 220 (Ky. 1960)(holding that a lease of coal known to be of inferior quality ended after the lessee s efforts to sell the coal were unsuccessful); Howard v. Hi Hat Elkhorn Mining Co., 295 F.2d 81 (6th Cir. 1961)(holding that a lease obligating a lessee to mine all the mineable and merchantable coal would terminate if the mineable and merchantable coal was exhausted); Krypton Coal Corp. v. Golden Oak Mining Co., 383 S.E.2d 37 (W. Va. 1989)(holding that a coal lease for two years or until exhaustion of the recoverable coal as determined in owner s sole judgment terminated when the owner determined that the mineable and merchantable coal had in fact been exhausted). 266

9 COAL LEASE TERMINATIONS 9.02 lessee s obligations to pay minimum royalties. 14 It is difficult to draw any universal conclusions from the many exhaustion cases, other than to say that (1) absent agreement to the contrary, a lessee will ordinarily be held responsible for payment of the agreed minimums so long as it continues to hold the leased premises; (2) where the lessee has vacated the leased premises, there is a split of authority, with West Virginia cases mostly favoring the lessor and Kentucky and Pennsylvania cases going both ways; and (3) ample authority exists to support the arguments of both lessor and lessee when exhaustion disputes arise. 14 See, e.g., National Coal Co. v. Overholt, 94 S.E. 735 (W. Va. 1917)(holding that exhaustion of the merchantable and obtainable coal did not relieve the lessee of the obligation to pay minimum royalties, the minimum royalty obligation being viewed as an unconditional covenant or guarantee of payment. Case distinguishes between leases of mineral known to exist but of unknown quantity and leases of mineral which is only supposed but not known to exist. According to the court in the first category of cases, the lessee assumes the risk of the existence of the mineral but not in the second category); Laurence E. Tierney Land Co. v. Kingston-Pocahontas Coal Co., 43 S.W.2d 517 (Ky. 1931)(holding that a coal lease for 30 years obligating the lessee to mine all the merchantable coal practicable did not terminate when falling markets rather than exhaustion or dwindling of coal supply rendered operations unprofitable); Powers v. Mahan-Jellico Coal Co., 51 S.W.2d 946 (Ky. 1932)(holding that a lease for 20 years or until exhaustion of the mineable coal was not terminated because the mineable coal was not exhausted, notwithstanding claims of faulty conditions, etc.); Hall v. Eversole s Adm r, 64 S.W.2d 891 (Ky. 1933)(holding that coal lease for a term of 25 years and the $5,000 per year minimum royalty obligation did not end because the coal, which persisted in the same quantity and quality as before, had become unprofitable to mine); Price v. Stonega Coke & Coal Co., 26 F. Supp. 172 (S.D.W. Va. 1938), aff d and modified, 106 F.2d 411 (4th Cir. 1939)(holding that lease remained in effect notwithstanding alleged practical exhaustion of the coal so long as the coal remained in the quantity and quality known to be expected as of the date of the lease; the lessee takes the risk of the market); Babcock Coal & Coke Co. v. Brackens Creek Coal Land Co., 37 S.E.2d 519 (W. Va. 1946)(holding that a lease for 30 years with a $3, per year minimum royalty was not terminated by exhaustion of the mineral, distinguishing between leases which require payment of minimum royalties regardless of the amount of minerals mined and those requiring minimum production. According to the court, exhaustion of the mineral does not discharge the obligation to pay minimums of the first class but does discharge a minimum production obligation); Orlandi v. Goodell, 760 F.2d 78 (4th Cir. 1985)(holding that coal lease for 20 years with right of surrender on four months notice was subject to termination only under proper exercise of the surrender clause and not otherwise by exhaustion of the coal, since the lessee assumed the risk of existence of coal); Bright v. Coastal Lumber Co., 962 F.2d 365 (4th Cir. 1992)(holding that a coal lease for 10 years 267

10 9.02 ENERGY & MINERAL LAW INSTITUTE [b] Claims for Failure to Diligently Mine. Lease terminations are frequently accompanied by claims for failure to diligently mine. Because minimum royalties are generally considered to be... but a standard of diligence set up by the parties, 15 lessees often assume that they have discharged their mining obligation by paying the agreed minimums. That is not, however, necessarily the case. Even though the minimum royalties are paid in full, the lessor may still have a cause of action for failure to mine diligently. North Star Co. v. Howard 16 and other cases 17 have reached the quite logical conclusion, certainly from the standpoint of traditional contract construction, that where a coal lease contains both a minimum royalty provision and a covenant requiring the coal to be diligently mined, both of these independent covenants will be given meaning and effect, and, consequently, the payment of minimum royalties alone will not relieve the lessee from the consequences of failure to diligently mine. 18 The courts have also implied an obligation to diligently mine where a coal lease contains neither a reasonably substantial 19 minimum royalty requirement, nor an express due diligence renewable to exhaustion with right of cancellation after the fourth year on 90 days notice were not subject to termination because of the absence of any merchantable and mineable coal. If the parties had intended to allow the lessees to terminate the lease if there was a total lack of merchantable and mineable coal underlying the land, they could have so stated. The court should not read terms into a contract when parties dealing at arm s length have not inserted them. 962 F.2d 365, 368; Gambill s Adm r v. Ellser Coal Co., 20 S.W.2d 286 (Ky. 1929)(suggesting that although exhaustion would terminate a lease when the lessee relinquishes the leased premises, he remains liable when he retains the premises); Taylor v. Thomas, 145 S.E. 633 (W. Va. 1928)(to the same effect as Gambill s Adm r, supra). 15 See, e.g., Cawood v. Hall Land & Mining Co., 168 S.W.2d 366, 370 (W. Va. 1943). 16 North Star Co. v. Howard, 341 S.W.2d 251 (Ky. 1960). 17 See, Coal Res., Inc. v. Gulf & Western Indus., Inc., 865 F.2d 761, 766 (6th Cir. 1989); See also Hutchison v. Sunbeam Coal Corp., 519 A.2d 385, 389 n.4 (Pa. 1986)(suggesting the same result as North Star). 18 The lease contains not only a provision for the payment of minimum royalty but also a covenant requiring Star to diligently mine the Howards coal. The parties to the lease obviously did not intend the minimum royalty provision as a limitation on the specific covenant requiring Star to mine diligently. Any other interpretation would render the requirement of due diligence meaningless. See North Star at Iafolla v. Douglas Pocahontas Coal Corp., 1250 S.E.2d 128 (W. Va. 1978). 268

11 COAL LEASE TERMINATIONS 9.02 requirement. 20 However, where a lease requires the payment of substantial minimums but does not expressly require diligence in mining, the courts have generally refused to imply a separate obligation to diligently mine. 21 Thus, where a coal lease contains either (1) a substantial minimum royalty requirement and also an express due diligence provision or (2) no substantial minimum royalty requirement and no disclaimer of a due diligence obligation, the lessee is exposed to the possibility of a claim for failure to diligently mine, which could result in a verdict for the payment of substantial damages. In North Star, the trial court awarded $43, as damages for failure to diligently mine, even though the lease also required payment of minimum royalties. Although the measure of damages for failure to diligently mine is not completely clear, 23 at least some cases have held that the damages should equal the number of tons of coal which should have been mined had the lessee mined with due diligence multiplied by the per ton royalty rate See, e.g., Mike Ross, Inc. v. Dante Coal Co., 230 F. Supp. 2d 716 (N.D.W. Va. 2002). 21 See, e.g., Mike Ross, Inc. v. Dante Coal Co., 230 F. Supp. 2d 716 (N.D.W. Va. 2002); Continental Fuel Co. v. Haden, 206 S.W. 8 (Ky. 1918); Begley v. Peabody Coal Co., 978 F. Supp. 861 (S.D. Ind. 1997) aff d, 210 F.3d 374 (7th Cir. 2000); Dulin v. West, 528 P.2d 411 (Colo. Ct. App. 1974); Archer v. Mountain Fuel Supply Co., 642 P.2d 943 (Idaho Ct. App. 1982); Hutchison 519 A.2d 385. But see, Ionno v. Glen-Gery Corp., 443 N.E.2d 504 (Ohio 1983) in which the Supreme Court of Ohio held that if the minimum advance royalties are credited against future production there is an implied obligation of development. 22 Clearly a substantial damage award in See discussion in Anderson v. Nichols, 359 S.E.2d 117 (W. Va. 1987) quoted below. A lessee would argue that the unmined coal remains in the ground and remains an asset which the lessor can exploit in the future, and, therefore, damages should be limited to time value of the royalties rather than full royalties; otherwise, the lessor will be made more than whole. The lessor, on the other hand, would argue that the lessee agreed, in effect, to pay royalty on all of the coal which should have been mined, and the lessee should be compelled to honor its promise, particularly since there is no guarantee that the coal will ever be mined. 24 See, e.g., Annotation, Implied Obligation of Purchaser or Lessee to Conduct, Search For, or to Develop or Work Premises For, Minerals Other Than Oil and Gas, 76 A.L.R.2d 721,

12 9.02 ENERGY & MINERAL LAW INSTITUTE [c] Claims for Failure to Mine All Mineable and Merchantable Coal. Claims for failure to mine all of the mineable and merchantable coal also commonly follow in the wake of lease terminations, if the lease obligates the lessee to mine all unmineable and unmerchantable coal. Although in recent years most lessees and their lawyers have been careful to avoid lease covenants requiring the lessee to mine all of the mineable and merchantable coal, 25 many such leases were written in prior decades, a number of which still remain in effect. There are two obvious problems for the lessee in making a commitment to mine all of the mineable and merchantable coal: (1) such a commitment may represent a burdensome and extensive undertaking, particularly on a large property and (2) no matter how much coal is actually mined, some coal will be left in the ground, and it is never 100 percent clear whether the remaining coal is or is not mineable and merchantable. In short, a commitment by a lessee to mine all of the mineable and merchantable coal is often a dispute waiting to happen when the lease ends. As in the case of failure to diligently mine, the measure of damages for failure to mine all the mineable and merchantable coal is not completely clear and for the same reason, i.e., the coal remains in the ground and the lessor can arguably still recover the royalty value in the future Mineable and merchantable coal is generally defined by the courts as coal which can ordinarily be mined and sold at a profit by a diligent and/or prudent and/or skillful operator, using appropriate equipment. See, e.g., Flavelle v. Red Jacket Consol. Coal & Coke Co., 96 S.E. 600 (W. Va. 1918); William C. Atwater & Co. v. Fall River Pocahontas Collieries Co., 195 S.E. 99, 102 (W. Va. 1937); Big Vein Pocahontas Co. v. Browning, 120 S.E. 247 (Va. 1923); Auxier Coal Co. v. Big Sandy & Miller s Creek Coal Co., 238 S.W. 189 (Ky. 1922). Coal leases frequently contain agreed definitions of Mineable and Merchantable. The common denominator of all definitions is profit. Without that limitation, any coal is mineable and merchantable at some cost. 26 In Anderson v. Nichols, 359 S.E.2d 117 (W. Va. 1987), the court acknowledged the issue without actually deciding it: The lease/sublease in the case before us required the lessees to remove all merchantable and minable coal (a term defined in the lease/sublease) from the leased premises... It is obvious from all the reasons stated by the arbitrators that the primary basis for the second $52,500 award was that 270

13 COAL LEASE TERMINATIONS 9.02 [d] Lost Coal Claims. Many coal leases obligate the lessee to pay for lost coal, i.e., coal rendered unmineable and unmerchantable in the course of or as a result of mining. 27 Although it has been argued that payment of minimum royalties should be regarded as a substitute for payment of royalties or damages on lost coal, the case law does not support that contention. 28 Lost coal and/or waste claims at the termination of a lease may be particularly likely where the lessee fails to complete its mining activities as projected and closes its mines prematurely. Even if the lease doesn t obligate the lessee to mine all the mineable and merchantable coal, the lessee, by failing to complete its projected mining, may render remaining isolated pockets of coal in the uncompleted mines unmineable and unmerchantable. [e] Waste Claims. Regardless of whether the lease does or does not have a lost coal provision, the lessee may be liable under common and statutory law for rendering coal unmineable, since doing so is generally understood to constitute waste and violates the lessee s duty to... do nothing nor leave undone anything reasonably necessary to protect the inheritance against waste and destruction, The lessor may prefer to seek there remained 225,000 tons of minable and merchantable coal for which the lessors were entitled to royalties... Although the lessors are entitled to royalties, they still own the coal and at some future time they can sell it. Yet because the appellants admit that there were roughly 225,000 tons of minable and merchantable coal left, it is hard to see how lessors under any jury instruction could have done worse in court than they did with the arbitrators. If royalties were about $3 per ton, lessors might have gotten as much as $675,000 from a jury. Id. at 119, 121. (emphasis in the original). 27 Even if the lease does not make the lessee responsible for lost coal, the lessor still may have a claim for waste under common and statutory law, as discussed below. 28 See, e.g., Elkhorn Coal Corp. v. By-Products Coal Co., 35 S.W.2d 898, (Ky. 1931): The lease requires payment of the minimum royalty, and for lost coal, too, and the payment of one does not alter or affect the obligation to pay the other. 29 See, Goodykoontz v. White Star Mining Co., 119 S.E. 862, 864 (W. Va. 1923). 271

14 9.02 ENERGY & MINERAL LAW INSTITUTE damages for waste rather than for violation of a lost coal requirement because recovery for waste can include treble damages. For example, in West Virginia, if the waste is wanton, the lessee is liable for three times the damages which would have been assessed if the waste had not been wanton. 30 Wanton waste, under West Virginia law, is waste which is done... intentionally, with design, without excuse and under circumstances evincing a reckless disregard of the lawful rights of others. 31 Kentucky law also provides for treble damages for waste, 32 and the courts of Kentucky have interpreted the statute as applicable to voluntary waste (a wanton or destructive act) but not permissive waste. 33 [f] Other Property Damage Claims. The coal may not be the only asset of the lessor which has arguably been damaged by the lessee s activities, including, for example, the surface and surface structures. 34 In recent years, environmental impairment of the leased premises would probably rank high on the list of concerns for both lessor and lessee. [g] Holdover Claims. It often takes a prolonged period of time for a lessee to complete mining and reclamation and vacate the leased premises, 35 frequently resulting in the lessee holding over after the end of the term, particularly 30 W. Va. Code (2004). 31 Hardma v. Brown, 88 S.E. 1016, 1019 (W. Va. 1916). See also, Cline v. Joy Mfg. Co., 772, 310 S.E.2d 835, 838 n.6 (W. Va. 1983). 32 Ky. Rev. Stat. Ann (Michie 2004). 33 See, Addison v. Brandenburg, 260 S.W. 381 (Ky. 1924); Smith v. Mattingly, 28 S.W. 503 (Ky. 1894); Mullins v. Dees, 124 S.W. 828 (Ky. 1910); Continental Fuel Co. v. Haden, 206 S.W. 8 (Ky. 1918). In general, see Restatement (Second) of Property See, e.g., Morris v. Saline County Coal Co., 211 Ill. App. 178 (Ill. App. Ct. 1918). 35 There are many different things which can delay the former lessee s departure from the leased premises, including, for example, the need to remove and dispose of equipment, the need to dispose of improvements owned by the lessee, the need to complete reclamation, or the desire to continue to use the property for limited purposes such as wheelage. 272

15 COAL LEASE TERMINATIONS 9.02 in the case of abrupt and/or unexpected lease terminations. If the lease allows for holding over, the lessee presumably will have no liability for doing so; otherwise, the holdover former lessee is vulnerable to either trespass damages or the obligations of a lease extension. In the case of leases in general, it is recognized that a landlord has the election of either treating his holdover former tenant as a trespasser or he may accept him as a tenant for a new term. 36 The extent to which a mineral lessor may elect to treat a holdover former lessee as a tenant for a new term is unclear. In general, mineral holdover cases have held the former tenant liable for the fair and reasonable value of the use and occupation of the leased premises during the holdover period. 37 Some cases have suggested that the minimum royalties agreed to in the now terminated lease may be the proper measure of the fair and reasonable value of the use and occupation of the property. 38 It has also been suggested that either reasonable royalties on coal mined or a reasonable minimum royalty, whichever is greater, may be the proper measure of damages. 39 [h] Claims for Miscellaneous Breaches. Coal leases typically contain many covenants, the breach of any or all of which could form the basis of damage claims at termination, such as failure to comply with applicable laws, rules and regulations, failure to pay property taxes or even failure to provide periodic mine maps. [i] Punitive Damage Claims. In West Virginia, at least, almost any case in which the plaintiff offers proof of a tort and wanton, willful, oppressive or reckless conduct 40 could 36 See, e.g., 49 Am. Jur. 2d Landlord & Tenant 1115; Restatement (Second) of Property See, e.g., Gambill s Adm r v. Ellser Coal Co., 20 S.W.2d 286 (Ky. 1929)(fair and reasonable value of the use plus agreed wheelage); Imperial Colliery Co. v. Oxy USA, Inc., 912 F.2d 696 (4th Cir. 1990)(fair rental or royalty plus proven special damages). 38 Saylor v. Howard, 18 S.W.2d 279 (Ky. 1929); Hall v. Landrum, 470 S.W.2d 830 (Ky. 1971). 39 Bethlehem Steel Corp. v. Shonk Land Co., 288 S.E.2d 139, 149 (W. Va. 1982). 40 See, for example, Mayer v. Frobe, 22 S.E. 58 (W. Va. 1895); Coleman v. Sopher, 499 S.E.2d 592 (W. Va. 1997). 273

16 9.02 ENERGY & MINERAL LAW INSTITUTE result in a punitive damage award. In the context of the relationship between coal lessor and coal lessee, the Supreme Court of Appeals of West Virginia has held that a lessee who is engaged in oppressive conduct (apparently consisting, in that case, of abandonment of the lease in a very abrupt and arrogant manner ) might justify punitive damages, even in an arbitration proceeding. 41 [j] Interest Claims. Any judgment or award carries with it the potential for pre-judgment and/or post-judgment interest. The circumstances under which prejudgment interest will be allowed vary from state to state. Under Ohio law, for example, the trial court has discretionary power to award prejudgment interest when necessary to make the plaintiff whole or to disgorge undeserved gain. 42 [k] Third Party and Indemnity Claims. A breakdown in the relationship between coal lessor and coal lessee may be the occasion for, or even occasioned by, third party claims against either or both. 43 Third party claims against both lessor and lessee are not uncommon under West Virginia law, which has recognized, at least for some purposes, what has been called the common purpose doctrine, i.e., the theory that both lessor and lessee are liable for damage to third parties resulting from the lessee s mining operations, because the lessor 41 Anderson 359 S.E.2d at 121: The appellants now focus on reason (f)(that finds that Mr. Nichols and N. F. Mining abandoned their lease and the property in a very abrupt and arrogant manner to sustain their complaint that the second $52,500 award was punitive damages. Even if the second award was punitive damages, however, we would not set it aside on that grounds alone. Arbitrators, like courts, are entitled to award punitive damages in appropriate circumstances as compensation for oppressive conduct. 42 See, e.g., Coal Resources, Inc. v. Gulf & Western Indus., Inc., 865 F.2d 761, 776 (6th Cir. 1989): The trial court, while recognizing its power to award pre-judgment interest when necessary to make the plaintiff whole, or to disgorge defendant of undeserved gain, declined to exercise that power. The trial court found that defendant made no gains because of its breach of contract. Further, the trial 274

17 COAL LEASE TERMINATIONS 9.02 and lessee are engaged in a common purpose, i.e., the common effort to derive profit from the mining of the coal. 44 The former Court of Appeals of Kentucky has employed a similar legal fiction implied agency in holding a lessor liable for damages caused by or in the course of the lessee s operations. 45 In another Kentucky case, a lessor was held jointly liable with a lessee for the lessee s trespass, where the lessor warranted title to the area where the trespass occurred. 46 In a Colorado case, a lessor s liability for acts of its lessee was predicated on knowledge of wrongdoing (pulling pillars which caused subsidence) coupled with acceptance of the royalties resulting from that activity. 47 The potential for state and federal governmental claims against lessors for environmental impairment or black lung benefits is now well understood. [l] Breach of Warranty Claims. Not all of the claims relating to a failed lease relationship are asserted by the lessor. If the lease contains express or implied warranties of title, court stated it was the province of the jury to make the plaintiff whole in this case, and it was unwilling to tamper with the jury s determination. We agree with the trial court and find no abuse of discretion in its denial of prejudgment interest on the jury verdict. 43 The mass flood litigation currently pending in West Virginia is an excellent example of the very real potential of third parties suing both lessors and lessees for damage allegedly resulting from mining operations. It probably is fair to say that the many lessors involved in these cases are very much aware of the desirability for coal leases to contain both indemnity and insurance provisions (discussed below). 44 See, O Dell v. McKenzie, 145 S.E.2d 388, 391 (W. Va. 1965): The evidence in this case shows that the defendants, lessors, and the lessee had a common purpose in the stripping of coal from the defendants land, that is, the defendants received a certain sum of money per ton for all coal removed and the lessee, it may be assumed, received or expected to receive a sum for each ton of such coal so as to show a profit from the enterprise. We hold therefore that, under the circumstances of this case, the defendants are jointly liable with the lessee for the resulting damage to plaintiff. 45 Kentucky Harlan Coal Co. v. Harlan Gas Coal Co., 53 S.W.2d 538 (Ky. 1932). 46 Davis v. Kentland Coal & Coke Co., 57 S.W.2d 542 (Ky. 1933). 47 Campbell v. Louisville Coal Mining Co., 89 P. 767 (Colo. 1907). 275

18 9.02 ENERGY & MINERAL LAW INSTITUTE quiet possession, quantity or quality of coal, or other express or implied warranties, the lessee may claim that its failure to mine, failure to comply with covenants or other lack of success was the result of breach of warranty by the lessor, 48 and under proper circumstances the lessee could even seek to recover damages for loss of its investment in the property, which is often substantial. [m] Claims of Interference by Lessor. Yet another possible termination-related claim which could be asserted by the lessee against the lessor would be a claim for lessor interference in the lessee s operations. In a 1938 case, the former Court of Appeals of Kentucky awarded damages to the lessee for the lessor s interference, measured by the loss of net profits sustained by the lessee. 49 [2] The Cost of Failing to End a Disadvantageous Relationship. At the same time that there is a fairly long list of potential claims arising out of or attendant to the termination of coal leases, failure to end a disadvantageous or broken relationship can also have undesirable consequences for the parties. [a] Lost Opportunity Costs for the Lessor. Not infrequently lessees, who may have made very large investments in the leased property, both in the form of infrastructure and unrecouped minimum royalties, are quite naturally reluctant to surrender the lease, even when their mining operations have ceased. In this situation, although the lessor would ordinarily be entitled to receive any agreed minimum royalties so long as the lessee retains possession of the leased premises, those minimums may very well be substantially below current market rates, in which case the lessor is left in the frustrating position of knowing, 48 See, e.g., Creson v. Scott, 302 S.W.2d 558 (Ky. 1957). 49 New v. Kinser, 115 S.W.2d 1054 (Ky. 1938). See also, Long v. Wilhorn, 250 Ky. 683, 63 S.W.2d 913 (1933). 276

19 COAL LEASE TERMINATIONS 9.02 or at least believing, that a better deal could be had. It may be to the lessor s advantage to investigate the possibility of forfeiting the lease or seeking equitable cancellation or recission, as discussed below. [b] Bankruptcy of the Lessee. In those situations where the relationship has faltered because of the financial precariousness of the lessee, the lessor needs to be aware that bankruptcy is always an option for the lessee, or the lessee s creditors, 50 which, if the lease is not ended prior to bankruptcy, could substantially prolong the relationship between the parties, or even result in a change in the terms of the relationship under some circumstances. 51 [c] Permanent Impairment of the Leased Property and Damage to Others. A financially strapped lessee may also be more likely to operate irresponsibly, with potential long term environmental and other consequences for the leased property. If the lease is not terminated before such problems arise, the lessor could become liable for resolving the problems, e.g., long term water treatment, other environmental remediation, employee claims or damage to third parties. [d] Carrying Costs for the Lessee. Lessees also need to carefully weigh the costs of termination vs. the costs of the status quo. As noted above, lessees not infrequently have made such a large investment in the leased property that they are reluctant to surrender the lease and cut their losses. Even though the carrying costs in terms of minimum royalties, taxes, maintaining idled mines, etc., may be very large indeed, lessees will sometimes hold on long after any realistic hope of profitable development has ended, hoping that the market will 50 Of course, the lessor is ordinarily a creditor of the lessee and could choose to join in initiating a bankruptcy proceeding under some circumstances. However, lessors usually prefer to resolve their issues outside bankruptcy, if possible, and avoid the protections bankruptcy provides to debtors. 51 See, e.g., Christian Land Corp. v. C&C Co., 422 S.E.2d 503 (W. Va. 1992). 277

20 9.03 ENERGY & MINERAL LAW INSTITUTE improve or that they will find someone to buy the leasehold and reimburse them for at least a portion of their investment. In hindsight, this choice may appear questionable How and When Coal Leases End. Before attempting to plan an exit strategy, it s necessary to understand the different ways in which a coal lease can end. 52 [1] Expiration. Many coal leases, like many marriages, die a natural death. Nothing is forever, 53 and coal leases, and the lessee s right of possession thereunder, expire at the end of the agreed term. 54 The courts have generally enforced the term limits and renewal provisions agreed to by the parties. For example, in the case of a coal lease with a term of ten years, subject to renewal by written notice six months prior to expiration, the Supreme Court of Pennsylvania held, in a 1955 decision, that, absent such written notice, the lease expired at the end of the original term and the lessee was... without any right to mine and remove coal... after the expiration of the fixed term, notwithstanding the fact that the lease was construed as a sale of the coal in place As to the termination of leases see generally, 49 Am. Jur. 2d Landlord & Tenant 215: Termination of a lease occurs (1) where it expires, upon the passage of time, according to its terms; (2) on the happening of a condition subsequent and re-entry or conditional limitation; (3) by operation of law, as in the case of the merger of the tenancy into a reversion in the same person, or (4) by cancellation by the act and with the consent of the lessor and the lessee or by a recission by the lessee in a proper case. 53 However, see discussion of perpetual leases below Am. Jur. 2d Landlord & Tenant, Boron v. Smith, 110 A.2d 169, 171 (Pa. 1955). But see, a 1991 case in which the Supreme Court of Kentucky held (over vigorous dissent) that an oil and gas lease did not terminate on the agreed expiration date, where the lessor knowingly allowed the lessee to continue development efforts after that date. 278

21 COAL LEASE TERMINATIONS 9.03 [2] Automatic Termination by Special or Conditional Limitations. The habendum or term clauses of mineral leases can, and frequently are, made subject to special or conditional limitations, which have the effect of automatically terminating the lease if the limiting condition occurs. 56 For example, oil and gas leases are commonly subject to the special limitation that the lease continues only so long as gas is produced in paying quantities. 57 Coal leases also frequently contain special limitations, such as commencement of mining operations within the primary term 58 and, more commonly, exhaustion of the coal. 59 Special limitations have been distinguished from conditions subsequent which allow for optional termination rather than automatic termination. 60 That distinction is important because it has been held that automatic termination by special limitation is not subject to the restrictions applicable to forfeiture, 61 but optional termination by the lessor as a result of breach Am. Jur. 2d Landlord & Tenant, See, e.g., McCullough Oil v. Rezek, 346 S.E.2d 788 (W. Va. 1986). 58 See, e.g., Dethloff v. Zeigler Coal Co., 412 N.E.2d 526 (Ill. 1980): The purpose of the habendum clause in a lease is to define and measure the duration of the lessee s interest in the property to be developed.... Habendum clauses of this type generally have been interpreted as vesting the lessee with an interest subject to this special limitation that mining operations must commence within the primary period of the lease. Thus, if no production or significant mining operations have been initiated within the primary period the lease automatically terminates at the end of that period or term. 59 Krypton Coal Corp. v. Golden Oak Mining Co., 383 S.E.2d 37 (W. Va. 1989); Winco Block Coal Co. v. Evans, 76 S.W.2d 241 (Ky. 1934); Kentucky & West Virginia Coal & Mining Co. v. Blue Diamond Coal Co., 106 F. Supp. 274 (E.D. Ky. 1952); Geier v. Eagle-Cherokee Coal Mining Co., 313 P.2d 731 (Kan. 1957). 60 McCullough Oil, 346 S.E.2d McCullough Oil, 346 S.E.2d at 795: In short, by the self-executing terms of such a habendum clause, the lease terminates, expires or lapses; it is not forfeited. The distinction is not merely one of nomenclature. As a consequence of this distinction, the rule that equity abhors a forfeiture is not applicable. In a subsequent decision the holding in Rezek was said to be applicable not only to oil and gas leases but also to other mineral leases. Bryan v. Big Two Mile Gas Co., 577 S.E.2d 258 (W. Va. 2001). 279

22 9.03 ENERGY & MINERAL LAW INSTITUTE of condition subsequent is, or may be, subject to forfeiture restrictions. 62 A lease provision will be construed as a condition subsequent rather than a limitation unless a contrary intent is clearly expressed. 63 If a lease provision calls for termination upon a contingency which is dependent on the conduct of the lessee, some courts will construe the provision as a condition subsequent 64 and, thus, subject to the restrictions applicable to forfeiture. 65 [3] Surrender by Agreement the Amicable Divorce. Although divorce more frequently entails acrimony, occasionally the parties agree that the relationship needs to end and agree to accomplish that. If both parties to a coal lease agree to end the lease, the lessee can simply surrender the lease and the leasehold to the lessor. 66 Surrender, when accepted by the lessor, terminates all future obligations of the lessee, but not obligations which accrued prior to termination. 67 Surrender can be accomplished either by agreement of the parties 68 or by operation of 62 Keller v. Model Coal Co., 97 S.E.2d 337 (W. Va. 1957) Am. Jur. 2d Landlord & Tenant, Id. 65 Certainly this is consistent with the commonly understood definition of forfeiture: The word forfeiture refers to the right of the lessor to terminate the lease because of a breach of covenant or some other wrongful act of the lessee. 49 Am. Jur.2d Landlord & Tenant In its simplest terms, a surrender is... the giving up of a lease before its expiration. State ex rel. Frazier & Oxley v. Cummings, 569 S.E.2d 796, 802 (W. Va. 2002). A more interesting definition is found in Annotation, Oral Surrender of Written Lease, 78 A.L.R. 2d (1961): By ancient definition, still undoubtedly valid, a surrender is the yielding up of an estate for life or years to him that hath an immediate estate in reversion or remainder, wherein the estate for life or yeares may drowne by mutuall agreement betweene them. (quoting from Coke on Littleton 686). 67 Casper Nat l Bank v. Curry, 65 P.2d 116 (Wyo. 1937). 68 Traditionally, at least, the law of surrender by agreement was strict, requiring an actual surrender in praesenti and not just an agreement to surrender in the future. Rees v. Emmons Coal Mining Co., 106 S.E. 247, 251 (W. Va. 1921), overruled on other grounds, 199 S.E. 361, 363 (1931). 280