An excerpt from LAW 360.
With the key question still unanswered, Chesapeake moved again for summary judgment on all the at-the-well leases, asking the district court to determine how the royalties should be calculated. On Oct. 25, 2017, Judge Sara Lioi granted Chesapeake’s motion. The court focused on two issues: ambiguity and intent.
Regarding ambiguity, the court rejected the plaintiffs’ argument that the leases were ambiguous, concluding instead that the leases’ clear and unambiguous language resolved the question. Based upon that language, the court concluded that “the Ohio Supreme Court would adopt the ‘at the well’ rule” in the leases that calculated royalties on ‘market value at the well.’”
In rejecting the marketable product rule, the court explained that states usually use that rule when leases do not address post-production costs. “Construing the lease under the ‘marketable product’ rule would ignore the clear language that royalties are to be paid based on ‘market value at the well.’” Additionally, the court emphasized that a close reading of the royalty provision showed that the parties intended to value the gas at the well, not downstream.
In addition to defining how royalties would be calculated in leases defining value at the well, the state and federal courts’ analysis and decisions in Lutz over the past 15 months have taught a lesson to landowners and gas producers alike who will enter into oil-and-gas leases in Ohio: Contractual language rules the day.
Following Lutz, the Ohio Supreme Court again highlighted the importance of analyzing contract language in oil and gas leases before signing them in its June 2017 decision in Bohlen et al. v. Anadarko E&P Onshore LLC, 150 Ohio St.3d 197 (2017). Mirroring the analysis in its ruling in Lutz et al. v. Chesapeake Appalachia, the Ohio Supreme Court reiterated its position that oil and gas leases are contracts under Ohio law and will be analyzed as such.
In Bohlen, the Ohio Supreme Court again indicated that the courts should “apply a cardinal principle of contract law [when interpreting oil and gas leases]: the unambiguous language of the contract governs and courts will not give the contract a construction other than that which the plain language of the contract provides” (internal quotations omitted).
Thus, the analysis of the royalty provisions in Lutz and Bohlen make it clear that both landowners and gas producers should carefully review the language in oil and gas leases because the express intent of the parties, demonstrated through the particular words used in a lease, will carry great weight with courts when interpreting oil and gas leases.
The district court’s recent decision defining at-the-well royalties brings Ohio law in line with oil and gas law in other significant gas-producing states such as Pennsylvania and Texas. The appeal deadline has not yet passed. Regardless of whether the plaintiffs appeal Judge Lioi’s decision, litigation over oil and gas leases in Ohio will continue, as the state’s oil and gas law continues catching up to the energy law in other states. And while parties will continue signing oil and gas leases during Ohio’s production boom, all parties should carefully analyze the provisions of a lease before attaching their signatures to any agreement.
Keith, that's absolutely right. The contract controls. Whatever the dispute is, whether it's over royalties or some other matter covered by the lease, the first place that the courts will look is the provisions of the lease. The courts look at the lease as a contract and the intentions of the parties as expressed in the lease are paramount and controlling. The parties are free to contract as to the royalty provision and its language, just like any other provision. Even if Ohio,and PA follow the "at the well," this can be changed by the parties.
How does this affect the dreaded "Market Enhancement" clause in the leases. If at the beginning of the lease it states no deductions directly and in directly for transporting, processing etc (on and on) but then has the "if however" followed by the usual Market Enhancement Clause. Does this ruling change anything to benefit the O&G owner or can the companies still deduct whatever they want under the guise of the Market Enhancement clause?