Northup Properties, Inc. v. Chesapeake Appalachia, L.L.C. ( 2009 )

RECOMMENDED FOR FULL-TEXT PUBLICATION
Pursuant to Sixth Circuit Rule 206
File Name: 09a0205p.06
UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
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Plaintiff-Appellant, -
NORTHUP PROPERTIES, INC.,
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No. 08-5718
v.
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Defendant-Appellee. -
CHESAPEAKE APPALACHIA, L.L.C.,
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Appeal from the United States District Court
for the Eastern District of Kentucky at Ashland.
No. 07-00030—Amul R. Thapar, District Judge.
Argued: April 28, 2009
Decided and Filed: June 8, 2009
Before: MERRITT, COOK, and WHITE, Circuit Judges.
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COUNSEL
ARGUED: Eldred Edward Adams, Jr., ADAMS & ADAMS, Louisa, Kentucky, for
Appellant. Leigh Gross Latherow, VanANTWERP, MONGE, JONES, EDWARDS &
McCANN, LLP, Ashland, Kentucky, for Appellee. ON BRIEF: Eldred Edward Adams,
Jr., ADAMS & ADAMS, Louisa, Kentucky, for Appellant. Leigh Gross Latherow, Keri E.
Lucas, VanANTWERP, MONGE, JONES, EDWARDS & McCANN, LLP, Ashland,
Kentucky, for Appellee.
COOK, J., delivered the opinion of the court, in which MERRITT, J., joined.
WHITE, J. (pp. 12-15), delivered a separate opinion joining in the affirmance.
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OPINION
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COOK, Circuit Judge. In 1968, the heirs of J. H. Northup, predecessors in interest
to appellant Northup Properties, Inc. (“Northup”), executed an oil-and-gas lease of 4,327
acres in Kentucky (the “Lease”) to United Fuel and Gas Company, the predecessor in
1
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 2
interest to appellee Chesapeake Appalachia, L.L.C. (“Chesapeake”). For nearly forty years,
no lessee—including Chesapeake—marketed either oil or gas from the leased property.
Northup then filed suit in Kentucky state court for a judgment declaring the Lease null and
void. Chesapeake removed the case on the basis of diversity jurisdiction, and the two parties
filed cross-motions for summary judgment. After a hearing, the district court granted
summary judgment for Chesapeake and denied Northup’s motion. Northup appealed, and
we affirm.
I.
Neither party disputes the facts in this case. In relevant part, the Lease contains the
following provisions:
It is agreed that this lease shall remain in force for the term of ten (10) years
from this date and as long thereafter as the said land is operated by the
Lessee in the search for or production of oil or gas, with an extended term
by payment of rentals as hereinafter set forth.
...
In the event that Lessee does not market the gas from said premises, Lessee
is to pay delay rental until such time as the gas is marketed.
...
Lessee shall pay the Lessor a rental at the rate of $1.00 per acre per annum
payable quarterly in advance beginning three months from the date hereof,
in lieu of development of the entire leased acreage; provided, however, that
each gas well drilled by Lessee on any portion of said land, whether the
same be productive or non-productive, shall liquidate and abate said delay
rental with reference to 250 acres of the leased premises.
...
It is agreed that said Lessee may drill or not drill on said lands as it may
elect, and the consideration and rentals paid and to be paid constitute
adequate consideration for such privilege.
Within the initial ten years (or “primary term”) of the Lease, Chesapeake drilled three wells
on the property that yielded neither oil nor gas. No other drilling occurred, and Chesapeake
plugged two of the original wells. Northup has yet to receive any oil or gas royalty as a
result of the Lease. In fact, since the Lease began, the only pecuniary benefit to Northup
arises from what Northup terms “nominal” delay-rental payments of $1.00-per-acre each
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 3
year. This “nominal payment” amounted to approximately $4,300 each year, or $164,430
for thirty-eight years.
Northup accepted a quarterly delay-rental payment in January 2006, but the next two
quarterly payments never arrived. When Chesapeake eventually tendered another payment
in December of the same year, Northup returned the check and notified Chesapeake that it
considered the Lease “expired by its own terms and therefore . . . terminated at will,” and
requested that Chesapeake execute a release “in order to remove any possible cloud on the
estate.” In defense of the Lease’s validity, Chesapeake pointed to its payment of delay
rentals—and Northup’s acceptance of the same—for nearly four decades.
After Northup filed suit in state court seeking to quiet title, Chesapeake removed the
case on the basis of diversity jurisdiction. Northup contested the removal, arguing that the
case failed to satisfy the amount in controversy, but the district court denied Northup’s
motion to remand. The parties filed joint stipulations and then cross-motions for summary
judgment. After a hearing, the district court concluded that the Lease did not terminate by
its own terms and granted summary judgment for Chesapeake. After unsuccessfully moving
to alter, amend, or vacate the judgment, Northup timely appealed.
II.
In denying Northup’s motion to remand, the district court credited the affidavit of
Chesapeake’s petroleum engineer, John D. Adams, which stated that the amount in
controversy exceeded $75,000 as required by 28 U.S.C. § 1332(a). Specifically, Adams
estimated: (1) the “future cash flows” from the natural gas well at $168,147; (2) the
discounted present value of the well as between $106,874 and $131,426; (3) the value of the
remaining undeveloped acreage of the entire leasehold estate at $426,700; and (4) the initial
cost of drilling the well as exceeding $75,000. We review determination of subject matter
jurisdiction de novo. Smith v. Nationwide Prop. & Cas. Ins. Co., 505 F.3d 401, 404 (6th Cir.
2007). The burden is on Chesapeake to show by a preponderance of the evidence that the
allegations in the complaint at the time of removal satisfy the amount-in-controversy
requirement. Hayes v. Equitable Energy Res. Co., 266 F.3d 560, 572 (6th Cir. 2001). The
district court concluded that Chesapeake’s “anticipated loss, as set forth in the Adams
affidavit, exceeds the jurisdictional minimum,” and we agree.
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 4
The parties’ dispute turns on how to ascertain the amount in controversy in a case
where the litigation does not seek monetary damages, but declaratory or injunctive
relief—here, the cancellation of a lease—involving a mineral interest. One principle is well-
settled: for actions seeking a declaratory judgment, we measure the amount in controversy
by “the value of the object of the litigation.” Hunt v. Wash. State Apple Adver. Comm’n, 432
U.S. 333, 347 (1977); see, e.g., Cincinnati Ins. Co. v. Zen Design Group, Ltd., 329 F.3d 546,
549 (6th Cir. 2003). But the question remains whether we understand the value of this Lease
as purely a possessory interest in the land or whether we account for the underlying mineral
interest. Complicating matters is the fact that the Lease never resulted in the marketing of
either oil or gas.
From Chesapeake’s perspective, the amount in controversy is not solely a possessory
interest but involves the underlying mineral interest. In other words, Chesapeake argues that
this court should measure the jurisdictional amount by weighing “Chesapeake’s loss of its
right to the natural gas contained under the 4,400 acres of land.” Pointing to Adams’s
affidavit, Chesapeake argues that the amount in controversy—including the discounted
future cash flow, the leaseholds’ minimum value, and the cost to drill the original
well—easily exceeds $75,000.
Weighing in Chesapeake’s favor is the fact that several courts, when faced with
1
similar facts, apply metrics similar to those used by Adams. Those metrics include: (1) the
tract’s fair market value, see Occidental Chem. Corp. v. Bullard, 995 F.2d 1046, 1048
(11th Cir. 1993) (using fair market value in assessing the amount in controversy, even
though that value exceeded the contract price); Thomas Well Serv., Inc. v. Williams
Natural Gas Co., No. 93-4090-SAC, 1993 WL 393708, at *2 (D. Kan. Sept. 8, 1993);
Perrin v. Tenneco Oil Co., 505 F. Supp. 23, 25 (W.D. Okla. 1980); Ehrenfeld v. Webber,
499 F. Supp. 1283, 1293–94 (D. Me. 1980) (finding the amount-in-controversy
1
This circuit has yet to decide whether we view the amount in controversy from the perspective
of the plaintiff or the defendant. See, e.g., Everett v. Verizon Wireless, Inc., 460 F.3d 818, 829 (6th Cir.
2006) (noting the controversy); Olden v. LaFarge Corp., 383 F.3d 495, 503 n.1 (6th Cir. 2004) (same).
But we need not decide that question here because we calculate the amount in controversy by accounting
for the mineral interest in the land, and not merely the possessory interest (or the value of the rentals). See
Petrey v. K. Petroleum, Inc., No. 07-168, 2007 WL 2068597, at *3 (E.D. Ky. July 16, 2007) (concluding
that the “value of the item to be obtained” was “sole interest” of the minerals, and examining “the value
attached to the interest by the defendant if that party offers competent evidence of its value”).
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 5
requirement unsatisfied where an expert witness testified that the market value of the
tracts at issue amounted to $3,500); (2) both fair market value and net value of the
mineral interest, Ladner v. Tauren Exploration, Inc., No. 08-1725, 2009 WL 196021, at
*2–3 (W.D. La. Jan. 27, 2009); and (3) the diminished value of the land burdened with
an oil-and-gas lease or the increased value without the lease, A.C. McKoy, Inc. v.
Schonwald, 341 F.2d 737, 739 (10th Cir. 1965).
Of course, accounting for mineral interests is not an exact science. The Supreme
Court acknowledged as much in ASARCO, Inc. v. Kadish, 490 U.S. 605 (1989), noting
that a “possible distinction between mineral leases and the lease of lands for other
purposes is that mineral rights can be difficult to appraise.” Id. at 628 n.3. Even so, the
Court maintained that the speculative character of such interests “does not defeat the
existence of a ‘market value’ in mineral rights.” Id. (citing Mont. Ry. Co. v. Warren, 137
U.S. 348, 352–53 (1890)). And as the Seventh Circuit observed in a tax context, a
mineral lease is not “worthless”—even in a tract where a sole well lies abandoned—as
long as some possibility exists to drill other wells that “might result in finding oil and
gas in productive quantities.” Davis v. C.I.R., 241 F.2d 701, 703 (7th Cir. 1957).
Indeed, the Davis court rejected the Tax Court’s argument that “stopping work on the
one well was an abandonment of the entire leasehold, and proof of the lack of value of
the entire lease at that time.” Id. at 703–04.
Here, Chesapeake’s affidavits prevent the accounting of the mineral interest from
becoming a matter of judicial star-gazing. See Frystak v. Cabot Oil & Gas Corp., 2008
WL 2357744, at *3 (M.D. Pa. June 5, 2008) (accepting an affidavit equating the
jurisdictional amount with the value of the lease and contending that “the full value of
the object of the litigation exceed[ed] $75,000”). Because Chesapeake convinces us that
the amount in controversy more likely than not exceeds the jurisdictional minimum of
$75,000, the district court properly denied Northup’s motion to remand.
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 6
III.
Proceeding to the merits, we review de novo the grant of summary judgment,
including all relevant issues of law. See Jones v. Potter, 488 F.3d 397, 402 (6th Cir.
2007). Drawing all inferences in Northup’s favor, we will affirm where no genuine issue
exists as to any material fact and Chesapeake is entitled to judgment as a matter of law.
See Fed. R. Civ. P. 56(c); Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S.
574, 587 (1986).
A.
Northup first argues that the Lease expired by its own terms after the primary
term concluded,2 and that Chesapeake cannot force Northup to extend the Lease by the
payment of “nominal” delay rentals. But we reject this argument, concluding that the
Lease expressly allows for extension by payment of delay rentals.
A brief historical excursus underscores the uniqueness of the Lease’s terms. Oil-
and-gas leases contemporary to the Lease often followed a form known as a “Producer’s
88.” See Owen L. Anderson et. al., Hemingway Oil & Gas L. & Taxation § 6.2 (4th ed.
2004) (“Hemingway Oil & Gas”). A Producer’s 88 lease customarily provides that the
primary term “shall terminate upon any anniversary date of the lease during its primary
term, unless the lessee either pays the delay rental then due or commences the operations
for the drilling of a well prior to each such date.” Hemingway Oil & Gas § 6.2. If such
operations occurred, a secondary term would ensue that typically depended on mineral
production for continued existence. Ordinarily, the primary term involved a definite
number of years for exploration and development of the minerals, while the secondary
term included an “as long as” or “so long as” clause that “operate[d] to extend the lease
. . . as long as oil or gas [was] produced by the lease.” Williston H. Symonds, Note, The
2
Kentucky law sets forth three grounds by which an oil and gas lessee may lose interest in a lease:
(1) forfeiture incident to breach of an express or implied covenant or obligation of the lease;
(2) abandonment, or the intentional and actual relinquishment of the leased premises; and (3) the lease
terminating by its own terms. Hiroc Programs, Inc. v. Robertson, 40 S.W.3d 373, 377 (Ky. Ct. App.
2000). Northup clarifies in its Reply Brief that it is not contending that the Lease terminated due to either
forfeiture or abandonment.
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Michelangelo of the Oklahoma Oil & Gas Industry: The Cessation of Production
Clause, Spontaneous Lease Terminations, and Cyclical or Marginal Production
Problems, 17 Okla. City U. L. Rev. 413, 415–16 (1992) (emphasis added). The
secondary term allowed the lessee to recover minerals on the lease without the risk of
sudden termination. Id. at 415.
The Lease does not follow the typical Producer’s 88 form, and its very language
confirms that delay rentals extended the Lease. Rather than including a habendum
clause that sets forth a secondary term holding the lease “as long as,” or “so long as,” oil
or gas is produced, see Hemingway Oil & Gas § 6.4, the Lease explicitly acknowledges
that delay rental payments extend the contract through a secondary term:
It is agreed that this lease shall remain in force for the term of ten (10)
years from this date and as long thereafter as the said land is operated by
the Lessee in the search for or production of oil or gas, with an extended
term by payment of rentals as hereinafter set forth.
The Lease’s discussion of a secondary term held by delay rentals does not include any
language equivalent to the typical “as long as” or “so long as” production phrases.
Rather, it provides:
In the event that Lessee does not market the gas from said premises,
Lessee is to pay delay rental until such time as the gas is marketed.
The Lease’s very language contemplates the possibility of gas not being produced from
the lease—and the Lease extending by way of delay rentals.
Northup’s arguments to the contrary are meritless. Northup cites Hiroc
Programs, Inc. v. Robinson, 40 S.W.3d 373 (Ky. Ct. App. 2000), for a discussion of the
term “marketed,” arguing that the duty to market requires due diligence and a good-faith
effort to market gas. Id. at 378. But the lease in Hiroc included a habendum clause that
specifically provided: “The life of this lease shall extend as long as oil or gas is
marketed from the property hereby leased.” Id. A case that includes a habendum clause
dictating that the lease term turns on production is inapposite to the Lease here, which
includes no such language. Next, Northup points to Vaughn v. Hearrell, 347 S.W.2d
542 (Ky. 1961), arguing that the lessee in that case unsuccessfully “attempted to extend
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 8
the lease by the payment of delay rentals by relying on language in the lease that seemed
to grant an open ended option to extend the lease beyond the primary term by continuing
the payment of delay rental.” But Vaughn merely dictates that Kentucky law will not
extend a lease by delay rentals where the habendum clause contains “indirect,
ambiguous, and negative language.” Id. at 544 (citation and quotation marks omitted).
Here, there is an express provision that discusses the payment of delay rentals to extend
the Lease. Finally, Northup contends that to interpret the Lease as subject to extension
by delay rentals would render the ten-year primary lease term meaningless—but the
Lease’s ten-year requirement still carries meaning because it forces a lessee to make
some attempt at developing the land.
The plain language of the Lease—a negotiated document, and not a Producer’s
88 lease—suggests that delay rentals may extend the Lease’s terms. Indeed, the parties’
conduct suggests that they understood the Lease to extend upon payment of delay
rentals; Chesapeake paid the rentals without contest for over thirty years, and Northup
became a successor-in-interest after the time when it now alleges that the Lease
terminated. We conclude that the district court properly held that the Lease expressly
provides for extension by payment of delay rentals.
B.
Next, Northup argues that the district court erred in granting summary judgment
for Chesapeake because the Lease is void as contrary to public policy. According to
Northup, Chesapeake is attempting to create a permanent lease by its tender of delay
rentals after the end of the ten-year initial term. Such leases, Northup argues, are
contrary to public policy as set forth in Kentucky Revised Statute (“KRS”) § 353.500.
Specifically, KRS § 353.500 notes that Kentucky public policy is “to encourage
exploration for [mineral] resources . . . and to encourage the maximum recovery of all
oil and gas from all deposits thereof now known and which may hereafter be
discovered.” KRS § 353.500(1). And arguing by analogy, Northup cites to a utility-
contract case, Electric & Water Plant Board of the City of Frankfort v. South Central
Bell Telephone Co., 805 S.W.2d 141 (Ky. Ct. App. 1990), which notes that “Kentucky
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 9
law does not favor contracts running into perpetuity,” and will void such clauses as
contrary to public policy. Id. at 143. In South Central Bell, the contract at issue
contained “no language explaining how long the [agreement would] continue,” and “[a]s
worded, the arrangement [would] continue forever.” Id. Given that Chesapeake has
held the Lease for forty years without oil or gas production, Northup argues that the
Lease is permanent or perpetual, and thus contrary to Kentucky public policy. We reject
this argument.
The district court properly observed that the Kentucky statute “focuses on the
importance of the conservation of all mineral resources, the exploration of such
resources, and the importance of preventing waste and unnecessary surface loss,” and
not “long-standing contractual relationships between lessors and lessees.” As the court
noted, Northup failed to cite to KRS § 353.720, which warns against construing KRS
§ 353.500 as “superseding, impairing, abridging or affecting any contractual rights or
obligations now or hereafter existing between the respective owners of oil, gas, coal, or
other minerals, or any interests therein.” KRS § 353.720(2).
In Wheeler v. Lemaster Oil & Gas Co. v. Henley, 398 S.W.2d 475 (Ky. Ct. App.
1965), the Kentucky Court of Appeals held that it “recognize[d] a strong policy against
a lessee holding land for an unreasonable length of time simply for speculative purposes,
or because of a lack of due diligence,” but that holding resulted “where the lessor’s only
revenue result[ed] from royalty payments received from continued production.” Id. at
477. Such is not the case here. For thirty years, Chesapeake paid delay rentals, which,
according to Hemingway Oil & Gas, “may be of substantial value where large tracts of
land are involved.” Hemingway Oil & Gas § 2.3. In fact, the treatise adds that “[w]here
no production is obtained, the right to delay rentals may well be the most valuable right
of the owner of the mineral estate.” Id.
Hemingway acknowledges that “[l]ong-term leases are discouraged in the oil-
and-gas industry because of the migratory character of substance.” See id. § 6.2
(“[U]ndeveloped petroleum may be drained by production from adjacent lands. For this
reason the industry soon abandoned fee conveyance or long-term leases.”). But here, the
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 10
policy to uphold the bargain struck between the parties—parties who likely understood
the migratory nature of oil and gas—favors Chesapeake’s position. See Collings v.
Scheen, 415 S.W.2d 589, 593 (Ky. Ct. App. 1967) (“The essential thing is for the court
to look at the contract from the standpoint of the parties at the time they executed it, and
the purpose they had in view in doing so.”). The predecessors in interest to the Lease
bargained for a contract that allowed for extension by rentals, and rejected use of a form
contract (like a Producer’s 88) in order to include clauses that provided for such delay
rentals. We conclude that the Lease does not violate Kentucy public policy.
C.
Finally, Northup challenges the district court’s summary judgment on the ground
that the Lease lacks mutuality of obligation. Essentially, Northup construes Chesapeake
as seeking a “unilateral right” to extend an expired lease by tendering quarterly
payments. But as the district court observed, the “lessors had a remedy if they were so
disposed to avail themselves of it by giving sufficient notice to the lessee and demanding
production within a reasonable time.” Although the requirement of giving notice only
arises in Kentucky forfeiture cases, see Hiroc, 40 S.W.3d at 377–78, the right of
providing a notice and demand on the lessee is available where a lessor determines that
property lies undeveloped despite a reasonable time for development. See, e.g., Mid-
South Oil Co. v. Jaynes, 271 S.W. 553, 554 (Ky. 1925); Maverick Oil & Gas Co. v.
Howell, 237 S.W. 40, 43 (Ky. 1922). Moreover, in Leeper v. Lemon G. Neely Co., 293
F. 967 (6th Cir. 1923), this court noted that the “Kentucky rule, . . . which imports into
every oil lease . . . a condition that it shall continue for only a reasonable time, unless by
the lessor’s continuing consent, seems to remove every aspect of unfairness or one-
sidedness that has sometimes been the basis for claiming illegality.” Id. at 970. Here,
Northup offered its “continuing consent” by accepting delay-rental payments for decades
without demanding production. Although Northup retains its right to notify Chesapeake
of its demand for production, we conclude that the Lease is not void for lack of
mutuality.
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 11
IV.
By its own terms, the Lease provided for extension by payment of delay rentals,
and the Lease survives both public-policy and mutuality challenges. As a result, we
affirm the grant of summary judgment for Chesapeake.
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_____________________
CONCURRENCE
_____________________
WHITE, Circuit Judge, concurring. I join in the affirmance, although my
reasoning differs somewhat from the majority’s.
I
As to the question of jurisdiction, Chesapeake submitted an affidavit purporting
to estimate the present value of the natural gas reserves for Well 820584, net of expenses
and production taxes, at between $106,874 and $131,426, depending on the rate of
discount to present value. The affidavit also placed an estimated $426,700 value on the
“undeveloped acreage,” and asserted that the cost of drilling the well was in excess of
$75,000. Northup challenged the affidavit by 1) arguing that no royalties had ever been
paid under the lease, 2) questioning the affiant’s qualifications and the bases for his
opinions, 3) producing evidence that the well was abandoned, and 4) asserting that the
yearly delay rental of $4,327.00, rather than projected profits, should control. Northup
offered no alternative value other than the delay rental.
I agree with Northup that the cost of drilling the well is irrelevant, except insofar
as that cost affects the value of the leasehold interest. Yet, I also agree with the majority
that the value of the leasehold interest is not necessarily the same as the rentals to be
paid under the lease. The value of the leasehold interest would, I think, be reasonably
based on the likelihood of recovering oil and gas, the value of the oil and gas that might
be recovered, the timing of such recovery, the costs of recovery and sale, the expenses
of delay, and any other factors normally considered by persons engaged in the enterprise
of valuing such interests. Chesapeake’s affidavit could have addressed these factors
more clearly, but Northup’s arguments against jurisdiction did not fatally undermine the
affidavit, and under all the circumstances, I agree that Chesapeake established that more
likely than not, the amount in controversy exceeds $75,000.
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 13
II
I also reach the same conclusion as the majority on the merits. The parties
entered into stipulations of fact and submitted the matter to the district court on cross-
motions for summary judgment. Northup conceded at argument that it contemplated that
the district court would decide the case one way or the other on the stipulations, motions,
and briefs, and without trial. Because I find that the lease is ambiguous regarding the
question at issue, I conclude that neither party was entitled to summary judgment solely
on the agreement. However, because the district court was authorized by the parties to
decide the case based on the submissions, and the court’s decision finds adequate factual
support in the stipulated record and is consistent with the controlling law, I concur in
the affirmance. Cf. Situation Mgmt. Sys., Inc. v. ASP. Consulting LLC, 560 F.3d 53, 58
(1st Cir. 2009) (“In a case stated, the parties waive trial and present the case to the court
on the undisputed facts in the pre-trial record. The court is then entitled to engage in a
certain amount of factfinding, including the drawing of inferences.” (quotation marks
and citations omitted)).
Under Kentucky law, a contract is ambiguous if it is “capable of more than one
different, reasonable interpretation.” Central Bank & Trust Co. v. Kincaid, 617 S.W.2d
32, 33 (Ky. 1981). I find the lease ambiguous with respect to whether the payment of
delay rentals is sufficient to extend the primary term without regard to the “search for
or production of oil or gas.” The lease can be read as set forth by the majority, or it can
be read as providing that the lease term is ten years, and thereafter for as long as the
lessee is engaged in the search for or production of oil or gas on the land, with that
extended term being conditioned on the payment of rentals under the lease.
The final portion of the habendum clause refers to “an extended term by payment
of rentals as hereinafter set forth,” not specifically payment of delay rentals. The word
“rentals” in a clause extending the lease term can be read to refer to royalties payable
under the lease. See Vaughn v Hearrell, 347 S.W.2d 542, 544-45 (Ky. 1961) (quoting
2 Summers on Oil and Gas § 302, at 278-79, § 351, at 482-83); see also 2 W.L.
Summers, The Law of Oil and Gas: With Forms § 14:22 (3d ed. 2006) (“It was urged
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 14
that the term ‘rental’ in this context meant the delay rental provided for in the drilling
clause. But that interpretation would permit the lessee to indefinitely postpone
development of the premises by the payment of delay rental . . . . When the question was
presented to the courts, they uniformly held that the rental referred to in this clause was
not delay rental provided for in the drilling clause, but gas or oil rentals to be paid to the
lessee after production, and that the lessee could not extend the lease beyond the definite
term by the tender or payment of delay rentals.” (citing cases)). Additionally, the lease
provides for abatements of the delay rentals based on the number of gas or oil wells
drilled. Thus, it is not unreasonable to contemplate that the lessee would be producing
and searching for oil and gas, paying royalties, and paying delay rentals all at the same
time. Further, the “drill or not drill” clause can be read as applying during the primary
term of the lease. All of which is to say that these additional provisions are themselves
subject to different interpretations and do not dictate that the habendum clause be read
one way or the other.
Taking into account both the terms of the lease and Kentucky case law with
respect to oil and gas leases, it would be reasonable to read the lease-term provision and
habendum clause as providing that the lease terminates after ten years (i.e., “this lease
shall remain in force for the term of ten (10) years”), unless the land is then operated by
the lessee in the search for or production of oil or gas (i.e., “and as long thereafter as the
said land is operated by the Lessee in the search for or production of oil or gas”), in
which case the lease can be extended for terms coincident with the obligation to pay
rentals under the lease by the payment of those rentals (i.e., “with an extended term by
payment of rentals as hereinafter set forth”).
That said, I agree with the majority that the lease at issue here differs in relevant
respects from the Producer’s 88 leases involved in the cases Northup relied on. Most
relevant is that the lease does not contain a typical “drilling clause,” requiring that the
lessee begin drilling within a specific period of time.
Were the case not submitted to the district court for decision on the stipulated
facts, the parties’ motions, and their briefs, I would conclude that summary judgment for
No. 08-5718 Northup Properties v. Chesapeake Appalachia Page 15
either party is inappropriate. However, because the case was so submitted, and the
parties contemplated that the court would decide the case without trial, I agree that the
judgment should be affirmed. Taking the ambiguous lease together with the
approximately thirty-year course of conduct after the alleged expiration of the lease,1
there was adequate support for the district court’s determination that the lease had not
terminated on its own at the conclusion of the primary term.
1
When a contract is ambiguous, Kentucky courts apply the doctrine of “contemporaneous
construction.” A.L. Pickens Co., Inc. v. Youngstown Sheet & Tube Co., 650 F.2d 118, 120 (6th Cir. 1981).
Under this doctrine, “‘courts are required to give great weight to the interpretation which the parties have
placed on an ambiguous contract. The construction of the parties is best evidenced by their conduct with
respect to the agreement.’” Id. (quoting Billips v. Hughes, 259 S.W.2d 6, 7 (Ky. 1953)).