Northup Properties, Inc. v. Chesapeake Appalachia, L.L.C.

567 F.3d 767, 178 Oil & Gas Rep. 909, 2009 U.S. App. LEXIS 12217, 2009 WL 1576506

Opinions

OPINION

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 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 ease. 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 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.

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, 97 S.Ct. 2434, 53 L.Ed.2d 383 (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 similar facts, apply metrics similar to those used by Adams.¹ 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 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 ABARCO, Inc. v. Kadish, 490 U.S. 605, 109 S.Ct. 2037, 104 L.Ed.2d 696 (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, 109 S.Ct. 2037. 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, 11 S.Ct. 96, 34 L.Ed. 681 (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 exceeded] $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.

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, 106 S.Ct. 1348, 89 L.Ed.2d 538 (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 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. Robertson, 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 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 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 & 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 resulted] 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 “[Bong-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 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 Kentucky 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, 208 Ky. 483, 271 S.W. 553, 554 (1925); Maverick Oil & Gas Co. v. Howell, 193 Ky. 433, 237 S.W. 40, 43 (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.

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.

CONCURRENCE

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”).

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.