Yoder v. Artex Oil Co.

2014 Ohio 5130

• Court: Ohio Court of Appeals
• Decided: November 13, 2014
• Docket: 14 CA 4
• Status: Published

Opinion

[Cite as Yoder v. Artex Oil Co., 2014-Ohio-5130.]

COURT OF APPEALS GUERNSEY COUNTY, OHIO FIFTH APPELLATE DISTRICT

MARION D. YODER, ET AL. : JUDGES: : : Hon. Sheila G. Farmer, P.J. Plaintiffs-Appellants : Hon. Patricia A. Delaney, J. : Hon. Craig R. Baldwin, J. -vs- : : Case No. 14 CA 4 : ARTEX OIL COMPANY, ET AL. : : : Defendants-Appellees : OPINION

CHARACTER OF PROCEEDING: Appeal from the Guernsey County Court of Common Pleas, Case No. 12-OG-75

JUDGMENT: AFFIRMED

DATE OF JUDGMENT ENTRY: November 13, 2014

APPEARANCES:

For Plaintiffs-Appellants: For Defendants-Appellees:

TIMOTHY B. PETTORINI JAMES S. HUGGINS LUCAS K. PALMER DANIEL P. CORCORAN J. BENJAMIN FRAIFOGL Theisen Brock Critchfield, Critchfield & Johnston, Ltd. 424 Second Street 225 N. Market St., P.O. Box 599 Marietta, OH 45750 Wooster, OH 44691 JOHN P. BRODY Kegler, Brown, Hill & Ritter Co., LPA 65 East State St., Suite 1800 Columbus, OH 43215-4294

DAN BROWN 803 Steubenville Ave. Cambridge, OH 43725 Guernsey County, Case No. 14 CA 4 2

Delaney, J.

{¶1} Plaintiffs-Appellants Marion D. Yoder, Reuben D. Yoder, and Esther A.

Yoder appeal the January 3, 2014 judgment entry of the Guernsey County Court of

Common Pleas.

FACTS AND PROCEDURAL HISTORY

{¶2} Marsh Lumber Company owned acreage located in Liberty Township,

Guernsey County, Ohio. On July 30, 1981, Marsh Lumber Company and LandPro, Inc.

executed an oil and gas lease, which was recorded on August 3, 1981 ("Marsh Lease").

The Marsh Lease stated the lease could not be communized or unitized and specific

language in the Marsh Lease permitting unitization was struck out as void.

{¶3} In 1982, a shallow well known as Marsh No. 1 Well was drilled pursuant to

the Marsh Lease. Defendant-Appellee Artex Oil Company succeeded LandPro, Inc.'s

interests. In 1995, Artex took over the Marsh Lease as lessee.

{¶4} Plaintiff-Appellant Marion D. Yoder took an interest in 95.809 acres of the

Liberty Township property by virtue of a warranty deed dated May 15, 2003 and

recorded July 30, 2003 ("Yoder Property"). Plaintiffs-Appellants Reuben D. Yoder and

Esther A. Yoder hold a 1/8th interest in the Yoder Property by virtue of a warranty deed

dated June 29, 2006 and recorded on July 11, 2006. When the Yoders took title to the

Yoder Property, all of the mineral rights, including the shallow and deep rights, were

encumbered by the Marsh Lease under which Artex was the lessee.

{¶5} The Marsh Well produced oil and/or gas in 2003 and 2006.

{¶6} On June 30, 2008, Artex entered into an oil and gas lease with the Yoders

("Yoder Lease"). The Yoder Lease granted Artex as lessee the right to investigate, Guernsey County, Case No. 14 CA 4 3

explore, prospect, drill for and produce oil, natural gas, coalbed methane gas, and any

other associated hydrocarbons from the Yoder Property. The Yoder Lease covers "all

formations from the top of the so called Queenston Formation and below." The pertinent

terms of the Yoder Lease state as follows:

1. This lease shall remain in force for a primary term of (3) three years

from this date and if lessee shall commence to drill within said primary

term or extension thereof, the said lessee shall have the right to continue

drilling to completion with reasonable diligence and said term shall extend

as long thereafter as such drilling operations are conducted and as long

as oil and gas, or either of them, is produced or is capable of being

produced from said land or from a communitized unit as hereinafter

provided.

***

9. Lessee is granted the right at any time to unitize the leased premises or

any portion thereof, as to any or all strata or stratum, with any other lands

for the production of oil and/or gas. No such unit shall embrace more than

160 acres, provided that if any governmental regulations or prudent

geological or engineering practices shall suggest or require a spacing

pattern for the development of the field, then any such unit may embrace

as much additional acreage as may be included in such spacing pattern.

Operations upon and production from the unit shall be treated as if such

operations were upon or such production were from the premises leased

hereby whether or not the well or wells are located thereon, provided, Guernsey County, Case No. 14 CA 4 4

however, that lessor shall receive, in lieu of other royalties, only such

proportion of the royalties specified above as the amount of lessor's

acreage placed in the unit bears to the total acreage in the unit, and

provided further that lessor may take free gas from a unit well only if the

well is located on lands actually owned by lessor.

15. This lease contains all of the agreements and understandings of the

lessor and the lessee respecting the subject matter hereof and no implied

covenants or obligations are contained herein and no verbal

representations or promises have been made or relied upon by lessor or

lessee supplementing or modifying this lease or as an inducement thereto.

{¶7} On October 9, 2008, Artex applied to the Ohio Department of Natural

Resources for a permit to drill a deep well on property located adjacent to the Yoder

Property and owned by Aino Lutterus. Artex consolidated its interest in the oil and gas

rights of the Yoder Lease with three other oil and gas leases to create a drilling unit

comprised of 145.3 acres named the Lutterus-King Unit. 10.03 acres of the Yoder

Property were unitized into the Lutterus-King Unit. At the time the Lutterus-King Unit

was drawn, Artex used existing plat mats to determine the planned location of the

Lutterus-King Unit well was located 500 feet from the boundary of the Yoder Property.

The Ohio Department of Natural Resources issued the drilling permit on October 14,

2008.

{¶8} On October 22, 2008, Artex recorded a partial release of its interest in the

Marsh Lease with the Guernsey County Recorder's Office. The partial release pertained Guernsey County, Case No. 14 CA 4 5

only to those certain formations lying below the top of the so-called Queenston

formation.

{¶9} Artex commenced drilling on Lutterus No. 1 Well ("Lutterus-King Well") on

November 3, 2008 and completed the drilling on November 12, 2008. The well was

drilled to a depth of 7,382 feet.

{¶10} On November 17, 2008, Artex sent the Yoders a letter stating that its

records indicated the Yoders were entitled to receive a portion of the oil and gas

royalties derived from the Lutterus-King Well. However, before Artex could make the

royalty payments, Artex asked the Yoders to sign a Division Order. The Division Order

stated the undersigned certified and guaranteed they were the legal owners of and

warranted the title to their respective interest in the oil and gas produced from the

Lutterus-King Well. The Yoders signed the Division Order in November 2008.

{¶11} On December 4, 2008, Artex recorded with the Guernsey County

Recorder's Office a Consolidation of Oil and Gas Leases to form the Lutterus-King Unit.

{¶12} The Lutterus-King Well was put into production on December 4, 2008.

{¶13} In 2009, Artex amended the size of the Lutterus-King Unit to

accommodate the drilling of the second well, which would incorporate a portion of the

original Lutterus-King Unit. The amended Unit for the Lutterus-King Well contained 40

acres. The portion of the Yoder Property utilized for the Unit was 2.76 acres. Under the

amended Unit, the landowners retained the same percentage interest in the production

from the Lutterus-King Well as under the original Unit. Guernsey County, Case No. 14 CA 4 6

{¶14} From March 15, 2009 to March 15, 2012, Artex paid the Yoders royalty

payments pursuant to the terms of the Yoder Lease and the Division Order from

production of the Marsh Well and the Lutterus-King Well.

{¶15} On December 6, 2011, the Yoders requested Artex to release them from

the Yoder Lease. Artex declined the request.

{¶16} The Yoders filed a complaint in the Guernsey County Court of Common

Pleas on February 21, 2012 against Artex and others as the current lessees under the

Yoder Lease.1 The Yoders sought declaratory judgment that the Yoder Lease

terminated and/or expired by its own terms and was null and void; that Artex forfeited its

rights in the Yoder Lease; that Artex abandoned any interests it had under the Yoder

Lease; and the Yoder Lease was invalid and not legally binding on the Yoder Property.

The Yoders also claimed breach of implied covenants, express duties, and implied

duties of good faith and fair dealing, requesting the Yoder Lease be forfeited or

cancelled as to the undeveloped acreage or an award of damages. The Yoders further

requested that their rights to the oil, gas, and mineral interests in and underlying the

Yoder Property be quieted as against Artex.

{¶17} On March 21, 2012, Artex filed their answer and counterclaim seeking a

declaration that the Yoder Lease was valid.

{¶18} On July 25, 2012 and October 17, 2012, Artex and Anadarko E & P Co.,

LP filed motions for summary judgment. The Yoders responded to the motions for

summary judgment. The trial court denied the motions for summary judgment on

December 27, 2012.

1 The 16 Defendants-Appellees will be collectively referred to as "Artex." Guernsey County, Case No. 14 CA 4 7

{¶19} On July 2, 2012, Artex conducted a second survey to determine the

distance from the Lutterus-King Well to the Yoder Property line. The surveyor

determined the distance from the Lutterus-King Well and the Yoder Property line was

498.35 feet.

{¶20} Artex filed first and second motions for partial judgment on the pleadings

on July 8, 2013. In the first motion for partial judgment on the pleadings, Artex argued

that pursuant to Civ.R. 12(C), the trial court should dismiss Count Two of the Yoders'

complaint that stated Artex breached the implied covenants. Artex argued the Yoder

Lease disclaimed all implied covenants. In the second motion for partial judgment on

the pleadings, Artex argued the trial court should dismiss Count Two of the Yoders'

complaint alleging breach of the implied covenant of good faith and fair dealing by

unitizing a portion of the Yoder Property into the Lutterus-King Unit. Artex argued the

terms of the Yoder Lease permitted unitization.

{¶21} Artex also filed a motion for judicial notice on July 8, 2013. Artex argued

the trial court could take judicial notice, pursuant to Evid.R. 201, of the distance from the

Lutterus-King Well to the edge of the Yoder Property. The distance was 498.35 feet.

{¶22} On July 11, 2013, Artex filed a second motion for partial summary

judgment. In the motion, Artex argued there was no genuine issue of material fact that

Artex did not breach the implied covenant of good faith and fair dealing by unitizing the

Yoder Property into the Lutterus-King Unit. Artex also filed a third motion for summary

judgment requesting judgment as a matter of law on its counterclaim. It argued there

was no genuine issue of material fact that the Yoder Lease permitted unitization and the Guernsey County, Case No. 14 CA 4 8

Yoders waived breach of the lease through the Division Order and acceptance of the

royalty checks.

{¶23} The Yoders responded to each of the motions. The Yoders also filed a

motion for summary judgment on July 15, 2013.

{¶24} On January 3, 2014, the trial court issued a judgment entry disposing of all

the pending motions. The trial court granted Artex's motion for judicial notice, first and

second motions for partial judgment on the pleadings, second motion for partial

summary judgment, and third motion for summary judgment. The trial court denied the

Yoders' motion for summary judgment. The Yoders' complaint was dismissed and the

trial court granted Artex's counterclaim to quiet title.

{¶25} It is from this decision the Yoders now appeal.

ASSIGNMENTS OF ERROR

{¶26} The Yoders raise six Assignments of Error:

{¶27} "I. The trial court erred when it granted defendant's second motion for

partial judgment on the pleadings because defendants' right to unitize the Yoder

property was subject to an express duty to unitize only for the production of oil and/or

gas and subject to an implied duty of good faith and fair dealing.

{¶28} "II. The trial court erred in granting defendants' first motion for partial

judgment on the pleadings because the general disclaimer of implied covenants

contained in the Yoder lease does not negate defendants' express obligation to unitize

only for production of oil and/or gas or their obligation to act in good faith in so doing.

{¶29} "III. The trial court erred in granting defendants' third motion for summary

judgment because the Yoders' execution of a division order and negotiation of certain Guernsey County, Case No. 14 CA 4 9

checks was neither an implied nor express waiver of their right to challenge bad faith

unitization of the Yoder property.

{¶30} "IV. The trial court erred in granting defendant's second motion for

summary judgment because a genuine issue of material fact exists as to the distance

between the L-K Well No. 1 and the Yoder property and, even if the distance were not in

dispute, Defendant Artex, at the time of formation of the units, was unaware that the

Yoder property was required by law to be included in either the original or amended

unit.

{¶31} "V. The trial court erred in granting defendants' second motion for

summary judgment because a genuine issue of material fact exists as to whether a

reasonable operator would exclude the Yoder property from either the original or

amended unit.

{¶32} "VI. The trial court abused its discretion in taking judicial notice that the L-

K Well was 498.35 feet from the Yoder property based solely upon the second survey

prepared by Artex's agent, Richard Max Graves in anticipation of litigation."

ANALYSIS

{¶33} The Yoders argue in their first and second Assignments of Error the trial

court erred in granting Artex's first and second motions for judgment on the pleadings.

In the third, fourth, and fifth Assignments of Error, the Yoders argue the trial court erred

in granting Artex’s second and third motions for summary judgment. The sixth

Assignment of Error argues the trial court erred in granting judicial notice of the distance

from the Lutterus-King Well to the Yoder Property. Guernsey County, Case No. 14 CA 4 10

{¶34} The Assignments of Error involve interrelated facts and questions of law.

We will discuss the issues as they arise in the analysis of whether Artex breached the

Yoder Lease.

Interpreting Oil and Gas Leases

{¶35} With respect to oil and gas leases, the Ohio Supreme Court stated in

Harris v. Ohio Oil Co., 57 Ohio St. 118, 129, 48 N.E. 502 (1897): "The rights and

remedies of the parties to an oil and gas lease must be determined by the terms of the

written instrument, and the law applicable to one form of lease may not be, and

generally is not, applicable to another and different form. Such leases are contracts, and

the terms of the contract with the law applicable to such terms must govern the rights

and remedies of the parties."

{¶36} A contract is to be interpreted to give effect to the intention of the parties.

Morrison v. Petro Evaluation Serv., Inc., 5th Dist. Morrow No. 2004 CA 0004, 2005-

Ohio-5640, ¶ 29 citing Employer's Liab. Assur. Corp. v. Roehm, 99 Ohio St. 343, 124

N.E. 223 (1919), syllabus. It is a fundamental principle in contract construction that

contracts should "be interpreted so as to carry out the intent of the parties, as that intent

is evidenced by the contractual language." Id. quoting Skivolocki v. E. Ohio Gas Co., 38

Ohio St.2d 244, 313 N.E.2d 374 (1974), paragraph one of the syllabus. "The intent of

the parties to a contract is presumed to reside in the language they chose to employ in

the agreement." Id. quoting Foster Wheeler Enviresponse, Inc. v. Franklin Cty.

Convention Facilities Auth., 78 Ohio St.3d 353, 361, 1997-Ohio-202, 678 N.E.2d 519.

{¶37} In order to demonstrate a breach of contract, the plaintiff must

demonstrate by a preponderance of the evidence (1) that a contract existed, (2) that the Guernsey County, Case No. 14 CA 4 11

plaintiff fulfilled her obligations, (3) that the defendants failed to fulfill their obligations,

and (4) that damages resulted from this failure. Moore v. Adams, 5th Dist. Tuscarawas

No. 2007AP090066, 2008-Ohio-5953, ¶ 22.

{¶38} If there is a breach of an oil and gas lease, the remedy of forfeiture or

cancellation is an equitable remedy that rests within the discretion of the trial court.

Moore at ¶ 23. Forfeiture is an appropriate remedy when legal damages resulting in the

contractual breach are inadequate; upon the breach of implied covenants; upon a claim

of abandonment; or when necessary to do justice. Id.

Standards of Review

Standard of Review as to Motions for Judgment on the Pleadings

{¶39} Motions for judgment on the pleadings are governed by Civ.R. 12(C),

which states: “After the pleadings are closed but within such time as not to delay the

trial, any party may move for judgment on the pleadings.” Pursuant to Civ.R. 12(C),

“dismissal is [only] appropriate where a court (1) construes the material allegations in

the complaint, with all reasonable inferences to be drawn therefrom, in favor of the

nonmoving party as true, and (2) finds beyond doubt that the plaintiff could prove no set

of facts in support of his claim that would entitle him to relief.” State ex rel. Midwest

Pride IV, Inc. v. Pontious, 75 Ohio St.3d 565, 570, 664 N.E.2d 931, 936 (1996). The

very nature of a Civ.R. 12(C) motion is specifically designed for resolving solely

questions of law. See Peterson v. Teodosio, 34 Ohio St.2d 161, 297 N.E.2d 113, 117

(1973). Reviewing courts will reverse a judgment on the pleadings if the plaintiffs can

prove any set of facts that would entitle them to relief. Flanagan v. Williams, 87 Ohio

App.3d 768, 772, 623 N.E.2d 185, 188 (1993), abrogated on other grounds by Guernsey County, Case No. 14 CA 4 12

Simmerer v. Dabbas, 89 Ohio St.3d 586, 2000–Ohio–232, 733 N.E.2d 1169. The review

will be done independent of the trial court's analysis to determine whether the moving

party was entitled to judgment as a matter of law. Id.

Standard of Review as to Motions for Summary Judgment

{¶40} We refer to Civ.R. 56(C) in reviewing a motion for summary judgment

which provides, in pertinent part:

Summary judgment shall be rendered forthwith if the pleading,

depositions, answers to interrogatories, written admissions, affidavits,

transcripts of evidence in the pending case and written stipulations of fact,

if any, timely filed in the action, show that there is no genuine issue as to

any material fact and that the moving party is entitled to judgment as a

matter of law.* * * A summary judgment shall not be rendered unless it

appears from such evidence or stipulation and only from the evidence or

stipulation, that reasonable minds can come to but one conclusion and

that conclusion is adverse to the party against whom the motion for

summary judgment is made, such party being entitled to have the

evidence or stipulation construed most strongly in the party's favor.

{¶41} The moving party bears the initial responsibility of informing the trial court

of the basis for the motion, and identifying those portions of the record before the trial

court, which demonstrate the absence of a genuine issue of fact on a material element

of the nonmoving party's claim. Dresher v. Burt, 75 Ohio St.3d 280, 292, 662 N.E.2d

264 (1996). The nonmoving party then has a reciprocal burden of specificity and cannot

rest on the allegations or denials in the pleadings, but must set forth “specific facts” by Guernsey County, Case No. 14 CA 4 13

the means listed in Civ.R. 56(C) showing that a “triable issue of fact” exists. Mitseff v.

Wheeler, 38 Ohio St.3d 112, 115, 526 N.E.2d 798, 801 (1988).

{¶42} Pursuant to the above rule, a trial court may not enter summary judgment

if it appears a material fact is genuinely disputed. Vahila v. Hall, 77 Ohio St.3d 421, 429,

674 N.E.2d 1164 (1997), citing Dresher v. Burt, 75 Ohio St.3d 280, 662 N.E.2d 264

(1996).

Disclaimer of Implied Covenants

{¶43} In its first motion for judgment on the pleadings, Artex argued it was

entitled to judgment on the pleadings on Count Two of the Yoders' complaint. Count

Two of the Yoders' complaint alleged Artex unitized 2.76 acres of the Yoder Property

into the Lutterus-King Unit only to maintain the secondary term of the Yoder Lease. By

unitizing into the Lutterus-King Unit, the Yoders alleged Artex breached the implied

covenants in oil and gas leases: the implied covenant to reasonably develop, to use

reasonable care and due diligence in its operations on the Yoder Property, to act as a

reasonably prudent operator when conducting its operations on the Yoder Property, and

the implied covenant to market.

{¶44} The first motion for judgment on the pleadings argued the Yoders could

not rely upon the implied covenants in oil and gas leases pursuant to the terms of the

Yoder Lease. Paragraph 15 of the Yoder Lease states:

This lease contains all the agreements and understandings of the lessor

and the lessee respecting the subject matter hereof and no implied

representations or promises have been made or relied upon by lessor or Guernsey County, Case No. 14 CA 4 14

lessee supplementing or modifying this lease or as an inducement

thereto.

{¶45} The terms of the oil and gas lease impose obligations upon the parties,

but obligations may also be imposed by operation of law. Obligations imposed by the

operation of law are called "implied covenants." Am. Energy Serv. v. Lekan, 75 Ohio

App.3d 205, 209, 598 N.E.2d 1315 (5th Dist.1992). Since the 1800s, courts have

recognized the existence of implied covenants in oil and gas leases. Hall, The

Application of Oil & Gas Lease Implied Covenants in Shale Plays: Old Meets New, 32

Energy & Min.L.Inst. (2011). The most commonly recognized implied covenants are the

covenant to drill a test well, the covenant to reasonably develop, the covenant of further

exploration, the covenant to protect against drainage, the covenant to diligently market,

and the covenant to restore the surface. Id.

{¶46} Parties to an oil and gas lease may disclaim implied covenants in the

terms of the lease, so that only the provisions contained in the lease govern the

obligations of the parties. Ohio courts consistently enforce express provisions in leases

that disclaim implied covenants. Bilbaran Farm, Inc. v. Bakerwell, Inc., 2013-Ohio-2487,

993 N.E.2d 795, ¶ 18 (5th Dist.) quoting Bushman v. MFC Drilling Inc., 9th Dist. Medina

No. 2403-M, 1995 WL 434409 (July 19, 1995). In referring to the implied covenant to

reasonably develop the leased property, the Ohio Supreme Court stated, "[t]he implied

covenant arises only when the lease is silent on the subject." Harris v. Ohio Oil Co., 57

Ohio St. 118, 128, 48 N.E. 502 (1897).

{¶47} Paragraph 15 of the Yoder Lease states that "no implied covenants or

obligations are contained herein." Paragraph 15 of the Yoder Lease expressly disclaims Guernsey County, Case No. 14 CA 4 15

all implied covenants, thereby rendering the obligations of the parties to be governed by

the terms of the Yoder Lease, not by operation of law. The Yoders' claim that Artex

breached the terms of the Yoder Lease by violating certain implied covenants cannot be

sustained pursuant to the express disclaimer of implied covenants contained in the

Good Faith and Fair Dealing

{¶48} In the second motion for judgment on the pleadings, Artex argued it was

entitled to judgment on Count Two of the Yoders' complaint. Count Two of the Yoders'

complaint argued Artex breached certain implied covenants, but it also claimed that

Artex breached the implied covenant of good faith and fair dealing by unitizing the

Yoder Property into the Lutterus-King Unit.

{¶49} The first issue to resolve is whether Ohio law recognizes an implied

covenant of good faith and fair dealing as to oil and gas leases. In Taylor v. MFC

Drilling, Inc., 4th Dist. Hocking No. 94CA14, 1995 WL 89710 (Feb. 27, 1995), the Fourth

District analyzed whether the appellees breached an implied covenant of fair dealing by

including only six acres of the appellant's property in a development unit. The appellant

alleged the appellees were draining oil and gas from the 100 acres owned by appellant

but the 100 acres were not part of the development unit. The court stated that it could

not find any Ohio case law that specifically recognized an implied covenant of fair

dealing in mineral leases. Id. at *2. The court found the nature of the appellant's

complaint fell within the implied covenant to reasonably develop the leased premises.

Id. Guernsey County, Case No. 14 CA 4 16

{¶50} The Yoders concede it is not clear under Ohio case law whether there is

an implied covenant of good faith and fair dealing as to oil and gas leases. The Yoders

argue, however, because the oil and gas lease is a contract, there is the obligation of

good faith in the performance of the contract. Because there is no Ohio case law on the

issue of an implied covenant of good faith and fair dealing as to oil and gas leases, we

begin our analysis with outside resources.

{¶51} Secondary sources examining implied covenants in oil and gas leases

have found that contractual concepts, such as good faith and fair dealing, apply to the

interpretation of the oil and gas lease. The oil and gas lease was historically seen as a

transaction between two parties with unequal bargaining powers -- an unsophisticated

farmer negotiating with an oil and gas corporation. See Merrill, The Law Relating to

Covenants Implied in Oil and Gas Leases 1926 (2d Ed 1940 & Supp. 1964); Pierce, The

Renaissance of Law in the Law of Oil and Gas: The Contract Dimension, 42 Washburn

Law Journal 909 (2004). Implied covenants, such as the implied covenant to protect

against drainage, focused on protecting the leasehold estate. Hardymon, Adrift on the

Implied Covenant to Market: Regulation by Implication, 24 Energy & Min.L.Inst. 8

(2004). However, because of the nature of the oil and gas lease, courts also focused on

the conduct of the parties to the oil and gas lease by applying contractually-based

covenants such as good faith and fair dealing to the oil and gas lease. Hall, The

Application of Oil & Gas Lease Implied Covenants in Shale Plays: Old Meets New, 32

Energy & Min.L.Inst. 8 (2011). Courts used implied covenants to fill the gaps in

contracts and promote fairness and cooperation between the lessor and lessee. Id. Guernsey County, Case No. 14 CA 4 17

{¶52} Turning back to Ohio case law, the Supreme Court in Harris v. Ohio Oil

Co. held that an oil and gas lease is a contract and should be interpreted as such. Also

under Ohio case law, it is well-established that every contract has an implied covenant

of good faith and fair dealing that requires not only honesty but also reasonableness in

the enforcement of the contract. PHH Mortg. Corp. v. Ramsey, 10th Dist. Franklin No.

13AP-925, 2014-Ohio-3519, -- N.E.3d --, ¶ 33 citing Littlejohn v. Parrish, 163 Ohio

App.3d 456, 2005-Ohio-4850, 839 N.E.2d 49, ¶ 21 (1st Dist.). “ ‘Good faith performance

or enforcement of a contract emphasizes faithfulness to an agreed common purpose

and consistency with the justified expectations of the other party.’ ” Id. at ¶ 26, quoting

Restatement of the Law 2d, Contracts, Section 205, Comment a (1981). Based on the

foregoing, it can be logically concluded that an oil and gas lease is a contract, and

because it is a contract, an oil and gas lease is subject to the implied covenant of good

faith and fair dealing.

{¶53} The next question is whether the parties can disclaim the implied covenant

of good faith and fair dealing through an express waiver of all implied covenants in the

oil and gas lease. This Court could find no Ohio case law in the realm of contract law or

oil and gas law addressing this issue. At the time of authoring this opinion, only one

federal district court case was discovered that addressed this question and in the end,

the court found that the answer was not necessary for its determination of the appeal:

But these principles do not answer one of the questions presented in this

case: may the parties to a contract by a single term wholesale disclaim the

implied covenant of good faith and fair dealing and thereby foreclose its

use for any purpose by a court construing a contract? The first issue is to Guernsey County, Case No. 14 CA 4 18

discern the parties' intent in including this provision. Then, assuming it

manifests an intent to strip a court of the ability to use the implied

covenant as an interpretive tool, the next issue is whether such a result

would offend the public policy of New York. While it may be convenient to

view the implied covenant as embodying virtue and, literally, goodness, it

has not been met so warmly in some of the literature and one author has

suggested that it may not be needed in view of other modern interpretive

tools. [ ] Fortunately, the Court need not reach the question at this juncture

because, even if it is assumed that the covenant should be implied despite

the contractual carve-out, the result on this motion is not altered.

In Touch Concepts, Inc. v. Cellco Partnership, 949 F.Supp.2d 447, 467 (S.D.N.Y.2013) ,

2013 WL 6182949 (Nov. 18, 2013). Fortunately, like the In Touch Concepts court, this

court need not reach the question at this juncture because even if it is assumed the

implied covenant of good faith and fair dealing cannot be waived, the result of the within

appeal is not changed based on the application of the plain and unambiguous

contractual language of the Yoder Lease.

Unitization of the Yoder Property into the Lutterus-King Unit

{¶54} Count Two of the Yoders’ complaint alleges Artex unitized the Yoder

Property into the Lutterus-King Unit in bad faith as pretext for holding the lease acreage.

The Yoders contend Artex breached the Yoder Lease by failing to unitize the Yoder

Lease pursuant to the express terms of the lease. The unitization provision of the Yoder

Lease states as follows: Guernsey County, Case No. 14 CA 4 19

9. Lessee is granted the right at any time to unitize the leased premises or

any portion thereof, as to any or all strata or stratum, with any other lands

for the production of oil and/or gas. No such unit shall embrace more than

160 acres, provided that if any governmental regulations or prudent

geological or engineering practices shall suggest or require a spacing

pattern for the development of the field, then any such unit may embrace

as much additional acreage as may be included in such spacing pattern.

Operations upon and production from the unit shall be treated as if such

operations were upon or such production were from the premises leased

hereby whether or not the well or wells are located thereon, provided,

however, that lessor shall receive, in lieu of other royalties, only such

proportion of the royalties specified above as the amount of lessor's

acreage placed in the unit bears to the total acreage in the unit, and

provided further that lessor may take free gas from a unit well only if the

Plain Language of the Yoder Lease Permits Unitization

{¶55} Because the Yoder Lease is a contract, we first look to the contractual

language to determine the intent of the parties as to unitization. The Yoder Lease

specifically addresses unitization in Paragraph 9. It states in pertinent part: "Lessee is

granted the right at any time to unitize the leased premises or any portion thereof, as to

any or all strata or stratum, with any other lands for the production of oil and/or gas."

The plain language of the Yoder Lease grants Artex the right to unitize any portion of

the Yoder Property with any other lands for the production of oil and/or gas. Guernsey County, Case No. 14 CA 4 20

{¶56} There is no factual dispute the Lutterus-King Well is used for the

production of oil and/or gas. The Civ.R. 56 evidence shows that the Yoders have

received royalty payments from the oil and/or gas produced from the Lutterus-King Well.

The Yoders argue, however, Artex did not unitize the Yoder Property “for the production

of oil and/or gas,” but rather for the purpose of holding onto the Yoder Lease through

the secondary term of the habendum clause. The Yoders contend the distance of the

Lutterus-King Well from the Yoder Property evidences Artex’s bad faith in unitizing the

Yoder Property.

Distance from the Lutterus-King Well is 498.35 Feet

{¶57} Ohio law regulates how Artex must drill a deep well. The Lutterus-King

Well was drilled to a depth of 7,382 feet. Ohio Adm.Code 1501:9-1-04 governs where a

deep well may be located:

(C) Location of wells:

(4) No permit shall be issued to drill, deepen, reopen, or plug back a well

for the production of the oil or gas from pools from four thousand feet or

deeper unless the proposed well is located: (a) Upon a tract or drilling unit

containing not less than forty acres; (b) Not less than one thousand feet

from any well drilling to, producing from, or capable of producing from the

same pool; (c) Not less than five hundred feet from any boundary of the

subject tract or drilling unit. (Emphasis added.)

{¶58} In 2008, at the time of the permit application for the Lutterus-King Well,

Artex utilized plat maps to determine the Lutterus-King Well was located 500 feet from Guernsey County, Case No. 14 CA 4 21

the boundary of the Yoder Property. Richard Dailey, president of Dailey Land

Professionals, Inc., provided land related services to Artex. Dailey testified in his

deposition:

Q. Is it accurate to say, given that it was at that point believed to be 500

feet from the boundary, you had this choice whether to include the Yoder

lease into this unit or not?

A. Legally, we would have had a choice in that the state minimum spacing

says that we need a minimum of 500 feet. But as a matter of practice, I try

in my determination for well units not to use hard cut-offs of 500 feet

because of the errors that you can get where a stake is moved a few feet

in a field by a rig hand or something, or the maps --. Clearly, when you're

looking at a paper map, the property line drawn on a map isn't necessarily

the property line in the field, or the fence line which could be moved five or

ten feet in the field. So a paper map is hard to distinguish where a true

property corner is. You never know a true property corner till the surveyor

goes out and actually establishes it on the field. So we normally do not cut

off our drilling units at 500 feet, just as a matter of good business practice.

We try to err on the side of caution and include additional property.

Q. And is that why the Yoder lease was included?

A. It was included because of those parameters, the fact that we had the

right to pull, the lease pursuant to the terms of the lease, and because of

geologic parameters that are proprietary.

(Dailey Depo., p. 57-58). Guernsey County, Case No. 14 CA 4 22

{¶59} On July 2, 2012, Richard Graves, a licensed surveyor, performed a survey

for Artex on the Lutterus-King Unit. The survey showed the distance from the Lutterus-

King Well to the edge of the Yoder Property was 498.35 feet.

{¶60} Artex filed a motion for judicial notice of the distance from the Lutterus-

King Well to the Yoder Property as 498.35 feet. The trial court granted the motion in its

January 3, 2014 judgment entry. The Yoders argue in their sixth Assignment of Error

that the trial court erred in granting the motion for judicial notice because there was a

dispute of fact as to the distance.

{¶61} The taking of judicial notice is governed by Evid.R. 201. Under Evid.R.

201(B), the trial court may take judicial notice of facts that is "one not subject to

reasonable dispute in that it is either (1) generally known within the territorial jurisdiction

of the trial court or (2) capable of accurate and ready determination by resort to sources

whose accuracy cannot reasonably be questioned." We review decisions by a trial court

regarding judicial notice under an abuse of discretion standard. Enviropro Plastics, Inc.

v. Trickett, 5th Dist. Stark No. 2013 CA 00195, 2014-Ohio-1707, ¶ 46 citing Molitor v.

Gaddis, 5th Dist. Morrow No. CA 875, 1999 WL 770688 (Aug. 25, 1999).

{¶62} The Yoders argue the distance from the Lutterus-King Well and the Yoder

Property is a fact subject to a reasonable dispute because Artex measured the distance

as both 500 feet and 498.35 feet. In Artex's second motion for summary judgment, Artex

argued there was no genuine issue of material fact as to the distance between the

Yoder Property and the Lutterus-King Well. Artex provided the affidavit of Richard Max

Graves who conducted a survey of the property and measured the distance between

the Yoder Property and the Lutterus-King Well as being 498.35 feet. The Yoders have Guernsey County, Case No. 14 CA 4 23

not provided any rebuttal evidence to the measurement of the distance between the

Yoder Property and the Lutterus-King Well.

{¶63} While the Yoders may have an argument as to whether the trial court

abused its discretion when it granted the motion for judicial notice as to the

measurement, we find that argument to be moot based on Artex's second motion for

summary judgment. Artex provided Civ.R. 56 evidence to demonstrate there was no

genuine issue of material fact as to the distance between the Lutterus-King Well and the

Yoder Property. Dailey testified the first measurement was based on plat maps. Dailey

testified that after a well is drilled, the projected distance can change because of the

drilling process. Graves testified the second measurement was based on an actual

survey of the property after the well was drilled. Upon our de novo review, we find that

reasonable minds could only conclude the distance between the Yoder Property and the

Lutterus-King Well is 498.35 feet.

{¶64} The distance of the Yoder Property from the Lutterus-King Well required

Artex to include the Yoder Property into the Lutterus-King Unit in order to comply with

Ohio state law. Further, the clear language of Paragraph 9 of the Yoder Lease

contemplates state regulation as to spacing requirements:

No such unit shall embrace more than 160 acres, provided that if any

governmental regulations or prudent geological or engineering practices

shall suggest or require a spacing pattern for the development of the field,

then any such unit may embrace as much additional acreage as may be

included in such spacing pattern. Guernsey County, Case No. 14 CA 4 24

Unitization Maintains the Habendum Clause of the Yoder Lease

{¶65} The unitization provision of the Yoder Lease states:

Operations upon and production from the unit shall be treated as if such

operations were upon or such production were from the premises leased

hereby whether or not the well or wells are located thereon, provided,

however, that lessor shall receive, in lieu of other royalties, only such

proportion of the royalties specified above as the amount of lessor's

acreage placed in the unit bears to the total acreage in the unit, and

provided further that lessor may take free gas from a unit well only if the

{¶66} The habendum clause of the Yoder Lease states:

1. This lease shall remain in force for a primary term of (3) three years

from this date and if lessee shall commence to drill within said primary

term or extension thereof, the said lessee shall have the right to continue

drilling to completion with reasonable diligence and said term shall extend

as long thereafter as such drilling operations are conducted and as long

as oil and gas, or either of them, is produced or is capable of being

produced from said land or from a communitized unit as hereinafter

provided. (Emphasis added.)

{¶67} There is no dispute of fact the Yoders are receiving a percentage of

royalties from production of the Lutterus-King Well based on the percentage of the

acreage in the Lutterus-King Unit. The plain language of the habendum clause and the Guernsey County, Case No. 14 CA 4 25

unitization clause supports Artex's argument the incorporation of the Yoder Property into

the Lutterus-King Unit was proper.

A Prudent Operator Would Include the Yoder Property

{¶68} The Yoders argue in their fifth Assignment of Error that no reasonable

prudent operator would include the Yoder Property into the Lutterus-King Unit. The

reasonable prudent operator standard in oil and gas cases is similar to the reasonable

person standard in tort cases. It is the "standard by which all actions taken by the lessee

in the production and operation of the wells on the leasehold are judged." Hardymon,

Adrift on the Implied Covenant to Market: Regulation by Implication, 24 Energy &

Min.L.Inst. 8.02 (2004). Research shows that few Ohio cases mention the standard, but

they do not develop the standard. See Holonko v. H.D. Collins, 7th Dist. Mahoning No.

87 C.A. 120, 1988 WL 70900 (June 29, 1988); State v. Baldwin Producing Corp., 10th

Dist. Franklin No. 76AP-892, 1977 WL 199981 (March 10, 1977); Rayl v. East Ohio Gas

Company, 46 Ohio App.2d 167, 348 N.E.2d 385 (9th Dist.1973).

{¶69} When applied, the reasonable prudent operator standard is utilized to

judge whether the lessee was completing the implied covenants to explore, develop,

produce, and market as any reasonably prudent operator would do under the

circumstances. Rayl, supra at 171. The reasonable prudent operator standard "may not

be an implied covenant per se, but an overreaching standard of performance with which

the lessee must comply in fulfilling all of his obligations, express or implied." Hardymon,

supra at 8.02.

{¶70} In this case, we find that reasonable minds could only conclude that based

on the plain language of the Yoder Lease, the distance of the Yoder Property from the Guernsey County, Case No. 14 CA 4 26

Lutterus-King Well, and the state law requirements for drilling a deep well, a prudent

operator would include the Yoder Property into the Lutterus-King Unit.

Acceptance of Royalty Payments Does Not Equate Ratification of Unitization

{¶71} Artex argued in its third Motion for Summary Judgment that the Yoders

waived their breach of contract claims because they accepted royalty payments from

production of oil and/or gas from the Lutterus-King Well. The Seventh District Court of

Appeals held in Price v. K.A. Brown Oil and Gas, L.L.C., 7th Dist. Monroe No. 13 MO

13, 2014-Ohio-2298, ¶ 25, that the acceptance of royalty payments pursuant to an oil

and gas lease does not result in a lessor from being estopped from asserting a breach

under a lease because the lessor is entitled to the benefit. See also Harding v. Viking

Internatl. Resources Co., Inc., 2013–Ohio–5236, 1 N.E.3d 872 (4th Dist.).

{¶72} The holding in Price could also be argued to negate Artex's argument that

the Division Order signed by the Yoders estopped the Yoders from arguing a forfeiture

of the Yoder Lease. The language of the Division Order stated Artex's records indicated

the Yoders were entitled to receive a portion of the oil and gas royalties derived from the

Lutterus-King Well pursuant to the terms and conditions of the oil and gas leases that

were included in the Lutterus-King Unit. However, before Artex could make the royalty

payments, Artex asked the Yoders to sign a Division Order. The Division Order stated

the undersigned certified and guaranteed they were the legal owners of and warranted

the title to their respective interest in the oil and gas produced from the Lutterus-King

Well. The Division Order appears to be a confirmation of the benefits the Yoders were

entitled to, such as royalty payments, pursuant to the terms of the Yoder Lease.

Reviewing this issue is a light most favorable to the Yoders, we do not find the Guernsey County, Case No. 14 CA 4 27

acceptance of royalty payments or the Division Order waived the Yoders' claims of

breach of the Yoder Lease.

{¶73} The Yoders' third Assignment of Error is sustained. Our finding as to this

issue, however, does not change our ultimate judgment.

CONCLUSION

The Plain Language of the Yoder Lease and the Civ.R. 56 Evidence Support Unitization

{¶74} Upon our de novo review of the questions of law and the Civ.R. 56

evidence, we find the language of the Yoder Lease supports the unitization of the Yoder

Property into the Lutterus-King Unit. Reasonable minds could only conclude from the

Civ.R. 56 evidence that Artex acted as a reasonably prudent operator when it included

the Yoder Property into the Lutterus-King Unit.

{¶75} The trial court did not err in finding judgment in favor of Artex and against

the Yoders. Guernsey County, Case No. 14 CA 4 28

{¶76} The Yoders' first, second, fourth, and fifth Assignments of Error are

overruled. The Yoders' third and sixth Assignments of Error are sustained. Our decision

to the third and sixth Assignments of Error does not affect our judgment that the trial

court correctly granted judgment in favor of Artex.

{¶77} The judgment of the Guernsey County Court of Common Pleas is

affirmed.

By: Delaney, J.,

Farmer, P.J. and.

Baldwin, J., concur.