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Filing of Declaration & Notice of Pooled Unit Held to be Operations

Krugliak, Wilkins, Griffiths & Dougherty Co., L.P.A.

On January 14, 2014, in Henry v. Chesapeake, the United States Court of Appeals for the Sixth Circuit reversed the district court’s judgment on the pleadings and held that Chesapeake’s filing of a declaration and notice of pooled unit constituted “operations” under the habendum clause of the lease in question, and therefore, extended the lease beyond it primary term. 

Issue:

Henry arose from a dispute between the plaintiffs and Chesapeake over the definition of “operations” as provided for in the lease. The Henry court was faced with determining whether Chesapeake had conducted “operations” as defined in the lease, sufficient to extend the lease beyond its primary term.

The Lease:

The lease’s habendum clause provided for a primary term of five years (ending on October 17, 2011), which could be extended into the secondary term by the conduct of operations on the leasehold, or lands pooled with the leasehold.

The lease defined operations broadly to include a variety of different activities, any of which would act to extend the lease. Two activities defined as operations were central to the Henry court’s decision, specifically: (1) any acts in search for or in an endeavor to obtain, maintain or increase the production of oil and/or gas, and (2) any act or acts similar or incidental to any of the foregoing.

The lease also permitted Chesapeake to pool the leasehold covering the plaintiffs’ property, at any time, with other leaseholds to form drilling or productions units. The pooling provision further provided that “[f]or all purposes under the provisions of this Lease, the Leasehold shall be deemed to be unitized upon submission of the drilling permit application pertaining to the relevant drilling or production unit to the governmental authority having jurisdiction . . .”

Drilling-Permit Applications and the Declaration of Pooled Unit:

Chesapeake submitted a drilling-permit application to the State on June 30, 2011, and a revised application on July 19, 2011. Chesapeake proceeded to submit three additional applications with the last one occurring on October 7, 2011. None of the applications listed the plaintiffs’ property as being within the unit.

Prior to expiration of the lease, on October 14, 2011, Chesapeake filed a “Declaration and Notice of Pooled Unit” (DPU), in the county recorder’s office, creating the Asuncion Unit, which listed the plaintiffs’ property as being included within its boundaries. Chesapeake then submitted two additional drilling-permit applications for the Asuncion Unit on November 9, 2011, both of which listed the plaintiffs as royalty holders.

Subsequently, plaintiffs brought an action in the Jefferson County Court of Common Pleas seeking a declaration that the lease had expired on October 17, 2011. Chesapeake subsequently removed the case to the United States District Court for the Southern District of Ohio based on diversity of citizenship. The district court granted plaintiffs’ motion for judgment on the pleadings holding that Chesapeake did not extend the lease beyond its primary term because drilling-permit applications pertaining to the leased property were not filed prior to the expiration of the lease, and Chesapeake appealed.

Arguments:

Chesapeake argued that by filing the DPU it had conducted operations as defined under the lease because the filing was an act “in an endeavor to obtain . . . the production of oil and/or gas,” and was also an act “incidental” to the “search” or “production” of gas. The plaintiffs argued that their property had not been properly unitized because no drilling-permit application pertaining to their property had been filed, and therefore, the DPU could not constitute operations.

In analyzing the facts, the Henry court looked to prior Ohio cases concerning operations, specifically, Duffield v. Russell and Kaszar v. Meridian. In Duffield the defendant/lessee staked out a well on the leasehold and contracted to buy timber for purposes of drilling a well on the last day of the lease’s term. The court held that the driving of a stake was sufficient to commence operations and further went on to state that “[a]ny act, the performance of which has a tendency to produce the desired result, is a commencement of operations.” The Ohio Supreme Court affirmed without comment.

In Kaszar, the court held that the lessee had commenced operations where it had surveyed the drill site, staked out the well and filed documents with the SEC prior to the expiration of the lease. In reaching this holding, the court cited the analysis and holding of the Duffield court.

The Henry court noted that both Duffield and Kaszar were factually distinguishable from the present case, as both cases applied the rule from Duffield in the context of “preliminary physical activities,” i.e., the driving of a stake, or surveying the site. However, the Henry court went on to state that “the act of filing the DPU did not occur in a vacuum . . . . [r]ather . . .  . the filing of the DPU was an act in an endeavor to join plaintiffs’ property in the production unit that Chesapeake was in the process of exploiting.” The court further noted that regardless of whether the DPU effectively unitized the lease, “it was clearly an act similar to or incidental to acts ‘in search for or in an endeavor to obtain, maintain or increase the production of oil and/or gas’ from the plaintiffs’ property.”

Takeaway:

As evidenced by the court’s decision in Henry, the language of the lease is critical. The court gave broad deference to acts that have a “tendency to produce the desired result,” where the lease broadly defined operations, regardless of whether the activities at issue were physical in nature. In determining whether a lessee has conducted activities under an oil and gas lease, sufficient to extend the term of the lease, one should consider the following: (1) whether the act has a tendency to produce the desired result, i.e., whether it was done honestly with the intention of furthering the development of the lease, and (2) whether the act satisfies the terms of the lease at issue.

NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.

If you have any questions, please don’t hesitate to contact Attorney Gregory W. Watts or Attorney Ian R. Hoke at 330-497-0700 or 1-877-876-9958.

 
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