Energy Law Update: Sixth Circuit Upholds Extension of Oil Lease by Paying Delay Rental in Northup Properties, Inc. v. Chesapeake Appalachia, L.L.C.
Oil and gas leases may now be extended indefinitely even if the lessee fails to produce oil or gas. The United States Court of Appeals for the Sixth Circuit recently held in Northup Properties, Inc. v. Chesapeake Appalachia, L.L.C., 2009 WL 1576506 (6th Cir. 2009) that a lessee may extend the term of an oil and gas lease by making delay rental payments.
In Northup, Chesapeake Appalachia, L.L.C. ("Chesapeake") prevailed in a suit to uphold its extension of a gas lease with Northup Properties, Inc. ("Northup"). The lease had a primary term of ten years, but Chesapeake could extend the term either by operating the land in search for or production of gas, or by "payment of rentals." Chesapeake failed to search for or produce gas on the property for several decades. Nevertheless, Chesapeake continued to make delay rental payments for forty years until 2006. In 2006, Northup refused to accept further payments from Chesapeake and considered Chesapeake's lease expired. Chesapeake brought an action to uphold the lease, and the United States District Court for the Eastern District of Kentucky granted Chesapeake's motion for summary judgment. Northup appealed to the Sixth Circuit, but the majority rejected each of Northup's arguments.
First, Northup argued that the lease expired by its own terms. The majority reasoned that the lease explicitly permitted extension by delay rental payments because the terms of the lease did not contain a "Producer's 88" form. Under a Producer's 88 form, the secondary term of a lease depended upon mineral production for continued existence. In contrast, in Northup, the lease could be extended by making payments of rentals. By choosing not to use a Producer's 88 form, the parties chose not to make extension dependent upon mineral production. Rather, the terms of the lease explicitly permitted Chesapeake to extend the lease by making delay rental payments.
Second, Northup argued that long-term leases are against public policy. Although Kentucky recognizes a strong public policy against long-term leases, this policy addresses the concern that a lessor's only source of income may be from royalty payments. Rather than accepting royalty payments, Northup accepted delay rental payments. The majority held that it is not against Kentucky public policy to extend a lease by accepting delay rental payments because delay rentals may well be the most valuable right of the owner of the mineral estate when no production is obtained.
Finally, Northup argued that the lease lacked mutuality of obligation because Chesapeake had a unilateral right to extend the lease. The majority concluded, however, that Chesapeake's right was not unilateral because Northup had the right to demand production within a reasonable time.
Jeffrey K. Phillips
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Charleston, WV 25301
859.219.8210
jeffrey.phillips@steptoe-johnson.com
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