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Oil & Gas Law Report Reporting on recent legal developments and trends in the oil and gas industry.

Lawsuits Over “Fraudulent” Oil & Gas Leases Often Lack Merit

Posted in Contracts and Leases, Other Articles, Real Estate, Regulatory, Shale

The Ohio shale boom started slowly when a few small companies quietly began acquiring mineral leases for as little as $25 per acre.  This soon gave way to a full blown land rush in the fall of 2010.  But as lease prices skyrocketed through the Fall of 2011, disillusioned lessors who signed before the peak of the market were the ones rushing – to the courthouse to file lawsuits to cancel their leases.

In order to gain leverage and legitimize their lawsuit, lessors frequently allege that their lease is “unconscionable” or they were fraudulently induced to sign it.  “Exhibit A” to these lawsuits is often a technical error in the lease signing or a “fraudulent” statement made by a landman.  There are exceptions, but many of these kinds of lawsuits have no legal basis.

Technical Notary Errors Do Not Void a Lease

A favorite technical error alleged by lessors is improper notarization of the lease.  ORC §5301.01 does indeed require documents like mortgages, deeds and leases to be signed and notarized.  That statute and related case law may lend some support to an argument to cancel a lease that completely omits a signature, notary acknowledgment, or name of the lessor.

However, Ohio law does not allow a lessor to cancel a lease because of a technical error by the notary.  “[A] defectively executed conveyance of an interest in land is valid as between the parties thereto, in the absence of fraud.” Citizens Nat. Bank in Zanesville v. Denison (1956), 165 Ohio St. 89, 95.  This principle, which is also reflected in ORC §2719.01, expresses the law’s refusal to nitpick technical errors in contracts to undermine the intent of parties.

In Swallie v. Rousenberg, 2010-Ohio-4573, ¶35 (Seventh Dist.) the court upheld the validity of a deed as to the parties to the transaction even though the grantee improperly acted as the notary.  In Logan Gas Co. v. Keith (1927), 117 Ohio St. 206, 208 the Court held that even though one of the lessor’s signatures was impermissibly acknowledged by telephone, the oil and gas lease remained valid.  Finally, ORC § 5301.071 provides that even if a notary fails to seal the acknowledgment, the validity of the agreement is unaffected.

Calling attention to a notary error may get a notary’s license revoked, or cause a consternation for a county recorder, but it is not grounds to disregard contractual obligations between parties.

Fraud or the Hard Truth?

Lessors often complain that a landman told them to sign immediately or “they would miss their chance” or “the company would just take their minerals anyway” or some similar statement.  These kinds of statements, even if they were made, probably do not amount to fraud.

First, predictions of future events typically do not constitute fraud.  “It is clear in Ohio that fraud cannot be predicated upon promises or representations relating to future actions or conduct.” Crase v. Shasta Beverages, Inc., 2012-Ohio-326, ¶42 (Tenth Dist.).  Further, such statements have proven to be true in many circumstances.

Next, Ohio oil and gas law does not require an operator limit production to within the boundary of a leased parcel.  Ohio follows the doctrine of “correlative rights,” which preserves each landowner’s opportunity to draw from a common resource.  ORC §1509.01(I).  Under this doctrine, so long as there is no waste or reservoir damage, each landowner has the right to take as much oil and gas as his or her wells will produce, although the minerals may be drained from the land of others.  Williams & Meyers, Abridged Fourth Edition, §203.2. 

There are a number of scenarios that would allow a lessee to drill a well on one parcel and draw oil and gas out from beneath adjacent, unleased, parcels in Ohio.  Drilling a well to intersect large natural fractures, for example, is one scenario that may allow a lessee to produce from beneath an adjacent parcel regardless of whether it is leased.  In that scenario, a landman’s statement that a lessee could take minerals from beneath an unleased parcel is accurate.

Next, statements by landmen that landowners should sign a lease quickly, before they “miss their chance” or that the offer was “for a limited time” seemed disingenuous in the early months of the landrush.  But when the landrush subsided in early 2012 some landowners saw lease offers of nearly $6,000 per acre withdrawn literally overnight.  This fluctuation in lease prices was dictated by unpredictable market forces, including competition among various lessees, the amount of land left to lease, the price of natural gas, and production from exploratory wells.  Landmen who urged landowners to seize the opportunity to lease were not committing fraud.  In many cases they were actually giving good advice.

Bad Timing Does Not Make a Contract Unconscionable

In order to prove that a lease is unconscionable, a lessor must produce clear and convincing evidence that the lease contains commercially unfair or unreasonable terms, that no voluntary meeting of the minds was possible, and there was an absence of meaningful choice for the lessors. Featherstone v. Merrill Lynch, Pierce, Fenner & Smith Inc., 2004-Ohio-5953, ¶13 (Ninth Dist.).

The legal theory of unconscionability is not yet well developed as it relates to modern leases focused on horizontal drilling.  What is “commercially reasonable” for this relatively new industry will undoubtedly challenge Ohio courts for years to come.

Likewise, most claims of unconscionability will probably fail because of the voluntary nature of the lease arrangement.  If a lessor tries to void a lease as unconscionable, the lessor will have to show that they had no choice but to sign a lease.  This will be a difficult task.  In most cases, lessors made a deliberate decision to lease with whatever information they chose to gather, and they would have been thrilled if they timed the market perfectly.  But, a lessor’s failure to time the market does not equate to fraud or render a lease unconscionable.  As explained in my prior blog on the subject, courts do not and should not decide what price is “enough” for a particular transaction.