Pooling in Bad Faith: Look to the Lease Terms for Clarity

AUTHOR(s)

monroe ohio

This case illustrates the significance of broadly drafted pooling provisions that offer wide discretion to the Lessee. In Ischy v. Northwood Energy Corp,[1] the plaintiff (“Lessor”) had leased 297 acres in Monroe County, Ohio. About a year before the expiration of the lease’s primary term, the Lessee pooled 0.19 acres of the leased acreage into a unit. Production from that unit began about four months after the lease’s primary term expiry. While the lease contained a lease extension bonus provision, the need for the bonus wasn’t triggered because the lease was pooled. Lessor argued Lessee pooled the lease in a bad faith attempt to avoid having to pay the extension bonus.

Lessor brought suit claiming the lease had expired by its terms and relied on the following four arguments in justifying its claim:

  1. That Northwood violated the implied duty of good faith and fair dealing in pooling the lease;
  2. That operations occurred off leased premises and therefore did not satisfy the terms for holding the lease;
  3. That the advanced minimum royalty payment didn’t count; and
  4. That Lessor’s attempts at notice did satisfy the lease terms.

The main issue addressed by the appellate court was the issue of good faith and fair dealing. Lessor argued that Lessee acted in bad faith when it pooled 0.19 acres of the 297-acre lease for the sole purpose of holding the lease beyond its primary term. Lessor stated that Lessee did this to avoid paying the $5,000/acre lease extension bonus. In analyzing, the appellate court pointed to the lease terms, which stated that “…it is expressly stipulated that no implied covenants or conditions whatsoever shall be read into this Lease…”[2] The court further pointed out that the lease provided broad authority to pool acreage at Lessee’s discretion. Thus, the court concluded that Lessee didn’t act in bad faith because Lessee didn’t violate the terms of the lease.[3]

Touching on the remaining arguments, the appellate court went on to state that the lease’s definition for “operations” also offered a broad meaning. As such, Lessee’s actions complied with the lease as it served to hold the lease into the secondary term without necessitating the extension bonus payment.[4] Although the court noted there could be some question concerning how effective the advanced minimum royalty payments were in holding the lease, it was a moot issue as the lease was clearly held beyond its primary term under the first two analyses.[5]

The court also briefly touched on the issue of notice, which warrants discussion here. Lessor claimed it satisfied the notice requirement in the lease, yet the court pointed out that the lease required written notice while Lessor verbally raised its concerns with Lessee’s land team. While the court found this issue irrelevant since the lease was held by pooling,[6] the court could have found notice was not met as Lessor’s verbal notice did not comply with the lease terms (i.e. written notice).

The bottom line in Northwood is that the lease terms prevail and pooling is unlikely to be considered in bad faith if the pooling complies with the mutually agreed upon lease terms. Thus, all parties should be aware of how lease terms can and will impact their assets now and beyond the primary term.

[1] 2022 Ohio App. Lexis 4474

[2] Id. at 19.

[3] Id. at 30.

[4] Id. at 41.

[5] Id. at 52.

[6] Id. at 61.

Note: The following legal update was featured in NADOA’s 2023 Q2 Magazine.

Andrew represents companies active in the oil and gas industry in both litigation and arbitration matters, from risk management to trial. He also advises clients on compliance and regulatory issues and handles proceedings in front of administrative agencies / governmental bodies, including the Ohio Department of Natural Resources and the Ohio Department of Commerce.

In addition to his energy practice, Andrew has broad experience in commercial and business litigation, including breach of contract / lease claims, construction disputes, non-compete / non-solicitation disputes, trade secrets, business torts, and real property-related claims. He is OSHA certified in Construction Safety and Health and has drafted and reviewed numerous construction contracts.

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