Court Construes Impact of Habendum Clause on Ratification Agreement

September 29, 2010 | Erin Herbold

 

A habendum clause is frequently utilized in deeds that transfer ownership interests in real estate.  The clause defines the nature of the legal estate that is being granted, the extent of the interest transferred and the rights and obligations associated with the property.  Such a clause in an oil and gas leases defines how long a lessee (oil and gas company) has to explore for oil and gas on lessor’s land.  Most oil and gas leases provide for a primary and secondary term. The primary term usually extends for a number of years until development takes place. The secondary term, generally, extends for “as long as oil and gas is produced in paying quantities.” The question in this case was whether, without express language to the contrary, the continuing payment to the property owners of an annual minimum-royalty that was not derived from the actual production of oil and gas extends the oil and gas lease into the secondary term.  How does the habendum clause impact the outcome of such an arrangement?

The landowners entered into a 2-year oil and gas lease on their farm. The lessee (oil and gas company) installed one gas well on the property, but it never produced oil or gas. Under the terms of the lease, the landowners were to receive at least $1,000 annually (after the second year) under a “minimum–royalty clause.” The landowners received the minimum payment every year, from 1998 through 2005. The oil and gas company concluded that these payments extended the lease beyond the primary term, into the secondary term. Seeking to clarify the arrangement and lock the landowners into a secondary term, the company presented them with a “ratification” of the lease. The landowners signed the agreement in May of 2006.  However, the landowners subsequently decided to end the relationship and notified the company that they wished to terminate the lease agreement two months later. The company continued to send $1,000 checks to the landowners, but the landowners returned the checks without cashing them.

At trial, the landowners prevailed and the lease was terminated. The trial court determined that the annual minimum-royalty payments did not extend the lease beyond the primary term.  The court determined that the lease could only be extended upon the production of oil or gas “in paying quantities.”  Because the oil well never yielded any actual production, the annual payments were merely rental-type payments.   In addition, the “ratification” document was unenforceable because, the court said, it was not “knowingly or intelligently” executed by the landowners - they did not understand what they were signing (there was no “meeting of the minds”).

On appeal, the oil and gas company claimed that the lease should be upheld because the payments benefitted the landowners and caused the company to rely on the existence of the lease.  But, the court disagreed.  The court noted that the developer would have to show that the landowner benefitted from the annual minimum-royalty payments and that they rightfully relied on those payments to their own detriment or prejudice.   However, the developers never notified the landowners that their acceptance of the payments would prolong the lease beyond 2 years.  As such, the payments were merely a type of rental arrangement - the landowner was not receiving a benefit because there was no production of oil or gas.  Thus, even though the landowners continued to receive the $1000 payment they were not barred from claiming the primary term of the lease terminated.

 The company also argued that the ratification agreement was valid.  But, the appellate court focused on the existence of the “habendum clause” and found that the $1,000 minimum-royalty payments did not “revive” the expired two-year lease.  The court noted that the “heart of every oil and gas lease is the habendum clause.” The primary term set out in the habendum clause was 2 years. Since there was no production and no provision in the lease for an extension, the lease terminated. The language of the habendum clause did not expressly state even a remote possibility of an extension of the primary term to allow for further exploration.  Thus, the lease terminated after its primary term of two years.  In addition, no consideration supported the ratification agreement.  Without additional consideration, the original lease could not be altered or extended.  But, the court went even further noting the ratification agreement would have failed even with consideration because there was no evidence that the landowners knew or intelligently signed the agreement.  The developer admitted that he was a successful financier, and the court noted that the landowners were elderly farmers in ill health and had little-to-no experience with leases of this kind.  But, the ratification agreement was not an unconscionable contract because there was no evidence of duress, fraud or mistake.  Palmer v. Bill Gallagher Enterprises, No. 102,150, 2010 Kan. App. LEXIS 111 (Kan. Ct. App., Sept. 24, 2010).