Case Study / Reservation Clauses and the Right to Receive Rental Payments (Ohio)

In June of 2020, the Supreme Court of Ohio held in LRC Realty, Inc. v. B.E.B. Properties, Slip Opinion No. 2020-Ohio-3196 that absent an express reservation, the right to receive rental payments runs with the land and follows legal title.

A brief recitation of the facts in LRC Realty, Inc. follow herein.  In 1994, B.E.B. Properties (“B.E.B.”) leased a portion of a commercial tract (“subject tract”) and granted an easement to Northern Ohio Cellular Telephone Company (“Northern Ohio Cellular”).  Id. at ¶ 2.  The lease and the easement were recorded, and Northern Ohio Cellular erected a cellular tower on the subject tract.  Id.  Shortly thereafter, in 1995, B.E.B. sold the subject tract to Keith Baker and Joseph Cyvas.  Id. at ¶ 3.  The deed from B.E.B to Baker and Cyvas (“B.E.B. Deed”) contains the following language:

 “B.E.B. Properties * * * the said Grantor, does for itself and its successors and assigns, covenant with * * * Grantees [Baker and Cyvas] * * * that it will warrant and defend said premises * * * against all lawful claims and demands whatsoever, such premises further to be subject to the specific encumbrances on the premises as set forth above.”  Id. at ¶ 18.

Several months later, two of the three B.E.B. general partners sold their partnership interests to the third partner and his wife, Bruce and Sheila Bird.  Id. at ¶ 3.  The Birds assumed that this transaction included the assignment of the right to receive future rental payments under the Northern Ohio Cellular lease.  Id.  The Birds actually received rental payments from Northern Ohio Cellular and its successor in interest, New Par, until 2013, when LRC Realty, Inc. (“LRC”) purchased the subject tract from 112 Parker Court, L.L.C. (“Parker Court”), the successor in interest of Baker and Cyvas.  Id. at ¶ 5.  In 2014, LRC filed a complaint against B.E.B., Parker Court, and New Par seeking a declaratory judgment that it was entitled to the rental payments under the Northern Ohio Cellular lease, and further seeking to recover the rents paid to the Birds in 2013.  Id. at ¶ 6.

The issues before the Court were (1) whether, absent an express reservation in a deed conveying real property, the right to receive rental payments runs with the land and (2) whether language in a deed indicating that the property being conveyed is “subject to” a recorded lease agreement and easement is sufficient to reserve the grantor’s right to receive future rental payments under that lease agreement.  Id. at ¶ 10.

As to the first issue, the parties and the Court agreed that absent a reservation in a deed conveying real property, the right to receive rental payments runs with the land.  Id. at ¶ 12.  This statement of law is firmly established by precedent and has been codified by the General Assembly in Ohio Revised Code Section 5302.04.  Therefore, the Court held that the right to receive rental payments runs with the land unless the grantor reserves such right in the deed conveying the property.  Id. at ¶ 15.

As to the second issue, the Court focused on the plain language of the B.E.B. Deed, which specifically states that the subject tract is “subject to the specific encumbrances on the premises set forth above.”  The Court then looked to Black’s Law Dictionary, which defines a reservation as “[t]he creation of a new right or interest (such as an easement), by and for the grantor, in real property being granted to another.”  Black’s Law Dictionary 1500 (10th Ed.2014).  The Court made note that no particular words are necessary for the creation of a reservation, but reservation clauses typically contain the words “reserve,” “reserving,” “reservation,” “except,” or “excepting.”  L.R.C. Realty, Inc. at ¶ 20.  See Gill v. Fletcher, 74 Ohio St. 295, 304, 78 N.E. 433 (1906).  However, the Court cautioned that an exception is technically distinct from a reservation.  L.R.C. Realty, Inc. at ¶ 20. 

The court declined to interpret the words “subject to the specific encumbrances on the premises as set forth above” as a specific reservation clause in the B.E.B. Deed.  Id. at ¶ 21.  Therefore, because no words of reservation appear on the face of the B.E.B. Deed in connection with the words “rent” or “rental payments,” the Court ultimately held that B.E.B did not reserve the right to receive future rental payments for the leased land in the B.E.B. Deed.  Id.  Thus, B.E.B.’s assignment to the Birds was ineffective to convey the right to receive rental payments under the Northern Ohio Cellular lease.  Id.

Article / Production in Paying Quantities in Ohio: How Much Is Enough?

The habendum clause of an oil and gas lease establishes the period of time for which the rights given in the granting clause will extend.  John S. Lowe, Oil and Gas Law in a Nutshell, at 192 (5th ed. 2009).  Modern habendum clauses typically provide for a primary term, during which the lessee has no obligation to operate on the leased premises, and a secondary term, which is triggered by production on the leased premises prior to the expiration of the primary term.  Id.  Moreover, most modern habendum clauses specify that production must be in “paying quantities” in order to perpetuate the secondary term.  As such, disputes often arise as to what constitutes production in “paying quantities.”  Thankfully, Ohio courts have shed some light on how to interpret production in “paying quantities” in the state.

Paying Quantities Test

In 1980, the Supreme Court of Ohio defined “paying quantities” as quantities of oil or gas sufficient to yield a profit, even small, to the lessee over operating expenses, even though the drilling costs, or equipping costs, are not recovered, and even though the undertaking as a whole may thus result in a loss.  Blausey v. Stein, 61 Ohio St.2d 264, 265-266 (1980).     

Burden of Proof

We note that in Ohio, a lessee is typically given discretion to determine whether a well is profitable.  Hogue v. Whitacre, 2017-Ohio-9377, 103 N.E.3d 314, ¶ 21 (7th Dist.).  However, the lessee must make its determination of profitability in good faith.  Id.  Nonetheless, when a “paying quantities” dispute arises between a lessor and lessee, it is important to understand which party bears the burden of proof.  In Ohio, the Plaintiff (lessor) bears the burden of proving by the preponderance of the evidence that the well is not producing in “paying quantities.”  Id.  That is, the lessor’s evidence that the well is not producing in “paying quantities” must convince the fact finder that there is more than a 50% chance that his or her claim is true.

Direct Operating Expenses

While Blausey sets forth the standard by which production in “paying quantities” disputes are analyzed, litigation in Ohio has focused, in large part, on the characterization of “operating expenses.”  Though a comprehensive list of “operating expenses” has yet to be decided by the Ohio courts, several recent decisions lend guidance on the issue.

  1. Royalties Paid to Lessor

In Paulus v. Beck Energy Corp., 2017-Ohio-5716, 94 N.E.3d 73 (7th Dist.), the Seventh District Court of Appeals, examined whether royalties should be subtracted from gross income (along with other operating expenses) in order to determine a lessee’s profit.  The lessee in Paulus calculated its profit figures for the life of the well by subtracting operating expenses from the well’s total income, without removing royalties from income.  The Court held that royalties paid to the lessor should be included in the lessee’s operating expenses, stating, “[l]ogically, a lessee cannot report income under the Blausey equation without first subtracting the royalties paid to the lessor from income or adding the royalties to the operating expenses.”  Id. at ¶ 53.  Thus, prior to the ultimate calculation of a well’s profit or loss, the lessee must include the lessor’s royalties in its operating costs.

  1. Labor Directly Related to Production

In Paulus, the Court also addressed whether the lessee’s operating expenses include direct expenditures for labor performed by the lessee’s employees or contractors.  Prior to 2013, the lessee in Paulus allocated amounts of operating expenses for the time spent by a salaried employee working the well.  However, in 2013, six years after the well went into production, the lessee stopped accounting for labor involved in pumping the well.  In citing the California case of Lough v. Coal Oil, Inc., 217 Cal.App.3d 1518, 1531, 266 Cal. Rptr. 611 (1990), the Seventh District states, “[l]abor directly related to production is considered an operating expense; the portion of labor incurred for lifting costs represents a periodic cash expenditure incurred in the daily operation of the well.”  Paulus at ¶ 63.  The Court ultimately held that the lessee artificially deflated its operating expenses after 2013 by failing to account for the salaried employee’s time spent working on the well.  Id. at ¶ 64.[1] 

Exclusions from Direct Operating Expenses

  1. Lessee’s Personal Labor Directly Related to Production

In Blausey, the Supreme Court of Ohio addressed whether the value of a lessee’s own labor should be included as a component of its operating costs.  During the six-year period for which evidence was introduced, the trial court found that the lessee’s gross receipts from the well in dispute totaled $2,220.28, while his operating costs totaled $3,741.04.  However, the trial court included the sum of $2,887.50, being the value attributed to the lessee’s own labor, in his total operating costs.  On appeal, the Court of Appeals reversed the trial court’s ruling, holding that the lessee’s own labor should not be included as a component of his operating costs.  The Supreme Court of Ohio affirmed the ruling of the Court of Appeals, and states, “because an oil and gas lessee bears the risk of nonproduction in a lease of this kind, we believe that appellee should be allowed to attempt to recoup his initial investment for as long as he continues to derive any financial benefit from production.”  Blausey, 61 Ohio St.2d at 266, 400 N.E.2d 408.

  1. Drilling and Equipping Costs

The Seventh District, in Paulus, later examined whether drilling and equipping costs incurred after the initial drilling of the well should be included in operating costs.  The Court noted thatin Blausey, the Supreme Court of Ohio excludes drilling and equipping costs from operating costs in its definition of “paying quantities.”  Paulus at ¶ 56 (citing Blausey, 61 Ohio St.2d at 265-266, 400 N.E.2d 408).  It is key to note that the Court in Blausey did not include the modifier of “initial” drilling and equipping costs in its “paying quantities” definition.  Paulus at ¶ 56.  In Paulus, the lessee spent $10,503.31 to “rework” the well by replacing a downhole pump and rebuilding the wellhead six years after the well went into production.

In Paulus, the Court looked to several out-of-state cases in its analysis of the lessee’s “reworking” costs.  Specifically, the Court cited  Imperial Colliery Co. v. Oxy USA Inc., 912 F.2d 696 (4th Cir. 1990), in which the United States Court of Appeals for the Fourth Circuit read West Virginia law as excluding capital expenditures from operating expenses as part of the paying quantities analysis.  Paulus at ¶ 57.  The Court also cited Pshigoda v. Texaco, Inc., 703 S.W.2d 416 (Tex.App.1986), which states that “one time investment expenses, such as drilling and equipping costs are to be treated as capital expenditures,” and that “a reworking expenditure is analogous, and closely related, to the initial drilling expenses.”   Paulus at ¶ 58 (quoting Pshigoda,at 418-419).  Similarly, the Court noted that in Louisiana, courts have ruled that “workover expenses, considered to be extraordinary expenses, are generally distinguished from operating expenses and should not be included as an operating expense when determining if there was production in paying quantities.” Paulus at ¶ 59 (quoting O’Neal v. JLH Enterprises, Inc., 862 So.2d 1021, 1027 (La.App.2003)).  Lastly, the Court distinguished Laugh, in which the Court of Appeals of California, Second District, Division Seven, found that re-perforation and testing of an existing casing is an operating expense because it did not involve the installation of new equipment on an existing well.  Laugh at 1531, 266 Cal.Rptr. 611 (1990). 

The Court in Paulus found that the downhole pump was new equipment, and rebuilding of the wellhead was required by the new equipment’s installation.  Paulus at ¶60.  Therefore the Court held that the $10,503.31 spent to replace the pump in 2013 was a nonrecurring capital investment, which was to be excluded from operating expenses as an equipping cost under Blausey.

  1. Business Overhead Costs

In Hogue, the Court examined whether business overhead costs, which were not directly attributable to the well in dispute, should be categorized as direct operating costs for the purpose of a “paying quantities” analysis.  The lessee in Hogue paid a third-party entity various sums of money for things such as office payroll, office lease, software, postage, professional services, building utilities, fire resistant clothing, vehicles, and machinery.  The lessor argued that such payments should be included in the lessee’s operating costs.  However, the lessee countered by explaining that the aforementioned payments would have been made regardless of the disputed well’s existence, and do not contribute to production from any specific well. 

The Court referenced a Williams & Myers, Oil and Gas Law, footnote which noted “that a regulation of the United States Department of Interior has interpreted the term ‘paying quantities’ as a ‘positive stream of income after subtracting normal expenses, which include royalties and direct operating costs.’” Hogue at ¶ 26 – 27 (quoting 6 Williams & Myers, Oil and Gas Law, Section 604.5 (2010), fn. 4).  Ultimately, the Court found traction in the aforementioned footnote and stated that, “in a ‘paying quantities’ analysis, we look to direct operating costs and exclude any indirect costs that do not contribute to the production of oil or gas.”  Hogue. at ¶ 27.  The Court went on to hold that the monthly administrative fees paid by the lessee to a third-party entity are not directly related to oil and gas production from the disputed well, and should not be included in a “paying quantities” analysis.  Id. at 31.

  1. Gathering and Compression Costs

In Neuhart v. Transatlantic Energy Corp., 2018-Ohio-4099, 121 N.E.3d 802 (7th Dist.), the Seventh District addressed whether gathering and compression costs paid by the lessee should be included in a “paying quantities” analysis.  The Court found guidance from the United States Court of Appeals for the Sixth Circuit in its definition of gathering as “the movement of lease production to a central accumulation and/or treatment point on the lease, unit or communitized area, or to a central accumulation or treatment point off the lease, unit or communitized area.”  Id. at ¶ 31 (quoting Poplar Creek Dev. Co. v. Chesapeake Appalachia L.L.C., 636 F.3d 235, fn. 1 (6th Cir. 2011)).  The Sixth Circuit also defined compression as “the process of raising the pressure of gas,” and further stated that “[compression] is often used to transport low pressure gas through the pipeline to a place where it can be sold.”  Poplar Creek Dev. Co. at fn. 2, 636 F.3d 235 (6th Cir. 2011).  Importantly, the Sixth Circuit reasoned that gathering and compression are post-production processes.  Id. at 239.  Relying on the Sixth Circuit’s decision in Poplar Creek Dev. Co., the Court in Neuhart held that “gathering and compression costs are not directly related to the production of oil and gas” and that “gathering and compression fees are not expenses for purposes of a paying quantities analysis in this matter.” Neuhart at ¶ 32.

Duration of Loss

While weighing revenue against operating expenses is a major component of the “paying quantities” analysis, there is also a temporal aspect.  Critical to the “paying quantities” analysis is the timeframe during which production does not result in a profit over operating expenses.  Ohio courts have not yet adopted a bright-line rule on this issue.  However, as the Court of Appeals acknowledged in Hogue, “no case can be found where an Ohio appellate court deemed a lease forfeited based on less than two years of nonproduction.”  Hogue at ¶ 45 (quoting RHDK Oil & Gas, L.L.C. v. Dye, 2016-Ohio-4654, 2016 WL 3522555, ¶ 22).  The Court further stated that “[i]n addition to the length of cessation, a court must consider all attendant circumstances.”  Id. at ¶ 45 (citing RHDK at ¶ 21).


The test for determining production in “paying quantities” in Ohio is a relatively simple equation on its face, which balances revenue generated from a well with its operating expenses.  Blausey.  However, identifying direct operating expenses is critical in the application of the Blausey equation.  For this reason, accurate recordkeeping is imperative.  We have seen that lessor royalties and payment for labor related to production are costs to be included in direct operating expenses.  On the contrary, a lessee’s own personal labor, drilling and equipping costs, general business overhead costs, and gathering and compression costs have been excluded from operating expenses.  As “paying quantities” disputes continue in Ohio, we anticipate continued development in the categorization of direct operating expenses.         

[1] We note that the holding in Paulus can be distinguished from the Ohio Supreme Court’s holding in Blausey that a lessee’s own personal labor performed in the production from the leasehold is not an operating expense.  Blausey, 61 Ohio St.2d at 266, 400 N.E.2d 408.     

Article / The Dynamics of COVID-19 and Force Majeure Clauses in Ohio Oil and Gas Leases

“Force Majeure” is a French term and literally means superior force.  Haverhill Glen v. Eric Petroleum Corp., 2016-Ohio-8030, 67.N.E.3d 845 ¶ 25 (7th Dist.).  It is commonly defined as an event or effect that can be neither anticipated nor controlled.  Black’s Law Dictionary 673-674 (8th Ed. 2004).  Moreover, force majeure clauses are typically included in oil and gas leases to preserve the lease when conditions beyond the control of the parties prevent the lease from operating or producing.  John S. Lowe, Oil and Gas Law in a Nutshell, at 255 (5th ed. 2009).

While they vary in breadth, most force majeure clauses in oil and gas leases specifically address conditions like the inability to procure equipment or materials, natural disasters, and laws and regulations which prevent the lessee from complying with the terms of the lease.  Some force majeure clauses will even cover any cause that is not reasonably within the lessee’s control.  Within the context of force majeure clauses, COVID-19 poses a new and interesting question.  Could the COVID-19 pandemic trigger the application of the force majeure clause in an oil and gas lease?  The answer is unclear, as we have not experienced a pandemic of this magnitude in the era of modern oil and gas leases.  Moreover, Ohio case law on the application of force majeure clauses is sparse.  Nonetheless, the from the several Ohio cases that address the application of force majeure clauses, we can glean insight into how such clauses are analyzed by the courts.   

Non-Performing Party Bears Burden of Proof

In Ohio, the non-performing party (lessee) bears the burden of proving that the event was beyond the its control.  Stand Energy Corp. v. Cinergy Serv., Inc., 144 Ohio App.3d 410, 416, 760 N.E.2d 453 (1st Dist. 2001).  The lessee must also show that the event was not the result of the lessee’s fault or negligence.  Id.  However, “[m]istaken assumptions about future events or worsening economic conditions . . . do not qualify as a force majeure.”  Id.

Sticking to the Terms of the Lease

Oil and gas leases are contracts, and the rights and remedies of the parties are determined by the terms of the written lease.  Haverhill at ¶ 24.  Therefore, courts will strictly construe the language of force majeure clauses, and limit their application to the events specified therein.  However, this is not to say that courts will not give effect to a broad force majeure clause.  Thus force majeure clauses with an extensive list of qualifying events afford the lessee a better opportunity to invoke the clause.


The ideal scenario for a lessee to invoke the force majeure clause would be if the clause specifically included a pandemic as a qualifying event.  However, most force majeure clauses in oil and gas leases do not specifically account for this.  To the contrary, many force majeure clauses account for conditions such as the inability to procure equipment or materials or the passing of new laws and regulations which prevent the lessee from complying with the lease terms.  Considering COVID-19’s potential for significant impact on supply chains and widespread quarantine mandates, the latter set of aforementioned conditions seems to provide more opportunity for a lessee to invoke a force majeure clause.