On September 30, 2022, in Hogue v. Whitacre (2022-Ohio-3616), the Seventh District Court of Appeals provided further clarification as to what qualifies as a “direct expense” when conducting a “paying quantities” analysis.
This case is the fourth in a series of cases decided by the Court involving the issue of whether a flat monthly fee paid by one entity to an affiliate is a “direct expense” related to production, and thus whether it should be deducted from the relevant revenue stream when determining whether a lease continues to produce in paying quantities. In Whitacre I[1] and Whitacre III,[2] the parties filed competing motions for summary judgment. While Whitacre offered evidence on the topic in both of these cases, the landowners did not, leaving the Court to hold that the monthly payment was not a direct expense due to the standard for deciding summary judgment motions. In Whitacre II, however, the landowners produced rebuttal evidence that created a genuine issue of material fact that precluded summary judgment and that resulted in a bench trial decision in favor of the landowners.
Like Whitacre I and III, the parties in this case filed competing motions for summary judgment, agreeing that there was no material fact in dispute, and the landowners offered no evidence to rebut the evidence produced by Whitacre. Relying on the Court’s decision in Whitacre II[3], and the fact that none of the producer’s investors made a profit on their interest in the well, the trial court determined that the monthly payment was a direct expense and that the lease had terminated due to a failure to produce in paying quantities.
On appeal, the Court began by emphasizing that, under the Ohio Supreme Court’s decision in Blausey,[4] any court determining whether a well is producing in paying quantities must undertake a mathematical calculation that subtracts the direct expenses attributable to the production of oil or gas from gross profits. Furthermore, the Court explained that investor reports are not relevant to any definition of direct expenses and noted that Blausey specifically states that a well can be considered “profitable” even if the operation as a whole does not result in a profit.
Turning to the evidence, the Court first addressed certain spreadsheets that Whitacre had prepared detailing the expenses of the well in question and Whitacre’s mislabeling of some of those expenses as direct when they were not. The Court noted that the witness who prepared the spreadsheets testified that she was not familiar with the paying quantities analysis or relevant caselaw, and that, as a result, she incorrectly subtracted indirect expenses from the gross profits. The Court observed that whether expenses are determined to be direct or indirect is a legal issue and that it was error to substitute Whitacre’s calculation for the paying quantities analysis that was required by Ohio precedent.
The Court then examined whether the monthly payment made by Whitacre is a direct or indirect expense and reiterated that it was the landowner’s burden to challenge the evidence provided by Whitacre. As this issue had been litigated multiple times by the Court and no new evidence was provided in this case, the Court held that the monthly payments were not a direct expense and were not to be considered in the paying quantities analysis. The Court then completed its own analysis and determined that the well in question did produce oil or gas in paying quantities during the time periods involved. Because Whitacre provided uncontested evidence that production from the well in question
[1] 2017-Ohio-9377.
[2] 2021-Ohio-4656.
[3] 2018-Ohio-2784.
[4] 61 Ohio St.3d 264.