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No. 102,150 IN THE COURT OF APPEALS OF THE STATE OF KANSAS CHARLES F. PALMER and DOLORES PALMER, husband and wife, Appellees/Cross-appellants, v. BILL GALLAGHER ENTERPRISES, L.L.C., Appellant/Cross-appellee.

SYLLABUS BY THE COURT 1. The habendum clause of an oil and gas lease defines how long a lessee has to explore for oil and gas on land owned by the lessor. Typically, this primary term extends for an agreed number of years as set out in the lease. Once development takes place, a secondary term extends the lease for as long as oil or gas is produced in paying quantities.

2. The payment of an annual minimum-royalty that is not derived from oil and gas production will not extend an oil and gas lease into its secondary term unless there is express language in the lease to that effect.

3. Equitable estoppel is the effect of the voluntary conduct of a party whereby it is precluded, both at law and in equity, from asserting rights against another person relying on such conduct. A party seeking to invoke equitable estoppel must show that the acts, representations, admissions, or silence of another party (when it had a duty to speak) induced the first party to believe certain facts existed. There must also be a showing the 1

first party rightfully relied and acted upon such belief and would now be prejudiced if the other party were permitted to deny the existence of such facts.

4. If the landowner, the lessor, receives a benefit from the payment of royalties, then the lessor is estopped from asserting that the lease terminated. But if the lessor did not receive a benefit from the payment of royalties, then the lessor should not be estopped from claiming the lease terminated.

5. If a lessee continues to make royalty payments to the lessor after the lease has terminated according to its own terms, the receipt of such payments will not work an estoppel against the lessor, and such lessor may nevertheless assert that the lease has terminated.

6. K.S.A. 55-202 grants district courts discretion to award attorney fees in cases dealing with the release of oil and gas leases.

7. In deciding the reasonableness of an attorney fee, courts must consider the eight factors set forth in Supreme Court Rule 1.5(a) (2009 Kan. Ct. R. Annot. 460) of the Kansas Rules of Professional Conduct.
Appeal from Wilson District Court; DANIEL D. CREITZ, judge. Opinion filed September 24, 2010. Affirmed in part, vacated in part, and remanded with directions.

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Ryan M. Peck and Clinton M. Goos, of Morris, Laing, Evans, Brock & Kennedy, Chartered, of Wichita, and Kurt F. Kluin, of Kluin Law Office, LLC, of Chanute, for appellant/cross-appellee.

W.J. Fitzpatrick, of Fitzpatrick & Bass, of Independence, for appellees/cross-appellants.

Before HILL, P.J., PIERRON and LEBEN, JJ. HILL, J.: Charles and Dolores Palmer granted a 2-year oil and gas lease on their farm in 1996. The lessee drilled one gas well on the property, but it has never produced any oil or gas. The lease has a minimum-royalty clause calling for the Palmers to receive at least $1,000 every year, beginning with the second year of the lease. The lease called for this minimum-royalty to come either from production earnings or, if there was inadequate production, by the lessee paying the Palmers the difference. Every year, from 1998 through 2005, the Palmers received $1,000 from the lessee. Kansas courts will not intervene to extend an oil and gas lease beyond the agreed terms of the parties. Here, because there was no production of oil and gas in paying quantities and no clause in the lease extending it, we hold this lease expired at the end of its 2-year primary term. Also, the $1,000 yearly payment did not extend the lease beyond its primary term because the money did not come from oil or gas production. Moreover, we cannot consider those annual payments a benefit to the Palmers (necessary to create an estoppel) because after the lease expired, the Palmers were entitled to all the oil and gas produced--less the costs of production. Therefore, we affirm the district court's ruling on this point. Similarly, we affirm the district court's holding that a claimed written "ratification" of the lease was ineffective for lack of consideration since the lessee tendered nothing of benefit to the Palmers to induce them to sign the document.

Despite our holding, we must vacate the amount of the attorney fees awarded to the Palmers. We do not question the grant of fees to the Palmers, but do question the amount awarded. The district court failed to analyze the question and offered no reasons for its ruling. Therefore, we remand the fee question for further analysis by the court, 3

asking it to consider the eight factors set out in Supreme Court Rule 1.5(a) (2009 Kan. Ct. R. Annot. 460) when it addresses the matter.

The Palmers signed a lease; the lessee drilled a dry hole and then assigned the working interest to another company. Charles F. and Delores Palmer granted an oil and gas lease to KanMap, Inc. for their farm in Wilson County in 1996. The primary term of the lease was 2 years. KanMap drilled a single gas well on the property in 1997. Since then, there has been no production of oil or gas from the leased land. After that, KanMap annually paid the Palmers $1,000 as minimum-royalty from 1998 through 2003.

Then in April 2004, Bill Gallagher Enterprises, L.L.C., bought the working interest in the lease. After that, Gallagher paid the Palmers $1,000 in 2004 and 2005 near the anniversary of the lease. In May 2006, at Gallagher's request, the Palmers signed a ratification of the lease. Gallagher did not make any payment to the Palmers at the time they signed the ratification or at any time after.

A few months later, in July 2006, the Palmers authorized their attorney to notify Gallagher the lease was forfeited because there was no production. In response, Gallagher contended the lease was still valid and continued to mail $1,000 checks to the Palmers from 2006 to 2008. But the Palmers returned those checks, uncashed, to Gallagher. After Gallagher filed an affidavit with the register of deeds asserting the lease was still in effect, the Palmers filed an action to cancel the lease.

Eventually, the court tried the case and the Palmers prevailed. After the district court decided that a shut-in royalty clause was stricken from the lease, and was therefore inapplicable, the court decided only production of oil or gas in paying quantities could extend the lease beyond its primary term. Thus, after the court found the well drilled on 4

the leased land was not producing in paying quantities, it concluded the lease expired at the end of the 2-year primary term.

Next, the court concluded the $1,000 annual payment made according to the minimum-royalty clause of the lease did not extend the lease past the primary term because a minimum-royalty clause can only extend a lease if the royalties come from actual production. Moreover, the district court held the doctrine of estoppel could not extend a lease already expired by its own terms.

Finally, the district court ruled that the written ratification of the lease was unenforceable because it was made without consideration and was not knowingly and intelligently executed by the Palmers. The district court granted the Palmers reasonable attorney fees and costs.

Now, Gallagher contends the district court erred when it ignored the minimumroyalty payments made to the Palmers. In Gallagher's view, either by the operation of the minimum-royalty clause or through the application of the doctrine of equitable estoppel, this lease survived beyond its primary 2-year term. Additionally, Gallagher contends the court erred when it ruled the ratification agreement failed for lack of consideration or that the Palmers did not make the agreement knowingly and intelligently. Finally, Gallagher asserts the court abused its discretion by awarding attorney fees to the Palmers.

In turn, in their cross-appeal, the Palmers argue the district court did not award enough attorney fees.

The $1,000 payments did not save this lease from expiration.

First, we examine the question of the effect of the minimum-royalty clause found in this lease. We conclude it does not revive this expired lease. Next, we look at the issue 5

of equitable estoppel. Based on our assessment that the payments were not a benefit to the Palmers and were never made in a way that would indicate to the Palmers that the lessees asserted the Palmers' acceptance would prolong the lease, the Palmers are not now equitably prevented from arguing the lease is terminated. We view this matter as an interpretation of a written contract along with a determination of its legal effect. Thus, we exercise an unlimited standard of review. See Conner v. Occidental Fire & Cas. Co., 281 Kan. 875, 881, 135 P.3d 1230 (2006).

The heart of every oil and gas lease is the habendum clause, sometimes called the "to have and to hold" clause. In it, the landowner allows the lessee "to have" access to the property to explore for oil and gas and develop the property if possible. This provision of an oil and gas lease defines how long the interest granted to the lessee will extend. Typically, oil and gas leases provide for a primary term--a fixed number of years during which the lessee has no obligation to develop the premises--and a secondary term lasting as long as oil and gas is produced in paying quantities, once development takes place. See Black's Law Dictionary 778 (9th ed. 2009). In this lease the primary term was 2 years.

Sometimes oil and gas leases have a shut-in royalty clause. In such cases, a working interest owner that operates a nonproducing gas well may choose to "shut in" the well and cease production and wait for a more favorable gas market. But in order to prolong the life of the lease, since there is no production, the working interest owner must pay a royalty--fixed by the shut-in royalty clause-- to the landowner. In those cases, the courts view the shut-in royalty clause as a part of the habendum clause. See Welsch v. Trivestco Energy Co., 43 Kan. App. 2d 16, 22, 221 P.3d 609 (2009).

But here, after examining the lease in question, the district court decided the shutin royalty clause had been stricken from the lease when it was signed and therefore it could not save this lease. Gallagher takes no issue with this ruling in its brief, and we

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therefore deem the matter abandoned by Gallagher. See Kingsley v. Kansas Dept. of Revenue, 288 Kan. 390, 395, 204 P.3d 562 (2009).

Instead, Gallagher contends the minimum-royalty clause of this lease serves the same purpose as a shut-in royalty clause. That clause states: "Lessee shall receive a minimum royalty of $1,000.00 beginning at the end of the second year, either through actual production or by a [sic] paying the difference of actual royalty paid and the amount due by a payment within 30 days of the annual anniversary date of this lease." We are not persuaded by this argument.

We must reject Gallagher's contention on this point for several reasons. First, the language of the clause itself does not say the payments will extend the lease into the secondary term. Also, this minimum-royalty clause does not indicate that the parties to the lease consider making those payments the same as if gas is being produced within the meaning of the habendum clause. With no such language, we cannot view this clause as part of the habendum clause. Therefore, we do not believe the payment of the minimumroyalty extends the lease past the primary term. Furthermore, minimum-royalty payments have always been viewed as royalties and not as rentals. Cherokee Resources, Inc. v. Gold Energy Corp., 11 Kan. App. 2d 436, 438-39, 724 P.2d 695 (1986).

Although there are no Kansas cases on this issue, a panel of the Texas Court of Appeals determined that the satisfaction of a minimum-royalty clause does not extend the lease beyond the primary term. See Morris Exploration, Inc. v. Guerra, 751 S.W.2d 710, 712-13 (Tex. App. 1988). The court stated: "It follows that there must be actual production and actual basic royalties due (paid or payable), before any minimum royalties are to be paid." 751 S.W.2d at 713. In Texas, with no actual production, the clause was inoperable. Even though the minimum-royalty clause in this case and the minimum-royalty clause in Guerra are not identical, the concept is the same; neither clause modifies or becomes an integral part of the habendum clause in any way that 7

extends the lease into the secondary term. The secondary term here only starts with production in paying quantities. Therefore, this clause cannot be used in the same way as a shut-in royalty clause to extend the lease beyond the primary term into the secondary term. Thus, this lease terminated according to its own terms in November 1998 because no oil or gas was produced from the leased land.

Equitable estoppel is not at play here.

The weight of oil and gas authority persuades us that the $1,000 payments the Palmers accepted do not prevent them from arguing their lease has expired by its own terms. A review of the law of equitable estoppel is helpful at this point:

"Equitable estoppel is the effect of the voluntary conduct of a party whereby it is precluded, both at law and in equity, from asserting rights against another person relying on such conduct. A party seeking to invoke equitable estoppel must show that the acts, representations, admissions, or silence of another party (when it had a duty to speak) induced the first party to believe certain facts existed. There must also be a showing the first party rightfully relied and acted upon such belief and would now be prejudiced if the other party were permitted to deny the existence of such facts. There can be no equitable estoppel if any essential element thereof is lacking or is not satisfactorily proved. Estoppel will not be deemed to arise from facts which are ambiguous and subject to more than one construction. [Citation omitted.] A party may not properly base a claim of estoppel in its favor on its own wrongful act or dereliction of duty, or for acts or omissions induced by its own conduct. [Citation omitted.]" Gillespie v. Seymour, 250 Kan. 123, 129-30, 823 P.2d 782 (1991).

Neither KanMap nor Gallagher ever told the Palmers that if they accepted the $1,000 payments, their acceptance would serve to prolong this lease beyond the primary 2-year term. There is no language in the lease to that effect. How then can the lessee, Gallagher, validly argue their acceptance of the payments induced Gallagher to believe the lease was still valid? It seems more likely that both lessees, first KanMap and then 8

Gallagher, treated the payments as some sort of rental payment, and no provision in the lease allows a delayed rental payment.

When applying equitable estoppel in the oil and gas arena, the authorities look at the nature of what the lessor receives. Generally, if the landowner, the lessor, receives a benefit from the payment of royalties, then the lessor is estopped from asserting that the lease terminated. But if the lessor did not receive a benefit from the payment of royalties, then the lessor should not be estopped from claiming the lease terminated. 3 Kuntz, Oil and Gas

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