Watch your Language with Oil and Gas Leases in Ohio (#2)

By: Stephen D. Richman, Esq. - Senior Counsel- Kohrman, Jackson & Krantz

(A Watch Your Language Series Article)

It’s a lease, it’s a contract, it’s a lease and a contract.

Just as Faye Dunaway’s character in the movie Chinatown was both mother and sister to “Katherine”, an oil and gas lease in Ohio (and other jurisdictions) is both a contract and a lease.

An oil and gas lease is a lease, not because of its name, but because it is a transfer of a part of an interest in land for a specific period of time, or “term,” in exchange for the payment of rent, royalties or other standard of value. In other words, it fits the classic definition of, and contains the common characteristics of a lease. In an oil and gas lease, mineral rights/interests of the “dirt” are leased instead of the actual “dirt” itself. Both the dirt and the oil and gas underneath the same are “parts” of real property that can be leased.

As a transfer of property, the lease, like a deed contains certain written and unwritten (implied) covenants. A deed’s covenants, for example include the covenant that the grantee shall have quiet possession, that the grantor is lawfully seized (in fee simple) of the property and a covenant that the grantor will execute such further assurances of the land as may be requisite. A typical lease of real property contains the implied (sometimes express) covenant of quiet enjoyment (or possession); and oil and gas leases are held to contain the implied covenant of reasonable development.

An oil and gas lease is also a contract because it meets the following, legal definition of the same: “an agreement between two or more parties creating obligations that are enforceable or otherwise recognizable at law.” For an oil and gas lease to be an enforceable contract, the following general, contractual requirements must be present: (i) meeting of the minds; (ii) consideration; (iii) capacity; (iv) legality; (v) definiteness; and (vi) the lease must be in writing. The significance of an oil and gas lease also being a contract is that the general law of judicial contract interpretation applies. Namely, that courts will uphold language in commercial agreements, unless it is contrary to statutory law or public policy (and will not add language to the contract). As the reader may recall from other “Watch Your Language” articles for this Blog, because of this judicial deference to “commercial language”, you must say what you mean, precisely, or a judge will decide what you meant.

Apparently, the plaintiffs in the recent Supreme Court of Ohio case, Alford v. Collins-McGregor Operating Co., Slip Opinion No. 2018-Ohio-8, lost sight of the dual nature of oil and gas leases, the rules of judicial interpretation of contracts, and the failure to say, precisely what they meant to say therein.

 The facts of the case are as follows:

Seven individual landowners (the “Landowners”) hold interests in approximately 74 acres of land in Washington County, Ohio. The land is subject to an oil and gas lease (the “Lease”) entered into in 1980, between the owners of the property at that time and Collins-McGregor Operating Company (later assigned to Winston Oil Company). Collins-McGregor and Winston were the appellees in this case and will be referred to hereinafter as the “Oil and Gas Companies”. According to the Lease, “[T]he sole and only purpose [of the lease is to permit] mining and operating for oil and gas and laying pipe lines, and building tanks, powers, stations, and structures thereon, to produce, save and take care of said products.” In return for permission to mine the land, the Oil and Gas Companies committed to make royalty payments based on the amount of gas produced from the land and to deliver a portion of the oil produced from the land to the Landowners.

The Lease further provides that it “shall remain in force for a term of One (1) years from [the effective] date, and as long thereafter as oil or gas, or either of them, is produced from said land by the lessee.” However, other than the specific term and general purpose, the Lease contains few other material terms. The Lease is conspicuously silent as to details of drilling and production. For example, the Lease contains no requirement or other information re: the specific number of wells or the planned depth of any well. The Lease also does not disclaim any implied covenants (such as the implied covenant of reasonable development).

Pursuant to the Lease, a well was drilled in 1981, and has produced oil and gas in paying quantities since then from a formation called the Gordon Sand. As of the date of the opinion, however there had not been any production from the land at any depths below the Gordon Sand, where the Marcellus and Utica formations are located—(the Oil and Gas Companies claimed that they failed to explore whether production can be obtained from those deep formations because they did not have the equipment or financial resources required to do so).

In November of 2015, the Landowners filed suit against the Oil and Gas Companies alleging that they breached several implied covenants, and improperly failed to explore or drill for oil at depths below the Gordon Sand. The Landowners sought a judgement declaring the portion of the Lease covering depths below the Gordon Sand terminated, so that the Landowners could presumably contract with an alternative oil/gas company willing to drill into the Marcellus and Utica formations.

Among the implied covenants that the Landowners claimed the Oil and Gas Companies breached are the implied covenant of reasonable development and an implied covenant to explore further. The Oil and Gas Companies described the judgement sought by the plaintiffs as “horizontal forfeiture” (i.e., forfeiture of the right to drill to a particular horizontal layer or formation beneath the surface) but moved to dismiss the case, arguing that Ohio law does not recognize the implied covenant to explore further, or the remedy of horizontal forfeiture. The trial court agreed with the Oil and Gas Companies and dismissed the case, holding that under the plain terms of the Lease, the still-productive well drilled in 1981 was “sufficient to hold the Lease across all acres and at all depths.” The Fourth District Court of Appeals affirmed, holding that Ohio law neither recognizes an implied covenant to explore further, nor partial, horizontal forfeiture of oil and gas rights as an available form of relief. The Landowners then applied to the Ohio Supreme Court.

Arguing before the Ohio Supreme Court, the Landowners cited several 5^th appellate district decisions that recognized the existence of an implied covenant to explore further. The Oil and Gas Companies countered that while cases from one appellate district in Ohio may have recognized such a covenant, none actually applied the covenant. Moreover, the Oil and Gas Companies argued that there was no need to recognize a new, state-wide implied covenant because the covenant of reasonable development provides sufficient protection for landowners. Furthermore, the Oil and Gas Companies argued that the plain language of the Lease contained no development details, no new covenants and no requirement to partially forfeit the lease, so it was not the court’s job to do any more than interpret the contract as written, and apply the only, universally recognized, implied (oil and gas lease) covenant; the covenant of reasonable development.

The Supreme Court of Ohio agreed with the Oil and Gas Companies and affirmed the ruling of the 4^th Appellate District.

In its opinion, the Supreme Court of Ohio first cited precedent, reiterating the dual nature of oil and gas leases. “Oil and gas leases are contracts, and therefore, ‘the rights and remedies of the parties to an oil and gas lease must be determined by the terms of the written instrument’ [however], notwithstanding this principle, we have long held that oil and gas leases are ordinarily subject to an implied covenant to reasonably develop the land.”

The court then explained that while the covenant of reasonable production is generally a protection implied to landowners (lessors), its standard is to only “impose on the lessee the obligation to act as a reasonably prudent operator would as it develops the land under the lease.” Applying the standard to the facts of the case, the court reasoned that since drilling below the Gordon Sand formation would cause the Oil and Gas Companies to lose profits in the venture, limiting production to the Gordon Sand formation only, would be reasonable. Citing the Oklahoma Supreme Court, the Ohio Supreme Court in Alford reasoned that ignoring the profit motive from the “reasonableness equation” “is to ignore the very essence of the contract.”

The court also agreed (quite emphatically) with the Oil and Gas Companies’ contract argument; stating, that the proposition of the rights and remedies of the parties to an oil and gas lease being determined by the terms of the written instrument was “uncontroversial” and “what this court has recognized since 1897.” The court reasoned that if the parties intended there to be specific drilling requirements beyond “reasonable development”, they would have specified same in their oil and gas…contract. However, the court noted that “the lease [in Alford]does not contain a disclaimer of implied covenants, nor does it otherwise address whether any specific number of wells must be drilled or the depth to which any wells must be drilled. As such, the lease, according to the Ohio Supreme Court was subject to the implied covenant of reasonable development, but no other covenants, express or implied.

What is the moral of this story?

Watch Your Language with oil and gas leases, and say what you mean, precisely, or a judge will decide what you meant. While oil and gas leases are often convoluted, and written in small font, “standard” forms; they are contracts, not holy tablets of stone, and accordingly, are negotiable. If you are expecting certain formations to be drilled, say so. If you want a minimum of wells drilled on your property, spell that out. Certainly, arguing for these types of clauses does not guarantee they will be included in your lease, but failing to include them before you sign will almost always guarantee that they will not be part of you contract.

Liquidated Damages in Residential Leases May Backfire

By: Stephen D. Richman, Senior Counsel - Kohrman, Jackson & Krantz

As you may know, Ohio’s Landlord-Tenant Act (Ohio Revised Code [O.R.C.] Chapter 5321) governs the relationship between landlord and tenant for residential property. As you may also know, there are many more tenant protections and landlord obligations for residential property (because of such Act) than for commercial property. For example, while often not advisable, a landlord in Ohio can utilize “self help” to evict a commercial tenant, provided there is no “breach of the peace” (See Northfield Park Associates v. Northeast Ohio Harness, 1987 Ohio App. LEXIS 10461 [8th Dist.]; Tie Bar v. Buffalo Mall, 1979 Ohio App. LEXIS 8786 [7th Dist.]; Carter v. Standard Oil Co. 1978 Ohio App. LEXIS 7861 [8th Dist.]). Pursuant to Ohio Revised Code Section 5321.15, however, a landlord of residential property may only use the court eviction process to recover possession from a defaulting tenant.

Security deposits (and the handling of same) are also treated differently. For example, landlords of residential (vs. commercial) property must pay interest on their tenants’ security deposits greater than $50 (pursuant to O.R.C. 5321.16(A)).

At the end of a lease, if a tenant owes its landlord rent (or has damaged the premises) the standard action of many landlords is to deduct whatever damages the Landlord has incurred and send to tenant any remainder.  When landlords of residential property take this approach, they must follow the procedures of O.R.C. 5321.16 (B), which provides that “Any deduction from the security deposit shall be itemized and identified by the landlord in a written notice delivered to the tenant together with the amount due, within thirty days after termination of the rental agreement and delivery of possession.” According to the Eighth District Court of Appeals in the recent case of Oldendick v Crocker, 2016-Ohio App.LEXIS-5621[8^th Dist.], however, residential landlords must be careful with what they deduct from their security deposits, or it may cost them more than their deduction.

The facts of the Oldendick case are as follows:

On September 10, 2013, Elisabeth Oldendick and her boyfriend (“Tenants” and “Appellants”) signed a one-year lease for a Cleveland Heights apartment owned by Mr. and Mrs. Crocker (“Landlords” and “Appellees”). The lease was to commence October 1, 2013 and end September 30, 2014 (the “lease” or the “lease agreement”). Under the lease, a monthly payment of $860 was due on the first day of each month and an $860 security deposit was also required. The lease also included an “early termination” provision, which required Tenants “to pay a fee of one month’s rent in addition to the regular rent until a tenant suitable to [landlord] executes a new lease term” if the Landlords agreed to an early termination (of the lease) request by the Tenants. Three days after Tenants signed the lease, they told Landlords they had changed their minds, and demanded the return of the $1,720 paid when they signed the lease. After just eight showings, and one month later, the Landlords were able to lease the apartment to a new tenant, whose lease commenced on November 1, 2013. The Landlords paid a manager $120 for her time in showing the apartment to the prospective new tenants and an additional $100 in commission for the newly executed lease. The Landlords refused to return the funds Tenants had paid them because they had been unable to re-rent the apartment until November 1, 2013 and, in their opinion, according to the terms of the lease, Tenants were responsible for the October rent and an early termination fee of one month’s rent. 

                

In November, 2013, Tenants filed a complaint in the Cleveland Heights Municipal Court (“trial court”) against Landlords seeking to recover (1) the $1,720 paid for the first month’s rent and security deposit, (2) “an equal amount as damages” and (3) attorney fees and costs. Tenants also sought to declare the entire lease void, claiming the early termination fee provision was an unconscionable liquidated damages clause which rendered the entire lease unenforceable.

On July 10, 2015, the trial court issued its decision, finding in favor of Appellees. The trial court determined that Tenants had entered into a valid lease and that the parties were “at that point bound by the terms and conditions of the lease agreement.” The trial court further held that the Tenants had breached the lease agreement by repudiating the lease and refusing to take possession of the premises. The trial court then concluded that the early termination provision was enforceable, that it was not an unconscionable penalty and that, as a result of Tenants’ breach of the lease, Landlords were entitled to keep the $1,720 they received from Tenants as the October, 2013 rent and the early termination fee. Some time thereafter, the Tenants then appealed the trial court’s decision to the 8^th District Court of Appeals.

At the court of appeals, the Tenants first contended that the trial court should have declared the entire lease unenforceable under O.R.C. 5321.14 because the lease included a provision authorizing the payment of the Landlords’ attorney fees and various self-help provisions.  The court of appeals, however did not find this argument persuasive, largely because the trial court did not award Appellees any attorney fees and because there was no claim that Appellees exercised any of the self-help remedies that Tenants objected to. Even assuming those provisions of the lease were invalid, the appellate court found no error by the trial court in refusing to declare the entire lease unenforceable, because under O.R.C. 5321.14(A), a court “may refuse to enforce the rental agreement or it may enforce the remainder of the rental agreement without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.”

Expectedly, Appellants further contended that “even if the lease was not unenforceable in its entirety, at the very least the trial court should have found the early termination provision to be unconscionable and refused to enforce it under R.C. 5321.14(A) and R.C. 5321.16(B).”

Appellees argued that the early termination fee was enforceable because courts have upheld liquidated damages clauses where actual damages may be difficult to prove, the amount of damages is reasonable and proportional to the contract as a whole, and that in this case, the Landlords and Tenants were parties of “equal bargaining power” who “agreed to and freely negotiated” the early termination provision.

Regarding enforceability of the liquidated damages provision, the court of appeals in Oldendick acknowledged Appellants’ argument that (while Chapter 5321 does not specifically prohibit liquidated damages clauses) there are indeed many Ohio courts that have declared such provisions unenforceable in a residential lease. The court in Oldendick stated that some of these courts have performed a penalty analysis in determining whether a fixed fee or charge set forth in a lease could be enforceable, refusing to enforce the same where the landlord failed to present evidence demonstrating that stipulated damages bore a reasonable relationship to actual damages sustained as a result of the breach. Other cases, according to the court have held that a liquidated damages clause in effect permits the landlord to retain a security deposit without itemization of actual damages, and this is inconsistent with O.R.C. 5321.16 (B), which requires itemization of damages. If the liquidated damages provision is inconsistent with O.R.C. 5231.16 (B), these courts have held that such provision may not be included in a rental agreement and is thus not enforceable.

The Court in Oldendick related more with the “inconsistent with O.R.C. 5321.16 and thus unenforceable decisions” (than to the “unenforceable as penalty decisions”), but seemed to want to simplify the analysis of these cases even further by not focusing on enforceability. According to the court in Oldendick, “the issue here is not whether liquidated damages provisions in residential leases are enforceable. The issue here is what a landlord is statutorily permitted to do, under the Landlord-Tenant Act, with a tenant’s security deposit. If deductions from a security deposit are at issue, the provisions of the Landlord-Tenant Act apply, which limits permissible deductions from a security deposit to ‘damages that the landlord has suffered by reason of the tenant’s noncompliance with section 5321.05 of the Revised Code or the rental agreement,’ i.e., actual damages sustained by the landlord as a tenant’s failure to comply with R.C. 5321.05 or the lease.”  

The Oldendick court cited other Ohio appellate courts that came to this same, “simplified” conclusion. ‘See, e.g., Ankney v. Dame, 6th Dist. Lucas No. L-76-307, 1977 Ohio App. LEXIS 10154, *5-8 (Apr. 29, 1977) (“It is not so much a matter of saying that liquidated damages are prohibited in leases, but the issue is whether the deposit put up herein is covered by the Act. * * * Any actual damages are permitted to be obtained by the landlord from the security deposit. * * * [T]he parties may contract for liquidated damages. However, if a deposit is required, then the provisions of the Landlord-Tenant Act must be followed.”)’

Because there was nothing in the record that established that the parties were of “equal bargaining power” and that as a general rule, damages resulting from a breach of a residential lease are not difficult to ascertain and quantify,  the court in Oldendick concluded that “even if we were required to perform a liquidated damages-penalty analysis to determine the appropriateness of Crocker’s deductions from Oldendick’s security deposit, we would find that the early termination fee operated as a penalty.”

So, according to the court in Oldendick, whatever way you look at it, the Landlords were not entitled to deduct the early termination fee from the Tenants’ security deposit. Landlord was, however entitled to deduct the $220 paid to the property manager as legitimate, itemized expenses. The court then concluded that pursuant to O.R.C. 5321.16 (B), the Landlords would need to remit $640.00 to the Tenant (the amount wrongly withheld, over and above the legitimate deductions).

Unfortunately for the Landlords, O.R.C. 5321.16 would prove more costly than remitting to Tenants the $640 worth of liquidated damages wrongfully withheld. While O.R.C. 5321 (B) deals only with what a landlord is obligated to do regarding the deduction of items from a security deposit, O.R.C. 5321.16 (C) deals with what tenants are permitted to claim as a result of their landlords failing to comply with O.R.C. 5321.16 (B).

O.R.C. 5321.16 (C) provides, in pertinent part, “If the landlord fails to comply with division (B) of this section, the tenant may recover the property and money due him, together with damages in an amount equal to the amount wrongfully withheld, and reasonable attorneys’ fees.” The Tenants in Oldendick in fact did make O.R.C. 5321.16 (C) claims, and the court awarded the Tenants damages of $640 and attorneys’ fees, on top of the $640 wrongfully withheld by the Landlords.

What is the moral of this story? For residential landlords, the expression “penny wise but pound foolish” comes to mind. While liquidated damages provisions are not per se prohibited in residential leases, the inclusion of same simply is not worth it because of the Ohio Landlord-Tenant Act, specifically, Ohio Revised Code Sections 5321.14 and 5321.16.

Watch your Language with Oil and Gas Leases in Ohio

By: Stephen D. Richman-Senior Counsel at Kohrman, Jackson & Krantz, PLL

As established in other “Watch Your Language” articles for this Blog, as a general rule, courts will uphold language in commercial agreements, unless it is contrary to statutory law or public policy. Because of this judicial deference to “commercial language”, you must say what you mean, precisely, or a judge will decide what you meant. Compounding the problem is the fact that courts typically refuse to consider extrinsic evidence of a party’s intent (offered by such party) if they determine the contract language is clear and unambiguous. What is said within the “four corners of an agreement” is simply deemed the best evidence of intent.  

The Ohio Supreme Court in Lutz v. Chesapeake Appalachia, L.L.C., Slip Opinion No. 2016-Ohio-754 recently espoused this basic tenet of Ohio law in regards to oil and gas leases.

Lutz v. Chesapeake came to the Ohio Supreme Court in a different manner than most cases. Frequently, a trial court decision in Ohio gets appealed to an Ohio court of appeals, and that decision may then be appealed to the Ohio Supreme Court. In Lutz, the case originated in the United States District Court for the Northern District of Ohio (Eastern Division), and then this federal court certified a question of law to the Supreme Court of Ohio pursuant to Ohio S.Ct.Prac.R. 9.01. A certified question is a formal request by one court to another for an opinion on a question of law.

The question of law the U.S.District Court wanted answered, was in an oil and gas lease, when figuring royalty payments due the landowner, “Does Ohio follow the ‘at the well’ rule (which permits the deduction of post-production costs [before royalty payments are calculated]) or does it follow some version of the ‘marketable product’ rule (which limits the deduction of post-production costs under certain circumstances)?”

The Ohio Supreme Court in Lutz respectfully declined to answer the question of law before it, basically because the court had no unique, broad oil and gas law for the U.S. District Court to apply to all oil and gas leases; rather, its holding would depend much more on facts and general contract (interpretation) law.

The facts of the case are as follows: The respondents, Regis and Marion Lutz, Leonard and Joseph Yochman, and C.Y.Y., L.L.C., the landowner-landlords claimed that petitioner, Chesapeake Appalachia, L.L.C., the tenant-oil and gas company, underpaid gas royalties under the terms of their leases. No one disputed that the oil and gas company needed to pay for all the production costs (i.e., the costs of producing the gas from below the ground and bringing it to the wellhead) incurred. The dispute centers on “postproduction costs”(such as the cost to gather, process and compress the gas, the cost to transport the gas and other costs incurred after the gas is produced at the wellhead and before it is sold). Specifically, the issue is whether or not postproduction costs should be deducted from the sale price of gas before royalty payments to the landowner are calculated. The language of the leases specifies that royalties are to be paid based on “market value at the well” and on the “field market price.”

The oil and gas company argued that the plain language of the leases controls and that since the leases specify that the  royalty is based on the value of the gas at the well, any postproduction costs would need to be deducted from the sale price to arrive at the well price before the royalty percentage can be calculated. The landowners claimed that there is no real market at the well, so the oil and gas company “has an implied duty to market the product once it leaves the wellhead, and therefore the lessee must bear the cost of bringing the product to the market and not deduct the costs before calculating the royalty.”

The Ohio Supreme Court declined to answer the U.S. District Court’s question, basically because it was the wrong question. The Supreme Court of Ohio concluded that there is no specific rule of law particular to oil and gas prices at the well head vs. afterwards. Instead, the law to be applied in this case would be the traditional rules of contract construction, because according to the court, an oil and gas lease is basically, a contract. Specifically, the court stated that the law to be applied should be the “well-known and established principle of contract interpretation that [c]ontracts are to be interpreted so as to carry out the intent of the parties, as that intent is evidenced by the contract language.”  

It will have to be the U.S. District Court, however to apply the law in this case, because the case was dismissed by the Ohio Supreme Court. The court explained that if the contract (lease) language is ambiguous, they cannot look to intent because there was no extrinsic evidence brought before their court. Alternatively, the Supreme Court of Ohio reasoned that if the lease language is not ambiguous, then the federal court should have no trouble interpreting the leases without its assistance.

What is the moral of this story? The only thing clear about Lutz v. Chesapeake (other than there being no specific rule of law in Ohio re: deduction of post production costs when calculating oil and gas royalties) is the need to be clear when drafting oil and gas leases. If the parties had specified exactly what costs are to be deducted when determining gas prices and calculating royalties, there would have been no need for litigation, and no worry regarding what  a judge will decide they meant.

Caveat (Property) Manager

In the “old days”, when one could get 10%+ in a money market, a real estate management fee of 4-6% on rents did not excite many folks in the real estate industry about jumping into the property management business.

Now that 1% is considered a “high rate of interest”, and the stock market is rather volatile, management fees (and real estate as an investment) are a lot more attractive.

Before you rush to form your “Property Management LLC” company, however, “caveat manager”.

In Ohio, subject to limited exceptions, property management companies must have a real estate broker's license.

While there is no specific Ohio statute governing property managers, Chapter 4735 of the Ohio Revised Code governing Real Estate Brokers is dispositive. Why? Because pursuant to ORC Section 4735.01 (A), there are a list of activities, that if performed for another party, require a real estate license, and a number of these activities (including leasing and renting) are key components of property management.

What property management activities performed for another party require a real estate license?

-Pursuant to ORC Section 4735.01 (A) (1), one who rents or leases, or negotiates the rental or leasing of any real estate must be licensed.

- Pursuant to ORC Section 4735.01 (A) (2), one who “offers, attempts, or agrees to negotiate the …. rental or leasing of any real estate” must be licensed.

-Pursuant to ORC Section 4735.01 (A) (5), one who “operates, manages, or rents, or offers or attempts to operate, manage, or rent, other than as custodian, caretaker, or janitor, any building or portions of buildings to the public as tenants must be licensed.

Also included in the list of activities typically performed by property managers that require a license are: advertising or holding oneself out as in the business of leasing, one who performs any acts directed at procuring tenants for a property and one who collects rental information for purposes of referring prospective tenants to a rental unit.

Are there any exceptions to the requirement that one engaged in property management activities have a broker's license?

- There is no requirement that a community association manager or condo association manager in Ohio hold a real estate broker's license.

- Property owners managing their own properties are exempt. Additionally, receivers or trustees in bankruptcy, or guardians, executors, administrators, trustees, assignees, commissioners, or others  under authority or appointment of, or incident to a proceeding in, any court ;or under any trust agreement, deed of trust, will, or other instrument creating a like bona-fide fiduciary obligation are exempt. Also, public officers while performing the officer's official duties, and attorneys at law in the performance of the attorney's duties are exempt.

- Companies/individuals performing custodial, caretaker, or janitor services only are exempt.

 -While a real estate salesperson cannot manage property in his/her own name, or in the name of a separate management company he/she has formed, generally, a salesperson working under a broker may engage in management activities (See also OAC Section 1301:5-5-07 summarizing what property management activities an unlicensed employee may or may not engage in with respect to residential real estate).

Are there specific property management rules required of brokers to follow?

Yes. The Ohio Association of Realtors “Property Management White Paper” (http://ohiorealtors.org/legal/topics/wpproperty-management-laws/pm-whitepaper/) is one of the best summary guides available, but as a general matter, such rules pertain to:

-Property Management Accounts (OAC Section 1301:5-5-11);

-Security Deposits (OAC Section 1301:5-5-11 (D); and

-Rules governing sales as well as management/leasing activities such as: Agreements (ORC Section 4735.55); Property Records (ORC 4735.18 (A)(24); Consumer Guide to Agency Relationships (ORC Section 4735.56) and Agency Disclosures (ORC Section 4735.58).

Assigning/Assuming the Benefits and Burdens of Rental Property

The purchase and sale of real property that is leased by one or more tenants presents a number of issues worth thinking about and planning for, before you “sign on the dotted line”. Usually, rental property is worth a premium because the owner receives…rents. Often, however, rental property can be a trap for the unwary who focus on the benefits, but not the burdens of income producing property.

Of course, when buying rental property, the best time to focus on these issues is…before you buy. Some sellers will allow potential buyers to review their leases before signing the purchase agreement. From the buyer’s perspective, this is preferable. Why spend the time and money on a contract, if, for example, your lease review uncovers that there is only one year left in the lease term of the anchor tenant, it is a down market, and the tenant has not renewed. Whether before the contract is signed, or during due diligence, the lease should be examined carefully for such items as: early tenant termination rights; inability to pass on to the tenant, real estate tax increases due to the sale of the property; landlord obligations to make tenant improvements upon renewal (or landlord obligations to make initial improvements for a recently signed-up tenant); rents that decrease after amortized improvements have burned off; caps on CAM increases; and poorly draft assignment/sublease provisions allowing the tenant, without landlord’s consent to assign the lease to an un-credit worthy assignee.

Assuming analysis of the lease demonstrates its benefits outweigh its burdens (and assuming the lease does not provide for its termination upon a sale), does anything further need to occur for the buyer to become the new landlord after the sale? Is a formal assignment of the lease from seller to buyer legally required?

As a general rule, the answer is no, and no.

In almost all cases, when the landlord sells his interest in real property, the purchaser takes subject to such lease, by operation of law. The lease is an encumbrance against the title that existed prior to the transfer, and consequently, it exists after the transfer.

So, if the lease automatically transfers with the property, by operation of law, and assignments are not required, why do lawyers prepare them? Is it just a ploy for attorneys to charge higher fees and complicate seemingly simple transactions? The answer, of course, is not at all.  It is usually when we try to simply, what is by nature complex, that unfortunate results ensue.

So why do we prepare assignment/assumption of lease agreements? First reason, as my Jewish grandmother used to say, is “it couldn’t hoit”. While typically, a landlord’s lease rights and obligations transfer to a buyer, without need for an assignment/assumption agreement, such an agreement provides certainty to the process. In limited circumstances, the buyer who wanted a “free and clear” property without leases might be able to argue the leases are not binding against the buyer (and prevail in a court of law) if he/she had no notice of the leases, same were not recorded, and that there were no visible signs of occupancy at the property. On the other hand, the buyer will have zero success trying to prove there was no notice of a lease if he/she signed an agreement assigning the lease to him/her.

 Equally, if not more important, the assignment/assumption agreement presents a good vehicle to finalize issues such as indemnifications (e.g., buyer indemnifies seller for post-closing landlord obligations; seller indemnifies buyer for pre-closing landlord obligations), responsibility for outstanding leasehold improvements and obligations re: past due rents owed by tenants. The buyer can ensure that it is not “buying” any extraordinary landlord’s obligations such as the build out of a tenant’s space, by simply exempting same from the otherwise catch all language making buyer responsible to assume all landlord obligations under the lease.

The issue of security deposits can also be dealt with in the assignment/assumption agreement. Without an agreement as between buyer and seller, pursuant to Ohio law, the tenant may look to the original owner (seller) for return of its security deposit. The case of Tuteur v. P. & F. Enterprises (21 Ohio App 2^nd 122 established this tenet of Ohio law in 1970. The result in Tuteur would be problematic for a seller (faced with having to return security deposits it no longer had) because security deposits are typically credited to the new buyer by the escrow agent at closing.

Many real estate investor/managers make a fine living off the benefits of rental real estate. However, many others (usually those who do not seek legal representation, or wait to consult an attorney until after everything is signed) unfortunately, find that the burdens can far outweigh the benefits. The assignment/assumption agreement is the perfect equalizer.

Sellers wanting to further insulate themselves from lease liability after a sale should be proactive when drafting/negotiating their leases and provide that the seller is automatically released from all liability under any leases, arising after the sale. When faced with this proposed language, tenants should negotiate for a qualification to the effect that such a release is effective, only on an express assumption by the new owner of the landlord's obligations under the lease, which brings us right back to the moral of this story:

When selling or buying rental real estate, insist upon an assignment/assumption agreement to ensure the benefits and burdens of rental real estate are fairly apportioned to buyer and seller, after the sale.

Appellate Court Ruling on Oil and Gas Leases Appealed to Ohio Supreme Court

On September 26, 2014, in Hupp v. Beck, the 7^th District Court of Appeals in Ohio overturned the trial court’s decision that certain oil and gas leases in Monroe County, Ohio between landowners and Beck Energy Corporation (Beck) were void from their inception.  On Friday, November 7, 2014, the plaintiff landowners filed an appeal with the Ohio Supreme Court.


The leases at issue contained clauses regarding the lease term that are commonly used in oil and gas leases, and therefore the outcome of this litigation can have far reaching effects in Ohio. The lease term was two-tiered, with a 10-year primary term and a secondary term that could continue indefinitely so long as certain conditions were met. During the primary term, if the property wasn’t being drilled, Beck, as the lessee, would be obligated to pay a ‘delay rental’ payment to the landowner.  Landowners challenged Beck’s form lease arguing that this two-tiered term structure rendered the leases “no-term” or “perpetual” leases, which are contrary to public policy and therefore void.


While the trial court agreed with the landowners, the 7^th District Court of Appeals disagreed and reaffirmed the viability of leases containing these typical provisions. The 7th District covers the following Ohio counties: Belmont, Carroll, Columbiana, Harrison, Jefferson, Mahoning, Monroe and Noble.  Now that an appeal has been filed with the Ohio Supreme Court, we wait.  The court typically (but not always) announces whether it will accept an appeal approximately 2 to 4 months after the appellee’s memorandum in response is filed. If the Ohio Supreme Court elects to hear the landowners’ appeal and decides in the landowners’ favor, it could trigger a massive scramble by gas and oil companies to rewrite their leases.

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Vacant Property Registration Ordinances: Understanding the Issues

Since the foreclosure crisis in 2008 – 2009, many communities in the U.S. have enacted “vacant property registration” ordinances (VPR ordinances) as a tool to help them deal with problem properties that are vacant. There are over 80 such ordinance issued or proposed in the state of Ohio alone.



VPR ordinances can take different approaches—some are triggered upon a property becoming ‘vacant’, others upon a foreclosure action being initiated, or use a combination of the preceding two approaches. The problem occurs with the implementation of these ordinances due to vague language and muddled objectives; i.e., the devil is in the details.


Many communities have a serious problem with vacant homes and buildings with owners that do not care (or do not have the resources) to properly maintain the property. Understandably, local communities want to address this problem, and VPR ordinances are often the result.  Because VPR ordinances don’t just apply to the bad actors, but pull in everyone else as well, it is important to look at the language in a draft VPR ordinance to evaluate how it might be unevenly enforced and what might be the unintentional results. Too many of these ordinances inadvertently punish the many for the crimes of a few.



Below are some of the potential issues in VPR ordinances:



How is “owner” defined? — Many VPR ordinances broadly define the “owner” of a property to include mortgagees and loan servicers, and agents of the foregoing, as well as anyone else who directly or indirectly controls the property.  There is often no clear guidance as to what constitutes “directly or indirectly in control of a property”.  With such vague language, any property manager or realtor or other vendor providing similar services could be pulled into the ordinance’s reach if an enterprising public employee chose to interpret it that way. Also, the vast majority of mortgages are owned by the federal government (e.g., FHA, HUD, VA, USDA-RD) or through one of its quasi-governmental entities (e.g., Fannie Mae or Freddie Mac). How does a local community expect to enforce its ordinance against the federal government? The likely result will be uneven enforcement that impacts the local lenders the hardest.



How does the ordinance define “vacant”? — Again, VPR ordinances can define how a structure is determined to be “vacant” in rather broad terms.  An over broad definition of “vacant” can pull in structures that are not in disrepair and therefore not a problem for the community. Definitions of “vacant” in many VPR ordinances include exclusionary terms such as “lawfully occupied” without ever defining what that means. Its use may be intended to appropriately exclude well-tended vacation homes and similar homes. However, vague and over broad language puts significant discretion into the hands of the local government to interpret it however is convenient, and results in arbitrary and unequal applications of the ordinance.


Inspections — Many VPR ordinances require property inspections as part of the registry process. Tightly drafted ordinances will make it clear as to what is being inspected and the precise standards against which the property will be measured. Unfortunately, many ordinances fall short, so property owners and other “owners” are left in the dark as to what will be expected of them. Also, many VPR ordinances fail to clarify what type of inspection will be conducted. Is the inspection only of the exterior grounds or can a municipal employee demand to inspect inside the structure? This latter demand triggers constitutional concerns as the 4^th amendment to the Constitution which protects citizens from unreasonable searches.

Cash Bonds — VPR ordinances often include requirements for a cash bond to be paid by the mortgagee prior to pursuing a foreclosure. Smaller local mortgage lenders cannot afford this and are more likely to simply stop making mortgage loans in that community. This reduces options for the residents living there.  Larger lenders might comply with the demand but will simply pass the higher risks and costs of VPR ordinances on to the borrower in the form of higher interest rates and closing costs. This again reduces affordable options for the residents of that community and increases the attractiveness of homes in other communities who have no such requirement. Further, if no problems arise on a particular property, how does the mortgagee obtain a return of the cash bond it provided?  Does the VPR ordinance provide a mechanism for segregating the cash bonds from its operating funds and a return of unused funds to the mortgagee when the property is no longer vacant?



Penalties — VPR ordinances typically charge fines for violations and some even include criminal charges. The issue with many such ordinances is the lack of any provision for waivers or reduced fees when the community has suffered no harm. Based on the language in many VPR ordinances, it is possible for an owner to be subject to criminal charges for a mere paperwork violation. VPR ordinances that provide for both civil penalties and misdemeanor charges often do not provide clear direction as to when a violation can escalate to the more serious criminal penalties.



Enforcement — Given the vague and over broad drafting of many VPR ordinances, owners will likely need to appeal decisions and time frames for filing appeals are often short. Further, the forum to hearing the appeal may or may not appropriate. As communities typically envision vacant dilapidated structures owned by slum lords as the target of the legislation, the appeal board will often be one that deals with that type of structure. With the over broad reach of many VPR ordinances, the appeal forum may be ill suited for its purpose.   Also, VPR ordinances frequently include language to limit the process for further appealing the decisions. While it is good to have clear language as to when administrative orders become final, that should not prevent a final administrative order from then being appealed through the court system. Vague or unduly limiting language on the appeal process can create due process concerns.



Whether these VPR ordinances actually work is open to question. Most communities do not have clear metrics in place to determine this, and they may unintentionally harm their residents in the process.   

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14 Predictions We Like for 2014

Real Estate Prognosticators See Commercial Real Estate Recovery Continuing to Accelerate in 2014

Reprinted with permission from: Mark Heschmeyer, the CoStar Group

Commercial real estate firms are moving into the New Year with a renewed sense of optimism - a positive outlook not seen for the past seven or eight years.

While many in the industry predicted a recovery in 2013, they did so with a sense of nagging worry over slower than expected job growth and concerns that the political brinkmanship in Washington could threaten the nation's credit rating and pitch the economy into stagnation or, even worse, recession.

Much of those concerns have ebbed as the two parties came to terms in December over next year’s budget. In addition, the Federal Reserve has established a clear path for rolling back the so-called quantitative easing steps taken in years past to bolster the economy. By spelling out its path for reducing debt purchases, the Fed has taken out much of the guesswork for when those financial supports will end.

Given the overhanging sense of dread seems to have disappeared from most forecasts, experts are predicting a better year in 2014.

CoStar News has encapsulated the following 14 outlooks for 2014 from forecasts offered by respected industry participants and observers. We’ve sorted them alphabetically by the firm making the forecast:

Cassidy Turley: Impact from Rising Rates

If the big economic story of 2013 was policy vs. housing, this year doesn’t promise much in the way of variety. Policy vs. Housing, Part II will see the same threats to economic growth as we continue to struggle with dysfunction in Washington and, most likely, more political brinksmanship that may undermine confidence in the economy. But, while the challenges will be the same, the underlying fundamentals will be slightly stronger. Perhaps the biggest difference is that by the middle of 2014, economic growth should be strong enough for inflation to start to be a possibility once again. This is actually a good thing. The timetable could vary, but we anticipate the Fed raising interest rates by the end of the second quarter-likely in May or June. So long as interest rates don’t move too far too fast, the impact on the overall economy will be minimal. But there will be one. This could slow the housing recovery and it will certainly have an impact on commercial real estate pricing as the price of borrowing becomes more expensive. But that is assuming the underlying economic fundamentals have heated up to the point of warranting such a move-which is ultimately a good thing. A stronger economy may bring higher interest rates, but it will also bring higher earnings, lower unemployment, greater consumer spending and-for landlords-better rental rate growth and NOI. In the meantime, look for the first big political squabble (over the debt ceiling once again) to start up again in late January.

CBRE: Office Market Recovery Poised To Accelerate

The office market recovery is poised to accelerate in 2014, as an improving economy should result in increased office-using employment according to CBRE, the world’s largest commercial real estate services and investment firm. The growth in office-using occupations, particularly in high-tech industries, is expected to increase demand for office space. The U.S. office market vacancy rate will continue to decline next year, falling by 80 basis points (bps) to 14.3% by the end of 2014, Steady improvement in the office market is expected to continue in 2015, with the vacancy rate forecasted to dip another 80 bps to 13.5%. CBRE forecasts that office rents will increase by 3%, on average, in 2014, and rise another 4.4% in 2015, as vacancy levels fall steadily toward the “equilibrium” level over the next two years.

Cornell Univ. and Hodes Weill: Big Money Will Continue To Rule

Institutions are significantly under-invested in real estate and are poised to allocate significant capital to new real estate investments. The weight of this capital can be expected to have broad implications for the industry, including transaction volumes, fund raising, lending activity and property valuations. The supply of capital may sustain current valuation and financing metrics (including capitalization rates and the cost of debt capital), according to Cornell University’s Baker Program in Real Estate and Hodes Weill & Associates, which co-sponsor the Institutional Real Estate Capital Allocations Monitor.

Deloitte: Steady Growth but Not Enough To Spur Much New Development

CRE fundamentals continue to improve across all property types, including vacancy, rent, and absorption levels, according to Deloitte's real estate forecast. However, demand is yet to increase enough to drive development activity, except for multifamily and hotel construction, which continues to be robust. These same sectors, which were the first to grow and recover after the recession, may see some tapering off in fundamentals as new supply comes to the market. Overall, it appears that fundamentals will continue to improve at a moderate pace, in line with the macroeconomic situation.

DTZ: Business Tenants Keep Bargaining Clout

The U.S. economy will continue to expand at a moderate rate, which will lead to more job growth and a related increase in demand for occupational space, reports global property services firm DTZ. However, with the expected moderate job growth, vacancy will only trend down slowly. Occupiers will remain in good bargaining positions over the next two years and occupancy costs will increase in line with inflation. They will continue to receive concessions as landlords compete to increase their properties' net operating income. Occupiers will gravitate to the most affordable markets and continue to reduce their costs through more efficient internal space build-outs.

EY: Private Equity Funds Getting Hands Dirty

Having emerged from the global recession and its aftermath, the real estate private equity sector is finally positioned for growth in 2014, according to a global market trends outlook in real estate private equity published by EY (Ernst & Young). Strategies being deployed by different PE firms and even funds to take advantage of this growth opportunity differ, as fund managers seek to differentiate themselves in a hotly competitive fundraising environment. But EY sees fewer opportunities in the future for fund managers to capitalize purely from the financial structuring side of their investments. The funds that come out ahead of the competition in this next phase of growth will have one thing in common: an 'old school' asset management approach that realizes maximum investment value by working closely with service providers to fill buildings and manage real estate.

Freddie Mac: The Emerging Purchase Market

Led by a resurgent housing sector, 2014 should shape up to be better than 2013 with a quickening recovery pace leading to more job creation. Freddie Mac expects single-family home sales and housing starts to be at their highest levels since 2007, and expect multifamily transactions and construction to post gains as well. The big shift ahead will occur as the single-family mortgage market begins transitioning from a rate-and-term refinance-dominated market, to a first purchase-dominated market. The emerging home-buyer purchase market should gather momentum in the coming year.

 Grant Thornton: Huge Boost Ahead for Industrial Markets

U.S. companies will bring production, customer service and IT infrastructure back home, reports tax-advisory firm Grant Thornton. The reshoring trend is real and about to dramatically reshape the U.S. economy. More than one-third of U.S. businesses will move goods and services work back to the U.S in the next 12 months, which means that as much as 5% overall U.S. procurement may return home. The Grant Thornton LLP "Realities of Reshoring" survey found that even IT services, one of the first business functions to move offshore, are likely to return within a year. The trend could provide an enormous boost to domestic manufacturers, retailers, wholesalers/distributors and service providers.

Jones Lang LaSalle: Pent Up Retail Demand Will Drive Investment

Total retail investment is expected to increase upwards of 20% in 2014, according to Jones Lang LaSalle, as pent up demand that was not satisfied in 2013 fuels investments and investors look to balance their portfolios. The retail market will continue to turn around despite store closings and consolidation. Vacancy rates are projected to inch downward driven by power center popularity, while rents are expected to increase albeit slightly for the fourth consecutive quarter. JLL also expects the number of retail property portfolios coming to market, which combine a broad spectrum of B and C retail assets, will increase as REITs look to sell assets and recycle capital in the year ahead.

Kroll Bond Ratings: Multifamily Resurgence in Conduit CMBS

The Federal Housing Finance Agency (FHFA) has begun to implement strategies to reduce the multifamily footprints of the two GSEs it oversees. As a result, Kroll Bond Rating Agency expects we will see a gradual decline in Fannie and Freddie’s securitized market share, which could revert to levels not seen since before the run-up to the CMBS market peak. At the peak of market in 2007, the conduit market’s share of the $36 billion securitized multifamily loan market was just over 78%. As the financial markets spiraled, that trend reversed and the GSEs became the primary source of loan production, dominating securitized new issues with more than a 95% market share.

Nomura: Muted CMBS Loan Maturity Risk

Based on the performance of loans maturing in 2012 and 2013, the investment bank Nomura estimates that 84% of loans maturing in 2014 will pay in full, a decline of just 3% from 2013 levels. Similar to 2013, Nomura expects the balance of loans rolling to delinquency to decline over the coming year, influenced by muted maturity risk and fewer term defaults resulting from improving CRE fundamentals. Most of the loans maturing in 2014 have 10-year terms and were underwritten prior to the sharp rise in property values that began in 2005. However, 15% of maturing loans have 7-year terms and were underwritten at the market peak. This set of loans has an increased risk of default at maturity.

PKF: U.S. Hotel Investors Poised To Do Well in 2014/2015

After a slight deceleration in growth during the last half of 2013, PKF Hospitality Research, LLC (PKF-HR) is forecasting very strong gains in revenues and profits for the U.S. lodging industry in 2014 and 2015. PKF projects national revenue per available room (RevPAR) to increase 6.6% in 2014, followed by another 7.5% boost in 2015. Concurrently, hotel profits should enjoy growth of 12.8% and 14.5% respectively over the next two years.

PwC US and ULI: Investor Activity Continues To Expand Beyond Core Markets

The U.S. real estate recovery is set to continue into 2014, with investors increasingly looking beyond some of the traditionally popular markets to secondary markets in search of higher yields, according to the latest Emerging Trends in Real Estate 2014, co-published by PwC US and the Urban Land Institute (ULI). The predicted growth in secondary markets will be driven by investors searching for returns as opportunities in core markets become harder to find and the most sought-after properties become more expensive. The move into secondary markets is underpinned by the anticipated increase in both debt and equity capital during 2014.

Transwestern: More Opportunities in Sale-Leasebacks and Net Lease

The cost of capital for owner occupants is on the rise, thanks to increasing interest rates. To cope with higher costs, owner-occupants are increasingly looking at selling their owned real estate as one strategy to generate funds for operating expenses, company expansion or retiring debt. This scenario presents an excellent sale-leaseback opportunity for investors looking to acquire real estate that comes with a long-term tenant in place. The lending environment is expected to bring more net-lease properties to market, as well. As interest rates increase, a larger number of office, industrial and retail buildings are projected to be marketed for sale.

That's 14 predictions for 2014. We look forward to covering these and many other major trends in commercial real estate in the year ahead. Here is a bonus prediction from CoStar's Property and Portfolio Research group:

CoStar: 2014 Best Year of Office Occupancy Gains in Recovery Cycle

Heading into New Year, office employment has been growing at the fastest rate since the start of the recovery, with the sole exception of early 2012. But there are two key differences between today's market and that of the past few years. First, the office market now has far less under-utilized "shadow" supply space, which will drive a higher level of net absorption as more office-using tenants expand. Second, with the demand outlook improving and new construction still at bay in most markets, the 2014 occupancy gains in US office markets should be the best of the entire recovery and should tip the scales toward greater rent growth during 2014 than in the past few years. However, developers have already shown their willingness to break ground at the first sign of improvement. This has already happened in Boston, Houston, Silicon Valley and most recently, San Francisco. As developers ramp up new supply, the office occupancy gains are likely to slow in 2015 and certainly by 2016. Investors should enjoy the benefits of occupancy gains in 2014, which are expected to be the best in the current recovery cycle.

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