Presentation: Oil & Gas Law Chapter 6: Implied Covenants

Presentation:

Oil & Gas Law
Chapter 6: Implied Covenants

Professors Wells
October 18, 2011

Implied Covenants:
Brewester v. Lanyon Zinc. Co

Brewster v. Lanyon Zinc Co, 140 F. 801:

1. Facts

2. Court reasoning
“The conclusion is that compliance with the covenant to continue with reasonable diligence the
work of exploration, development, and production after the expiration of the five-year period, if
during that time oil and gas, one or both, be found in paying quantities, is by the terms employed
made a condition the breach of which entitles the lessor to avoid the lease.”

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Implied Covenant to Develop:
Waggoner Estate v. Sigler Oil Co

Waggoner Estate v. Sigler Oil Co, 19 S.W.2d 27:

1. Facts

2. Court reasoning
“The usual remedy for breach of the lessee’s implied covenant for reasonable development of oil
and gas is an action for damages, though, under extraordinary circumstances– where there can be
no other adequate relief– a court of equity will entertain an action to cancel the lease in whole or
in part.”

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Model Lease Agreement:
Implied Covenant to Develop

Paragraph 9

The breach by Lessee of any obligation arising hereunder shall not work a forfeiture or
termination of this lease nor cause a termination or reversion of the estate created hereby nor be
grounds for cancellation hereof in whole or in part. In the event Lessor considers that operations
are not at any time being conducted in compliance with this lease, Lessor shall notify Lessee in
writing of the facts relied upon as constituting a breach hereof, and Lessee, if in default, shall have
sixty (60) days after receipt of such notice in which to commence the compliance with the
obligations imposed by virtue of this instrument. After the discovery of oil, gas or other mineral
in paying quantities on said premises, Lessee shall develop acreage retained hereunder as a
reasonable prudent operator but in discharging this obligation it shall in no event be required to
drill more than one well per forty (40) acres of the area retained hereunder and capable of
producing oil in paying quantities and one well per 640 acres plus an acreage tolerance not to
exceed 10% of 640 acres of area retained hereunder incapable of producing gas or other mineral in
paying quantities.”

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Implied Covenant to Develop:
Sauder v. Mid-Continent Petroleum Corp.

Sauder v. Mid-Continent Petroleum Corp, 292 U.S. 272:

1. Facts

2. Court reasoning
“It is conceded that a covenant on respondent’s part to continue the work of exploration,
development and production is to be implied from the relation of the parties and the object of the
lease.
****
The dissenting judge in the court of appeals thought that a decree should be entered cancelling the
lease as to the 320 acre tract (the E1/2 of the Section) unless within a reasonable time an
exploratory well should be drilled therein to the Mississippi lime, and that the 40 acres embaraced
in SE ¼ of the SW ¼ of Section 16 should remain under the lease. We are of the opinion that such
a decree would recognize and protect the equities of both parties.”

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Implied Covenant to Develop:
Clifton v. Koontz

Clifton v. Koontz, 325 S.W.2d 684:

1. Facts

2. Court reasoning
“[Y]et it is equally try that the burden rests upon the lessor to prove that the producing stratum
required additional wells, or that strata different from that form which production is being
obtained, in reasonable probability, exist, and that by the drilling of additional wells there would
be a reasonable expectation of profit to the lessee. Under such circumstances, the lessee’s
obligation as to development is measured by the rule of reasonable diligence or what an ordinarily
prudent and diligent operator would do, and he is not required to continue in the performance of
these duties or to engage in the performance of such implied duties unless there is a reasonable
expectation of profit, not only to the lessor, but also the lessee.”

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Implied Covenant to Develop:
Post-Clifton v. Koontz Issues

Notes to Clifton v. Koontz

1. Elements Necessary for Lessor to Prevail
2. Measure of Damages
3. How should damages be measured in a development covenant lawsuit?
4. Clifton exceptions.

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Implied Covenant to Develop:
Sun Oil v. Jackson

Sun Oil v. Jackson, 783 S.W.2d 202:

1. Facts

2. Court reasoning

“This court has held that no implied covenant of further exploration exists independent of the
implied covenant of reasonable development. In Clifton, the court held that the covenant of
reasonable development encompassed the drilling of all additional wells after production on the
lease is achieved. By “additional wells” the court meant both additional wells in an already
producing formation or stratum, or additional wells in “that strata different from that from which
production is being obtained. The critical question was whether the lessor could prove a
reasonable expectation of profit to lessor and lessee. Therefore, under Clifton if a party could
prove that a reasonably prudent operator would have drilled the well, that well fell within the
implied covenant of reasonable development, without regard to whether the well was classified as
exploratory or developmental.”

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Implied Covenant to Protect:
Amoco Production Co. v. Alexander

Amoco Production Co. v. Alexander, 622 S.W.2d 563:

1. Facts

2. Court reasoning
“A lessor is entitled to recover damages from a lessee for field-wide drainage upon proof: (1) of
substantial drainage of the lessor’s land; and (2) that a reasonably prudent operator would have
acted to prevent substantial drainage from the lessor’s land.”

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Model Lease Agreement:
Offset Well Clause

Paragraph 6

In the event a well or wells producing oil or gas in paying quantities should be brought in on
adjacent land and within three hundred thirty (330) feet of and draining the lease premises, or
acreage pooled therewith, Lessee agrees to drill such offset wells as a reasonable prudent operator
would drill under the same or similar circumstances.”

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Implied Covenant to Administer Leasehold:
Empire Oil and Refining Co. v. Hoyt

Empire Oil and Refining Co. v. Hoyt, 112 F.2d 356:

1. Facts: Acid job causes well to water out. Lessor sues Lessee for damages for lost royalty due to loss of
the well.

2. Who wins?
“[T]he care to be exercised is what would be reasonably expected of operators of ordinary
prudence having regard to the interest of both lessee and lessor and, although the lessee acts in
good faith, if, in so doing, he commits some act which a reasonably prudent person would not do
under the same or similar circumstances, he is liable for the resulting damages. . . . [I]t is manifest
that it was implied that the lessee would exercise reasonable diligence to avoid the destruction of
the oil pool by water encroachment.”

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Implied Covenant to Administer Leasehold:
Baldwin v. Kubetz

Baldwin v. Kubetz, 307 P.2d 1005:

1. Facts: Well hazards and safety violations by Lessee prevented Lessee from being able to obtain permits
to drill further wells. Lessor sues to terminate lease, claiming that Lessee failed to fulfill implied duty to
manage the lease.

2. Who wins?

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Implied Covenant to Administer Leasehold:
Waseco Chemical Supply Co. v. Bayou State Oil Corp.

Waseco Chemical Supply Co. v. Bayou State Oil Corp, 371 So.2d 305:

1. Facts: Lessee operated marginally producing wells. Fire flooding would increase recoverability from
5% to 60% and could increase production one hundred fold. Other operators were using this technique in
adjacent tracts. Lessor sued for termination of lease.

2. Who wins?

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Implied Covenant to Administer Leasehold:
HECI Exploration v. Neel

HECI Exploration v. Neel, 982 S.W.2d 881:

1. Facts

2. Court reasoning
“A covenant to notify of an intent to sue is not the type of agreement that was so clearly in the
parties’ contemplation that they thought it unnecessary to express. To the extent that the Neels’
causes of action for breach of contract and negligent misrepresentation are premised on the
existence of an implied covenant that a lessee will notify royalty owners that it intends to file suit,
the Neels’ claim fail.”

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Implied Covenant to Administer Leasehold:
Coastal Oil & Gas Corp. v. Garza

Coastal Oil & Gas Corp. v. Garza, 268 S.W.3d 1:

1. Facts

2. Court reasoning
“We have held that one measure of damages for breach of the implied covenant of protection is
the amount of royalties that the lessor would have received from the offset well on its lease. But
this would overcompensate the lessee if production from the offset well exceeded the drainage.
Another measure of damages is the value of the royalty on the drained gas, but this, too, would
overcompensate the lessee if not all of the drainage could have been prevented, either because of
the nature of the field, or the regulatory system, or for whatever reason. The correct measure of
damages for breach of the implied covenant of protection is the amount that will fully
compensate, but not overcompensate, the lessor for the breach– that is, the value of the royalty
lost to the lessor because of the lessee’s failure to act as a reasonably prudent operator.”

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