Presentation:
Oil & Gas Law
Chapter 6: Implied Covenants
Professors Wells
October 21, 2015
Overview:
Covenants versus Conditions
It is essential to understand the difference between the two in an oil and gas lease.
1.  Conditions are not covenants. Conditions are rooted in property law, not contract law. Conditions
determine how long an interest in property endures.
E.g., an oil and gas lease is granted “for 3 years and as long thereafter as oil and gas are produced.” No
production occurs at the end of 3 years, the lease ends. The condition was not met.
The Lessee never promised to obtain production.
2.  Covenants are promises or obligations. Failing to satisfy a covenant generally represents a breach of
contract.
E.g., Lessee promises to pay a 1/6 royalty on production.
Breach of a covenant is like breach of contract. Damages as a remedy.
The lease does not end because of breach of contract.
2 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.”
3 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.”
4 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.”
5 Implied Covenant to Develop:
Sauder v. Mid-Continent Petroleum Corp.
Sauder v. Mid-Continent Petroleum Corp, 292 U.S. 272:
1.  Facts
360 acres
SW ¼ SE ¼
§16
§16
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.”
6 Implied Covenant to Develop:
Clifton v. Koontz
Clifton v. Koontz, 325 S.W.2d 684:
Sipes
Well
1.  Facts
350 acres
Strawn
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.”
Ellenberger &
Marble Falls
7 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.
8 Implied Covenant to Develop:
Sun Oil v. Jackson
Sun Oil v. Jackson, 783 S.W.2d 202:
1.  Facts
2.  Court reasoning
10,000 a
cres
“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.”
9 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.”
10 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.”
11 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.”
12 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?
13 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?
14 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.”
15 Adverse Possession: Discovery Rule
BP America Production Co. v. Marshall
BP America Production Co. v. Marshall,
342 S.W.3d 59:
1.  Facts
2.  Court Reasoning:
While the J.O. Walker No. 1 well log contained highly technical information regarding the
resistivity, conductivity, and spontaneous potential at various intervals in the formation, it
was this information regarding the reservoir’s geology that led the Marshalls’ expert to
conclude that BP’s continued activities on the well were not in good faith. * * * Although
technical, the public documents concerning BP’s operations were available to the Marshalls.
While the Marshalls did not examine them until internal BP documents put this publicly
available log information in context with BP’s efforts to keep the lease alive by continued
operations, they could have. It is not significant that BP’s internal documents helped the
Marshalls discover the injury in this case, as the information was otherwise discoverable.
Because the Marshalls had a duty to exercise reasonable diligence in protecting their mineral
interests, and since the low probability of success of BP’s continued operations could have
been dis- covered with the exercise of reasonable diligence, the injury was not inherently
undiscoverable.
16 Adverse Possession: Discovery Rule
Samson Lone Star Ltd. Partnership v. Hooks
Samson Lone Star Limited Partnership v. Hooks, 389 S.W.3d 409:
1.  Facts: Lessee was found to have engaged in fraud, misrepresentations, and bad-faith pooling and had
concealed all of these actions and lied to its lessors.
2.  Houston 1st Dist. Appellate Court: Lessee wins due to the statute of limitations and inapplicability of the
discovery rule Justice Sharp’s Concurring Opinion:
This burden the Court imposes upon lessors is severe. It is now a lessor's duty to presume that any
statement made by its lessee is false and to ransack the esoteric and oft-changing records at the
Railroad Commission to discover the truth or falsity of its lessee's statements.
I believe the Texas Supreme Court has placed an unnecessary and very heavy burden on lessors by
its ruling in BP America, one that will result either in much money being spent unnecessarily on
prophylactic forensic review of Railroad Commission records or in many viable claims being lost
to limitations. As we are, however, bound to follow the Court's rulings, I reluctantly concur in that
part of the opinion that finds the Hooks' fraud, fraudulent inducement, and statutory fraud claims
barred by limitations as a matter of law.
3.  Supreme Court: Reversed and remanded, holding that it was a fact question whether the discovery rule
could apply. The Court distinguished BP America v. Marshall because “the public record itself was not
tainted” in BP America v. Marshall while the public record was tained in the Hooks case. “We cannot say
that, as a matter of law, Hooks should have discovered the accurate information when the more recent
filing falsely conveyed that the well had been completed outside the protected zone.”
17 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.”
18