Implied Covenants in Oil and Gas Leases — Past,

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					Implied Covenants in Oil and Gas Leases-Past,
Present & Future
Patrick H. Martin *
    I.Introduction.............................................................                                                               639 

   II.The Prudent Operator. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .             640
 III. Drainage ...............................................................                                                                641 

 IV.  Reasonable Development................................................ .                                                                644 

   V. Further Exploration.. ... ...... . .. ..... . .. ... ...... . .. ... .. .. . .. ...... .. . .                                           650
  VI. Marketing ..............................................................                                                                653 

 VII. Restoration of the Surface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              658
VIII. The Administrative Covenant ......................................... . . . .                                                           660 

 IX.  The Future. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   666
      A. The Con-tort ........................................................                                                                666 

      B. Punitive Damages ....................................................                                                                666 

      C. Increased Statutory Influence. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                     667
   X. Conclusion..............................................................                                                                669 



                                                     I. INTRoDucnoN
     Implied covenants have been a sturdy fixture of oil and gas law
for a hundred years or SO.l The cases developing the law of implied
covenants doubtlessly number in the many hundreds. At times it
seems that scholarly discussions of implied covenants are nearly as
numerous. This plenitude of materials makes it daunting to attempt
an overview of the subject. One cannot write on it without leaving out
at least some important cases, relevant topics and significant writers.
At the risk of giving an idiosyncratic and impressionistic treatment of
the subject, this paper will focus on a few of the leading implied cove­
nant cases to identify what the implied covenants are, to describe their
rationale, and to suggest where the courts are likely to take them in
the future.
     The oil and gas lease has aspects of both a property conveyance
and a contract. In its property aspects, the oil and gas lease is a rather
complete document, just as most deeds require very few words to con­
vey a particular interest in land. The lease typically grants the lessee
the present right to go on the land and use it, together with the exclu­
sive right to take oil and gas from the land. The lease states what the
lessee gives in exchange for this present right to go upon and take
from the land-cash money and a share of the production. The
lessee's perspective thus emphasizes the right to property arising at
the granting of the lease, subject to the express provisions of the con­
veyance that appear to define its obligations. The lessor, bonus

     * Campanile Professor of Mineral Law, Louisiana State University; B.A., 1967, L.S.U.;
M.A., 1%9, L.S.U.; J.D., 1974, Duke; Ph.D., 1974, L.S.U.
     1. My earlier examination of this topic is Patrick H. Martin, A Modern Look at Implied
COllenants to Explore, Dellelop, and Market under Mineral Leases, 27 INST. ON OIL & GAS L. &
TAX'N 177 (1976).


                                                                                                                                              639
640                              Washburn Law Journal                                  [Vol. 33

money in hand, has tended to focus more on what is yet to come, the
royalty that can arise only from drilling and production; thus the les­
sor places emphasis on the continuing contractual relationship, which
is primarily made up of obligations owed by the lessee to the lessor.
As a contract that provides for a continuing relationship in a myriad
of circumstances, the oil and gas lease is somewhat incomplete. Mat­
ters that arise between lessor and lessee that are not expressly pro­
vided for in the agreement must be resolved.
      When a court implies covenants or obligations in the lease is it
finding them (as made by the two parties) or making them (as impos­
ing a duty upon the lessee)? While some have contended that implied
covenants are implied in fact, candor requires us to acknowledge that
implied covenants are judicial creations, just as we are all now legal
realists who will admit that courts often make law rather than merely
find it. The strongest proponents of implying obligations on lessees
for the benefit royalty owners have readily admitted the artificial
character of such obligations, though perhaps rooting them ultimately
in the broad purposes of the oil and gas lease. "Of course," declared
Maurice Merrill, "the implied covenant is a fiction, used like other
fictions by the law in order to achieve a desirable result."2 It is not the
agreement of the parties that imposes the obligations but the opera­
tion of law, he states. More recently, the late Charles Meyers has also
asserted the fictitious nature of the implied covenants:3
           The judicial implication of covenants into oil and gas leases is
      nothing more than a response to the problem of lessees acting op­
      portunistically. Given the relational nature of the oil and gas lease,
      and the "generic agency" between the lessor and lessee, the courts
      have recognized that without the imposition of judicially created im­
      plied covenants to effectuate the controlling intention of the parties
      as manifested in the lease, a lessee would have the ability to act
      opportunistically, that is, to manipulate the contract so as to maxi­
      mize its wealth at the expense of the lessor.

                          II.    THE PRUDENT OPERATOR

     Recognizing that the implication of obligations is a fiction that
arises from the relationship between lessor and lessee, it follows that
there is actually not a series of implied covenants that are found in the
lease. Rather, the courts require that the lessee conform to some
standard of fair dealing with the lessor.4 This standard is the judicial
     2. MAURICE MERRILL, CoVENANTS IMPLIED IN OIL AND GAS LEASES § 7, at 27 (2d ed.
1940 & 1964 Supp.).
     3. Charles J. Meyers & Steven M. Crafton. The Covenant of Further Exploration-Thirty
Years Later, 32 ROCKY MTN. MIN. L. INST. 1-1 (1986).
     4. For an indication that some courts treat the enumeration of certain implied covenants
by treatise writers or by courts as establishing an exclusive list of such implied covenants, see
Amoco Production Co. v. Ware, 602 S.W.2d 620 (1980). The court listed five types of implied
1994]               Implied Covenants-Past, Present & Future                               641

requirement that the lessee perform under the lease as a prudent op­
erator. s The implied obligation of being a prudent operator requires
"the doing of that which an experienced operator of ordinary pru­
dence would do in the premises, having due regard for the interests of
both lessor and lessee."6 This standard is not determined by the lessor
or the lessee; rather it looks to the interests of both.
     An enumeration of the headings under which one might find a
duty to take action as a prudent operator usually includes the
following:
     1. The implied obligation to protect against drainage (also
known as the offset well covenant or sometimes as the duty to refrain
from depletory actions);
     2. The implied obligation to drill sufficient wells for the lessor to
realize the reasonable value of the leasehold through royalty pay­
ments, an obligation that may be divided into the reasonable develop­
ment covenant and the further exploration covenant;
     3. The implied obligation to market diligently; and
     4. The implied obligation to restore the surface.
     A fifth implied covenant is the duty to represent the lessor ad­
ministratively but it should be seen generally as a method of fulfilling
the other implied covenants. These enumerated covenants simply in­
dicate the common situations that arise in which the lessee's conduct
under the lease will be called into question.

                                    III.    DRAINAGE

     The most compelling situation for implying an obligation of the
lessee to drill and produce is when drainage of the lease tract is taking
place through production of a well from the same reservoir on an ad­
jacent tract. The lessor is suffering an actual present loss that cannot
be recouped by later drilling. Moreover, the lessee also is suffering a
loss if drilling would in fact be profitable. Why would such a lessee
not want to drill a well with such facts? If the lessee is causing the
drainage, then the lessee is suffering no loss; in fact the lessee may

covenants given in W.L. SUMMERS, OIL AND GAS (penn. ed.), and followed the list by the state­
ment that it found "no authority for the type of implied covenant the chancellor imposed in this
case." [d. at 624.
      5. This is often expressed as a requirement that the lessee act as a "reasonably prudent
operator." What does the addition of the adverb "reasonably" accomplish in modifying "pru­
dent operator"? From participation in legislative drafting activities, I have found that lawyers
and judges are so enamored with the desirability of reasonable conduct they like to throw in the
word "reasonably" whenever they reasonably get a chance to. The use of "reasonably" in con­
nection with "prudent operator" seems to suggest that one should not demand too much of the
lessee-that he be only reasonably prudent, rather like suggesting that one need not be fully
virtuous, only reasonably virtuous. In this way, reasonably does seem redundant for "prudent"
in itself signifies reasonable behavior.
      6. Gerson v. Anderson-Prichard Production Corp., 149 F.2d 444, 446 (10th Cir. 1945).
642                               Washburn Law Journal                                   [Vol. 33

have an economic incentive to produce only from the draining well if
the lessee enjoys a higher interest in production from that well or can
avoid costs of drilling an additional well.
     The courts then have implied a duty of the lessee to protect
against drainage because a prudent operator would certainly act to
prevent drainage from taking place. This duty certainly arises when
the production from the well would exceed the cost of drilling and
operating the well.7 The implied duty will even trump the express
right of the lessee to pay delay rental and not to drill during the pri­
mary term of the lease, using the rationale that the express provision
for delay rentals relates to lease maintenance for habendum clause
purposes. s
     The interesting issues that arise on the offset well covenant con­
cern the extent of the lessee's duty when it is the lessee who is causing
the drainage. Should the standard that a court applies to determine if
the covenant has been breached change when the lessee is causing the
drainage? Should a court award compensatory royalty to the lessor or
other royalty owner even if that owner cannot establish that an offset
well could produce in paying quantities? The decisions are divided in
responding to this question. The more usual answer has been that the
royalty owner should be no better and no worse off if the lessee is
causing drainage. 9 However, some courts have been willing to require
more of a common lessee,10 though the rationale is neither clear nor
persuasive why this should be so. The underlying concern seems to be
that the lessee is engaged in some sort of fraud upon the lessor or is
enjoying an unjust enrichment.n

        7. [d.
        8. Sundheim v. Reef Oil Corp., 806 P.2d 503 (Mont. 1991); see also Millette v. Phillips
Petroleum Co., 48 So. 2d 344 (Miss. 1950); Texas Co. v Ramsower, 7 S.W.2d 872 (Tex. Comm'n
App.I928). Compare Orr v. Comar Oil Co., 46 F.2d 59 (10th Cir. 1930); McCoy v. State Line
Oil & Gas Co., 143 So. 58 (La. 1932).
        9. Gerson v. Anderson-Prichard Production Corp. 149 F2d 444 (10th Cir. 1945); Breaux v.
Pan American Petroleum Corp., 163 So. 2d 406 (La. Ct. App. 1964); Blair v. Clear Creek Oil &
Gas Co., 230 S.W. 286 (Ark. 1921); Shell Oil Co. v. Stansbury, 410 S.W.2d 187 (Tex. 1966); TIde
Water Associated Oil Co. v. Stott, 159 F.2d 174 (5th Cir. 1946), cert. denied, 331 U.S. 817 (1946).
A recent statement is found in Rogers v. Heston Oil Co., 735 P.2d 542 (Okla. 1984):
       [W)here the lessee is the owner of an adjoining lease which is draining the lessor's tract,
       the "prudent operator" rule applicable to the lessee's implied covenant to protect
       against drainage is whether the lessee as a prudent operator would drill a protection
      well on the lessor's tract if the draining lease were owned by a third party, and not the
       lessee.
[d. at 547.
      10. Phillips Petroleum Company v. Millette, 72 So. 2d 176, 74 So. 2d 731 (Miss. 1954); R.R.
Bush Oil Co. v. Beverly-Lincoln Land Co., 158 P.2d 754 (Cal. Ct. App. 1945); Cook v. EI Paso
Natural Gas Co., 560 F.2d 978 (10th Cir. 1977).
      11. Richard Maxwell notes that when one considers this aspect of drainage it is "almost
obligatory" to quote a passage from Geary v. Adams Oil & Gas Co., 31 F. Supp. 830, 834 (E.D.
lll. 1940), Richard C. Maxwell, Appropriate Damages for Breach ofImplied Covenants in Oil and
Gas Leases, 42 INST. ON OIL & GAS L. & TAX'N 7-17 (1991). Following Professor Maxwell's
excellent counsel we do so herewith:
1994]                Implied Covenants-Past, Present & Future                                  643


      The case that I find most instructive in dealing with the drainage
covenant is the Texas Supreme Court opinion in Amoco Production
Co. v. Alexander.12 The lessors, located downdip in a field, claimed
the lessee was causing drainage of their land by the lessee's updip
wells on other leases. The lessee defended on the ground that it was
not allowed by the Railroad Commission to drill additional wells to
prevent drainage. The court held that the lessee had a duty under the
circumstances to seek Rule 37 exception wells. In this way the lessee
could have fulfilled its obligation to protect against drainage. What
about the lessee's duties to the lessors on the land where the draining
wells are located? The court disposed of this by indicating the duties
to the drained lessors are not diminished because of the lessee's con­
flicting interests and obligations. If a lessee finds the ownership of
different lease interests a source of conflict, the proper way to over­
come the problem is to give up the lease and allow another lessee to
do what a prudent lessee who is not burdened by conflicting interests
would do. An especially interesting aspect of the court's approach is
the suggestion of a duty of the lessee to seek voluntary unitization.
      Several other cases have noted that in a common-lessee situation
there may be a greater possibility for the lessee to establish pooling
that will overcome the drainageP The Louisiana court of appeals
held in Pierce v. Goldking Properties, Inc. 14 that a lessee may fulfill
the implied covenant to protect against drainage by drilling a well or
by seeking a unit from the state agency. Since the lessee had sought a
unit in the manner of a prudent operator, he had not breached his
obligation to protect against drainage. In Cone v. Amoco Production
Co. ,15 the New Mexico Supreme Court noted that it was possible to
avoid the duty to drill an offset well through unitization of lands held
by a common lessee. However, it did not go so far as to hold that
there was a duty to unitize under the facts of the case when there was
no showing of substantial drainage of the plaintiff's lands. We will
return to this line of cases when we consider the administrative
covenant.

          But here the mind is haunted by the fact that the defendant is the beneficiary of
      the oil drained from the plaintiffs' land by the wells on the north and south which
      belong to the defendant. It has not only been saved the cost of drilling, equipping and
      operating a protecting well but it gets the oil anyway without plaintiffs being paid for it.
Adams Oil, 31 F. Supp. at 834.
     12. 622 S.W.2d 563 (Tex. 1981).
     13. Breaux v. Pan American Petroleum Corp., 163 So. 2d 406, 415-416 (La. Ct. App. 1964);
see also Williams v. Humble Oil & Refining Co., 290 F. Supp. 408 (E.n. La. 1968), affd, 432 F.2d
165 (5th Cir.), reh'g denied, 435 F.2d 72 (5th Cir. 1970), cert. denied, 402 U.S. 934 (1971); George
W. Hardy, Drainage of Oil and Gas from Adjoining Tracts-A Further Development, 6 NAT.
RESOURCES 1. 45 (1966).
    14. 396 So. 2d 528 (La. Ct. App. 1981).
     15. 532 P.2d 590 (N.M. 1975).
644                              Washburn Law Journal                                 [Vol. 33

                       IV.     REASONABLE DEVELOPMENT

     The principle of reasonable development is easily stated and simi­
lar terminology is employed in most jurisdictions. As stated in the
Kansas case of Temple v. Continental Oil: 16
            It is well settled that where the existence of oil in paying quan­
      tities is made apparent ... it is the duty of the lessee to continue the
      development of the property and to put down as many wells as may
      be reasonably necessary to secure the oil for the common advantage
      of both the lessor and lessee.
This means that the lessee will drill to a known producing formation
when the well would recover all drilling and operating costs, including
a reasonable profit to the lessee. 17
     The controversies over the years have included questions over
the extent to which the lessee might limit the obligation to develop
through an express provision. The issue was explored in the familiar
case of Gulf Production Co. v. Kishi. 18 Two leases were involved in
this suit. Paragraph 3 of the first lease (covering some 150 acres) pro­
vided that the lessee would drill another well within sixty days after
discovering oil and begin an additional well within sixty days after
each well completion until a total of twelve wells had been drilled. On
this lease fifteen wells were drilled in the period 1921-27 and all but
three were producers. Paragraph 14 of the second lease (covering
some twenty acres) had a similar provision for drilling, with a maxi­
mum of ninety-day intervals between wells until four producing wells
were drilled. On this lease, some six producing wells were drilled in
the same period.
     The lessee had clearly complied with the express covenants of the
leases. However, the plaintiffs claimed that the defendant had
breached an implied covenant of reasonable development that was in
addition to the express covenants. They claimed that reasonable dili­
gence would require the defendant to drill an additional fifteen wells
per year on the first lease and five per year on the second lease, and
they sought as damages the royalties that would have been produced
if such wells had been drilled in the period 1927-31. The jury and trial
court held for the plaintiff. The court of civil appeals reversed on the
    16. 320 P.2d 1039, 1055 (Kan. 1958).
    17. For an argument that the standard "profitability" test for the prudent operator test is
destructive of wealth see Stephen F. Williams, Implied Covenants' Threat to the Value of Oil and
Gas Reserves, 36 INST. ON OIL & GAS L. & T AX'N ch. 3 (1985). Judge Williams has asserted that
because "self-interest normally motivates lessees to embark on any investment or expense that is
profit-maximizing, the lessee's decisions should be entitled to enjoy a powerful presumption of
compliance with his implied duties." Id. at 3-6. He has elaborated his alternative concept of
profitability in several other articles: Stephen F. Williams, Implied Covenants in Oil & Gas
Leases: Some General Principles, 29 KAN. L. REv. 153 (1981); Stephen F. Williams, Implied
Covenants for Development and Exploration in Oil & Gas Leases-The Determination of Profit­
ability, 27 KAN. L. REV. 443 (1979).
    18. 103 S.W.2d 965 (Tex. 1937).
1994]                Implied Covenants-Past, Present & Future                                645


ground that the express covenants for development precluded the
existence of an implied covenant for additional development. The
Texas Supreme Court affirmed the decision of the court of civil
appeals.
     The court rejected the plaintiffs' contention that there is always
an implied covenant for reasonable development, stating that an im­
plied covenant arises only out of necessity and in the absence of an
express stipulation for development. When there is no provision in
the lease for further development after drilling the first well, a cove­
nant for reasonable development is implied in order that the purpose
of the lease may be accomplished, that purpose being the production
of oil and gas with payment of royalty to the lessor. Here the parties
in the lease had provided for development beyond the first well.
There was no necessity for implying a covenant because there was an
express covenant. The express covenant may not have provided for
the same number of wells as would be required by reasonable devel­
opment. Nonetheless, the parties had stipulated what the develop­
ment should be and this covered the question of development entirely.
     The plaintiffs countered this position by arguing that the express
covenants and the implied covenants relate to different subject mat­
ter. That is, that the express drilling provisions are part of the estate
granted, that failure to drill in accordance with these provisions results
in termination of the lease, whereas failure to comply with the implied
covenant leads only to liability of damages. The court did not accept
this. Both express and implied covenants related to the subject of de­
velopment. The express provisions were to be the full extent of the
lessee's duty and not just the starting point.19
     Despite the well-established principle that parties to a lease may
contract to limit the implied development covenant, some courts may
find that an implied covenant displaces an express lease clause rather
than vice-versa. A Louisiana case has found that an express acreage
retention clause could not trump the implied development obligation,
in part because the development obligation reflected public policy. In
Dawes v. Hale,zo a lease of forty acres provided that in case of termi­
nation or cancellation of the lease for any cause, the lessee should
have the right to retain around each producing well the number of

    19. See also Oliver v. Louisville Gas and E1ec. Co., 732 S.W.2d 509 (Ky. Ct. App. 1987)
(discretionary review denied by Kentucky Supreme Court) where the Kentucky court holds that
there was no room for an implied covenant to develop where the lease was primarily concerned
with gas storage and incidentally allowed oil and gas drilling. The court rejected the approach of
the Texas court. Compare Cowden v. Broderick and Calvert, Inc., 114 S.W.2d 1166 (Tex. 1938),
in which the court held that "discretion" did not mean the uncontrolled will of the lessee, and
such discretion was subject to an equitable standard of what is just and proper under the
circumstances.
    20. 421 So. 2d 1208 (La. Ct. App. 1982).
646                            Washburn Law Journal             [Vol. 33


acres allocated to each well under any relevant spacing or proration
rules, or, if there were none, forty acres around each well. The lessee
drilled three wells in the northwest corner of the tract, each of which
was producing two barrels of oil per day. It was the court's opinion
that under article 122 of the Mineral Code, the parties may stipulate
what constitutes reasonable development but they may not contractu­
ally abrogate it entirely. Here, said the court, the acreage retention
clause reflected no clear intent to limit or define the development ob­
ligation of the lessee. Thus, it could not displace the duty to develop
reasonably. In somewhat extravagant language, the court stated that
the "principle of reasonable development is a matter of public policy,
necessary in order to give effect to the parties' intent inherent in all
mineral leases, to assure reasonable development of the state's natural
resources, and to prevent property being taken out of commerce."21
It seems to me most questionable that public policy today really favors
the drilling of new wells every time a lessor can persuade a court that
a well might prove productive in paying quantities.
     An acreage retention clause also was in controversy in Goodrich
v. Exxon Co., U.S.A.,22 and this case is a good example of a recent
implied covenant decision exploring remedies. Lessors here had
sought partial cancellation of an oil and gas lease for failure to de­
velop as a prudent operator. The trial court ordered the horizontal
cancellation of the lease, less and except those areas located within
forty acres (as provided for by the acreage retention clause of the
lease) of the bottom hole of each producing well to the base of the
deepest producing sand as well as areas presently held by unitized
production. The court reviewed six factors to be considered in apply­
ing the reasonable development covenant: "geological data; number
and location of wells drilled on or near the leased property; produc­
tive capacity of existing wells; cost of drilling compared with profit
reasonably expected; time interval between completion of last well
and demand for additional operation; and acreage involved in the
lease under consideration."23 Reviewing the trial court's application
of the legal standard using these factors, the appeals court upheld the
partial cancellation of the lease. Excepted from cancellation were
those areas located within forty acres, as provided for by the acreage
retention clause of the lease, of the bottom hole of each producing
well to the base of the deepest producing sand as well as areas held by
unitized production. The appeals court upheld this determination
even though units established by the Commissioner of Conservation

   21. Id. at 1211.
   22. 608 so. 2d 1019 (La. Ct. App. 1992).
   23. Id. at 1023.
1994]             Implied Covenants-Past, Present & Future                       647

were in some instances smaller than forty acres; the acreage retention
clause controlled even if the area actually drained by a well was
smaller.24 The appeals court modified the judgment to the extent that
the trial court required additional activity to maintain each forty-acre
area once production ceased from a well located thereon; instead the
appeals court held that proper application of the forty-acre retention
clause required that the forty-acre tracts all be considered part of a
single lease. The court put it thus: 25 "The lease no longer covers a
contiguous 686 acre area. It now covers a series of forty acre tracts, all
of which fall under one maintenance obligation. Accordingly, we re­
verse that portion of the trial court's judgment which provides for sep­
arate lease obligations on each retained area."
     The trial judge allowed Exxon to maintain its lease as to those
unitized sands located on the leased property which are produced
from wells located on lands adjoining the leased property. It was un­
clear whether the trial judge intended to except from lease cancella­
tion just the unitized sands, or all depths from the surface of the earth
to the base of the unitized sands, and the court remanded for
clarification.
     Just as lessees are aware of the possibility of lease clauses that
may limit their development and exploration obligations, lessors can
insist on lease clauses that require the lessee to develop all parts of the
lease that the lessee wishes to retain. The Pugh Clause is a well­
known device for requiring lessees to continue exploration and devel­
opment for areas that are not included in a unit.26 The lessor may also
consider a clause such as that at issue in Parten v. Cannon.27 Here a
lease on a 658.62-acre tract included a provision for the filing of a
written description of the portions of the lease to be held by produc­
ing wells at the end of the primary term. The lease clause provided: 28
         Lessee must within ninety (90) days after the end of the pri­
    mary term of this lease as to the leased premises which is not pooled
    under the provisions of Paragraph 4 hereof, designate in writing and
    place same of record with the County Clerk in Madison County,
    Texas, a description of that part of the leased premises which shall
    be allotted to such well for production purposes, no more than 320
    acres plus 10% tolerance to be allotted in and around each well
    classified as a gas well by the Railroad Commission of Texas, if com­
    pleted at a depth of 8,500 feet or less below the surface nor more
    than 640 acres plus 10% tolerance to such gas well if completed at a
    depth of more than 8,500 feet below the surface, and no more than

   24. The court limited Dawes v. Hale to its fact.
   25. Goodrich, 608 So. 2d at 1029.
   26. On the varieties of Pugh Clauses and their operation, see generally 1 BRUCE M.
KRAMER & PATRICK H. MARTIN, POOLING AND UNITIZATION ch. 9 (1993).
   27. 829 S.W.2d 327 (Tex. Civ. App. 1992).
   28. ld. at 329.
648                              Washburn Law Journal                                  [Vol. 33

     10 acres plus 10% tolerance to be allotted in and around each well
     classified as an oil well by the Railroad Commission of Texas if com­
     pleted at a depth of 2,500 feet or less below the surface. In the case
     of an oil well completed at a depth of more than 2,500 feet below
     the surface, there shall be allotted to that well for production pur­
     poses no more land than is allowed by the permanent field rules of
     the Railroad Commission for oil units for that horizon, nor more
     than 80 acres in the absence of permanent rules. Production or op­
     erations on said allotted area by the Lessee shall maintain this lease
     in effect only with regard to the land within the described area. This
     lease shall terminate as to such part or parts of the leased land lying
     outside the allotted area unless this lease is perpetuated as to such
     land outside the allotted area by operations conducted thereon or
     by production of oil or gas or by such operations and such produc­
     tion in accordance with the provisions hereof.
      The court determined that a distinction existed between the
designation-and-filing provision in the first sentence of this paragraph
and the production-and-allotment provision in the last two sentences
of the paragraph. The production-and-allotment provision was a con­
dition but the designation-and-filing provision was a covenant. No au­
tomatic termination of the lease resulted from the alleged breach of
the designation-and-filing provision. With a clause such as this, the
lessee will have to drill each portion of the lease that it wishes to
retain.
      There are a number of interesting cases we might note that can be
included under the heading of "reasonable development." I would
include under this heading an implied obligation to use new methods
of recovery, though others might denominate this as a covenant to
conduct operations with reasonable care and due diligence. 29 Thus I
would include here the case of Waseco Chemical & Supply Co. v.
Bayou State Oil Corp.30 In this case the wells in question had been
producing for nearly sixty years, although the number of producing
wells and the amount of production had dropped substantially in the
years immediately preceding the litigation. 31 There had also been
substantial activities by other operators in the area in the use of en­
hanced recovery operations to increase production. In fact, two
nearby operators had begun a fire flood operation, albeit with federal
governmental funding, and greatly increased the amount of recover­
able oil. The leasehold tract was large enough to support an enhanced
recovery project. The court relied heavily on scholarship that sup­
ported the concept that lessees had a duty to institute enhanced recov­

    29. 5 HOWARD WILLIAMS & CHARLES J. MEYERS, OIL AND GAS LAW § 861 (1993).
    30. 371 So. 2d 305 (La. Ct. App. 1979).
    31. The field was discovered in 1921, and Bayou State acquired its interest in 1953. At the
time of its acquisition there were approximately fifty producing wells, but by 1976 the number of
producing wells had declined to nine, and production had declined to an average of six barrels
per day from forty-six barrels per day. [d. at 310-11.
1994]                Implied Covenants-Past, Present & Future                                 649

ery operations under their implied covenant to engage in diligent
operation. 32
     The Waseco court used a six-factor analysis in determining
whether a reasonable and prudent operator would begin a fireflood
project on the plaintiffs acreage. The court was greatly assisted by
the fire flood projects that had been instituted on lands within the
area, which provided both cost and production figures that were not
totally speculative in nature. The six factors analyzed by the court
were: (1) geological data, (2) number and location of the wells drilled,
both on and off of the leasehold, (3) productive capacity of the wells,
(4) cost and profit data as projected by the expert witnesses, (5) devel­
opment of the lease by the present lessee, including additional wells, if
any, that were drilled after the lessee came into possession of the
lease, and (6) the size of the leasehold estate. 33 Applying these factors,
the court concluded that the lessee had not operated in a reasonable
and prudent matter and upheld the trial court's order cancelling the
lease. 34
     Another case that has recognized, albeit in dictum, a duty to en­
gage in enhanced recovery operations is Bi-County Properties v. Wam­
pler.35 The major issue did not involve a duty to engage in enhanced
recovery operations but instead the interpretation of a royalty reser­
vation that required increased payments based on the production
levels attained by the lessee. The lessor claimed that constructive pro­
duction from the unitized area, which was attributed to the leasehold
acreage under the unitization agreement, should be counted. But in
reaching a result that included such constructive production, the court
said:36
          Such a construction is in keeping with the policy of the State of
     Illinois of promoting the secondary recovery of oil . . . . It is an
     implied right and duty of a reasonably prudent operator under an
     oil and gas lease to adopt a system providing for the secondary re­
     covery of oil.
In a similar vein, one could easily find that there is an implied cove­
nant to employ horizontal drilling techniques. Several writers have

     32. See Maurice Merrill, Implied Covenants and Secondary Recovery, 4 OKLA. L. REV. 177,
181 (1951). For other scholarly works on this issue, see 5 EUGENE KUNTZ, LAW OF OIL AND GAS
§ 59.1 (1986); Oliver H. Hughes, Legal Problems of Water Flooding, Recycling and Other Secon·
dary Operations, 9 INST. ON OIL & GAS L. & TAX'N 105, 116·20 (1958); Roscoe Walker,
Problems Incident to the Acquisition, Use and Disposal of Repressuring Substances Used in Sec·
ondary Recovery Operations, 6 ROCKY MTN. MIN. L. INST. 273, 285·88 (1961). See also Carter
Oil Co. v. Dees. 92 N.E.2d 519 (Ill. App. Ct. 1950).
     33. Waseco, 371 So. 2d at 311·12.
     34. See Patrick H. Martin. Mineral Rights, 40 LA. L. REV. 588.597-600 (1980).
     35. 378 N.E.2d 311 (Ill. App. Ct. 1978).
     36. Id. at 315. The court cited Reed v. Thxas Co., 159 N.E.2d 641, 644 (III. App. Ct. 1959),
and Ramsey v. Carter Oil Co., 74 F. Supp. 481 (E.D. Ill. 1947), affd, 172 F.2d 622 (7th Cir. 1949),
cert. denied, 332 U.S. 844 (1949) to support that broad statement.
650                              Washburn Law Journal                                 [Vol. 33

explored this topic, but as yet there is no case thrashing out the
issues.37

                           V.     FURTHER EXPLORATION

      The implied covenant of further exploration would require the
lessee to undertake additional operations in unexplored strata, both
vertically and laterally, on the leasehold. To establish breach of the
covenant, the lessor would have to give evidence that the strata is po­
tentially productive and that it is unreasonable not to drill exploratory
wells even though the lessor cannot prove that the drilling would
probably be profitable. The loss to the lessor from breach of the im­
plied covenant is said to be the value of a test on the land for new
producing horizons. Since this is largely unquantifiable, the remedy is
not damages, but cancellation or conditional cancellation of the unex­
plored portions of the lease should the lessee refuse to drill. The pru­
dent operator, it is presumed, would, under the proper circumstances,
drill exploratory wells without a reasonable expectation of profitable
production from its operations. The factors to be shown by the lessor
to establish breach of the covenant are similar to the ones discussed in
relation to the implied covenant of reasonable development.
      Does the further exploration covenant actually exist? It is found
in the scholarly literature among those debating whether it does or
should exist.38 It is expressly accepted in Colorad039 and perhaps tac­

     37. Christy M. Schweikhardt, Horizontal Perspective: Texas Oil & Gas Law In Light Of
Horizontal Drilling Technology, 34 S. TEX. L. REV. 329 (1993); Patricia A. Moore, Horizontal
Drilling: New Technology That Will Raise New Issues About 'Old' Law, THE LANDMAN, May·
June 1990, at 7; Skipper Lay, Cloudy Horizons on a Sunny Day: Horizontal Drilling and Produc­
tion, L-1 (unpublished paper for the University of Houston Law Center Oil and Gas Law Semi­
nar, Jan. 1991) .
     38. The leading work on further exploration is Charles Meyers' seminal and controversial
article The Implied Covenant of Further Exploration, 34 TEX. L. REV. 553 (1956). Some of the
articles and books which have come after the Meyers article that discuss the covenant of further
exploration include: EARL A. BROWN, THE LAW OF OIL AND GAS LEASES § 16.05 (2d ed. rev.
1973); Maurice Merrill, The Implied Covenant of Further Exploration, 4 ROCKY Mm. MIN. L.
INST. 205 (1958); Charles J. Meyers, The Covenant of Further Exploration: A Comment, 37 TEx.
L. REv. 179 (1958); Earl A. Brown, The Proposed New Covenant of Further Exploration: Reply
to Comment, 37 TEX. L. REV. 303 (1959); James A. Boone, The Implied Covenant for Additional
Development, 31 MISS. L.J. 34 (1959); Charles O. Galvin, Meyers v. Brown-Jurisprudence in
Action,7 UCLA L. REV. 589 (1960); Maurice Merrill, The Implied Covenant of Further Explora­
tion in Oklahoma, 13 OKLA. L. REv. 249 (1960); Roger C. Cohen,Implied Covenants in Kansas
Oil and Gas Leases, 9 KAN. L. REv. 7 (1960); Annot., 79 A.L.R.2d 792 (1961); Charles J. Meyers
& Howard Williams, The Implied Duty to Explore Further: Recent Texas Developments, 41 TEX.
L. REV. 789 (1963); James K. Smith, The Implied Duty to Explore Further: Recent Texas Devel­
opments-A Disagreement, 42 TEX. L. REV. 199 (1963); Jacqueline L. Weaver, Implied Cove­
nants in Oil and Gas Law under Federal Energy Regulations, 34 VAND. L. REv. 1473 (1981). For
the suggestion of a hybrid that is more than development but less than requiring wildcat drilling
throughout the lease, see Gary D. Allison, Explorvelopment: A Theoretical Hybrid Searching for
Fertile Legal Soil in an Unfertile Economy, 39 INST. ON OU. & GAS L. & TAX'N 9-1 (1988).
Allison indicates that the "explorvelopment" term was coined by Jerry Pickerell, Is There a New
Implied Covenant of Explorvelopment? 31 INST. ON OIl.. & GAS L. & TAX'N 245 (1980).
     39. Gillette v. Pepper Tank Co., 694 P.2d 369 (Colo. Ct. App. 1984). See also North York
Land Assoc. v. Byron Oil Indus., Inc., 695 P.2d 1188 (Colo. Ct. App. 1984).
1994]                Implied Covenants-Past, Present & Future                                  651

itly in Arkansas,40 Louisiana41 and Oklahoma,42 though one does not
speak of it by name in these latter states.
      The Colorado case that has explicitly recognized an implied cove­
nant of further exploration is Gillette v. Pepper Tank CO.43 Here the
lessor sought cancellation of a lease executed in 1951 covering some
3,360 acres. Various wells had been drilled on the property, and a
waterflood project had been undertaken in 1963 and abandoned in
1971. All wells had been abandoned except one which was producing
at a marginal rate. A unitization agreement affected a portion of the
leasehold, but it is not clear from the opinion what the extent of such

    40. See generally James W. McCartney & John C. LaMaster, The Implied Covenant of Ex­
ploration in Texas and Arkansas, 13 U. ARK. LITTLE ROCK 25 (1990). While Arkansas courts do
not expressly adopt an exploration covenant, the authors conclude that the "implied covenant of
development ... is defined and applied so broadly in Arkansas that it has become, in effect if not
in name, very similar to the traditional definition of the implied covenant of exploration." Id. at
49. The reason for this is that the prudent operator standard is applied to prevent the lessee
from holding acreage for speculation. See Skelly Oil Co. v. Scoggins, 329 S.W.2d 424 (Ark.
1959); Byrd v. Bradham, 655 S.W.2d 366 (Ark. 1983). In the latter the court stated, H[i]n oil and
gas leases where royalties constitute the chief consideration, an implied covenant exists that the
lessee will explore and develop the property with reasonable diligence. The duty to explore
extends to the entire tract, and this is especially true where paying quantities of oil have been
found on a part of the tract." Id. at 367. The Arkansas court has recently followed this approach
in Crystal Oil Co. v. Warmack, 855 S.W.2d 299 (Ark. 1993) where a lease was found to have
terminated for nondevelopment thus "activating" a top lease.
    41. A thorough and thoughtful review of the Louisiana jurisprudence has been done by my
colleague Thomas A. Harrell, A Mineral Lessee's Obligation to Explore Unproductive Portions
of the Leased Premises in Louisiana, 52 LA. L. REv. 387 (1991). Although some federal court
decisions looking to Louisiana law have interpreted Louisiana jurisprudence as literally requir­
ing that wells be drilled or the lease forfeited, he indicates that the Louisiana courts have not
actually imposed such a rule. Professor Harrell does imply some duty for the lessee to explore,
observing that the "oil company that obligates itself to develop land for its mineral value must
impliedly be promising not only to mine the minerals that it finds but also to do those things
necessary to determine where the minerals are located." Id. at 391. He uses'a treasure chest
analogy to call into question the approach that would place the burden on the lessor to prove
that a well would likely be productive;
            The lessee who attempts to excuse his failure to do anything toward the discovery
     of oil and gas on the grounds that the lessor must show where a successful and profita­
     ble well can be drilled is in the same position as a treasure hunter who obligates himself
     to a landowner to diligently search the land for Jean Lafitte's hidden treasure in return
     for 3/4 of what he finds and then explains his failure to take any action whatsoever
     toward locating the treasure by complaining that the landowner has not told him where
     it is.
Id. at 401 n.33.
     I would agree with much of what he says about the Louisiana jurisprudence, particularly his
observation that some decisions indicate that the lessee's duty may be satisfied by something
short of drilling. E.g., Frazier v. Justiss Mears Oil Co., Inc., 391 So. 2d 485 (La. Ct. App. 1980);
but see Vetter v. Morrow, 361 So. 2d 898 (La. Ct. App. 1978).
    42. Mitchell v. Amerada Hess Corp., 638 P.2d 441 (Okla. 1981). The Oklahoma court de­
clared: "We thus hold there is no implied covenant to further explore after paying production is
obtained, as distinguished from the implied covenant to further develop." Id. at 449. But the
court has apparently not disturbed the established Oklahoma doctrine that achieves much the
same effect by shifting the burden from the lessor to prove a breach of the implied covenant of
reasonable development after the passage of a reasonable period of time to the lessee to show
why a prudent operator would continue to hold acreage without additional drilling. See Dixon v.
Anadarko Production Co., 505 P.2d 1394 (Okla. 1973); Crocker v. Humble Oil & Ref. Co., 419
P.2d 265 (Okla. 1965); Lyons v. Robson, 330 P.2d 593 (Okla.1958); Trawick & Boddie v. Castle­
berry, 275 P.2d 292 (Okla. 1953). See also Doss Oil Royalty Co. v. Texas Co., 137 P.2d 934
(Okla. 1943). Compare Sonat Petroleum Co. v. Superior Oil Co., 710 P.2d 221 (Wyo. 1985)
(Wyoming court expressly rejects the Oklahoma burden-shifting approach).
    43. Gillette v. Pepper Tank Co., 694 P.2d 369 (Colo. Ct. App. 1984).
652                            Washburn Law Journal                                [Vol. 33


acreage was. The trial court held that the defendant had breached the
implied covenants of the lease and, applying a judicial-ascertainment
clause, issued a conditional decree of cancellation. Under it, if the
lessee filed within 60 days a plan of development, the cancellation
would be ineffective; but, if the lessee failed to submit a plan, in order
for the cancellation to be effective, the lessor was required to file a
plan of development. In regard to the producing area around the one
well, the lease would not be cancelled if the lessee made certain
repairs.
      The appellate court affirmed the trial court except to the extent
that the trial court failed to segregate the unitized portion of the land
from the nonunitized. The court ruled that whether the lessee had
breached the implied covenants of reasonable development and fur­
ther drilling on the unitized portion had to be considered in view of
the entire unit. In affirming as to the breach of implied covenants
relating to drilling, the court said that Colorado recognizes four im­
plied covenants: "to drill; to develop after discovery of oil and gas in
paying quantities; to operate diligently and prudently; and to protect
leased premises against drainage."44 The court stated that this "obli­
gation to explore, develop, and produce, once production is acquired,
includes both an implied covenant of reasonable development and an
implied covenant of further exploration."45 In determining whether
the implied covenant of further exploration has been breached, rele­
vant factors include the period of time that has lapsed since the last
well was drilled, the size of the tract and the number and location of
existing wells, favorable geological inferences, the attitude of the
lessee toward further testing of the land, and the feasibility of further
exploratory drilling as well as the willingness of another operator to
drill. Applying these, there was evidence to support the trial court's
determination of a breach by the lessee.
      Other states have rejected the notion of a separate implied explo­
ration covenant. The most recent Texas case doing so is Sun Explora­
tion and Production Co. v. Jackson. 46 In controversy here was a lease
granted in 1938 that covered 10,000 acres. The lessors sought addi­
tional drilling, and the lessee sought a declaratory judgment that the
lease was held by the existing production without the necessity of fur­
ther exploration. On a jury verdict, the trial court granted judgment
for the lessors, cancelling the lease as to a portion and conditional
cancelling as to another portion. The Texas Supreme Court on re­
hearing rejected the proposition that there is a separate implied cove­

   44. [d. at 372 (citing Mountain States Oil Corp. v. Sandoval, 125 P.2d 964 (Colo. 1942)).
   45. [d. (citing WILLIAMS & MEYERS, supra note 29, §§ 831-847).
   46. 783 S.W.2d 202 (Tex. 1989).
1994]                Implied Covenants-Past, Present & Future                               653


nant of further exploration in Texas. The critical question, the court
stated, is "whether the lessor could prove a reasonable expectation of
profit to lessor and lessee." Without a known producing formation, it
is nearly impossible to prove that a well would be profitable. 47

                                    VI.    MARKETING

      The cases arising from the implied covenant to market the prod­
uct from the lease have primarily concerned natural gas production.
Natural gas marketing has required extending expensive pipeline fa­
cilities to the point of production, and there has been a significant
disparity in pricing between the interstate and the intrastate markets
for gas, resulting from government control of wellhead prices. The
implied covenant is that the lessee has a duty to use due diligence in
marketing the product once it has been discovered and produced.48
      Although the phrase "due diligence" is used generally, the courts
put more emphasis on good faith in this context than in the "reason­
able development" cases. Courts give greater deference to the busi­
ness decisions of the lessee even when in hindsight they seem not to
have been the most favorable ones for the lessor or even for the
lessee. 49
      The relationship between the royalty clause and the implied cove­
nant to market is the subject of some controversy. In jurisdictions that
follow the Vela so market value rule it may be urged that the marketing
covenant has a somewhat diminished role in comparison with a Tara­
typeS1 jurisdiction. That is to say, if the lessor is to be paid royalty on
the basis of the market value of the natural gas, then the terms that

    47. The earlier relevant Texas case was Clifton v. Koontz, 325 S.W.2d 684 ('Thx. 1959). It
seemed to imply that a further exploration covenant could be found in an appropriate case. That
seeming implication was the basis for the Fifth Circuit implying such a covenant in Sinclair Oil
and Gas v. Masterson, 271 F.2d 310 (5th Cir. 1959), cert. denied, 362 U.S. 952 (1960). A later
Texas appeals court decision "overruled" the Fifth Circuit. Felmont Oil Corp. v. Pan American
Petroleum Corp., 334 S.W.2d 449 (Tex. Civ. App. 1960). See Weymouth v. Colorado Interstat~
Gas Co., 367 F.2d 84, 102 n.57 (5th Cir. 1966).
    48. On the marketing covenant generally, see Bruce M. Kramer & Chris Pearson, The Im­
plied Marketing Covenant in Oil and Gas Leases: Some Needed Changes for the 80's, 46 LA. L.
REV. 787 (1986). Relevant points are also considered in several recent articles. David E. Pierce,
Royalty Calculation in a Restructured Gas Market, 13 E. MIN. L. INST. 18-1 (1992); James C.T.
Hardwick & J. Kevin Hayes, Gas Royalty Issues Arising from Direct Gas Marketing, 43 INsT. ON
OIL & GAS L. & TAX'N 11-1 (1992).
    49. See Greenshields v. Warren Petroleum Corp., 248 F.2d 61 (10th Cir.), cert. denied 355
U.S. 907 (1957); Waechter v. Amoco Production Co., 537 P.2d 228 (Kan. 1975). See also Nor­
dan-Lawton Oil & Gas Corp. of Texas v. Miller, 272 F. Supp. 125, 137 (W.D. La. 1967) ("opera­
tors are not held to such an all-knowing standard that is only revealed by ex post facto
judgments"), 276 F. Supp. 16 (W.D. La. 1967), affd 403 F.2d 946 (5th Cir. 1968).
    50. Texas Oil & Gas Corp. v. Vela, 429 S.W.2d 866 (Tex. 1968). A full discussion of the
market value controversy is beyond the scope of this paper; for more background on this subject,
see the articles cited supra note 48 and Allen K. Harris, Jr., Gas Royalties-Leading State and
Federal Cases Reviewed: Alice's Adventures in "Royalty-Land",37 OKLA. L. REv. 699 (1984).
    51. Tara Petroleum Corp. v. Hughey, 630 P.2d 1269 (Okla. 1981), cerro denied sub. nom.
Shell Oil Company v. Piney Woods Country Life School, 471 U.S. 1005 (1985).
654                              Washburn Law Journal                                   [Vol. 33


the lessee agrees to for the natural gas sale are largely irrelevant, par­
ticularly price. The marketing covenant is reduced simply to selling
the gas at some terms so as to set the stage for the payment of royalty
on the basis of market value. 52 This seems to me to miss the mark, but
then I do not think that the Vela line was rightly decided. We are now
in a new era of gas marketing, the dimensions of which are not fully
developed. Yet historically gas price has been related to a number of
other contract terms. In a Tara-type jurisdiction one will inquire
whether the lessee has marketed as a prudent operator. The same
inquiry should be made in any jurisdiction when the lease provides for
royalty to be paid on the basis of the proceeds of the lessee's sale.
     Several interesting controversies have been litigated in recent
years that involve the implied covenant of marketing. One of the
most controversial has been whether the lessor/royalty owner is to re­
ceive a share of take-or-pay payments and gas purchase contract liti­
gation settlements. The cases denying the royalty owner a share of
such payments have largely turned on the express terms of the royalty
clause.53 However, an implied covenant analysis can be made, and
that approach was part of the decision in Frey v. Amoco Production
Co. ,54 the first court opinion that has allowed the royalty owners a
share of take-or-pay settlements in rather broad terms.
     The Louisiana Supreme Court in Frey v. Amoco addressed the
obligation of a lessee to pay royalty to its lessors on money it received
from a purchaser of gas under a take-or-pay clause. 55 Although ob­
serving that the "purpose of interpretation is to determine the com­

    52. Of course, the lessee probably needs to do this in most jurisdictions anyway to satisfy
the habendum clause of the lease. See Thomas A. Harrell, Recent Developments in Nonregu­
latory Oil and Gas Law, 31INST. ON OIL & GAS L. & TAX'N 327 (1980). "The decision of the
Texas Supreme Court in Vela is logically indefensible unless one is in fact willing to abandon the
implied obligation to market as being inconsistent with the intention of the parties to the ordi­
nary oil and gas lease containing a market value royalty." Id.330.
    53. Hurd Enterprises, Ltd. v. Bruni, 828 S.W.2d 101 (lex. Civ. App. 1992); Wyoming v.
Pennzoil Co., 752 P.2d 975 (Wyo. 1988); Gerard J.W. Bros. & Co., Inc. v. Harkins & Co., 883
F.2d 379 (5th Cir. 1989); Diamond Shamrock Exploration Co. v. Hodel, 853 F.2d 1159 (5th Cir.
1988).
    54. 603 So. 2d 166 (La. 1992).
    55. In this case, royalty owners brought suit for royalty they claimed was due under a settle­
ment their lessee, Amoco, had made with the buyer of gas, Columbia. Amoco had paid them
royalty on the $280.2 million portion of the settlement that reflected payment for past and future
price deficiencies but not the $66.5 million portion that was for take-or-pay deficiencies. $45.6
million of the total was a recoupable take-or-pay payment and the remaining $20.9 million was a
non-recoupable take-or-pay payment. By "recoupable" it is meant that the buyer can offset the
cost of future gas takes by the amount of the payment. The federal district court held that
royalty was not due on the take-or-pay portion of the settlement because a sale of gas did not
occur without physical production and severance of the gas; thus, under Louisiana law, take-or­
pay payments did not constitute part of the sale price of natural gas. Frey v. Amoco Production
Co., 708 F. Supp. 783, 786 (E.D. La. 1989). On appeal to the Fifth Circuit, that court reversed,
holding that take-or-pay payments were part of the "amount realized" from the sale of gas under
the lease form in question, and such payments were thus subject to the lessor's royalty. Frey v.
Amoco Production Co., 943 F.2d 578 (5th Cir. 1991), op. withdrawn, in part, on reh'g, ques.
certified, 951 F.2d 67 (5th Cir. 1991) (per curiam). The defendant filed for rehearing, and the
Fifth Circuit then withdrew the portion of its opinion on the entitlement of the plaintiffs to a
1994]               Implied Covenants-Past, Present & Future                             655

mon intent of the parties" the Frey court nevertheless said that "a
search for the parties' specific intent relative to the obligation to pay
royalty on the take-or-pay proceeds would prove fruitless."56 The
court therefore had to look to the nature of the relationship to under­
stand the parties' "general intent in entering an oil and gas lease." A
lessor, said the court, would not relinquish a valuable right without
receiving something in return. Obligations were implied in oil and gas
leases to effectuate the basic objectives of the lease. The lessee had an
obligation to market oil and gas as a prudent operator under the Min­
eral Code. Thus the court concluded that the lessor should receive a
share of take-or-pay settlement benefits flowing to the lessee. The
court declared:
         [A]n oil and gas lease, and the royalty clause therein, is ren­
     dered meaningless where the lessee receives a higher percentage of
     the gross revenues generated by the leased property than contem­
     plated by the lease. The lease represents a bargained-for exchange,
     with the benefits flowing directly from the leased premises to the
     lessee and the lessor, the latter via royalty. An economic benefit
     accruing from the leased land, generated solely by virtue of the
     lease, and which is not expressly negated ... is to be shared between
     the lessor and lessee in the fractional division contemplated by the
     lease. 57
      Looking to the prudent operator obligation of the Mineral Code
that requires the lessee to enjoy the thing leased as a good administra­
tor, the court observed the lessee has the duty to market diligently and
thus to obtain the best price reasonably possible. The court noted that
without the take-or-pay clause, the buyer of gas would presumably
have to pay a higher price for the gas, and thus the royalty owner
ought to share in the benefits accruing to the lessee under the take-or­
pay clause of a gas purchase contract. Likewise, take-or-pay pay­
ments effectively increase the price for the gas paid by the pipeline,
and the royalty owner is entitled to share in that price. Moreover, the
benefits accruing to the lessee under the gas purchase contract are
derived from the lease itself, and the lessor should enjoy a portion of
those benefits. The court was also concerned with avoiding opportu­
nistic behavior that would be encouraged by a contrary approach: 58

royalty interest on the proceeds of the take·or-pay settlement and certified to the Louisiana
Supreme Court the question of the lessee's liability for royalty.
    56. 	 Frey, 603 So. 2d at 181:
           As we have stated, the duty before us is not to divine the intent of the royalty
     clause in the abstract. Rather. the process reflects our appreciation of the cooperative
     nature of the lease arrangement as well as an understanding of the economic and prac­
     tical considerations underlying the royalty clause.
ld.
    57. Id. at 174.
    58. Id. at 182 (citations omitted).
656                               Washburn Law Journal                                  [Vol. 33

           The practical considerations sustain our position. For example,
      "if lessors did not share in take-or-pay payments, lessees would
      have an incentive to compromise volume gas prices under their con­
      tracts or settlements with pipelines in exchange for favorable take­
      or-pay terms." .... Accordingly, we fmd justice best served by the
      decision we reach today.
The Frey opinion is a landmark decision that will long affect the rela­
tionship between lessor and lessee in Louisiana.59
     In several cases plaintiffs have tried to second-guess the lessee on
specific marketing decisions. In Robbins v. Chevron U.S.A., Inc.,6O
the plaintiff claimed that the lessee had made marketing decisions that
were imprudent, but the Kansas Supreme Court could find no basis
for determining that a prudent operator would have done anything
other than what this lessee had done. The court observed: "It is not
the place of courts, or lessors, to examine in hindsight the business
decisions of a gas producer." In Davis v. CIG Exploration, Inc. ,61 it
was claimed that the lessee should have included a price-redetermina­
tion clause in the contract. The court concluded that the federally reg­
ulated price was the market price and thus the lessee had not
breached its marketing duties. 62
     The Robbins and Davis cases were properly resolved in favor of
the lessee by the courts; the lessors' interest and the lessees' interests
were mutual. Yet there arise occasions when the interests of lessee
and lessor are not mutual in the marketing of natural gas. One such
situation is when a producer becomes committed to a sale of gas to a
pipeline or consumer at a fixed price and only later secures a lease to
commit to the sales contract. The royalty clause may provide ex­
pressly that the lessee will pay royalty on the basis of the proceeds

    59. The lead attorney for the plaintiffs in the Frey case was the late Frederick Ellis, a close
friend and former colleague of the author. He was a zealous advocate for the interests of lessors,
and this paper is affectionately dedicated to his memory.
    60. 785 P.2d 10to (Kan. 1990). But see Thcker v. Hugoton Energy Corp., 855 P.2d 929
(Kan. 1993), where the Kansas Supreme Court ruled that because at the time of a shut-in there
was a limited market available to defendants-lessees for the gas producible from the six wells at
issue, the shut-in royalty clauses could not be invoked to perpetuate the leases; the court appar­
ently relied on the marketing covenant as a basis for saying that the shutting-in of wells was not
prudent.
    61. 789 F.2d 328 (5th Cir. 1986).
    62. The court noted wryly in a footnote:
          We realize that our conclusion that Exploration did not breach its duty to reason­
     ably market may appear harsh in light of the fact that the Davises' neighbors received
     substantially more royalties for similar gas and that the Davises had no control over
     who would be their ultimate lessee. We note, however, that the Davises' past misfor­
     tune may now be their good fortune. With the recent decline in the price paid for
     natural gas, the Davises may receive more than the market price for gas, and the price
     the Davises receive will escalate annually while the market price for gas may fluctuate.
     We further note that the amount of royalty lessors receive is often beyond the control
     of the lessor. Had Exploration discovered the gas before February 19, 1977, or above
     15,000 feet, the National Gas Policy Act would not have classified the gas as section 107
     gas and deregulation would have occurred at a later date.
[d. at 334.
1994]             Implied Covenants-Past, Present & Future           657


received, but the lessor may not even be aware that the lessee has a
prior commitment to sell the gas on terms that may well be lower than
what would be possible if the lessee were not burdened by that ex~
isting contract. Should the lessee in such circumstances be found in
breach of the marketing covenant? I would think so. The Arkansas
Supreme Court in Diamond Shamrock Corporation v. Harris 63
thought so too.
     The lease in question in Diamond Shamrock was entered into
July 1, 1977. The lessee was already a party to a long-term gas
purchase contract with Arkla, Inc., dated December 7, 1971, that cov­
ered all production by Diamond Shamrock from wells in an area in~
cluding the acreage leased from Harris. The 1977 lease provided for
gas royalty based upon market value at the well for production sold or
used off the premises, and based upon proceeds from gas sales at the
well. The lessee asserted that the market value for gas produced from
the Harris lease was established by the 1971 Arkla contract. The les­
sor claimed royalties based on market value. The Arkansas Supreme
Court affirmed the trial court's ruling that the lessor was entitled to
royalty based upon market value; this value was determined to be the
price paid other participants in the same well. The Arkansas court
concluded that it would be unfair to hold the lessor to a gas contract
price which the lessor was neither aware of nor a party to.
     The facts in Ainsworth v. Calion Petroleum CO.64 were similar to
the facts of Diamond Shamrock Corporation v. Harris. The Missis­
sippi Supreme Court found no breach of a duty in Ainsworth but I
would hasten to note that the royalty owners and the producer settled
before the conclusion of the trial, and the disposition of the case only
involved the liability of the gas buyer. Thus it should be a rather weak
basis for saying that the marketing covenant of the lessee does not
extend to getting the best terms that a prudent operator could get. I
would think that there would be at the very least a duty to disclose
such a prior arrangement to the lessor.
     A case that properly requires the lessee to look to the interests of
each lessor is Amoco Production Co. v. First Baptist Church. 65 The
lease in this case also provided for royalty based on the amount real­
ized from the sale. Some twenty months after the well began produc­
ing gas, Amoco committed the gas to long-term contracts on terms
approximately one-half of the amount at which gas was then being
sold to other purchasers from the same well; there was no right of
future price redetermination based on market increases. According to

   63. 681 S.W.2d 317 (Ark. 1984).
   64. 521 So. 2d 1272 (Miss. 1987).
   65. 579 S.W.2d 280 (Tex. Civ. App. 1979).
658                             Washburn Law Journal                               [Vol. 33

the court, Amoco obtained for itself extra benefits in respect to other
properties in which the appellees had no interest. The court con­
cluded that the lessee had breached its marketing duty.

                    VII.    RESTORATION OF THE SURFACE

      One area in which I would anticipate expansion of implied cove­
nants is the obligation of the lessee to restore the surface. 66 The
courts of only a few states now recognize such a duty. This may be
because most leases give express rights to use the land for oil and gas
development and also make some provision for damages to the land.
A prudent lessee in today's legal environment will make agreements
with landowners that spell out precisely what the lessee will and will
not be responsible for.
      Many courts have refused to impose an implied contractual duty
to restore the surface estate to its original condition as it existed prior
to the commencement of drilling operations in the absence of an ex­
press provision in the minerallease.67 Some states have enacted stat­
utes which expressly impose strict liability upon the drilling operator
for surface damage caused by his operations despite the rule that the
owner of the mineral estate may use so much of the surface estate as is
reasonably necessary for his drilling operations.68 We can compare
and contrast the differing approaches in several recent decisions.
     In a New Mexico case, Amoco Production Co. v. Carter Farms,69
Carter Farms Company brought suit to recover damages for the al­
leged negligent construction and operation of Amoco's drilling site
and the alleged willful and wanton refusal by Amoco to restore the
area in question to the condition it was in prior to the commencement
of its oil and gas operations. Amoco filed an answer denying liability
and asserting in defense that Amoco's use of a 4.53-acre site for its
well was reasonable and necessary to fully effectuate Amoco's rights
and obligations under its oil and gas lease. Amoco also counter­
claimed, asserting that Carter Farms unjustly and unreasonably inter­
fered with Amoco's attempts to prepare and make reasonable use of
the drill site.
     The jury returned a verdict in favor of Carter Farms, but the trial
court refused to accept that part of the jury's verdict which returned
damages in the amount of $13,485 for the cost of restoring the reserve­
    66. See generally James M. Colosky, The Implied Covenant for Diligent and Prudent Opera­
tions in an Environmental Era, 39 ROCKY MTN. MIN. L. INST. ch. 15 (1993).
    67. The cases are collected and discussed in Karen L. Ellmore, Annotation, Duty of Oil or
Gas Lessee to Restore Surface of Leased Premises upon Termination of Operations, 62 A.L.R.
4TH ll53 (1993).
    68. See N.D. CENT. CoDE §§ 38-11.1·01 to ·10 (1980 & Supp. 1983); MONT. CoDE ANN.
§§ 82·1O-S01 to -511 (1983); OKLA. STATS. ANN. tit. 52, §§ 318.2 to -9 (West Supp. 1984-85).
    69. 703 P.2d 894 (N.M. 1985).
1994]               Implied Covenants-Past, Present & Future                              659


pit area constructed to service the drilling site occupied by Carter
Communitized No. 1 Well. The court granted judgment to Amoco
notwithstanding the verdict. Carter Farms appealed, objecting to the
denial of damages for the cost of restoring the surface area occupied
by Amoco's reserve pit. The Court of Appeals reversed the trial court
with instructions to reinstate the jury verdict, holding that there is an
implied duty to restore the surface estate to its original condition as
nearly as possible. The New Mexico Supreme Court reversed and af­
firmed the trial court.
      The New Mexico Supreme Court observed that Carter Farms re­
fused to allow Amoco to level the reserve pit and clean all debris from
the drilling site in this manner. Carter Farms insisted that Amoco
completely restore the surface area of Carter Communitized No. 1
Well to its original condition by removing from the premises all of the
drill cuttings and contaminated soils. The market value of the land
occupied by the reserve pit was $500 for pasture purposes. The jury
found that the cost of completely restoring the site to its original con­
dition amounted to $l3,485. It was undisputed that the use of such a
pit is necessary to the drilling operation of any exploratory or test
well. Amoco, said the court. is entitled to use as much of the surface
area as is reasonably necessary for its drilling and production opera­
tions. The trial court found that Amoco's proposed method of level­
ing the reserve pit and cleaning the debris was reasonable. The
Supreme Court rejected a private nuisance theory, saying recovery or­
dinarily can be based upon standard theories of negligence.70 The
court held that damage to the surface estate by the owner of the min­
eral estate is founded upon the unreasonable, excessive or negligent
use of the surface estate. The measure of damages under a negligence
theory of liability for permanent damage to real property is the differ­
ence between the fair market value of the land prior to the injury and
the fair market value of the land after the full extent of the injury has
been determined.
      A contrast to Amoco Production Co. v. Carter Farms is seen in
the Arkansas decision in Bonds v. Sanchez-O'Brien Oil & Gas Co. 71
The landowner sued the oil and gas lessee for failure to restore the
surface of the property after the wells were plugged and abandoned.
The Arkansas court reversed a verdict for the lessee and held that the
operator of an oil and gas lease had an implied duty to restore the
surface of the land as nearly as practicable to the same condition it

    70. ld. at 120, citing Marvin D. Truhe, Surface Owner vs. Mineral Owner or "They Can't Do
That, Can They?", 27 S.D. L. REV. 376 (1982).
    71. 715 S.W.2d 444 (Ark. 1986); see T. Craig Jones, Implied Covenant To Restore Surface­
Judicial "Wildcatting" Yields Valuable Rights for Surface Owners: Bonds v. Sanchez-O'Brien Oil
& Gas Co., 41 ARK. L. REV. 173 (1988).
660                             Washburn Law Journal                                 [Vol. 33


was in prior to the commencement of operations. Although observing
that the majority of courts have found that there is no implied duty to
restore the surface of the land to its original condition, the Arkansas
court concluded that the current trend was toward placing the burden
of restoration on the lessee. The lessee was in the better position to
bear the responsibility for restoring the surface to its original use even
without an express provision in the lease to that effect. Instead of
placing the burden on the landowner to specify a restoration require­
ment in the lease, the burden should be on the oil and gas lessee to
negate this responsibility. This would, said the court, recognize con­
cern for the environment, and it would prevent the lessee from contin­
uing to occupy the surface long after the lease ended by virtue of the
unrestored condition of the land, thus constituting an unreasonable
use.
     I suspect that the Arkansas position is likely to prevail over the
longer term. Pollution or damage to land is the modern counterpart
to blasphemy and heresy in an earlier society; it is secular sin, sin that
can be expiated only by confession and penance (in the form of dam­
ages and fines) and perhaps time in prison.72 I would anticipate that
this view of harm to the environment will provide the impetus to a
wider recognition of the implied duty to restore the land.
     A glimpse of the future may be provided by the Louisiana case of
Broussard v. Waterbury.73 In this case, a lessee who took over the
operation of oil wells that were already there when he was granted the
lease and then left property in same condition as it was in when he
took over the operation, was held to have the obligation to restore the
land to the same state as before drilling and production. Note that the
lessee was not the assignee of the prior lessee, yet the lessee was re­
quired to restore the surface to a condition that was better than when
he took the lease. Other recent cases out of Oklahoma74 and Louisi­
ana75 reflect a significant judicial concern for well-site conditions that
can lead to the imposition of large liability to the lessee, though these
were not implied covenant cases as such.

                   VIII.    THE ADMINISTRATIVE COVENANT

    There is an emerging body of law to the effect that conservation
regulation imposes certain duties on lessees. 76 This developing trend
     72. E.g., United States v. Mills, 817 F. Supp. 1546 (N.D. Fla. 1993).
     73. 346 So. 2d 1342 (La. Ct. App. 1977).
     74. Marshall v. EI Paso Natural Gas Co., 874 F.2d 1373 (10th Cir. 1989).
     75. Magnolia Coal Terminal v. Phillips Oil Co., 576 So. 2d 475 (La. 1991).
     76. The seminal work in this area is by Professor Maurice Merrill, who was also responsible
for the leading work on implied CQvenants. See Maurice Merrill, Current Problems in the Law of
Implied Covenants in Oil and Gas Leases, 23 TEx. L. REv. 137, 140 (1945) and Maurice Merrill,
Fulfilling Implied Covenant Obligations Administratively, 9 OKLA. L. REV. 125 (1956). See also
1994]                Implied Covenants-Past, Present & Future                                661

would recognize a duty on lessees to seek favorable administrative
action when it would be of mutual benefit to lessor and lessee to do
so. One might look at this duty also as a means of fulfilling other
implied covenants, as the duty to represent the lessor will arise in con­
nection with some other action that the lessee should undertake, such
as additional drilling or marketing.77 Several cases show the duty and
illustrate its application.
      In Baldwin v. Kubetz ,78 the lessee said he could not drill addi­
tional wells to fulfill the implied covenant of reasonable development
because of zoning restrictions. The court held that there could be a
duty for the lessee in such circumstances to seek a zoning exception to
permit drilling as the lessee had done for drilling some other wells.
     The lessor in Sinclair Oil & Gas Co, v. Bishop79 claimed that the
lessee should have produced oil from a shut-in well on the lease to
prevent drainage by neighboring wells that were producing oil. The
lessee asserted as a defense that the reservoir was primarily gas and
that it would have to flare much gas to produce any oil; thus, it was
not acting imprudently by waiting for a market for the gas before pro­
ducing oil. The court agreed with the lessee that it was not acting
imprudently in not producing but that to prevent drainage the lessee
should have gone to the Corporation Commission to stop the wasteful
flaring of gas on the adjacent land. 80
     The court stated:

the thorough exploration of the topic in Lawrence Donohoe, Implied CovelUmts in Oil and Gas
Leases and Conservation Practice, 33 INST. ON OIL & GAS L. & TAX'N 97 (1982).
    77. Dean Eugene Kuntz has made the following observations on the administrative cove­
nant in connection with the case of Sunray DX Oil Co. v. Crews, 448 P.2d 858 (Okla. 1969)
(discussed infra notes 82-85 and accompanying text):
          The various implied covenants that have been identified and classified deal princi­
     pally with some phase of the lessee's exercise of operating rights. That is, they have to
     do with drilling exploratory wells, drilling development wells, drilling offset wells to
     protect against drainage, operating wells in a diligent manner, and marketing the prod­
     uct. Each such operation may resort to administrative procedure, either as a routine
     matter (such as seeking a drilling permit) or as a formal and perhaps controversial
     matter (such as seeking a permit to drill an exception well). In either case, if resort to
     administrative procedure is required in order to perform some obligation relating to
     operation, the lessee should be required to seek administrative relief as part of his
     fundamental duty to perform the required operation.
Eugene Kuntz, Discussion Notes, 32 Oil & Gas Rep. 214.
    78. 307 P.2d 1005 (Cal. Ct. App. 1957).
    79. 441 P.2d 436 (Okla. 1968).
    SO. A case offering an interesting contrast to Bishop is Osborn v. Texas Oil & Gas Corp.,
661 P.2d 71 (Okla. Ct. App. 1983). A six-section fieldwide unit had been formed, and oil was
being produced from the reservoir by a combination of reservoir gas pressure and water injec.
tion. TXO then drilled a new well outside the unit and began producing gas from the same
reservoir. The unit operator, apparently fulfilling its duty to act as a reasonable prudent opera·
tor, went to the Corporation Commission to limit TXO's production so as not to waste the
reservoir energy needed for the enhanced oil production program. The commission declined to
do so because TXO's royalty owners would not agree to the unit; the commission felt it lacked
the power in such circumstances to limit production. The unit operator appealed, and the court
reversed the commission. Once the commission found that waste existed, it had a duty to pre·
vent it.
662                              Washburn Law Journal                                 [Vol. 33

           Necessarily, we determine the lessee was acting prudently when
      he ascertained that it was illegal and improper to flare gas in the
      quantities shown by the evidence, in order to produce the unallo­
      cated allowable of oil. The ensuing question is whether lessee was
      acting in its own interest and in the interest of lessors when it per­
      mitted the offset wells to flare great quantities of gas while produc­
      ing oil? We think not. .... We take judicial notice of the statutes
      which permit any interested party to seek relief from the Corpora­
      tion Commission for the protection of his correlative rights.
      Although both the lessor and the lessee had access to the Corpora­
      tion Commission for relief, we feel the greater responsibility was
      with the lessee. S!
      In Sunray DX Oil Co. v. Crews,S2 the plaintiffs were lessors of a
quarter section of land. They learned that another lessee on a tract to
the immediate north was submitting an application to the Corporation
Commission to be given permission to produce a well at 180 percent
of the allowable applicable to an eighty-acre unit through attribution
of additional acreage to the well. The lessors sought to have the de­
fendant lessee oppose the application before the Corporation Com­
mission, in order to protect the lessors against drainage. The
defendant declined to do so, saying that the wells they had would ade­
quately protect against drainage and achieve maximum recovery of
oil. The lessors then hired an attorney and an engineer and appeared
before the Corporation Commission to oppose the application. The
commission granted the application over the plaintiffs' protests, and
the orders were affirmed despite a court challenge. s3 Undaunted, the
lessors then sought cancellation of the lease and damages for breach
of implied covenants; in the alternative, they sought to require the
defendant to assist in opposing other applications pending before the
Corporation Commission. The Oklahoma Supreme Court overturned
a trial court judgment for the plaintiffs. The court did not rule out the
existence of an implied covenant to represent the lessorB4 though it
found that such a duty had not been breached under the facts of the
case when the lessee was justified in relying on its own experts'
judgment.BS

    81. Bishop, 441 P.2d at 447.
    82. 448 P.2d 840 (Okla. 1968).
    83. 413 P.2d 508 (Okla. 1966).
    84. The court observed that Professor Merrill's theory had been subject to criticism, citing
Jack Conn, Trends in the Application of the Implied Covenant of Further Development, 12 OKLA.
L. REV. 470, 485 (1959) and John F. Eberhardt, Effect of Conservation Laws, Rules and Regula­
tions on Rights of Lessors, Lessees, and Owners of Unleased Mineral Interests, 5 INST. ON OIL &
GAS L. & TAX'N 125, 151 (1954).
    85. The court stated:
          [W]e are of the view that defendant's reliance on the judgment of its own experts
     in determining to present no defense (on behalf of its lessors) against applications flied
     with the Oklahoma Corporation Commission for increased oil a1lowables from the ad­
     jacent oil and gas leases surrounding the lease operated by such lessee was reasonable
     under the circumstances of this case and the lessors having failed in their own efforts in
     such behalf, that the order of the trial court, based upon the theory of implied cove­
1994]               Implied Covenants-Past, Present & Future                                663


      A year after the decision in Sunray DX Oil Co. v. Crews the
Oklahoma Supreme Court was again presented with a claim of breach
of an implied covenant to represent the lessor administratively. This
occurred in Hall Jones Oil Corp. v. Claro 86 in which the lessors urged
that the lessee had a duty to seek administrative relief if spacing regu­
lations prevented the lessee from protecting the lessors against drain­
age. The court found it unnecessary to address the issue as the
defendants would not be allowed to benefit from their wrongdoing,
adding "Oklahoma has not decided this specific question. "87
      In Forman v. MacKellar Drilling Co. ,88 a lessor brought suit
against his lessee for cancellation of a lease for failure to develop and
failure to protect against drainage. The lessor also sought to recover
the plaintiffs expense in resisting an application filed by another party
before the Corporation Commission on the theory that the lessee had
the duty to resist the application, relating to operations on a contigu­
ous lease, and failed to discharge that duty. The trial court granted
summary judgment for the defendant. The Oklahoma Supreme Court
reversed and remanded, thus indicating that recovery on such a theory
was possible. There is no subsequent report of the disposition on re­
mand, and thus the Oklahoma courts did not have occasion to give
further discussion of this theory in this case.
      The Tenth Circuit in a case arising in Oklahoma has upheld a
decision in favor of a lessor based on the premise that there is an
administrative covenant in Oklahoma. In Spaeth v. Union Oil Co. of
California,89 Union had refused to take steps to offset drainage it was
causing and opposed efforts by its lessor to get an offset well through
administrative relief from the Corporation Commission. The trial
court jury had awarded $22,807 in actual damages and three million
dollars in punitive damages. In affirming liability at an earlier phase
of the litigation, the Tenth Circuit stated: "Union had a duty, which it
could not ignore, to seek administrative relief [from the spacing and
drilling order]."90 However, the Tenth Circuit revised the actual dam­
ages to $17,452 and remanded the punitive damages for further pro­


      nants so to do, requiring defendant to furnish representation to plaintiff lessors in fu·
      ture hearings on such applications and to reimburse lessors for past expenses in
      litigating some of such applications, being clearly against the weight of the evidence,
      should be reversed.
Sunray DX. 448 P.2d at 845.
     86. 459 P.2d 858 (Okla. 1969).
     87. ld. at 863.
    88. 43 OKLA. B.J. 457, 41 Oil & Gas Rep. 65 (Okla. 1972).
     89. 762 F.2d 865 (10th CiT. 1985).
     90. Spaeth v. Union Oil Co. of California, 710 F.2d 1455, 1458 (10th Cir. 1983). citing Sin­
clair Oil & Gas Co. v. Bishop, 441 P.2d 436 (Okla. 1967).
664                               Washburn Law Journal                                  [Vol. 33

ceedings, as the court found the amount shocking to their collective
judicial conscience.91
     The Louisiana Court of Appeals held in Pierce v. Goldking
Properties, Inc. 92 that a lessee may fulfill the implied covenant to pro­
tect against drainage by drilling a well or by seeking a unit from the
state agency. Since the lessee had sought a unit in the manner of a
prudent operator, he had not breached his obligation to protect
against drainage.
     A case arising in Louisiana was the subject of a Fifth Circuit opin­
ion indicating the possible existence of an administrative covenant re­
lated to the duty to prevent drainage. However, the case held that the
claim could not be heard as it was a collateral attack on an order of
the Louisiana Commissioner of Conservation. In Trahan v. Superior
Oil Co. ,93 the lessors alleged that the lessee failed to present fairly
certain evidence at agency unitization hearings, and as a result their
acreage was not included in a unit. They did not allege fraud, lack of
good faith, or intentional deception. The court found the suit to be an
impermissible collateral attack on an order of the Commissioner of
Conservation. However, the court discussed and intimated that there
may well be a breach of a duty to the lessor when the lessee has not
taken an appropriate matter to the administrative agency. The court
stated:
           We do not suggest that where, after a unit order is entered,
      subsequent developments, such as those arising from new wells or
      reported pressure changes or the like, indicate the unit should be
      changed, the lessee is necessarily free to disregard such develop­
      ments simply because of the prior order. The lessee may be under a
      duty to have the matter of unit amendment brought before the
      Commissioner, or to inform the lessor so he can do so. Breach of
      such a duty might authorize relief predicated on adequately estab­
      lished proof as to what action the Commissioner would have taken,
      had he acted in the premises. 94

     91. Spaeth, 710 F.2d at 1460. On remand, the trial court directed the plaintiff to remit one
million dollars and entered a judgment for punitive damages in the amount of two million dol­
lars. Considering the "egregious" conduct of the defendant and the net worth of the defendant
($3.3 billion), the court did not find two million dollars shocking to the collective judicial con­
science. Spaeth v. Union Oil Company, 762 F.2d 865 (10th Cir. 1985).
     92. 396 So. 2d 528 (La. Ct. App. 1981).
     93. nahan v. Superior Oil Co., 700 F.2d 1004 (5th Cir. 1983).
     94. ld. at 1025. See also Savoy v. TIdewater Oil Company, 218 F. Supp. 607 (W.D. La.
1963), affd 326 F.2d 757 (5th Cir. 1964). The Savoy court succinctly stated the points relevant to
this topic as follows:
           It is the position of plaintiff that the lease should be cancelled because TIdewater
      did not recommend to the Commissioner the inclusion of Mr. Savoy's land in perma­
      nent Unit No. 8-6, as his experts indicate that this land can be more effectively drained
      by the well serving that Unit. This argument is clearly without merit for two reasons,
     first, the plaintiff did not exhaust his administrative remedies at the Commissioner's
      hearing, he offered no evidence, made no objection nor did he take any other action at
      that time to bring the matter into focus as provided by the Louisiana Statute in ques­
      tion, LSA-R.S. 30:1, 6, and secondly, because the decision taken as a result of the infor­
1994]              Implied Covenants-Past, Present & Future                            665

      A case somewhat similar to Trahan was decided by a federal
court in North Dakota. The claim in Murphy v. Amoco Production
CO.95 was that the lessee had misrepresented certain geological facts
at well-spacing hearings that caused that plaintiff to incur substantial
expenses to protect its correlative rights. Based on the evidence, the
court could not conclude that the lessee did not act fairly and in good
faith. It may be observed that while the court apparently treated the
matter as involving what would be described as the administrative
covenant, the court discussed the lessee's duties of exercising its pool­
ing powers under the lease. The lease had a pooling clause, but it is
obvious from the facts given by the court that the clause was not used
in pooling; instead, the issues raised related solely to applications and
appearances before the North Dakota Industrial Commission.
     Several Texas cases have indicated the existence of the implied
covenant to represent the lessor administratively. In Bolton v.
Coats ,96 the Texas Supreme Court indicated the possibility that a
lessee might have the duty to seek administrative relief by getting a
permit to allow the drilling of additional wells so as to prevent drain­
age. In Bolton the Railroad Commission had classified a well as a gas
well. An owner of overriding royalty brought suit against the lessee/
well operator for breach of express and implied covenants of the
lease, claiming the lessee should have drilled additional wells in the
Burnett sand to offset drainage by adjacent oil wells. The court ruled
that the classification of the well as a gas well in the Burnett sand was
not tantamount to a finding that there were no separate oil-productive
horizons or segments of the Burnett sand anywhere underneath the
673 acres of the gas production unit. The Texas court stated:
         In no event does the order shield Coats and his assignees from
     damages due to drainage of oil from the Burnett sand by wells on
     adjacent leases if it is found that a reasonably prudent operator
     would have sought a permit to drill protective off-set wells on the
     673 acres. 97
     The Texas Supreme Court more expressly indicated the existence
of the administrative covenant and the duty to seek voluntary unitiza­
tion in a 1981 case. In Amoco Production Co. v. Alexander,98 the les­
sors, located down dip in a field, claimed the lessee was causing

     mation submitted at the hearing is the decision of the Commissioner, and not the
     defendant Tidewater, and as such it is not subject to collateral attack.
218 F. Supp. at 609.
     See also Mayer v. Tidewater Oil Company, 218 F. Supp. 611 (W.O. La. 1963) (to the same
effect).
    95. Murphy v. Amoco Production Co., 590 F. Supp. 455 (D. N.D. 1984).
    96. 533 S.W.2d 914 (Tex. 1975), rev'g 514 S.W.2d 482 (Tex. Civ. App. 1974).
    97. Id. at 917.
    98. 622 S.W.2d 563 (Tex. 1981) (discussed in more detail supra note 12 and accompanying
text).
666                           Washburn Law Journal                [Vol. 33


drainage of their land by the lessee's updip wells on other leases. The
lessee defended on the ground that it was not allowed by the Railroad
Commission to drill additional wells to prevent drainage. The court
held the lessee had a duty under the circumstances to seek Rule 37
exception wells or to seek from the other operators the creation of a
voluntary unit. In this way the lessee could have fulfilled its obligation
to protect against drainage.
     In U. V. Industries, Inc. v. Danielson,99 the Montana Supreme
Court ruled, in response to an assertion from the defendant lessees
that the lessor should have sought an exception well permit if it
wanted to prevent drainage, that such a duty was on the lessees: "the
applicants [lessees] had a duty to apply for such a permit if one were
necessary under the implied covenant of good faith and fair
dealings. "100

                                IX.   THE FUTURE

                                A.    The Con-tort
     The implication of covenants has much in common with tort law.
The purpose of implying obligations in the oil and gas lease is gener­
ally to control the behavior of the lessee by holding it to a standard
that is the oil and gas analog to tort law's "reasonable man" standard.
One does find practitioners alleging "tortious breach of contract" in
implied covenant cases from time to time. The reason for such plead­
ings is not simple confusion about the nature of the claim but more
often a desire to achieve certain consequences. For example, the stat­
ute of limitations on a tort claim is typically much shorter than the
limitations period on breach of contract, but punitive damages may be
available for tort while not available for breach of contract; the plain­
tiffs attorney may wish the more favorable aspects of both and hence
alleges that the implied covenant claim embraces both tort and con­
tract. Grant Gilmore in The Death of Contract (1974) spoke of the
"reabsorption" of contract into tort.

                             B. Punitive Damages
     In recent years there has been a great rise in the United States in
the use of punitive damages to show disapproval of conduct by a de­
fendant. Oil and gas law has not been spared this development. The
Spaeth v. Union Oil Co. case discussed above may be a harbinger of
things to come. I should add that the Marshall v. El Paso case that
was also mentioned involved an award of punitive damages of five

   99. 602 P.2d 571 (Mont. 1979).
  100. Id. at 581.
1994]                Implied Covenants-Past, Present & Future                                 667

million dollars in circumstances that could easily arise in an implied
covenant setting.
     Thus far the Texas courts have rejected the application of puni­
tive damages to breach of implied covenants claims. lOl I would not be
surprised to see this change in light of the great willingness of the
Texas courts to allow most issues to go to a jury and in light of the
creative use of fraud claims in Texas to achieve punitive damages.

                         C.     Increased Statutory Influence

     Another development that has occurred and that may expand is
statutory changes that have the effect of obviating some implied cove­
nant litigation. A number of states have enacted statutory "Pugh
clauses" that, in effect, require additional development by a lessee to
maintain a lease.
     The Kansas Deep Rights Act, Kan. Stat. Ann. §§ 55-223 to 55-229
creates a presumption in favor a the lessor in a claim on an implied
development or exploration covenant, if:
           (a) At the time such action is commenced there is no mineral
      production pursuant to such lease from a subsurface part or parts of
      the land covered thereby with respect to which such relief is sought
      and
           (b) initial oil, gas or other mineral production on the lease
      commenced at least 15 years prior to the commencement of such
      action ....
     The presumption may be overcome by the lessee by a preponder­
ance of the evidence. The Act was upheld against various constitu­
tional attacks in Amoco Prod. Co. v. Douglas Energy Co. 102
     Arkansas has a statutory Pugh clause that applies to all leases
executed on or after July 1, 1983. It provides as follows:
          The term of an oil and gas or oil or gas lease extended by pro­
     duction in quantities [sic] in lands in one (1) section or pooling unit
     in which there is production shall not be extended in lands in sec­
     tions or pooling units under the lease where there has been no pro­
     duction or exploration. 103
    The act does not apply when drilling operations have commenced
on any part of lands in sections or pooling units under the lease within
one year after the expiration of the primary term, or within one year

   101. Amoco v. Alexander, 622 S.W.2d 563 (Tex. 1981) (discussed supra note 12 and accom­
panying text).
   102. 613 F. Supp. 730 (D. Kan. 1985).
   103. ARK. CODE ANN. § 15-73-201(a) (Michie 1987). In Crystal Oil Co. v. Warmack, 855
S.W.2d 299 (Ark. 1993), the court noted that the statute could not be applied because the lease
pre-dated the statute, but the court achieved the same result through its ruling under the implied
covenant because the statute "makes good sense." [d. at 301.
668                              Washburn Law Journal                                   [Vol. 33

after the completion of a well on any part of lands in sections or pool­
ing units under the lease. 104
     The Mississippi legislature provided a statutory rule similar to a
Pugh clause that applies to reservoir-wide units and not individual
well pooled units.1 05 It states:
           The portion of unit production allocated to a separately owned
      tract within the unit shall be deemed, for all purposes, to have been
      actually produced from such tract, and operations with respect to
      any tract within the unit area shall be deemed for all purposes to be
      the conduct of operations for the production of oil or gas, or both,
      from each separately owned tract in the unit area. Provided, how­
      ever, when an oil, gas and mineral lease contains land partially
      within and partially without said unit area, the unit agreement and
      production from the unit shall have no force and effect on lands
      lying outside of such unit area and failure of the lessee or lessees
      thereof to drill and develop such lands lying outside said unit area
      within one (1) year or during the term of the lease, whichever is a
      longer period of time, from the date of the determination of the unit
      area by the State Oil and Gas Board shall render such lease or
      leases on lands outside said unit area void and of no force and ef­
      fect, unless otherwise held by production other than from unit
      production.
     The Oklahoma legislature also enacted a statutory Pugh clause in
1977. It provides that acreage of a lease that is partially in a unit will
not be continued as to the area outside the unit by unit well produc­
tion if the unit is 160 acres or more in size. The pertinent portion of
the act states: "In case of a spacing unit of one hundred sixty (160)
acres or more, no oil and/or gas leasehold interest outside the spacing
unit involved may be held by production from the spacing unit more
than ninety (90) days beyond expiration of the primary term of the
lease. "106
     This statute is not to be applied retrospectively to leases executed
before its enactment,l07 It apparently will be applied to a unit formed
by a despacing order .108
     North Dakota in 1983 enacted a statutory Pugh clause providing
that when an oil and gas lease covers and affects lands partially within
and partially without the unit area, unit operations and unit produc­

   104. ARK. CoDE ANN. § 15-73-201(b) (Michie 1987).
   105. MISS. CODE ANN. § 53-3-111 (1990).
   106. OKLA. STAT. ANN. tit. 52, § 87.1(b) (West Supp. 1994).
   107. Wickham v. Gulf Oil Corp., 623 P.2d 613 (Okla. 1981). This holding was based on the
court's interpretation that the legislature did not intend the act to be retroactively applied,
thereby avoiding a constitutional issue of divesting of property rights. See also Walker &
Withrow, Inc. v. Haley, 653 P.2d 191 (Okla. 1982). This non-retroactivity is true even if the unit
was formed and the well was drilled after the effective date of the statute. Siniard v. Davis, 678
P.2d 1197 (Okla. Ct. App. 1984). Note, however, that this case was released for publication by
the court of appeals and does not constitute precedent in Oklahoma. See French Energy, Inc. v.
Alexander, 818 P.2d 1234 (Okla. 1991).
   108. Union Thxas Petroleum v. Corporation Comm'n, 651 P.2d 652 (Okla. 1982).
1994]               Implied Covenants-Past, Present & Future                                     669


tion allocated to the lease may not be deemed operations on or pro­
duction from the lease as to the lands covered by the lease lying
outside the unit area after two years from the effective date of the
order of the Industrial Commission creating and approving the unit or
the expiration of the primary term of the lease, whichever is the later
date. loo In Slaaten v. Amerada Hess Corp. no the North Dakota court
affirmed a trial court decision that concluded that the 1983 amend­
ment could not be applied retroactively to impair prior obligations of
the parties.

                                    X.    CONCLUSION

     This brief survey of the doctrine of implied covenants only
scratches the surface of a rich lode of legal material. For those writers
and courts who treat upon the subject in the future, I would suggest
that they consider the fact that the conditions of the present are not
those of the formative period of the implication of terms in oil and gas
leases. An environmental ethic has largely displaced a development­
at-all-costs mentality. Wise stewardship of resources should be the
operative concern in defining the prudent operator rather than mak­
ing the quick buck. This would suggest more deference to the lessee
in the development area but would not diminish judicial concern for
the lessor where the interest of lessor and lessee may conflict in the
marketing of production. The process of implying covenants is a
method of imposing obligations and liabilities on lessees. These costs
have consequences. In the long run it is not likely to be helpful to
lessors as a class to drive the domestic industry overseas; the search
for oil and gas abroad is not simply to find untapped sources but also
to avoid unwarranted costs imposed upon the oil and gas industry.




  109. N.D. CENT. CoDE § 38-08-09.8, as amended in 1983. It provides in part:
         Nothing herein or in any plan of unitization may be construed as increasing or
    decreasing the express or implied covenants of a lease in respect to a unit source of
    supply or lands not included within the unit area of a unit. However, when an oil and
    gas lease covers and affects lands partially within and partially without the unit area,
    unit operations and unit production allocated to the lease, as provided in this section,
    may not be deemed operations on or production from the lease as to the lands covered
    by the lease lying outside the unit area after two years from the effective date of the
    order of the commission creating and approving the unit or the expiration of the pri­
    mary term of the lease, whichever is the later date. After the later date, the lease as to
    lands outside the unit area may be maintained in force and effect only in accordance
   with the terms and provisions contained in the lease.
  110. Slaaten v. Amerada Hess Corp., 459 N.W.2d 765 (N.D. 1990).