RECENT DEVELOPMENTS

Affecting Petroleum Land Practices

November, 1999

"Relationships"

By Professor Marla E. Mansfield

The University of Tulsa, College of Law

The complexity of relationships of a personal nature has been the subject of many a writer more capable than I. Therefore, I will skirt such territory and ponder the nature of relationships in oil and gas development. Cases in the interim since I last wrote have considered several of these relationships: lessor-lessee, operator and non-operator, mineral interest co-owners, and surface and mineral owners.

The case of operator and non-operator involved Wilson and Amoco Production Company. They entered into a Joint Operating Agreement (1956 Model Form), of which Amoco was the operator.  The typewritten Exhibit A, which listed lands subject to the agreement,  referred to the following: "Section 35: all rights below the base of the Huguton Formation." Wilson had a lease of all the interests in the S ½ of the Section. As to the N ½, Amoco had a 1944 lease purporting to be unlimited, but which Amoco knew did not cover formations deeper than 3,400 feet. Amoco then leased the deeper formations and refused to allow Wilson to participate in a well at such depth. Wilson sued, seeking to apply the JOA to the well. Amoco claimed the lease was an after-acquired interest and not subject to the JOA. Moreover, Amoco alleged that Wilson was a sophisticated investor who could have protected his interest by a title examination. The trial court and court of appeals agreed with Amoco.

In Amoco Production Co. v. Wilson, 976 P.2d 941 (Kan. 1999), the Supreme Court of Kansas reversed. The use of the present tense in the opening "whereas" clause of the JOA did not limit the agreement to the leases in effect when the JOA was executed, especially with the more specific typewritten statement in Exhibit A. The Exhibit did not limit Amoco's rights in the lands referenced there. The provisions of the JOA as to title examination were modified so as to require no title opinions; therefore, Wilson had no duty to examine title. As Amoco knew or should have known of its lack of deep ownership, at most this was a unilateral mistake and Amoco should not be able to use the JOA's failure of title provisions to its advantage. Most importantly, the Unit Area is defined as "all the lands, oil and gas leasehold interests and oil and gas interests intended to be developed" and references Exhibit A.

More generally, the court found that Amoco had a duty to deal with the non-operator in a fair and equitable manner in regard to the subject matter of the agreement. This duty arises because they were joint adventurers. The fact that the JOA provided that they did not intend to create a mining partnership or render them liable as partners does not limit liability as a joint adventurer. Therefore, the JOA applied to the later-acquired lease, making the agreement subject to being performed as it was originally intended. Parties to a JOA may demand and expect full, fair, and honest disclosure from each other.

The Texas courts have recently looked at what a lessor might expect from a lessee in regard to pooling. The scenario was familiar. The lessee, Southeastern, drilled a successful gas well in 1990. In 1991, it negotiated three year leases to the north of the producing lease ( the "Leveridge lease").  It then drilled two more wells on the Leveridge lease. In 1993, Southeastern desired to extend its northern leases, but the lessors declined, citing the failure to diligently develop the leases. Four days before the first of the northern leases were to expire, Southeastern pooled the northern leases with a portion of the Leveridge lease. The lessors of the northern leases sought to invalidate the pooling for being in bad faith and sought damages for drainage. At trial, the pooling was found to be in good faith, but damages for drainage were based on what would have been paid to the lessors had Southeastern pooled pursuant to the opinion of the lessor's expert witness. Southeastern appealed the damage instructions.

In Southeastern Pipe Line Co., Inc. v. Tichacek, 997 S.W.2d 166 (1999), the Texas Supreme Court agreed with Southeastern. Once the pooling decision was found to be in good faith, it could not be ignored. Therefore, the instructions regarding damages were defective and a new trial is required. Damages must be divided to compute what drainage occurred to the leases themselves prior to pooling and what damage occurred to the unit after pooling.

Louisiana also examined the covenant of diligent development. The lessor, Edmundson, leased two tracts, one referred to as the Shell lease (1765 acres) and the other known as the Durham lease (1194 acres). The Shell lease was executed in 1975 and Moncrief drilled the EE #2 on it in 1984. The Durham lease was executed in 1980 and Moncrief drilled the EE #1 on it in 1983. Both were vertical wells in the Austin Chalk. There was production from both wells, but the EE #2 ceased production for more than 90 days in 1987-88. The lessor did not know this, and demanded further development on both leases in December of 1991. Moncrief initially indicated a well would be drilled on each lease, but then drilled one horizontal well on the Shell lease, which was completed on March 27, 1992. In June of 1993, the lessors sought a judgment that both leases be canceled for lack of production and that Moncrief failed to reasonably explore and develop both leases.

The trial court found for the lessor. It awarded money for lost leasing revenue and lost production revenues, and shares of future revenue from the time of judicial demand forward. In this regard, Moncrief could only deduct costs up to certain dates in late 1997. Thereafter, no production costs would be deducted from the revenue owed the lessors.

In Edmondson Brothers Partnership v. Motex Drilling Co., 731 So.2d 1049 (La.App. 1999), the Court of Appeals affirmed on liability, and modified the damages for future production. The covenant of further development and exploration on the Durham lease was breached because only one well was drilled in 10 years. The horizontal well on the Shell lease did not "explore" or "develop" the Durham lease; oil was known to be there and no additional information was needed. The Shell lease was also inadequately developed by 2 wells on 1765 acres. Moreover, the lessors were not estopped from claiming that the Shell lease automatically terminated pursuant to its cessation of production clause in 1998. Although the request for development is inconsistent with a claim that the lease terminated for failure to produce, the lessors had no way of knowing the facts when they requested development. Moncrief had filed inaccurate reports with the Railroad Commission, which reports showed production and on which the lessors could have relied. These errors did not arise to the level of fraud, but because only the lessee's negligence kept it and the lessors unaware of the Shell lease's termination, Moncrief produced in bad faith in regard to the two wells on the Shell lease. Therefore, as a trespasser in bad faith, no costs could be deducted from revenues at all. As to the well on the Durham lease, Moncrief was in bad faith from the date of judicial demand, 1993. The Durham lease also expired for failure to produce in paying quantities. Even if overhead expenses were not included, the best Moncrief could show was profit of $139 per month for the 18 month period preceding filing of suit. This amount is not sufficient to "induce a reasonably prudent operator to continue production." The court also concurred that leasing activity would have made the acreage attractive to buyers when the leases had terminated. The award of loss of leasing damages was thus appropriate.

Three Louisiana judges on the Court of Appeals for the Third District entered into a lively debate on the rights and responsibilities of co-owners of minerals. The vehicle for the discussion was  Johnco, Inc. v. Jameson Interests, 1999 WL 415386 (La.App. 3^rd Dir. No. 98-1295) (June 23, 1999). This case involved the successors in interest to three siblings, namely the Jameson Interests, Johnco, and Lords. Each group owned an undivided 1/3 interest in the minerals in a 17,000 acre tract. The Jameson Interest group contacted a geologist to appraise seismic information about the tract. In 1992, the first geologist consulted and another concluded that the tract might be developed for shallow gas. The geologists agreed to negotiate for the development of the tract and give the Jameson Interests ½ of both any overriding royalties they would receive and of any moneys over $50,000 that they would receive as a finder's or consulting fee in regard to the lease. The geologists then reached a tentative agreement with Bridewell Oil Co. Bridewell wanted to lease the entire mineral interest. When the Lords did not agree, Johnco and Jameson Interest sought a partition of the interests in 1994. They did so, and in March, Johnco and Jameson Interest combined their mineral rights in proportions of an undivided 53.9663% to Jameson Interests and an undivided 46.0337% interest to Johnco. In April, the lease to Bridewell was executed. Soon thereafter, the geologists assigned a portion of their overriding royalty interest to Jameson Interests pursuant to their agreement. Upon learning of this, Johnco sued for an accounting of profits under the agreement. The trial court rejected his claims.

The appeals court affirmed, with some differences of opinion. Judge Gremillon found, inter alia, that the parties were not co-owners of the minerals. While they were co-owners originally, the interests were then partitioned. The judge interpreted the agreement combining the minerals to granting each party not a right to a percentage share of the minerals, but a right to a percentage of the minerals. Moreover, there was no joint venture or breach of warranty on the interests conveyed to Johnco. Finally, the judge found no unjust enrichment. Johnco had alleged that the override received by Jameson Interests was an impoverishment to it because the payment came from production of the minerals it owns. Judge Gremillon, however, noted that the payments to the Jameson Interests came from the geologist's fees.  Johnco and Jameson received a twenty percent royalty as mineral owners.

This opinion did not end the discussion, however. Judge Amy concurred, but differed with Judge Gremillon on whether the Johnco and Jameson Interests were co-owners of the minerals. The judge concluded they were co-owners. They owned the minerals in indivision when Jameson negotiated with the geologists. Although they later partitioned the interests, they then re-united them. However, Judge Amy found that the negotiations and subsequent failure to disclose the relationship did not constitute a breach of any duty as a co-owner by the Jameson Interests, but were valid exercises of Jameson Interests' rights as an owner of a mineral servitude. There was no structuring of a deal that deprived a mineral interest owner of a share in additional royalty. Each received their proportional share of royalty.  To complete the disagreement, however, Judge Peters dissented. The judge not only found a co-ownership relationship existed, but also found that the secret relationship violated a duty owed to its co-owners. Article 174 of the Mineral Code provides that "[a] use or possession of a mineral right inures to the benefit of all co-owners of the right." This was not an instance of one co-owner preventing waste, but one co-owner, while representing the other, taking advantage of its position by arranging a secret profit to the detriment of its co-owners. Therefore, the relationship's duties were violated.

In another case, the Louisiana court also looked at the relationship of the servitude owner and the surface owner. A mineral servitude owner leased oil and gas several months before the servitude would be extinguished by prescription. The lessee went bankrupt and the landowner sought to hold the servitude owner liable for damage to the surface. The servitude owner claimed that the servitude owner is only obligated to restore the surface if the owner or its employees or agents actually conduct mineral operations. A lessee would be liable if a lessee developed. La. R.S. 31:22 and 31:122. The trial court granted a summary judgment to the servitude owner, but in Dupree v. Oil, Gas & Other Minerals,731 So.2d 1067 (La.App. 1999), the court of appeals reversed. The servitude owner is benefitted by the development of a lessee; it interrupts the running of prescription. It therefore would be incongruous to have the servitude owner avoid responsibility to the land owner for development by a lessee. As between the lessee and the lessor, the lessee may be liable primarily by contract (as was the case in this lease), but this does not eliminate the servitude owner's duty to use the surface reasonably and to reclaim it if possible. 

Finally, another case from Louisiana examined an oil and gas lease that granted rights to use the leased tract for roads for development of minerals on the tract and "adjacent lands." The lease was partially assigned. The lessees that actually operated the leased premises used an unimproved "pig trail" for access to the wells on the leasehold and carefully locked the gate. Another lessee, who did not operate on the leasehold, removed the gate and improved the road solely for access to wells on an adjacent tract. Traffic increased. The trial court refused to enjoin the access activity, although it did compute surface damages. The Court of Appeals reversed, holding any increase on the burden of the servient estate must be shown to have been conducted in good faith and for the mutual benefit of the parties.

In Caskey v. Kelly Oil Co., 737 So. 2d 1257 (La. 1999), the Supreme Court reversed again.  Article 122 of the Mineral Code requires the lessee to operate the leasehold in good faith and as a reasonably prudent operator for the mutual benefit of the lessor and lessee, but the Supreme Court held that the "mutual benefit" principle codified in Article 122 did not apply to the "adjacent lands" clause, which was a contractually bargained for exchange between the parties.  Article 122 applies to what are commonly referred to as the implied obligations of the lessee, not to contractual provisions about the reasonable use of the surface. The purpose of an "adjacent lands" clause is efficient development of the mineral. It absolves the lessee of the need to ascertain beforehand what lessors will be benefitted by a well or a road. If there are several leases with the clause in a field, there is a potential benefit to all the lessors, even if one use of the surface of a particular tract does not ultimately benefit it. The court further rejected the arguments that the adjacent lands clause only covered lands also owned by the lessor and that only the operator of the leased lands could avail itself of use of the leased lands for development of adjacent land. Finally, the court upheld the trial court's finding that that the road as upgraded and used was a "reasonable" use of the surface, necessary for drilling and completion of the well on the adjacent lands.

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