Affecting Petroleum Land Practices

May, 1999

"Back to the Basics"

By Professor Marla E. Mansfield

The University of Tulsa, College of Law

Basic oil and gas law predominates this time around - basic law that takes one from the "cradle to grave" of an oil and gas well. For example, one court has been looking at the core issues between a lessee and lessor, namely, what is required to have "paying production" on a leasehold and what is necessary to develop and explore a leased tract. Taking development one level higher, the relationship between parties to a Joint Operating Agreement has sparked interest. Finally, Louisiana has considered who is liable for the clean-up from development in two cases.

The case that looks at the lessor-lessee relationship arose in Texas and involved two leaseholds from one lessor. The Shell lease comprised 1765 acres and was executed in 1975. Moncrief drilled the EE #2 on this leasehold in 1984. The Durham lease was 1194 acres and was executed in 1980. Moncrief drilled the EE #1 on the that lease in 1983. Both wells 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 cost would be deducted from the revenue owed the lessors.

In Edmondson Brothers Partnership v. Motex Drilling Co., 1999 WL 274145 (La.App. 3rd Cir. No. 98-1564) (May 5, 1999), the Court of Appeals affirmed on liability, and modified the damages for future production. The court made rulings in three distinct areas: 1) requirements under the implied covenant to develop and explore; 2) the nature of paying quantities; and 3) when a lessee under a terminated lease is to be deemed a bad faith trespasser. On the implied covenant issue, the court looked at the two leases separately. It found 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.

The court also looked at these errors for two other considerations. First, it held that the errors did not arise to the level of fraud.  However, 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.

Finally, on the issue of production in paying quantities, the court found that 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.

The next two cases look at the relationship between working interest owners. In the first, Samson was the operator of a unit that had a lease on a term mineral interest that was to expire in 1991, at which time the United States would own the minerals. In 1981, Samson requested a sale of a future interest lease and purchased the lease at auction. ENI, a working interest owner, sued Samson for fraud by not notifying it of the lease sale. The trial court granted a summary judgment in Samson's favor on all counts. An Oklahoma Court of Appeals found a material question of fact on the fraud claim.  In ENI  Producing Properties Program Limited Partnership v. Samson Investment Co., 1999 WL 170707 (Okla. No. 90,045) (March 30, 1999), the Supreme Court reversed. The court acknowledged that an operator owes a fiduciary duty to working interest owners, but noted that the extent of this duty is defined by the operating agreement. The A.A.P.L Form 610 in Article VII(B) ("Renewal or Extension of Leases") required any party who acquired a renewal of a lease to give the other parties an opportunity to participate in the lease. This was not applicable to the situation where a new lease was taken out on a future interest. The parties knew a term mineral interest was leased and could have provided for participation in the future interest lease but did not. Because Samson did not have a duty to speak in regard to the future interest lease, it could not have committed fraud by failing to notify ENI.

In a second case also looking at parties to a Joint Operating Agreement, Wilson and Amoco had entered into a Joint Operating Agreement (1956 Model Form), of which Amoco was the operator.  The typewritten Exhibit A referred to "Section 35: all rights below the base of the Huguton Formation."  Wilson had a lease of all the interests in the S of the Section. As to the N ,  Amoco had a 1944 lease purporting to be unlimited, but which it 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. Wilson sued, seeking to apply the JOA to the well. Amoco claimed the lease was an after-acquired interest not subject to the JOA and Wilson was a sophisticated investor who could have protected his interest by a title examination. The trial court and a Kansas Court of Appeals agreed with Amoco.

The Kansas Supreme Court reversed. Amoco Production C. v. Wilson, P.2d , 1999 WL 165461 (Kan. No. 77,999) (March 12, 1999). The court held that 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 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.  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.

Finally, two Louisiana cases looked at who is responsible for the costs incumbent when production ends. The first of these cases, Yuma Petroleum Co. v. Thompson, So.2d. , 1999 WL 105306 (La. No. 98-C-1399) (March 2, 1999), involves the statutory liability of various lessees. More specifically, Yuma Petroleum Co. ("Yuma") acquired a lease from Oil Lift by document signed November 15, 1990, but effective as of November 1st. A November 8th inspection of the site revealed an improperly closed pit and led to a compliance order against Yuma on April 15, 1991. Yuma complied, but requested a hearing in front of the Commission to ascertain responsibility between the parties who owned the lease before Yuma for reimbursement to Yuma for site closure and remediation costs. The Commission denied the request, a denial that the Court of Appeals found was improper because current statutes defined an "owner" of a lease as including those "who has or had the right to drill." La.R.S. 30:3(8).  The Supreme Court disagreed. It found that the recent revisions of the statutes were intended to increase the sources of responsibility and to increase the discretion of the Commissioner to determine from whom it would seek compliance. The statutes were not designed to increase the burden of the Commissioner by obligating the Commissioner to ascertain the respective rights and responsibilities as between various private parties. Additionally, the Oilfield Site Restoration Law (La. R.S. 30:80 et seq.) does not apply because there is a current and locatable financially able "owner" to restore the site. The Restoration Act deals with "orphaned" sites.

The last case deals with whether a mineral servitude owner is liable to the surface owner for clean-up under Louisiana statutes. 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 the Court of Appeals reversed.  Dupree v. Oil, Gas & Other Minerals, 1999 WL 274855 (La. App. 2 Cir No. 31-869-CA) (May 5, 1999). The court noted that 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 contractually (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. 

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