An oil, gas, and mineral lease (“OGML”) is a contract between the mineral rights owner leasing the minerals (“Lessor”) and the production company that is leasing the minerals (“Lessee”). That OGML contains specific rights and obligations – or “covenants” – that the Lessor and Lessee have and owe to each other under the lease’s terms. These are called “express covenants,” because they are expressed in the lease. There are, however, additional duties that the oil company may owe the Lessor that are not contained within the OGML itself. These are called “implied covenants.” Implied covenants require a written lease agreement, and exist to enforce what the parties’ intended when they executed the OGML. Watts Guerra has encountered the following examples of implied covenants, although many more exist. For more information or for a review of your particular lease and facts, please contact us directly.
What Implied Covenants Exist?
The Texas Supreme Court identified the following as implied covenants owed to Lessors:
1. covenant to develop the lease;
2. covenant to protect the lease; and
3. covenant to manage and administer the lease.
Implied Covenant to Develop the Lease:
The implied covenant to develop is considered to be enforcement of the parties’ primary intention when executing the lease. Namely, the Lessor wanted the minerals produced so that royalties would be paid and paid sooner rather than later (which is why OGML primary terms are only 3 years and not 20 years). Conversely, the Lessee wants the minerals produced because if they are not and the lease lapses for nonproduction, then the Lessee’s costs and bonus payments paid to acquire the lease are all lost. Plus, the Lessee retains 75% of all revenues from the production of minerals. The duty to develop includes, at a minimum, drilling a test well in an effort to initiate production.
More commonly, however, this duty generally becomes an issue after some production has been achieved but the Lessee does not drill additional wells (generally because one well holds the lease in place indefinitely, so the Lessee can drill a well on another lease to hold that, then eventually come back and fully develop the first lease). More recently, with the discovery of the Eagle Ford Shale formation in Texas, the “duty to develop additional formations” has become an issue. This generally arises when the Lessee is producing from only one formation containing valuable minerals, and the other formations are not being developed. Generally, the Lessee has a duty to fully develop all known formations under the lease if the minerals in the additional formation contain minerals covered by the lease and if a reasonable prudent operator would drill to produce those minerals.
Implied Covenant to Develop the Lease:
This implied covenant requires the Lessee to protect against drainage and typically arises when a neighbor’s land is drilled and that lease could be draining oil out from under the leased land. This is more likely to arise in a traditional oil formation, where free liquids are able to flow from one tract to another, than in more static shale formations such as the Eagle Ford Shale that require hydraulic fracking to free the minerals from the shale formation.
Implied Covenant to Manage and Administer the Lease:
This implied covenant is the “catch-all” that requires the Lessee to act as a prudent and sophisticated business owner. This duty includes the obligation to reasonably market production (get a fair price when selling the produced minerals, and not sell to their affiliated company for half market value to underpay royalties then make their profit on the second sale to at market price), to operate with reasonable care (not contaminating the land, prevent environmental releases, not destroy roads, etc.).
Mr. Allred routinely assists oil & gas mineral right owners and companies in their disputes
Written By:*
Edward Allred
Watts Guerra LLP
4 Dominion Drive, Bldg 3, Suite 100
San Antonio, Texas 78527
Office (210) 447-0500
Mobile (210) 685-1845
eallred@guerrallp.com
*This information is provided to supply relevant information concerning the subject matter of this article, and should not be received as legal advice. Legal advice is only given to persons or entities with whom Watts Guerra LLP has established an attorney-client relationship. Available causes of action and remedies vary from case to case and depend on the underlying facts of each. If you have another lawyer, you should consult with your own attorney, and rely upon his or her advice, rather than the information contained herein.
© Watts Guerra LLP 2015
