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04.15.16   |   Insights

Oil & Gas Leases May Include Implied Requirement of Minimum Number of Wells to Fully Develop Property

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Under Ohio law, oil and gas leases constitute contracts. As a general matter, the rights and remedies of the parties entering into a contract must be determined by the terms of the written agreement.

Over the years, however, Ohio courts have determined that oil and gas leases should include a number of “implied covenants”—provisions which the courts will assume the parties meant to include, even if the contract does not specifically address the issue. These implied covenants include a producer’s obligation: (1) to drill an initial exploratory well; (2) to protect the lease from drainage from wells on neighboring properties; (3) to reasonably develop the land; (4) to explore further after an initial well is drilled on a large tract of land; (5) to market the oil and gas produced; and (6) to conduct all operations that affect the mineral owner’s royalty interest with reasonable care and due diligence. Of these implied covenants, the covenant to reasonably develop the land covered by the lease is one of the most important.

The implied covenant of reasonable development originates from the goal of an oil and gas lease. Namely, the courts have long recognized that a mineral owner’s goal in leasing acreage is to collect royalties on oil and gas produced after wells are drilled. Further, Ohio public policy supports the development of the state’s natural resources. Thus, the implied covenant of reasonable development requires producers to use reasonable diligence to develop the leased acreage. Where a lease covers a significant block of acreage, a producer must often drill multiple wells on the acreage included in the lease. When additional oil and gas development takes place in an area, the implied covenant of reasonable development may also require a producer to further develop the leased property based upon changing circumstances. If a court decides that a producer has violated the implied covenant of reasonable development, the court may award money damages or may order the release of undeveloped acreage, thereby allowing the mineral owner to seek out a producer who will fully develop the acreage.

The implied covenant of reasonable development does not apply to oil and gas leases which explicitly state the number of wells that are to be drilled on the leased acreage. In such circumstances, the courts have held that there is no need to imply provisions regarding development to protect the mineral owner, because the parties explicitly agreed how the property should be developed in the lease itself.

Since courts first recognized the existence of implied covenants in oil and gas leases more than 100 years ago, many producers have sought to avoid such implied covenants. The implied covenants generally impose additional obligations on producers that they would not otherwise have. For instance, the implied covenant of reasonable development can prevent producers from speculating and banking acreage by signing a lease, paying a comparatively small per acre bonus, then waiting to see how the market develops without actually drilling a well, or drilling only one well on a large tract of land. Thus, many leases prepared by producers now disclaim the implied covenants by including language such as “all implied covenants are disclaimed.” Where a contract includes a disclaimer of implied covenants, Ohio courts have found that a single well may hold 300 acres of leased property without obligating the producer to make any further development.

If you have leased your mineral rights to a producer, take a look at the terms. Does the lease state that implied covenants are disclaimed? If not, know that, under Ohio law, the lease most likely includes a set of implied rights, which mostly benefit the mineral owner, even though they are not stated. If you are considering leasing your minerals, be aware that disclaiming implied covenants can significantly affect your rights and the producer may be willing to negotiate on this (or other) issues.

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