Circle Dot Ranch, Inc. v. Sidwell Oil and Gas, Inc.

• Decision Date: 26 January 1995
• Docket Number: No. 07-94-0076-CV,07-94-0076-CV
• Citation: 891 S.W.2d 342
• Parties: 132 Oil & Gas Rep. 417 CIRCLE DOT RANCH, INC. and Euline Walser, Appellants, v. SIDWELL OIL AND GAS, INC., et al., Appellees.
• Court: Texas Court of Appeals

Page 342

891 S.W.2d 342

132 Oil & Gas Rep. 417

CIRCLE DOT RANCH, INC. and Euline Walser, Appellants, v. SIDWELL OIL AND GAS, INC., et al., Appellees.

No. 07-94-0076-CV.

Court of Appeals of Texas Amarillo.

Jan. 26, 1995.

Rehearing Overruled Feb. 21, 1995.

Lemon Shearer Ehrlich Phillips & Good (Mitchell G. Ehrlich and Robert D. Lemon), Perryton, for appellants.

Templeton Smithee Hayes & Fields (Joe W. Hayes and Robert L. Templeton), Amarillo, for appellees.

Before REYNOLDS, C.J., and DODSON and BOYD, JJ.

REYNOLDS, Chief Justice.

Circle Dot Ranch, Inc. and Euline Walser perfected this appeal to contend the trial court improperly directed a verdict against them in their action to cancel a voluntarily pooled gas unit and to recover royalties under their lease based upon the alleged bad faith of lessees Sidwell Oil and Gas, Inc., et al. (Sidwell). ¹ By a cross-point, Sidwell asserts error in the trial court's overruling of its motion for partial new trial on the issue of attorney's fees. For the reasons to be expressed, we will reverse and remand.

Circle Dot Ranch, Inc. and Euline Walser (collectively, Circle Dot) owned all of the oil, gas and other minerals underlying Section 3, Block A-5, B S & F Survey, in Wheeler County, containing 643.23 acres (the Circle Dot property). In September of 1987, an oil and gas lease covering the acreage (the Circle Dot lease) was obtained from Circle Dot by Vise Energy, Inc. The lease was for a primary term of three years and provided for a 3/16ths royalty payable to lessors. By paragraph six of the lease, the lessee was

granted the right and option to consolidate the lands covered hereby, or any portion or portions thereof, with other lands ... to form a unit for the production of (1) oil and casinghead gas, or (2) dry or gas well gas, ... the unit or units to be in such shape and of such dimensions as Lessee may elect; provided that such unit ... formed for the production of oil and casinghead gas shall not exceed forty (40) acres in surface area plus a tolerance of ten per cent (10%) thereof; and any such unit formed for the production of dry gas or gas well gas ... shall not exceed six hundred forty (640) acres in surface area plus a ten per cent (10%) tolerance thereof.

Sidwell subsequently obtained the lease from Vise Energy, Inc.

On 5 July 1988, a well was staked 467 feet from the south and west lines of the Circle Dot property in the Candice (Morrow) Field. Prior to the initiation of drilling efforts, Sidwell applied on 11 July 1988 to the Railroad Commission for a permit to drill a gas well by signing and submitting form W-1, to which was attached a plat showing that all of section 3, containing 643.23 acres, was the designated drilling unit for the Circle Dot 103 well, and that it was not a pooled unit. Drilling operations were commenced and completed in the Upper Shelton sand by 17 August 1988, and production of gas was obtained in October of 1988.

In April of 1989, more than six months after production had been procured, Sidwell executed a "Designation of Consolidated Gas Leasehold Estate" creating the Circle Dot Ranch No. 1 Gas Unit (the Circle Dot unit), which became effective when it was filed for record on 16 May 1989. The unit was irregular in shape, its diagonal corners being in excess of 11,000 feet apart, and contained 668.23 acres. Included in the pooled 668.23 acres were 123.23 acres under the Circle Dot lease, carved out of the southwest corner of the Circle Dot property where the Circle Dot 103 well was located, and 545 acres covered by six leases on three contiguous sections of land. Except for the consolidation, the primary term of one of the six leases would have expired in three months, and the primary terms of four of the leases would have expired within 18 months.

The creation of the Circle Dot unit was founded on the right of consolidation contained in paragraph 6 of the Circle Dot lease. As a result of the formation of the unit, Circle Dot's royalty interest in gas produced from the well was reduced from 3/16ths to 123.23/668.23 of 3/16ths. ²

On 2 November 1989, Circle Dot filed its original petition, alleging that Sidwell had failed to exercise good faith in the formation of the Circle Dot unit, and seeking to cancel the pooled gas unit and to recover a full 3/16ths royalty under the Circle Dot lease covering production from the Circle Dot 103 well. ³ Sidwell counterclaimed, seeking a declaratory judgment with respect to (1) the validity of the Circle Dot unit, including a declaration of who was entitled to past and future royalties from the Circle Dot gas well or, in the alternative, reformation of the Circle Dot unit; (2) its entitlement to the disputed royalty proceeds under the terms of the lease; and (3) its right to recover attorney's fees.

In addition to the earlier recounted events, there were adduced, through pretrial discovery and during the trial before a jury, Sidwell's admissions that it was not necessary to create the Circle Dot unit to obtain a full gas allowable for the Circle Dot 103 well, and that acres productive from the Upper Shelton sand under section 3 were excluded from the Circle Dot unit; testimony from John Vise, who secured the original Circle Dot lease, that there was no pooling of any section in the Candice (Morrow) Field except for pooling within one section; and Vise's testimony that he was not aware of any other gas unit in Wheeler County having diagonal corners 11,000 feet apart. Sidwell also admitted that no Form P-12, Certificate of Pooling Authority, for the Circle Dot unit had been filed with the Railroad Commission; however, upon Sidwell's objection, the admission was excluded by the trial court.

When Circle Dot had presented its evidence, the parties stipulated the issue of attorney's fees would be tried to the court alone. Then, Sidwell orally moved for a directed verdict on the ground that Circle Dot had produced no evidence to meet its burden of proof that it, Sidwell, had failed to exercise good faith in the formation of the Circle Dot unit. The court granted the motion and, afterwards, denied Sidwell's claim for attorney's fees, resulting in the rendition of a take-nothing judgment on all claims. Sidwell moved for a partial new trial on the issue of attorney's fees, but its motion was overruled. This appeal ensued.

With two points of error, Circle Dot contends the trial court erred in (1) withdrawing the case from the jury and directing a verdict against them, because a fact issue had been raised with respect to whether Sidwell had exercised its authority to pool in fairness and good faith, and (2) excluding Sidwell's admission that no P-12 plat was filed with respect to the Circle Dot unit. By a cross-point of error, Sidwell charges the trial court with error in overruling its motion for a partial new trial on the issue of its entitlement to the recovery of attorney's fees.

The cause was pleaded and defended, tried and decided, and briefed and argued on appeal, on the contested issue whether Sidwell exercised its pooling authority in fairness and good faith, taking into account the interests of both the lessor and lessee. Elliott v. Davis, 553 S.W.2d 223, 227 (Tex.Civ.App.--Amarillo 1977, writ ref'd n.r.e.). However, during oral argument upon submission of the appeal, Sidwell posed a novel challenge to the validity of the duty of good faith imposed on lessees in pooling circumstances by Elliott and other authorities. Sidwell proposed that the duty of good faith applied to pooling determinations was rejected in Amoco Production Co. v. Alexander, 622 S.W.2d 563, 568 (Tex.1981), by the pronouncement that "[t]he standard of care in testing the performance of implied covenants by lessees is that of a reasonably prudent operator under the same or similar facts and circumstances." Id. at 567-68. We granted leave to file, and Sidwell and Circle Dot submitted, post-submission briefs for our determination of the nature and extent of the duty imposed on a lessee exercising the pooling powers granted in an oil and gas lease.

At the outset, we notice that the paragraph 6 consolidation provision is an express covenant, which is independent in nature because actual performance by the lessee is not dependent on any performance by the lessor. Black's Law Dictionary 363 (6th ed. 1990). Historically, Texas courts, in considering the lessee's exercise of a pooling option granted by such a covenant, have held the lessee to a standard of good faith in making a determination to pool. Vela v. Pennzoil Producing Co., 723 S.W.2d 199, 206 (Tex.App.--San Antonio 1986, writ ref'd n.r.e.); Elliott v. Davis, 553 S.W.2d at 226; McCarter v. Ransom, 473 S.W.2d 235, 239 (Tex.Civ.App.--Corpus Christi 1971, no writ); Banks v. Mecom, 410 S.W.2d 300, 303 (Tex.Civ.App.--Eastland 1966, writ ref'd n.r.e.); Tiller v. Fields, 301 S.W.2d 185, 190 (Tex.Civ.App.--Texarkana 1957, no writ). Accord Smith v. Killough, 461 S.W.2d 510, 513 (Tex.Civ.App.--Eastland 1970, writ ref'd n.r.e.) (holding that to cancel a unitization declaration, the lessor had to prove the lessee acted in bad faith). In holding the lessee to a standard of good faith, some of the authorities characterized the standard as an implied requirement, see, e.g., Elliott v. Davis, 553 S.W.2d at 226; Tiller v. Fields, 301 S.W.2d at 190, or an implied obligation, see, e.g., McCarter v. Ransom, 473 S.W.2d at 239, but none of them designated the good faith standard as an implied covenant.

Insofar as the parties' and our own research has shown, the Supreme Court has not directly articulated the duty or standard of care of a lessee in exercising the pooling power. However, as is evident from the writ histories of the decisions just cited, the Supreme Court has not disapproved the imposed requirement or obligation of good faith. Indeed, the Court has noted, with some indication of approval, the contention that good faith is the standard by which the lessee's...