Davis v. Cramer

• Decision Date: 25 March 1991
• Docket Number: No. 90SC133,90SC133
• Citation: 808 P.2d 358
• Parties: J.W.C. DAVIS and Gwendolyn Davis, Petitioners/Cross-Respondents, v. R.K. CRAMER, Richard Haines, Irene M. Light, Louis S. Madrid, Gary Sandlin and Sandlin Oil Corp., Respondents/Cross-Petitioners.
• Court: Colorado Supreme Court

Page 358

808 P.2d 358

J.W.C. DAVIS and Gwendolyn Davis, Petitioners/Cross-Respondents, v. R.K. CRAMER, Richard Haines, Irene M. Light, Louis S Madrid, Gary Sandlin and Sandlin Oil Corp. Respondents/Cross-Petitioners.

No. 90SC133.

Supreme Court of Colorado En Banc.

March 25, 1991.

Rehearing Denied April 15, 1991.

Samuel L. McClaren, P.C., Samuel L. McClaren, Tucson, Ariz., for petitioners/cross-respondents.

Burns, Wall, Smith and Mueller, P.C., George W. Mueller, Denver, for respondents/cross-petitioners.

Justice ERICKSON delivered the Opinion of the Court.

We granted certiorari to review Davis v. Cramer, 793 P.2d 605 (Colo.App.1990), and now reverse and remand with directions. We limited our review to a determination of whether an implied duty to market gas arises during the primary term of an oil and gas lease, and whether the court of appeals erred in remanding this case to the trial court on the issue of breach of the drilling clause.

This dispute arises out of a complex series of claims and counterclaims, which is essentially a quiet title action pursuant to C.R.C.P. 105. The issues in this case depend upon the interpretation that is to be afforded to the habendum clause and implied covenants in the oil and gas lease between J.W.C. and Gwendolyn Davis, as lessors, and the remaining parties, including Gary Sandlin and Sandlin Oil Corp., as lessees, ¹ and the rights created by the Allensworth oil and gas lease.

There is no standard oil and gas lease, and each lease must be construed to give effect to the particular wording that has been agreed to by the parties. 2 Kuntz, The Law of Oil and Gas, at § 18.2 (1989) (hereinafter Kuntz). In addition, certain implied covenants in oil and gas leases arise out of the lessor/lessee relationship. We have previously noted that the law of oil and gas is unlike any other area. Spaulding v. Porter, 94 Colo. 496, 31 P.2d 711 (1934).

On March 16, 1978, the Davises filed an action against Sandlin and the other lessees claiming, among other things, that the lease had terminated because of the lessee's breach of the implied covenant to market oil and gas produced from the Davis lease. Sandlin counterclaimed for damages resulting from the Davises' refusal to allow him onto the property to drill for oil or gas. On May 23, 1986, the district court found that the lease had terminated but that Sandlin had a property interest by virtue of a lease between Sandlin and a third party, the Allensworths.

The district court found that on November 1, 1968, the Davises entered into an oil and gas lease with Roy Sharpe for a primary term of ten years (the Davis lease). The Davis lease included all mineral rights, except a one-half mineral interest in a quarter section of the property that was reserved by the Allensworths, who were the Davises' predecessors in interest. ² The habendum clause in the Davis lease provided for a primary term of ten years "and as long thereafter as oil and gas or other minerals are produced from said land by the lessee ..." (the secondary term). There was also a shut-in royalty clause, which provided: "When no reasonable or convenient gas market is available, the lessee may pay $1.00 per acre per annum for the total acres allotted to each while held as a shut-in well."

Finally, the lease contained a drilling clause that stated that if no well was commenced by November 1, 1969, the lease would terminate unless the lessee paid a rental charge of $1.00 per acre, which would extend the lease for twelve months. The lessee could continue paying delay rental charges each year thereafter to keep the lease in effect if no well was drilled. The agreement stipulated that if a well was drilled but was a "dry hole," the lease would terminate unless the lessee drilled a second hole or resumed payment of delay rentals.

By May 1972, the Davis lease had been assigned to Amoco Production Co. and Equity Oil Co., and the same two companies entered into a separate agreement with the Allensworths for their mineral interest, which had a primary term of five years. On July 21, 1972, drilling was commenced by either Marlis Production, Nebraska Drillers, or by both companies. The trial court found that the well was capable of producing oil and gas for purposes of the habendum clause, and that it was completed in October 1972.

Through a series of assignments from September 1972 through June 1973, the interest in the two leases was split between Amoco, Equity Oil, and Morris Fox. Sometime prior to 1973, Amoco and Equity Oil began paying what were termed annual delay rental payments attributable to the interests of Amoco Production and Equity Oil. Those payments were made annually through October 31, 1977. There is no finding, however, that Fox made any payments, or that the well was producing oil and gas during the time that he held a leasehold interest. The interests in the leases remained the same until 1977, when the Allensworth lease to Amoco and Equity Oil expired by its own terms.

In September 1977, Fox assigned his rights to a group of investors including Gary Sandlin and Sandlin Oil. The following year, on March 16, 1978, the Davises commenced this action to obtain an order that the Davis lease had terminated. Three days later, Sandlin acquired the lease rights from the other investors. On June 26, 1978, Sandlin entered into a new lease with the Allensworths for their mineral interest. Thereafter, between October 1978 and January 1979, Sandlin acquired practically all of the interest of the other lessees under the Davis lease.

On either October 30 or 31, 1978, one or two days before the end of the primary ten-year term of the Davis lease, gas from the well was sold to Panhandle Eastern, through a gas line constructed in 1975.

The March 16, 1978, action by the Davises alleged that the Davis lease terminated, and that Sandlin had no right to drill for oil and gas on that land. Sandlin counterclaimed that the lease was still in effect, and that he had a leasehold interest in the land by virtue of the Allensworth lease. The trial court found that the Davis lease expressly required an annual delay rental payment unless the first well was not a dry hole. The court then ruled that a well capable of production in paying quantities was required to satisfy the drilling clause. The court held that Sandlin and his predecessors had produced oil in paying quantities during the primary term of the lease, in October 1978. The court said, however, that the well was capable of production prior to 1973, and so was a shut-in gas well from that date until it started to produce in 1978. The court concluded that, notwithstanding the shut-in royalty clause, there was an implied covenant in the lease to exercise due diligence to produce and market the oil and gas that operated during the primary term of the lease.

Because no gas was marketed until 1978, even though production was possible in 1973, the court ruled that the lease had expired on November 1, 1974, for failure to pay shut-in royalties after November 1, 1973. The court construed the shut-in royalty clause as a special limitation on the leasehold estate, so shut-in royalty payments were necessary to maintain the lease in force. In addition, the court found that, even if the shut-in royalty payments were optional, Sandlin and his predecessors had breached the implied covenant to market gas by waiting until 1978 to produce and market gas, although there was an available pipeline to sell the gas in 1975. This provided an additional ground for the court's conclusion that the lease had terminated. Finally, the court held that the Davises had improperly prevented Sandlin from entering the property to drill, since Sandlin still had the interest granted by the Allensworth lease.

The court of appeals affirmed the award of damages to Sandlin based on the Davises' unreasonable interference with Sandlin's right under the Allensworth lease to enter the property and drill. The court, however, held that in 1975, the Davis lease was still in existence and had not expired. 793 P.2d at 607. The opinion also held that there was no general duty to produce gas during the primary term of the lease, and that the shut-in royalties were the constructive equivalent of production and therefore optional. The court ruled that the implied duty to market gas did not arise during the primary term of the lease. The Davises' claim that the lease had expired because of failure to comply with the drilling clause was remanded to the trial court for further findings.

I

The fundamental purpose of an oil and gas lease is to provide for the exploration, development, production, and operation of the property for the mutual benefit of the lessor and lessee. 5 Kuntz, supra, at § 55.1. "Where the purpose of the lease is thus disclosed, but the lease does not itself contain express provisions creating duties in the lessee to do such acts as are necessary for the accomplishment of that purpose, the law implies them." 2 Summers, Oil and Gas, § 395 (1959) (hereinafter Summers). It is those implied duties that are at issue here. ³

Most commentators divide the implied covenants into four categories: exploration, development, production (including marketing), and protection against drainage. Merrill, The Law Relating to Covenants Implied in Oil and Gas Leases, § 4 (2d ed. 1940); Kulp, Oil and Gas Rights, § 10.66 (1955); Sullivan, Handbook of Oil and Gas Law, §§ 87-93 (1955); see 5 Kuntz, supra, at § 55.1. Another commentator divides production into the duty to produce and to market. Brown, The Law of Oil and Gas Leases, § 16.02 (1958). Regardless, the necessity of the duty to market "is obvious in order that the lessor may receive the consideration for the lease, that is, the royalties which are to be paid." 2 Summers, supra, at § 400; see also Hemingway, Law of Oil and Gas, § 6.4 (1983).

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