Johnson v. Hamill, 11072

CourtUnited States State Supreme Court of North Dakota
Citation392 N.W.2d 55
Docket NumberNo. 11072,11072
PartiesRaymond J. JOHNSON, Elna C. Johnson, Richard D. Johnson and Clifford A. Johnson, Plaintiffs and Appellants, v. Claud B. HAMILL; Terra Resources, Inc., formerly Farmland International Energy Company; Solar Petroleum, Inc.; Paris-Williston Corporation now doing business as Burgan Resources Corporation; Koch Exploration Company; TXO Production Corporation; Daharavi Investments N.V.; Dover Fiduciary Corporation; and Theo-Davies-Williston, Inc., Defendants and Appellees. Civ.
Decision Date28 July 1986

Michel W. Stefonowicz, Crosby, Jeffrey J. Peterson, Bowbells, and C.B. Thames, Jr., Bismarck, for plaintiffs and appellants; argued by Jeffrey J. Peterson; appearances by Michel W. Stefonowicz and C.B. Thames, Jr.

Fleck, Mather, Strutz & Mayer, Bismarck, for defendants and appellees; argued by Jane Fleck Romanov.

ERICKSTAD, Chief Justice.

The Johnsons (lessors) appealed from a district court judgment dismissing their action against the defendants (hereinafter referred to as either Terra or the lessees) for cancellation of an oil and gas lease. We affirm.

Raymond and Elna Johnson own the surface and mineral estates in the following land, comprising 678.32 acres in Divide County:

Township 161 North, Range 102 West

Section 19: NW 1/4

Township 161 North, Range 103 West

Section 26: NE 1/4, NW 1/4SE 1/4

Richard and Clifford Johnson own one-half of the mineral owner's royalty interest in a part of the above-described property.

On February 9, 1974, the lessors executed an oil and gas lease of the land to Tom A. Schwartz for a primary term of seven years. The lessees are assignees of Schwartz.

No wells have been drilled on the leasehold. The 40 acres located in the S 1/2 of Section 25 (NW 1/4SE 1/4), however, are located in a 320-acre spacing unit covering all of the S 1/2 of Section 25, upon which two producing oil wells are located and from which the Johnsons are receiving royalty payments.

In 1980 and 1981, the lessors received offers to lease parts of their land, but the offers did not result in leases because all of the leasehold was held by production from the 40 acres located within the spacing unit on the S 1/2 of Section 25.

By letters of January 5, 1982, to the lessees, the lessors asserted expiration of the primary term of the lease and requested release of the lease except for the NW 1/4SE 1/4 of Section 25. On February 3, 1982, the lessors served upon the lessees notice, pursuant to Sec. 47-16-36, N.D.C.C., that the lease (except for the NW 1/4SE 1/4 in Section 25) "has terminated or become forfeited by breach of the terms hereof" and demanded a surrender of the lease. The lessees responded as required by statute. By letters of June 7, 1982, the lessors demanded of the lessees "that you comply with the implied covenant to further develop the balance of the property not included in the production unit. In the alternative, please release the property not included in the production unit."

By summons and complaint filed in the district court on January 25, 1983, the lessors sought a judgment decreeing "that the lease has terminated as to those portions of the leased property lying outside the existing governmental spacing unit," or, in the alternative, decreeing "that Defendants comply with the duties to reasonably develop and further explore the leased property within a time set by the Court or file a release of record." The complaint was later amended to seek damages for oil and gas alleged to have been lost by drainage.

The trial court found that "[n]o substantial drainage, if any at all, has occurred or is occurring"; that Terra has conducted itself as a prudent operator; and that "[t]here has been no breach by the defendants of any implied covenant to develop, explore or protect the Johnson lease." The lessors have appealed from the judgment dismissing their complaint and amended complaint. They have raised the following issues, which relate only to the implied covenants and not to the matter of drainage:

"1. Should the District Court have found that the implied covenant to reasonably develop and/or the implied covenant to further explore the mineral acreage described in the oil and gas lease dated February 9, 1974, was not complied with.

"2. Should the District Court Judgment have provided for a forfeiture of the acreage described in the oil and gas lease or in the alternative provided for a forfeiture of that acreage outside of the established spacing unit or a portion of the acreage outside of the spacing unit."

Essentially, the lessors allege that the lessees have breached implied covenants because of a lack of development or exploration and seek either the drilling of a well or forfeiture of the lease. The lessees allege that they have acted as a prudent operator in not yet drilling; that they have explored; and that they wish to and are entitled to retain the lease while, as a prudent operator, they await further developments in nearby wells.

Development and exploration are not carried out only by drilling operations. They are also performed by such other activities as geophysical surveys and farm-out operations [Felmont Oil Corp. v. Pan American Petroleum Corp., 334 S.W.2d 449 (Tex.Civ.App.1960) ]; efforts to gather geological information [Dupree v. Relco Exploration Co., Inc., 354 So.2d 1083 (La.App.1978) ]; and "participation in the preliminary play to an eventual deep test in the area" [Frazier v. Justiss Mears Oil Co., Inc., 391 So.2d 485, 488 (La.App.1980) ]. See also 5 H. Williams and C. Meyers, Oil and Gas Law Sec. 843.8 (1985).

A lessee must "prosecute drilling operations with reasonable diligence" [Hermon Hanson Oil Syndicate v. Bentz, 77 N.D. 20, 40 N.W.2d 304, 308 (1949) ], "having regard to the interests of both lessor and lessee" [Brewster v. Lanyon Zinc Co., 140 F. 801, 814 (8th Cir.1905) ]. In Olson v. Schwartz, 345 N.W.2d 33, 38 (N.D.1984), we stated:

"It is well settled that the lessee of an oil and gas lease has an implied obligation to the lessor to do everything that a reasonably prudent operator would do in operating, developing, and protecting the property, with due consideration being given to the interests of both the lessor and the lessee, if there is no express clause in the lease relieving the lessee of this implied duty. Feland v. Placid Oil Co., 171 N.W.2d 829, 835 (N.D.1969). See also 38 Am.Jur.2d Gas and Oil Sec. 127, page 601."

While a lessee may consider its own interests in operating, developing, and protecting a leasehold, Terra's assertion that a prudent operator is only required to drill when it would be profitable to do so goes too far. Relying on Doss Oil Royalty Co. v. Texas Co., 192 Okla. 359, 137 P.2d 934 (1943), we held in Olson v. Schwartz, supra, that a lessor may be entitled to relief upon a theory of breach of the implied covenant of reasonable development 1 where a long period of time passes without drilling on substantial unexplored portions of a leasehold held by production on part of the leasehold without proving that a well on the undeveloped portion would be profitable. See also Sauder v. Mid-Continent Petroleum Corp., 292 U.S. 272, 54 S.Ct. 671, 78 L.Ed. 1255 (1934); Sinclair Oil & Gas Co. v. Masterson, 271 F.2d 310 (5th Cir.1959); Texas Consolidated Oils v. Vann, 208 Okla. 673, 258 P.2d 679 (1953); 5 H. Williams and C. Meyers, Oil and Gas Law Secs. 806.3, 841-847 (1985).

In Olson v. Schwartz, supra, 345 N.W.2d at 39, we stated that:

"... the question of whether or not there has been reasonable development of a leasehold is determined by reference to the 'prudent operator' standard. It is impossible to state a formula by which a court can determine whether a particular lessee has developed a particular lease in conformity with the prudent operator standard. Each case must be decided on the facts peculiar to it and the burden of proving a breach of the implied covenant is on the party asserting it."

We also set forth, at 345 N.W.2d 39-40, a nonexclusive list of factors to be considered in applying the prudent-operator standard:

"(1) the quantity of oil and gas capable of being produced as indicated by prior exploration and development; (2) the local market and demand therefor; (3) the extent and results of the operations, if any, on adjacent lands; (4) the character of the natural reservoir--whether such as to permit the drainage of a large area by each well; (5) the usages of the business; (6) the cost of drilling, equipment, and operation of wells; (7) the cost of transportation, storage, and the prevailing price ... (8) general market conditions as influenced by supply and demand or by regulation of production through governmental agencies ... (9) evidence of the willingness of another operator to drill on the tract in question; (10) the attitude of the lessee toward further development; and (11) the elapsed time since drilling operations were last conducted." [Citations omitted.]

A lessor alleging breach of implied covenants is not entitled to forfeiture of a lease until he has notified the lessee of the breach, demanded that the terms of the implied covenant be complied with within a reasonable time, and given the lessee a reasonable time for such compliance. Olson v. Schwartz, supra. In this case, the lessors first demanded compliance with the implied covenants on June 7, 1982, although they had previously requested release of the lease and had previously asserted that the lease was forfeited. The lessors brought suit for cancellation in January 1983.

The lessees have asserted that our review is governed by Rule 52(a), N.D.R.Civ.P. The lessors have asserted: (1) that the trial court's decision is based on an erroneous conception of the law of implied covenants; (2) that the question of what a prudent operator should do is one of law; and (3) that if the...

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