The Lawletter Vol 39 No 11
It is well established that an oil and gas lease can be subject to certain implied covenants or duties. These can include, for example, the implied covenant or duty of the lessee to reasonably develop the leased property, to use reasonable care and due diligence in its operations, to act as a reasonably prudent operator, and to market. However, few courts have explored the issue of whether an oil and gas lease is subject to the basic implied covenant of good faith and fair dealing traditionally found in contracts.
Recently, in Yoder v. Artex Oil Co., 2014-Ohio-5130, 2014 WL 6467477 (Ct. App.), the Ohio Court of Appeals held that an oil and gas lease is subject to the implied covenant of good faith and fair dealing found in contracts. To support its conclusion, the court relied on several secondary sources, as well as Ohio law. The court explained:
( ¶ 51) Secondary sources examining implied covenants in oil and gas leases have found that contractual concepts, such as good faith and fair dealing, apply to the interpretation of the oil and gas lease. The oil and gas lease was historically seen as a transaction between two parties with unequal bargaining powers—an unsophisticated farmer negotiating with an oil and gas corporation. See Merrill, The Law Relating to Covenants Implied in Oil and Gas Leases 1926 (2d Ed 1940 & Supp.1964); Pierce, The Renaissance of Law in the Law of Oil and Gas: The Contract Dimension, 42 Washburn Law Journal 909 (2004). Implied covenants, such as the implied covenant to protect against drainage, focused on protecting the leasehold estate. Hardymon, Adrift on the Implied Covenant to Market: Regulation by Implication, 24 Energy & Min.L.Inst. 8 (2004). However, because of the nature of the oil and gas lease, courts also focused on the conduct of the parties to the oil and gas lease by applying contractually-based covenants such as good faith and fair dealing to the oil and gas lease. Hall, The Application of Oil & Gas Lease Implied Covenants in Shale Plays: Old Meets New, 32 Energy & Min.L.Inst. 8 (2011). Courts used implied covenants to fill the gaps in contracts and promote fairness and cooperation between the lessor and lessee. Id.
(¶ 52) Turning back to Ohio case law, the Supreme Court in Harris v. Ohio Oil Co. held that an oil and gas lease is a contract and should be interpreted as such. Also under Ohio case law, it is well-established that every contract has an implied covenant of good faith and fair dealing that requires not only honesty but also reasonableness in the enforcement of the contract. PHH Mortg. Corp. v. Ramsey, 10th Dist. Franklin No. 13AP-925, 2014-Ohio-3519, ___ N.E.3d ___, ¶ 33 citing Littlejohn v. Parrish, 163 Ohio App.3d 456, 2005-Ohio-4850, 839 N.E.2d 49, ¶ 21 (1st Dist.). "'Good faith performance or enforcement of a contract emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party.'" Id. at ¶ 26, 839 N.E.2d 49, quoting Restatement of the Law 2d, Contracts, Section 205, Comment a (1981). Based on the foregoing, it can be logically concluded that an oil and gas lease is a contract, and because it is a contract, an oil and gas lease is subject to the implied covenant of good faith and fair dealing.
Id. ¶¶ 51-52, 2014 WL 6467477, at *8.
However, the court also suggested the possibility that the implied covenant of good faith and fair dealing could be effectively disclaimed by the language of the lease. In that case, the lease contained the following provision:
This lease contains all of the agreements and understandings of the lessor and the lessee respecting the subject matter hereof and no implied covenants or obligations are contained herein and no verbal representations or promises have been made or relied upon by lessor or lessee supplementing or modifying this lease or as an inducement thereto.
Id. ¶ 7, 2014 WL 6467477, at *2. But the court ultimately did not reach this issue, and it affirmed summary judgment in favor of the lessee on other grounds—that the lessee had acted as a reasonably prudent operator in "unitizing," or combining, the lessor's property into the 145.3-acre drilling unit at issue.