Implied Duties in an Oil and Gas Lease
One of the fundamental concepts that I learned in my first-year Contract Law course was the nature of “arm’s length transactions.” Parties that enter arm’s length transactions stand on equal footing. Each side must independently perform their own due diligence to ensure that the agreement will produce the outcome respectively desired. Often, one party to a contract will have vastly superior expertise in the subject goods or services. However, in an arm’s length transaction, the more sophisticated party generally doesn’t have an obligation to consider the welfare of the counterparty.
Arm’s length transactions differ from relationships involving duties implied by law. For instance, in the consumer insurance context, the law recognizes the knowledge disparity between you and the insurance company and protects you by imposing duties on the company to act in your best interest. As a result, you don’t need to hire an attorney to scrutinize a policy before buying typical homeowner’s insurance.
In general, parties to an oil and gas lease are dealing “at arm’s length.” The operator seeking to lease your mineral rights has no obligation to design terms that serve your interests. However, depending on the jurisdiction, the operator may be subject to certain “covenants,” or implied legal duties owed to you, the lessor. Oil and gas companies are bound to the implied covenant, or standard of conduct, of a “reasonable, prudent operator.” The reasonable, prudent operator must act in good faith with consideration of your interests. Within this umbrella standard of conduct, oil and gas operators (lessees) are often bound by more defined legal duties. Those include:
The implied covenant to test – requires the lessee to examine the property for oil and gas after execution of the lease;
The implied covenant to market – requires the lessee to market oil and gas expeditiously at a reasonable price;
The implied covenant to reasonably develop – requires the lessee to develop the oil and gas within a reasonable period of time in productive fashion;
The implied covenant to protect against drainage – requires the lessee to protect the oil and gas in your reservoir from traveling to adjacent properties;
The implied covenant for further exploration – requires the lessee, after initial production, to explore undeveloped parts of your property for more oil and gas.
Oil and gas operators are well acquainted with these implied duties and the extent to which they are enforced in any jurisdiction. As a result, they will design leases that attempt to either disqualify these covenants or require a period to “cure” any performance defects. Mineral leases are complex and bind the parties to lengthy contractual terms. Although some protections exist at law, you should assume that you will be treated as party to an arm’s length agreement and, therefore, tasked with doing your own due diligence. Consult an experienced mineral rights attorney if you have questions about a proposed or existing lease.
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