Implied Covenants Including the Implied Covenant to Market

This article was written with the assistance of Jamie Lavergne of Hughes & Luce, L.L.P.

One of the most hotly litigated concepts in oil and gas law is that concerning implied covenants in an oil and gas lease. Lessors seem to presume that there are implied covenants that alter the relationship with the Lessee from that established by the written lease. At the same time, Lessees seem to equally misunderstand their obligations. What is becoming clearer is how the Texas Supreme Court views implied covenants. What remains to be seen, though, is how implied covenants will be utilized in the future to the ever-changing oil and gas industry.

In order to adequately represent your client, you have to understand the concept of implied covenants - most don't. If you think it creates a relationship outside the oil and gas lease and that the written words in the lease are irrelevant, you are wrong. If you think that it requires the producer to put the royalty owner's interests first, you are wrong. Implied covenants, to the extent they apply, do nothing more than require the producer to act as a reasonably prudent operator would under the same or similar circumstances in the event, and only in the event, the lease is silent on the subject and the covenant is necessary for the fulfillment of the intent of the parties.

I. The Relationship between a Lessor and a Lessee

To understand why implied covenants are not the "white knight" lessors believe exists, you have to understand the relationship an oil and gas lease creates between a lessor and a lessee under Texas law. An oil and gas lease conveys title to the minerals in fee simple determinable. Jupiter Oil Co. v. Snow, 918 S.W.2d 466, 468 (Tex. 1991). The court, though, interprets the lease using the rules of contractual construction. The relationship under a lease is purely contractual. See Amoco Production Co. v. Alexander, 622 S.W.2d 563, 571 (Tex. 1981); Exxon Corp. v. Middleton, 613 S.W.2d 240, 245 (Tex. 1981). There is no duty of good faith and fair dealing owed by a lessee to a lessor. Hurd Enterprises Ltd. v. Bruni, 828 S.W.2d 101, 109-10 (Tex. App.-San Antonio 1992, writ denied); Cambridge Oil Co. v. Huggins, 765 S.W.2d 540, 544 (Tex. App.-Corpus Christi 1989, writ denied). See also Texas Oil & Gas Corp. v. Hagen, 31 Tex. Sup. Ct. J. 140-42 (1987), judgment and opinion withdrawn, judgment of court of appeals set aside, 760 S.W.2d 960 (Tex. 1988). There is no fiduciary, confidential or trust relationship that requires one party to place the interests of the other before his own. See Crim Truck & Tractor v. Navistar International, 823 S.W.2d 591, 594 (Tex. 1992); Hagen, 31 Tex. Sup. Ct. J. at 142; Atlantic Richfield Co. v. Long Trusts, 860 S.W.2d 439-44 (Tex. App.-Texarkana 1993, writ denied). Moreover, the lessee is not the agent of the lessor for the sale of production. Long Trusts, 860 S.W.2d at 445 (oil and gas lease does not create an agency relationship but merely a contractual obligation to pay a royalty). Simply stated, if there is a breach of the lease, the cause of action against the lessee is for breach of contract and nothing more. Amoco Production Co., 622 S.W.2d at 571 (breach of implied duty states a cause of action for breach of contract and nothing more).

II. Circumstances for Implying a Covenant

Having said the above, courts will, under certain circumstances, imply a covenant into a lease. The concept of implied covenants has existed in Texas oil and gas law since at least 1928. See Freeport Sulphur Co. v. American Sulphur Royalty Co. 117 Tex. 439, 6 S.W.2d 1039 (1928). Covenants are not, however, lightly implied into oil and gas leases since it is not the province of a court to make contracts for the parties. HECI Exploration Co. v. Neel, 982 S.W.2d 881, 888 (Tex. 1998) (citing Gulf Prod. Co. v. Kishi, 129 Tex. 487, 103 S.W.2d 965, 968 {Tex, Comm. App. 1937, opinion adopted}). A covenant is not implied into an oil and gas lease as a matter of law - it is implied, if at all, in fact based on the language, or lack thereof, contained in the lease. Danciger Oil & Refining Co. v. Powell, 137 Tex. 484, 154 S.W.2d 632, 635 (1941). The question that has continuously been asked, consequently, of Texas courts is when should a covenant be implied and, if so, the extent of the implication?

For the last seventy (70) years, the Texas Supreme Court has consistently answered this question by holding that implying a covenant is justified only on the grounds of necessity and nothing more. HECI Exploration Co., 982 S.W.2d at 889; Danciger Oil & Refining Co., 154 S.W.2d at 635; W.T. Waggoner Estate v. Sigler Oil Co., 118 Tex. 509, 19 S.W.2d 27, 31 (1929). The express terms of an oil and gas lease will not be altered by an implied covenant in order to achieve what a court believes is a more balanced or fairer contract. Id. As stated in HECI Exploration Co.:

A covenant will not be implied unless it appears from the express terms of the contract that "it was so clearly within the contemplation of the parties that they deemed it unnecessary to express it" and therefore they omitted to do so, or "it must appear that it is necessary to infer such a covenant in order to effectuate the full purpose of the contract as a whole as gathered from the written instrument."

HECI Exploration Co., 982 S.W.2d at 888 (quoting Danciger Oil & Refining Co., 154 S.W.2d at 635). In other words, a covenant will be implied only if it is necessary to fulfill the intent of the parties as disclosed by the contract as a whole. Danciger Oil & Refining Co., 154 S.W.2d at 635. As further explained in HECI Exploration Co.:

We have imposed implied covenants only when they are fundamental to the purposes of a mineral lease and when the lease does not expressly address the subject...