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Thursday, April 21, 2016

Potential Oil and Gas Lessees Should Look Closely for "Implied Requirement" in Leases

From Gas & Oil:
Under Ohio law, oil and gas leases constitute contracts. As a general matter, the rights and remedies of the parties entering into a contract must be determined by the terms of the written agreement. Over the years, however, Ohio courts have determined that oil and gas leases should include a number of “implied covenants”—provisions which the courts will assume the parties meant to include, even if the contract does not specifically address the issue. These implied covenants include a producer’s obligation: (1) to drill an initial exploratory well; (2) to protect the lease from drainage from wells on neighboring properties; (3) to reasonably develop the land; (4) to explore further after an initial well is drilled on a large tract of land; (5) to market the oil and gas produced; and (6) to conduct all operations that affect the mineral owner’s royalty interest with reasonable care and due diligence. Of these implied covenants, the covenant to reasonably develop the land covered by the lease is one of the most important.

The implied covenant of reasonable development originates from the goal of an oil and gas lease. Namely, the courts have long recognized that a mineral owner’s goal in leasing acreage is to collect royalties on oil and gas produced after wells are drilled. Further, Ohio public policy supports the development of the state’s natural resources. Thus, the implied covenant of reasonable development requires producers to use reasonable diligence to develop the leased acreage. Where a lease covers a significant block of acreage, a producer must often drill multiple wells on the acreage included in the lease. When additional oil and gas development takes place in an area, the implied covenant of reasonable development may also require a producer to further develop the leased property based upon changing circumstances. If a court decides that a producer has violated the implied covenant of reasonable development, the court may award money damages or may order the release of undeveloped acreage, thereby allowing the mineral owner to seek out a producer who will fully develop the acreage.
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