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Ohio Does Not Recognize the Implied Covenant to Explore Further

By Paul R. Yagelski, Esq.

Landowners Must Rely on Implied Covenant of Reasonable Developments

A group of landowners in Ohio sued Collins-McGregor Operating Company and Winston Oil Company (collectively “Collins-McGregor”), seeking the partial termination of an oil and gas lease.  The landowners held interests in approximately 74 acres of land in Washington County, Ohio, not far from the Ohio River.  The land is subject to an oil and gas lease entered into on September 6, 1980, between the owners of the property and at that time Collins-McGregor, whose interest was assigned to Winston Oil Company. Did Collins-McGregor breach the implied covenant?

A well had been drilled in 1981 and had produced oil and gas in paying quantities since that time from a formation called the Gordon Sand, but there had not been any production from the land at any depths below the Gordon Sand.  The landowners contended that exploration and the production of oil and gas had been occurring near their property from below the Gordon Sand; specifically, from the Marcellus and Utica formations; however, Collins-McGregor had failed to explore whether production could be obtained from those formations because it did not have the equipment or financial resources required to do so.

In their suit, the landowners alleged that Collins-McGregor improperly failed to explore or drill for oil at depths below the Gordon Sand.  They sought a judgment that, that portion of the lease covering depths below the Gordon Sand had terminated because it had either expired or been abandoned and that Collins-McGregor had breached numerous implied covenants; specifically, the implied covenant of reasonable development and the implied covenant to explore further.  Ultimately, the remedy sought by the landowners was a partial forfeiture of Collins-McGregor’s rights under the lease such that all rights to explore for, develop and exploit resources from depths below the Gordon Sand reverted to the landowners.  Collins-McGregor moved to dismiss the case. The trial court agreed and dismissed the case.  This was affirmed by Ohio’s Fourth District Court of Appeals.  The landowners then sought appeal to the Ohio Supreme Court.

On appeal, the Ohio Supreme Court noted that it had not previously considered the implied covenant to explore further.  In the landowners’ view, recognition of the implied covenant to explore further would support the purpose of the lease by encouraging exploration and development of mining activities for the mutual profit of the parties.  In opposition, Collins-McGregor argued that there is no need for the covenant because the covenant of reasonable development provides sufficient protection to landowners concerning the productive use of the land.

The Ohio Supreme Court agreed with Collins-McGregor.  Although the landowners have an interest in development of the land, that interest is sufficiently protected by the implied covenant of reasonable development and does not require recognition of a new implied covenant to explore further.

The purpose of the implied covenant of reasonable development is to protect the lessor’s interest in the lease, which is to obtain production and, hence, profits once the right to drill has been granted to the lessee.  This protection is needed because oil and gas leases typically provide, as the one before the Ohio Supreme Court, that the lessor’s compensation is a royalty payment based on the production from the land.  On the other hand, the Ohio Supreme Court recognized that the implied covenant of reasonable development is not entirely one-sided in favor of landowners.  The Ohio Supreme Court noted that it had recognized that lessees face various risks in any oil and gas lease, including substantial upfront investments within a certain potential for returns.  According to the Ohio Supreme Court, it has held that the covenant imposes on the lessee only the obligation to act as a reasonably prudent operator would as it develops the land under the lease.  In light of this, the Ohio Supreme Court held that the landowners’ interest in exploration in deep formations below the Gordon Sand are sufficiently protected by the implied covenant of reasonable development.  It therefore declined to recognize a separate covenant to explore further.

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