Implied Covenant to Reasonably Develop – Acreage
Many of my clients come to me hoping that I can help break their oil and gas lease. As a general proposition, oil and gas leases are hard to terminate. Given that they are drafted by oil and gas companies, it should not be surprising that they often favor the oil and gas companies themselves. Every landowner’s situation will be different, but as long as the lessee to the oil and gas lease (the producer) pays a royalty to the lessor (the landowner), the lease is nearly bullet-proof.
However, there might be other ways to terminate an oil and gas lease even if the lessee is paying a royalty to the landowner. One particular method to cancel an oil and gas lease has to do with implied covenants to reasonably develop the entire leasehold. This method doesn’t cancel the lease in its entirety, but only cancels it to those lands that have not been drilled or included in a drilling unit. Ohio has long held that a mineral lease includes an implied covenant to reasonably develop the land. (see Ionno v. Glen-Gery Corp., 2 Ohio St. 3d 131, 132-133)
For example, consider an oil and gas lease taken on 200 acres. Let’s say that thirty years ago one well was drilled on the 200 acre lease, and that this well unit only included 40 acres. Under the implied covenant to reasonably develop, a judge may very well cancel the lease to the remaining, unused 160 acres (200 acres – 40 acres = 160 acres). How could a judge do that? The basic question that needs to be answered is whether or not the oil and gas producer has behaved as a reasonable oil and gas producer would in similar circumstances. If any reasonable producer would have drilled more than one well on the 200 acre lease, then a reviewing judge might void the lease to the remaining 160 acres. However, if the existing well was not a very good well, then it might be that the producer did behave reasonably when they decided not to drill additional wells.
This same concept can be applied to unused geological formations (i.e. the Utica shale), as well as unused acreage.
This covenant to reasonably develop is nice in theory, but in practice is not as favorable to the landowners as it might seem. Most new leases contain provisions that effectively waive the implied covenant to reasonably develop the subject land. In other words, leases with such language impose no duty on the producer to reasonably develop the land. Many Ohio courts have found this language legitimate, effectively eliminating the landowner’s efforts to void the lease for a failure to reasonably develop.