R. A. Bristol and Ralph A. Bristol, Trustee v. Colorado Oil and Gas Corporation, a Corporation, and Colorado Interstate Gas Company, a Corporation ( 1955 )

MURRAH, Circuit Judge.

The appellants, lessors- of undivided mineral interests in lands in Cimarron County, Oklahoma, brought this suit to cancel the oil and gas lease and quiet their title to their fractional mineral interests, contending that the lease expired by its own terms for failure of the lessees to produce oil or gas therefrom in paying quantities within its primary term. This is an appeal from a judgment denying cancellation and validating the lease. The suit is between citizens of different states and involves the requisite amount in controversy.

The “unless” lease was for a term of five years and as long thereafter as oil or gas or either of them was produced from the said land. During the definite term of the lease a well was drilled and completed capable of producing gas in paying quantities, but because of the un-bumable quality of the gas and the absence of any pipe line facilities, the well was capped and no gas sold therefrom until seven and two-thirds years after the expiration of the definite term. During that time the co-tenants of appellants executed annual shut-in royalty agreements and accepted stipulated “rental or royalty”. While the appellants refused to execute the shut-in agreements, they did accept their pro rata share of the rentals or royalties for seven years without protest until the year before a pipe line connection was made, when they refused to accept the proffered payments and later brought this suit to cancel the lease and quiet their title.

Following the general rule announced in Christianson v. Champlin Refining Co., 10 Cir., 169 F.2d 207, the trial court found that the original lessee and its successors exercised extraordinary diligence in their efforts to market the gas after discovery within the primary term, and that when they did finally succeed, the lease had not terminated but continued in full force and effect, and that the mineral interests of the appellants were subject thereto. See Bristol v. Colorado Oil & Gas Corp., D.C., 126 F.Supp. 487.

In the Christianson case we stated the general rule to the effect that where production results from drilling operations and the operator is unable to market the production immediately on account of lack of an available market or pipe line connections, no forfeiture results if in the exercise of due diligence on the part of the operator the well is equipped and a market is obtained within a reasonable time. That case involved a Kansas lease, and Kansas has subsequently expressly repudiated the notion that discovery of oil or gas without actual production would operate to extend the lease beyond its definite term. See Tate v. Stanolind Oil & Gas Co., 172 Kan. 351, 240 P.2d 465 and Home Royalty Ass'n, Inc., v. Stone, 10 Cir., 199 F.2d 650. Cf. Freeman v. Magnolia Petroleum Co., 141 Tex. 274, 171 S.W.2d 339. The rule has also been criticized by Professor Summers as an application of “fireside equities” to write a new contract for the parties. See Summers, Oil and Gas, Vol. 2, § 300, Pages 157-8.

But this lease. is an Oklahoma contract, and the parties apparently agree, at least for the purposes of this case, that under Oklahoma law, actual production within the definite term of the lease is not a condition precedent to the extension of the lease beyond its definite term; that the lessee has a reasonable time to market the gas after discovery and expiration of the definite term of the lease. And see Roach v. Junction Oil & Gas Co., 72 Okl. 213, 179 P. 934; Strange v. Hicks, 78 Okl. 1, 188 P. 347; Parks v. Sinai Oil & Gas Co., 83 Okl. 295, 201 P. 517; Eggleson v. McCasland, D.C., 98 F.Supp. 693. Cf. Skelly Oil Co. v. Wickham, 10 Cir., 202 F.2d 442 and Bain v. Portable Drilling Corp., 200 Okl. 569, 198 P.2d 207.

While accepting the rule as stated, the appellants state the question for decision as whether the gas was marketed within a reasonable time, and relying upon the literal language of the Christian-son case, supra, the question is said to be not whether the lessees exercised due diligence under an implied covenant to market, as the trial court reasoned, but whether they discharged “an absolute duty to market within a reasonable time to prevent termination.” Otherwise stated in the language of the appellants, the question is “not how hard Pure Oil Company tried to market the gas or sell the lease, but whether it succeeded in marketing the gas within a reasonable time.”

As a necessary corollary to the beneficent rule which protects lessees from termination or forfeiture for failure to actually produce and market gas discovered within the primary term, the Oklahoma courts have implied a covenant to operate the validated lease in a prudent manner and with reasonable diligence. Strange v. Hicks, supra; Indiana Oil & Gas & Development Co. v. McCrory, 42 Okl. 136, 140 P. 610; Newell v. Phillips Petroleum Co., 10 Cir., 144 F.2d 338; Saulsbury Oil Co. v. Phillips Petroleum Co., 10 Cir., 142 F.2d 27; Wolfe v. Texas Co., 10 Cir., 83 F.2d 425; Summers, Oil and Gas, Vol. 2, § 400. Like implied covenants for exploration and development, the covenant to operate prudently and diligently is based upon considerations of fairness, having regard for the mutual rights and duties of the parties. And where the sole of primary consideration for the lease is the payment of royalties from the production, it is incumbent upon the lessee to make sure that conflicting interests are not weighted against the lessor. See Merrill, Covenants Implied in Oil and Gas Leases, Second Edition, Sec. 72, and cases cited.

The covenant to operate necessarily embraces a duty to market the production to the mutual advantage of both parties. See Merrill, Sec. 84. But since the “covenant is not to operate absolutely but to operate reasonably and with diligence”, Merrill, Sec. 90, the component duty to market must be tempered by the rule of reason and prudence. It follows that in the adjustment of the rights of the parties under the contract, and particularly in determining whether the implied covenants have been kept, we deal not in absolutes but in facts and circumstances, and with rules or criteria flexibly adaptable to the practical exigencies of the case. Trust Co. of Chicago v. Samedan Oil Corp., 10 Cir., 192 F.2d 192. Considered in this light, diligence and reasonable time become related terms in the promulgation of a rule of conduct based upon equitable considerations applicable to particular facts for the adjustment of the rights of the parties to a contract where it speaks only by implication.

While reasonable time and due diligence do not have the same meaning in the application of the rule of reason, they are both essential ingredients of the rule. For reasonable time is measured, in some degree at least, by the diligence with which the lessee attempts to secure a market. And conversely, the reasonableness of the time may influence the question of diligence. This does not mean, however, that reasonable time is unlimited in the face of diligent effort. Indeed, we do not understand the learned trial judge to infer that the lease would endure so long as the lessee can show diligent efforts to market the production. The rule of reason will bring the term to an end some time, regardless of intensity of effort. In determining whether the lease has been forfeited for breach of the covenant to market, equity “will impose a rigid standard of good faith on the part of the lessee”, measured in each case not only by the lapse of time, but the diligence of the operator as well. Cf. Phillips Petroleum Co. v. Peterson, 10 Cir., 218 F.2d 926.

We start with the premise that nine and one-half years have ' elapsed since the completion of the well and seven and two-thirds years since the expiration of the definite term of the lease. During this time the lessors have not received any of the primary consideration for the lease. On its face, and in the very nature of things, this period of time is inordinately long and undoubtedly places the burden upon the lessees to excuse the delay.

They have come forward with these facts. The well was drilled on a large block of leases in “wildcat” territory more than twenty miles from a gas pipe line. There was no demand for the production, hence no available market. Moreover the gas was unsuited for domestic use without blending or treatment. In its effort to find or create a market the original lessee, the Pure Oil Company, contacted all of the companies which might be interested in taking the gas or assuming the lease with its obligations. It drilled a total of fourteen wells on the block, three of which were gas wells, five oil wells, and five dry holes. The original well drilled within the term cost approximately $126,000. Each of the other wells cost approximately $50,-000. The Pure Oil Company expended another $100,000 in seismographic exploration. There were no other gas wells in this vicinity connected to a pipe line. There was no drainage. Neither Pure nor its successors received any return on their investment until the pipe line connection in 1952. After the leases were assigned to the Colorado Oil and Gas Corporation, five additional gas wells were drilled and there is some intimation that if Pure had drilled the additional wells with resulting reserves, the availability of the market would have been hastened.

But the facts are that the market was not available until Colorado Interstate Gas Company constructed its twenty-inch pipe line from Texas to Denver from which it extended a ten-inch line to the wells in question after it had acquired the acreage including the producing oil wells. When the connections were finally made and Colorado Interstate commenced taking the gas and paying the royalties, the market price of the gas had increased from 3%0 and 40 per mcf to 7%0 per mcf in 1952, 8%0 per mcf in 1953, and at the time of the trial the base price for the gas from these wells yielded the royalty owners' 120 per mcf.

.[6] And it is significant, we think, to note the attitude of the lessors during this long period of delay. The record is barren of any demands upon the lessees to further develop, find a market or release the leases. It seems fair to say that it was not until the pipe line connections were imminent that the lessors sought cancellation. Meanwhile they accepted without protest their prorata part of the payments made as shut-in royalties in lieu of further development or sale. And while the acceptance of these payments without signing the shut-in agreements may not operate strictly as an estoppel or waiver of their rights to insist upon a breach, it is proper, we think, to consider it in the light of all of the other facts and circumstances in the determination of the ultimate question of prudent operation in the light of time and effort. See Stanolind Oil & Gas Co. v. Kimmel, 10 Cir., 68 F.2d 520 and Eggleson v. McCasland, supra. Furthermore, the courts, recognizing the insurmountable problems of storing gas above ground or transporting it without a pipe line, have been prone to “uphold lease extensions where gas is discovered and determined to exist in marketable or paying quantities but for one reason or another cannot be readily produced and marketed.” Town of Tome Land Grant, Inc., v. Ringle Development Co., 56 N.M. 101, 240 P.2d 850, 851; Summers Oil and Gas, Vol. 2, § 299.

All of these are practical considerations which enter into and determine the question whether a forfeiture will be decreed. It was these considerations which prompted the trial court to deny forfeiture, and a rightful regard for the findings and conclusions of the chancellor in cases of this kind brings us to an affirmance of his judgment.