Little v. Page

REYNOLDS, Justice.

This appeal is from a decision of the Court of Appeals which reversed the judgment of the circuit court. The circuit court found that an oil and gas lease terminated on its expiration date since no production had occurred during the primary lease term so as to extend it.

On January 8, 1981, Herman Little and wife, Imogene Little, as lessors, executed an oil and gas lease on their ten and 20-¾ acre tracts of land in Clinton County, Kentucky, to James L. Tabb and Donald L. Kessler, as lessees. The instrument is referred to as a Kentucky 88-Gas Provision Agreement, which recited that its sole purpose was for the mining and operating for oil and gas, to produce, save and take care of the said products. The lease was to remain in force for a term of one year and as long thereafter as oil and gas, or either of them, was produced from the land by the lessees. The parties had modified the instrument with a drill-or-pay commitment provision which required the drilling of a well within 90 days or the payment of $2,000 to lessors and a well was timely drilled.

On January 20, 1981, the lessees assigned to Robert A. Page, respondent, an overriding royalty interest in the lease for the apparent consideration of assistance in obtaining the lease and a transfer of interest in a separate oil and gas lease. The assignment was subject to all terms and limitations of the original lease.

Drilling equipment was moved back onto the premises on January 5 or 6, 1982, and drilling operations began again. A strong showing of gas was encountered on January 7, 1982, and drilling was continued in the same hole when oil was encountered in marketable quantities either January 10th or 11th. Neither' before nor during the drilling operation did lessors tell the driller to cease operations, even though the lessors were in a position to observe the lessee’s drilling activities. However, on January 29, 1982, the movant, Herman Little, wrote a letter to the lessee, Tabb, requesting him to cease operations and, on the very same day, the Littles executed a second oil and gas lease to Mr. Tabb. The consideration for this latter lease was $2,000 front money and a ’/is of ⅜ of Vi overriding royalty interest plus a landowner’s, Vi royalty. There was no reference or inclusion of respondent's overriding royalty. No production resulted by reason of drilling conducted after the date of the second lease, but marketable production was achieved from the well in which oil was discovered on January 10th or 11th.

The trial court, following a bench trial, entered judgment for lessors and concluded that the January 8, 1981, lease terminated on its expiration date of January 7,1982, as no production had resulted during the primary term of the aforementioned lease and there was a lack of evidence that lessors’ actions or passivity extended the term by reason of the drilling activities.

Thus, in the absence of an express provision in the oil and gas lease, did the commencement of drilling, within the primary term, keep the lease in force pending completion of the well, or, stated in the alternative, was the lessee entitled, under the terms of the contract, to longer hold the lease?

Movants maintain the Court of Appeals was in error in determining that the primary term of the lease was extended by-commencement of drilling operations near the termination date of the lease and distinguish Lester v. Mid-South Oil Co., 296 F. 661 (6th Cir.1924); Hicks v. Mid-Kansas Oil & Gas Co., 182 Okl. 61, 76 P.2d 269 (1938); and Vaughn v. Hearrell, Ky., 347 S.W.2d 542 (1961).

A situation with a lease of similar terms and facts has not heretofore been presented to this Court and the cases cited by counsel may be distinguished by the clauses/provisions of the respective leases. Movants make reference to Summers Oil and Gas, Volume 2, p. 128, and The Law Of Oil And Gas Leases, Brown 2d edition, § 5.04 (1987), to buttress their argument that most state courts rigidly hold that production must be obtained before the expiration of the primary term in order to continue the lease in force and where the lease itself provided that it shall continue in force for a certain term of years and as long thereafter as oil and gas are produced.

Kentucky, to the contrary, has demonstrated a reasoned fairness, and it has been stated that as a matter of public policy which looks to the facilitation of development work in oil and gas and other minerals, a lessee, who in good faith is prosecuting work for development with reasonable diligence, will be protected against cancellation of his lease. Reynolds v. White Plains Oil & Gas Company, 199 Ky. 243, 250 S.W. 975 (1923).

In a case where on the termination date the lessee had discovered oil at a shallow level and drilled to deeper sand and upon no showing of oil therein discontinued his operations for the winter and did not resume operations the following spring, it was held that there was production under provisions of the lease. Hutchinson v. Schneeberger, Ky., 374 S.W.2d 483 (1964). Accordingly, the Kentucky courts have made reference to the reasoning and holdings of the Oklahoma courts. Oklahoma has favored an interpretation of lease rights as will favor development and permit completion of a well rightfully commenced. Moncrief v. Pasotex Petroleum Co., 280 F.2d 235 (10th Cir.1960).

In this case the lease did not contain a provision that the commencement of drilling within the primary term kept the lease in force pending completion of the well. The primary purpose of this Kentucky 88-Gas Provision Lease is for the express purpose of mining and operating for oil and gas. The lease did not provide that production must be had within the primary term or it would be rendered null and void. The lack or failure of actual production would, in some jurisdictions, result in termination of the lease by virtue of its own terms even with drilling operations commenced. This harsh provision is not always acceptable as has been demonstrated in some Texas and West Virginia cases. The uncertainty and vagaries attendant to commencement and drilling and with an effort to assure completion before the expiration of a lease adds to the risk which may result in lease expiration and economic loss. The forms of leases which provide a commencing-operations clause minimize the hazard aforesaid.

The Court of Appeals rationalized that the rule enunciated in Lester v. Mid-South Oil Co., supra, which had relied upon the earlier case of Hicks v. Mid-Kansas Oil & Gas Co., supra, as stating Oklahoma law to be that “[t]he right to commence a well during the primary term carries with it, by necessary legal implication, the right to complete the well after expiration of the primary term unless negatived by contract terms or loss by abandonment.” Moncrief v. Pasotex Petroleum Co., supra. We concur that the law in this jurisdiction is the same as that of Oklahoma. Thus, the rule is that a well commenced during the primary term may be completed after expiration of the term. We find this view to have been expressed in Vaughn v. Hearrell, supra, wherein the court noted that the term clause of an oil and gas lease dictates the period for which the lease shall run, unless the clause is properly modified by another lease provision. The lease form in Vaughn, supra, contained both a delay rental clause and a dry hole clause, which are intended to keep the lease in force only within the primary term. Vaughn overruled so much of Simpson v. Buckner’s Adm’r, 247 Ky. 564, 57 S.W.2d 464 (1933), as held that those clauses would extend the primary terms of the lease. The case involved an instrument that did not contain a commencing-operation clause. In Vaughn, 347 S.W.2d at 545, it was stated:

Appellee relies upon Simpson v. Buckner’s Adm’r, 247 Ky. 564, 57 S.W.2d 464, to sustain the validity of the lease sued on, and, in truth, the opinion in that case held that performance under the dry-hole and rental provisions would operate to extend the lease indefinitely, in fact, ad infinitum, if the lessee so desires. That case could and should have been decided on the basis of the lessee’s having commenced drilling within the primary term. Cf. Lester v. Mid-South Oil Co., supra. The Simpson opinion went far out and gave to the printed dry-hole and delay-rental provisions a literal construction which overrode the primary term and bestowed upon the printed form the same significance as if it had been composed on the spot and had really evolved out of the negotiations of the parties. We conclude that opinion made bad law and ought to be overruled insofar as it goes further than to say that a drilling operation in progress at the end of the primary term holds the lease in force pending the completion of the well. (Emphasis added.)

We concur with the decision of the Court of Appeals in that the circuit court was incorrect in determining the January 8, 1981, lease to be invalid.

The judgment of the trial court following its bench trial recognized that the issue of estoppel had been presented without objection. Under the specific facts of this case we hold that the doctrine was applicable. CR 8.03, CR 15.02, and Bailey v. Thompson, Ky., 300 S.W.2d 235 (1957).

While forfeitures are not generally favored by the law, forfeitures which arise in gas and oil leases are rather favored because of the peculiar character of the product to be produced.

In this case the trial court found that a strong showing of gas was encountered during the drilling operation on January 7, 1982, at an approximate depth of 450-500 feet and that the drilling continued without any interruption or protest from lessors. Oil was encountered in marketable quantities, about January 10th or 11th.

Initially, the lessees drilled a well within 90 days of the execution of the lease. No production of oil was shown to have occurred, but an inserted term in the lease provided that should gas be discovered and not commercial oil, lessees agreed to leave the casing in subject well and cap same for use by lessors as a domestic gas well. The record discloses that this first well had been assigned by lessees to the lessors.

In view of the trial court’s findings, we believe the movants should not be heard to say that they did not consent to the development work by the lessee nor be allowed to claim or have a forfeiture of the lease because to do so would be contrary to the fundamental principles of equitable estop-pel. Cadillac Oil & Gas Co. v. Harrison, 196 Ky. 290, 244 S.W. 669 (1922); Reynolds v. White Plains Oil & Gas Co., supra. The demand for the execution of a second lease did not occur until after oil production occurred. The record demonstrates that front money and overriding royalties, in addition to the landowners’ royalty, were demanded and given with no requirement of additional drilling. The subsequent lease was based on production.

The decision of the Court of Appeals is affirmed and this cause is remanded to the circuit court for proceedings consistent with this opinion.

STEPHENS, C.J., and COMBS, LEIBSON and WINTERSHEIMER, JJ„ concur. SPAIN, J., dissents by separate opinion, in which LAMBERT, J., joins.