Mid-Continent Petroleum Corp. v. Sauder

PHILLIPS, Circuit Judge. . Philip Sauder brought this suit against the Mid-Continent Petroleum Corporation seeking the cancellation of an oil and gas lease covering the east half, and the southeast quarter of the southwest quarter, Sec. 16, Tp. 23 South, Range 13, Greenwood County, Kansas, as to the undeveloped portion thereof. We shall refer to the land just described as the Sauder lease. During the pendency of the cause, Philip Sauder died, and it was revived in the names of appellees herein, who are all his heirs at law. The lease was entered into June 6, 1916, and ran from Philip Sauder and Annie Sauder, his wife, to W. A. Moon and J. W. Phillips. It passed through mesne assignments to the Petroleum Corporation. It contained the following provision: “That the said parties of the first part * * * do hereby Lease and Let unto the said parties of the second part the exclusive right for Ton Years from date hereof, and as long thereafter as Oil or Gas can be procured thereon in paying quantities, to enter upon* operate for and procure Oil and Gas upon the following described premises. * * * ” During the primary term of the lease, the predecessors in title of the Petroleum Corporation completed two wells on the southeast quarter of the southwest quarter of section 16. The first well was completed November 1, 1921, and the second January 1, 1922. There has been no further drilling on the Sauder lease. The only evidence introduced by the appellees was a map showing producing wells situated east of the Sauder lease in sections 10,15, and 22, and south and west thereof in sections 17, 20, and 21. The producing wells nearest to the Sauder lease were: One situated 660 feet east of the east line, one 200 feet west of the west line, and two 200 feet south of the south line. The last mentioned wells were offset by the two wells drilled on the Sauder lease. The wells to the east of the Sauder lease were producing from the 'Bartlesville sand, and those to the south and west from the Mississippi lime. The uneontroverted evidence on the part of the Petroleum Corporation established these facts: The total revenue from the two wells drilled by the predecessors of the Petroleum Corporation, up to December 31, 1931, was $83,079, of which it received seve.n-eighths, and the Sauders one-eighth as royalty. Up to December 31, 1931, the Sauder lease had yielded to the Petroleum Corporation 5.1% per annum on the cost of the present development. The Bartlesville sand in the vicinity of the Sauder lease is found in long narrow strips averaging about three well locations in width. The wells are located a distance of about 460 feet apart, and not nearer than 200 feet to the lease lines. The producing area of the strip of Bartlesville sand here involved has been well defined by drilling. Dry holes have been drilled between this producing area and the east line of the Sauder lease. Wells along the west edge of the producing area have produced more water and less oil than the wells farther east. The sand along such edge is thinner and is found at greater depths than at points farther east. Wells drilled north, south, and west of the Sauder lease encountered no production in the Bartlesville sand. These facts demonstrate that such producing area lies to the east of the Sauder lease. The wells on the Sauder lease and those to the south and west thereof are producing from the Mississippi lime. The Mississippi lime produces oil at its higher points and is barren of oil at its lower points, that is, the oil is found where the lime is nearer to the surface. The two wells drilled on the Sauder lease, and the wells drilled to the north, west, and south thereof indicate [11] that the lime, on this lease dips sharply in every direction toward the Sauder lease, except from the northwest to the southeast, and that the lime is so low on the Sauder lease that probably no oil will be found therein in paying quantities except in the southeast quarter of the southwest quarter. The geologist for the Petroleum Corporation estimated the lime on the undeveloped portion of the Sauder lease to lie at a depth of from 580 to 610 feet below sea level. The wells that encountered the lime at a greater depth than 570 feet below sea level in the vicinity of the Sauder lease, were usually dry holes or produced oil in negligible quantities. Absence of oil in paying quantities in the Mississippi lime on the Sauder lease is indicated also by the following facts: Pour dry holes were drilled near such lease, one in the southeast' quarter of section 9, 1,880 feet north of the north line and 200 feet west of 'the east line of the lease, one in the northwest quarter of section 16, 630 feet west of the west line of the lease and 290 feet north of the center of section 16, and one in the southwest quarter of the southwest quarter of section 16, 200 feet west of the west line and 1,000 feet north of the south line of the lease. 'A well in the southwest quarter of section 15, 760 feet east of the east line of the lease, and a well in the northwest quarter of that section were drilled to, and failed to encounter oil in paying quantities in the Mississippi lime. The westerly well drilled on the Sauder lease encountered a thicker lime than the one to the east. The former produced 75 barrels of oil per day, while the production from the latter was slight. The former reached the lime at 558 feet, and the latter reached the lime at 574 feet below sea level. Mr. Moody, vice president of the Petroleum Corporation in charge of production of oil and gas, testified that the geological information indicated that oil and gas would not be found in paying quantities on the undeveloped portion of the Sauder lease; that such was the opinion of the representatives of the Petroleum Corporation; that if future development' or additional geological information should indicate that their opinion was wrong, they would be willing to drill additional wells on such lease; that they had not abandoned such lease, and it was their intention to hold it under the terms of the lease for future development. The trial court canceled the lease, except as to a small tract in the southeast quarter of the southwest quarter of section 16, surrounding the two producing wells. In Denker v. Mid-Continent Petroleum Corp. (C. C. A. 10) 56 F.(2d) 725, 727, 84 A. L. R. 756, this court said: “In order to comply with the implied covenants of a lease to drill offset wells and to diligently develop the lease, a lessee must do that which, under the circumstances, an operator of ordinary prudence, having regard to the interests of both lessor and lessee, would do. Brewster v. Lanyon Zinc Co. (C. C. A. 8) 140 P. 801; Pelham Petroleum Co. v. North, 78 Okl. 39, 188 P. 1069, 1072; Goodwin v. Standard Oil Co. (C. C. A. 8) 290 F. 92; Humphreys Oil Co. v. Tatum (C. C. A. 5) 26 F.(2d) 882; Orr v. Comax Oil Co. (C. C. A. 10) 46 F.(2d) 59, 63; 40 C. J. p. 1067, § 684.” This is the rule announced by the great weight of authority. It has been approved by the Kansas decisions. See Webb v. Croft, 120 Kan. 654, 244 P. 1033, 1035; Howerton v. Kansas Nat. Gas Co., 81 Kan. 553, 106 P. 47, 34 L. R. A. (N. S.) 34; Id., 82 Kan. 367, 108 P. 813, 34 L. R. A. (N. S.) 46; Day v. Kansas City Pipe Line Co., 82 Kan. 861, 109 P. 186. It has been recently followed in Broswood O. & G. Co. v. Mary O. & G. Co. (Okl. Sup.) 23 P.(2d) 387, where the court, under a state of facts similar to those in the instant ease, refused to cancel the undeveloped portion of an oil and gas lease. In Webb v. Croft, supra, decided April 10, 1926, the court said: “The lease is silent as to the number of wells that shall be drilled on the land, and in such a ease there is an implication that there shall be reasonable development of the land by drilling such number of wells as an ordinary prudent man would do under the circumstances, taking into consideration the results of the development and whether or not there was sufficient production to warrant the continuance of exploration and drilling.” However, in McCarney v. Freel, 121 Kan. 189, 246 P. 500, decided June 12, 1926, after the lease here involved was .entered into, the court stated the facts as follows: “The lease was dated June 15, 1912, and embraced a quarter section of land. The term was for 10 years, and as much longer as oil or gas could be produced in paying quantities. In October, 1912, a well was drilled which produced and still produces oil in paying quantities. In November, 1917, a dry [12] hole was drilled. No further effort has been made to develop the oil and gas resources of the land, although numbers of producing wells have been drilled and are in operation on all the surrounding land. Plaintiff’s evidence warranted the inference that defendants have not reasonably developed her land, and have no present intention to do so.” (Italics ours.) And then said: “A lessee may not hold an entire quarter section of land with a single producing well after expiration of term, any more than he may do so before expiration of term. The implied covenant, fairly to exhaust capability of the land to produce mineral, subsists. If the undeveloped portion of the land will not produce mineral in paying quantities, and the lessee would not be justified in drilling more wells, he may not continue to hold by virtue of a provision in the lease extending the term so long as oil or gas may be produced in paying quantities.” There must be ground for the cancellation of an oil and gas lease. In the absence of fraud or mistake, there must be a substantial breach of an express or implied covenant of the lease. The burden of proof to establish such a breach was upon the appellees. Goodwin v. Standard Oil Co. (C. C. A. 8) 290 F. 92, 98. With respect to development, there is an implied obligation on the part of a lessee to drill such wells as under the circumstances an operator of ordinary prudence, having regard for the interests of both the lessor and lessee, would drill. The trial court did not find that the Petroleum Corporation had breached such implied obligation. Indeed, such a finding would have been wholly without support in the evidence. The trial court’s decision in the instant case was predicated on the doctrine announced in McCarney v. Freel, supra. The Supreme Court in that case said the evidence justified the inference that there was a breach of the covenant to develop. The decree was predicated on that breach. Here, as before stated, there was no breach of any covenant to develop, express or implied. We think it is distinguishable from the instant case. If the doctrine announced in McCarney v. Freel, supra, is to be applied broadly to a state of facts such as exist in the instant ease, it amounts to this: That where, under the existing circumstances and the known .geological information, an operator of ordinary prudence having regard to the interests of both lessor and lessee would not drill on a portion of the lease, notwithstanding the provision of the lease that it shall extend to the whole tract as long as oil or gas is produced therefrom in paying quantities, the lessee by failing to drill on such portion forfeits his lease as to that portion. In other words, he must either do that which a prudent operator would not do or forfeit a portion of his lease. The implied covenant to develop imposes no such burden. Since McCarney v. Freel, supra, was decided long after the date this lease was entered into, while persuasive, it is not binding on us. Kuhn v. Fairmont Coal Co., 215 U. S. 349, 30 S. Ct. 140, 54 L. Ed. 228; Denker v. Mid-Continent Petr. Corp. (C. C. A. 10) 56 F.(2d) 725, 727, 84 A. L. R. 756. It is true that in Day v. Kansas City Pipe Line Co., 87 Kan. 617, 125 P. 43, decided July 6, 1912, the Kansas court uttered a dictum which supports McCarney v. Freel, supra. But in the lease there involved, there was an express covenant to “continue drilling as long as paying wells were found or royalties were paid,” and there was an express finding that the lessee had not diligently developed the leased premises. It is clearly distinguishable from the instant ease, because here there was no breach of the implied covenant to develop, and there is no express covenant in the lease to continue drilling as long as paying wells are found or royalties are paid. We are unable to subscribe to the doctrine of McCarney v. Freel, supra, as construed by the trial court, because in our opinion it either imposes a greater obligation under the implied covenant to develop than is recognized by the great weight of authority, including many Kansas decisions, or it places an obligation on the lessee not imposed by the lease contract, and in effeet makes a new contract for the parties. With much geological information at hand strongly indicating an absence of oil and gas in paying quantities in the undeveloped portion of the Sander lease, we think it cannot be said that the Petroleum Corporation has done other than what a prudent operator, under the existing circumstances, having regard for the interests of both lessor and lessee, would have done. In view of the long lapse of time since any development has taken place on the lease, the large area undeveloped, and the fact that the lessor is precluded from exploring it himself or through a third person, slight indication that the undeveloped portion contains oil or gas in paying quantities, regard for the interests of the lessee as well as the lessor, would require further development. But, under the [13] facts as they existed when this suit was tried, we are of the opinion that the Petroleum Corporation had violated none of the express or implied covenants of the lease contract. Until it has, or the lease has expired by its terms, it is entitled to continue to hold the whole of the Sauder lease. The costs will be assessed against appellees and the decree reversed without prejudice to the bringing of a new suit, in the event changed conditions should indicate a breach of the implied covenant to develop.