086 Neel v. HECI Exploration Company

Wednesday, September 2nd, 2015

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
In Neel v. HECI Exploration Co., 942 S.W.2d 212 (Tex. App. — Austin, Jan. 23, 1997, n.w.h.) the court concludes that the implied covenant to protect the leasehold in an oil and gas lease requires that a lessee who decides to sue neighboring producers for damages resulting from overproduction must give notice of that decision to the uninformed and unrepresented lessor. In expressing this opinion, the court used language which is so broad that its holding may be intended to extend to other interest-holders, such as overriding royalty owners and non-operators. The court also held that the discovery rule is applicable in determining whether the various causes of action alleged for failure to give notice are barred by limitations.
Neel leased to HECI, which drilled successfully on the lease, before learning that AOP, a neighboring operator, was producing excessively from the same field. HECI then successfully pursued regulatory action and litigation against AOP, which resulted in a judgment for HECI in the amount of almost $2,000,000.00 in actual damages and $2,000,000.00 in punitive damages. The damages were awarded for damages to the reservoir that resulted in lost reserves under HECI’s lease. HECI never informed Neel of the over production, the legal action, or the judgment, which Neel actually discovered much later.
The most interesting question was the scope of lessee’s duty under the implied covenant of the lease to protect the leasehold and to account under the royalty clause. Neel contended that HECI had to represent Neel in the AOP litigation and that the recovery was “production” upon which royalty was due. HECI contended that (i) it had no duty, right, or ability to represent Neel in the AOP litigation, (ii) that HECI did not represent Neel, and (iii) that the damage award was not “production” upon which royalty was due.
The court determined that the duty of the implied covenant to protect the leasehold did not extend to the filing of unauthorized suits, but it also did not permit abandonment of a part of the leasehold. It concluded that the covenant required that a mineral lessee “who determines that a suit for damages is necessary to protect the leasehold, but lacks the power to sue for all who have interests in the leasehold, must notify the unrepresented interest-holder, of the need for suit and the lessee’s intent to sue.” The other interest owners can then have the option of pursuing their own action, joining the lessee’s action, assigning their interest to the lessee, or waiving their rights. The court was careful to note that lessee’s failure to notify will not always mean that the lessee owes damages to the lessor. For example, the lessor may have independent knowledge of the need for a suit. The court suggests that the measure of damages for failure to notify might be measured by reference to lost royalty. The court also concludes that limitations will not begin to run on this type of claim until the lessor knows or should have known of the injury.
The case is significant because it broadens the lessee’s duty to protect the leasehold to either act for the entire leasehold or give notice of its actions to those for whom it cannot act.