010 Sun Explor. and Prod. Co. v. Jackson

CASE OF THE MONTH

Richard F. Brown

 
The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
 
Sun Exploration and Production Company v. Jackson, S.W.2d, 31 Tex. S. Ct. J. 604 (1988), is focused on whether there is an implied covenant in an oil and gas lease to reasonably “explore” the leased premises as distinguished from the established implied covenant to reasonably “develop” the leased premises. Ten thousand acres of the Jackson Brothers Ranch were placed under a single oil and gas lease in 1938. The Oyster Bayou Field was discovered on the lease in 1941, and $25,000,000 was spent drilling 66 wells on the lease, including at least 16 wells outside the known field. This prolific field generated more than $42,000,000 in royalties in just the last ten years, and royalties of more than $10,000 per day were not unknown. The Oyster Bayou Field encompassed 1,800 acres, and the Jacksons contended that the lease had terminated as to the remaining 8,200 acres under lease for failure to reasonably develop and/or to reasonably explore.
 
The jury found that Sun had not failed to reasonably develop the lease, but that Sun had failed to reasonably explore the lease. The trial court unconditionally canceled a portion of the lease and the Court of Appeals affirmed. The Texas Supreme Court reversed, held that the lease remained valid, and returned the case to the trial court to determine whether Sun was entitled to attorney’s fees.
 
The Supreme Court agreed with the lessors that there are two distinguishable implied covenants. All the activities taking place within a known or producing formation come under the implied covenant of reasonable development. All those activities outside a known producing formation come under the implied covenant of further exploration. However, the lessor must show that the activity holds a reasonable expectation of profit to both lessor and lessee to impose an obligation on the lessee to drill under either covenant. The proof cannot be mere speculation. Although it is not clear, the Court seems to imply that the proof must be based on the probability of discovering hydrocarbons from a single well. The Jackson’s best evidence was that one location had a 25% chance of success. The Court held that a 25% chance of success is not sufficient proof for a court to force an unwilling operator to drill. Again, it is not clear, but it is possible that the Court’s opinion could be construed to hold that the chance of success must exceed 50% to support a verdict that there is a reasonable expectation of profit to the lessee. Because the Court validated the lease in this case, it did not consider whether the remedy of unconditional lease cancellation would be appropriate if the lessee failed to reasonably explore the lease.
 
Although the case creates a new implied lease covenant, it is more significant that the case does not seem to expand the lessee’s obligation to drill. In fact, if the case says that there is no obligation to drill unless there is at least a 50% chance that the well will be profitable, it makes the duty on the lessee less onerous than previously assumed. At least five of the justices noted in concurring opinions that the Court’s opinion was unclear. If the justices are uncertain of its meaning, then it seems other litigation will surely follow.