Implied Covenants: The Lease Doesn’t Say that, so Why do We Have to do it?

Definition:  Implied covenants in an oil and gas lease are obligations, usually by the lessee, that may not be spelled out specifically in the lease.

History:  For more than 100 years, courts have held that a mineral lessee’s duties include various implied covenants that are not expressly stated in the lease.  The earliest case may have been Stoddard v. Emery in 1889, wherein the Pennsylvania Supreme Court stated (in comments) that oil and gas leases are bound by an implied covenant to reasonably develop the leased property.  Three years later, the Pennsylvania Supreme Court again stated that a lessee was bound by an implied covenant of reasonable development, and just a few years later, the same court held that lessees are bound by an implied covenant to protect against drainage.  Other jurisdictions soon followed.  Today, it appears that any state with any significant amount of oil and gas development has recognized these covenants.

Reasons Needed:  Public policy occasionally is cited as a justification for implied covenants, but the two most commonly stated reasons are that implied covenants fill gaps in contracts and promote fairness.

Most Common:  The most common implied covenants are:

1. Market – there is an implication that a lessee will market the oil or gas that is produced under the lease.  The lessee may hold out for a reasonable and economic price.
2. Protect from Drainage – this covenant requires that the lessee drill viable wells to protect the lessor from drainage by wells that are not on lessor’s lease.  Modern spacing rules have somewhat diminished the need for this covenant.
3. Further Explore – after the primary term, this covenant determines that a producing field cannot hold the non-producing lands or non-producing horizons indefinitely.  No HBP, no coverage of the land under the lease.  If delay rentals are paid, the term of exploration is specifically set forth.
4. Operation – there is an implied covenant to operate prudently.

Application:  Implied covenants are most often called into play, and usually defined or interpreted by courts when disputes arise.