No. 14755 IN THE SUPREME COURT OF THE STATE OF MONTANA 1979

U. V. INDUSTRIES, INC

# ., A corporation, et al., Appellants,

RUSSEL D. DANIELSON, ROBERT V. DANIELSON, and MYRNA BRODHEAD, Respondents.

Appeal from: U. S. District Court, Billings Division, Hon. U.S. District Judge James Battin,presiding. Counsel of Record: For Appellant: Crowley,Haughey, Hanson, Tool & Dietrich, Billings,

Montana Cale Crowley argued,Billings, Montana For Respondents: Raymond K. Peete argued, Billings, Montana

Submitted: September 18, 1979 ~ecided: 

### NOV 

## 11979Mr. ~ustice Gene B. Daly delivered the Opinion of the Court. This matter isbefore this Court on certification from the United StatesDistrictCourt for the Districtof Montana. Plaintiffs-respondents aregrantees under a mineral deed from the owner and lessor of the oiland gasbeneath the ~1/2 of section 10inRichland County, Montana. Defendantsapplicants arethe lessee and its assigns under the "Danielson" oiland gas leasecovering this tract; some of the applicants areorwere alsolessees under the "Lewis" oil and gas leasecovering an adjacent tract, the NW1/4 of section 10. On May 12, 1975, respondents, the grantees, brought s u i t i n stateDistrictCourt inRichland County, requesting damages from the applicants for theperiod between February 3, 1970 and September 14, 1972, for failure todrillan offsetwell toprotect their oilinterests from drainage by a producing wellon an adjacent tractof land (Lewis lease). The casewas removed tothe United States DistrictCourt for theDistrictof Montana, which has certified several issues tothisCourt for declaratory judgment regarding applicable Montana law, on applicationof the lessees pursuant toRule 1of the Rules of thisCourt. The facts inthiscase arecomplex, but the parties are insubstantialagreement asto those facts, which follow in summary form. There are two oiland gas leases involved in this suit--the "Danielson" lease covering the E1/2 of S~Ction 10, and the "Lewis" leasecovering the adjacent NW1/4 of Section 10. On December 30, 1968, Hilda ~anielson, respondents' mother and predecessor ininterest, executed a five-year primary term, "unless delay rentals" oiland gas lease ("~a~ielson" lease) toapplicant Empire State

### oilCo., which subsequently assigned it tothe other applicants.This lease contained a clause providing that no change in ownership of the mineral interestwould be binding upon the lessee until it received written notice thereof. On July 24, 1970,Mrs. ~anielson conveyed her interest to her five children, three of whom are respondents, in a mineral deed subject to the existing lease. The deed was recorded on September 20, 1971. Meanwhile, a producing well was completed by King Resources Co. on the adjacent Lewis tract on February 3, 1970. Two of the applicants,U. 

### V. Industries, Inc. (through itspredecessor United States Smelting,Refining and Mining Company), and Wolf Corporation were at relevant times part owners of this leasehold interest in the Lewis tract. Under the dates July 1 and July 26, 1972,U. 

### V. Industries received letters on behalf of two of the plaintiffs demanding that U. V. Industries drill an offsetwell in the NE1/4 and compensate them for drainage resulting from production from the well on the adjacent Lewis lease. This demand was refused. U. 

### V. Industries first received a copy of the mineral deed fromMrs. Danielson to her five children on August 2, 1972. All delay rentals through December 1972

were paid and accepted. Prior to September 14, 1972, the spacing of wells drilled on Section 10was governed by statewide spacing orders issued by the Board of Oil and Gas Conservation. The statewide spacing order governing well spacing in the formation and depth to which the Lewis well was drilled in effect at the time the well was drilled provided that one well could be drilled and operated on each quarter section

(160acres). This order was changed by the ~oard'sOrder No. 16-71 of May 13, 1971,which provided that one wellcould be drilledand produced on 320 acres atthisdepth. Under theMay 13, 1971order, the 320 acre spacing unit would be composed of two contiguous north-south oreast-west quarter sections designated by the lease operator, which did not necessarily have tobe within the same section. On September 14, 1972, theMontana Oiland Gas Conservation Board held a hearing atwhich respondents and applicant U. V. Industries were represented. The Board issued a specificwell spacingorder superseding the statewide spacing order for the particular production field involved in thepresent controversy (LonetreeCreek field). This order designated theN1/2 of Section 10asa production spacing unit. The designatedwell spacing unitincludes the existing, producing Lewis wellon the NW1/4 and it alsoincludes theNE1/4 owned by the respondents, where they arealleging applicants had a duty todrillan offsetwell. Subsequently,

on September 15, 1972, allparties entered a voluntary pooling and unit agreement covering this field. Respondents brought the present action seeking damages under the common law "offsetdrillingrule." The common law theory implies inevery oiland gas lease a covenant on the partof the lessee toprotect thepremises of his lessor from drainage of an adjacent producing wellby drilling an offsetwell. The threshold issue is: (1)Whether ornot the common law judicial remedy of a civil suitfordamages in state DistrictCourt under the offset drilling rulehas been abolished by enactment of the 1953Montana Oiland Gas Conservation law; i.e., does the Board of Oiland GasConservation have exclusivejurisdiction todetermine such controversies? If thisquestion isdetermined adversely toapplicants, there are several subsidiary issues: (2)Was the lessor orher grantees (respondents) required to servewritten notice ordemand on the lessee or its assigns (applicants) todrillan offsetwell; if so, did the lessee have a reasonable timethereafter inwhich to comply; and, when does the obligationof the lessee, if any, topay damages commence? (3) What is the effectof the "no change inownership untilwrittennotice" clause inthe lease and certainprovisions of themineral deed on the rightsof theparties? (4) What is the appropriate statuteof limitations? The applicants' contentions are as follows: Issue 

### - #l. Enactment of the 1953 Oiland Gas ConservationAct, sections 82-11-101 et seq., MCA, has eliminated and abolished actions toprevent drainageby producing wells

on adjacent land based on the common law offset drilling rule theory. The power toconduct public evidentiary hearings, issue subpoenas, establishwell spacing units, order involuntarypooling of interests within the same, grantor deny permission todrillwells, prevent waste and protect correlativerights isnow committed by statute to the discretion of theBoard of Oiland Gas Conservation. StateDistrict Courts, therefore, no longer have jurisdiction to entertain and decide an isolated part of thewhole scheme of discretionary administrative determinations vested inthe Board by statute. Involuntary pooling of interestswithin a well spacing unitby order of the Board affords the same kind of relief aswas formerly granted by the common law judicial remedy of a civil suitfordamages inthe state DistrictCourt under the offsetdrillingrule. Atany time after they acquired their interest and before the Boardorder of September 14, 1972,plaintiffs-respondents had the statutory right to apply to the Board of Oil and Gas Conservation for relief but did not do so. No implied covenant

can exist which would authorize a District Court to require

a lessee to drill an offsetwell without permission of the Board, or onewhich would, if drilled, violate statutory purposes or restrictions or a valid order of the Board, nor award damages if the lessee failed to do so. Second, the same issues of fact regarding the extent and location of the reservoir or pool with respect to the lands, and whether or not the Lewis well does in factdrain oil from beneath the NE1/4, are involved in both a common law action based on implied covenant and any statutory proceedings before the Board. Plaintiffs-respondents cannot collaterally impeach the Board's determination of these same factual issues, which ithas already decided and which are

res judicata. Furthermore, the District Court cannot invade the power to make discretionary determinations vested by statute in a stateboard such as where, howmany, and under what circumstanceswells can be drilled and the spacing and pooling thereof. It cannot substitute its discretion for a valid discretionary order made by the ~oard. Third,plaintiffs-respondentswaived their right, if any, to require applicants to drill an offsetwell to protect them from drainageby a producing well on the ~ewis tractby their acceptance of delay rental payments through December 1972. Issue - #2. The following arguments need only be considered if the Courtdetermines the threshold issue adversely to the applicants; that is, if the Courtdecides that the remedy of a civil suit for damages in the ~istrict Court isstill available for a lessee's breach of the implied covenant to protect his lessor from drainage by drilling an offsetwell. First, the lessor or her grantees were required to serve written notice or demand on the lessee or his assigns (applicants)to drill an offsetwell. This is required under the common law drilling rule. Berthelote v. Loy Oil Co. (1933), 95Mont. 434, 28 P.2d 187. Since no notice or demand was made until the demand letters of July 1 and July 26, 1972, applicants could not be under any duty to drill an offsetwell before those dates. Furthermore, the law gives a lessee a reasonable time in which to drill an offsetwell following demand by his lessor, and subjects the lessee to damages for failure to do so only after a reasonable time has passed. Applicants here did not have a reasonable time to comply after they received notice, because a reasonable time would be longer than the two and one-half months that elapsed before the parties entered a voluntary pooling and unit agreement. Therefore, the obligation to pay damages never accrued. Issue - #3. The oil and gas lease from Hilda Danielson to Empire State Oil Company provides that "[nlo change in the ownership of the land or assignments of rentals or royalties shall be binding on the lessee until after the lessee has been furnishedwith a written transfer or assignment or a true copy thereof 

# ..."and the mineral deed from Hilda Danielson to the three plaintiffs-respondentsprovided that it was subject to any rights existing in the lessee or its assigns. The law recognizes the validity of such "no change in ownership" clauses, and because applicants received no actual or constructive notice that Hilda Danielson had conveyed her interest to plaintiffs until August 2,1972, plaintiffs cannot assertany rights against the defendants before thatdateunder the termsof the lease. Issue 

### - #4. This action isbarred by Montana's two-year statuteof limitations forwaste or injury toreal or personal property in section 93-2607, R.C.M. 1947 (subsequently amended in 1975, and now sections 27-2-207 and 27-2-303, MCA)

# . Allparties are inagreement that the common law offset drilling theory was the applicable rule inMontana, atleast before enactment of the 1953 Oiland Gas Conservation Act. The offset drilling rulewas recognized inBerthelote v. Loy OilCo. (1934), 95 Mont. 434, 28 P.2d 187, 190, and Severson

v. Barstow (1936), 103Mont. 526, 63 P.2d 1022, 1024-25. This common law rule implies inevery oiland gas lease a covenant on the part of the lessee toprotect the premises of his lessor from drainage by an adjacentproducing wellby drillingan offsetwell. Severson v. Barstow, supra. The purpose of implied covenants ingeneral is togive effect to the intention of the parties to the lease. The intentionof the parties is toproduce oiland gas for a profit, which is recognized by the lessor asproduction royalties, the primary consideration he receives for his lease. Severson, 63 P.2d at1024; Berthelote, 28 P.2d at 190. Generally, the implied covenant toprotect the premises from drainage by drilling an offsetwellis strictlyapplied, particularly when the lessee has an interestinthe adjacent acreage on which the draining wellis located, because of the permanent loss of oilthat results to the lessor when it is drained from beneath his land. Gordon, Remedies forBreach of 

### - Implied Covenants 

### ---- inOiland Gas Leases 

### - inMontana (1967)t 28 Mont.L.Rev. 187, 192-93. The implied duty of the lesseetoprotect the land from drainage is a duty toexercise reasonable care and diligence toprevent substantial drainage from the leased lands by drilling offsetwells. "Reasonable care and diligence" isdefined asthatwhich a reasonably prudent operator would do under allof the circumstances of the particular situation toprotect the interests of both the lessor and the lessee. 2 Summers, Oil - and Gas, S399, p. 572 (1968). 

### -- Issue 

### - #1. The firstquestion certified tothis Court by the United StatesDistrictCourt iswhether or not the 1953Montana Oiland Gas ConservationAct has abolished the

common lawoffset drilling rule and the judicial remedy of a civil suitfor damages in stateDistrictCourt. The primary purpose of the Actistoprevent "waste" of oiland gas, as thattermisdefined, by vesting power in the Board of Oil and Gas Conservation toregulate the drilling, producing, and spacing of wells and the pooling and utilization of oil and gas interests. Sections 82-11-101, -111, -121, -124, 

## - 201 and -205, MCA. The Act islargelybased upon model legislation for an oiland gas conservation statutepromulgated by the Interstate OilCompact Commission. Marchi, Conservation - inMontana (1955), 17Mont.L.Rev. 100, 102. The Montana Act, however, does not contain the provisions of the model law, nor any provisions whatsoever, directly relating to the protection of correlative rights. "Montana's Act makes no reference to 'correlative rights.'" Pattiev. Oiland Gas Conservation Commission (1965), 145 Mont. 531, 402 P.2d 596, 599. This fact is important toan understanding of the three cases which have been decided to date under Montana's 1953 Oiland Gas Conservation Act.Nothing intheAct expressly abolishes the common law offsetdrilling rule or the judicial remedy of a civil suit for damages. Nevertheless, the Board of Oiland Gas Conservation has broad powers toconduct evidentiary hearings, establishwell spacing units, order involuntary pooling of interests within such units, grant or deny permission to drillwells, and issuerules, regulations and orders to prevent waste. Applicants argue that the legislative assembly intended to substitute for the common law remedy an administrative determinationof allthe issues involved inthe present case. The statuteisnot thatbroad. Section 82-11-144, MCA, provides that any interestedperson who is adversely affected by the Act orby a ruleororder of the Board can obtain judicial review. The term "interested person" isbroadly defined. The Actprovides forrestraining orders and injunctions (section82-11-145, MCA), for an appeal to the Montana Supreme Court (section 82-11-146, MCA), and it allows the Board tobring suitforviolations of the Actor of its rules ororders (section 82-11-147, MCA). Section 82-11- 142, MCA, provides: "This chapter, a suitby or against the board, a violation charged or asserted against a person under thischapter, or a rule or order issued under thischapter does not impair, abridge, ordelay a cause of action for damages or other civilremedy which a person may have or assertagainst a person violating thischap- ter or a rule or order issued under it." (Em----- 

### - phasis supplied.) These are the only provisions of theAct that address judicialactions. None of them purports torestrict any of the

common lawremedies available toprivate litigants, especiallywhere the common law cause of actionwould not conflictwith a valid rule ororder of the Board. On the otherhand, the savings provision contained in section 82-11-142, MCA, applies only to a cause of action against a person "violating this chapter or a rule or order issued under it." This savings clause clearly does not address the common law remedies for implied covenants. In summary then, the 1953 Oil and Gas Conservation Act is silent in respect to common law causes of action. Section 82-11-201,MCA, allows the Board, in the interest of preventing waste, to establishwell spacing units for a pool of oil or gas and to grant exceptions in appropriate

cases allowing a well to be drilled outside the location generally authorized by the Board's spacing orders. Furthermore, "[tlhe size and the shape of spacing units shall be such as will result in efficient and economic developmentof the pool as a whole, and the size shall be the area that can be efficiently drained by one well." Section 82-11-201(2), MCA

# . There are two ways inwhich the Board of Oil and Gas Conservation establishes well spacing units. The first is by a statewide spacing order pursuant to ARM 536-3.18(10)- S18040. Such an order is issued on the Board's own motion without the necessity of notice or hearing. The statewide order affects all areas of Montana as to which the Board has not issued a specific spacing order. The second way is by a specific order of the Board upon application of an interested party. A specific order, issued after notice and hearing before the Board, covers a specific area overlying a pool or reservoir of oil or gas. Prior to September 14, 1972, the spacing of wells drilled on Section 10was governed by statewide spacing orders issued by the Board of Oil and Gas Conservation. Thestatewide spacing order governing well spacing in the formation and depth to which the Lewis well was drilled, in effectat the time of drilling,provided that one well could be drilled and operated on each quarter section (160acres). his order was changed by the Board's Order No. 16-71 of May 13, 1971,which provided that one well could be drilled and produced on 320 acres at this depth. Under the May 13, 1971, order, the 320 acre spacing unit would be comprised of two contiguous north-south or east-west quarter sections designated by the lease operator, which did not necessarily have to be within the same section. On September 14, 1972, the Board of Oil and Gas Conservation held a hearing, atwhich respondentsand applicant U. V. Industries were represented. The Board issued a specific well spacing order superseding the statewide spacing order for the particular production field involved in the present controversy (LonetreeCreek field). This order designated the N1/2 of Section 10 as a production spacing unit. The designated well spacing unit includes the existing, producing Lewis well on the NW1/4 and it also includes the NE1/4 owned by respondents,where they are alleging applicantshad a duty to drill an offsetwell. In summary, then, the applicable statewide spacing order in effect before May 13, 1971,would allow two wells to be drilled on respondents' property; one on the ~~1/4 and

one on the SE1/4. After May 13, 1971,and before the ~oard's specificwell spacing order of September 14, 1972, the applicable statewide well spacing order would allow only one well to be drilled on respondents'property,which comprised 320 acres (E1/2 

### of Section 10)

# -State laws and the Board's orders and rules are incorporated into oil and gas leases as a matter of law. Armstrong v. High Crest Oils, Inc. (1974),164Mont. 187, 520 P.2d 1081, 1084. The Danielson lease itself subjects all of its express and implied covenants to these state provisions. Williams and Meyers, in their treatise Oil 

### ---- and Gas Law (1959), state the following in regard to the effect of conservation laws, and well spacing regulations in particular, on implied covenants: "The suggestion has been made that conservation laws put an end to implied covenants in oil and gas leases. In Mark Twain's phrase, reports of the death are greatly exaggerated." 5Williams and Meyers, supra, 5865 p. 438. Well spacing regulations affect the implied covenant to protect from drainage. A lessee who fails to drill an offset well 

### - in violation of a valid well spacing regulationdoes not breach his duty under the prudent operator standard. 5Williams and Meyers, supra, 5866, p. 440, citing cases from other jurisdictions. This is true

even though substantial drainage results. Well spacing regulationsdo not eliminate the offset drilling covenant, but they override the covenant when the two are - in conflict with each other. 5Williams and Meyers, supra, 5866,p. 441, citing cases from other jurisdictions. "If the drilling of an offsetwell is opposition 

### - to existing rules and regulations of the conservation commission, the implied covenant to prevent drainage is inapplicable." Sullivan, Handbook of 

### ----- Oil and Gas Law, 593,p. 177; 5101,p. 191 (1955). Both this rule of law and also the express terms of the Danielson lease relieve the lessee of liability for damages only 

### if he isprevented fromperforming his obliga-tions under the leaseby such state law, ruleor order. Montana's statutesand case law recognize these principles inthe analogous situationof statutoryunitization: "Operations conducted pursuant toan order of the board providing forunit operations shall constitute a fulfillment of allthe express or implied obligations of each lease or contract covering lands inthe unit area tothe extent that the obligations cannot be performed because of the order of the board." Section 82-11- 211(2), MCA. See also, Armstrong v. High Crest Oils, Inc., supra. The relevant question becomes: would the offsetwell that respondents claimapplicants had a duty todrill to protect theirpremises from drainage under the offset drilling rule be inviolation of the Board's well spacing requirements? "Where an operator could protect against drainage by drilling

a well thatwould be profitable and would 

### not violate conservation regulations, failuretooffset is a breach of covenant." 5Williamsand Meyers, supra, 5866, p. 442, citing cases from other jurisdictions. (Emphasis added.) Contrary toapplicants' contentions, nothing inthe 1953Act or any rule, regulation ororder of the Board prevented the lessee from complying with its implied covenant todrillan offsetwell. The statewide spacing orders applicable tothe lease during the period of uncompensated drainage did not restrict applicants' ability to offsetthe Lewis well. Applicants were not prevented from drilling an offsetwellon the NE1/4 of Section 10until the specific well spacing order of September 14, 1972, placed the Lewis well and the NE1/4 of Section 10inthe same well spacing unit. Therefore, since it would not be inconflictwith any applicable state law orBoard rule, regulation or order, the implied covenant todrillan offset well was ineffectbetween the parties tothe lease, and respondents have a civil suit for damages astheir remedy for applicants' breach of the implied covenant. The 1953Oiland Gas Conservation Actprovides for the voluntary and involuntary pooling of interests within a spacing unit: "When two ormore separately owned tracts are embraced within a spacing unit orwhen there are separately owned interests inallor a part of the spacing unit, then the persons owning those interestsmaypool their interests for the development and operation of the spacing unit. In the absence of voluntary pooling within the spacing unit, the board, upon the application of an interested person, may enter an order pooling allinterests inthe spacing unit for the development and operation thereof. The pooling order shallbe made afterhearing and shallbe upon terms and conditions that are just and reasonable and that afford tothe owner of each tractor interest inthe spacing unit the opportunity torecover orreceive without unnecessary expense hisjust and equitable share of the oilor gas produced and saved from the spacing unit. 

# .

# ." Section 82-11-202(1), MCA. (Emphasis supplied.) Section 82-11-201(3), MCA, grants the Board authority toallow exceptionwellsinappropriate situations: "Subject tothis chapter, the order establishing spacing units shall direct that no more than one wellmay be drilled and produced from the common source of supply on any spacing unit and that thewell shall be drilled ata location authorized by the order, with 

### -- such exception asmay be reasonably necessary where it is shown, upon - application, notice, and hearing, and the board finds that the spacing unit is located on the edge of a pool or field and adjacent toa producing unit or, for some other reason, the requirement todrillthewellatthe authorized locationon the spacing unit would be inequitable orunreasonable." (Emphasis supplied.) Applicants contend that atany time before September 14, 1972, respondents could have, but failed to, apply to the Board for an exception well, or if an exception well would have constitutedwaste and thus been unlawful, for an involuntary pooling order pooling their interestswith thoseof the Lewis well. They argue that the common law offset drilling rule has been superseded by the administrative remedy, on the grounds that the involuntary pooling of interestswithin a well spacing unit by order of the Board affords the same kind of relief as was formerly granted by the common law judicial remedy of a civil suit for damages in state District Court. The applicantstargument is faulty for several reasons. First, the Act does not compel respondents to apply to the Board for relief, as the administrative relief is purely optional with an interested person who may apply for it. Second, the administrativeremedy of obtaining a permit to drill an offset well was not available to respondents because under the terms of the Danielson lease,as is generally the rule in oil and gas leases, the lessee was given the sole and exclusive right to drill. Rieckoff v. Consolidated Gas Co. (1950), 123Mont. 555, 217 P.2d 1076, 1081. Respondents themselves consequently had no right under the lease to apply to the Board for a permit to drill an offset well. To the contrary, the applicantshad a duty to apply for such a permit if one were necessary under the implied covenant of good faith and fair dealings. Baldwin v. Hubetz

(Calif. 1957), 307 P.2d 1005. A third reasonwhy applicantstargument is unpersuasive is that the Board of Oil and Gas Conservation does not have any authority to adjudicate disputes involving private rights. Pattiev. Oil and Gas Conservation Commission, supra, 402 P.2d at 601,holds that the Board "has the authority and duty to consider correlative rights and private interests inmaking regulatory orders, but itdoes not 

## -have the authority to adjudicate disputes involving these rights,"and that "correlative rightsdisputes between adjacent landowners must be disposed of by civil action in the District Courts" according to common lawprinciples of oil and gas, citing Sullivan,Handbook of Oil and Gas Law, S141,p. 

### ----- 262 (1955). (Emphasissupplied.) The present case is primarily concerned with respondents' private rights under

an implied covenant of the lease as against the applicants

as lessees. Correlative rights are peripherally involved here because two of the applicants,U. V. Industries, Inc., and Wolf Corporation,besides being assigns of the lessee,

were also owners of interests in the adjacent Lewis lease where the draining well was located. "Correlative rights"

were defined in Pattie, 402 P.2d at 599: "Theterm 'correlativerights' has been variously defined to mean those rights of each landowner, lessee, or operator in the common source of petroleum. The rights are limited to corresponding duties to the neighboring operator. The duties are not to take an undue amount of petroleum or to do injury to the common supply. Operation and production is to be carried on only in suchmanner or amount as not to harm the rights of the others. As it applies in this action, correlative rightswould mean the interestof plaintiffs in securing a portion of the natural gas underlying their lease. Their opponent is the Commission rather than an adjacent owner, but the right to share of the common supply is still in issue." The Pattie case involved oil and gas lessees on adjoining lands. Sumatra had applied to the Board and been granted permission to drill an oilwell within lawful spacing limits. The well produced gas instead and was in violation of the well spacing rule for gas. Sumatra applied to the Board for

an exception to spacing rule for gaswells. Plaintiffs, who

were the lessees on the adjoining lands, also applied to the Board for an exception to drill an offsetwell to protect their correlative rights. The Board authorized Sumatra'swell as an exceptionwell, but denied plaintiffs' request for permission to drill an offset on the grounds that the Board lacked authority to consider correlativerights. Plaintiffs obtained judicial review of the Board's order in the ~istrict Court, which found that the Board had authority to adjudicate correlativerights. The Supreme Court affirmed, modifying the District Court's holding to mean only that the Board had authority to consider correlative rights in issuing its regulatory orders,but 

### -- that the adjudication of - those rights remained -- in the courts. The issue in Pattie arose because Montana's 1953 Oil and Gas ConservationAct makes no reference to correlative rights. Reduced to simplest terms, the holding in Pattie is that notwithstanding the absence of any reference to correlative rights in the Act, the legislature intended that the Board consider those rights in issuing its regulatory orders, relying on what isnow section 82-11-201(3), MCA. Pattie therefore cannotbe cited in support of the argument that the 1953Act has abolished the common law offsetdrilling rule. Furthermore,while Pattiemay be narrowly construed to apply only to correlative rights, aswas the specific holding in the case, it ismore reasonable to interpret it broadly to apply to other private interests such as respondents' rightsunder the covenant implied by the offset drilling rule. In the latter situation, the holding would be support for respondents' position that the Board lacks authority to adjudicate disputes involving rights under the

common law implied covenants. Chevron Oil Co. v. Oil and Gas Conservation C~mmi~sion (1967), 150Mont. 351, 435 P.2d 781, adds nothing to the holding in Pattie. In Chevron the Board authorized theapplicants' drilling of an offsetexception well but denied Chevron's request tolimitproduction of the offsetwell so

asnot to violate Chevron's correlative rights, asChevron

was lessee of the adjacent lands being offsetby the exception well. Chevron's request for an order limiting production from the new offset exception wellwas denied by the Board on the grounds that it lacked authority torestrict production inthe absence of a showing of waste. The District Court sustained thisruling by the Board. The Supreme Court reversed, relying on Pattie, and held that the Board had such authority toprotect Chevron's correlative rights by limiting production from the adjacent exception well, notwithstanding the absence of a showing of waste. In the course of itsdiscussion, the Court said: "Just asthe Act protects the rights of the owner tocapture his share of the oiland gaswhen the pool isonly under part of his land, it must protectthe adjoining landowners from having their share of the oiland gas appropriated by the exeption locationwell. To hold otherwisewould be the equivalent tooperating under the Rule of Capture theory but without the protection afforded an adjoining landowner under the Off-set DrillingRule theory." 435 P.2d at784. Applicants argue that this statement supports their contention that the Oiland Gas Conservation Act has eliminated the common law remedy of a civil suit for damages under the offsetdrilling rule. To the contrary, this statementby the Court merely draws an analogy tomake the point that the Actprotects the correlative rights of 

## - allparties. Itdoes nothing inthe way of dispensingwith the offset drilling rule.The finalcase relied on by applicants, Armstrong v. High CrestOils, Inc. (1974), 164 Mont. 187, 520 P.2d 1081, says nothing to support their contention thatNontana's Oiland Gas Conservation Act has eliminated the common law cause of action under the offset drilling rule. High Crest, the assignee of a lease executed by Armstrong's predecessor in interest, applied to the Board and was granted, over Armstrong's protest, an order under the statutory unitization provisions of the Act unitizing a large tract which included the Armstrong lease. Armstrong filed a complaint for judicial review of the Board's order, as provided by the Act, and subsequently, while judicial reviewwas pending, brought

an action in another District Court to cancel the lease for breach of a one-well pooling provision in the lease. The Court held that because the same factual arguments and

reasons were advanced by Armstrong in the suit for cancellation of the lease aswere made in the action for judicial reviewof the Board's unitization order, the suit for cancellationwas an attempt to circumvent the statute by an improper collateral attack on the Board's order. The Board's unitization order was held to be res judicata except in the appropriate District Court on judicial review as provided by what is now section 82-11-144,MCA. Armstrong v. High Crest Oils, Inc., supra, 520 P.2d at 1086. Applicants in the matter presently certified and before this Court urge that respondents cannotmaintain a common law suit under the offsetdrilling rule because to do so would be a collateral attack upon the Board's order of September 14, 1972, establishing the Lonetree Creek field and special well spacing rules. The argument does notwash. First, respondents are not seeking to circumvent the Act as
was the case in Armstrong since there was no decision of the Board to collaterally impeachbefore the order of September 14, 1972,and no proceeding for judicial reviewpending.Second, respondents' contentions are supported, if anything, by the Board's September 14, 1972 order because the designation of the N1/2 of Section 10 as a well spacing unit tends to establish the fact of drainage alleged by respondents since a well spacing unit is required to be such aswill be efficiently drained by onewell. Section 82-11-201(2), MCA. Third, respondents are not seeking to do anything thatwould challenge the validity of the Board's order; their claim relates only to damages for the period before the Board issued its order. Finally, the Court in Armstrong stated: "Weagree with respondents' argument that the cancellation of the oil and gas lease may be a separate issue upon which another courtmay have jurisdiction." 520 P.2d at 1084. In the present situation, the suit for damages for breach of an implied covenant, like a suit for cancellation of the lease, is a separate issue. Applicants emphasize that the remedy of applying to the Board of Oil and Gas Conservation for an involuntarypooling order was at all pertinent times available to respondents. This relief was available to the respondentsunder section 82-11-232,MCA. Respondents argue, without citing any authority, that the administrative relief available under the involuntarypooling statute is only available in the event the Board has issued,after notice and hearing, a specificwell spacing order, and that it is not available in those areaswhere only statewide is applicable,aswas the

case here before September 14, 1972. This argument ignores the fact that respondents had the right, as interested persons, to apply to the Board for a specific well spacing order under section 82-11-201(1), MCA. Although the remedy of applying to the Board for an involuntarypooling orderwas available to respondents as an alternate form of relief, itwas not, however, their only remedy to the exclusion of the common law offset drilling rule. See the discussion in 5 Williams and Meyers, supra, S866. ~efendants allege plaintiffs waived their right to require defendants to drill an offsetwell by the acceptance of delay rentals through December 1972. The issue raised in defendants' brief is not one of the issues certified to this Court for a declaratory ruling as to Montana law, and it has not been briefed by plaintiffs-respondents. Therefore, it should not be considered. In summary of the first issue, the enactmentof Montana's Oil and Gas Conservation Act has not, per se, eliminated the

common law right of action under the offset drilling rule. An oil and gas lessee still has a duty under the implied covenant to protect his lessor's premises from drainage by drilling an offset well, if doing so would not be in violation of the Act or of a valid rule or order of the Board. Issue 

### - #2. The second issue certified to this Court is whether or not the lessor or her grantees (respondents)was required to serve written notice or demand on the lessee or its assigns (applicants)to drill an offset well; if so,did the lessee have a reasonable time thereafter in which to comply; and when does the obligation of the lessee, if any, to pay damages commence? The offset drilling rule generally requires the lessor or its grantees to serve written notice

or demand upon the lessee or its assigns to drill an offset well as a precondition to the latter's duty to drill. Sullivan,Handbook 

### ----- of Oil and Gas Law, S94,p. 180 (1955). The rationale for this rule is explained in ~erthelote v. Loy Oil Co., supra, 28 P.2d at 190:

# ".



# . .A usual implied covenant is one against drainage, which isnot here involved. The necessity of drilling offsetwells is not brought about by the acts of the lessee, but by those of third parties, unless the lessee owns adjoining acreage. Hence,before a breach of an implied covenant could be claimed as substantial, the necessity of protecting the leased premises must be brought home to the lessee in some manner by reasonable notice or demand on the part of the lessor." (Emphasissupplied.) This quotation, while it illustrates the obligation to give notice, also showswhy the obligation is not applicable to two of the applicants in this case. Both U. V. Industries and Wolf Corporation owned an interest in the adjoining acreage and in the Lewis well which was causing the drainage to their lessors, the respondents. Thus, the reason for requiring notice--to bring home to the lessee the necessity of protecting the leased premises--does not apply. The drainage was not brought about by acts of third parties; it

was brought about by a well inwhich U. V. Industries and Wolf Corporationheld an interest. Since neither Empire State Oil Co. nor its successor,Ashland Oil Co., ever owned any interest in the Lewis lease, the foregoing reasoning does not apply to them. Plaintiffs-respondentsras the lessor's grantees, were required to give notice before Empire State Oil Co. or Ashland Oil Co. could be charged with a duty to protect the premises from drainage. Since no such notice was ever given, neither Empire State nor Ashland

can be held liable for breach of the implied covenant to drill an offsetwell. U. V. Industries, Inc. (formerly United States Smelting, Refining and Mining Company), took an assignment of the Lewis lease to the NW1/4 through its predecessor onMarch 8, 1962. Although U. V. Industries subsequently assigned an undivided one-half of its interest in the lease on January13, 1970, it retained the remainder of its interest through and beyond the time that the Lewis well was drilled as a producer, February 3, 1970. Thus, it was not necessary for plaintiffs-respondents to give U. V. Industriesnotice or demand to drill an offsetwell to protect them from drainage, since U. 

### V. Industrieshad knowledge of the drainage from the time the Lewis well was completed as a producer. Wolf Corporation eventually acquired the undivided onehalf interest in the Lewis lease that had been assigned to others by U. V. Industries except for a reversionary working interestnot important here. This was accomplished by an assignment datedAugust 13, 1970, some six months after the Lewis well was brought in as a producer. Wolf Corporation thus had notice of drainage to the NW1/4 from at least the time it acquired its interest in the Lewis lease, and itwas not necessary for plaintiffs-respondents to demand protection fromWolf Corporation. Under the reasonably prudent operator standard, the law gives a lessee a reasonable time in which to drill an offset well following either notice or demand by the lessor or its equivalent, acquisition by the lessee of an interest in the adjacent draining lands. 2 Summers Oil 

## --- and Gas, S412, 414 (1959). Therefore, the obligation to pay damages for failure to offset the producing Lewis well on the adjacent lease dates back to a reasonable time after the lessee had notice of the need to protect the premises from drainage. What constitutes a reasonable time is a question of fact. Summers, supra, S412. Thus, in the case of U. V. Industries,the obligation to pay damages dates from a reasonable time after March 23, 1971, the date that U. 

### V. ~ndustries acquired the entire leasehold interest in the Danielson lease to the ~1/2of Section 10. The reason for this is that U. 

### V. Industries held an interest in the adjacent Lewis lease and in the producing ~ewis well, and therefore knew about the drainage and the need to protect the Danielson premises, from the time itwas drilled as a producer--February 3, 1970. On May 15, 1971, the predecessor of U. V. Industries assigned 3/8 of its interest in the Danielson lease to Wolf Corporation and 1/8 to other parties. Wolf Corporation's obligation to pay damages for breach of the implied covenant, therefore,begins a reasonable time after May 15, 1971. The reason for this is thatWolf Corporation held an interest in the adjacent Lewis well, and therefore knew about the drainage and the need to protect the Danielson lease, since August 13, 1970. The failure of respondents to give notice to Wolf Corporation at any time and their failure to give notice to U. V. Industriesbefore the demand lettersdated July 1, 1972 and July 26, 1972, are irrelevantbecause both had notice of the need to protect respondents from drainage by virtue of their ownership of interests in the adjacent Lewis well which was causing the drainage. These defendants are liable for the covenantsmaturing while the lease is held by them as assignees. Hergistad v. Hardrock Oil Co. (1935), 101Mont. 22, 37, 52 P.2d 171. Issue - #3. The Oil and Gas Lease from Hilda ~anielson to Empire State Oil Company provides that "[nlo change in the ownership of the land or assignments of rentals or royalties shall be binding on the lessee until after the lessee has been furnished with a written transfer or assignment or 

### a true copy thereof 

# . .."and the mineral deed from Hilda Danielson to the three plaintiffs-respondents providedthat it was subject to any rights existing in the lessor or its assigns. What is the impact of those provisions on the rights of the parties? The short answer is that they have

no effect on the rights arising under the implied covenant here in issue. Defendants argue that because they received

no notice of the change of ownership of the mineral estate until they received a copy of the mineral deed from a cograntee who isnot a party to this case on August 2, 1972, plaintiffs cannot assert any rights against them before that date under the terms of the lease. A "no change in ownership without notice" clause is designed to prevent the lessee's forfeiture of the lease for failure to pay delay rentals to the proper party. Sullivan, supra, 854,p. 115. This clause is valid and is binding on the lessor's grantee. Sullivan, supra, S85. Such a clause has nothing to do with implied covenants, which runwith the land and can be enforced by the lessor or its grantees against the lessee and its assigns. 3 Summers, 

### --- Oil and Gas 8553,p. 589 (1958). Additionally, applicants' argument ignores a provision in the lease to this effect: "If the estate of either party hereto is assigned or sublet, and the privilege of assigning or subletting in whole or in part is expressly allowed, the expressed and implied covenantshereof shall extend to the sub-lessees or assigns, their heirs, executors, administrators and successors

# ..." Plaintiffs were therefore given the right, asmineral grantees, to enforce the implied covenant to protect against drainage and to sue for damages under the terms of the lease. Thus, plaintiffs' failure to give defendants notice of the transfer of ownership before August 1972 does not prevent them from enforcing the implied covenant to protect the land from drainage. To interpret the "nochange in ownership withoutnotice" clause in the manner contended for by the applicants would be to ignore the purpose of the clause. Issue - #4. The final issue is to determine the appropriate statute of limitations. Defendants-applicantscontend that this action isbarred by Montana's two-year statute of limitations for waste or injury to real or personal property in section 93-2607,R.C.M. 1947 (subsequently amended in 1975,now sections 27-2-207 and 27-2-303, MCA). This is not

a correlative rights suit for waste or injury to real or personal property. It is a suitby the grantees of an oil and gas lessor against the lessee and its assigns for breach of an implied covenant to protect from drainage by drilling

an offset well. The implied covenant is asmuch a part of the written lease as the expressed covenants. Bertholote v. Loy Oil Co. (1933),95Mont. 434, 28 P.2d 187, 190, citing Brewster v. Lanyon Zinc Co. (8thCir. 1905), 140 F. 801, 809, stated: "Whatever is implied in a contract is as effectual aswhat is expressed." The appropriate statute of limitations is therefore eight years, the limitation for actions based on a written contract. Section 27-2-202(1), MCA

# .

We concur:

Chief Justice /

'.II\ ,LC ') ,,u CbL"

### 1 Justices 

# J