Opinion ID: 1154750
Heading Depth: 3
Heading Rank: 6

Heading: The Breach of Implied Covenants Blending and High-Grading.

Text: Our conclusion that the statutes of limitations barred the plaintiffs' contract and fraud claims cannot logically reach two issues: the failure to blend and high-grading during the second run of production. Because the second run did not begin until 1976, the plaintiffs' contractual claims concerning blending and high-grading necessarily fall within the six-year limitations period. In addition, the plaintiffs claim that they did not discover that National had performed high-grading until after they filed their complaint in 1982. The jury found and the trial court held that the defendants failed to act as a reasonably prudent operator when they failed to blend ore during the second run of production beginning in 1976. The court also held that the defendants acted in bad faith and failed to act as a reasonably prudent operator when they began high-grading ore in 1978. On appeal, the plaintiffs claim that the trial court correctly implied a duty of reasonable diligence and care upon the defendants, which the defendants breached when they failed to blend and failed to refrain from high-grading. The defendants claim that the express agreements between the parties supersede and foreclose the existence of any implied covenants.
In interpreting mining agreements, courts generally have applied the rules for interpreting contracts and leases. 4 American Law of Mining § 130.04, at 130-9 (2d ed. 1992). That is, courts will give effect to the intent of the parties, and when the terms of the agreement are clear and unambiguous, courts try to ascertain the intent of the parties from the ordinary meaning of the language in the agreement. Id. This has long been the rule in New Mexico: The primary objective in construing a contract is to ascertain the intention of the parties. Mobile Investors v. Spratte, 93 N.M. 752, 753, 605 P.2d 1151, 1152 (1980). The purpose, meaning and intent of the parties to a contract is to be deduced from the language employed by them; and where such language is not ambiguous, it is conclusive. The court's duty is confined to interpretation of the contract which the parties made for themselves and may not alter or make a new agreement for the parties. Davies v. Boyd, 73 N.M. 85, 87-88, 385 P.2d 950, 951 (1963). We are impressed with a Texas court's analysis of whether an implied covenant exists in the context of mining law, and we adopt it. The Texas Court of Civil Appeals has stated: In the outset it should be noted that when parties reduce their agreements to writing, the written instrument is presumed to embody their entire contract, and the court should not read into the instrument additional provisions unless this be necessary in order to effectuate the intention of the parties as disclosed by the contract as a whole. An implied covenant must rest entirely on the presumed intention of the parties as gathered from the terms as actually expressed in the written instrument itself, and it must appear that it was so clearly within the contemplation of the parties that they deemed it unnecessary to express it, and therefore omitted to do so, or it must appear that it is necessary to infer such a covenant in order to effectuate the full purpose of the contract as a whole as gathered from the written instrument. It is not enough to say that an implied covenant is necessary in order to make the contract fair, or that without such a covenant it would be improvident or unwise, or that the contract would operate unjustly. It must arise from the presumed intention of the parties as gathered from the instrument as a whole. Kingsley v. Western Natural Gas Co., 393 S.W.2d 345, 350-51 (Tex.Civ.App.1965) (quoting Danciger Oil & Refining Co. of Tex. v. Powell, 137 Tex. 484, 154 S.W.2d 632 (1941)).
Thus, implied covenants are not favored in law, especially when a written agreement between the parties is apparently complete. Stern v. Dunlap Co., 228 F.2d 939, 942 (10th Cir.1955). The general rule is that an implied covenant cannot co-exist with express covenants that specifically cover the same subject matter. Kingsley, 393 S.W.2d at 350. When it is clear, however, from the relevant parts of the contract taken together and considered with the facts and circumstances surrounding the execution of the agreement, that the obligation in question was within the contemplation of the parties or was necessary to effect their intention, then such obligation may be implied and enforced. Stern, 228 F.2d at 942-43. But when the contract between the parties speaks to the obligation sought to be implied, courts will not write that implied obligation into the contract. Kerr-McGee Corp. v. Bokum Corp., 453 F.2d 1067, 1073 (10th Cir.1972). Stated conversely, there may be an implied covenant on the part of the lessee ( in the absence of any expressed on the subject as in this lease ).... State ex rel. Shell Petroleum Corp. v. Worden, 44 N.M. 400, 404, 103 P.2d 124, 126 (1940) (emphasis added).
We believe that the express provisions in the contract according the defendants exclusive discretion and control in the mining operations left no room for the implied covenants that the trial court enforced against the defendants. The situation here is very similar to that discussed in an often-cited treatise. Instead of imposing duties upon the operator for the benefit of the owner of a nonoperating interest, the instrument creating the interest may contain a clause relieving the operator from certain obligations which might otherwise be alleged to exist. Such clauses take a variety of forms; typical is the following: Development of, and operations on the premises, if any, and the extent and character thereof, as well as the preservation or forfeiture of the leasehold, shall be solely at the will of said (assignee) or its successors or assigns.... 2 Howard R. Williams & Charles J. Meyers, Oil and Gas Law § 429, at 489-90 (1992). Here, the contract specified that the nature and extent of all work done by Freeport on the Mining Lands and the time and manner of doing the same shall rest in the sole judgment and discretion of Freeport. The contract also stated that the nature and extent of all exploration, development and mining operations and the time and manner of performing the same shall be as Freeport in its sole judgment and discretion shall determine and Freeport shall have the right at all times to determine the quantity of ore to be mined and what ore is to be left unmined.... In addition, the contract provided that National may at any time and from time to time suspend mining operations or other operations for as long as it may determine whenever in its opinion economic conditions or other causes make it desirable so to do. These express provisions supersede any implied obligation regarding operation of the mine and preclude the implication of any implied covenants advocated by the plaintiffs and enforced by the trial court. The implied covenants were not necessary to give effect to the intentions of the parties as reflected in the language of the contract. On the contrary, the implied covenants were inconsistent with the intentions of the parties as expressed in the written agreements. Given the specific language in the written agreements between the parties, it was error for the trial court to imply obligations that were inconsistent with the unambiguous language expressing the intention of the parties to extend the defendants absolute control over mining operations.
Were it not for the express contractual provisions governing the relationship between the plaintiffs and the defendants and superseding any implied covenants, the plaintiffs' argument would still fail. Much of the precedent that the plaintiffs cite in support of the implied covenants pertains to the relationship and the concomitant duties between a lessor and a lessee, not between the holder of an overriding royalty interest and a working interest (lessee), which was the relationship between the parties here. The trial court found that there was no lessor-lessee relationship at any time between the parties. Again, we find guidance from Williams & Meyers: The owner of an overriding royalty is not entitled to the benefit of the covenants of the base lease, express or implied, in the absence of an express provision in the instrument creating the overriding royalty. The benefits of such express and implied covenants of the lease touch and concern the lessor's estate and the burdens of such covenants touch and concern the lessee's estate. The assignment, either in whole or in part of the burdened estate, will not permit enforcement of the covenants which burden the assigned estate by a person other than the lessor or claimants through him of a portion or all of the benefitted estate. 2 id. § 420, at 356-57. Because the plaintiffs' cases pertain to the legal relationship between a lessor and lessee and not the rights of a lessee and a holder of an overriding royalty, the plaintiffs' cases are not persuasive. There are occasions, however, when courts will imply covenants to protect the interests of an owner of an overriding royalty that is carved out of a working interest such as the case here. 2 id. § 420.1, at 356.1. The only instance in which courts seem to be in universal agreement is in implying a covenant against drainage in an oil and gas lease. See, e.g., Cook v. El Paso Natural Gas Co., 560 F.2d 978 (10th Cir.1977). The plaintiffs rely heavily upon Cook, but we find the analogy from the covenant against drainage in an oil and gas lease to the mineral lease here untenable. The plaintiffs cite Cook for two propositions: that a lessee-operator has an implied duty to act in compliance with the reasonably prudent operator standard for the benefit of the nonoperator royalty holder; and that an express covenant does not necessarily negate the existence of an implied covenant. In Cook, however, the Tenth Circuit Court of Appeals held that an implied covenant obligating the lessee to act as a reasonably prudent operator did not apply. Id. at 984. Rather, the court held that an implied covenant existed obligating the operator to refrain from depleting gas on the owner's property by drainage from the operator's adjacent leasehold. Courts generally will uphold an implied covenant to protect against drainage because drainage is tantamount to conversion. See id. at 983. In addition, the Cook court did not go so far as to state categorically that an express covenant is always subject to implied obligations; rather, the court simply construed the express provision at issue in that case as ambiguous and found that it did not supersede an implied covenant against drainage. Id. at 986. The plaintiffs also rely upon Darr v. Eldridge, 66 N.M. 260, 346 P.2d 1041 (1959), as upholding the trial court's finding of an implied covenant to exercise reasonable diligence. In Darr, this Court stated that courts have developed the implied covenant `to make diligent efforts to market the production in order that the lessor may realize on his royalty interest.' Id. at 263, 346 P.2d at 1044 (citing Libby v. De Baca, 51 N.M. 95, 99, 179 P.2d 263, 265 (1947)). The plaintiffs' reliance again is misplaced; this is another lessor-lessee case. Nevertheless, the holding in Darr might support the plaintiffs' claim on the surrender breach (failing to market potash when National terminated production in 1968), but we have held that the six-year statute of limitations barred plaintiffs' claim on that issue. The plaintiffs were notified of the shut-down in 1968, and they could have brought an action supported by Darr and Libby, if any, then or six years thereafter, but that claim was time-barred by the time they filed their complaint in 1982.
In the absence of any covenants implied into the agreement between the parties, the owner of an overriding royalty interest is not without protection. Whether express or not, every contract in New Mexico imposes the duty of good faith and fair dealing upon the parties in the performance and enforcement of the contract. Watson Truck & Supply Co. v. Males, 111 N.M. 57, 60, 801 P.2d 639, 642 (1990). The breach of this covenant requires a showing of bad faith or that one party wrongfully and intentionally used the contract to the detriment of the other party. Id. The trial court found that the defendants acted in wanton disregard of the plaintiffs' interests by high-grading the ore in the Lea County mine. We cannot agree with the trial court that the defendants acted in bad faith by high-grading when the contract expressly gave them exclusive discretion in mining operations. The covenant of good faith and fair dealing does not impose affirmative duties upon one party to protect another; instead, it proscribes action that in this case would have resulted in avoiding royalty payments. See Tidelands Royalty B Corp. v. Gulf Oil Corp., 804 F.2d 1344, 1354 (5th Cir.1986). To show bad faith in this case, for example, the plaintiffs would have had to prove that the defendants would not have conducted a high-grading program in the absence of the overriding royalty interest, that by high-grading the defendants somehow sought to avoid making royalty payments. Merely asserting that National failed to take action that might have been beneficial to the royalty holders does not show bad faith. Instead, the plaintiffs would have to prove that but for the pecuniary advantage of avoiding the royalty payments, the defendants would not have performed high-grading at the Lea County mine. See id. Adopting the plaintiffs' position (implying a duty to refrain from high-grading) would be the same as imposing a fiduciary duty upon the defendants, which we already have stated did not exist. The defendants were not obligated to act to their economic detriment for the benefit of the plaintiffs. See Murdock v. Pure-Lively Energy 1981-A, Ltd., 108 N.M. 575, 579, 775 P.2d 1292, 1296 (1989) (covenants of good faith, unlike fiduciary duties, do not require exclusive operator to subordinate its interest to that of royalty holders). In fact, it could be said that high-grading was in furtherance of the royalty holders' interests. The aim of high-grading as the plaintiffs admitted is profits, albeit short-term profits. As long as the defendants were seeking profits, that was beneficial for the royalty holders and in furtherance of their interests. Any resulting inconvenience in the retrieval of the remaining ore might constitute waste, but that would be actionable only by the lessor, not the holders of an overriding royalty interest.
It was beyond question that the parties left the mining operation within the sole discretion of the defendants. National could exercise exclusive control, discretion, and judgment regarding all its operations and performance, and it could determine the quantity of ore mined and the quantity left unmined. In addition, National could elect to suspend operations for as long as it may determine whenever in its opinion economic conditions or other causes make it desirable so to do. Implied covenants generally exist only in a lessor-lessee relationship, and covenants will not be implied when express contractual provisions govern, with the one exception of a covenant against drainage. Thus, the trial court erred as a matter of law in finding and enforcing implied covenants against the defendants that were inconsistent with the provisions of the written agreements. The trial court also erred when it held that the defendants' high-grading constituted bad faith when the contract allowed the defendants to conduct mining operations at their discretion. It would be incongruous to hold that the defendants acted in bad faith in acting in accordance with an express contractual provision.