Opinion ID: 1862385
Heading Depth: 3
Heading Rank: 2

Heading: Implied Covenant To Market

Text: Despite the purely contractual relationship between the lessor and lessee, the respective parties' obligations can not be determined absent reference to the covenants implied in every oil and gas lease. See Pearson & Watt, To Share or Not To Share: Royalty Obligations Arising out of Take-or-Pay or Similar Gas Contract Litigation, 42 Inst. on Oil & Gas L. & Tax'n 14-1, at ง 14.04[1] (1991). These covenants address matters not expressly covered by the lease, including protection of the lessor's interest, R. Hemingway at ง 8.1; 5 E. Kuntz, Law of Oil & Gas ง 54.2 (1991), and assist the court in ascertaining the duties incident to the relationship of lessor and lessee. Martin, 27 Inst. on Oil & Gas L. & Tax'n 177,195. At the heart of the implied obligations in Louisiana is the notion the parties consent to perform these obligations in order to effectuate the basic objectives of an oil and gas lease. L. McDougall at ง 4.1 (footnote omitted). See, e.g., Carter v. Arkansas-Louisiana Gas Co., 213 La. 1028, 36 So.2d 26 (1948). In Louisiana, the implied covenants originate not in the general principle of cooperation found in the law of contracts, see 5 Williams and Meyers, Oil and Gas Law ง 802.1 (1991), but rather as particularized expressions of Civil Code Article 2710's mandate that the lessee enjoy the thing leased as a good administrator. LA.REV.STAT. ง 31:122, comment; La.Civ.Code art. 2710. [10] The duty to act as a reasonably prudent operator, imposed on the mineral lessee by Article 122 of the Mineral Code, is thus an adaptation of the obligation of other lessees to act as good administrators. LA.REV.STAT. ง 31:122, comment. See, e.g., Waseco Chemical & Supply Co. v. Bayou State Oil Corp., 371 So.2d 305 (La.App. 2d Cir.), writ denied, 374 So.2d 656 (La.1979); Williams v. Humble Oil & Refinery Co., 290 F.Supp. 408 (E.D.La. 1968), aff'd, 432 F.2d 165 (5th Cir.1970). Article 122 of the Mineral Code provides: A mineral lessee is not under a fiduciary obligation to his lessor, but he is bound to perform the contract in good faith and to develop and operate the property leased as a reasonably prudent operator for the mutual benefit of himself and his lessor. Parties may stipulate what shall constitute reasonably prudent conduct on the part of the lessee. The legislature intended to incorporate within Article 122 the existing jurisprudence on the subject, and accordingly, the mineral lessee's obligation to act as a good administrator or reasonably prudent operator is clearly specified in four situations. See LA.REV.STAT. ง 31:122, comment; McCollam, 50 Tul L.Rev. at 803. Relevant for our purposes is the implied obligation to market diligently the minerals discovered and capable of production in paying quantities in the manner of a reasonable, prudent operator. [11] LA.REV.STAT. ง 31:122, comment. See generally Shell Oil Co. v. Williams, Inc., 428 So.2d 798, 803 (La.1983); Risinger v. Arkansas-Louisiana Gas Co., 198 La. 101, 3 So.2d 289 (1941); Wall, supra ; Hutchinson v. Atlas Oil Co., 148 La. 540, 87 So. 265 (1921); Wemple, supra ; Merritt v. Southwestern Elec. Power Co., 499 So.2d 210, 214 (La. App. 2d Cir.1986); Lelong v. Richardson, 126 So.2d 819 (La.App. 2d Cir.1961); Pierce v. Goldking Properties, Inc., 396 So.2d 528 (La.App. 3d Cir.), writ denied, 400 So.2d 904 (La.1981). Encompassed within the lessee's duty to market diligently is the obligation to obtain the best price reasonably possible. See, e.g., Tyson v. Surf Oil Co., 195 La. 248, 196 So. 336 (1940). See also LA.REV.STAT. ง 31:122, comment; Martin, 27 Inst. on Oil & Gas L. & Tax'n at 191; L. McDougall at ง 4.5; Pearson & Watt, 42 Inst. on Oil & Gas L. & Tax'n at ง 14.04[1]. Regarding the fulfillment of the implied covenants, including the duty to market diligently, the lessee's conduct must conform to, and be governed by, what is expected of ordinary persons of ordinary prudence under similar circumstances and conditions, having due regard for the interest of both contracting parties. LA.REV. STAT. ง 31:122 and the comments thereto. See generally Carter, supra; Gennuso v. Magnolia Petroleum Co., 203 La. 559, 14 So.2d 445 (1943); Coyle v. North American Oil Consolidated, 201 La. 99, 9 So.2d 473 (1942); Caddo Oil & Mining Co. v. Producers' Oil Co., 134 La. 701, 64 So. 684 (1914). Our analysis is complicated by the paucity of litigation dealing with the implied obligation to market diligently, as well as the recognition that the lessee's conduct must be evaluated with due regard for the facts known at the time the Morganza Contract was executed. See 5 E. Kuntz at ง 60.3; L. McDougall at ง 4.5. Consequently, an examination of the take-or-pay provision, a clause found in nearly all gas purchase contracts, including the contract between Amoco and Columbia, is essential to resolving the issue before us. Under a take-or-pay provision, the pipeline-purchaser commits to take or, failing to take, to pay for a minimum annual contract volume of natural gas which the producer has available for delivery. Williams & Meyers, Manual of Oil & Gas Terms 1233 (1991). Where gas is paid for but not taken, the contract normally permits the purchaser to make-up the deficiency by taking an excess amount of gas (make-up gas) over a specific term and, in turn, to receive a refund or credit. See id. At the time of execution of the Morganza Contract, long-term gas contracts containing take-or-pay provisions were standard in the industry, as are take-or-pay clauses. See Henry, 418 So.2d at 1336; Kramer, Royalty Obligations Under the GunโThe Effect of Take-or-Pay Clauses on the Duty To Make Royalty Payments, 39 Inst. Oil & Gas L. & Tax'n 5-1, at ง 5.02 (1988). In the past, long-term contracts were universally insisted upon by pipeline purchasers to enable acquisition of financing for the construction of capital intensive pipeline facilities. Henry, 418 So.2d at 1336. Additionally, take-or-pay provisions allow the pipeline flexibility in the amount of gas taken, assuaging the difficulties caused by the cyclical nature of demand and the absence of an open market for natural gas. See Johnson, Natural Gas Sales Contracts, 34 Inst. on Oil & Gas L. & Tax'n 83, 111 (1983). Indeed, because gas ordinarily can not be stored upon production, the only economic means of transporting gas is via pipeline. See Merritt, supra (production is futile without distribution of the product); 1 B. Kramer & P. Martin, The Law of Pooling and Unitization ง 5.01[3] (3d ed. 1991) (A producer without a contract with a nearby pipeline is unable to sell its gas whatever the price.). The producer also benefitted from a guaranteed minimal annual cash flow and was protected from decline in demand, minimizing the likelihood it would be unable to recoup the substantial costs associated with operation and maintenance. See Medina, McKenzie, & Daniel, Take or Litigate: Enforcing the Plain Meaning of the Take-or-Pay Clause in Natural Gas Contracts, 40 Ark.L.Rev. 185, 191 n. 16 (1986) and the authority cited therein; Comment, The Lessor's Royalty and Take-or-Pay Payments and Settlements Under Gas Sales Contracts in Louisiana, 47 La. L.Rev. 589, 591 (1987). Further, because take-or-pay clauses made it more likely the purchaser would take at a more consistent level, drainage to the reservoir was minimized while the ultimate recovery, and the resultant economic benefits to the lessor and lessee, were maximized. White, The Right to Recover Royalties on Natural Gas Take-or-Pay Settlements, 41 Okla. L.Rev. 663, 680 n. 96 (citing Masten & Crocker, Efficient Adaptation in Long-Term Contracts: Take-Or-Pay Provisions for Natural Gas, 75 Am.Econ.Rev. 1083 (1985); Comment, 47 La.L.Rev. at 591. At the time the Morganza Contract was executed, a lessee who failed to execute with a pipeline purchaser a long-term gas sales contract containing a take-or-pay clause would likely be deemed to have acted imprudently. See Henry, supra ; Miller v. Nordan-Lawton Oil & Gas Corp., 403 F.2d 946, 948-49 (5th Cir.1968); 5 E. Kuntz at ง 60.3; Pearson & Watt, 42 Inst. on Oil & Gas L. & Tax'n at ง 14.04[1]. By the same token, the producer who failed to renegotiate a long term gas contract in the face of the pipeline's financial inability to perform fully under a long-term gas purchase contract, given the market conditions caused by the decline in demand and the rise in producer-pipeline litigation, would also likely be deemed to have acted imprudently. [12] See infra. Part II, ง B.