New Oil & Gas Law Established in California
The Fifth Appellate District Court of Appeal recently decided two oil and gas cases that have been certified for publication, and thus have become law in California. The first case, The Lundin/Weber Co. v. Brea Oil Co. (2004) 117 Cal.App.4th 427, in which Downey Brand represented the defendant, deals with the issue of implied covenants in oil and gas leases. The second case, Armstrong Petroleum Corp. v. Tri-Valley Oil & Gas Co. (2004) 116 Cal.App.4th 1375, relates to a statute of limitations issue under a joint operating agreement. A summary of both cases is provided in this newsletter.

In Lundin/Weber, the plaintiff landowner brought a lease cancellation action against defendant Brea Oil Company, Inc. for the alleged breach of an implied covenant of further exploration. Brea had acquired an old oilfield in Kern County that had contining shallow production. The Plaintiff alleged, however, that Brea had an implied duty of further exploration to drill deeper wells on the property.

Brea prevailed on a summary adjudication motion on the basis that, as a matter of law, California does not and should not recognize an implied covenant of further exploration. Brea argued that this issue was a matter of first impression and relied on Texas and Oklahoma law which reject the theory of an implied covenant of further exploration. The trial court agreed.

The Plaintiff appealed to the Court of Appeal. The Court affirmed the summary adjudication ruling but did not directly address whether the implied covenant of further exploration exists generally in California. The Court, rather, relied on the rule in Hartman Ranch Co. v. Associated Oil Co. (1937) 10 Cal.2d 232, which holds that covenants will only be implied in the absence of express provisions in oil and gas leases. The Court reaffirmed that there can be no conflict between the express terms of a lease and an implied covenant. As applied to the Lundin/Weber case, the Court held that the two leases covered all aspects of drilling and left nothing to implication. In this regard, Brea is the lessee under a 1926 lease that specifically requires the drilling of 10 wells, and a 1995 lease that, like most modern leases, requires the drilling of wells “until oil or gas was found in quantities deemed paying by lessee.” The Court relied on this language and held:

Where parties have chosen not to extend the obligation to explore for oil and gas beyond the discovery and development of paying quantities, the Court should not insert obligations in direct conflict with the limitation expressed by the parties.

Accordingly, the Court took a very narrow and conservative interpretation of oil and gas leases. Under its holding, however, and as a practical matter, a covenant of further exploration will never be implied into a modern California oil and gas lease that relies on production in paying quantities of oil and gas to extend the lease term.

In Tri-Valley, Tri-Valley Oil & Gas Company was the operator and Armstrong Petroleum Corporation the non-operator under a joint operating agreement. The parties disagreed as to the net revenue interest of Armstrong based on whether Armstrong should bear the burden of a particular overriding royalty interest. The trial court found in favor of Armstrong and, thus, awarded damages to Armstrong based on the improper payments previously made to Armstrong.

Tri-Valley appealed on the grounds that the four-year statute of limitations had run on Armstrong’s claim because the entire claim accrued when Tri-Valley first rejected Armstrong’s interpretation of how to calculate its net revenue interest. Armstrong, however, argued that the statute of limitations was a rolling statute of limitations that accrued each month when the incorrect payment was made.

The Court of Appeal held that monthly payments and deliveries made to Armstrong were divisible one from another so that Armstrong had a continuing statute of limitations that accrued every month but could go back only four years from the filing of the complaint for damages. In reaching this conclusion, the Court relied heavily on the language in the applicable joint operating agreement that specifically provided for monthly accountings of production.