An Implied Covenant of Good Faith and Fair Dealing Exists in Oil and Gas Leases Under Ohio Law

In Yoder v. Artex Oil Co., 2014-Ohio-5130, 2014 Ohio App. LEXIS 4984, (5th Dist. Guernsey County), the Fifth Appellate District concluded that Ohio law recognizes an implied covenant of good faith and fair dealing in oil and gas leases.

In Yoder, the Appellants, Marion, Reuben and Esther Yoder, were title owners of 95.806 acres of land in Liberty Township, Guernsey County, Ohio (the “Yoder Property”). In June 2008, Artex Oil Company, the Appellees (“Artex”), entered into an oil and gas lease with the Yoders (the “Yoder Lease”). The Yoder Lease was for a primary term of 3 years, and continued for as long as drilling operations were conducted and as long as oil and/or gas is produced or is capable of being produced from the Yoder Property or from a communitized unit. The Yoder Lease granted Artex the right to unitize and contained a disclaimer of implied covenants, which, in part, provided:

“This lease contains all of the agreements and understandings of the lessor and lessee respecting the subject matter hereof and not implied covenants or obligations are contained herein. . .”
Yoder, at ¶44.

In October 2008, Artex consolidated its interest in the oil and gas rights of the Yoder Lease with three other leases to create the Lutterus-King unit, comprised of 145.3 acres, including 10.03 acres of the Yoder Property. Using existing plat maps, Artex determined that the planned location of the Lutterus-King Well was 500 feet from the boundary of the Yoder Property. Artex sent the Yoders a letter stating that the Yoders were entitled to receive a portion of the royalties derived from the Lutterus-King Well, and the Yoders signed a Division Order in November 2008. The well began producing in December 2008.

In 2009, Artex amended the size of the Lutterus-King Unit to accommodate the drilling of a second well. The amended unit contained 40 acres, including 2.76 acres the Yoder Property. Artex paid the Yoders royalty payments pursuant to the terms of the Yoder Lease and Division Order from March 2009 to March 2012.

The Yoders filed suit in February 2012, seeking declaratory judgment that the lease was terminated and/or expired by its own terms and an asserted breach of implied covenants, express duties, and implied duties of good faith and fair dealing. Artex argued that the Yoders disclaimed all implied covenants and that the terms of the Yoder Lease permitted unitization. Artex also conducted a survey to determine the distance from the Lutterus-King Well to the boundary of the Yoder Property and learned that the well was 495.35 feet from the boundary of the Yoder Property.

The Yoders argued on appeal that by including their property in the Lutterus-King Unit, Artex breached the implied covenants to reasonably develop, to use reasonable care and due diligence in its operations on the subject property, to act as a reasonably prudent operator when conducting operations, and the implied covenant to market. Yoder, at ¶43. The Court dismissed the breach of implied covenant arguments because the Yoder Lease expressly disclaimed any implied covenants, and “Ohio courts consistently enforce express provisions in leases that disclaim implied covenants.” Id., at ¶46 (citing Bilbaran Farm, Inc. v. Bakerwell, Inc., 2013-Ohio-2487, 993 N.E.2d, ¶ 18 (5th Dist.), quoting Bushman v. MFC Drilling Inc., 9th Dist. Medina No. 2403-M, 1995 Ohio App. LEXIS 3061, 1995 WL 434409 (July 19, 1995)).

Second, the Yoders argued that the general disclaimer of implied covenants contained within the lease did not negate Artex’s obligation to act in good faith and fair dealing. The Yoders contended that, at 500 feet, the distance of the well from their property evidenced Artex’s bad faith in unitizing the Yoder Property into the Lutterus-King Unit. The Court analyzed Ohio case law to determine whether there was an obligation on Artex to act in good faith and fair dealing implicit in the Yoder Lease, and whether such obligation survived the general disclaimer of implied covenants.

While it is settled law in Ohio that oil and gas leases are contracts and should be interpreted as such, Harris v. Ohio Oil. Co., 57 Ohio S. 118, 129, 48 N.E. 502 (1897), it was unclear whether Ohio recognized the implied covenant of good faith and fair dealing in oil and gas leases. Because of a lack of caselaw, the Court also considered secondary sources and explained such sources “found that contractual concepts, such as good faith and fair dealing, apply to the interpretation of an oil and gas lease.” Yoder, at ¶51. Next, the Court explained that a duty of good faith and fair dealing is implicit in oil and gas leases:

“[I]t is well-established that every contract has an implied covenant of good faith and fair dealing that requires not only honest but also reasonableness in the enforcement of the contract. PHH Mortg. Corp. v. Ramsey, 10th Dist. Franklin No. 13AP-925, 2014-Ohio3519, 17 N.E.3d 629, ¶ 33 citing Littlejohn v. Parrish, 163 Ohio App.3d 456, 2005-Ohio-4850, 839 N.E.2d 49, ¶ 21 (1st Dist.). “’Good faith performance or enforcement of a contract emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party.’” Id. at ¶ 26, quoting Restatement of the Law 2d, Contracts, Section 205, Comment a (1981). Based on the foregoing, it can be logically concluded that an oil and gas lease is a contract, and because it is a contract, an oil and gas lease is subject to the implied covenant of good faith and fair dealing.”

Id., at ¶52. The Court did not address whether the implied covenant of good faith and fair dealing could be disclaimed because it concluded that Artex did not breach the covenant of good faith and fair dealing because the distance of the well from the Yoder Property complied with state laws and regulations. Id., at ¶70.

Operators in Ohio should be aware that oil and gas leases include an implied covenant of good faith and fair dealing. An operator should include an express disclaimer that identifies and disclaims the implied covenant of good faith and fair dealing. However, Ohio courts have yet to determine whether a disclaimer will disclaim the implied covenant of good faith and fair dealing despite that other implied covenants may be disclaimed.