Chapter 18 - § 18.5 • OIL AND GAS LEASES

• Jurisdiction: Colorado

§ 18.5 • OIL AND GAS LEASES²⁸²

§ 18.5.1—In General

The typical oil and gas lease may be distinguished from other leases in that it creates an estate on limitation through the use of the "unless" clause. A typical "unless" clause provides:

If no well be commenced on said land on or before one year from the date hereof, this lease shall terminate as to both parties, unless tenant on or before that date shall pay or tender to the landlord or to the landlord's credit in the __________ Bank at __________, or successors, the sum of __________ Dollars ($__________) which shall operate as a rental and cover the privilege of deferring the commencement of a well for twelve months from said date. In like manner and upon like payments or tenders the commencement of a well may be further deferred for like periods of the same number of months successively.²⁸³

The amounts payable for the privilege of deferring the commencement of a well are referred to as "delay rentals." Delay rentals are not "rentals" in the true sense of the word, but rather compensation for delay in development.²⁸⁴

The "unless" clause is a covenant running with the land. Where the "unless" clause is employed and no well has been drilled and no delay rental has been paid in the manner and within the time fixed by the lease, the lease automatically terminates by virtue of the limitation itself. While appellate courts have frequently referred to the termination of an "unless" lease as a forfeiture, there is actually no element of forfeiture involved. The landlord is not required to do anything (notice of termination is not necessary), but the tenant's failure to meet the conditions of the lease automatically terminates it. The interest created in the tenant by an "unless" lease does not become forfeited upon failure to comply with its conditions; it simply expires.²⁸⁵

A royalty clause in an oil and gas lease should be construed in its entirety and in light of the fact that it is the means by which the lessor receives the primary consideration for the lease.²⁸⁶

The term of the typical oil and gas lease is for a primary term of fixed duration (subject to the commencement of drilling or the payment of delay rentals) followed by a secondary term for "as long thereafter as oil, or gas of whatsoever nature or kind, or either of them is produced from said land."²⁸⁷ An oil and gas lease which continues in effect during the secondary terms is said to be "held by production." Where a portion of the leased premises is included in a unit, a well drilled within the unit continues the lease in effect as to lands both within and without the unit, regardless of whether the well was drilled on the leased premises or on other lands.²⁸⁸ But such a well may not satisfy the implied covenant of further exploration and development as to the non-pooled lands.²⁸⁹

Oil and gas leases are strictly construed against the lessee and in favor of the lessor.²⁹⁰

When an oil, gas, or other mineral lease which has been recorded becomes forfeited or expires by its own terms, it is the duty of the tenant, his or her successors or assigns, within 90 days after the date of the forfeiture or expiration to have the lease surrendered in writing, the surrender to be signed by the party making the same, acknowledged, and placed of record in the county where the leased land is situate, without cost to the owner of the leased premises.²⁹¹ If the holder of the lease neglects or refuses to execute the release, then the owner of the leased premises may bring an action in a court of competent jurisdiction to obtain the release.²⁹² If a lease is held by production, an affidavit of production must be recorded within six months after the expiration of the primary term, after which time if such affidavit is not recorded, the record of the lease ceases to be constructive notice.²⁹³

A "top lease" is an oil and gas lease granted by a landlord during the existence of another oil and gas lease, which is to become effective if and when the existing lease expires or is terminated.²⁹⁴

§ 18.5.2—Implied Covenants in Oil and Gas Leases²⁹⁵

The purpose of an oil and gas lease is to make the mineral estate profitable to both parties through exploration, development, and production of resources located under the leased premises.²⁹⁶ The primary consideration in such lease transactions is the royalty derived from the development of the resource. As a result, development is a recognized expectation of both parties.²⁹⁷ The work of exploration, development, and production should proceed with reasonable diligence for the common benefit of the parties. Reasonable diligence is whatever, in the circumstances, would be reasonably expected of operators of ordinary prudence, having regard to the interests of both lessor and lessee.²⁹⁸ Consistent with these expectations, Colorado courts recognize four implied covenants: to conduct exploration drilling, to develop after discovery of oil or gas in paying quantities, to operate diligently and prudently, and to protect the leased premises against drainage.²⁹⁹

The covenant to conduct exploratory drilling includes both exploration before discovering an initial reservoir and later exploration for additional reservoirs in unproven areas.³⁰⁰ The obligation to explore, develop, and produce, once production is acquired, includes both an implied covenant...