McDowell v. PG & E RESOURCES CO.
1995 WL 371281, 1995 La. App. LEXIS 1816, 658 So.2d 779 (1995)
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Rule of Law:
A mineral lease cannot be cancelled for breach of the implied covenant of diligent marketing without the lessor first formally placing the lessee in default, and a lessee satisfies the 'reasonably prudent operator' standard when diligently pursuing multiple, expensive avenues to re-establish a market, even if it takes time.
Facts:
- In 1978 and 1980, W. Howard McDowell granted two separate oil and gas leases covering approximately 133 acres in Jackson Parish to another party.
- Plaintiffs, the McDowells, became successors to the original lessor, while defendants, PG & E Resources Company ("Resources"), acquired all the leasehold interests and became the operator of the McDowell No. 1 Well in August 1989.
- Prior to March 1990, Resources combined "wet gas" produced by the McDowell well with "dry gas" from the Breedlove No. 1 Well (located on lands not covered by the leases) to meet quality standards for transmission through a United Gas Pipeline Company pipeline for ultimate sale.
- In early 1990, the Breedlove No. 1 Well stopped producing, and in March 1990, United Gas Pipeline Company refused to accept the unmixed wet gas from the McDowell well, resulting in a shut-in well predicament.
- From March 1990 to April 1991, Resources undertook extensive, continuous, and simultaneous efforts to reestablish a market, including pursuing "liquid exceptions" from United Gas, engaging in reworking and recompletion operations on Breedlove No. 1, drilling Breedlove No. 2 (which resulted in a dry hole), contacting Crystal Oil Company and Tex/Con for purchase arrangements, contemplating sales agreements, securing necessary pipeline rights-of-way, and building a required pipeline.
- By December 4, 1990, Resources reached an agreement for a three-well sale of gas (including McDowell) to Tex/Con.
- Around March or April 1991 (about one month prior to the resumption of production), the McDowells executed another lease on the same lands in favor of Jim C. Shows, Ltd., considering the prior agreements no longer valid.
- On April 28, 1991, after the construction of the new pipeline, the McDowell Well was placed back on line, and in May 1991, the McDowells again began receiving royalties on the minerals sold from their property.
Procedural Posture:
- The McDowells, believing their 1978 and 1980 leases were no longer valid due to a 90-day cessation of production, brought suit in the district court (trial court) seeking a judicial declaration that the leases had expired by their own terms.
- PG & E Resources Company and other defendants countered, arguing that the leases remained in effect by virtue of force majeure provisions and the payment of shut-in royalties.
- After trial, the district court found a breach of the implied covenant to diligently market production and ordered the two leases cancelled.
- PG & E Resources Company and other defendants appealed the district court's judgment to the Court of Appeal of Louisiana, Second Circuit.
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Issue:
Does a mineral lessee breach the implied covenant of diligent marketing, warranting cancellation of the lease, when a well is shut-in due to lack of a pipeline outlet, the lessee pays shut-in royalties, and undertakes continuous, expensive efforts to reestablish a market, especially without being formally placed in default by the lessor?
Opinions:
Majority - Hightower, Judge
No, a mineral lessee does not breach the implied covenant of diligent marketing under these circumstances, nor does it warrant lease cancellation, because the leases did not expire by their own terms, the lessor failed to formally place the lessee in default, and the lessee acted as a reasonably prudent operator. The court first determined that the leases did not expire 'by their own terms' under Paragraph 6 (a 90-day cessation clause) because the shut-in clause in Paragraph 5 explicitly provides that production 'continues constructively' when shut-in royalties are paid due to a lack of a market 'at the well' or an available pipeline outlet. The court found that the preliminary offers from Crystal and Tex/Con would have necessitated pipeline construction, meaning no 'market at the well' existed to negate the shut-in situation. More critically, the court held that cancellation for breach of an implied covenant requires the lessor to formally 'put the lessee in default' prior to judicial intervention, which the McDowells failed to do. This default requirement serves to notify the lessee of the alleged breach and provide a reasonable opportunity to perform. Even on the merits, the court found no breach of the implied covenant. Resources made continuous and simultaneous efforts over thirteen months, incurring significant expense (reworking/recompletion, drilling, negotiating, pipeline construction), to reestablish a market. Applying the 'reasonably prudent operator' standard (LSA-R.S. 31:122), which evaluates conduct by what is expected of ordinary prudence under similar circumstances for the mutual benefit of both parties, the court concluded that Resources' diligent actions, which were not shown to involve self-dealing or fraud, did not constitute a substantial breach warranting the harsh remedy of lease cancellation.
Dissenting - Brown, Judge
Yes, a mineral lessee did breach the implied covenant of diligent marketing under these circumstances, and the leases should have expired by their own terms. Judge Brown argued that the majority's conclusion that no market existed 'at the well' was flawed. He contended that other means for transmitting the gas, such as offers from Crystal Oil Company and Tex/Con, were quickly identified, indicating that a market did exist. The dissenting opinion highlighted that Resources chose to dedicate its primary efforts and expense to restoring production in an unrelated oil and gas unit (Breedlove) which primarily benefited Resources' interest, rather than immediately availing itself of the means to readily restore the McDowell well to a producing status through an existing or easily constructible connection to another carrier. This demonstrated a divergence of interests, where the lessee lacked the immediate economic incentive to diligently market the McDowell gas. Therefore, Judge Brown concluded that because a market 'at the well site' did exist, the shut-in provisions of Paragraph 5 were inapplicable, and consequently, the leases should have expired automatically under Paragraph 6 due to the cessation of production for more than 90 days.
Analysis:
This case significantly reinforces the procedural requirement in Louisiana mineral law that lessors must formally 'put a lessee in default' before suing to cancel a lease for breach of an implied covenant, such as diligent marketing, clarifying that informal demands or claims of automatic expiration are insufficient. Substantively, the decision elaborates on the 'reasonably prudent operator' standard in shut-in situations, indicating that persistent, good-faith efforts by the lessee, involving substantial investment and a pursuit of multiple marketing avenues, will generally satisfy this obligation, especially when these actions are for the mutual benefit of both parties. This ruling provides a protective shield for lessees against premature lease cancellations during periods of operational and market challenges, defining the scope of their marketing duties under Louisiana law.
