663 S.E.2d 639
Appellant Mary Maxine Welch seeks relief from the November 15, 2006, order of the Circuit Court of Ritchie County, granting the motion of Appellee Dominion Exploration and Production, Inc. (Dominion) to dismiss those portions of Appellant's complaint relating to partial rescission in connection with an oil and gas lease dispute. (See footnote 1) Maintaining that Dominion has failed to fully develop the leased property, Appellant seeks the equitable remedy of partial rescission as a remedy for the alleged underdevelopment of the leased property. (See footnote 2) When Dominion sought to drill additional wells on the leased property during the pendency of this litigation, Appellant sought injunctive relief from the trial court to halt any further development of the subject property by Dominion.
Upon our careful review of the law in this area in conjunction with the actions taken by the parties, we conclude that the trial court should impose a reasonable time period during which Dominion may undertake efforts to further develop the leased property. If at the conclusion of that time period, Dominion has failed to commence additional drilling operations on the property, the trial court should proceed to take evidence to determine whether Appellant can prove either a breach of the implied duty of further development or that she has suffered extreme hardship due to the alleged underdevelopment of the leased property. If either breach of an implied covenant to develop or extreme hardship can be established, then the remedy of partial rescission may be utilized to prevent Dominion from continuing to hold onto the lease without meeting its obligation to explore, exploit, and develop. Accordingly, we hereby reverse the ruling of the trial court on the issue of partial rescission and remand this matter for further proceedings consistent with this opinion.
[u]nder our decisions, the lessee, upon the completion of
a paying well, acquires a vested right in the oil and gas
underlying the leased premises. And having acquired such
right, he may not arbitrarily refuse further development, for by
virtue of the very nature of the lease, the subject matter thereof,
and the situation of the parties, there is always, in the absence
of an express covenant, an implied obligation on his part to drill
the number of wells reasonably necessary to develop the
property and prevent drainage by operation on adjoining lands.
113 W.Va. at 492-93, 168 S.E. at 367 (internal citations omitted). Based on this reasoning, we held in syllabus point one of Adkins that [i]n the absence of an express provision requiring the lessee to protect the leased premises from drainage by oil or gas wells on adjacent property, an implied obligation will be read into the lease to give such protection.
Id. at 490, 168 S.E. at 366.
In discussing the implied covenant or duty of development in Adkins, we stated:
As already indicated, a lessor cannot require further development of the premises, after the lessee has acquired a vested interest in the minerals by the completion of a paying well, except upon proof to the effect that operators for oil and gas of ordinary prudence and experience in the same neighborhood under similar conditions have been proceeding successfully with the further development of their lands or leases, and the further fact that additional wells would likely inure to the mutual profit of both lessors and lessee.
Id. at 497, 168 S.E. at 369 (emphasis supplied). Review of the evidence presented in Adkins compelled this Court to conclude that the lessors had failed to introduce sufficient proof to establish that the lessee had breached the implied covenant of further development. See ibid.
Despite the lack of evidence to establish breach of an implied covenant of
development, (See footnote 15) there was sufficient evidence in Adkins that fraudulent drainage had been
occurring in substantial quantities. 113 W.Va. at 497, 168 S.E. at 369. As we explained,
fraud is one of the three established grounds (abandonment, fraud, and extreme hardship)
that allow complete or partial cancellation of an oil and gas lease. 113 W.Va. at 493, 168
S.E. at 367; see also United Fuel Gas Co. v. Smith, 93 W.Va. 646, 656, 117 S.E. 900, 904
(1923) (observing that equity will not enforce a forfeiture unless upon grounds of
abandonment by the lessee, or upon circumstances of fraud or great hardship). Based on
the evidence of fraudulent drainage proffered in Adkins, the lessee was required to drill an
off-set well or make an annual payment in lieu thereof until such well was drilled or the lease
abandoned. In the event that neither the offset well was drilled or the lease abandoned, the
court directed that the remedy of partial cancellation would be invoked so that the lease be
cancelled as to all the property, with the exception of the designated acreage around the
present well. Adkins, 113 W.Va. at 498, 168 S.E. at 369.
Responding to Appellant's demand for partial rescission, Dominion argues that the availability of monetary damages bars the use of the equitable remedy of rescission. In Doddridge County Oil and Gas Co. v. Smith, 154 Fed. 970 (N.D. W.Va. 1907), the district court recognized that an oil and gas lessor's remedy for failure on part of [the] lessee to further develop the leased premises, or to properly protect the lines thereof from drainage through wells on adjacent property, is ordinarily by action at law for damages, and not by way of forfeiture of the lessee's right to bore or drill for oil. Id. at 979. Iterating the well- established rule of disfavoring equitable remedies where legal ones are available, we articulated in Hall v. South Penn Oil Co., 71 W.Va. 82, 76 S.E. 124 (1912):
Failure or refusal, while occupying the lease and operating it, to drill additional wells, under circumstances imposing a duty to do so, makes the lessee liable in damages to the lessor, for which the remedy at law is held to be an adequate one by courts in all jurisdictions, and affords no ground for either partial or total cancellation or rescission, and this rule has been repeatedly asserted by this Court.
Id. at 84, 76 S.E. at 124-25; accord Syl. Pt. 3, Core v. New York Petroleum Co., 52 W.Va. 276, 43 S.E. 128 (1902) (Under such a lease, the remedy for a breach of an implied covenant is ordinarily not by way of forfeiture of the lease in whole or in part, but by an action for damages caused by such breach.).
The preference for legal remedies over equitable ones with regard to oil and
gas lease disputes evolved as a natural result of the legal system favor[ing] . . . the vesting
of estates based upon the significant investment intrinsic to oil and gas exploration and
development. United Fuel, 93 W.Va. at 655, 117 S.E. at 904; see Brewster v. Lanyon Zinc
Co., 140 Fed. 801, 814 (8th Cir. 1905) (recognizing large expense incident to the work of
exploration and development). Notwithstanding this leaning towards monetary damages,
equitable relief has been awarded when the factual circumstances of a given case clearly
compel an alternative remedy. Typically, the type of factual predicate that gives rise to the
use of partial cancellation or partial rescission of an oil and gas lease occurs when, after an
initial period of exploration and discovery, there is only nominal mineral extraction
occurring on a limited section of the leased property. Often the lessor's motivation for
seeking partial rescission of an oil and gas lease stems from drainage-related concerns due
to drilling operations on adjacent properties, which may or may not be fraudulent in nature.
At the core of Appellant's claim for partial rescission is her contention that Dominion has violated the implied covenant of development. Stated otherwise, this covenant requires that when the existence of either of these valuable mineral substances [oil and gas] in paying quantities becomes apparent from operations on the premises leased or on adjoining lands, the lessee shall drill such number of wells as in the exercise of sound judgment he may deem reasonably necessary to secure either oil or gas or both, for the mutual advantage of the owner of the land and of himself as operator under the lease; also for the protection of the lands leased from drainage through wells on adjoining or contiguous lands. Jennings v. Southern Carbon Co., 73 W.Va. 215, 219, 80 S.E. 368, 369 (1913). Five years after discovery of a gas well that continued to produce in paying quantities, the lessor in Jennings sought relief for the lessee's failure to further develop her property and to protect the same from drainage-related issues. After examining the bill of particulars which demonstrated that the lessee was fraudulently extracting oil and gas by means of drilling operations on contiguous properties, this Court ruled:
Thus the defendant Carbon company, under the cloak of an
agreement, has, by its failure to perform the conditions of the
lease, in effect and in fact intentionally withheld development
of plaintiff's lands, in direct violation and disregard of
plaintiff's property rights in the oil and gas underlying her
lands, the existence of one or both of which therein is
reasonably assured from developments on hers and neighboring
lands. Thus a situation appears wherein, by defendants'
conduct, has occurred an impairment of valuable property,
resulting in irreparable injury, and demanding a measure of
relief not available at law.
73 W.Va. at 225, 80 S.E. at 372. Rejecting the trial court's ruling that the lessor's relief was limited to monetary damages, this Court ruled that the proper relief was either complete or partial cancellation of the lease. Ibid.
As further support for its position, Appellant argues that Dominion has violated the prudent operator standard first announced in Brewster. This oft-cited standard frames the issue in terms of objectively considering whether further development would mutually benefit the parties:
The object of the operations being to obtain a benefit or profit
for both lessor and lessee, it seems obvious . . . that both are
bound by the standard of what is reasonable.
. . . .
. . . The large expense incident to the work of exploration and
development, and the fact that the lessee must bear the loss if
the operations are not successful, require that he proceed with
due regard to his own interests, as well as those of the lessor.
No obligation rests on him to carry the operations beyond the
point where they will be profitable to him, even if some benefit
to the lessor will result from them. It is only to the end that the
oil and gas shall be extracted with benefit or profit to both that
reasonable diligence is required. Whether or not in any
particular instance such diligence is exercised depends on a
variety of circumstances. . . .Whatever, in the circumstances,
would be reasonably expected of operators of ordinary
prudence, having regard to the interests of both lessor and
lessee, is what is required.
Brewster, 140 Fed. at 814.
In its seminal decision on the issue of development, the United States Supreme Court examined whether the lessee had failed to develop the leased tracts with reasonable diligence. See Sauder v. Mid-Continent Petroleum Corp., 292 U.S. 272 (1934). The leased tracts at issue included a half section of 320 acres along with a separate 40-acre tract. Fourteen years after the lease was originally signed, only two offset wells had been drilled on the smaller tract; these wells were producing oil in small but paying quantities. 292 U.S. at 277. Based solely on production from the two offset wells, the lessee maintained a
right to hold onto the lease despite having no intention to conduct further drilling explorations. Applying the prudent operator standard, the high court reasoned in Sauder:
The respondent's officers state that they desire to hold this tract
because it may contain oil; but they assert that they have no
present intention of drilling at any time in the near or remote
future. This attitude does not comport with the obligation to
prosecute development with due regard to the interests of the
lessor. The production of oil on a small portion of the leased
tract cannot justify the lessee's holding the balance indefinitely
and depriving the lessor not only of the expected royalty from
production pursuant to the lease, but of the privilege of making
some other arrangement for availing himself of the mineral
content of the land.
Id. at 281 (emphasis supplied). Finding no adequate remedy at law, the Court in Sauder ruled that equitable relief was required and suggested that upon remand a provisional decree be entered by the trial court which would cancel the lease as to the 320-acre tract unless an exploratory well was drilled within a reasonable time, while allowing the 40-acre tract to remain under lease. Id. at 281-82.
This Court has recognized the unfairness of allowing a lessee to effectively tie up land when others stood ready to develop the same. In Steelsmith v. Gartlan, 45 W.Va. 27, 29 S.E. 978 (1898), we discussed the relative positions of the lessee and lessor following the abandonment of exploration after an unsuccessful test drill:
An oil lease yields nothing to the landowner when not worked,
and is an incumbrance on his land, tying his hands against
selling or leasing to others; but, when idle, it costs the lessee
nothing, and is valuable, or may prove valuable, if he can hold
it waiting developments in its vicinity. . . . Holding on to a lease after ceasing search is often for purposes of speculation, the thing which a prudent landowner guards against. Forfeiture for nondevelopment or delay is essential to private and public interests in relation to the use and alienation of property.
Id. at 35, 29 S.E.at 980-81 (quoting Munroe v. Armstrong, 96 Pa. 307 ). Recognizing the inequity of allowing a lessee to hold onto a non-producing lease arrangement, this Court questioned in rhetorical fashion why a lessor should be permitted to continue under these circumstances:
Then why should she [lessor] pay for it by a nonoperating and
indefinite extension of the lease, to await the will and pleasure
of the lessee, who claims the option to operate, abandon,
surrender, or forfeit at his pleasure, while numerous others are
clamoring for the privilege of diligent operation, and offering a
large bonus therefor? Such a holding would be unconscionable,
and contrary to both right and justice.
Steelsmith,45 W.Va. at 36, 29 S.E. at 981.
We later reaffirmed this principle in Parish Fork Oil Co. v. Bridgewater Gas Co., 51 W.Va. 583, 42 S.E. 655 (1902) in recognizing as universal the principle of law
which discourages tying up and rendering unproductive the vast
fields of mineral wealth, construes every contract and lease as
to both lessor and lessee so as to best promote production,
development and progress, and frowns upon every attempt to
evade it as being in contravention of both good morals and
Id. at 595-96, 42 S.E. at 660. While both Parish Fork and Steelsmith involved issues of abandonment, the principle against tying up the land is nonetheless applicable to cases involving lack of development. As we recognized in syllabus point three of Parish Fork: When its terms will permit, it under the rules of law, an oil lease will be so construed as to promote development and prevent delay and unproductiveness. (See footnote 16) Id. at 584, 42 S.E. at 655.
In suggesting that the remedy of partial rescission is the equivalent of a forfeiture based on the similarity of the grounds that are used to prove entitlement to both types of equitable relief, the trial court is mistaken. The analogy fails because the remedial effect of a forfeiture, as compared to a partial cancellation, is markedly different. Whereas forfeiture of an oil and gas lease is disfavored based upon concerns rooted in the high costs of exploration and development conjoined with the vesting of land-use rights, the remedy of partial rescission does not produce results as severe as a total forfeiture. A compromised result is effected with a partial rescission as the lessee is typically permitted to continue the lease as to the currently producing portion of the leased tract. Moreover, to deny a partial rescission where the facts compel the same would be to sanction the extended holding of land subject to a mineral rights lease with no correlative obligation to explore, develop, and produce: a result which is clearly not permitted under long-established principles of oil and gas law. See Parish Fork, 51 W.Va. at 595-96, 42 S.E. at 660.
Upon our review of this state's oil and gas law, it is clear that the equitable remedy of partial cancellation or partial rescission has long been recognized as a viable means of resolving various oil and gas lease disputes. See, e.g., Adkins,113 W.Va. at 497- 98, 168 S.E. at 369; Jennings, 73 W.Va. at 225-26, 80 S.E. at 372. To dispel any lingering confusion on the remedial use of partial rescission, we hold that a trial court may consider the equitable remedy of partial rescission in fashioning the relief to be awarded upon proof sufficient to establish a breach of the implied covenant of development in connection with an oil and gas lease dispute. (See footnote 17) In ruling that rescission is not a proper remedy in the event a legal remedy exists, the trial court was misguided. Where monetary damages are inadequate as a matter of law, this Court has clearly approved the use of either partial cancellation or partial rescission in analogous cases. See Jennings, 73 W.Va. at 225-26, 80 S.E. at 372. In this case, Appellant argues that monetary damages are inadequate because they will not impel the objective of forcing Dominion to commence drilling operations.
While Appellant claims that it seeks to compel Dominion to conduct further
drilling operations as support for its position that monetary damages are an insufficient
remedy, its actions in this case suggest otherwise. The record in this case demonstrates that
when Dominion sought to drill as many as eleven additional wells on the leased property
after the market price for natural gas suddenly increased the potential profitability of
exploratory drilling, Appellant sought injunctive relief to prevent such drilling efforts.
While Appellant argues that it was too late at this time, the real motivation for its
unwillingness to permit Dominion to conduct additional drilling efforts appears to be the top
lease arrangement it had with Jay-Bee. See supra, n.6.
We agree with Dominion's assertion that Appellant should be indifferent as to whom drills additional wells. If indeed the issue is production, the identity of the producer should be irrelevant. Moreover, it is axiomatic that one who seeks equity must have clean hands. See Pittsburgh & W. Va. Gas Co. v. Nicholson, 87 W.Va. 540, 547-48, 105 S.E. 784, 787 (1921) (denying injunctive relief based on maxim that he who comes into equity must come with clean hands). Given the refusal of Dominion's efforts to drill and the threat of litigation to prevent those efforts, Appellant's hands are arguably lacking the requisite cleanliness of a litigant who seeks to enforce equitable rights.
In this case, it is clear that Dominion has expressed a willingness to develop additional drilling sites on the leased tract. Given the fact that Dominion already has a vested interest in that portion of the tract which is currently producing based on the three existing wells as well as a valid lease arrangement, it stands to reason that Dominion should be given an opportunity to further develop the property. On remand to the trial court, a reasonable period of time should be established to provide for such additional development efforts on the part of Dominion. (See footnote 18) If the trial court finds that no significant additional development efforts have been pursued by Dominion at the conclusion of such reasonable period of time, then the trial court should proceed to take evidence on the issue of whether Dominion has breached the implied covenant of further development or whether evidence can be produced on the issue of undue hardship. We agree with the trial court's ruling that the record, as developed, does not suggest any evidence of undue hardship. Depending on the evidence that may be produced in the event of such proceedings, the equitable remedy of partial rescission is an appropriate remedy to be considered if either a breach of the implied covenant of further development or undue hardship can be established and the trial court is convinced that monetary damages alone are an insufficient remedy. (See footnote 19)
Based on the foregoing, the decision of the Circuit Court of Ritchie County is hereby reversed and remanded for further proceedings consistent with the rulings herein.