Implied Covenants in Mineral Land Transactions: A Comprehensive Analysis of Freeport Sulphur Co. v. American Sulphur Royalty Co. (117 Tex. 439, 1928)

Implied Covenants in Mineral Land Transactions: A Comprehensive Analysis of Freeport Sulphur Co. v. American Sulphur Royalty Co. (117 Tex. 439, 1928)

Introduction

The case of Freeport Sulphur Company et al. v. American Sulphur Royalty Company of Texas presents a pivotal examination of implied covenants within mineral land transactions. Decided by the Supreme Court of Texas on May 23, 1928, the case delves into the obligations of a mineral land operator beyond the express terms of contractual agreements. The primary parties involved are the Freeport Sulphur Company (plaintiff in error) and the American Sulphur Royalty Company of Texas (defendant in error).

Summary of the Judgment

The Supreme Court of Texas affirmed the decision of the Court of Civil Appeals, which had reversed a lower court's judgment in favor of the Sulphur Company. The core issue revolved around whether the Sulphur Company had breached an implied covenant to develop and operate sulphur mines diligently. The Court held that, notwithstanding the express terms of the contract, an implied duty to operate with reasonable diligence existed to ensure the realization of the agreed-upon royalties. The Sulphur Company's failure to meet this standard, despite having built more than the contracted number of plants, constituted a breach warranting damages.

Analysis

Precedents Cited

The Court referenced several pivotal cases to underpin its ruling:

  • Grass v. Big Creek Development Co. (75 W. Va. 719, 84 S.E. 750): Established that implied covenants must arise out of legal necessity to effectuate the contract's purpose.
  • Merrill on Mines: Differentiated between English and American courts regarding implied obligations in mineral leases.
  • Brewster v. Lanyon Zinc Co. (140 Fed. 801): Advocated for a standard of "reasonable diligence" based on ordinary prudence.
  • Multiple Texas cases such as Benavides v. Hunt and Munsey v. Marnett Oil Gas Co. emphasized the local jurisprudence supporting implied covenants in mineral transactions.

These precedents collectively reinforced the notion that while English law might not imply operational duties merely due to royalty reservations, American jurisprudence, particularly Texas law, recognized an implied obligation to ensure reasonable and diligent development of mineral properties.

Legal Reasoning

The Court's reasoning was multifaceted:

  • Express vs. Implied Covenants: The contract explicitly required the erection of a one-unit plant. The Court determined that this express provision negated any implication of additional development covenants.
  • Implied Duty to Diligently Operate: Despite fulfilling the express terms by building additional plants, the Sulphur Company failed to operate the one-unit plant with reasonable diligence, leading to unwarranted suspensions.
  • Consideration and Purpose: The substantial royalties constituted a key part of the consideration, necessitating diligent operation to realize these financial benefits.
  • Measure of Damages: The Court upheld that damages should encompass the royalties lost due to non-operation, inclusive of interest, rather than merely the interest on potential royalties.

Essentially, the Court balanced the explicit contractual terms with the overarching purpose of ensuring that the royalty company's interests were protected through reasonable and diligent operation of the mineral property.

Impact

This judgment had significant implications for future mineral land transactions in Texas and beyond:

  • Affirmation of Implied Covenants: Reinforced the recognition of implied duties to operate mineral properties diligently, even when not expressly stated.
  • Standard for Reasonable Diligence: Established a clear standard based on ordinary prudence, guiding future courts in assessing breaches of implied covenants.
  • Damage Assessment: Clarified the appropriate measure of damages, supporting comprehensive compensation for lost royalties.

As a result, companies engaging in mineral land transactions must be cognizant of their implied obligations to operate diligently, ensuring they meet both express and implied contractual commitments.

Complex Concepts Simplified

Implied Covenants

An implied covenant is an unwritten agreement inferred by the law based on the nature of the transaction and the intentions of the parties involved. In the context of this case, it refers to the Sulphur Company's obligation to operate the sulphur mines diligently, even though the contract did not explicitly state this requirement beyond the erection of a plant.

Reasonable Diligence

This standard requires parties to act with a level of care that an ordinary, prudent person would exercise in similar circumstances. It ensures that obligations are met diligently, preventing neglect or intentional delays in fulfilling contractual duties.

Measure of Damages

In legal terms, damages refer to the compensation awarded to a party for losses suffered due to another party's breach of contract. In this case, the Court determined that damages should include the royalties the Royalty Company lost due to the Sulphur Company's failure to operate diligently, along with interest on those lost royalties.

Conclusion

The Freeport Sulphur Co. v. American Sulphur Royalty Co. decision serves as a cornerstone in Texas jurisprudence concerning mineral land transactions. By affirming the existence of implied covenants to operate diligently, the Court ensured that royalty owners are protected against negligent or intentional delays in the development of mineral properties. This judgment not only clarified the obligations of mineral operators but also established a robust framework for assessing damages, thereby reinforcing the integrity and reliability of contractual engagements in the mining sector.

Case Details

Year: 1928
Court: Supreme Court of Texas.

Judge(s)

William Pierson

Attorney(S)

W. T. Andrews, C. P. Northrop, C. R. Wharton, Jno. A. Mobley, S. H. German, Palmer Bradley, Baker, Botts, Parker Garwood and Andrews, Streetman, Logue Mobley, for plaintiff in error. Implied covenants are not favored by the law and are never imputed to a contract except as a legal necessity for the purpose of effectuating the plain, clear and unmistakable intention of the parties. The reasonable, fair and unmistakable construction to be placed upon the contract between Simms and Swenson Sons and the deed of conveyance, arrived at from a consideration of all the terms of same, is that it constitutes a conveyance in fee, for a valuable consideration, of said lands, with the agreement that same shall be held subject to the payment of royalties on sulphur when same is mined and produced; and same is not in any sense a contract for development of said lands for sulphur upon the basis of anticipated royalties. Grass v. Big Creek Development Co., L. R. A., 1915 E., 1057, 84 S.E. 750; Morrison-De Soto's Oil and Gas Rights, 71; Griffin v. Bell, 202 S.W. 1034; Greenwood Tyrell v. Helm, 264 S.W. 221; Hawkes v. Taylor, 70 Ill. App. 255; Feather v. Baird (West Va.), 102 S.E. 294; Carper v. United Fuel Gas Co., 89 S.E. 14; Allen v. Colonial Oil Co., 115 S.E. 842. When there has been an express covenant pertaining to a particular matter about which the parties are contracting, there is no room for an implied covenant relating to the same matter, and none will be created by law. The contract and conveyance under which plaintiff in error holds having expressly provided for the building and putting in operation of a plant of one unit, of the kind described, and thus clearly evidencing the intention of the parties as to the matter of development of the lands for sulphur, this excludes the idea of any additional covenant relating to the matter of development not expressly written in the contract, and no general covenant for the development of the land in good faith and with reasonable diligence will be implied. Burt v. Deorsan, 227 S.W. 354; Humble Oil Refining Co. v. Strauss, 243 S.W. 528; Nabors v. Producers Co., 74 So. 527; Becker v. Submarine Oil Co., 204 P. 245; Greek v. Willie, 109 A. 529; Aye v. Philadelphia, 44 A. 555; Grimes v. Goodman, 216 S.W. 204; Stoddard v. Emery, 18 Atl. (Penn.), 339; Crouch v. Fowle, 9 N.H., 219. Plaintiff in error having installed four plants instead of one, as provided for in the contract, and having for many years developed the sulphur in a manner far in excess of the contract requirement, during which time defendant in error was paid royalties exceeding by five times the amount it would have received if development had been confined to a one unit plant, as originally contracted, such payments will be recognized as covering the period of suspension, and if covenant to operate said one unit plant in good faith and with reasonable diligence could be implied, it conclusively appears that such covenant was not breached. If the contract and conveyance between the parties in this case created an implied covenant for development of the land for sulphur, then such covenant was not necessarily one for continuous development, but merely contemplated such development as, under all the circumstances and conditions, was in the judgment and discretion of plaintiff in error mutually profitable and beneficial to the parties; and in the absence of allegations and proof that plaintiff in error had abused this discretion, or was guilty of fraud and bad faith, it appearing that there was no such delay in operations as amounted to an abandonment of the enterprise, the issue as to the breach of such implied covenant (if any) was not raised by the pleadings and the proof. The undisputed evidence showed that the two periods of suspension of actual production complained of by defendant in error were such suspensions as were justified from the standpoint of good business judgment and economical administration of the business enterprise, and that in suspending actual production (but not operations), as was done, plaintiff in error acted in good faith and in the exercise of sound business judgment as to what was right and proper under all the circumstances and conditions; and there was therefore no proof raising the issue of a breach of an implied covenant (if any) for development in good faith and with reasonable diligence. Benavides v. Hunt, 79 Tex. 383; L. R. A., 1915 E, 1057; Allen v. Colonial Oil Co., 115 S.E. 844; Texas Pacific Coal Oil Co. v. Bruce, 233 S.W. 535; Caddo Oil Mining Co. v. Producers Oil Co., 134 La. 701. Even if there was a general implied covenant to develop the properties in question for sulphur in good faith and with reasonable diligence, yet the anticipated royalties were to be a part consideration for sulphur removed from the land, when removed, and were not anticipated profits, hence, until sulphur was removed, defendant in error suffered no loss, but was merely subjected to delay in receiving that which it will receive in the future; therefore, the proper measure of damage for any unreasonable suspension of operation is legal interest on such royalties as defendant in error might have received under the terms of the contract if there had been no unreasonable delay, as the sulphur remained in the ground, and defendant in error, under the contract, would receive royalties thereon when mined. Such was held to be the proper rule in the ably considered case of Grass v. Big Creek Development Co., 75 W. Va. 719; 84 S.E. 750; L. R. A. 1915 E 1057, which is apparently the only case which has been decided that fits the facts here involved. Implied covenants are those which are imputed in law as having been necessarily intended by the parties from the nature of the transaction or the words used, and which the law presumes would have been stated by them in express language if deemed necessary or if the matter had been called to their attention. They are never read into a contract unless the parties have omitted to insert covenants in the writing. Belle-Meade Lumber Co. v. Turnbull, 87 S.E. 382; Hawkes v. Taylor, 70 Ill. App. 255; Munsey v. Marnett Oil Gas Co., 113 Tex. 212; Allen v. Colonial Oil Co., 115 S.E. 842. As to the right of plaintiff in error to use its sound judgment and a reasonable discretion in the matter of suspending operations: What we have maintained and what has not been controverted by counsel is that in the administration of a large commercial enterprise the discretion of the operator to determine what is a reasonable development is absolute, subject to be brought into question in a judicial proceeding under proper averments. Blue Creek Development Co. v. Howell, 133 S.E. 699; Weisant v. Follett, 17 Ohio App. 271; Caddo Oil Mining Co. v. Producers Oil Co., 64 So. 690. W. H. Wilson, W. S. Sproles, W. T. Williams, and Presley K. Ewing, for defendant in error. In the absence of a provision to the contrary in the contract, the law implies a covenant on the part of the grantee or lessee of mineral lands to begin operations within a reasonable time and continue to work the mine in a proper manner and with reasonable diligence, so that the grantor or lessor may receive the compensation or income contemplated when the grant or lease was made, where, under the terms of the grant, the right to mine is granted in consideration of the reservation of a certain portion of the product (or of royalties proportioned to the production) to the grantor. Corpus Juris, Vol. 40, Mines and Minerals, pp. 1020-1021, Notes 43-44-45 and cases; Sharp v. Wright, 28 Beav., 150, 54 Reprint English Cases p. 323; Munsey v. Marnett Oil Gas Co., 199 S.W. 686-689-690, approvingly followed by the Supreme Court in a recent decision, 254 S.W. 311-313; Benavides v. Hunt, 79 Tex. 383-394-396; Grubb v. McAfee, 109 Tex. 527-530-535, and cases cited; J. M. Guffey Petroleum Co. v. Oliver, 78 S.W. 884-888; J. M. Guffey Petroleum Co. v. Jeff Chaison Townsite Co., 107 S.W. 609-612; Brewster v. Lanyon Zinc Co., 140 Fed., 812-815; Kleppner v. Lemon, 176 Pa., 502; Bryan's Law of Petroleum Natural Gas, Sec. 215, p. 189 citing Koch's Appeal, 93 Pa., 442; Bryan's Law of Petroleum Natural Gas, Sec. 224, p. 196; Thornton's Oil Gas, Vol. 1, Sec. 98, p. 155; Ray v. Gas Co., 138 Pa. St., 571, 20 A. 1065; Harris v. Ohio Oil Co., 157 Ohio St. 118-127, 28 N.E. 502-505. A reasonable, diligent production in good faith means production in the interest of the royalty owner as well as in the interest of the operator: Iams v. Carnegie Natural Gas Co., 145 A. 54-55; Glasgow v. Glasgow, 152 Pa., 48, 25 A. 232. The principle that the law implies an obligation in the mine operator (unless excluded by the express terms of the writing) to operate the mine with reasonable diligence, to the end that the royalties on operation may be paid as agreed, applies equally whether the operator is the grantee in a deed or the lessee in a mineral lease, for in Texas in every mineral lease there being an exclusive appropriation of the mineral which in a contingency may last forever, the instrument is a conveyance of the legal fee title to a mineral as land and in its essentials not different from a deed: Texas Co. v. Davis, 254 S.W. 304; Robinson v. Jacobs, 254 S.W. 309; Munsey v. Marnett Oil Gas Co., 254 S.W. 311; Thomason v. Ham, 254 S.W. 316. The principle that the law implies, in the absence of an express provision to the contrary, an obligation in the grantee of mineral land, and in his assigns, to operate the mines with reasonable diligence in the interest of the royalty owner as well as of the operator, where the conveyance is made in consideration of royalties proportioned to production and agreed to be paid by the operator, applies equally where the obligation to pay royalties is the sole consideration of the deed and where there is also a money or other consideration additional to the agreement to pay royalties on production; for if the agreement to pay royalties be a material and integral consideration of the deed the law certainly has no bias against the royalty part of the consideration in a sale of what is mineral land, but in the interest of justice contemplates the reasonable development of the minerals and payment of the royalties thereon; particularly is this true in the instant case. Emery v. League (Civ. App.), 172 S.W. 603-607. Cash consideration paid equal to the full value of the land if not mineral; Fisher v. Crescent Oil Co., 178 S.W. 905-906-907. Cash consideration of $6,400 paid. Implied obligation to mine and operate during continuance of lease ( 178 S.W. 907); Munsey v. Marnett Oil Gas Co., 254 S.W. 313-314. Holding that in Fisher v. Crescent Oil Co. a vested estate in the minerals passed, burdened inseparably with a continuing duty to mine and operate the land for minerals ( 254 S.W. 313-314). To place the decision in the operator, of whether he has operated the mine with reasonable diligence under the obligation imposed on him by law, would make the operator the judge in his own case; and the rights of the royalty owner, given him by law, to development of the minerals with reasonable diligence by the operator, would be of little value if the operator is made the judge of his own legal obligation — a situation anomalous in the English and American law and contrary to the primary conceptions of justice, that the operator should be judge in his own case and that the royalty owner should hold his rights, conferred by law, at the will and decision of the operator who might have one or a number of adverse interests. Texas Co. v. Ramsower (Com. of App., decision Section A, opinion filed February 29, 1928), 7 S.W.2d 872; Brewster v. Lanyon (U.S. App.), Fed., 801-813-814; Daughetee v. Ohio Oil Co., 151 Ill. App. 101, 263 Ill. 518, 105 N.E. 308; Munsey v. Marnett Oil Gas Co., 199 S.W. 686-689; Grubb v. McAfee, 109 Tex. 527, 212 S.W. 464; Jeff Chaison Townsite Co. v. Guffey Petroleum Co., 107 S.W. 609; Kleppner v. Lemon, 176 Pa. St., 502, 35 A. 109. A covenant in a mining lease or grant stipulating for royalties to be paid quarterly, based on current production, is by necessary implication a covenant for quarterly production — that is, for practically continuous production. The language used in this covenant giving to it its natural meaning and such implied meaning as necessarily inheres in the words used, leaves nothing to implication of law but the degree of diligence to be used by the operator in carrying out his covenant of production. To this there is but one answer — the law will never consider a diligence that is less than reasonable or that is not in good faith in the interest of the party for whose benefit the covenant of production is made. Munsey v. Marnett Oil Gas Co., 199 S.W. 689; Sharp v. Wright, 28 Beav., 150, 54 Eng. Reprint 323; Jarvis v. Tomlinson, 1 H. N., English Reprint, Vol. 156, p. 1173; Fisher v. Crescent Oil Co., 178 S.W. 95-96-97; Munsey v. Marnett Oil Gas Co., 254 S.W. 313-314; Harris v. Oil Co., 157 Ohio St., 28 N.E. 502-505. Plaintiff will not be held to have cut itself off from its legal rights to a reasonable production of sulphur by language used in the contract, unless that language, fairly construed, means in law that Sec. VII was intended to be (construed according to its language and under the circumstances surrounding the transaction) a stipulation governing production. Especially is this the case as it is the policy of the law where the terms of the agreement will permit of it, to so construe the agreement as to permit development and to prevent delay and unproductiveness. (40 Corpus Juris, paragraph 666, p. 1053; Logan Natural Gas Co. v. Great Southern Gas Co., 126 Fed. 623, 61 C. C. A., 359; Huggins v. Daley, 99 Fed., 606, 40 C. C. A., 12, 48 L. R. A., 320; Donaldson v. Josey Oil Co., 106 Okla. 11, 232 P. 821; Carter v. Blackwell Oil Co., 83 Okla. 243, 201 P. 252; Garfield Oil Co. v. Champlain, 78 Okla. 91, 189 P. 514; Custer v. Fortuna Oil Co., 77 Okla. 257, 187 P. 248; Provant v. Sealy, 77 Okla. 244, 187 P. 235; Curtis v. Harris, 76 Okla. 226, 184 P. 574; New State Oil Co. v. Dunn, 75 Okla. 141, 182 P. 514, Parish Fork Oil Co. v. Bridgewater Gas Co., 51 W. Va. 583, 42 S.W. 655.) Sec. VII would seem naturally to have been intended for a test of the Frasch process, as it could not be certainly known that that process would successfully work in the field until it was tried. The rule is general in the occurrence in a lease or mining grant of a provision which, fairly construed, is a provision for a test or exploration plant — that such stipulation will not be held to limit or affect the implied covenant of the law for a reasonably diligent production in good faith, and will not be permitted to overrule or impair an express provision in the contract applying to production (where there is one), but will be confined to the purpose for which it was intended. Texas Co. v. Ramsower (Com. App., decision Feb. 29, 1928), 7 S.W.2d 872; Munsey v. Marnett Oil Gas Co., 199 S.W. 686-690; Grubb v. McAfee, 109 Tex. 527, 530, 535; J. M. Guffey Petroleum Co. v. Oliver, 79 S.W. 884, 885, 888; Emery v. League, 72 S.W. 603.

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