## Facts

- Lessors owned two tracts totaling about 350 acres in Wise County, Texas, subject to a 1940 oil-and-gas lease with a ten-year primary term and a habendum clause extending the lease “as long thereafter as oil, gas or other mineral is produced.”
- A well drilled in 1949 during the primary term produced gas and minimal oil; the Texas Railroad Commission classified it as an associated gas well.
- The lease included a 60-day savings clause allowing the lease to continue if, after a cessation of production, the lessee commenced drilling or reworking operations within 60 days.
- After an acidizing attempt in 1950, no further drilling or reworking occurred until September 12, 1956, when the well was successfully reworked by sandfracing.
- Lessors claimed the lease terminated after the primary term because production was not in paying quantities, relying on asserted operating losses during portions of 1955–1956.
- In the alternative, lessors sought partial cancellation (all but 40 acres around the well) and damages, alleging breach of implied covenants to reasonably develop and to explore.
- The trial court found continuous production of gas in paying quantities and denied cancellation and damages; the court of civil appeals affirmed the lease-validity holding and removed an order requiring a second well.

## Issues

1. Whether the lease terminated after the primary term because the well ceased to produce in paying quantities.
2. Whether lessees breached an implied covenant to reasonably develop (and whether Texas recognizes a separate implied covenant to explore) warranting partial cancellation.
3. How to measure “production in paying quantities,” including (a) whether depreciation must be treated as an operating expense and (b) whether overriding royalties should be excluded from income.

## Decision

- The Supreme Court of Texas affirmed the judgment upholding the lease’s continuing validity.
- The Court held the well produced in paying quantities under a prudent-operator profitability standard applied over a reasonable period, not on isolated months.
- The Court held depreciation and similar non-cash charges were not required operating expenses for the paying-quantities calculation.
- The Court declined to exclude overriding royalties from “total income” when evaluating paying quantities.
- The Court held no breach of the implied covenant to reasonably develop was shown and declined to recognize a separate implied covenant to explore distinct from development on these facts.
- The Court left undisturbed the denial of damages as speculative.

## Legal Principles

- After the primary term, an oil-and-gas lease continues so long as production yields a profit (however small) over operating expenses, measured by whether a reasonably prudent operator would continue operations for profit rather than speculation.
- Whether production is in paying quantities is a fact question assessed in light of all relevant circumstances and over a reasonable period.
- For paying-quantities analysis, the focus is on actual cash income and actual cash drilling/operating expenses; depreciation is not a required operating expense in that computation.
- Overriding royalties are not excluded from the income figure used to determine paying quantities.
- The implied covenant to reasonably develop requires proof that a prudent operator would undertake additional development with a reasonable expectation of profitable production; absent such proof, cancellation and damages are not warranted.
- Temporary cessation principles and contractual savings clauses may preserve a lease when reworking operations timely commence following any asserted cessation.

## Conclusion

The court sustained the lease because the existing well’s production satisfied a prudent-operator, cash-flow profitability test applied over a reasonable period, and the lessors failed to prove that additional development would probably be profitable or that any recoverable damages could be shown with reasonable certainty.


Clifton v. Koontz, 325 S.W.2d 684 (Tex. 1959)