## Facts

- In 1951, the lessors executed an oil and gas lease covering approximately 3,360 acres with a four-month primary term and a secondary term lasting “as long thereafter as oil or gas is produced.”
- The lease contained an anti-forfeiture/saving clause stating the lease would not be “forfeited or cancelled” for failure to perform implied covenants until (1) a final judicial determination of failure and (2) a reasonable time after that determination for the lessee to comply.
- The lease was assigned in 1959, principally to Pepper Tank Company (Pepper).
- Before the assignment, multiple successful wells were drilled in 1952–1953 and another producing well in 1957.
- After the assignment, Pepper drilled one well in 1972; it was plugged and abandoned the same year, and there were no further drilling efforts on the leased property.
- Pepper’s main later effort was a water-flood operation begun in 1963 and abandoned in 1971.
- By the time of suit, all wells had been abandoned except Gillette well #10, which continued to produce only at a marginal rate.
- A unitization agreement executed in 1963 affected certain portions of the leased lands.
- Plaintiffs (including Charles Underwood, a lessor) sued alleging (a) termination during the secondary term for failure to produce in paying quantities and (b) breach of implied covenants, including further development/exploration and prudent/diligent operation, and sought cancellation and to quiet title.
- After a bench trial, the trial court found Pepper breached implied covenants to further develop/explore and to operate prudently.
- The trial court ordered conditional cancellation: Pepper could avoid cancellation of nonproducing areas by filing a plan of development within 60 days (otherwise the lessors could cancel by filing their own development plan), and could avoid cancellation of the producing area by making necessary repairs to Gillette #10.
- Both sides appealed.

## Issues

1. Whether the lease’s saving clause prevented termination or cancellation for breach of implied covenants until a final judicial determination and a reasonable post-judgment time to comply.
2. Whether the evidence supported the trial court’s findings that Pepper breached implied covenants of further development/exploration and prudent, diligent operation.
3. Whether conditional (and partial) cancellation was a permissible equitable remedy under the lease language and Colorado law.
4. Whether the trial court properly applied implied-covenant standards and remedies to acreage affected by the 1963 unitization agreement, or instead had to evaluate performance based on unit-wide operations.

## Decision

- The Court of Appeals held the saving clause was enforceable and barred forfeiture/cancellation for breach of implied covenants until judicial determination of breach and a reasonable time to comply after that determination.
- The court affirmed the trial court’s findings that Pepper breached implied covenants to drill/develop and to operate diligently and prudently, based on the long cessation of drilling, abandonment of the water-flood effort, marginal production from a lone well, and related circumstances.
- The court approved the trial court’s use of conditional cancellation as an equitable remedy that gave Pepper defined conditions and time to avoid termination by performing.
- The court required reconsideration as to lands covered by the unitization agreement, directing that implied-covenant performance (and any cancellation remedy) be assessed in light of operations and production across the unit as a whole, not solely tract-by-tract.

## Legal Principles

- Oil and gas leases generally include implied covenants, including covenants to further develop/explore and to operate diligently and prudently for the mutual benefit of lessor and lessee.
- A lease clause providing that the lease will not be forfeited or cancelled for breach of implied covenants until a final judicial determination of breach, followed by a reasonable time to comply, is valid and postpones forfeiture/cancellation until those conditions occur.
- Where a lessee has effectively stopped drilling for an extended period, abandoned recovery efforts, and maintained only marginal production, a court may find breach of implied covenants to further develop and to operate prudently.
- Equity may grant conditional or partial cancellation to enforce implied covenants while allowing the lessee a defined opportunity to cure, especially when the lease itself calls for post-judgment time to comply.
- For unitized acreage, implied-covenant duties and related remedies must account for unit-wide production and development; performance cannot be measured solely by activity or output on a single tract within the unit.

## Conclusion

Gillette v. Pepper Tank Co. enforced an anti-forfeiture/saving clause requiring a final judicial breach finding and a reasonable time to perform before cancellation for breach of implied covenants, affirmed findings that Pepper breached implied duties to develop and operate diligently, upheld a conditional cancellation remedy giving Pepper time to file a development plan and repair the remaining producing well, and remanded for reconsideration of relief affecting unitized lands because implied-covenant performance in that setting must be evaluated based on unit-wide operations.


Gillette v. Pepper Tank Co., 694 P.2d 369, 83 O. & G.R. 271 (1984)