## Facts

- Noel L. Sundheim, Bertha Sundheim, and Leona M. Johnson owned mineral interests in Roosevelt County, Montana.
- In May 1967, the owners executed oil and gas leases (10-year primary terms) covering their minerals; the leases were later assigned to Woods Petroleum Corporation in March 1969.
- Woods entered a dry hole contribution agreement with Anadarko Production Company, the operator on adjacent land; under the agreement, Woods received well data and structural/geologic information from the adjoining acreage.
- Woods drilled a well on the Sundheim leasehold that initially produced. When production later declined, Woods concluded the decline was due to reservoir conditions and shut the well in, ceasing production by 1977.
- In 1978, Reef Oil Corporation acquired the well and took new leases from the Sundheims. Reef generated information suggesting the production decline might have been due to mechanical problems rather than reservoir depletion.
- Reef did not rework the well (assertedly due to financial constraints) and later the leasehold interest passed to Frank Hiestand, doing business as Saratoga Production Company (represented in the case by Andy Hiestand as personal representative of the estate).
- Later operations included an attempt to drill another well, which was nonproductive.
- In 1986, the Sundheims sued Woods, Reef, and the Hiestand estate for damages, alleging nearby wells on adjacent tracts drained oil from beneath their land (about 145,000 barrels) and that defendants breached implied covenants by failing to drill an offset well or otherwise protect the leasehold from drainage.
- The Sundheims did not give written notice of drainage or a formal demand to drill an offset well before filing suit.
- The district court granted summary judgment for defendants and imposed Rule 11 sanctions on the Sundheims and their attorney.

## Issues

1. Whether summary judgment was proper on the Sundheims’ claims against Reef Oil and the Hiestand estate for breach of the implied covenant to protect against drainage, breach of the implied covenant to reasonably develop, and breach of a purported independent “prudent operator” obligation.
2. Whether summary judgment for Woods Petroleum was proper on the ground that the Sundheims’ claims were barred by the statute of limitations.
3. Whether the district court properly imposed Rule 11 sanctions against the Sundheims and their counsel.

## Decision

- Affirmed summary judgment for Woods Petroleum because the Sundheims’ claims against Woods were barred by the applicable statute of limitations.
- Affirmed summary judgment for Reef Oil and the Hiestand estate on the implied covenant of reasonable development claim.
- Reversed summary judgment for Reef Oil and the Hiestand estate on the implied covenant to protect against drainage and remanded; the court held the district court erred by treating written notice and an offset-well demand as an absolute prerequisite where the lessee may have had actual or constructive notice of drainage.
- Held the “prudent operator” standard is not an independent cause of action; it is the measure used to evaluate performance of implied covenants.
- Reversed the Rule 11 sanctions.

## Legal Principles

- An oil and gas lease includes implied covenants, including (among others) covenants to reasonably develop the leasehold and to protect against drainage.
- For a drainage-based implied-covenant claim, “reasonable notice” may be sufficient; a written notice and a formal demand to drill an offset well are not always required when the lessee has actual or constructive notice of drainage risk.
- Constructive notice may be shown by evidence that the lessee had access to, or obtained, offset well data or other information from adjacent operations bearing on drainage.
- The “prudent operator” standard is the test for whether the lessee met its implied-covenant duties; it does not create a separate, freestanding claim apart from those covenants.
- Acceptance of delay rentals and the lease’s primary-term structure may defeat or postpone an alleged duty to drill additional wells under a reasonable-development theory, supporting summary judgment where the record shows no actionable breach.
- Claims against a former operator are subject to ordinary statutes of limitation; when suit is filed after the limitations period runs, summary judgment is proper absent a valid basis to toll the statute.
- Rule 11 sanctions are improper when the claims and legal arguments are supported by existing authority or a good-faith argument for extending or changing the law.

## Conclusion

The Montana Supreme Court affirmed that the Sundheims’ claims against Woods were time-barred and upheld dismissal of the reasonable-development claim, but reinstated the implied-covenant claim for failure to protect against drainage because written notice and a formal offset-well demand were not strictly required if defendants had actual or constructive notice; it also ruled that “prudent operator” is a standard rather than a standalone claim and vacated the Rule 11 sanctions.


Sundheim v. Reef Oil Corp., 247 Mont. 244, 806 P.2d 503, 114 O. & G.R. 42 (1991)