Opinion
CIVIL ACTION CAUSE NUMBER 2:01-CV-354-J
August 25, 2003
ORDER GRANTING MOTION FOR SUMMARY JUDGMENT
Before the Court is Plaintiffs' motion, filed June 2, 2003, for summary judgment on their breach of contract claims asserted against Defendants Chesapeake Panhandle Limited Partnership and Chesapeake Operating, Inc. For the following reasons, Plaintiffs' motion is granted.
Factual Background
The majority of this case has settled. What remains are breach of contract claims asserted by royalty owners against the non-settling operators of a producing gas well located on a 640-acre consolidated oil and gas lease. Plaintiffs allege that the two leases underlying the consolidated lease have been breached in three different ways. First, by underpayment of gas royalties. Second, by improperly charging gathering and other post-production charges and transportation fees against the royalty owners' interests. Third, by failure to pay for substitute gas or otherwise provide free gas as required under a 1930 lease, a 1937 lease, a 1937 consolidated lease, and a 1993 contractual agreement, which require such gas to be provided to the resident lessor for his domestic heating, cooking and light use.
This case involves two leases covering 640 acres out of Section 18, Block 4, in Carson County, Texas. The first lease is a 1930 lease from William F. Ramming covering 560 acres. The second lease is a 1937 lease from Bertha Ramming and others covering 80 acres. The 1930 Ramming lease requires royalties to be paid for the sale of oil from that lease on the basis of 1/8; of the net proceeds from sale at the mouth of the well. It further provides that the lessor shall have gas free of charge, from any well located on the leased premises, for stoves and inside lights in the principal dwelling house on the 560 acres.
The 1937 lease states that royalties are to be paid from production on the basis of 1/8 of the market value, at the well, of the gas sold or used on the basis set out in a 1937 division order executed by lessor to lessee. It further provides that the lessor shall have the privilege of making a connection and using gas from any gas well on the leased premises for stoves and inside lights in the principal dwelling house on the 80 acres.
On December 23, 1937, Plaintiffs' predecessors-in-interest executed a consolidation agreement aggregating the 640 acres as a single unit expressly for production of natural gas. Apportioned royalties from natural gas produced from the consolidated leases are payable on the terms and conditions provided for in the 1937 division order, regardless of the portion of the acreage from which production is taken, or as set forth in later division orders. The gas royalty payment provisions of the 1937 division order were revoked and replaced at various times over the years, the last revocation occurring effective February 5, 1997. The parties agree that none of these controlling agreements are ambiguous and that there is not any doubt as to the meaning and intent of the parties to the 1937 agreements.
Plaintiffs are successors and assigns of the original lessors under the leases and are entitled to receive the 1/8; th royalties called for in these agreements. Defendants are the current operators of the Ramming leases and sellers of natural gas produced therefrom. Effective March 3, 1998, Defendants acquired the Ramming #1E well, the payment of production royalties from which forms the basis of this suit.
Summary Judgment Standards
Once the moving party has initially shown its entitlement to judgment by tendering competent evidence, "the non-movant cannot rest on the pleadings." Green v. Touro Infirmary, 992 F.2d 537, 538-39 (5th Cir. 1993). The party opposing judgment must point the Court to "specific facts with sufficient particularity to meet all the elements necessary to lay a foundation for recovery, including those necessary to negate the defense" offered by movant. Brown v. Texas A M University, 804 F.2d 327, 333 (5th Cir. 1986). See also Celotex Corp. v. Catrett, 477 U.S. 317, 322-23, 106 S.Ct. 2548, 2552, 91 L.Ed.2d 265 (1986) (initial burden is on movant to show entitlement to summary judgment with competent evidence); Fed.R.Civ.Pro. 56(c) (e).Legal conclusions, self-serving affidavits, and general allegations do not satisfy this burden. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250, 106 S.Ct. 2505, 2511, 91 L.Ed.2d 202 (1986); Lechuqa v. Southern Pacific Transp. Co., 949 F.2d 790, 798 (5th Cir. 1992); Galindo v. Precision Am. Corp., 754 F.2d 1212, 1216 (5th Cir. 1985).
Accord Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 249, 106 S.Ct. 2505, 2510, 91 L.Ed.2d 202 (1986); Celotex Corp., 477 U.S. at 323-25, 106 S.Ct. at 2553; Liberty Lobby, Inc., 477 U.S. at 247-48, 106 S.Ct. at 2510. The nonmoving party must designate specific facts showing there exists a genuine issue of material fact on those elements sought to be negated by the movant. Ibid.
Discussion and Analysis
The Court will separately discuss Plaintiffs' three breach of contract claims, beginning with their underpayment of royalties claim.
Underpayment of Royalties
The 1930 Ramming lease requires royalties to be paid for the sale of hydrocarbons from that lease on the basis of 1/8; of the net proceeds from sale at the mouth of the well. The 1937 Ramming lease states that royalties are to be paid from production on the basis of 1/8; of the market value, at the well, of the gas sold or used on the basis set out in a division order executed by lessor to lessee. The 1937 consolidation agreement provides that royalties from gas produced on the consolidated leases are payable pursuant to the terms and conditions provided in the 1937 division order. The consolidation agreement was not intended to modify the market value or proceeds provisions of the underlying leases, stating that it is "intended only to apportion the royalties that may be due from natural gas production under the terms of this consolidation agreement."
The 1937 division order states that "until further notice" the lessee will make royalty payments from gas produced from all wells on the land in proportion to the respective interests of the royalty owners "for the remaining life of this contract one eighth (1/8) of Five Cents per thousand cubic feet" for all gas sold from the leases. The 1937 division order was revoked and the price per thousand cubic feet (MCF) was adjusted upward by division orders in 1945 (to 8\?\per MCF) and in 1978 (to FERC § 104 MMBTU rates). Five cents (5\?\) per MCF has not been the basis for royalty payments for at least fifty years — from at least July 1, 1952.
From December 1, 1978 until March of 2002, Defendants and their predecessors-in-interest paid Plaintiffs monthly royalties based upon the "Inside FERC Mid-Continent Index" published price for "large producer flowing gas price per MMBTU of Section 104, under the Natural Gas Policy Act, at 14.73 psia, plus 100% tax reimbursement" for all natural gas produced from the leases, or similar predecessor index prices. Over the years that gas price ranged, for example, from $1.60 in the mid-1990s to $2.00 in 1998 to $10.00 in 2001 to a high of over $13.00 per thousand cubic feet. Beginning in March, 2002, after this lawsuit was filed, Defendants unilaterally decided to base royalty payments upon l/8th of five cents per MCF (1/8; of 5 ¢ = .00625 ¢ /MCF) for all gas produced from the leases. It is uncontroverted that the true market value of that gas, and the actual proceeds received by Defendants from the sales of Plaintiffs' gas, greatly exceeded 5 ¢ per MCF.
Defendants assert the 1937 division order provides that the royalty that must be paid for the life of the leaseis one-eighth of 5\?\ per MCF, and that the 1937 division order controls even though in 2003 they are selling the gas for over $4.00 per MCF. They make this contention despite the undisputed fact that: 1) in 1997 the 1937 division order and all earlier division orders were revoked, 2) since 1945 no lessee, including the Defendants, paid royalties in accordance with the Defendants' contentions, 3) the 1937 division order states that royalties are to be paid at 5\?\ only "until further notice," 4) effective July 1, 1952, the division order was amended to provide for royalty upon 8\?\ per MCF, 4) effective December 1, 1978, it was again amended to pay at Section 104 gas prices, and 5) in 1997 Defendants' predecessor-in-interest (MC Panhandle, Inc.) wrote to Plaintiffs as "interest owners" notifying them that "prior division orders . . . have been revoked and replaced with new ones." Clearly, by 2002 the lessors and lessees understood that the 1937 division order could be, and had been, repeatedly amended, just as the 1937 division order stated ("until further notice") that it could be.
Nevertheless, Defendants contend that the 1937 division order is different from the customary division order, which they concede is binding only until revoked. Defendants claim that the 1937 division order expressly amends the operative leases and provides an unchangeable express covenant, frozen in time, related to the payment of royalties. That claim is without factual or legal merit, as is their defensive contention that "prior to [March of 2002] Plaintiffs were simply mistakenly overpaid."
Texas law provides that, as here, when a oil and gas division order is revoked it is superceded by subsequent division orders. Exxon Corp. v. Middleton, 613 S.W.2d 240, 250 (Tex. 1981). Division orders are revokable by either party to the order. Tex. Nat. Res. Code § 91.402(g). In accordance with Texas law and the plain language of the applicable agreements, pursuant to the terms of the 1978 division order Defendants and their predecessors-in-interest paid Plaintiffs royalties based upon FERC index sales prices per MCF adjusted by MMBTU. That royalty payment provision was followed from 1978 until March of 2002 when, some six months after this suit was filed, the Defendants unilaterally reduced that price to 5\?\ per MCF. No division order was executed before, during or after March of 2002 revoking the FERC-index-pricing royalty aspects or reinstating the superceded 1937 division order.
Furthermore, as a matter of law division orders are revoked when suit is filed notwithstanding language contained therein that they are binding. Exxon, 613 S.W.2d at 249-50.
Defendants' unilateral rollback from 2002 prices to 1937 gas prices therefore breached, without any contractual justification or other legal excuse, the applicable royalty payment provisions of their contractual agreements. Defendants are liable in money damages for that breach in an amount to be determined at trial, plus Plaintiffs' reasonable attorneys' fees.
Improper Charges Against Royalty Interests
Plaintiffs allege that beginning in April of 1998 until March of 2002 Defendants improperly and illegally deducted post-production gathering charges such as pipeline charge deductions, fuel deductions, gathering/transportation fees, and fixed gathering charges from the proceeds of gas sales made from the leases. Plaintiffs allege that these are all post-wellhead charges which under the terms of the leases are not properly chargeable against their royalty interests.
Plaintiffs allege that it was not until they engaged in discovery in this lawsuit that they discovered that beginning in April of 1998 Defendants began to deduct these post-production gathering charges and transportation fees from the proceeds of gas sales made from the leases. It cannot be disputed that the royalty statements given to Plaintiffs hid and did not disclose that these deductions had been made. Defendants' statements as delivered to the Plaintiffs stated the post-deductions gas sales prices, not a relevant FERC index sales price or even the gross price, without deductions, received from the gas marketing company.
Defendants justify the hidden deductions by alleging that their gas "leasehold estate is subject to the paragraph 4.2 of a July 1, 1997, Gas Sales and Purchase Agreement executed by MC Panhandle, Inc. as seller and MidCon Gas Services Corp. as buyer." At that time MC Panhandle and MidCon were affiliated companies, both owned by Occidental Petroleum Corp. Defendants also allege that they never made the deductions because the deductions were made by their gas purchaser, MidCon Gas Services.
Paragraph 4.2 states:
IV. PRICE AND GATHERING CHARGES
4.1 Base Price. The price payable by Buyer to Seller for all gas delivered at the Point(s) of Delivery shall be the Index Price, as adjusted pursuant to the Gathering Charge set forth in paragraph 4.2 below.
4.2 Gathering Charge. In consideration for the gathering service provided by Buyer hereunder, Buyer shall be able to deduct from the amount payable to Seller pursuant to 4.1 the following:
(i) a fuel and lost gas charge equal to eight point five percent (8.5%) of the gas volumes delivered by Seller to Buyer at Point(s) of Delivery;
(ii) a gathering fee which shall be the sum of:
(a) a fixed monthly charge of Three Hundred Forty-five Thousand and 00/100's Dollars ($345,000), and
(b) a variable charge of seven cents per MMBtu ($.07/MMBtu) actually delivered by Seller to Buyer at the point of delivery.
While paragraph 4.3 of the 1997 agreement states that "[t]he gathering charge set in paragraph 4.2 shall remain in effect for a period of five (5) years," it is uncontroverted that none of the previous operators of the leases — including MC Panhandle, MidCon and even the Chesapeake entities until April, 1998 — charged post-production costs and transportation fees against the Ramming gas royalties. When in March of 2002 Defendants began to pay royalties upon l/8th of 5\?\per MCF, they discontinued deduction of post-production gathering charges and transportation fees from the proceeds of gas sales made from the leases, allegedly because such deductions greatly exceeded the reduced monthly royalties and, if not discontinued, in effect would have required Plaintiffs to pay Defendants hundreds of dollars a month to produce gas from the consolidated lease.
Defendants attempt to counter Plaintiffs' summary judgment motion by asserting, in part, that the 1997 gas purchase contract — an insiders trade — is a very good deal for the Chesapeake entities. Perhaps it is. However, that fact is not relevant to any issue in this breach of contract lawsuit.
Defendants concede that paragraph 4.2 of the 1997 agreement "was not intended to equate to the actual cost of gathering," and further concede that it has a "high gathering component." Nevertheless, they assert that when gas prices are "relatively high . . . in comparison to liquids" the 1997 contract is also "very favorable" to Plaintiffs. That contention is immaterial. The 1997 contract does not determine price at the wellhead for royalty payment purposes. It is not the applicable gas index price under the 1978 division order. It is not even the applicable royalty pricing methodology under the 1930 or 1937 leases.
Defendants rely upon the 1997 contract executed between wholly owned subsidiaries of Occidental Petroleum Corp. to support the post-production deductions and charges about which Plaintiffs complain. While Defendants concede that the 1997 contract was not the result of an arms-length transaction, but rather consisted of an agreement among affiliates, Defendant Chesapeake Panhandle, Inc. claims that it is an original party to the 1997 agreement because it is the successor by stock purchase and name change to MC Panhandle, Inc., one of the Occidental affiliates. That contention, even if true, does not excuse underpayment of royalties due under the royalty terms of the leases and the last applicable division order. A sham sale to a subsidiary does not provide the proper basis for calculation of royalties. Texas Oil Gas Corp. v. Haqen, 683 S.W.2d 24, 28 (Tex.App.-Texarkana 1984, writ dismissed).
A "royalty" is by definition the mineral interest owner's share of production, free of expenses of production but subject to post-production costs such as taxes, treatment costs to render the product marketable, and transportation costs to the point of sale. Heritage Resources, Inc. v. NationsBank, 939 S.W.2d 118, 121-22 (Tex. 1996). In this case the leases call for royalties to be paid based upon sales made at a defined pricing point — at the mouth of the Ramming #1E well. Deductions of post-wellhead gathering and transportation fees and expenses, none of which are based upon treatment costs or severance taxes, constitute a further breach of the royalty payment provisions of the leases.
However, while a breach of contract has occurred, the amount of Plaintiffs' damages remains to be determined at trial. Failure to Provide Free Gas for Domestic Use
Plaintiff R.A. Ramming claims that Defendant Chesapeake Operating, Inc. has breached its contractual obligation to pay for or otherwise provide free gas from the W.F. Ramming #1E gas well for his domestic use as required under the W.F. Ramming lease and a 1993 contractual agreement. Since assuming control and operation of the surface estate in 1951, Ramming received gas from the #1E well located on the property referenced in the 1930 lease. The 1930 lease and the 1937 consolidation lease each contain a clause providing that the lessor is entitled to take gas from any well located on the property covered by the lease for his domestic use. Up until 1993, Ramming was provided gas directly from the #1E well for his use on Section 18.
In 1993, Ramming was approached by MidCon Gas Services Corp., Defendants' predecessor-in-interest, and asked to accept substitute gas payments in exchange for taking gas directly from the well. It was explained to Ramming that change was necessary in order to install equipment required to continue delivery of gas from the well into the pipeline. Ramming agreed and entered into a contractual agreement on December 2, 1993, whereby MidCon paid for Ramming's domestic gas bills from his local natural gas supplier. From the execution of that agreement until September of 1999 Ramming was paid consistent with the terms of the agreement.
Defendants acquired the leases in 1998. In January of 1999 Ramming received from Chesapeake the usual $2,000.00 advance gas payment for the years 1999 and 2000. In September of 1999 Ramming received a letter from Chesapeake Operating, Inc. explaining that Chesapeake Panhandle L.P. had unilaterally decided that they would no longer make the periodic advance payments and semi-annual billing adjustments (a "catch-up" provision to reimburse Ramming for higher than expected gas bills) called for in the 1993 agreement. Instead, Chesapeake would pay only a flat amount Defendants felt was sufficient for only his heating needs.
Chesapeake has since refused to make gas cost adjustments required under the 1993 agreement for the 1998 through 1999 two-year period. Until Plaintiffs' summary judgment motion was filed, Ramming had not received any other advance payments from Chesapeake Operating, Inc. or Chesapeake Panhandle L.P. or any other party for natural gas bills since his January, 1999 check. Chesapeake did not make its advance payment for the 2001 through 2002 period, nor the usual payment for the 2003 through 2004 period. Defendant does contend, however, that on June 23, 2003, it sent Ramming a check in the amount of $4,000.00 as "payment in full of all amounts due under the" 1993 substitute gas agreement. Defendants contend this issue is therefore moot.
It is not moot. Plaintiff R.A. Ramming's affidavit states that he has paid and is due a total of $8,475.23 more for domestic gas than has been reimbursed to him as required under the 1993 agreement. Assuming it is true that Defendants recently tendered $4,000.00 of that amount, that would not be "payment in full" of all of Plaintiff Ramming's alleged damages.
In either event, Defendants' decisions to, first, pay for only heating costs, and subsequently to not pay at all, are breaches of the 1993 contractual agreement for substitute gas to be provided to the resident lessor for his domestic uses. While that breach may have been mitigated by Defendants' payment of partial damages in June of 2003, it was still a contractual breach for which Defendants are liable in an amount to be determined at trial.
Conclusions
Summary judgment on the issue of Defendants' liability for breach of contract is granted to the Plaintiffs. Damages will be determined at trial.
It is SO ORDERED.