Condra v. Quinoco Petroleum, Inc.

954 S.W.2d 68, 1997 WL 375206

• Court: Court of Appeals of Texas
• Decided: August 28, 1997
• Docket: 04-95-00492-CV
• Status: Published

Opinions

OPINION

HARDBERGER, Chief Justice.

Appellants appeal a take nothing judgment rendered in favor of appellees. In three points of error, appellants contend: (1) appellants’ division orders entitle them to share in take-or-pay settlement proceeds; (2) appellants are entitled to damages for breach of the express or implied covenant to market; and (3) the trial court erred by not entering findings of fact and conclusions of law. In response to appellants’ third point of error, we abated the appeal and ordered the trial court to enter findings of fact and conclusions of law. Our subsequent receipt of such findings and conclusions renders appellants’ third point of error moot, and it will not be further addressed.¹

FACTS

Appellants are assignees of the original Lessee, Lively Energy Company (“Lively”), under an Oil and Gas Lease Agreement dated July 5, 1979 (the “Lease”). Lively initially assigned the rights and obligations under the Lease to appellee American Quasar Petroleum Co. of New Mexico, reserving an overriding royalty interest. Thereafter, Lively assigned the overriding royalty interest to appellants.

Appellees are the producer-operators under a certain Gas Purchase Agreement with El Paso Natural Gas Company (“El Paso”) dated June 30, 1972. The gas produced under the Lease was to be sold to El Paso in accordance with the terms of that agreement. The Gas Purchase Agreement contained a take-or-pay clause obligating El Paso to take a specified quantity of gas produced under the Lease each year or pay for the gas not taken. El Paso failed to take the specified quantity of gas from 1982 through 1986, and further failed to pay for the gas not taken.

Under the Gas Purchase Agreement, El Paso was obligated to pay the NPGA price for gas rather than the “spot” or market price. Although El Paso was in breach of the agreement, appellees did not make any spot or market sales while El Paso was in breach because they wanted to get the maximum value for the gas which was the price payable under the El Paso agreement.

In January of 1987, appellees sent the lessors/royalty owners under the Lease a letter enclosing shut-in payments for the wells. The letter stated that the wells were shut-in because El Paso did not have a market for the gas from the wells. The letter informed the royalty owners that the gas contract required El Paso to pay the NPGA Section 107(c)(5) rate (then $6.32/MMBTU) as compared to the spot price of approximately $1.20/MMBTU. The letter further stated that the appellees were reluctant to release El Paso from the contract because the contract provided for a greater price and the term of the contract extended beyond the projected period of gas surplus then being experienced by the country.

Ultimately, appellees filed suit against El Paso for breach of the Gas Purchase Agreement on June 30, 1987. Thereafter, appel-lees and El Paso resolved their dispute by entering into a Settlement Agreement dated March 31, 1988. Under the terms of the Settlement Agreement, El Paso was required to pay appellees a recoupable payment of $3,500,000 and a nonrecoupable payment of $2,310,000. The recoupable payment was a prepayment for approximately one billion cubic feet of gas to be delivered in the future. The nonrecoupable payment was consideration for certain amendments to the Gas Purchase Agreement and settlement of other claims, one of which was identified as El Paso’s failure to take rateably from the ap-pellees’ wells. The Gas Purchase Agreement was amended to:(l) delete the favorable price provisions and insert market or spot pricing; (2) eliminate the take-or-pay obligation; and (3) extend the term of the agreement for an additional three years. The Settlement Agreement was subsequently amended by letter agreement dated September 28, 1988, to permit appellees to market gas produced under the Lease to third parties on the spot market without jeopardizing El Paso’s right of recoupment.

Following the settlement, appellants filed the instant suit seeking in pertinent part: (1) a declaratory judgment that appellants were entitled to share in the proceeds of the take- or-pay settlement under the terms of the Lease, assignment and division orders; and (2) compensatory damages for breach of the express covenant to market.² On April 10, 1989, the parties submitted an agreed record to the trial court and requested leave to file briefs addressing the documents introduced into the record and the legal authorities to support their contrasting positions. Post-trial briefs were submitted on May 5 and May 15, 1989. Supplemental briefs were submitted in November 1989. Further post-trial briefs were filed on September 23, 1994, and the trial court entered its take nothing judgment on February 3,1995.³

In the findings of fact and conclusions of law filed by the trial court in response to this court’s order, the trial court held, as a matter of law, that appellants were not entitled to be paid an overriding royalty on or share in the proceeds received pursuant to the Settlement Agreement. In addition, the trial court held, as a matter of law, that appellees did not breach the division orders and that there was no implied covenant to market under the Lease. Finally, the trial court held that appellees’ settlement was not a breach of the express covenant to market under the Lease.

DISCUSSION

1. Division Orders

In their first point of error, appellants assert that their division orders entitle them to share in the take-or-pay settlement proceeds.

Division orders govern the distribution of oil and gas proceeds, directing to whom such proceeds will be paid and in what proportion. See Gavenda v. Strata Energy, Inc., 705 S.W.2d 690, 691 (Tex.1986); De Benavides v. Warren, 674 S.W.2d 353, 361 (Tex.App.—San Antonio 1984, writ refd n.r.e.). Thus, until withdrawn, division orders define the payment to be received by the royalty owner. See Gavenda v. Strata Energy, Inc., 705 S.W.2d at 691; De Benavides v. Warren, 674 S.W.2d at 361.

The assignments creating the overriding royalty interest claimed by appellants provide for the retention of “an overriding royalty of no less than three and one-third percent of eight-eights (8.333% x 8/8ths) of all the oil, gas and similar hydrocarbons that may be produced, saved and marketed from Said Lease.” The division orders entitle the appellants to receive their proportional interest in “all proceeds derived from the sale of products produced from or attributable to said property....”

Appellants contend that the phrase “attributable to” modifies the term “proceeds” in the foregoing provision, and, therefore, they should receive their proportional interest in the settlement proceeds because such proceeds are attributable to the property. We believe, however that the phrase “attributable to” is intended to modify the term “products.” Thus, royalty is due under the division orders on proceeds derived from the sale of products that are either (1) produced from the property; or (2) attributable to the property.

Given this interpretation, we discern no reasonable basis for distinguishing the aforementioned language from that set forth in the lease interpreted in this court’s prior decision in Hurd Enterprises, Ltd. v. Bruni, 828 S.W.2d 101, 106 (Tex.App.—San Antonio 1992, writ denied). The royalty clause interpreted in Bruni provided for the payment of royalties on gas "... produced from said land and sold or used off the premises.... ” Hurd Enterprises, Ltd. v. Bruni, 828 S.W.2d at 106. Similarly, the division orders in the instant case contemplate the sale of products as a prerequisite to the payment of royalties.⁴

As the dissent argues, the facts in the Bruni decisions are distinguishable from the instant case for the reason set forth in footnote 8 of the second Bruni decision—that is, $2.31 million of the settlement is a nonrecou-pable payment. Hurd Enterprises, Ltd. v. Bruni, 828 S.W.2d at 106 n. 8 (recognizing that cogent arguments exist concerning the royalty owner’s interest where the settlement terminates the purchaser’s recoupment rights). Nevertheless, in TransAmerican Natural Gas Corp. v. Finkelstein, 933 S.W.2d 591, 596-97 (Tex.App.—San Antonio 1996, writ requested), this court considered whether royalties were payable on a portion of a take-or-pay settlement paid as repudiation damages for gas not taken when there was subsequent production. We held that no royalties were due because the repudiation damages still represented nonproduction. Id. at 599. Our decision in TransAmerican has since been followed by at least one other Texas appellate court. See Alameda Corp. v. Transamerican Natural Gas Corp., 950 S.W.2d 93 (Tex.App.—Houston [14th Dist.], 1997 n.w.h.). The Houston court agreed with our analysis in TransAmerican and held that repudiation damages were not royalty bearing because the royalty interest at issue was tied to production. Id., at 6-97-99. Relying on TransAmerican, the Houston court concluded that “a royalty owner’s right to payment under these circumstances is no longer an open question in Texas.” Id., at 99.

Similar to the repudiation damages considered in TransAmerican, the nonrecoupable payment in the instant case was not paid for production. Therefore, we hold that the appellants’ division orders do not entitle them to royalties on the take-or-pay settlement in this ease. Similarly, the nonrecoupable payment in the instant case was not paid for production. Therefore, we hold that the appellants’ division orders do not entitle them to royalties on the take-or-pay settlement in this case.

2. Covenant to Market

In their second point of error, appellants assert that the settlement was a violation of the express covenant to market. Appellants’ argument under this point of error asserts that appellees’ actions violated both the express and implied covenant to market. Appellees counter that appellants are not entitled to enforce any express or implied covenants in the Lease, and, in any event, both the express covenant and implied covenant to market relate to production only.

a.Ability of Assignee to Enforce Express Covenant

Appellees contend that since appellants acquired their overriding royalty interests through an assignment from the original Lessee, they have no right to enforce the express covenants of the Lease. As noted in appellees’ brief, the treatise by Williams and Meyers addresses the issue as follows:

The owner of an overriding royalty is not entitled to the benefit of the covenants of the base lease, express or implied, in the absence of an express provision in the instrument creating the overriding royalty. The benefits of such express and implied covenants of the lease touch and concern the lessor’s estate and burdens of such covenants touch and concern the lessee’s estate. The assignment, either in whole or in part, of the burdened estate will not permit enforcement of the covenants which burden the assigned estate by a person other than the lessor or claimants through him of a portion or all of the benefitted estate.

Howaed R. Williams & Chaeles J. Meyers, Oil and Gas Law § 420 (1981).

Although both the lessors under the Lease and the appellants under the assignment are entitled to certain royalties, their rights arise from different instruments. While the Texas Supreme Court has recognized an analogy between implied covenants in a lease and those in an assignment, that opinion does not support permitting an assignee to enforce an express covenant in the original lease. See Bolton v. Coats, 533 S.W.2d 914, 916 (Tex.1975). Therefore, we conclude that appellants are not entitled to enforce the express covenant to market in the Lease.

b. Ability of Assignee to Enforce Implied Covenant

The Texas Supreme Court has recognized an assignee’s right to enforce implied covenants arising under an assignment. See Bolton v. Coats, 533 S.W.2d at 917; Cole Petroleum Co. v. U.S. Gas & Oil Co., 121 Tex. 59, 41 S.W.2d 414, 416 (Tex.1931); see also Wes-Tex Land Co. v. Simmons, 566 5.W.2d 719, 721-22 (Tex.Civ.App.—Eastland 1978, writ ref d n.r.e.)(extending implied covenant to protect against drainage to assign-ee); see generally Richard D. Watt, To Share or Not to Share: Royalty Obligations Arising Out of Take-or-Pay or Similar Gas Contract Litigation, 42nd Inst, on Oil & Gas L. & Tax’n 14-68, 14-69 (1991)(recognizing extension of implied covenant to overriding royalty owners). One of the covenants implied in such assignments is the covenant to market. See Cole Petroleum Co., 41 S.W.2d at 416 (implying covenant to market in assignment creating overriding royalty interest where express covenant was absent). Following this precedent, therefore, we conclude appellants have the right to enforce the implied covenant to market arising under their assignment. Since the implied covenant arises out of the assignment, the terms of the express covenant in the Lease, which is a different instrument, should not be used to negate or restrict the breadth of the implied covenant.⁵

c. Breach of Implied Covenant

Having concluded an implied covenant to market arises under the assignment and is enforceable by the appellants, the final issue to be considered is whether the implied covenant can be breached through the appel-lees’ settlement of a claim for breach of the take-or-pay provisions in a gas purchase contract.⁶ Appellees maintain that the implied covenant to market is limited to the marketing of actual production quoting from the language in Mandell v. Hamman Oil and Refining Co., 822 S.W.2d 153, 164 (Tex. App.—Houston [1st Dist.] 1991, writ denied).

In Mandell, the appellants were contending that the operator breached its marketing duties. Id. The court held that the marketing covenant requires the lessee to ensure that “gas that is produced is sold for the best price or under the best terms.” Id. The court concluded:

We hold that take or pay is not a benefit that appellants [the royalty owners] received via execution of the lease with Ham-man [the producer] and does not flow from the marketing covenant of the lease. Hamman was required to obtain for appellants only benefits received that were related to the sale of gas that had been produced.

Id. at 165. This court also has recently held that the duty to reasonably market is not triggered in the absence of production. TransAmerican Natural Gas Corp. v. Finkelstein, 933 S.W.2d at 598. We stated that “[t]ake or pay is not a benefit which flows from the marketing covenant of a lease.” Id. at 600. Since the appellees were only required to obtain benefits for the appellants under the marketing covenant after the actual production of gas and the settlement payments at issue here were paid in the absence of production, the duly to reasonably market has not been breached. See id.; see also Alameda Corp. v. Transamerican Natural Gas Corp., 950 S.W.2d at 99-100 (duty to market not triggered in absence of production).

CONCLUSION

Appellants’ division orders do not entitle them to share in the take-or-pay settlement proceeds. Furthermore, the implied covenant to market was not breached because production was absent. For these reasons, we affirm the judgment of the trial court.

RICKHOFF, J., dissents, joined by GREEN and DUNCAN, JJ.

1 . We note that our order also allowed the parties to file supplemental briefs in this court after the trial court entered its findings of fact and conclusions of law.

2 . We note that although appellants’ pleadings only assert a claim for violation of the express covenant to market, given the trial court’s findings and conclusions, it appears the breach of the implied covenant to market issue was tried by consent.

3 . Appellees’ Brief states that the delay was due to the inadvertent sealing of the trial court’s file.

4 . While the language of the original Lease does not control appellees’ overriding royalty interest, we note the Lease contains royalty language that is virtually identical to the Bruni lease, entitling the lessors to a royalty "... on any and all gas, ... produced from any well and sold by Lessee, or used by Lessee,.... ”

5 . Since the express covenant in the Lease may be interpreted more narrowly than the implied covenant arising under the assignment, the trial court’s conclusion that the express covenant was not breached does not reach the issue as to whether the implied covenant was breached.

6 . Although the trial court erroneously concluded •that there was no implied covenant to market, if the settlement of a claim for a breach of such a take-or-pay provision cannot result in a violation of the implied covenant to market as a matter of law, the trial court's conclusion would be harmless. Therefore, we address whether the implied covenant can be breached by such a settlement.