Finley v. Marathon Oil Co.

• Citation: 75 F.3d 1225
• Parties: Florence I. FINLEY, Trustee, under U/D/T dated
• Decision Date: 23 March 1991
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

Page 1225

75 F.3d 1225

34 Fed.R.Serv.3d 63

Florence I. FINLEY, Trustee, under U/D/T dated March 23 1991, f/b/o John E. Finley, Sr., Trustee under U/D/T dated March 23, 1991 f/b/o Florence I. Finley, John E. Finley Jr., and Julie Wright, Plaintiff-Appellant, v. MARATHON OIL COMPANY, Defendant-Appellee.

No. 95-2376.

United States Court of Appeals Seventh Circuit.

Argued Dec. 8, 1995.

Decided Feb. 14, 1996.

Appeal from the United States District Court for the Southern District of Illinois, Benton Division. No. 94 C 4086; Philip M. Frazier, United States Magistrate Judge.

Jerry D. Miller (argued), Bowen & Miller, Olney, IL, Robert E. Shaw, T. David Purcell, Mitchell, Neubauer, Shaw & Hanson, Mt. Vernon, IL, and James D. Stout, Bridgeport, IL, for plaintiff-appellant.

Jerome E. McDonald (argued) and Craig R. Hedin, Campbell, Black, Carnine & Hedin, Mt. Vernon, IL, for defendant-appellee.

Before POSNER, Chief Judge, and LAY ^* and ROVNER, Circuit Judges.

POSNER, Chief Judge.

The appeal in this diversity suit presents interesting questions, exotic in this circuit, of oil and gas law, as well as questions concerning the application of amendments made in 1993 to the rules governing pretrial discovery in federal district courts.

The Finleys own two adjacent parcels of land in southern Illinois. At different times they leased oil and gas rights in the two parcels to Marathon Oil Company. The leases provided that the Finleys would receive one-sixth of any oil produced and Marathon would keep the other five-sixths as compensation for the risk and expense of producing. Later the Finleys entered into a "communitization" agreement with Marathon, consolidating the two leases into one but not altering the terms of the leases in any respect relevant to this appeal.

Immediately to the north of the Finleys' two parcels is a parcel owned by the heirs of McCroskey, who have leased their oil and gas rights to a different oil company. The underground formation from which the oil in the Finleys' land is pumped extends under the McCroskey parcel. The oil is extracted from the formation by the method known as secondary recovery, which involves injecting water into the formation with the aim of forcing the oil into producing wells and thence up to the surface. Marathon drilled an injection well at location T-2 on the Finleys' property and over a period of many years poured hundreds of thousands of barrels of water down it in an effort to extract additional oil. The Finleys presented evidence, vigorously contested by Marathon, that the injection caused oil to migrate from the plaintiffs' part of the formation to the part under the McCroskey parcel and that this migration, or "drainage" as it is called in the trade, would have been prevented if only Marathon had drilled another producing well on the Finleys' property between the injection well and the boundary with the McCroskey parcel. The Finleys claim that in failing to prevent this drainage Marathon broke its contract with them and committed a breach of fiduciary duty as well. The trial judge dismissed the latter claim before trial; the jury brought in a verdict for Marathon on the breach of contract claim; and so the suit was dismissed and the Finleys appeal.

The lease required Marathon to prevent, so far as it was commercially practicable (that is, cost-justified) to do so (an important qualification), the drainage of oil from the lessor's property to that of adjacent landowners. The requirement was explicit in certain agreements made between Marathon and McCroskeys' heirs--agreements of which the Finleys, we may assume, were third-party beneficiaries. It is also an implicit corollary of the implied duty of an oil and gas lessee to operate the leasehold prudently rather than wastefully. Fransen v. Conoco, Inc., 64 F.3d 1481, 1487 (10th Cir.1995); Tidelands Royalty "B" Corp. v. Gulf Oil Corp., 804 F.2d 1344, 1348-49 (5th Cir.1986); Williams v. Humble Oil & Refining Co., 432 F.2d 165, 171-72 (5th Cir.1970); Amoco Production Co. v. Alexander, 622 S.W.2d 563, 568 (Tex.1981). Both the general duty of prudent operation and the subsumed duty to avoid drainage illustrate the office of the common law of property and contracts in interpolating into a contract or conveyance provisions that the parties would almost certainly have agreed to had the need for them been foreseen. Although oil and gas litigation is not frequent in Illinois, there is no doubt that the common law of Illinois recognizes the duty to avoid drainage. See Carter Oil Co. v. Dees, 340 Ill.App. 449, 92 N.E.2d 519, 523 (1950); Ramsey v. Carter Oil Co., 74 F.Supp. 481, 482 (E.D.Ill.1947) (applying Illinois law); Geary v. Adams Oil & Gas Co., 31 F.Supp. 830, 835 (E.D.Ill.1940) (ditto).

Whether Marathon complied with its duty to avoid drainage was a question of fact that, if we set to one side for a moment the Finleys' objection to two of the trial judge's evidentiary rulings, the jury was entitled to resolve as it did in favor of Marathon. Marathon presented expert evidence that there was no recoverable oil in the portion of the Finleys' property in which the injection well at T-2 was drilled and so there could not have been a diversion of oil to the McCroskey leasehold as a consequence of the pumping of water into that well.

Had Marathon been the lessee of the McCroskey oil and gas rights and had deliberately diverted oil from the Finleys' properties to the McCroskey property because it had a better deal with the heirs--had Marathon, in other words, been the common lessee of the two properties--it might have been guilty of conversion. Ramsey v. Carter Oil Co., supra, 74 F.Supp. at 483. Indeed, even without such a nefarious purpose, diversion by a common lessee might be deemed a per se violation of the duty to avoid drainage, making the lessee liable for the loss to the lessor without regard to the cost to the former of avoiding the drainage. E.g., Cook v. El Paso Natural Gas Co., 560 F.2d 978, 982-84 (10th Cir.1977); Geary v. Adams Oil & Gas Co., supra, 31 F.Supp. at 834-35. Or might not. The per se rule illustrated by Cook and less clearly by Geary has been severely, and as it seems to us justifiably, criticized, 5 Howard R. Williams & Charles J. Meyers, Oil and Gas Law §§ 824.1, 824.3 (1995), and has been rejected in many jurisdictions. See, e.g., Tidelands Royalty "B" Corp. v. Gulf Oil Corp., supra, 804 F.2d at 1353-54; Williams v. Humble Oil & Refining Co., supra, 432 F.2d at 172-73; Rogers v. Heston Oil Co., 735 P.2d 542, 547 (Okla.1984). Rogers states clearly what we take to be the correct view, that as in other cases of fiduciary duty the common lessee must treat the lessor as well as he would treat himself, but not better. Maybe, despite Geary, which is after all just the opinion of one district judge, and not a recent opinion at that, Illinois would adopt this view and reject Geary.

We need not pursue these byways. Marathon was not the lessee of the heirs' oil and gas rights, had therefore no incentive to divert the oil to them, had in fact an incentive not to do so, was found not to have done so, and at worst merely blundered (if drainage there was, as apparently there was not, and if the drainage could have been prevented at a cost less than the value of the oil drained away) rather than committed a deliberate wrong. We shall see in a moment that Marathon's incentive to avoid drainage may have been impaired. But the Finleys neither remark this nor presented at trial any evidence that Marathon was acting deliberately rather than mistakenly, or indeed that it had committed any wrong more serious than a garden-variety breach of contract; for an oil and gas contract does not make the lessee the fiduciary of the lessor in the absence of special circumstances not shown here. O'Donnell v. Snowden & McSweeney Co., 318 Ill. 374, 149 N.E. 253, 255 (1925); Kirke v. Texas Co., 186 F.2d 643, 648 (7th Cir.1951) (applying Illinois law); Norman v. Apache Corp., 19 F.3d 1017, 1024 (5th Cir.1994). So the Finleys could not have obtained punitive damages, Mijatovich v. Columbia Savings & Loan Ass'n, 168 Ill.App.3d 313, 119 Ill.Dec. 66, 69, 522 N.E.2d 728, 731 (1988); Naiditch v. Shaf Home Builders, Inc., 160 Ill.App.3d 245, 111 Ill.Dec. 486, 496, 512 N.E.2d 1027, 1037 (1987); Amoco Production Co. v. Alexander, supra, 622 S.W.2d at 571, which was the main reason they had for dressing their claim in fiduciary-duty breeches.

The basis for the claim that Marathon was the Finleys' fiduciary is that the "communitization" agreement was the equivalent of a unitization agreement, with Marathon corresponding to the unit operator. Many cases do hold that the unit operator, that is, the manager of the unitized field, is the fiduciary of the owners of the field, Fransen v. Conoco, Inc., supra, 64 F.3d at 1487; Leck v. Continental Oil Co., 971 F.2d 604, 607 (10th Cir.1992); Young v. West Edmond Hunton Lime Unit, 275 P.2d 304, 308-09 (Okla.1954); 6 Williams & Meyers, supra, § 990, p. 869, and while other cases think it enough that the participants should have a duty of good faith toward each other, e.g., Amoco Production Co. v. Heimann, 904 F.2d 1405, 1411-13 (10th Cir.1990); Rutherford v. Exxon Co., U.S.A., 855 F.2d 1141, 1145-46 (5th Cir.1988), Illinois is in the former camp. Carroll v. Caldwell, 12 Ill.2d 487, 147 N.E.2d 69, 74 (1957). Unitization refers to the exploitation of an oil or gas field that lies under the surface of a number of landowners as if it were under joint ownership, in order to optimize the rate, and minimize the cost, of production. It eliminates the temptation to socially wasteful conduct that would otherwise exist, when an oil field is owned in common, because each operator has an incentive to remove as much oil as fast as he can, even though the cost of production for the field as a whole might be less and the total amount recovered...