Amoco Production Co. v. Douglas Energy Co., Inc.

• Decision Date: 26 June 1985
• Docket Number: No. 82-1865.,82-1865.
• Citation: 613 F. Supp. 730
• Parties: AMOCO PRODUCTION COMPANY, a corporation, Plaintiff, v. DOUGLAS ENERGY COMPANY, INC., et al., Defendants.
• Court: U.S. District Court — District of Kansas

613 F. Supp. 730

AMOCO PRODUCTION COMPANY, a corporation, Plaintiff, v. DOUGLAS ENERGY COMPANY, INC., et al., Defendants.

No. 82-1865.

United States District Court, D. Kansas.

June 26, 1985.

COPYRIGHT MATERIAL OMITTED

Judson S. Woodruff, John A. Kenney, Eugene Kuntz, Oklahoma City, Okl., Larry Withers, Kahrs, Nelson, Fanning, Hite & Kellogg, Wichita, Kan., Charles T. Krol, Mary Haskins, Denver, Colo., R.H. Frick, Chicago, Ill., for plaintiff.

Don O. Concannon, Concannon, Traster & Concannon, Hugoton, Kan., Gary Johnson, Dotson, Babcock & Scoefield, Houston, Tex., David Fist, Rosenstein, Fist & Ringold, Tulsa, Okl., for defendants.

Craig R. Carver, Gibson, Dunn & Crutcher, Denver, Colo., for defendant Douglas Energy Co., Inc.

MEMORANDUM AND ORDER

CROW, District Judge.

This case is presently before the court for consideration of Amoco's motions for summary judgment, to dismiss defendants' counterclaim and for a ruling on the burden of proof. The court has reviewed the record including the voluminous memoranda presented in support of the various motions and has heard oral argument. For the reasons stated below, the court is persuaded the motion for summary judgment should be denied and the motion to dismiss should be granted.

The net result of the ruling concerning the burden of proof proposed by Amoco would be to deny the defendants the statutory presumption created by K.S.A. 55-224. The court has reviewed that statute and concludes that it should be applied retroactively. Accordingly, Amoco's motion to rule on the burden of proof will be denied as to defendants' counterclaim.

This case concerns the natural gas and oil resources located in southwestern Kansas, commonly known as the Hugoton field, where Amoco holds mineral leases granted by the defendant landowners or their predecessors in interest. These leases contain the standard habendum clause which provides they shall continue for as long as oil or gas is produced in paying quantities. Amoco has drilled shallow gas wells on these leaseholds and contends such production is sufficient to hold the leases by production under the habendum clause. Defendants allege there are considerable oil and gas reserves in deeper formations which Amoco has not developed. In 1981 and 1982, defendant Douglas Energy Company obtained top leases to a sizeable portion of Amoco's leaseholdings. Amoco has filed the present lawsuit as a result of the Douglas top leasing program.

I. Motion to Dismiss

Plaintiff's motion to dismiss addresses the question whether defendants' amended counterclaim, alleging speculation and abandonment, states viable claims for relief. Dismissal of defendants' claims pursuant to Fed.R.Civ.P. 12(b)(6) is inappropriate unless it appears that the defendants can prove no set of facts that would entitle them to the relief requested. Kensell v. State of Oklahoma, 716 F.2d 1350 (10th Cir.1983).

Defendants' position that a cause of action of speculation is cognizable under Kansas law is in part based on the principle that in Kansas, as in other jurisdictions, holding leases for speculative purposes is condemned. "Leases of this kind contemplate exploration and development, and not the bottling up of land for speculative or other purposes or the postponement of reasonable development...." Webb v. Croft, 120 Kan. 654, 657, 244 P. 1033, 1035 (1926). As is apparent from the Webb decision, and other cases, speculation is often conceptually linked to the implied covenant of exploration and development. Harris v. Morris Plan Co., 144 Kan. 501, 61 P.2d 901 (1936); Alford v. Dennis, 102 Kan. 403, 170 P. 1005 (1918). See also 5 E. Kuntz, A Treatise on the Law of Oil and Gas, §§ 58.3 at 74, 62.1 at 184 (1978); H. Williams and C. Meyers, Oil and Gas Law, §§ 842.1, 842.3 (1983). Speculation is a policy consideration underlying the obligations imposed by this implied covenant, not a recognized separate cause of action. Permitting the assertion here of both speculation and the implied covenant to develop and explore would, in view of Kansas case law, be similar in many ways to allowing, in a tort context, assertion of both negligence and failure to exercise due care as separate and distinct claims.

As an alternative basis for recognition of an independent claim of speculation, defendants suggest that the facts may compel forfeiture even if they would not indicate that Amoco has violated the prudent operator standard. It is argued that holding deep rights indefinitely until a change in technology, price or other economic development is evidence, under a broader "relational contract" theory, of a complete breakdown of the contract. Defendants contend such opportunistic behavior on the part of the lessee would justify unconditional forfeiture, without prior demand and notice, even where the lessee was acting as a prudent operator.

In support of this proposition, defendants suggest that the Kansas Supreme Court might subscribe to the recent Colorado Court of Appeals ruling in North York Land Associates v. Byron Oil Industries, Inc., 695 P.2d 1188, VIII Br.T.Repr. 1227 (Colo.App.1984). There, the court affirmed the trial court's cancelling of a non-pooled area of a lease for breach of the implied covenant to explore and develop. The rationale for this result, however, was not that the lessee failed to perform as a prudent operator. The trial court had found that a prudent operator would not explore or develop the leasehold. Rather, the court affirmed cancellation based upon the finding that the lessee was holding the land for speculation.

There are several observations which can be made about the North York Land case. First, the claim asserted was breach of the implied covenant to explore and develop. Second, the court's treatment of profitability in testing compliance with this implied covenant runs counter to well-established law in Kansas. See, e.g., Sanders v. Birmingham, 214 Kan. 769, 522 P.2d 959 (1974). Finally, regardless of the test employed to determine whether the implied covenant has been breached, demand, or its futility, remains a prerequisite for forfeiture. See Section II, infra. The trial court in North York Land found that the lessor made verbal demands for further development, and that the responses received created a reasonable belief that further demands would have been futile. Other cases defendants cite which address speculation similarly raise implied covenant claims and do not support the proposition that demand, or a showing of futility, is unnecessary for unconditional forfeiture.

Defendants' alternative counterclaim of abandonment is closely related to the claim of speculation in the sense that both focus on Amoco's alleged opportunistic behavior in postponing exploration and development, and under both claims demand and notice is allegedly not an issue. Defendants support the viability of the abandonment claim primarily on the basis of their interpretation of the recent Kansas Supreme Court case of Rook v. James E. Russell Petroleum, Inc., 235 Kan. 6, 679 P.2d 158 (1984). There, the Kansas court refers to Dr. Merrill's description of certain situations where abandonment may be confused with breach of an implied covenant. See Merrill, Covenants Implied in Oil and Gas Leases §§ 8, 9 (2d ed. 1940). The court states: "The second situation ... is where the lessee consciously intends to give up the lease and commits some positive act of abandonment. This is true abandonment ... The third situation ... is where there has been no act done to demonstrate an intention to abandon but the lessee intends to postpone work of development while keeping the lease." Id. at 16, 679 P.2d 158. Defendants contend it is not entirely clear which of these theories is applied in Rook, that both are species of abandonment, that under either theory demand and notice is unnecessary, and that the facts of that case closely parallel the case at bar.

After closely reviewing the Rook case, and after hearing oral argument, the court is not inclined, as it once indicated it might be, to reconsider its view of the applicability of this decision. Despite the unusual factual circumstances, the holding of Rook appears clear and indicates that termination, without demand and notice, is appropriate under facts supporting a finding of true abandonment. The court is not persuaded by defendants contention that the Rook court may be applying Merrill's "third situation" mentioned above, where the lessee does not intend to relinquish rights under the leases, but rather to postpone development indefinitely.

The case presents, as the Kansas court observes, an unusual situation involving two leases "under which production ceased but which were nevertheless continued in force and effect by the express provisions of the habendum clauses ... relative to gas storage rights." Id. at 17, 679 P.2d 158. Lease assignments had effectively severed the gas storage portion of the leases from the oil and gas production portion. Exercise of the gas storage rights continued the leases, creating a situation where reference to the implied covenant of diligent and prudent operation was appropriate, despite the cessation of production. It was the lack of any ongoing production, however, which distinguished Rook from other implied covenant cases, and similarly distinguishes Rook from the instant case.

The supreme court approved the trial court's determination that the oil and gas production portion of the leases was severable, and that the evidence clearly supported a finding of abandonment of the production portion of the leases. Upon a finding of abandonment, termination without prior demand and notice was an appropriate remedy. The court states:

The foregoing written acknowledgment and undertaking by Russell, in the assignment, coupled with Russell's positive acts which followed, all clearly support the finding of the trial court that Russell and his assignee abandoned these leases. Russell's

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