Energy Oils, Inc. v. Montana Power Co.

• Decision Date: 29 August 1980
• Docket Number: No. 78-1066,78-1066
• Citation: 626 F.2d 731
• Parties: 6 Fed. R. Evid. Serv. 1256 ENERGY OILS, INC., a Texas Corporation, General Crude Oil Company, a Delaware Corporation, Rainbow Resources, Inc., a Wyoming Corporation, Erving Wolf, William E. Andrau, Helene B. Wolfe, and Barbara A. Powell, Plaintiffs-Appellants, v. The MONTANA POWER COMPANY, Defendant-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 731

626 F.2d 731

6 Fed. R. Evid. Serv. 1256

ENERGY OILS, INC., a Texas Corporation, General Crude Oil Company, a Delaware Corporation, Rainbow Resources, Inc., a Wyoming Corporation, Erving Wolf, William E. Andrau, Helene B. Wolfe, and Barbara A. Powell, Plaintiffs-Appellants, v. The MONTANA POWER COMPANY, Defendant-Appellee.

No. 78-1066.

United States Court of Appeals Ninth Circuit.

Argued and Submitted May 19, 1980.

Decided Aug. 29, 1980.

Morris R. Massey, Brown, Drew, Apostolos, Massey & Sullivan, Casper, Wyo., for plaintiffs-appellants.

Kendrick Smith, Corette, Smith & Dean, Butte, Mont., for defendant-appellee.

Appeal from the United States District Court for the District of Montana, Billings Division.

Before CHOY and FERGUSON, Circuit Judges, and BARTELS, ^* District Judge.

BARTELS, District Judge:

This is an appeal in a diversity action by Energy Oils, Inc., et al. ("Energy" or "appellants") from a judgment in favor of the defendant, The Montana Power Company ("Montana") entered in the United States District Court for the District of Montana (Battin, J.) after a trial without a jury. At issue for review are the construction and interpretation of two agreements with virtually identical provisions ("Energy-Bond agreements"), pursuant to which Energy assigned certain oil and gas leases to Roland Bond and Lone Star Exploration, Inc. ("Bond-Lone Star group"), ¹ who in turn subsequently assigned their interests in the leases to Montana ("Bond-Montana agreement").

In the two agreements with the Bond-Lone Star group, Energy reserved overriding royalty interests ("ORRs") ² aggregating 6.25% which were convertible at Energy's option, upon recovery by Bond-Lone Star group of certain costs and expenses, into working interests ³ aggregating 25%. The questions presented by this appeal are whether (1) under the terms of the Energy-Bond agreements appellants' option for 25% working interests was triggered by the sale of the leases by the Bond-Lone Star group to Montana for a sum which exceeded the costs and expenses incurred by Bond-Lone Star with respect to the properties; and (2) the receipt by the Bond-Lone Star group, pursuant to its agreement with Montana, of payments of a portion of the purchase price predicated upon the actual production of oil and gas from the properties, constituted "proceeds from the sale of production" within the meaning of the Energy-Bond agreements. Energy claims that under the terms of the agreements with the Bond-Lone Star group, the sale to Montana entitled appellants to exercise the option of obtaining a 25% working interest. Montana denies that the agreements so provide.

Facts

Beginning in 1967, appellants had assembled two blocks of oil and gas leases in northern Montana, one block in what is known as the "Bullwacker" area, and one in the so-called "Rocky Boy" area. After an exploration program Energy decided not to develop the properties but to interest third parties in the exploitation of the leases. Energy's efforts were successful and led in November 1970 to the consummation of two agreements assigning the Bullwacker and Rocky Boy oil and gas leases, wells and well equipment to the Bond-Lone Star group. One agreement, dated November 3, 1970, pertains to leases in the Bullwacker area, and the other, dated November 11, 1970, relates to the Rocky Boy area. Both agreements reserved ORRs of 6.25% which under certain conditions could be converted at appellants' option into working interests aggregating 25%. The key provision of the agreements, about which this controversy revolves, reads as follows:

If, as and when Bond and Lone Star, and their respective heirs, successors and assigns, have recovered from the ownership, operation and development of the properties and interests herein assigned and conveyed to them (including by way of illustration, proceeds from the sale of production, contributions to drilling, or advance payments made by a purchaser of production ) all of the costs and expenses of whatsoever nature theretofore incurred by them in (acquiring), drilling, developing, completing, operating and maintaining such properties and interest. ⁴ (Emphasis supplied.)

Between the time of its acquisition of the properties in 1970 and September 1975, the Bond-Lone Star group made substantial expenditures in drilling and developing the properties, incurring recoupable costs of $4,387,714 with respect to the Bullwacker area and $1,498,641 with respect to the Rocky Boy area, for a total of $5,886,355. On September 8, 1975, Bond-Lone Star sold the properties to Montana for a purchase price substantially in excess of these costs and expenses. The sales agreement provided for delivery to the Bond-Lone Star group of a purchase price ⁵ consisting of three types of payment: (i) a fixed sum in cash; (ii) a fixed sum in unconditional promissory notes maturing and payable at various dates, with interest at 7% per annum; and (iii) a contingent balance which could amount to almost two and one-half times the prior cash and note payments, together with interest at 4% per annum. The third type of payment was contingent upon the amount of oil and gas produced from the properties, or the amount of gas "deemed to be produced" therefrom, and payable only out of the proceeds thereof.

On January 20, 1976, Energy brought this suit, seeking a declaration that it became entitled to exercise its option to obtain a 25% working interest in the Bullwacker and Rocky Boy properties when the Bond-Lone Star group sold the leases to Montana. The district court found for Montana on the alternative grounds that (1) the agreement was unambiguous and precluded the interpretation asserted by appellants (Finding XXIX; Conclusion II); or (2) assuming the agreements were ambiguous, the facts indicated no intention by the parties that proceeds of outright sale of the leases would be considered as option-triggering recoupment within the meaning of the agreements, so that any ambiguity must be resolved against appellants. (Conclusion III). At the same time the district court concluded that "there was no evidence to indicate that any portion of the consideration paid by Montana Power was to be allocated to, or was allocated to, any part of the gas reserves or estimated gas reserves in the gas fields." (Conclusion IV).

Standard of Review

As a general rule, the interpretation of written contracts is a matter of law and reviewable as such on appeal. C. Wright and A. Miller, Federal Practice and Procedure, Civil § 2588 n.47 (1971); Republic Pictures v. Rogers, 213 F.2d 662 (9th Cir.), cert. denied, 348 U.S. 858, 75 S.Ct. 83, 99 L.Ed. 676 (1954). In construing both these agreements we are bound by the fundamental principles of contract construction as set forth in the Revised Code of Montana ("RCM") 1947 and applied by Montana courts. ⁶ Sections 13-714 and 13-713 read respectively as follows:

Section 13-714:

Contract restricted to its evident object. However broad may be the terms of a contract, it extends only to those things concerning which it appears that the parties intended to contract.

Section 13-713:

A contract may be explained by reference to the circumstances under which it was made and the matter to which it relates.

In Kintner v. Harr, 146 Mont. 461, 408 P.2d 487, 494 (1965), the Montana Supreme Court stated:

It is a fundamental rule that in the construction of contracts the courts may look not only to the language employed, but to the subject-matter and the surrounding circumstances, and may avail themselves of the same light which the parties possessed when the contract was made. (Citation omitted.) To ascertain the intention, regard must be had to the nature of the instrument itself, the condition of the parties executing it, and the objects which they had in view.

See also Custer v. Missoula Public Service Co., 91 Mont. 136, 143, 6 P.2d 131 (1931). In interpreting and construing the wording of a contract the purpose of and circumstances leading up to its execution must be seriously weighed. As stated in Liberty National Bank & Trust Co. v. Bank of America National Trust & Savings Association, 218 F.2d 831 (10th Cir. 1955), cited with approval in 4 Williston Contracts § 607 at 379 (3d ed. 1961):

The primary function of judicial interpretation is to ascertain and give effect to the intention of the parties as expressed in their writing (taking) into consideration the writing itself, its purpose and the circumstances leading up to and attending its execution, endeavor(ing) to ascertain what the parties purposed and intended by their agreement.

218 F.2d at 840.

The Energy-Bond Agreements

After carefully reading the key provisions of these agreements, we believe that any ambiguity in their meaning is resolved when the purpose and circumstances of their execution are considered, and in view of the extrinsic evidence introduced in aid of their interpretation. Since the district court has held in the first instance that the agreements were unambiguous, we need refer to the extrinsic evidence only if we disagree with or doubt the district court's construction.

The objective of the assignment of the leases to the Bond-Lone Star group was the exploration and development of the Bullwacker and Rocky Boy properties. This is acknowledged by all the parties. Upon the assignment of the leases the Bond-Lone Star group agreed to bear the entire risks and expenses of exploration and development. The small interest retained by appellants through the reservation of the 6.25% overriding royalty interests was free of these risks and expenses. The agreements also afforded appellants an opportunity to enlarge their interest to a working interest of 25% at such time as the Bond-Lone Star group recovered all of its "costs and expenses."

The district court interpreted this language to mean that Energy would have a right to convert its ORRs into working interests only when Bond-Lone Star, or their "heirs,...