Farmland Indus. v. National Union Fire Ins. Co.

• Decision Date: 27 August 2004
• Docket Number: No. 02-4135-JAR.,02-4135-JAR.
• Citation: 333 F.Supp.2d 1133
• Parties: FARMLAND INDUSTRIES, INC., Plaintiff, v. NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PENNSYLVANIA, et al., Defendants.
• Court: U.S. District Court — District of Kansas

333 F.Supp.2d 1133

FARMLAND INDUSTRIES, INC., Plaintiff, v. NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PENNSYLVANIA, et al., Defendants.

No. 02-4135-JAR.

United States District Court, D. Kansas.

August 27, 2004.

Lee M. Smithyman, Overland Park, KS, for Plaintiff.

Christopher F. Burger, Peter K. Curran, Lawrence, KS, Ethan V. Torrey and Matthew M. Burke, Ropes & Gray, Boston, MA, for Defendants.

MEMORANDUM ORDER DENYING MOTION FOR SUMMARY JUDGMENT & DENYING CROSS-MOTION FOR SUMMARY JUDGMENT

ROBINSON, District Judge.

This diversity action involves coverage under an all-risk insurance policy in a dispute between the insured plaintiff, Farmland Industries, Inc. ("Farmland") and the insurer defendants National Union Fire Insurance Company of Pittsburgh, Pennsylvania; Qatar General Insurance and Reinsurance Company; Certain Underwriters at Lloyd's of London; Gerling Konzern Allgemeine Versicherungs-AG; and Allianz Insurance Company (the "Insurers"). This matter comes before the Court on Farmland's Motion for Summary Judgment (Doc. 29) and the Insurers' Cross-Motion for Summary Judgment (Doc. 33). For the reasons stated below, Farmland's motion is denied and the Insurers' cross-motion is denied.

I. Uncontroverted Facts¹

On October 1, 1998, Farmland entered into a natural gas storage agreement with Manchester Gas Storage, Inc., ("Manchester") that entitled Farmland to purchase, receive and store natural gas at the Manchester Storage Facility ("Facility") in Grant County, Oklahoma. The Facility is a depleted natural gas reservoir consisting of "working gas" and "cushion gas." Working gas is the amount of gas in a storage reservoir that may be withdrawn. Cushion gas is gas that must remain in the reservoir to provide the pressure necessary to allow the withdrawal of working gas. Manchester's owner, William Davis, also owned Mountain Energy Corporation ("MEC"). In 1999, Mr. Davis sold MEC to Michael Eichenberg and Roderick Donovan. On February 1, 1999, Manchester appointed MEC as its marketing and managing agent for the Facility.

On April 1, 1999, MEC entered into a Gas Sales and Purchase Contract with Anadarko Energy Services Company ("Anadarko"), a large natural gas supplier. Pursuant to the contract, Anadarko would provide natural gas to MEC for storage and resale. Anadarko also entered into a Firm Storage Service Agreement with Manchester for utilization of the Facility.

On April 5, 2000, Craig Smyth of Farmland and Mr. Eichenberg reached an oral agreement in which "Farmland buys .5 bcf [or 500,000 MMBtu] physical gas from [MEC], transferred in place to 2nd Farmland account with Manchester." The agreement further provided that "Farmland agrees to take the gas out in October — either by withdrawal or in-place transfer to Farmland's regular storage account, or settle financially." Farmland had no right to receive, withdraw, or use the natural gas until October 2000. At the same time as Farmland's sale, MEC also entered into a virtually identical transaction with Tenaska Marketing Ventures (Tenaska).

Prior to Farmland's purchase, MEC bought 1.5 BCF of natural gas from Terra Nitrogen Corporation ("Terra"). The Terra natural gas was physically present in the Facility. Mr. Donovan testified that the 500,000 MMBtu sale of natural gas to Farmland "was natural gas that related directly to the purchase of the remaining storage balance of Terra." Both Mr. Donovan and Mr. Eichenberg testified that the 500,000 MMBtu of natural gas sold to Farmland was physically present in the Facility at the time of the sale. Additionally, Farmland employee Richard Schuck testified that based upon his review of storage records and the testimony of Mr. Donovan and Mr. Eichenberg, he concluded that the natural gas was physically present in the Facility in April 2000.

From February 2000 through June 2000, MEC prepared a monthly storage inventory for the Facility reflecting the amount of cushion gas and working gas, by account, in the Facility. From July 2000 through October 2000, similar storage inventory records were prepared by Manchester. The storage inventory records were one way to track the amount and ownership of gas in the Facility. Manchester also periodically confirmed the total amount of gas in the Facility through a physical estimate of the gas using reservoir size and current average reservoir pressures, which was performed by Lee Keeling and Associates.

MEC and later Manchester generated monthly statements reflecting the beginning and ending inventory and any activity during the month for each customer. Farmland received these monthly statements, which showed that 500,000 MMBtu of natural gas was physically present in the facility from April 2000 through August 2000. Farmland relied on the monthly statements, among other documents, to account for the existence and amount of natural gas held at the Facility. Manchester did not receive a statement showing Farmland's purchase of 500,000 MMBtu of natural gas; instead the statement listed only Terra's account.

Sometime in April of 2000, MEC committed to the withdrawal of 635,000 MMBtu of the Terra gas on a ratable basis over the month of April for sale to its customers in the Kansas City area. Manchester's intention was to sell the remaining approximately 800,000 MMBtu of Terra gas into the market during the summer of 2000. On April 17, 2000, however, Manchester sent MEC a letter accusing MEC of violating its contractual obligations as agent of the Facility and prohibited MEC from releasing any portion of the Terra gas. MEC subsequently sold the remainder of the Terra gas to Anadarko.

In July 2000, Manchester terminated MEC as agent of the Facility and commenced managing the Facility itself. On July 15, 2000, MEC sent Manchester a fax concerning financial disagreements, which stated "you asked me not to-call on Farmland because if they choose to withdraw gas the facility will not physically be able to perform for Anadarko and Farmland both." Farmland was unaware of the dispute or the communication between Manchester and MEC.

In September, MEC had difficulties in delivering gas to all of its customers. On September 27, 2000, Mr. Schuck had a conversation with Mr. Donovan, in which Mr. Schuck asked MEC to deliver Farmland's natural gas in October or to transfer it into another storage account with Manchester. Mr. Donovan indicated that he could not make delivery of the gas and could not transfer it to Farmland's other storage account. This conversation made Mr. Schuck believe "at that time that the gas was not there. Otherwise, he would have been able to do one or the other." Sometimes in early October after Farmland was unable to receive delivery of its gas, Mr. Schuck reviewed Manchester's inventory records. Mr. Schuck's record review led him to conclude that Manchester, MEC or Anadarko took Farmland's 500,000 MMBtu of natural gas. Around this same time, Tenaska conducted an audit which similarly revealed a shortage of gas at the Facility. By October 2000, MEC had outstanding deals with various parties totaling at least 5 BCF, but the total natural gas in the Facility was 7.01BCF, and of that amount 6.139 BCF was cushion gas and .871 BCF was working gas.

On October 25, 2000, Manchester issued a press release concerning its problems with MEC which stated that "Manchester has allowed all of [MEC's] customers to conduct independent audits of the storage records to establish that the `alleged' purchased gas was never located in the Manchester storage facility." MEC and Manchester subsequently went into bankruptcy. Manchester contended in court filings connected to its bankruptcy that although MEC represented to certain customers that it had purchased natural gas for future delivery that was currently stored in the Facility, the gas was not actually purchased by MEC.

MEC never paid Farmland for the 500,000 MMBtu of natural gas Farmland purchased in April 2000. Farmland has not recovered any of the natural gas. Farmland did, however, recover $700,000 from this transaction.

Farmland is covered by an all-risk policy (Policy) for which the Insurers have underwritten various percentages of liability. The policy period is November 1, 1997 to November 1, 2000. The annual premium for the Policy was $3,705,000.00. The policy insures: "ALL RISKS OF DIRECT PHYSICAL LOSS OR DAMAGE, except as hereinafter excluded, to the property of the Insured as described herein, and for the coverages designated in the policy territory." The definition of property provided by the Policy is:

All Real and Personal Property of any kind and description, now owned by the Insured or hereafter acquired or in which the Insured has or may acquire an interest including property in the course of construction or installation, including contractors interest, property of others for which the Insured may have assumed liability or property in the Insured's care, custody, and control for which the Insured may be legally liable, all while situated in or while in transit within the territorial limits of this policy.

The territorial limits of the Policy are the United States, Mexico and Canada.

A policy exclusion addresses natural gas. Specifically excluded from the Policy is: "Subterranean strata except coverage is provided for crude petroleum and its products including but not limited to natural gas and other minerals while stored in strata of any nature after initial recovery above ground unless otherwise provided for under this policy...."

The Policy also excludes:

Unexplained or mysterious disappearance of any property, or shortage revealed only by audit or upon taking inventory; or any fraudulent, dishonest or other act intended to result in the financial gain of the Insured or any associate, proprietor, partner, director, trustee, elected officer, employee or agent of the Insured....

Farmland has filed a notice of claim and made demands for payment for the loss of natural gas under the...