Grynberg v. Citation Oil & Gas Corp.

• Decision Date: 02 December 1997
• Docket Number: No. 19258,19258
• Parties: Jack J. GRYNBERG, d/b/a Grynberg Petroleum Company; Janex Oil Co., Inc.; Andrew Kugler, Jr.; W.B. Newberry; Janex Oil Co. Reserve Fund 90-7A Ltd.; Headington Oil Properties, Inc.; H.A. Mayor, Jr.,; Carl G. Mammel; Dr. Keith Mccorrmic; Preston Investments; and Lloyd Peterson, Plaintiffs and Appellees, v. CITATION OIL & GAS CORP., Defendant and Appellant.
• Court: South Dakota Supreme Court

Page 493

573 N.W.2d 493

1997 SD 121

Jack J. GRYNBERG, d/b/a Grynberg Petroleum Company; Janex

Oil Co., Inc.; Andrew Kugler, Jr.; W.B. Newberry; Janex

Oil Co. Reserve Fund 90-7A Ltd.; Headington Oil Properties,

Inc.; H.A. Mayor, Jr.,; Carl G. Mammel; Dr. Keith

Mccorrmic; Preston Investments; and Lloyd Peterson, Plaintiffs and Appellees, v. CITATION OIL & GAS CORP., Defendant and Appellant.

No. 19258.

Supreme Court of South Dakota.

Argued Oct. 24, 1996.

Reassigned July 10, 1997.

Decided Oct. 22, 1997.

Rehearing Denied Dec. 2, 1997.

Max S. Main of Bennett, Main & Frederickson, P.C., Belle Fourche, Tom C. Toner of Yonkee & Toner, Sheridan, WY, for plaintiffs and appellees.

Craig A. Pfeifle, Steven J. Helmers of Lynn, Jackson, Shultz & Lebrun, P.C., Rapid City, for defendant and appellant.

GILBERTSON, Justice.

¶1 Defendant Citation Oil and Gas Corporation (Citation) ^* appeals a jury verdict in favor of plaintiffs for breach of contract, fraud and punitive damages resulting from its wrongful actions as operator of certain oil wells. We affirm in part, and reverse and remand with remittitur on the issue of punitive damages.

FACTS AND PROCEDURAL BACKGROUND

¶2 This case involves the operation of two oil fields located in Fall River County near the Wyoming-South Dakota border: the North Hollingsworth Field and the East Simms Field. At various times, the plaintiffs acquired oil and gas leases in one or both of the fields and entered into or became subject to Joint Operating Agreements (JOAs) with Citation. Citation was the operator of the fields. As operator, Citation was responsible for managing the exploration and production of oil and for accounting for profits and expenses on behalf of all of the owners.

¶3 The JOAs provided for what is referred to as a "nonconsent penalty." Under the JOAs, if an owner wanted to drill a well, that owner would make a proposal to the other owners and submit an Authorization For Expenditure (AFE) setting forth the cost to drill and complete the well. The other owners could then elect to either share in the cost of drilling the proposed well or go "nonconsent" and not share in those costs. If the well was drilled and was a dry hole, the owners who elected to go nonconsent did not have to pay any of the costs of the unsuccessful drilling. However, if the well produced oil, the owners who elected to share in the cost of drilling the well were entitled to recover their costs plus a nonconsent penalty from the nonconsenting owners. There were two tiers of nonconsent penalties, the first ranging from 300 percent to 400 percent of the costs incurred up to the wellhead (costs incurred for work done below the surface of the ground, such as drilling, casing, and completing). The second tier ranged from 100 percent to 200 percent of the costs incurred after the wellhead (costs incurred for surface equipment, production roads, and operating expenses). In short, the owners who put up the money to drill the well were entitled to recover from the production of that well several times their actual costs as a penalty before the nonconsenting owners would receive any share of the proceeds from that well.

¶4 The JOAs further required that Citation provide the owners with monthly Payout Status Reports (PSRs), which were itemized statements of the costs of drilling, completing, and equipping each well, and any nonconsent penalties owed. The JOAs also provided for the removal of Citation as operator, by majority vote of the nonoperators, should Citation fail or refuse to carry out its duties.

¶5 In 1984 Citation proposed the drilling of the North Hollingsworth 1-19 well (the 1-19 well). According to the AFE submitted by Citation, it would cost $327,000 to drill, complete and equip the well. Some of the plaintiffs or their predecessors elected to go nonconsent. Citation drilled the 1-19 well, which came in as a good producing well. Therefore, Citation, along with the other owners who elected to share in the cost of the 1-19 well, was entitled to nonconsent penalties from the nonconsenting owners with respect to costs associated with the 1-19 well. Within approximately twelve months, two additional wells were drilled on the North Hollingsworth field. None of the owners went nonconsent with respect to these additional wells, both of which produced oil.

¶6 After the wells were drilled, Citation began improperly allocating costs to the 1-19 well. This allocation maximized Citation's receipt of nonconsent penalties. Specifically, Citation misallocated to the 1-19 well: (1) the entire cost of a production road ($27,000), which actually served all seven wells in both fields; (2) the entire cost of a tank battery ($39,416), which was used to store oil from all of the wells in the North Hollingsworth Field; (3) the entire cost of converting a well used to dispose of salt water produced from wells in both fields ($13,571); and (4) other costs for work actually done on other wells. In addition, Citation improperly moved items which belonged in the 200 percent nonconsent penalty category (costs incurred after the wellhead) into the 400 percent category (costs incurred up to the wellhead). ¹

¶7 For approximately two years, these misallocations continued undetected by the owners. The PSRs did not itemize expenses, instead using "lump sum" amounts. Additionally, PSRs were not provided on a monthly basis as required by the JOAs. Although over seventy PSRs should have been sent out by Citation over the period it was operator, only eleven PSRs were provided.

¶8 In 1986 an audit was conducted by TIPCO, one of the owners. TIPCO discovered Citation's improper charges to the 1-19 well. TIPCO submitted its audit report to Citation in September 1986 objecting to the allocation. Citation did not respond until June 15, 1988, but agreed that it had misallocated costs associated with the production road, the tank battery, and the salt water disposal well. Citation granted TIPCO's exceptions. However, Citation did not reallocate these costs to the other owners and neither the TIPCO audit nor Citation's response were provided to the other owners.

¶9 On June 23, 1989, Citation sent out another inaccurate PSR. This report was again not itemized and still contained the improper allocations.

¶10 From 1984 to 1991 Citation allocated operating costs (e.g., salaries, vehicles, insurance, and supervision) equally among the seven wells on the North Hollingsworth and East Simms Fields. In August 1991 Citation unilaterally converted to a volumetric method of allocation. ² As a result, costs which had previously been charged to owners of the East Simms Field (which had become uneconomical) were shifted to the owners of the North Hollingsworth Field. In effect, the owners of wells in the North Hollingsworth Field were subsidizing the East Simms Field, allowing the East Simms Field wells to continue to produce. Citation was then able to continue to collect overhead charges and allocate salary expenses to East Simms Field wells.

¶11 Representatives of the owners met with Citation on September 20, 1991. Although Citation had already changed to the volumetric method of allocation, Citation stated during the meeting that it was still allocating costs on a per-well basis. Citation also represented that it would relinquish its position as operator, if a majority of the owners so desired. Based on Citation's representations regarding the cost allocation method and its willingness to step down as operator, the owners allowed Citation to continue as operator.

¶12 Finally in March 1992 a majority of the owners of each field voted to remove Citation as operator. Despite its earlier representation that it would step down, Citation refused to do so.

¶13 Plaintiffs filed suit against Citation alleging fraud and breach of contract, seeking compensatory and punitive damages and the removal of Citation as operator. The jury returned a verdict in favor of the plaintiffs, awarding $222,850 for breach of contract, $354,250 for fraud, and $4.8 million in punitive damages. The trial court denied Citation's motions for judgment notwithstanding the verdict and for new trial, and Citation appealed.

¶14 Citation raises the following issues on appeal:

1. Did Citation's actions give rise to an independent tort cause of action for fraud and a claim for punitive damages?

2. Was the jury properly instructed on the elements of deceit?

3. Did the trial court err in providing the jury with a "global" punitive damages form?

4. Was the punitive damages verdict unreasonable and excessive as a matter of law?

ANALYSIS AND DECISION

¶15 1. Did Citation's actions give rise to an independent tort cause of action for fraud and a claim for punitive damages?

¶16 This Court has recently handed down two decisions on the issue of independent torts arising from contract. See Sundt v. State ex rel. SD Dep't of Transp., 1997 SD 91, 566 N.W.2d 476; Fisher Sand & Gravel Co. v. State ex rel. SD Dep't of Transp., 1997 SD 8, 558 N.W.2d 864. Both Sundt and Fisher involved highway construction contracts, ³ and in both cases, we held that there was no independent tort which would give rise to punitive damages. The distinctively different facts of the case now before us justify a different result.

¶17 Punitive damages "are not ordinarily recoverable in actions for breach of contract, because, as a general rule, damages for breach of contract are limited to the pecuniary loss sustained." Hoffman v. Louis Dreyfus Corp., 435 N.W.2d 211, 214 (S.D.1989) (quoting 22 Am.Jur.2d Damages § 751 (1988)). There are public policies underpinning this general rule. First, breach of contract is generally a private injury, unlike a malicious tort, which some authorities have held to be a public injury. L. Schleuter & K. Redden, 1 Punitive Damages § 7.2 (3d ed. 1995). Second, our free market system allows economically efficient breaches of contract, for example, when it costs less for one party to...