Hanna Oil and Gas Co. v. Taylor, 88-144

• Decision Date: 14 November 1988
• Docket Number: No. 88-144,88-144
• Citation: 297 Ark. 80,759 S.W.2d 563
• Parties: HANNA OIL AND GAS COMPANY, Appellant, v. David Patton TAYLOR, Appellee.
• Court: Arkansas Supreme Court

Page 563

759 S.W.2d 563

297 Ark. 80

HANNA OIL AND GAS COMPANY, Appellant, v. David Patton TAYLOR, Appellee.

No. 88-144.

Supreme Court of Arkansas.

Nov. 14, 1988.

Dorsey Ryan, Fort Smith, for appellant.

Michael G. Thompson, M. Gayle Corley, Little Rock, for appellee.

DUDLEY, Justice.

The sole issue presented by this appeal is whether appellant, Hanna Oil and Gas Company, is entitled to deduct a pro rata share of its compression costs from appellee's, David Taylor's, royalties. The chancellor held that appellant was not entitled to deduct the costs. We affirm.

In 1975, appellee, David Taylor, entered into an oil and gas lease with appellant, Hanna Oil and Gas Company. The leased land was pooled with other land to form a production unit. In 1976, appellant completed a producing natural gas well. Gas from the well was sold to Arkansas Louisiana Gas Company pursuant to a gas purchase contract between appellant and Arkansas Louisiana Gas Company. The gas purchase contract was entered after the lease agreement and required appellant to deliver the gas at a pressure of 500 pounds per square inch.

During the first eight (8) years, from 1976 to April 1984, it was not necessary to compress the gas in order to deliver it at the required pressure. Beginning in April 1984, however, appellant had to compress the gas. Yet, compression costs were not deducted from the royalty paid to appellee until October 1986. On May 5, 1987, appellee filed his petition in chancery court challenging the deduction of the compression costs.

In determining whether appellant is entitled to deduct compression costs, we must first examine the language of the oil and gas lease. Compression costs are not specifically mentioned in the lease; however, the pertinent portion of the lease provides:

Lessee shall pay Lessor one-eighth of the proceeds received by Lessee at the well for all gas (including all substances contained in such gas) produced from the leased premises and sold by Lessee.

We have not had an opportunity before now to consider a proceeds royalty clause such as this.

Unless something in the context of an agreement provides otherwise, "proceeds" generally means total proceeds. Warfield Natural Gas Co. v. Allen, 261 Ky. 840, 88 S.W.2d 989 (1935). Webster's New World Dictionary's first definition of "proceeds" provides: "what is produced by or derived from something (as a sale, investment, levy, business) by way of total revenue: the total amount brought in: yield, returns." Thus, we find it unnecessary to go beyond the clear language of the agreement between the parties to hold that appellant is not entitled to deduct compression costs. If it had been their intention to do so, they would have made some reference to costs, or "net" proceeds.

Further, even if we found this lease provision to be ambiguous, we would be compelled to construe it in favor of appellee. Ambiguities in an oil and gas lease should be construed in favor of the lessor and against the lessee. Bodcaw Oil Co., Inc. v. Atlantic Refining Co., 217 Ark. 50, 61, 228 S.W.2d 626, 633 (1950).

Finally, perhaps the most compelling support for our conclusion that the compression costs are not deductable lies in the construction the parties themselves placed upon their agreement for more than two years. Compression became necessary in April 1984; however, the costs associated with compression were not deducted from the royalty paid to appellee until October 1986. Thus, for over two years appellant's construction of the lease was consistent with that urged by appellee. The construction placed upon an agreement by the parties is an important, and often decisive factor in construing an instrument. Skaggs v. Heard, 172 F.Supp. 813 (S.D.Tex.1959).

HAYS, J., dissents.

HAYS, Justice, dissenting.

The majority opinion has approached the issue in a straightforward and literal way. However, the oil and gas lease does not readily lend itself to literal analysis. The majority focuses on the plain meaning of the words of this lease. While that may be a logical starting point, to simply analyze the term "proceeds," asserting the plain, ordinary meaning, without placing the lease in its proper context, i.e. the oil and gas industry, seems destined to produce an erroneous result.

The majority reasons that no compression costs can be deducted merely because the term "proceeds" was used in the lease. They state "if it had been their intention to do so [to deduct compression costs] they would have made some reference to costs, or 'net' proceeds." However, this analysis addresses only part of the problem. Lease language somewhat more pertinent, but ignored by the majority, provides that the lessor's proceeds are to be paid on what the lessee receives "at the well for all gas produced from the leased premises and sold by Lessee." (My emphasis).

The legal effect of the proceeds clause in the lease is to give some fractional value, e.g. one-eighth, of the gas sold at the wellhead to the lessor. The term "at the well" is a term of art describing the place where the royalty is calculated. Here, due to the low pressure of the gas, there would be no sales at the well, and hence no royalties, but for the compression. Yet, the majority reads the language of this lease and grants the lessor the royalties based upon the proceeds of the appellant's sales, via long-term gas purchase contracts, with ARKLA. Interpreting this clause in its ordinary meaning requires the lessee to bear the entire cost of enhancing the gas product in order to make it saleable.

In Hillard v. Stephens, 276 Ark. 545, ...