Klein v. Jones

• Decision Date: 22 January 1993
• Docket Number: 91-2239,Nos. 91-1995,s. 91-1995
• Citation: Klein v. Jones, 980 F.2d 521 (8th Cir. 1993)
• Parties: Bob KLEIN and Genevieve Klein, John Frank Pendergrass, Sam Thompson, Margaret Schaffer, Clymer Law, and Donnie Hall, Plaintiffs/Appellants, v. Jerral W. JONES and Michael V. McCoy, Defendants/Appellees. Bob KLEIN and Genevieve Klein, John Frank Pendergrass, Sam Thompson, Margaret Schaffer, Clymer Law and Donnie Hall, Plaintiffs/Appellants, v. ARKOMA PRODUCTION COMPANY, Arkla, Inc., Arkla Exploration Company, Jerral W. Jones and Michael McCoy, Defendants/Appellees.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 521

980 F.2d 521

Bob KLEIN and Genevieve Klein, John Frank Pendergrass, Sam

Thompson, Margaret Schaffer, Clymer Law, andDonnie Hall, Plaintiffs/Appellants, v.Jerral W. JONES and Michael V. McCoy, Defendants/Appellees.

Bob KLEIN and Genevieve Klein, John Frank Pendergrass, Sam

Thompson, Margaret Schaffer, Clymer Law and Donnie

Hall, Plaintiffs/Appellants, v.ARKOMA PRODUCTION COMPANY, Arkla, Inc., Arkla Exploration

Company, Jerral W. Jones and Michael McCoy,

Defendants/Appellees.

Nos. 91-1995, 91-2239.

United States Court of Appeals Eighth Circuit.

Submitted Jan. 8, 1992.

Decided Nov. 25, 1992.

Rehearing and Rehearing En Banc

Denied Jan. 22, 1993.

Douglas O. Smith and Bradley D. Jesson, Fort Smith, Ark., argued (Rex M. Terry, P.K. Holmes III, and Lonnie C. Turner, on the brief), for appellant.

Roger W. Yoerges, Washington, D.C., argued (Gary D. Wilson, Washington, D.C. and Mark A. Moll, Fort Smith, Ark., on the brief,) for Jones & McCoy.

Jerry Canfield, Fort Smith, Ark., argued, for Arkoma Co.

Before BEAM, Circuit Judge, BRIGHT, Senior Circuit Judge, and VAN SICKLE^*, Senior District Judge.

VAN SICKLE, Senior District Judge.

BACKGROUND

The events leading up to this lawsuit occurred against a background that was recently discussed by the Supreme Court.We quote from the syllabus:

In response to ongoing natural gas shortages, Congress enacted the Natural Gas Policy Act of 1978 (NGPA), which inter alia, established higher price ceilings for "new" gas in order to encourage production and carried over the pre-existing system of "vintage" price ceilings for "old" gas in order to protect consumers.However, recognizing that some of the vintage ceilings might be too low, Congress, in § 104(b)(2) of the NGPA, authorized the Federal Energy Regulatory Commission to raise them whenever traditional pricing principles under the Natural Gas Act of 1938 (NGA) would dictate a higher price.After the new production incentives resulted in serious market distortions, the Commission issued its OrderNo. 451, which, among other things, collapsed the existing vintage price categories into a single classification and set forth a single new ceiling that exceeded the then-current market price for old gas; established a "Good Faith Negotiation"(GFN) procedure that producers must follow before they can collect a higher price from current pipeline customers, whereby producers may in certain circumstances abandon their existing obligations if the parties cannot come to terms; and rejected suggestions that the Commission undertake to resolve in the OrderNo. 451 proceeding the issue of take-or-pay provisions in certain gas contracts.Such provisions obligate a pipeline to purchase a specified volume of gas at a specified price, and, if it is unable to do so, to pay for that volume.They have caused significant hardships for gas purchasers under current market conditions.

Mobil Oil Exploration & Producing Southeast, Inc. v. United Distribution Cos, 498 U.S. 211, ----, 111 S.Ct. 615, 617, 112 L.Ed.2d 636(1991).

FACTS

The named plaintiffs/appellants are the representatives of a class of about 3,000 royalty owners.Their claims derive from oil and gas leases on property located in the Arkoma Basin, in Western Arkansas.Defendant/appelleeArkla, Inc.(Arkla) is a corporation with its principal place of business in Shreveport, Louisiana.Defendant/appelleeArkla Exploration Company(AEC) is likewise a corporation with its principal place of business in Shreveport.At all times relevant, it was a wholly-owned subsidiary of Arkla, Inc., and operated as the exploration and production company of Arkla, Inc. Arkla Energy Resources (AER), while not a named party, is a division of Arkla, Inc, which operates Arkla's pipeline.

Defendants/appellees Jones and McCoy founded Arkoma as an Arkansas corporation in 1981.Jones owned two-thirds of the stock and McCoy owned one third.Jones was chairman of Arkoma's board of directors and a corporate officer, and McCoy was Arkoma's president and its chief geologist and engineer.Arkoma was in the business of natural gas exploration, development and production.They sold their interests in the company to AEC on December 31, 1986.Jones and McCoy were joined as defendants in this action by virtue of this sale and the assignment to Arkoma, prior to that sale, of their interests in various producing wells involved.

The various Arkla entities will be collectively referred to as "the Arkla parties" or as, simply, "Arkla" unless the context otherwise warrants.In such casesthey will be designated as "Arkla", "AER", "AEC", or "Arkoma".

Development in the two primary fields, the Aetna and Cecil Fields, commenced in the 1950's.Typically, mineral owners gave leases to production companies which provided for the payment of royalty based on the market value of 1/8 of the gas sold or used off the premises, or 1/8 of the amount realized from the sale at the wellhead.Many leases in the Cecil Field contained a fixed rate royalty provision which calculated the royalty at 1/8 of the value fixed at a certain amount per thousand cubic feet (mcf) of gas sold.Those fixed price leases were converted to market value leases in separate litigation in the Chancery Court of Franklin County, Arkansas, in 1990.

On December 31, 1982, Arkoma, then owned by Jones and McCoy, agreed with Arkla, a major developer in the Arkoma Basin, to purchase one-half of Arkla's leasehold interest for $15 million.Arkoma agreed to spend an additional $30 million in a drilling program over a four year period, and to share additional acreage acquired in the Aetna and Cecil Fields from other lease owners.This transaction resulted in Arkoma and Arkla owning virtually all of the rights to drill new wells in the Aetna and Cecil Fields.Shortly thereafter, Jones became a member of the board of Arkla.

On February 24, 1983, Arkoma and Arkla executed a gas purchase contract, identified as GPC 5239, covering new wells to be drilled in the Aetna and Cecil Fields, as well as any other acreage to be acquired by Arkoma, and by which Arkla agreed to pay Arkoma the maximum lawful price under §§ 102and103 of the NGPA.At the time of the agreement, the § 102 price for the gas was $3.83 per mcf.The contract contained a pricing provision which allowed Arkoma to renegotiate the contract price during its term.It provided a 75% minimum take-or-pay provision by which Arkla was obligated to take 75% of the daily deliverability from Arkoma's wells, or to pay for a like amount of the gas at the contract rate ¹.Arkoma committed its working interests together with all royalty interests of the appellant class to the contract.

Arkoma began an aggressive drilling program, achieving a success ratio in excess of 90%, against an industry standard of only approximately 50%.In the process, Arkoma became one of Arkla's largest suppliers of gas.

In 1985-86, Arkla curtailed the quantities of gas it took from Arkoma, but did not honor the pay provisions of GPC 5239.By March, 1986, the outstanding take-or-pay billings from Arkoma to Arkla were in excess of $36 million, and were accruing at a monthly rate of approximately $3 million.At about that time, Jones resigned from the Arkla board.Arkla then refused to pay for the gas it had not taken.Arkla calculated that it was obligated to buy 40,000 mcf per day and was taking only 12,000 mcf; that the potential take-or-pay obligation owed to Arkoma could reach $54 million by the end of 1986 and would increase by $40 million during 1987; and it determined that only 10% of the take-or-pay billings were debatable.

Arkla entered into negotiations with Jones and McCoy to resolve the problem.The negotiations for settlement of the take-or-pay obligations were resolved on December 31, 1986, when Arkla simply bought its problem.The tax partnerships, (controlled and primarily owned by Jones and McCoy), which actually owned the producing wells, assigned all of their interests to Arkoma, as did Jones and McCoy.AEC then purchased all of Jones' and McCoy's stock in Arkoma, thus acquiring Arkoma Production Company and gaining the ability to renegotiate GPC 5239.Jones and McCoy assigned all drilling interests to Arkoma in exchange for a promissory note in the amount of $35 million, guaranteed by AEC.That note was paid the same day.

"New" Arkoma, that is, Arkoma as it existed after acquisition by AEC, also agreed to furnish Jones and McCoy, free of cost to them, 5.8 billion cubic feet (bcf) of gas over a five year period.AER agreed to purchase this gas at prices beginning at $4.77 per mcf in 1987, and escalating to $6.08 per mcf in 1992.To secure its obligation to purchase this gas, AER gave Jones and McCoy a promissory note in the amount of $24 million, which was the net present value of that gas purchase contract.

"New" Arkoma agreed to pay Jones and McCoy at the rate of $1.62 per mcf for any newly established additional reserves.For the stock in Arkoma, Arkla paid Jones and McCoy, in addition to satisfying the promissory note of $35 million, a cash consideration of $14 million.The total consideration paid by Arkla on December 31, 1986, was $73 million, $35 million for the promissory note, $24 million for the gas purchase contract to buy free gas, and $14 million for the Arkoma stock.

After the sales by Jones and McCoy to Arkoma of their lessee interests, and after the sale of Arkoma to AEC, and during the period of the settlement of the take-or-pay claims and renegotiation of GPC 5239, Arkoma was wholly owned by AEC (Arkla's production company).And AER, (the pipeline), was also wholly owned by Arkla.

On February 13, 1987, AER, AEC and Arkoma amended the price provisions and the take-or-pay provisions in GPC 5239.They reduced the contract price for gas from $3.83 per mcf to $2.20 per mcf, and released gas on the spot market for sale at prices less than $1.50 per mcf.Appellants, who knew nothing of the details...