Lenape Resources Corp. v. Tennessee Gas Pipeline Co.

Citation925 S.W.2d 565
Decision Date16 August 1996
Docket NumberNo. 94-0278,94-0278
PartiesUtil. L. Rep. P 26,527, 29 UCC Rep.Serv.2d 759, 39 Tex. Sup. Ct. J. 496 The LENAPE RESOURCES CORPORATION d/b/a Pomfret Production Company, Inc., and d/b/a Enercorp Resources, Inc., Tesoro Exploration and Production Company, Gulf Energy Pipeline Company and Coastal Oil & Gas Corporation, Petitioners, v. TENNESSEE GAS PIPELINE COMPANY, Respondent.
CourtSupreme Court of Texas

Jane M.N. Webre, Austin, William T. Armstrong, III, San Antonio, Rudy A. England, Houston, Dwight A. Dalrymple, Houston, Emerson Banack, Jr., San Antonio, Charles R. Roberts, San Antonio, Ernest E. Smith, III, Austin, Frank Douglass, Austin, Elizabeth N. Miller, Austin, Steve Selby, Austin, for petitioners.

Thomas H. Watkins, Austin, C.A. Davis, Austin, Elizabeth G. Bloch, Austin, John R. Hathaway, Austin, Theodore R. Tetzlaff, Chicago, IL, Donald R. Cassling, Chicago, IL, Norman M. Hirsch, Chicago, IL, Ralph H. Duggins, Fort Worth, Sloan B. Blair, Fort Worth, H. Carter Burdette, Fort Worth, for respondent.

ENOCH, Justice, delivered the opinion of the Court on Motion for Rehearing, in which CORNYN, SPECTOR, BAKER, and ABBOTT, Justices, join.

We grant Petitioners' motions for rehearing. We withdraw our opinion and judgment of August 1, 1995 and substitute the following opinion.

The principal issue in this case is whether the good faith and proportionality restrictions of section 2.306 of the Uniform Commercial Code, TEX.BUS. & COM.CODE § 2.306, apply to the take-or-pay gas purchase agreement between Lenape Resources Corporation and Tennessee Gas Pipeline Company. The court of appeals held that the take-or-pay contract was an output contract subject to section 2.306. 870 S.W.2d 286. We disagree. We reverse in part and affirm in part the judgment of the court of appeals.

Tennessee transports and stores natural gas for distribution to customers who provide natural gas to consumers throughout the southern United States. Tennessee entered into the Gas Purchase Agreement (GPA) in 1979 with Lenape's predecessor in interest. Under the GPA, Tennessee agreed to take, or pay for if not taken, gas produced from gas reserves committed under the GPA. The committed reserves include the Fantina Yzaguirre Gas Unit and the Jesus Yzaguirre Gas Unit in Zapata County.

In entering into the GPA in August 1979, Tennessee sought to obtain as much gas as could be produced from the committed reserves. The GPA plainly reflects this objective. Specifically, the GPA provides that Lenape is not obligated to deliver to Tennessee any predetermined quantities of gas or to maintain any predetermined level of deliverability; that Lenape may unitize its leases with other properties in the same field; and that Lenape, in its sole discretion, may drill new wells to all depths and horizons and repair or rework old wells.

From the beginning of the GPA term in 1979 until 1989, Lenape produced gas from only two wells on the committed acreage, one of which was a low-producing stripper well. Despite this low production, Tennessee sought to be released from its obligations under the GPA. In the early 1980s, market conditions for natural gas changed dramatically. The price and demand for natural gas plummeted. Roland, Comment, Take-or-Pay Provisions: Major Problems for the Natural Gas Industry, 18 ST. MARY'S L.J. 251, 262 (1986). In 1983, Tennessee sent its producers, including Lenape, notice that it was instituting an "emergency gas purchase policy," whereby Tennessee proposed to reduce its purchases and limit its take-or-pay obligations and refused to recognize any take-or-pay obligations for producers who refused to amend their contracts as Tennessee demanded. See Mandell v. Hamman Oil & Ref. Co., 822 S.W.2d 153, 156-57 (Tex.App.--Houston [1st Dist.] 1991, writ denied) (Tennessee reduced its take-or-pay obligations with gas producer by half under emergency gas purchase policy). Again in 1985 and 1986, Tennessee sought to be released from its obligations under the GPA first by seeking to amend the GPA and next by asserting a force majeure defense based on depressed market conditions.

In light of these developments, Lenape had little incentive to increase production or develop new wells. Lenape's lessors grew impatient with the low production and sued Lenape for breach of its implied covenant to develop the leases underlying the committed acreage, for failure to produce in paying quantities, and for abandonment of the leases. Tesoro Exploration and Production Company obtained lease options from the lessors and backed the lessors in their lawsuit against Lenape. Lenape settled the lawsuit with its lessors and agreed to unitize part of the committed acreage with adjacent property. The unitization formed the Guerra A and B units, each comprised of one-half of the committed acreage and additional acreage outside the GPA's committed acreage. After unitization, Lenape entered into a farmout agreement with Tesoro and Coastal Oil & Gas Corporation. As a result of the farmout, Tesoro and Coastal became "Sellers" under the GPA. Tesoro drilled three wells, one bottomed on the committed acreage and two inside the Guerra A and B units on acreage outside the acreage originally committed to the GPA. The two wells on the Guerra A and B units were highly successful.

The successful Guerra A and B wells would vastly increase Tennessee's take-or-pay obligations. Tennessee sued Lenape and the other Sellers in August 1990 seeking a declaration under various theories that it was not obligated to take or pay for any of the increased production resulting from the Guerra A and B wells. Specifically, Tennessee sought a declaration that:

(1) the GPA is governed by section 2.306 of the UCC and that current and anticipated gas production from the Guerra A and B wells 1 is in bad faith and unreasonably disproportionate to prior production in violation of section 2.306;

(2) alternatively, if not governed by section 2.306, the GPA is void and unenforceable for indefiniteness and lack of mutuality;

(3) alternatively, Tennessee is not obligated to take or pay for quantities of gas tendered in bad faith and which do not comport with prior history and course of performance;

(4) the GPA covers only the Sellers' interest in the reserves physically located under the leases originally dedicated to the GPA and Tennessee is not obligated to purchase gas produced from wells outside the original leases;

(5) the GPA does not permit pooling;

(6) the Fantina Yzaguirre Gas Unit leases terminated for Lenape's failure to produce in paying quantities, failure to reasonably develop, and abandonment of the leases and thus are no longer subject to the GPA; and

(7) the parties did not intend for the price of non-regulated gas to escalate by the annual inflation adjustment factor plus a growth factor.

In addition, Tennessee asserted that Lenape, Tesoro, and Coastal's conduct, including their "bad faith pooling," violated the Deceptive Trade Practices and Consumer Protection Act. TEX.BUS. & COM.CODE §§ 17.41-.63.

Lenape counterclaimed, alleging breach of contract, anticipatory repudiation, and that Tennessee's DTPA claims were asserted in bad faith. Tesoro and Coastal asserted similar counterclaims. These counterclaims and the DTPA claims have been resolved and are not at issue in this appeal.

The trial court granted a partial summary judgment for the Sellers, determining: (1) the GPA is not an output contract subject to section 2.306; (2) the GPA permits pooling/unitization; and (3) Tennessee could not contest the validity of the leases underlying the GPA. After a bench trial on the remaining issues, the trial court rendered judgment for the Sellers on all of Tennessee's remaining claims. Specifically, the trial court found: (1) the Sellers had not acted in bad faith in drilling the new wells or forming the Guerra A and B units; (2) the GPA is not void for indefiniteness or lack of mutuality; (3) the GPA allows for unitization and obligates Tennessee to purchase the Sellers' interest in gas produced anywhere within the pooled units; (4) the GPA mandates that the price for non-regulated gas escalate in accordance with section 102(b)(2) of the Natural Gas Policy Act; and (5) escrow monies and attorneys' fees should be paid to the Sellers.

The court of appeals reversed the trial court's summary judgment on the section 2.306 issue, holding that the GPA is an output contract subject to the good faith and proportionality restrictions of section 2.306. 870 S.W.2d at 291-92. With the exception of Tennessee's DTPA claims, which were voluntarily resolved by agreement of the parties, the court of appeals affirmed the remainder of the trial court's judgment. All parties sought writ of error in this Court. We consider the Sellers' contentions first, then those of Tennessee.


Whether section 2.306 of the UCC applies to this take-or-pay contract is a question of first impression in this jurisdiction. Section 2.306 applies only if (1) the take-or-pay contract is an output contract, and (2) the parties have not otherwise opted to vary the quantity obligations by agreement. TEX.BUS. & COM.CODE § 2.306; Jon-T Chems., Inc. v. Freeport Chem. Co., 704 F.2d 1412, 1416 (5th Cir.1983). The GPA defines the quantity of gas Tennessee must take or pay for as a percentage of the Sellers' capacity to deliver gas. Specifically, section 3(a) of the GPA provides:

3. Quantity:

(a) Seller agrees to sell and deliver to Buyer, and Buyer agrees to purchase and receive, or pay for if available and not taken, Seller's pro rata part of the following quantities of gas produced from the committed reserves:


* * *

(ii) A quantity of gas well gas equal to eighty-five percent (85%) of Seller's delivery capacity.

Delivery capacity is defined in section 1(f) of the GPA as:

Seller's pro rata part of the average amount of gas well gas per day...

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