Michigan Wisconsin Pipeline Co. v. Michigan Nat. Bank

• Decision Date: 07 October 1982
• Docket Number: 45942,Docket Nos. 44872
• Citation: 118 Mich.App. 74,324 N.W.2d 541
• Parties: MICHIGAN WISCONSIN PIPELINE CO., Plaintiff, v. MICHIGAN NATIONAL BANK, as Trustee, Defendant-Appellant, and Gerhardt Kethe, Clara Kethe, Giaconda Paonessa, Walter H. Beier, and Stanley Szczawinski, Defendants-Appellees. MICHIGAN WISCONSIN PIPELINE CO., Plaintiff-Appellant, v. MICHIGAN NATIONAL BANK, as Trustee, Defendant, and Gerhardt Kethe, Clara Kethe, Giaconda Paonessa, Walter H. Beier, and Stanley Szczawinski, Defendants-Appellees.
• Court: Court of Appeal of Michigan — District of US

Page 541

324 N.W.2d 541

118 Mich.App. 74

MICHIGAN WISCONSIN PIPELINE CO., Plaintiff, v. MICHIGAN NATIONAL BANK, as Trustee, Defendant-Appellant, and Gerhardt Kethe, Clara Kethe, Giaconda Paonessa, Walter H.

Beier, and Stanley Szczawinski, Defendants-Appellees.

MICHIGAN WISCONSIN PIPELINE CO., Plaintiff-Appellant, v. MICHIGAN NATIONAL BANK, as Trustee, Defendant, and Gerhardt Kethe, Clara Kethe, Giaconda Paonessa, Walter H.

Beier, and Stanley Szczawinski, Defendants-Appellees.

Docket Nos. 44872, 45942.

Court of Appeals of Michigan.

Submitted May 5, 1981.

Decided July 19, 1982.

Released for Publication Oct. 7, 1982.

Mika, Meyers, Beckett & Jones, Grand Rapids, for Michigan Wisconsin Pipeline Co.

Braun, Kendrick, Finkbeiner, Schafer & Murphy, Saginaw, for Michigan National Bank.

William B. Beier, Mount Clemens, for defendant landowners.

Before KELLY, P. J., BRONSON and DANIELS, ^* JJ.

BRONSON, Judge.

Appellants contest the Macomb County Circuit Court's affirmance of probate court decisions holding that the lessee's interests in certain oil and gas leases had expired, those interests reverting to the lessors. This Court granted leave to appeal to both appellants and consolidated the cases for purposes of hearing and disposition.

Appellees own land above the Muttonville natural gas field, in Macomb County. They executed oil and gas leases in favor of R. A. Wells in 1961. Wells retained a fractional overriding royalty interest and assigned the working lessee's interest to Michigan Consolidated Gas Company (hereafter Consolidated). Wells later sold a share of his remaining interest to a buyer represented in this action by Michigan National Bank.

Beginning in 1966, Consolidated developed Muttonville as a natural gas field. It drilled seven productive wells and 13 dry holes. Consolidated used the natural gas it produced from the field in its public utility business. This arrangement continued into 1973, resulting in substantial royalty payments to defendant lessors. On November 1, 1973, plaintiff, Michigan Wisconsin Pipeline, contracted with Consolidated to purchase Consolidated's various interests in the field, including all of its interests as lessee under the oil and gas leases executed by appellees. This sale was closed on October 30, 1975.

Plaintiff is an interstate gas transmission company. In 1973, plaintiff became interested in using the Muttonville field for the storage of natural gas. To use the field for storage, gas is injected underground and withdrawn when needed. In 1973, 15% of the original gas reserves (approximately 1.6 billion cubic feet) remained in the field. Plaintiff planned to use this gas as "cushion gas". Subsequently, stored gas could thereby be more efficiently withdrawn from underground storage.

Plaintiff failed in its efforts to buy all of the outstanding interests in the field. In December of 1973, plaintiff applied to the Michigan Public Service Commission for a certificate of necessity, a requirement precedent to the filing of a condemnation action. Plaintiff was empowered to condemn property for use as a natural gas storage facility by M.C.L. Sec. 486.252; M.S.A. Sec. 22.1672. Commission hearings were completed in March, 1974, and the commission issued its certificate of necessity on September 9, 1974. On September 17, 1974, plaintiff filed its condemnation petition in probate court. In the action, plaintiff sought to acquire, among other things, the royalty interests of defendants which were subject to the oil and gas leases owned by Consolidated. After the condemnation petition was filed, the probate court separated the proofs on necessity and damages. Three commissioners were appointed to hear the trial on necessity. The commissioners found necessity in their report filed January 23, 1975. This finding was confirmed by the probate court, which granted plaintiff possession of the condemned interests on March 12, 1975. Consolidated continued as operator of the field until October 30, 1975, the date of closing of its sale agreement with plaintiff.

Meanwhile, in March of 1974, Consolidated severely cut back on production from the Muttonville field. From that point on, Consolidated limited its production of natural gas from the field to an amount sufficient to operate heaters at its Columbus compressor station in St. Clair County and to provide appellees with "free gas" for domestic use in their dwellings, as required by the terms of the oil and gas leases.

On October 26, 1976, during the preliminary stages of the damages phase of the condemnation action, appellees sought to challenge the validity of the oil and gas leases. Over plaintiff's objection, the probate court allowed them to amend and supplement their pleadings to assert that the oil and gas leases covering their property had automatically terminated prior to plaintiff's being granted possession on March 12, 1975. The probate judge agreed and held that the leases automatically expired due to lack of production by the lessee. This holding was affirmed in the circuit court. ¹

Although appellants raise many issues, this appeal essentially turns on the construction of the oil and gas leases covering the Muttonville field. Since we agree with appellants that the lower courts incorrectly construed the leases, we address only those claims going to the proper construction of these lease agreements.

In construing an oil and gas lease, this Court is guided by the Supreme Court's decision in J J Fagan & Co. v. Burns, 247 Mich. 674, 226 N.W. 653, 67 A.L.R. 522 (1929). In J J Fagan, the Court noted the widespread use of standard oil and gas lease forms. The Court further noted that the language used in those lease forms had evolved through the process of trial and error with careful attention being paid to judicial decisions interpreting the standard contractual verbiage. An oil and gas lease is not an isolated agreement drafted by uninformed neighbors to express roughly their agreement but, rather, is a technical contract reflecting the development and present status of the law of oil and gas. Id., 678, 226 N.W. 653. Such a lease, the Court concluded, should be read "not only according to its words, but in connection with the purpose of its clauses". Id., 678, 226 N.W. 653. See, also, Howard v. Hughes, 294 Mich. 533, 293 N.W. 740 (1940).

The following paragraph governs the terms of the oil and gas leases found to have expired in the present case:

"It is agreed that this lease shall remain in force for a primary term of ten years from this date and if lessee shall commence to drill within said primary term or any extension thereof, the said lessee shall have the right to continue drilling to completion and reasonable diligence and said term shall extend as long thereafter as oil and gas; or either of them, is produced by lessee from said land or from a communitized unit as hereafter provided."

The underlined passage is commonly called the habendum clause. The most significant matters raised by appellants on appeal concern the interpretation of this clause.

Appellants assert that production continued for purposes of the habendum clause because Consolidated acted as a reasonable and prudent operator in deciding to cut back its marketing of gas from the Muttonville field in the face of the impending condemnation action. The word "production" in the habendum clause would literally be satisfied by the production of any oil or gas. Despite the usual meaning of the word, courts have construed the term "production" to be limited to production in paying quantities to the lessee. Superior Oil Co. v. Devon Corp., 458 F.Supp. 1063 (D.Neb., 1978), rev'd on other grounds 604 F.2d 1063 (CA 8, 1979), 3 Williams, Oil and Gas Law, Sec. 604.5, p. 57, Hemingway, The Law of Oil and Gas, Sec. 6.4, pp. 255-262.

The reasonable and prudent operator standard recognizes that interruptions in production may have causes other than the operator's desire to hold the lease for its speculative value, Robinson v. Gordon Oil Co., 258 Mich. 643, 648, 242 N.W. 795 (1932); 1 Brown, Law of Oil and Gas Leases (2d ed.), Sec. 5.02, pp. 5-4 to 5-7. In some cases, interruptions in production may benefit both the operator and the lessors.

The Texas Supreme Court listed some of the matters to be considered in determining whether an operator meets the reasonable and prudent standard in Clifton v. Koontz, 160 Tex. 82, 89, 325 S.W.2d 684 (1959):

"In determining paying quantities, * * * the trial court necessarily must take into consideration all matters which would influence a reasonable and prudent operator. Some of the factors are: The depletion of the reservoir and the price for which the lessee is able to sell his product, the relative profitableness of other wells in the area, the operating and marketing costs of the lease, his net profit, the lease provisions, a reasonable period of time under the circumstances, and whether or not the lessee is holding the lease merely for speculative purposes."

In determining if an operator acts in a reasonable and prudent manner, a court must give deference to his judgment on decisions concerning the appropriate development of a field. Amoco Production Co. v. Ware, 269 Ark. 313, 602 S.W.2d 620 (1980). Courts must consider whether an operator shows good faith in continuing to develop a property for the purpose of making a profit and is not merely holding the lease for speculation. Robinson, supra, 648, 242 N.W. 795; 1 Brown, Law of Oil and Gas Leases (2d ed.), Sec. 5.02, pp. 5-7. The expectations of the parties to the lease are fulfilled when the operator does what would reasonably be expected of operators of ordinary prudence acting with regard to the interests of both the lessor and the lessee. Robinson, supra, 649, 242 N.W. 795. To terminate an oil and gas lease, it is necessary for the lessor to establish two propositions: first, that the operator/lessee was not making a profit from the operation of the field;...