Moore v. Tristar Oil and Gas Corp.

• Decision Date: 25 November 1981
• Docket Number: No. 80 Civ. 3383 (JMC).,80 Civ. 3383 (JMC).
• Citation: 528 F. Supp. 296
• Parties: James I. MOORE, Paul L. Meaders and Lorna P. O'Brien, as tenants in common, Donald K. Lourie, on his own behalf and on behalf of Cynthia Janeway, Edward N. Cogen, George F. Fisher, Jr. and Martha C. Fisher, as tenants in common, Brad Hvolbeck and Marian Hvolbeck, as tenants in common, Donald C. Alexander on his own behalf and on behalf of Hiram D. Black and C. Benson Wigton, Jr., Plaintiffs, v. TRISTAR OIL AND GAS CORPORATION, Bryant Oil & Gas Corporation, Sheldon J. Dubow, James B. Lundquist and Clayton Brokerage Co. of St. Louis, Inc., Defendants.
• Court: U.S. District Court — Southern District of New York

528 F. Supp. 296

James I. MOORE, Paul L. Meaders and Lorna P. O'Brien, as tenants in common, Donald K. Lourie, on his own behalf and on behalf of Cynthia Janeway, Edward N. Cogen, George F. Fisher, Jr. and Martha C. Fisher, as tenants in common, Brad Hvolbeck and Marian Hvolbeck, as tenants in common, Donald C. Alexander on his own behalf and on behalf of Hiram D. Black and C. Benson Wigton, Jr., Plaintiffs, v. TRISTAR OIL AND GAS CORPORATION, Bryant Oil & Gas Corporation, Sheldon J. Dubow, James B. Lundquist and Clayton Brokerage Co. of St. Louis, Inc., Defendants.

No. 80 Civ. 3383 (JMC).

United States District Court, S. D. New York.

November 25, 1981.

COPYRIGHT MATERIAL OMITTED

Milton S. Zeiberg, New York City, for plaintiffs.

Cleary, Gottlieb, Steen & Hamilton, New York City (Edwin B. Mishkin and Thomas J. Moloney, New York City, of counsel), for defendants Tristar Oil and Gas Corp., Bryant Petroleum Corp., Sheldon J. Dubow and James B. Lundquist.

Cowan, Liebowitz & Latman, P. C., New York City (Peter R. Porcino, New York City, of counsel), for defendant Clayton Brokerage Co. of St. Louis, Inc.

OPINION

CANNELLA, District Judge:

After a trial on the merits of plaintiffs' amended complaint, the Court finds for defendants. The amended complaint is dismissed.

The Court reserves decision on defendants' counterclaim¹ pending further proceedings consistent with this Opinion.

FACTS

Background

Plaintiffs bring this diversity action for breach of contract and breach of fiduciary duty against Tristar Oil and Gas Corp. "Tristar" and Bryant Petroleum Corp. "Bryant",² the two former general partners of the Tristar Thermoil Oil Income Program the "partnership", a California limited partnership, Sheldon J. Dubow and James B. Lundquist, the presidents, chief executive officers and sole shareholders of Tristar and Bryant respectively, and Clayton Brokerage Co. of St. Louis, Inc. "Clayton".³ Throughout this Opinion, the Court will refer to Tristar, Bryant, Dubow and Lundquist as the Tristar defendants.

Each of the plaintiffs invested in the partnership as limited partners, holding collectively 7-½ of the 40-½ limited partnership units. In brief, plaintiffs allege that the Tristar defendants improperly divided among the limited and general partners the proceeds from (1) the sale of the limited partnership's primary asset, a leasehold interest in certain oil-bearing property in California, and (2) the concurrent sale of interests in the leasehold held by the general partners.⁴ Plaintiffs claim that this division of proceeds violated the terms of the limited partnership agreement in that the general partners received a larger portion of the proceeds than that to which they were entitled, thereby decreasing the share of each limited partner. Plaintiffs also charge that defendants breached their fiduciary duties owed to the limited partners, by acting in concert in furtherance of their own interests to the exclusion of plaintiffs' interests.

The Offering Period

The following are the Court's findings of fact: Prior to July 1979, the Thermoil Company "Thermoil", a wholly-owned subsidiary of Bryant, held an 80% net leasehold in the property at issue, known as the Kern River field. Bryant thus had the right to explore for and extract oil and gas from the property. The lessor of the property, Tenneco West, Inc. "Tenneco", retained a 20% interest in the lease, known as a landowner royalty, which entitled it to 20% of the production and sale of oil and gas. Under the lease, Tenneco could demand its payment either in oil and gas or in money and its interest was not subject to the lessee's production expenses.⁵ The lease was to expire in July 1983, although it could be renewed for so long as the lessee determined that oil and gas could be produced in paying quantities.⁶ The lease also prohibited the drilling of new oil wells after July 25, 1983.⁷ The first wells were drilled on the property in 1964, and by July 1979 forty-nine wells were in place on the property's 110 acres.⁸ Over time, however, it had become clear that artificial means of stimulating production were necessary to recover oil in commercial quantities. Bryant decided that a "steam flooding" process would be required to reduce the viscosity of the oil and to increase its flow to the wells. But between December 1977, when Bryant acquired Thermoil, and early 1979, Bryant was unable to raise sufficient funds to engage in a large-scale enhanced recovery program through steam flooding.⁹

To meet its capital requirements, Bryant decided to organize a limited partnership. Its plan was to raise $2 million by arranging in conjunction with Tristar, which was in the business of organizing oil and gas investor participation programs, an offering of fifty units of the limited partnership, at a cost of $40,000 per unit.¹⁰ Bryant and Tristar determined, however, that the operation could commence with as little as $1.2 million although they also determined that the recovery program might be adversely affected if less than $1.7 million was raised.¹¹ Upon the completion of the offering and the formation of the partnership, Bryant planned to convey its interest in the lease to the partnership¹² for $600,000 in cash and the assumption by the partnership of $186,000 in notes.¹³ This amount approximated Bryant's original cost in acquiring the lease through its acquisition of Thermoil as well as the cost of subsequent improvements on the property.¹⁴

In July 1979, the general partners retained Clayton to act as underwriter on their behalf in the sale of the fifty units. Clayton agreed to use its best efforts to find buyers for the units during a sixty-day offering period in return for 10% of the initial capital raised. The underwriting agreement gave the general partners the sole power to extend the offering period.¹⁵ Because the minimum thirty units had not been sold by September 1979, the general partners extended the offering period.¹⁶

In October 1979, Lundquist advised Stephen C. Holmes, who was Clayton's syndication manager on this offering, that in September the Getty Oil Corporation had offered $1.8 million to purchase Bryant's interest in the Kern River lease and that in October Santa Fe Industries, Inc. had offered $3.5 million toward the same end.¹⁷ After consulting his superiors at Clayton, Holmes asked Lundquist if the general partners would give Clayton another extension and refrain from selling the property. The general partners decided not to exercise their right to withdraw from the offering and granted the requested extension.¹⁸ By mid-November, Clayton had achieved the minimum capitalization,¹⁹ and by late-November, 40-½ units had been sold to thirty-one persons for a total sum of $1,620,000.²⁰

The limited partnership offering was made through the use of a Private Placement Memorandum the "Memorandum".²¹ Each investor, including plaintiffs, signed a subscription agreement certifying that he had read the Memorandum and the Certificate and Agreement of Limited Partnership the "Partnership Agreement",²² and, in making his investment, had relied on the information contained therein.²³ By signing the subscription agreement, each investor also agreed to be bound by the terms of the Partnership Agreement.²⁴ During the offering, Clayton undertook to ascertain whether each subscriber met the offering criteria, namely, that the subscriber was a wealthy and sophisticated investor and capable of bearing the economic risks of an investment in the limited partnership. All of the plaintiffs met the offering criteria.²⁵

The Memorandum is a fifty-one page document, plus appendices, and contains a detailed description of the limited partnership, its purpose and goals, and the rights and obligations of the general and limited partners. The Memorandum also contains a copy of the Partnership Agreement. The Memorandum and Partnership Agreement state that upon formation of the partnership the general partners would receive a one-time fee of 5% of the initial capital to cover their expenses in organizing the partnership.²⁶ These documents also reveal that as compensation for organizing and promoting the limited partnership, the general partners would receive 1% of the partnership's net income.²⁷ The general partners would also receive an annual overhead reimbursement fee of $20,000,²⁸ and, upon dissolution, 10% of the distributable assets of the partnership.²⁹

Of particular import to this litigation are the Memorandum and Partnership Agreement's provisions relating to the general partners' so-called "overriding royalty" and "working interest." Both documents explain that the general partners would receive, as consideration for managing the partnership, a 5% overriding royalty in the revenues from the property until the limited partners recovered 100% of their initial capital contributions at "payout," and, after payout, a 10% overriding royalty and a 10% working interest in all the limited partnership's property.³⁰ Thus, as explained in the Memorandum, after Bryant conveyed its interest in the lease to the partnership, the partnership would hold a 100% working interest in a 75% net leasehold, Tenneco would retain its 20% net leasehold by virtue of its landowner royalty, and the general partners would own a 5% net leasehold by virtue of their 5% overriding royalty.³¹ After payout, the partnership would hold a 90% working interest in a 70% net leasehold, Tenneco would continue to hold its 20% landowner royalty, and the general partners would hold a 10% net leasehold through their stepped-up overriding royalty, as well as a 10% working interest in the partnership's 70% net leasehold.³²

An overriding royalty is defined in the Partnership Agreement as "an interest in the oil and gas produced pursuant to a specified oil and gas lease or leases, or the proceeds from the sale thereof, carved out of the working interest, to be received free and clear of all costs of development,...