Nami Res. Co. v. Asher Land & Mineral, Ltd.

• Decision Date: 16 August 2018
• Docket Number: 2016-SC-000235-DG,2015-SC-000489-DG
• Citation: 554 S.W.3d 323
• Parties: NAMI RESOURCES COMPANY, L.L.C., Trust Energy Company, L.L.C., Vinland Energy Operations, L.L.C., Vinland Energy Eastern, L.L.C., and Vinland Energy Gathering, L.L.C., and Asher Land and Mineral, L.T.D., Appellants/Cross-Appellees v. ASHER LAND AND MINERAL, LTD., Vanguard Natural Resources, LLC, Vanguard Natural Gas, LLC, and Nami Resources Company, LLC, Appellees/Cross-Appellants
• Court: United States State Supreme Court — District of Kentucky

554 S.W.3d 323

NAMI RESOURCES COMPANY, L.L.C., Trust Energy Company, L.L.C., Vinland Energy Operations, L.L.C., Vinland Energy Eastern, L.L.C., and Vinland Energy Gathering, L.L.C., and Asher Land and Mineral, L.T.D., Appellants/Cross-Appellees

v.ASHER LAND AND MINERAL, LTD., Vanguard Natural Resources, LLC, Vanguard Natural Gas, LLC, and Nami Resources Company, LLC, Appellees/Cross-Appellants

2015-SC-000489-DG

2016-SC-000235-DG

Supreme Court of Kentucky.

AUGUST 16, 2018

COUNSEL FOR APPELLANTS/CROSS-APPELLEES: Michael D Bowling, 1217 E. Cumberland Ave., Suite 3, P.O. Box 130, Middlesboro, KY 40965, Benjamin Todd Keller, Donald Joseph Kelly, Virginia Hamilton Snell, Wyatt, Tarrant & Combs, LLP, 500 West Jefferson Street, Suite 2800, Louisville, KY 40202.

COUNSEL FOR APPELLEES/CROSS-APPELLANTS ASHER LAND AND MINERAL, LTD: Michael J. Gartland, Delcotto Law Group, PLLC, 200 North Upper St., Lexington, KY 40507, James C. Helton, Helton and Helton, P O Box 1070, Pineville, KY 40977, Darrell L. Saunders, 700 Master Street, P.O. Box 1324, Corbin, KY 40702.

COUNSEL FOR APPELLEES/CROSS-APPELLANTS VANGUARD NATURAL GAS, LLC: Mason L. Miller, Lexington, Miller Wells, PLLC.

OPINION OF THE COURT BY JUSTICE VENTERS

Appellants, Nami Resources Company, LLC, and four associated entities¹ (collectively identified as "Nami") appeal from an opinion of the Court of Appeals which upheld a jury verdict against Nami in the sums of $1,308,403.60 in compensatory damages and $2,686,000.00 in punitive damages. The verdict arises from an action brought by Appellees, Asher Land and Mineral, Ltd., and two other entities² (collectively identified as "Asher") asserting that Nami had violated its contractual obligations by fraudulently underpaying royalties owed under the leases that governed Nami’s extraction of natural gas from Asher’s land.

Asher asserted its claim for unpaid royalties under two overlapping theories: (1) breach of contract and (2) fraudulent misrepresentation of the factors that determined the royalties owed to Asher, specifically the quantity of gas extracted from Asher land, the actual costs associated with Nami’s processing of the gas, and the market price for which the gas was ultimately sold.

Nami argues on discretionary review that: (1) the Court of Appeals and the trial court erred by failing to set aside the award of compensatory damages which Nami contends was based upon flawed evidence which should have been excluded by the trial court; and (2) the award of punitive damages was improper because Asher’s claim is fundamentally a breach of contract action. Nami contends that the judgment should be reversed, and Asher’s claims dismissed. In the alternative, Nami argues that a new trial must be granted for various trial errors that occurred.

On cross-appeal, Asher asserts that: (1) Nami’s appeal should have been dismissed by the Court of Appeals because Nami’s motions for post-judgment relief preserving the issues were not timely presented in the trial court; and (2) the trial court erroneously denied Asher’s motion to amend its complaint to allege that Nami committed trespass by extracting gas from land not subject to the gas leases.

For the reasons stated below, we conclude that the award of punitive damages, for what is essentially a breach of contract, was improper and must be vacated. Otherwise, we affirm the Court of Appeals' decision upholding the award of compensatory damages as determined by the trial court and jury. We also affirm the Court of Appeals' conclusion that Nami’s post-verdict motions were made timely, that no errors committed during the trial warrant a setting aside of the verdict and the granting of a new trial, and that the trial court properly denied Asher’s motion to amend its complaint.

I. FACTUAL AND PROCEDURAL BACKGROUND

Asher acquired from its predecessors-in-interest the rights as lessor under three separate gas leases, executed respectively in 1929, 1952, and 1953, covering certain natural gas reserves in Bell County, Kentucky. As relevant to our review, all three leases contain essentially the same royalty provisions. As the successor lessee under all three leases, Nami acquired the right to extract Asher’s natural gas in return for the royalty payments prescribed in the leases. As a result of this relationship, Nami’s gas wells on Asher’s property became part of Nami’s network of small regional pipelines connecting more than eight hundred gas wells to the larger natural gas transmission systems operated by Columbia Gas and Delta Gas.

The dispute before us concerns the validity of Nami’s calculation of royalties payable to Asher over a period of several years. Meters attached to each wellhead measured and recorded the volume of natural gas extracted. Each month, Nami sent Asher a royalty check with a report citing the volume of gas extracted from each well, the price per thousand cubic foot unit (Mcf) Nami received from the sale of the gas, and the post-production costs that Nami deducted from the sales price in the royalty calculation.

As was customary in the era in which they were executed, royalties payable under the Nami-Asher gas leases are based upon the market price for gas sold at the wellhead, the "at the wellhead" price.³ Because of subsequent technological and market changes, gas is no longer marketed at the well and there is no market price for gas at the wellhead. Instead, gas is collected by the lessee at the wellhead, processed to remove water and other impurities, and transported with gas from other wells in the area through pipelines to a central point of sale and distribution.

To accommodate that shift, the industry has adopted the customary and proper business practice of calculating the lessor’s royalty by replicating an "at the wellhead" price. This is done by deducting from the gross price what the lessee receives for the gas, certain post-production expenses incurred by the lessee to process the gas and to move it from the wellhead to the point of sale. Known as "gathering costs" and "post-production costs," these expenses are generally understood to include the expenses incurred to remove water vapor and other impurities such as carbon dioxide, nitrogen, and hydrogen sulfide found in gas in its natural state. The gas is moved through the pipelines by compressors which are fueled by consuming a small portion of the extracted gas. That process results in "line loss," meaning that less gas reaches the market than was metered at the wellhead.

These types of costs are generally regarded as part of the natural and unavoidable expenses associated with the production and marketing of natural gas after it is extracted from the well. Our recent cases have made clear that such costs are properly deducted by the lessee in calculating its royalty obligation to the lessor. See Baker v. Magnum Hunter Production, Inc., 473 S.W.3d 588 (Ky. 2015) ; Appalachian Land Co. v. EQT Production Co., 468 S.W.3d 841 (Ky. 2015). Nami and Asher agree with this industry-wide practice. Nami’s calculation of Asher’s royalties ostensibly adhered to this customary practice, although the parties vigorously dispute the accuracy of the figures Nami used in its calculation of these costs.⁴

In December 2006, Asher filed suit against Nami in Bell Circuit Court alleging that Nami breached the Asher leases, underpaying the contractual royalties by intentionally overstating its post-production costs, understating the quantity of gas extracted, and understating the market price of the gas sold. Asher demanded the forfeiture or termination of the leases, an accounting of the royalties payable under the leases, and compensation for the underpayment of the royalties payable under the leases. Nami denied that it had breached the leases. In light of the forfeiture claim, Nami filed a counterclaim alleging that Asher breached the leases by preventing Nami from drilling additional wells during a period of elevated gas prices, thereby causing Nami to lose revenues and profits available from expanded gas production.

In March 2011, Asher filed a fifth amended complaint asserting a claim for conversion based upon the allegation that Nami’s Well #35 was drawing natural gas from beneath a tract of Asher’s property (the Carlson tract) not covered by any of Nami’s leases. After the trial court granted summary judgment for Nami dismissing Asher’s conversion claim pertaining to Well #35, Asher sought to amend its complaint, restating the dismissed conversion claim as a claim for trespass.

As to Asher’s overall claims, the trial court concluded that disputed issues of material fact precluded summary judgment and the case went to trial. The trial court opted to submit the issues of fact to the jury through the use of special interrogatories rather than general instructions on the law. The jury determined in response to jury instruction Interrogatories No. 1 and No. 2 (titled "Breach of Contract-Royalties") that Nami had underpaid royalties owed to Asher by deducting post-production costs which were not actually incurred and were not reasonable. On the answer blank labeled, "Unpaid royalties," the jury fixed the amount owed by Nami at $1,308,403.60. The jury also determined in response to Interrogatories No. 6 and No. 7 (titled "Fraud") that Nami had underpaid royalties due under the lease by "(a) reporting incorrect volumes of natural gas produced from the [Asher] wells ... (b) reporting inaccurate sales prices for the natural gas produced from the [Asher] wells ... (c) reducing the gross sales figures by improper expenses." In the answer blank provided for that interrogatory, labeled "Financial loss," the jury reiterated that Nami owed Asher $1,308,403.60.

It is clear from a review of these jury interrogatories that the improper deduction of "costs" described in Interrogatories No. 1 and No. 2 is part of the same financial loss covered by Interrogatory No. 6 as "improper expense" and awarded under Interrogatory No. 7. Recognizing that the ...