Paragon Resources, Inc. v. National Fuel Gas Distribution Corp., 81-3813
| Decision Date | 21 January 1983 |
| Docket Number | No. 81-3813,81-3813 |
| Parties | 35 UCC Rep.Serv. 352 PARAGON RESOURCES, INC., Plaintiff-Appellee, v. NATIONAL FUEL GAS DISTRIBUTION CORPORATION, Defendant-Appellant. Summary Calendar. |
| Court | U.S. Court of Appeals — Fifth Circuit |
Phillips, Lytle, Hitchcock, Blaine & Huber, Heino H. Prahl, Buffalo, N.Y., Cook, Yancey, King & Galloway, F. Drake Lee, Jr., Shreveport, La., for defendant-appellant.
Blanchard, Walker, O'Quin & Roberts, William T. Allen, III, Shreveport, La., Kavinoky, Cook, Sandler, Gardner, Wisbaum & Lipman, Allan R. Lipman, Buffalo, N.Y., for plaintiff-appellee.
Appeal from the United States District Court for the Western District of Louisiana.
Before CLARK, Chief Judge, POLITZ and HIGGINBOTHAM, Circuit Judges.
We review an interpretation of an escalator provision in a gas purchase agreement between Paragon Resources, a natural gas producer, and National Fuel Gas Distribution Corp., a gas distributor. The escalator provision required Distribution Corp. to increase the price it paid Paragon for natural gas each year by the amount that "the average cost of gas" supplied by three pipelines to Distribution Corp. and related companies had increased. Distribution Corp. reads the escalator as permitting it to reduce its price to Paragon by the amount of refunds the three pipelines were required to make by the Federal Energy Regulatory Commission. Paragon reads "average cost" to mean the average price that Distribution Corp. actually paid in the given year, with no deduction for any refunds. The district court, after a bench trial, agreed with Paragon and awarded it damages for breach of contract. Concluding that the district court applied correct legal principles and that its factual determination was supported by the evidence, we affirm.
Distribution Corp.'s predecessor, Iroquois Gas Corp., was a subsidiary of National Fuel Gas Co., a corporation that, along with its subsidiaries, purchased natural gas and sold it to retail customers in New York, Pennsylvania, and Ohio. Some of the gas purchases were from interstate sources, whose rates were then regulated by the Federal Power Commission, now the FERC. Other purchases were from intrastate sources, including producers in western New York.
In February 1974, there was concern over available supplies of gas and representatives of Iroquois and two other subsidiaries met in Warren, Pennsylvania, to review pricing of intrastate natural gas. The three companies hoped to develop a pricing policy that would stimulate local production which then made up less than five percent of their purchases. At the Warren meeting they agreed to include a price escalation clause in the contracts with local producers. Under the escalator the price paid per thousand cubic feet, "MCF," would increase each year by the amount that the average cost of gas purchased by National Fuel Gas Co. and its subsidiaries in the interstate market from three pipeline companies, Tennessee Gas Pipeline Co., Texas Eastern Transmission Corp., and Transcontinental Gas Pipeline Co., had increased during the previous year.
The Natural Gas Act permits natural gas companies within the jurisdiction of the FERC to increase rates pending determination of reasonableness, subject to the Commission's right to suspend the new rates for up to five months. At the same time, the natural gas company is liable for a refund if the new rates are not found just and reasonable. 15 U.S.C. Sec. 717c(e). See also United Gas Pipe Line v. FERC, 657 F.2d 790, 793 (5th Cir.1981). The subsidiaries agreed that the escalator would not adjust for amounts paid the three pipelines that were subject to refund but would guarantee a minimum annual increase of $0.02 per MCF.
Paragon was formed in 1972 and started drilling in western New York in 1973 with plans for additional production. In June 1974 Iroquois and Paragon entered into a gas purchase agreement. The agreement, effective July 1, 1974, contained the standard price escalator:
Beginning January 1, 1975, and on each anniversary of that date, the above prices shall be increased by the amount in cents per one thousand (1,000) cubic feet, calculated to the nearest tenth of a cent, that the average cost of gas volumes actually purchased by National Fuel Gas Company and its subsidiary companies from Tennessee Gas Pipeline Company, Texas Eastern Transmission Corporation and Transcontinental Gas Pipeline Company during the preceding calendar year increased from the next preceding calendar year. In determining the average cost of gas actually purchased from said three pipeline suppliers, only final adjudicated one hundred percent (100%) load factor rates will be used, excluding sums collected subject to refund, demand credits and curtailment surcharges. In no event shall such annual increase be less than $0.02 per MCF.
Shortly thereafter, National Fuel Gas Co., Iroquois, and the other subsidiaries were reorganized. Distribution Corp., a newly-formed corporation, was assigned the "intrastate" assets of the system, including the gas purchase agreement with Paragon. John Fox, Assistant Secretary of Distribution Corp., was responsible for the negotiation and administration of contracts with local producers. Fox was concerned that the price escalator clause did not provide an adequate incentive for local production given the time necessary to finally adjudicate rates. He discussed deleting the reference to "final adjudicated rates" in the standard price escalator with other Distribution Corp. officials. On February 10, 1975, Fox wrote J.C. Templeton, the President of Paragon, as follows:
Pursuant to the escalation clause contained in section numbered VII on page 10 in the above contract, National Fuel Gas has computed the escalation to be 14.3 cents per MCF for calendar year for the method shown on attached Exhibit 'A.'
This computation was made by dividing the total dollars paid during calendar years by the total MCF delivered. Amounts subject to refund (unadjudicated rates) were not deducted from this calculation, a method which will always be to the benefit of the producer, because of the complexity of the calculation.
If this meets with your approval, this letter shall act as an amendment to the contract, substituting the following language in section numbered VII:
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(b) Beginning January 1, 1975, and on each anniversary of that date, the above prices shall be increased by the amount in cents per one thousand (1,000) cubic feet, calculated to the nearest tenth of a cent, that the average cost of gas volumes actually purchased by National Fuel Gas Company and its subsidiary companies from Tennessee Gas Pipeline Company, Texas Eastern Transmission Corporation and Transcontinental Gas Pipeline Company during the preceding calendar year increased from the next preceding calendar year. In no event shall such annual increase be less than $0.02 per MCF.
Templeton signed and returned the letter.
The letter from Fox to Templeton also contained a schedule that listed the sums paid and amounts of gas purchased from the three parity pipelines in 1973 and 1974 and calculated the increase in average cost. The schedule did not reflect any "refunds" received by National Fuel Gas Company or its subsidiaries from the three pipelines in those two years. Similarly, Distribution Corp.'s calculation of the price increase effective January 1, 1976, did not reflect refunds received in 1975, nor did its calculation of the price increase for January 1, 1977, reflect refunds for 1976. In addition, throughout 1977 Distribution Corp. furnished projections of the 1978 increase that did not take refunds into account.
On October 24, 1977, Tennessee Gas Pipeline Co. refunded $16,326,064 to one of National Fuel Gas Co.'s subsidiaries. This was by far the largest refund that any of the system companies had received from the three pipelines during the years 1973-77. By comparison in October 1974 Tennessee had been ordered to pay $1,164,870; in March 1976 Texas Eastern Transmission Corp. had been required to pay $1,084,052; and in August 1977 Texas Eastern had been required to pay $2,746,547. There were many smaller refunds during that time.
The very sizeable Tennessee refund resulted from a rate proceeding in progress since 1973. An administrative law judge recommended disallowance of most of the rate increase sought by Tennessee in 1975. Yet it was March of 1978 before Distribution Corp. advised Paragon that refunds were included in the average cost of gas calculation. It also continued to change its refund formula using at least three distinct approaches.
First, in 1978 Distribution Corp.: (i) allocated the refunds received during 1975, 1976, and 1977 to the years to which they were attributable; (ii) calculated per MCF refund figures for each of those years; (iii) subtracted the sum of those figures from the difference between the average cost of gas for 1977 (not counting refunds) and the average cost of gas for 1976 (not counting refunds).
Second, Distribution Corp. in 1979 used the "year of receipt method" by which it (i) subtracted refunds received in 1978 from the amount paid for gas in 1978 in determining the average cost of gas for 1978, (ii) made the same calculation for 1977, and (iii) subtracted the 1977 figure from the 1978 figure. This 1979 method was also used in 1980, except that no deduction for refunds was made where the refunds were attributable to a year preceding a year in which only the minimum $0.02 per MCF price escalation was awarded.
At the time of trial Distribution Corp. adopted a third method, the "perfect hindsight theory." Under this theoretically simple method, refunds are allocated to the year to which they are attributable, then price escalators for past years are calculated as if the refunded amounts had never been...
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