REO Industries, Inc. v. Natural Gas Pipeline Co. of America

Decision Date03 June 1991
Docket NumberNo. 90-1660,90-1660
Citation932 F.2d 447
PartiesREO INDUSTRIES, INC., Plaintiff-Appellant, v. NATURAL GAS PIPELINE COMPANY OF AMERICA, Defendant-Appellee.
CourtU.S. Court of Appeals — Fifth Circuit

Marshall Searcy, Sam Dalton, Locke, Purnell, Rain & Harrell, Dallas, Tex., Jody G. Sheets, Culton, Morgan, Britain & White, Amarillo, Tex., for plaintiff-appellant.

Dennis M. Dylewski, Mark A. Bukaty, Daniel R. Cabianca, Calvin, Dylewski, Gibbs, Maddox & Verner, Houston, Tex., Jerome Mrowca, Asst. Gen. Counsel, MidCon Corp., Lobard, Ill., for defendant-appellee.

Appeal from the United States District Court for the Northern District of Texas.

Before BROWN, SMITH, and WEINER, Circuit Judges.

JOHN R. BROWN, Circuit Judge:

REO Industries appeals from summary judgment for Natural Gas Pipeline (NGPL) in this action for declaratory judgment and damages for the alleged breach of an operating agreement. REO complains that NGPL has breached the agreement governing rights to produce oil and gas by interfering with its right to produce gas. Federal jurisdiction is based on diversity, and Texas law is applied. The dispute centers on the interpretation of the contract, and so we review, as with any question of law, de novo on appeal from summary judgment. Finding no genuine issues of material fact and no legal error, we affirm.

Here's What Happened

REO owns oil rights, and NGPL owns gas rights on the same 640 acres in the West Panhandle field. 1 They are successors to the parties to a 1933 operating agreement governing oil and gas development activities on the subject property and other properties. 2 The agreement specifies procedures to be followed when, in drilling, the oil operator finds gas or the gas operator finds oil. 3

The one drilling the well may offer the well to the other, who is not obligated to buy. If tender is made and the option to purchase is exercised, the price is to be determined in part by a joint production test. If the option is not exercised, the drilling party retains his well and "its production," and must pay the royalties on such production. See infra, note 5.

NGPL and its predecessor (Texoma), as gas operators have been producing gas from a well on the land since 1935. 4

In 1985, REO drilled a well designated Troutman No. 1, seeking oil but finding gas. Paragraphs V and VII of the contract address this situation. 5 Paragraph V applies when a joint production test on a gas well shows capacity to produce more than 3,000,000 cubic feet of gas per day, and Paragraph VII applies to gas wells showing an open flow volume of 3,000,000 or less cubic feet per day. Under Paragraph V, the oil operator must offer the gas well to the gas operator at the net cost of the well, and under Paragraph VII the well is to be offered at half its cost.

For our purposes, the significant provisions of Paragraph V are as follows:

"[T]he Gas Operator shall have the option to purchase such well, (but it shall not be required to do so ).... [S]hould Gas Operator fail within said ten (10) days to notify Oil Operator of its election to so purchase said gas well, then Oil Operator shall own said well and have the right, subject to the limitations herein named, to operate such well ... for its own use and benefit. In the event Oil Operator operates such gas well, it shall pay to the lessor, his heirs or assigns, the gas rental or royalty provided for in the lease upon which said well is located."

The language of Paragraph VII is similar, providing that "[i]f the party entitled to purchase said well" does not, then "the party drilling the well shall own said well and the production therefrom, and shall have the right to operate such well for its own use and benefit...."

REO offered the well to NGPL (by letter dated August 6, 1985 and received September 9, 1985). NGPL declined to participate in a joint production test or to purchase the well, stating that "Natural [NGPL] is satisfied with the performance of its existing gas well on the section and, as long as Natural continues to produce its existing gas well, no one can legally operate the referenced well as a gas well under current Railroad Commission regulations." The Texas Railroad Commission's Rule 38 6 and the appropriate field rules permit only one gas well on 640 acres, so the well is useless to NGPL (and to REO) unless NGPL plugs its pre-existing well or the Commission grants an exception to the rule. Exceptions to the Railroad Commission's rule are granted only to prevent waste or the confiscation of property. 7

REO made a second offer to perform a joint production test and to sell its well, which was also refused. NGPL continued to operate its gas well. REO applied to the Commission for an exception, which NGPL opposed. The parties' arguments before the Commission focused on ownership of the gas reserves under the operating agreement as well as the questions of waste or confiscation of property. NGPL asserted that the Commission was the wrong forum since it lacked the legal power either to construe the contract or determine title to the gas.

Presumably bowing to the Commission's lack of primary jurisdiction, REO withdrew its application from the Commission and sued in state court seeking declaratory judgment and damages for NGPL's alleged interference with its operations in breach of Paragraphs II and XV of the operating agreement.

Paragraph II provides: "[I]t is further understood that each party shall so conduct its operations and so locate its improvements and equipment on said premises as to interfere as little as possible with operations of the other." Paragraph XV further states: "Each party agrees ... to comply with all state and federal laws and to protect any interest of the other party in such leases against liens or encumbrances caused by its acts or omissions...." (Emphasis added.)

REO asserted that these provisions obligated NGPL not only to refrain from opposing REO's application to the Commission, but more significantly to either buy REO's well or plug its own well and forfeit all its rights under its gas lease in order to permit REO to operate its well under Rule 38.

NGPL moved for summary judgment after removing to federal court, claiming i) REO had not fulfilled conditions precedent imposed by the agreement; ii) NGPL was not obligated to buy the proffered well or plug its own well; iii) NGPL had not breached the agreement by opposing REO's Rule 38 application; iv) NGPL's conduct was not a proximate cause of any damage to REO; and v) REO's claims were not ripe for judicial determination.

REO filed cross motion for partial summary judgment on the issues of liability for and causation of damages, 8 claiming i) it had fulfilled the conditions precedent (or they were merely covenants); ii) NGPL was obligated to buy the well; iii) NGPL had interfered, in breach of Paragraphs II and XV of the contract, with REO's contractual right to operate the gas well by opposing REO's application for an exception and failing to plug its own well; and iv) NGPL's conduct proximately caused damages to REO.

The court granted NGPL's motion and dismissed REO's claim, determining that: i) NGPL did not breach the agreement because it did not require NGPL to refrain from opposing REO's application to the Commission and certainly did not impose the Hobson's choice either to buy REO's well or abandon its leasehold rights by plugging its own; ii) REO's claims were not ripe because REO had shown no injury; and iii) even if there was an injury, NGPL's conduct was not the cause of any damages to REO. The trial court denied REO's motion for reconsideration and new trial.

No Title

Texas has adopted the theory of ownership of oil and gas in place, beneath the surface of the land. 9 Under Texas law, oil or gas in place, beneath the surface, is part of the realty, 10 and becomes personalty upon production and severance. 11 Generally, a Texas oil or gas lease operates not as an ordinary lease, but as a deed or conveyance of a determinable fee simple estate, investing the lessee with title either to the oil or the gas, or both, in place. 12

It is undisputed that NGPL is the record title holder of gas rights under an oil and gas lease and thereby owns the gas under the subject acreage. But REO argues that upon NGPL's election not to purchase the well, the Operating Agreement transferred to REO title to all the gas its well "could produce," with the consequence that NGPL forfeits all its pre-existing, exclusive rights to the gas reserves under the acreage. This ownership by implied transfer is the basis of REO's claim that NGPL interfered with REO's operations, in breach of the agreement, by failing either to refrain from opposing REO's application for an exception to Rule 38 or to plug its own well.

REO sought as damages the amount of money it could have earned if NGPL had not interfered with its right to operate the well. REO has not, and cannot, claim that NGPL has converted gas belonging to REO by continuing to produce gas from NGPL's pre-existing well.

Nonetheless, since the parties have agreed that in this field one well can produce all the gas under the 640 acres, REO essentially contends that by failing to purchase a well it does not need, NGPL has forfeited the entirety of its exclusive rights to gas under its lease on this acreage.

Since, despite REO's lamentations, it has to be uncontradicted that no gas--whoever owns it--can be produced from REO's well without a Rule 38 exception, REO's other claims are of secondary importance to that of the claimed forfeiture of NGPL's exclusive ownership of all the gas in place under the acreage.

Construing a contract under Texas law, the following principles apply: Interpretation of an unambiguous contract is a question of law, 13 and the determination of whether a contract is ambiguous is also a question of law. 14 A contract is not ambiguous merely because the parties have a disagreement on the correct...

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