Schroeder v. Terra Energy, Ltd., Docket No. 184132

• Decision Date: 25 April 1997
• Docket Number: Docket No. 184132
• Citation: 223 Mich.App. 176,565 N.W.2d 887
• Parties: Theodore Paul SCHROEDER, Karl M. Schroeder and Jennifer J. Schroeder, Plaintiffs-Appellants, v. TERRA ENERGY, LIMITED, Defendant-Appellee.
• Court: Court of Appeal of Michigan — District of US

Page 887

565 N.W.2d 887

223 Mich.App. 176

Theodore Paul SCHROEDER, Karl M. Schroeder and Jennifer J Schroeder, Plaintiffs-Appellants, v. TERRA ENERGY, LIMITED, Defendant-Appellee.

Docket No. 184132.

Court of Appeals of Michigan.

Submitted Dec. 4, 1996, at Grand Rapids.

Decided April 25, 1997, at 9:00 a.m.

H. Keith DuBois, Grayling, for plaintiffs-appellants.

Joel R. Myler, P.C. by Joel R. Myler, Traverse City, and Loomis, Ewert, Parsley, Davis & Gotting, P.C. by James R. Neal and Michael H. Rhodes, Lansing, for defendant-appellee.

Stead & Heath, P.C. by

Robin Stead and Donald F. Heath, Jr., Oklahoma City, OK, for National Ass'n of Royalty Owners, Inc.

Rosi Law Offices, P.C. by Philip R. Rosi, and Julie A. Harrison, Traverse City, for Antrim Mineral Owners Ass'n.

Before SAWYER, P.J., and MARKMAN and H.A. KOSELKA, ^* JJ.

MARKMAN, Judge.

Plaintiffs appeal as of right from an order granting summary disposition in favor of defendant pursuant to MCR 2.116(C)(8) and awarding defendant costs as sanctions against plaintiffs. We affirm in part, reverse in part, and remand in part.

Plaintiffs own natural gas rights associated with real property located in Charlton Township, Otsego County. Plaintiffs and defendant entered into an oil and gas lease agreement and a "letter" agreement on May 29, 1991. On July 11, 1991, plaintiffs and defendant entered into a surface use agreement. Together the three agreements (hereafter agreement) allowed defendant to mine and explore for oil and gas on plaintiffs' property. The agreement also allowed defendant to operate oil and gas wells and lay pipe across the property for transportation of the oil or gas. In return for these privileges, defendant agreed to pay plaintiffs "one-eighth ( 1/8) [later changed by the parties to 19.375 percent] of the gross proceeds at the wellhead, payable monthly for the gas from each well where gas is found, while the same is being used off the premises." ¹ Defendant also agreed to pay plaintiffs "for gas produced from any oil well and used off the premises or in the manufacture of gasoline or any other product a royalty of [19.375 percent] of the proceeds, payable monthly at the prevailing market rate at the wellhead."

Plaintiffs filed a complaint alleging that until April 20, 1993, defendant paid them 19.375 percent of the gross proceeds without deducting postproduction costs. ² However, by letter dated April 20, 1993, defendant advised plaintiff Theodore Schroeder that it would deduct postproduction costs in the future and would also reduce plaintiffs' future revenues to recoup past overpayments. Plaintiffs contended that, by reducing their payments, defendant breached a material provision of their contract. In their second amended complaint, plaintiffs further alleged that defendant's predecessor/subsidiary, Energy Reserves, Inc., had contracted with Michigan Consolidated Gas Company (Michcon) to sell gas at the rate of $3.15142 per Mcf until December 31, 1996. Plaintiffs asserted that, by letter dated February 24, 1992, defendant wrongly warranted to Michcon that " 'Antrim production from' the subject premises 'will never subject Michcon to any duty to purchase gas pursuant to said gas contract.' " Plaintiffs alleged that defendant thereby breached its duty under the contract by failing to obtain the "best available market price" and by failing to obtain assignment of the Michcon contract.

The trial court held that the designation of the wellhead as the place for calculation of the royalty payment subjected plaintiffs to the deduction of downstream postproduction costs of marketing the gas. The court further held that this principle was "so firmly established in Michigan oil and gas jurisprudence that plaintiffs' argument, that the assessment of these costs approximately ten months after first production is indicative of a contrary agreement, is wholly unpersuasive." The court also held that defendant was obligated to sell the gas at the prevailing market rate and not at the best available price. Finally, the court sanctioned plaintiffs for filing a frivolous complaint and awarded defendant costs and attorney fees.

Plaintiffs first argue that the trial court incorrectly held that they were required by the contract to bear the proportionate burden of postproduction costs. We conclude that the trial court reached the correct result with regard to this issue and accordingly that appellate relief regarding this aspect of the case is unwarranted.

The principal issue in this case is whether the language "gross proceeds at the wellhead" used in the agreement fairly contemplates the deduction of postproduction costs from the sales price of the gas. ³ This is an issue of first impression in Michigan. There is apparent difficulty in practical application of the contractual phrase "gross proceeds at the wellhead," in that natural gas is not typically sold at the wellhead and thus has no readily determinable price at that point from or in relation to which gross proceeds may be determined. The gas is normally sold by producers or pipeline companies only after it has been processed and transported to the "market."

Both parties use various principles of contract interpretation to support their interpretation of the contractual language at issue. Defendant urges this Court to interpret the language in a manner requiring plaintiffs to pay a proportionate share of postproduction costs by arguing that industry usage of the language and custom mandates such a result.

Plaintiffs and amici curiae counter that the language does not require plaintiffs to pay any portion of the postproduction costs. First, they argue that, because defendant had paid the postproduction costs from the time the contract was executed until April 20, 1993, such conduct was evidence of how the language should be interpreted. Second, they argue that within the contract there is an implied duty to market the gas and that this duty necessarily includes bearing the costs of making the gas salable. Finally, they argue that any ambiguities in the language should be resolved in favor of the lessors because the lessees, being familiar with trade and industry practice, are the more knowledgeable party and would otherwise be in a position to take advantage of the lessors.

Generally, contractual language is interpreted according to the plain meaning of the language in the contract rather than a technical construction of the language. G & A Inc. v. Nahra, 204 Mich.App. 329, 330-331, 514 N.W.2d 255 (1994). However, in Michigan Wisconsin Pipeline Co. v. Michigan Nat'l Bank, 118 Mich.App. 74, 80-81, 324 N.W.2d 541 (1982), the Court held:

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., [at] 678. 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., [at] 678. See, also, Howard v. Hughes, 294 Mich. 533, 293 N.W. 740 (1940).

However, these precedents do not stand for the proposition that any usage of trade in the oil and gas industry necessarily controls the interpretation of this contract. A general principle of contract law is that, even where such usage or custom is well established, it is not controlling if only one party meant the usage or custom to be operative and the other party had no reason to know of this interpretation. 3 Corbin, Contracts, § 555, p. 238. The law imposes no requirement that the terms and provisions of a contract shall be the same as, or similar to, those that neighbors and trade associates of the contracting parties are accustomed to agree upon. Id., § 556, p. 242. Before a usage or custom of trade, otherwise affirmatively proved to exist, can be invoked to construe a contract, it first must be shown that the party against whom it is asserted knew of the usage and had reason to know that the other party assented to the words of the contract in accordance with it, or that, if the party against whom it is asserted did not know of the usage, an ordinary person in that party's position would have known of it. Id., § 557, pp. 246-247.

J.J. Fagan, supra, must be understood in this context. Nothing therein purported to abolish general precepts of contract construction. To the contrary, the Supreme Court in J.J. Fagan expressly recognized that another general precept of contract law, that a contract is construed against the party responsible for drafting a disputed provision, applies to oil and gas leases such that use of form contracts, as here, requires that the terms of the contract be construed "for the benefit of the lessor and against the lessee...." J.J. Fagan at 681, 226 N.W. 653. Moreover, the Supreme Court noted that, in a situation similar to that here presented, such form agreements could be modified to clarify such understandings or meanings and that the rule by which these leases are construed for the benefit of the lessor and against the lessee should not be relaxed when the lessee has opted to rest on ambiguity. Id.

Thus, plaintiffs and amici curiae correctly argue that ambiguities in the oil and gas lease should be resolved in favor of the lessors as a policy matter. ⁴ Nonetheless, both on the basis of how other courts have construed this language and in consideration of the language itself, defendant's...