WALLACE B. RODERICK REVOCABLE LIVING v. XTO ENERGY

• Decision Date: 12 January 2010
• Docket Number: Case No. 08-1330-JTM.
• Citation: 679 F. Supp.2d 1287
• Parties: WALLACE B. RODERICK REVOCABLE LIVING TRUST, Trustee Wallace B. Roderick, on Behalf of Itself and all others Similarly Situated, Plaintiffs, v. XTO ENERGY, INC., Defendant.
• Court: U.S. District Court — District of Kansas

679 F.Supp.2d 1287

WALLACE B. RODERICK REVOCABLE LIVING TRUST, Trustee Wallace B. Roderick, on Behalf of Itself and all others Similarly Situated, Plaintiffs, v. XTO ENERGY, INC., Defendant.

Case No. 08-1330-JTM.

United States District Court, D. Kansas.

January 12, 2010.

Barbara C. Frankland, Rex A. Sharp, Gunderson Sharp & Walke, LLP, Prairie Village, KS, David E. Sharp Gunderson Sharp & Walke, LLP, Houston, TX, Joseph R. Gunderson, Gunderson Sharp & Walke, LLP, Des Moines, IA, for Plaintiffs.

Douglas M. Crotty, III, Crotty Law Office, Garden City, KS, Karissa K. Cottom, Mark Banner, Hall, Estill, Hardwick, Gable, Golden & Nelson, P.C. Tulsa, OK, for Defendant.

MEMORANDUM AND ORDER

J. THOMAS MARTEN, District Judge.

Several motions are before the court in this prospective class action by the plaintiff Wallace B. Roderick Revocable Living Trust alleging that the class — composed of royalty owners of natural gas wells in Colorado, Kansas, and Oklahoma — received inadequate royalties for natural gas produced by defendant lessee XTO Energy, Inc. The defendant XTO has filed two motions to dismiss. The first alleges that the implied covenant to market underlying plaintiff's claims is recognized only in Colorado law, not in Kansas or Oklahoma. The second alleges that certain portions of the present case should be dismissed in light of a similar class action under way in Oklahoma. XTO has also filed a summary judgment motion, seeking dismissal of certain claims in light of prior, settled class actions in Oklahoma and Colorado on the grounds of release and res judicata. The plaintiff Roderick Trust has moved for additional time to respond to the motion for summary judgment, in order to conduct discovery on certain issues. These motions are granted or denied as provided herein.

Implied Covenant to Market

XTO seeks dismissal of that portion of the Amended Complaint advancing claims for violation of the "Marketable Condition Rule." (Dkt. 37, at ¶ 57). It notes that the Amended Complaint states that the leases included implied covenants requiring XTO to "bear all costs of placing the gas (and constituent parts) in `Marketable Condition,'" (Id. at ¶ 18), and that XTO "alone bears the expense of making all products marketable. Gas and its constituent parts are marketable only when in the physical condition and location to be bought and sold in a commercial marketplace." (Id. at ¶ 19). XTO seeks dismissal of all of the claims alleging breach of the Market Condition Rule outside of Colorado, arguing that the Rule is a unique feature of Colorado law, and that the cause of action is not recognized in Kansas or Oklahoma. XTO notes that in Rogers v. Westerman Farm Co., 29 P.3d 887 (Colo.2001), the Colorado Supreme Court has observed:

Gas is marketable when it is in the physical condition such that it is acceptable to be bought and sold in a commercial marketplace, and in the location of a commercial marketplace, such that it is commercially saleable in the oil and gas marketplace.

Id. at 906. It contends that the Kansas and Oklahoma have adopted versions of the rule which are more restrictive, that the law in those states recognizes that the "at the well" language in lease agreements authorizes the lessee to make reasonable charges for gathering and processing the gas. See Smith v. Amoco Production Co., 272 Kan. 58, 31 P.3d 255 (2001); Sternberger v. Marathon Oil Co., 257 Kan. 315, 894 P.2d 788 (Kan.1995); Matzen v. Hugoton Production Co., 182 Kan. 456, 321 P.2d 576 (Kan.1958); Howell v. Texaco, Inc., 112 P.3d 1154 (Okla.2004); Mittelstaedt v. Santa Fe Minerals, Inc., 1998 OK 7, 954 P.2d 1203 (Okla.1998); Johnson v. Jernigan, 475 P.2d 396 (Okla.1970).

The plaintiff responds with two arguments. First, it contends that the Amended Complaint does not advance some Colorado-specific version of the Marketable Condition Rule. It stresses the "location" language cited from paragraph 19 of the Amended Complaint is the only time this term is used in the lengthy, 24-page complaint, and that the complaint provides no specific definition of the Marketable Condition Rule. The plaintiff contends that the Amended Complaint's language makes clear that it seeks recovery for breach of an implied covenant of marketability generally. Second, it argues that in any event the law of the three states is not dissimilar. According to the plaintiff, all three states recognize the existence of an implied condition of marketability, the only distinction being that Colorado holds that the determination of marketability, and hence the proper allocation of costs, is a question of fact, while Kansas and Oklahoma treat the issue as one of law.

A careful review of decisions from the three states establishes that, for gas leases which require that royalty interests are determined by the marketability of the gas "at the well," all three states impose a general obligation on the part of the lessee to render the gas marketable, and hold that such expenses may not be charged to lessors. However, the states disagree on whether the lessors may be charged for transportation expenses, and whether the issue is a question of law or fact.

The issue arises because natural gas is almost never produced in a marketable condition straight from the well.

It is common knowledge that raw or unprocessed gas usually undergoes certain field processes necessary to create a marketable product. These field activities may include, but are not limited to, separation, dehydration, compression, and treatment to remove impurities.

Mittelstaedt, 954 P.2d at 1208. Of the most recent decisions from the three relevant states as to how to allocate these expenses between lessor and lessee, the decision by the Kansas Supreme Court in Sternberger v. Marathon Oil Co., 257 Kan. 315, 894 P.2d 788 (1995) is the earliest.

In Sternberger, the court addressed the propriety of the lessee's charges for amortized transportation costs. Reviewing its earlier decisions in Scott v. Steinberger, 113 Kan. 67, 213 P. 646 (1923), Voshell v. Indian Territory Illuminating Oil Co., 137 Kan. 160, 19 P.2d 456 (1933), and Molter v. Lewis, 156 Kan. 544, 134 P.2d 404 (1943), the court concluded that those cases

are dispositive of the issue in this case and clearly show that where royalties are based on market price "at the well," or where the lessor receives his or her share of the oil or gas "at the well," the lessor must bear a proportionate share of the expenses in transporting the gas or oil to a distant market.

894 P.2d at 796. The court distinguished such reasonable transportation costs, which might be allocated to lessors, from "`gathering' or other production costs," which would not be. Id. at 800. The court explicitly agreed with the Colorado Supreme Court's conclusion in Garman v. Conoco, Inc., 886 P.2d 652 (Colo.1994) which "held as we believe the law in Kansas to be." Id. The court then summarized that holding:

Once a marketable product is obtained, reasonable costs incurred to transport or enhance the value of the marketable gas may be charged against nonworking interest owners. The lessee has the burden of proving the reasonableness of the costs. Absent a contract providing to the contrary, a nonworking interest owner is not obligated to bear any share of production expense, such as compressing, transporting, and processing, undertaken to transform gas into a marketable product. In the case before us, the gas is marketable at the well. The problem is there is no market at the well, and in that instance we hold the lessor must bear a proportionate share of the reasonable cost of transporting the marketable gas to its point of sale.

Id.

In 1998, the Oklahoma Supreme Court in Mittelstaedt addressed a certified question from the Tenth Circuit as to the validity of fees imposed by lessees for transportation, blending, compression, and dehydration. 954 P.2d at 1204. Applying its prior decisions in Johnson v. Jernigan and Wood v. TXO Production Corp., 1992 OK 100, 854 P.2d 880 (1992), the court held:

Generally, costs have been construed as either production costs which are never allocated, or post-production costs, which may or may not be allocated, based upon the nature of the cost as it relates to the duties of the lessee created by the express language of the lease, the implied covenants, and custom and usage in the industry. We conclude that dehydration costs necessary to make a product marketable, or dehydration within the custom and usage of the lessee's duty to create a marketable product, without provision for cost to lessors in the lease, are expenses not paid from the royalty interest. However, excess dehydration to an already marketable product is to be allocated proportionately to the royalty interest when such costs are reasonable, and when actual royalty revenues are increased in proportion to the costs assessed against the royalty interest. It is the lessee's burden to show that the excess dehydration costs charged against the royalty interest occurred to a marketable product, i.e., that the cost is a post-production cost. It is also the burden of the lessee to show both the reasonableness of the costs and that the royalty revenues increased in proportion with the costs assessed against the royalty interest.

954 P.2d at 1209 (emphasis in original).

The court declined to hold that compression or blending costs to an already marketable product could not be proportionally charged against the lessors' interests:

The certified question asks us to determine whether blending costs are a post-production expense. The exact nature of the "blending" is not identified. The analysis for blending costs is the same as for dehydration costs. Blending costs necessary to make a marketable product are not costs allocated to the royalty interest. Blending costs to an already marketable product are to be allocated proportionately to the royalty interest when such costs are reasonable and when actual

...