Xae Corp. v. Smr Property Management Co., 87466.

• Decision Date: 09 June 1998
• Docket Number: No. 87466.,87466.
• Citation: 968 P.2d 1201,1998 OK 51,69 OBJ 2137
• Parties: XAE CORPORATION; Richard L. Beasley and Evelyn H. Lee as Co-Trustees of the Clayton E. Lee Irrevocable Trust; Evelyn H. Lee in her individual capacity; Rachel Beasley; William Lee Beasley; and Carl Jean Scully, Plaintiffs/Appellees, v. SMR PROPERTY MANAGEMENT COMPANY; SMR Preferred Partners II 1991 Limited Partnership; SMR Preferred Partners Development Fund 1992 L.P., a Delaware limited partnership; SMR Preferred Investors 1993 Limited Partnership; SMR Energy Inc.; SMR Natural Gas Income Fund 1993 Limited Partnership; Tandem Oil & Gas Company, L.L.C.; SMR Natural Gas Partners 1994 Limited Partnership; SMR Energy Inc-W.P.; and SMR Private Income Fund 1993 Limited Partnership, Defendants/Appellants.
• Court: Oklahoma Supreme Court

968 P.2d 1201

1998 OK 51

XAE CORPORATION; Richard L. Beasley and Evelyn H. Lee as Co-Trustees of the Clayton E. Lee Irrevocable Trust; Evelyn H. Lee in her individual capacity; Rachel Beasley; William Lee Beasley; and Carl Jean Scully, Plaintiffs/Appellees, v. SMR PROPERTY MANAGEMENT COMPANY; SMR Preferred Partners II 1991 Limited Partnership; SMR Preferred Partners Development Fund 1992 L.P., a Delaware limited partnership; SMR Preferred Investors 1993 Limited Partnership; SMR Energy Inc.; SMR Natural Gas Income Fund 1993 Limited Partnership; Tandem Oil & Gas Company, L.L.C.; SMR Natural Gas Partners 1994 Limited Partnership; SMR Energy Inc-W.P.; and SMR Private Income Fund 1993 Limited Partnership, Defendants/Appellants.

No. 87466.

Supreme Court of Oklahoma.

June 9, 1998.

Rehearing Denied November 3, 1998.

Certiorari to the Court of Civil Appeals Division 1.

¶ 0 The Hon. Ray Dean Linder, District Judge, granted summary judgment for plaintiffs, finding that there was no dispute that gas from wells was unmarketable at the wellhead and that, accordingly, the lessee bore the costs of obtaining a marketable product, even where the overriding royalty owner's interest was deliverable in-kind. We vacate the opinion of the Court of Civil Appeals, reverse the trial court judgment, and hold that the implied covenant to market is not enforceable by overriding royalty interest owners who were granted their interests in-kind and where the assignment imposed no express obligation on the lessee to market their interest.

CERTIORARI PREVIOUSLY GRANTED; COURT OF CIVIL APPEALS' OPINION VACATED; TRIAL COURT'S JUDGMENT REVERSED.

James C.T. Hardwick, Donna N. Blakley, Sharon Taylor Thomas, Hall Estill, Hardwick, Gable, Golden & Nelson, P.C., Oklahoma City, for Appellants.

Philip D. Hart, C. David Stinson, McAfee & Taft, P.C., Oklahoma City, for Appellees.

Mark D. Christiansen, Crowe & Dunlevy, P.C., Oklahoma City, and Rand Phipps, Chairman of Legal Committee, Oklahoma Division of Mid-Continent Oil & Gas Association, Oklahoma City, for Amicus Curiae.

HARGRAVE, Justice.

¶ 1 We granted certiorari to review the question whether the implied covenant to market under the oil and gas lease extends to an overriding royalty interest owner. The overriding royalty interest in this case was an in-kind interest granted by separate conveyance rather than reserved in the assignment of oil and gas leases. Specifically, the question is whether the defendants/appellants (hereinafter "SMR") improperly deducted from the overriding royalties paid to plaintiffs their proportionate share of the costs incurred in gathering, processing and compressing gas produced from the subject wells. The trial judge determined as a matter of law that the gas was not in marketable form at the wellhead, and that SMR had a duty to make the gas marketable. The trial judge granted summary judgment for the overriding royalty interest owners. We hold that there is no implied covenant to market applicable in this case because no obligation was undertaken in the instrument creating the overriding royalty interest and because the interest was an in-kind interest deliverable at the wellhead.

FACTS

¶ 2 The plaintiffs are the successors in interest to an overriding royalty interest conveyed by SMR's predecessor in title. The conveyance was a grant of overriding royalty interest executed in 1967, which provided:

"Whereas, it is the present intent of J.C. Barnes Oil Company to assign, transfer, set over and deliver unto Clayton E. Lee and R.L. Beasley, in equal shares, hereinafter called Assignees, the overriding royalty interest in and to the leases described on Exhibits . . . hereto attached in accordance with the terms and conditions thereof . . .

"An overriding royalty interest of an undivided 1/8 of 7/8 of all gas, gas condensate or other gaseous hydrocarbons which may be produced under the terms of the oil and gas leases described in Exhibits "A" and "B" attached hereto and made a part hereof, the same to be delivered to the Assignees herein, free and clear of all costs and expenses whatsoever, save and except gross production taxes or other governmental taxes properly chargeable thereto."

¶ 3 The parties agree that this clause created an in-kind overriding royalty interest, meaning that the overriding royalty granted was a fraction of the gas produced rather than of the gas sold. The assignment stated that it applied to all extensions or renewals of the oil and gas leases, and contained a proportionate reduction clause. The overriding royalty interests were made subject to previously existing overriding royalty interests and a production payment. The assignment contained no express provision placing a duty on the lessee to market the product.

¶ 4 Plaintiffs did not take their share of gas in-kind, but instead authorized SMR Property Management Company to market their share. SMR, acting as agent for itself and the other defendants, paid plaintiffs for gas produced and sold from the leased premises. SMR deducted from the amounts paid to the plaintiffs a charge for gathering and delivering the gas to an amine treatment facility where large quantities of hydrogen sulfide and carbon monoxide were removed from it. The gas was sold at the outlet from the amine treatment facility. Plaintiffs' brief states that the amine treatment facilities are located "on or near" the subject leases.

¶ 5 Plaintiffs sued to recover all deductions made by SMR for the gathering, delivery and treatment charges, alleging that they were entitled to be paid their overriding royalty interests on gas produced from the subject wells without any deductions for gathering, delivery and treatment of the gas. Plaintiffs sought summary judgment that as a matter of law they were entitled to receive their overriding royalty interest free and clear of any such costs or charges, arguing that the "production" process does not end until a marketable product has been obtained, and that because the gas was not marketable in its natural state, the lessee was required to bear the costs of making it marketable. They relied upon three lessor royalty cases: TXO v. Commissioners of the Land Office, 903 P.2d 259 (Okla.1994); Wood v. TXO, 854 P.2d 880 (Okla.1992) and Clark v. Slick Oil Co., 88 Okla. 55, 211 P. 496 (1922). Plaintiffs urge us to adopt the rationale of Garman v. Conoco, 886 P.2d 652 (Colo.1994), which applied the implied covenant to market under the oil and gas lease to the overriding royalty interests.

¶ 6 Additionally, plaintiffs argue that the specific language of the assignment means that their interests were to be free and clear of all costs except taxes. Plaintiffs attached an affidavit from an agent of the original assignor stating that the assignor's intent was that the overriding royalty was to be free and clear of all costs of production, including any and all costs of treating the gas to meet pipeline specifications for the purchase or transportation of natural gas, and that the only costs the overrides were to bear were the taxes specified in the assignment. The defendants argue that the plaintiff's royalty is deliverable in kind, so that any language about costs can refer only to costs of exploration and production.

¶ 7 SMR also moved for summary judgment, arguing that plaintiffs' overriding royalty interest provided for delivery of the plaintiffs' overriding royalty interest in kind, which under Oklahoma law means that the gas is deliverable to plaintiffs at the wellhead and that the plaintiffs are responsible for any expenses incurred thereafter, citing Application of Martin, infra. Defendants argue that marketability of the gas is not an issue but that, in any event, SMR has sold the gas at the wellhead of each of the wells since December 1, 1995, and has paid plaintiffs the price received by SMR under its gas purchase contract. SMR argues that the implied covenants of the oil and gas lease do not apply to the overriding royalty owners, who are not parties to the oil and gas lease.

¶ 8 The trial court and the Court of Civil Appeals found non-marketability of the gas to be the primary issue in the case. The plaintiffs maintain that the agreement of the parties is silent as to the point at which the in-kind overriding royalty is to be delivered free of all costs and expenses and as to the required condition of the gas at the point of delivery.

¶ 9 SMR maintains that the conveyance of an in-kind royalty means that the place of delivery is at the wellhead and that there is no duty to market an in-kind interest. SMR argues that plaintiffs' election to have SMR market their share of the gas, instead of taking delivery in kind, did not change the fact that plaintiffs were required to bear their proportionate share of costs incurred after the gas leaves the wellhead, citing Application of Martin, 321 P.2d 659 (Okla. 1957). Thus, they say, plaintiffs were entitled to receive their share free of cost at the wellhead, and any expenses incurred beyond the wellhead were properly deducted. SMR argues that the Wood v. TXO and TXO v. Commissioners cases have no bearing in this case because those cases involved lessor royalties and the lessee's marketing covenant under the oil and gas lease.

IMPLIED COVENANT

¶ 10 We decided the royalty owner cases based on the implied covenant of marketability under the oil and gas lease. The implied covenants in the oil and gas lease ordinarily can not be enforced by an overriding royalty interest owner. See, 3 Summers, The Law of Oil and Gas, § 554 (Perm. ed. Supp.1997). Williams and Meyers, Oil and Gas Law, § 420, p. 356-7 (1981) states the general rule:

"The owner of an overriding royalty is not entitled to the benefit of the covenants of the base lease, express or implied, in the absence of an express provision in the instrument creating the overriding royalty. The benefits of such express and implied covenants of the lease touch and concern the...