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Fawcett v. Oil Producers, Inc. of Kansas

Court of Appeals of Kansas

July 19, 2013

L. Ruth FAWCETT, Appellee,
v.
OIL PRODUCERS, INC. OF KANSAS, Appellant.

Page 319

Syllabus by the Court

When the royalty clause of an oil and gas lease provides for a royalty of one-eighth or three-sixteenths of the proceeds from the sale of gas at the well, the term " proceeds" refers to the gross sale price in the contract between the gas purchaser and the lessee, producer, or seller, so long as the contractual rate per thousand cubic feet has been approved by the applicable regulatory authority. If the lessee, producer, or seller claims that it is entitled to compute and pay royalties based upon an amount less than the gross sale price, it must find the authority to do so somewhere other than in the lease's royalty clause. For purposes of calculating royalty payments, the lessee, producer, or seller is not allowed to deduct the cost of the stipulated price adjustments contained in the gas purchase agreements from the gross sale price of the gas, even though the gas purchaser, according to the terms of its gas purchase agreement, or otherwise, withholds the price adjustments from its payment to the lessee, producer, or seller.

Robert W. Coykendall and Will B. Wohlford, of Morris, Laing, Evans, Brock & Kennedy, Chtd., of Wichita, and Julia Gilmore Gaughan, of the same firm, of Topeka, for appellant.

Rex A. Sharp and Barbara C. Frankland, of Gunderson, Sharp & Walke L.L.P., of Prairie Village, and David E. Sharp, of the same firm, of Houston, Texas, for appellee.

David W. Nickel, of DePew Gillen Rathbun & McInteer, LC, of Wichita, for amicus curiae Kansas Independent Oil and Gas Association.

Before ATCHESON, P.J., GREEN and McANANY, JJ.

GREEN, J.

This interlocutory appeal under K.S.A. 60-2102(c) involves a class action brought by a royalty owner in Seward County, Kansas, on behalf of all royalty owners who were paid royalties from Oil Producers, Inc. of Kansas (OPIK), which owned the working interest or which operated Kansas wells from January 1, 1996, to the present. The plaintiff, L. Ruth Fawcett Trust, with [49 Kan.App.2d 195] Les Spaulding as the Trustee (Fawcett) claimed that OPIK had underpaid royalties, and sought recovery of the underpayments. Namely, plaintiff contended that the stipulated price adjustments contained in the gas purchase agreements between OPIK and certain gas purchasers were actually deductions of expenses that OPIK was not allowed to deduct from plaintiff's royalty share. Both parties moved for summary judgment. OPIK argued that it had complied with the express requirement of the leases to pay royalties based on actual proceeds of sales of gas that it had sold at the well. Moreover, OPIK maintained " that it would require a gross adulteration of the gas sales contracts to interpret the price adjustments to be improper ‘ expense’ deductions."

The trial court granted partial summary judgment in favor of the plaintiff. On appeal, OPIK contends that the trial court erred when it held that OPIK impermissibly calculated the plaintiff's royalty payments on the net proceeds OPIK received from certain gas purchasers instead of calculating plaintiff's royalty payments on the gross proceeds of the gas purchase contracts. We disagree. Accordingly, we affirm.

There are 25 oil and gas leases at issue in this case. Each of the oil and gas leases

Page 320

contain the same or similar language giving the lessor (royalty owner) either a one-eighth or three-sixteenths share of the gas produced and sold at the mouth of the well. Two examples of the specific lease language are as follows:

" The lessee shall pay to the lessor for gas produced from any oil well and used by the lessee for the manufacture of gasoline or any other product as royalty 1/8 of the market value of such gas at the mouth of the well; if said gas is sold by the lessee, then as royalty 1/8 of the proceeds of the sale thereof at the mouth of the well. The lessee shall pay lessor as royalty 1/8 of the proceeds from the sale of gas as such at the mouth of the well where gas only is found...."

or

" The lessee shall monthly pay to lessor as royalty on gas marketed from each well where gas only is found, one-eighth (1/8) of the proceeds if sold at the well, or if marketed by lessee off the leased premises, then one-eighth (1/8) of its market value at the well...."

OPIK, the producer/operator of the gas wells, had gas purchase contracts with ONEOK Midstream Gas Supply, L.L.C. (ONEOK), [49 Kan.App.2d 196] Duke Energy Field Services, LP (Duke), Unimark L.L.C. (Unimark), and DCP Midstream, LP (DCP). ONEOK deducted a gathering and compression fee and a dehydration fee. It is clear, based on the record, that ONEOK deducted these various fees from the total value of the gas purchased.

Duke deducted a gathering fee, a conditioning fee, and a fuel reimbursement fee for possible lost or unmeasured gas. In addition, if the gas did not meet the quality as required under the contract, Duke could elect to accept the delivery of the gas and deduct any costs it incurred to bring the gas within the quality specifications.

Unimark deducted all third-party costs, fees, and charges incurred that were associated with selling the gas, including treating, gathering, transporting, and compressing fees.

Although the record does not contain the contract between DCP and OPIK, there is a billing statement which states that DCP deducted fees and adjustments from the total value of the gas purchased.

Fawcett, one of the royalty owners, filed a class action lawsuit against OPIK alleging that OPIK had underpaid royalty owners by taking several deductions before the gas products were in a marketable condition. A check stub submitted by Fawcett for a royalty payment indicated that the only fee subtracted from the gross value of the gas proceeds was a state tax. The check stub did not contain any information regarding the deductions taken by the gas purchasers before they paid OPIK for the gas products. Apparently, OPIK calculated the royalty it owed to the royalty owners based on the gross proceeds of gas sales at the well to gas purchasers less the cost of the stipulated price adjustments contained in the gas purchase contracts between OPIK and the gas purchasers.

Both parties filed motions for partial summary judgment. The trial court granted Fawcett's partial motion for summary judgment, finding that OPIK impermissibly reduced the royalty payments by failing to compute the royalty payments based on the gross proceeds of gas sales at the well to the gas purchasers. In addition, the trial court granted class certification.

[49 Kan.App.2d 197] OPIK filed an application for interlocutory appeal, which was granted.

Did the trial court err when it held that OPIK impermissibly calculated the royalty payments on the gross proceeds of gas sales at the well to gas purchasers less the cost of the stipulated adjustments contained in the gas purchase contracts?

OPIK argues that the trial court erred when it granted Fawcett's partial motion for summary judgment. Specifically, OPIK contends that under the express language of the oil and gas leases, it was only required to calculate royalty payments based upon the actual proceeds it received from the gas purchasers. In addition, OPIK asserts that the implied duty to market rule does not reach as far as the trial court has allowed it to

Page 321

extend. Amicus curiae Kansas Independent Oil and Gas Association, in supporting OPIK's position, argues " that the marketable condition rule can be met by selling natural gas in its raw form at the well to natural gas purchasers under arm's-length transactions." Nevertheless, Fawcett argues that OPIK cannot alter its obligations under the oil and gas leases or under the marketable condition rule with its confidential gas contracts with third parties. Moreover, Fawcett contends that OPIK had the duty to transform the gas into a marketable product and OPIK alone bore the expense of making the gas marketable.

We come, therefore, to the question of whether the royalty payments are to be computed on the gross proceeds of gas sales at the well or on gross proceeds of gas sales at the well less cost of the stipulated price adjustments contained in ...


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