Amoco Production Co. v. First Baptist Church of Pyote
579 S.W.2d 280, 67 Oil & Gas Rep. 568, 1979 Tex. App. LEXIS 3215 (1979)
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Rule of Law:
An oil and gas lessee has an implied covenant to market natural gas with due diligence and in good faith to obtain the best price reasonably obtainable for its lessors, even when the lease provides for royalty payments based on the 'amount realized' from the sale, especially when the interests of the lessor and lessee diverge.
Facts:
- Amoco Production Company owned oil and gas leases on eighteen tracts in Ward County, Texas, each providing for a 1/8th royalty based on the 'amount realized from such sale' of gas at the wells.
- In 1973, working interest owners pooled their leases to form the Caprito 100 Unit, and a well was completed, producing gas from both Devonian and Ellenberger Formations.
- Gas from the Caprito 100 Unit well was sold to four different purchasers (Lone Star, Pioneer, Delhi, Natural Gas Pipeline Co.), each with its own pipeline connected to the well.
- In November 1969, Amoco entered a 20-year gas purchase contract with Pioneer Natural Gas Company for 17¢ per MCF, covering other leases in Ward County.
- In October 1970, Amoco amended the 1969 Pioneer contract to include six of the eighteen leases involved in this case.
- In June 1975, Amoco entered a supplemental agreement with Pioneer and Odessa Natural Gasoline Company, dedicating the remaining twelve leases (belonging to the Appellees) to the 1969 contract. This agreement increased the price for gas from the Caprito 100 Unit to 70¢ per MCF (retroactive to August 1, 1974) with a 1¢ annual acceleration.
- During the period of 1973-1977, Lone Star and Delhi, other purchasers from the same Caprito 100 Unit well, paid significantly higher prices (e.g., $1.30, $1.90, $1.95 per MCF) for gas under contracts that included annual price redetermination provisions.
Procedural Posture:
- Plaintiffs (lessors) sued Amoco Production Company (lessee) in a state trial court for alleged deficiencies in royalty payments for natural gas.
- The trial court found that Amoco did not breach its duty regarding six leases that were dedicated to a gas purchase contract in 1970.
- The trial court found that Amoco did breach its legal duty regarding twelve other leases (those of the Appellees) that were dedicated to a gas purchase contract in 1975, and awarded the plaintiffs damages based on the difference between the amounts they were paid and the prices Lone Star Gas Company was paying for gas from the same well.
- The trial court also ordered that future royalty payments for these twelve leases be based on the price paid by Lone Star Gas Company.
- Amoco Production Company appealed the trial court's judgment concerning the twelve leases and the order for future payments to the Court of Civil Appeals of Texas, Eighth District, El Paso.
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Issue:
Does an oil and gas lessee have an implied covenant to market natural gas at its fair market value, even when the lease stipulates royalty payments based on 'the amount realized from such sale,' and was this duty breached by dedicating gas to a long-term contract at significantly lower prices than other purchasers from the same well?
Opinions:
Majority - Osborn, Justice
Yes, an oil and gas lessee has an implied covenant to exercise good faith in the marketing of gas, particularly where the interests of the lessor and lessee are not identical, and Amoco breached this duty for the twelve leases dedicated in 1975 by selling gas at less than the current fair market value while obtaining additional benefits for itself. The court established that a lessee's obligation includes the duty to obtain the best price possible for the gas, drawing on authorities emphasizing 'diligence in marketing' and 'fair dealing.' When a lessee's interests diverge from those of its lessors, a stricter standard of supervision over the lessee's business judgment is required. Amoco's dedication of the twelve leases to an existing, lower-priced, long-term contract, while other purchasers from the same well were paying demonstrably higher prices under annual redetermination clauses, constituted a breach of this duty. The court found that prices paid by other purchasers for the same gas from the same well, under contracts with annual redetermination clauses, serve as strong, almost conclusive, evidence of market value. Furthermore, the court clarified that division orders, which typically protect the purchaser in distributing proceeds, do not alleviate the lessee's implied duty to market in good faith, nor do they amend the lease or relieve the lessee of its obligations to the royalty owner. However, the court found that the trial court erred in mandating that future payments be based exclusively on the price paid by one specific purchaser (Lone Star Gas Company), as market price should reflect a broader comparison of sales at a given time and place, for which Lone Star's price may be the best evidence but not conclusive.
Dissenting - Preslar, Chief Justice
No, Amoco did not breach its duty, and the trial court's judgment should be reversed. The express terms of the leases, which provided for royalty payments based on 'the amount realized from such sale,' should govern, and Amoco fully complied by paying Appellees their share of the actual proceeds. The dissent argued that there was no sufficient proof of Amoco's 'failure to act in good faith'; merely selling gas for less than others is not enough to demonstrate bad faith, as gas contracts involve numerous terms beyond just price. Furthermore, the dissent asserted that the court should not create a new contract for the parties by imposing a monthly market value payment when the gas was sold under an industry-standard long-term contract. The trial court's finding of 'fair market value' based on the price paid by only one of four purchasers was deemed erroneous, as there was no expert testimony on market value, and multiple elements contribute to determining such value. Finally, the dissent contended that the division orders, which the Appellees signed, constituted binding contracts affirming payment based on proceeds of sale. Given that an Appellee testified to knowing about the Pioneer contract when signing, the division orders effectively ratified Amoco's conduct, and the Appellees presented no pleadings (such as fraud or mistake) to overcome these binding agreements.
Analysis:
This case significantly shaped the scope of a lessee's implied covenant to market natural gas in Texas, reinforcing that the duty extends beyond merely finding a buyer to actively seeking the best price reasonably obtainable for royalty owners. It established that 'amount realized' or 'proceeds' clauses do not grant a lessee unfettered discretion to sell gas at any price if it conflicts with the lessor's interests. The ruling provides a critical check on potential conflicts of interest, particularly when a lessee's broader corporate strategies might lead to less favorable terms for specific royalty interests. Furthermore, the case clarified the limited role of division orders, preventing them from being used by lessees to sidestep their implied lease obligations. This decision impacts future cases by holding lessees to a higher standard of commercial prudence and good faith in marketing, necessitating robust evidence of fair market value when royalty payments are disputed.
