Lafitte Co. v. United Fuel Gas Co. (177 F. Supp. 52, 1959)

SWINFORD, District Judge.

The plaintiff seeks an accounting, declaration of rights, and damages, growing out of an alleged violation on the part of the defendant of its covenants and obligations as lessee under an oil and gas lease on properties in Floyd and Knott Counties, Kentucky, owned by the plaintiff, lessor.

On October 3, 1924, the Elk Horn Coal Corporation executed a lease to the Ohio Fuel Oil Company for the working interest in 14,983 acres of land, which was a part of a tract in Eastern Kentucky and identified throughout the record as the “Checkerboard” area. The whole Checkerboard area contained 42,880 acres. It is important, and a circumstance considered by the court, to identify the various owners of the respective interests through which, by mesne conveyances, the litigants acquired their interests.

The plaintiff is a successor in title to the original lessor. The defendant is a successor in title to the original lessee. On April 20, 1932, the Elk Horn Coal Corporation conveyed its interest to Louisville Gas Royalties, Inc.; Louisville Gas Royalties, Inc., to Producers Pipe Line Company, August 2, 1932; Producers Pipe Line Company to First National Bank and Trust Company of Lexington, Kentucky, June 21, 1945; First National Bank and Trust Company to The Lafitte Company (plaintiff), March 1, 1946. There was also a deed from Producers Pipe Line Company to The Lafitte Company, dated February 23, 1955 (Exhibit No. 115).

The original lessee conveyed its interest to the Warfield Natural Gas Company, November 1, 1928. The Warfield Natural Gas Company conveyed the interest to the United Fuel Gas Company (defendant), December 26, 1946.

The plaintiff asks judgment in the sum of $767,648.50 as damages resulting from alleged violations of the terms of the lease. It is agreed that the rights and obligations of the original parties to the contract are identical with those of the present parties, which are in accord with the terms of the lease (paragraph 26).

The plaintiff’s claims are as follows: (1) Failure on the part of the defendant to remit to the plaintiff the correct amount of royalty as dictated by the terms of the lease; (2) failure on the part of the defendant adequately to develop the property resulting in drainage of gas from beneath the premises by foreign gas wells on adjoining premises; (3) failure on the part of the defendant to remit to the plaintiff its one-eighth part of the proceeds received from the sale of by-products manufactured from gas taken from the leased premises by the defendant.

The defendant, by its answer, denies most of the material allegations of the complaint and pleads affirmatively the defenses of payment, accord and satisfaction, laches, estoppel, and the Kentucky five-year and fifteen-year statutes of limitations, KRS 413.090, 413.120.

Before proceeding to discuss the terms of the lease and the rights of the parties thereunder, it is proper for the court to say that it does not consider the lease ambiguous and all evidence contained in the record which 'purports to explain the terms of the lease because of conceived ambiguity is incompetent and not considered by the court in its decision.

The plaintiff rests its case upon the construction and interpretation of Paragraphs (2) and (8) of the lease which provide that in consideration of the premises, the Lessee covenants and agrees to deliver to the credit of the Lessor, its successors or assigns, free of cost, in the pipe line to which Lessee may connect its wells “(2) * * * one-eighth (%) of the gross income received by the Lessee from the sale or disposition in whatever manner and for each and every purpose, of gas produced and sold or marketed in its natural or reduced state from the demised premises.

“Also one-eighth (%) part of the proceeds received from the manufactured by-products of natural gas if said natural gas be manufactured into by-products by the Lessee or its assigns less the Lessor’s proportionate part of the transportation charges. Said transportation charges to be the delivery cost of said byproducts from the point of manufacture to the place of sale or market, it being the intention and purpose that the Lessor is to receive the one-eighth (%) part of all monies received by the Lessee from the sale of the gas from the demised premises whether sold in its natural state or sold after the extraction of the byproducts of the natural gas and also one-eighth (%) of the proceeds of said byproducts as above set out. The Lessee agrees that it will sell the gas produced by it from the leased premises hereunder and the by-products thereof, herein mentioned for not less than the fair wholesale market value of the same in the vicinity thereof at the time of making any contract for the sale of the same, or any part thereof, and that any contract for the sale of same shall contain such provisions as will reasonably insure to the Lessor the fair wholesale market value of its part of same throughout the term of said contract. Every contract for the sale of gas from the leased premises, as well as the by-products thereof, shall be fairly made; it being the agreement and intention of the parties hereto that the said' gas and by-products thereof shall be marketed upon such terms as will enable the Lessor to obtain at all times the fair value of the same in the open market. If, however, lessee sells the natural gas or any product thereof mentioned in the foregoing paragraph, either to itself or to any subsidiary corporation owned or controlled by it, the price of such gas or product for which the lessee shall be accountable to the lessor shall be at the lessor’s option— either the contract price therefor, or the fair, wholesale market price thereof in the vicinity where same is produced or sold.

“Should gasoline be manufactured from wells on the premises hereby leased, the lessor shall receive in full payment for such gas so used at its option one-eighth (y8) of the gasoline thus manufactured and saved, delivered in tanks provided by the lessee on the premises, but not to exceed a maximum capacity of three hundred barrels, free of expense, and one-eighth (%) of the proceeds of sale of the residue or stripped gas if same is sold by lessee; or one-eighth (%) of the proceeds of gasoline if sold by lessee, less the cost of marketing same, and one-eighth (%) of proceeds ■of gas sold, payable to the lessor monthly.

“Settlement and payment shall be made by the Lessee monthly not later than the '20th day of the following month, for all -gas and by-products produced from the •demised premises and used or disposed of by the Lessee during the preceding month. * * *

“ (8) In the event oil and gas, or either, shall be found in paying quantities on the leased premises, the Lessee shall proceed to market the same with all reasonable dispatch, and after a well has been connected with a pipe line, it is understood and agreed that the extraction of gas or oil from any such well shall be prosecuted continuously with reasonable diligence so long as the capacity is such as to make such production profitable, so far as consistent with marketing conditions, and the Lessee shall not discriminate against the oil or gas wells on the demised premises in favor of any other oil or gas well operated by the Lessee in marketing gas and oil, or either, from ■oil and gas wells operated by the Lessee in the vicinity or adjacent to said demised lease.”

In construing these portions of the lease the whole contract must be considered. The court has placed considerable emphasis upon the following which I paraphrase rather than quote for the sake of brevity: (3) The gas taken from the premises shall be measured by orifice pitot tube or meter of other standard type, to be furnished by the lessee. (4) The lessor to furnish on the premises sites where the meter or meters may be located and maintained. (5) The lessee shall read the meters daily or as often as the meters require, but each party shall have constant access to the meters. At the end of each month a statement shall be rendered to the lessor, showing the amount of gas taken in that month. (6) The statements on meter measurements are to be rendered by the lessee to the lessor at the end of each month, and shall be conclusive on the parties thereto, unless exceptions in writing shall be made by the lessor and mailed to the lessee within ten days after the lessor receives the statements. (7) The lessee further agrees to keep all proper records to enable a correct determination of the quantity of gas and oil and by-products marketed or delivered to the lessor’s credit in pipe lines or otherwise, to which records the lessor, or its duly authorized agent, shall have access at reasonable times for the purpose of verification of statements furnished by the lessee to lessor. (16) The payment of all royalties deemed and treated as rents, the lessor to have all remedies for the recovery thereof given by law for the recovery of rents, but such remedies to be cumulative and not exclusive.

These paragraphs and sections and other numbered paragraphs and sections of the lease will be referred to throughout this opinion.

The original lessee went upon and proceeded to develop the leasehold in accordance with the terms of the lease. The first development was in 1925. The first fifteen gas wells were developed and gas brought into production, with continuing development, without any controversy or disagreement between the original parties or their successors and assigns for a period of more than twenty five years. The differences between the parties which resulted in the bringing of this action arose in the following way.

On January 31, 1951, the defendant wrote a letter to the plaintiff in which it stated that the wholesale market price of gas had, for the past years, been 12¡5 per Mcf and it proposed to increase the price to 15(5 per Mcf, effective January 1, 1951. The letter also made a request that certain changes in the lease be agreed tc with reference to meter readings and asked the plaintiff for its approval of such a change. The letter was acknowledged by an official of the plaintiff but no consent to change was granted. Evidently the letter of January, 1951 prompted the present officials of the plaintiff company to reexamine the lease of October 3, 1924 and a controversy arose as to interpretation of its terms which could not be settled between the parties.

I will consider the plaintiff’s claim on the three grounds set forth above and in the order stated.

The lease provides no set price for the gas so the consideration must be judged from Paragraph 2 which gives one eighth of the gross income on the wholesale market price in the vicinity where the gas is produced or sold. It will be noted that the words “produced” or “sold” are intended to be used synonymously. I do not consider this an ambiguity in the light of the whole context of the contract. It prompts, as the first determination in this matter, a finding of what is, or was throughout, the wholesale market price in the vicinity of the Checkerboard area.

By the terms of the lease, meters were to be located on the leased premises by the lessee and maintained by the lessee during the term of the contract. The lessee bought gas from various producers, gathered and commingled it, and delivered it to a terminus, which was off the leased premises, for distribution through pipelines to various points of consumption throughout the country. It was undoubtedly the intention of the parties at the time the lease was executed that the gas was to be measured at the wellhead and not at some distant point of sale to a subsidiary of the lessee or a stranger. There would have been no point in putting meters at the wellhead if their measurements carried no significance. The original lessee neither owned nor operated gas transmission lines. It sold gas originally to Ivyton Oil & Gas Company, a subsidiary of the Louisville Gas and Electric Company, which constructed pipelines into the Checkerboard area and bought gas from the original lessee at the wellhead for 12^ per Mcf. The original lessee, the Ohio Fuel Oil Company, also sold gas to-the Warfield Natural Gas Company in. 1927 and 1928. Warfield built pipelines into the Checkerboard to the wellhead where the gas was measured and sold for 12{S per Mcf. On November 1,1928, Ohio-Fuel Oil Company merged into Warfield. From the time of the execution of the lease in October 1924, until the end of its-existence, Ohio Fuel Oil Company made-all the sales from the leased premises, to the gas companies who built gathering lines up to the wellheads where the gas was measured and delivered to the purchaser.

By the merger of Ohio Fuel Oil Company with Warfield, Warfield then became-the owner of the gathering and transmission lines which it had constructed in 1927 on the leased premises to the wellheads. The lessor, Elk Horn Coal Corporation, was fully advised of the merger and executed a right of way agreement toWarfield to enable Warfield to market gas from several wells on the leasehold.

The exhibits disclose that there was considerable correspondence between the management of Elk Horn and Warfield and that the lessor kept a careful check on the gas production. It also continued to accept royalties based on the value of the gas produced at the wellhead.

It can be pointed out here that the original lessor and all of its successors in title accepted the wellhead measurements and the price of 12{í per Mcf without question and, as the record clearly discloses, with full knowledge of the price for which the lessees in succession were selling the gas, until discussions arose in 1951 after the plaintiff had received the letter of January 31 of that year.

No question of the royalty clause was raised until January 23,1952. The plaintiff continued to accept the royalties tendered until September 1954. The royalties were paid on a monthly basis at the rate of 1.5$ per Mcf, which is one eighth of 12{í per Mcf, for all gas produced before January 1, 1953, at which time the rate was increased to 2<¡> per Mcf. On the back of each check appeared the following: “In full payment for all claims of royalty, on certain oil and gas lease described hereon, for the - month ■ended-”. With each check was an .accounting letter setting forth in detail for each meter the amount of gas on which royalties were being paid.

As early as 1942 the lessee had furnished to the lessor records of the in•dividual wells, logs, line pressures, days on line, and which wells were hooked to ■each meter, and other information. It was the practice between the parties for the lessee to furnish any information re■quested by the lessor of anything pertaining to the property covered by the lease. Between 1942 and 1944, an accountant for the lessor visited the home •office of the lessee on more than one occasion and there was made available to him all records of the lease pertaining to the matters of the lease and the sale of :gas from the wellhead.

Another fact disclosed by the record is that the odd numbered blocks (the Lafitte property) in the Checkerboard area have produced, under the development of the 'defendant, thirty five billion cubic feet