SMITH v. MARSHALL OIL CORPORATION

SMITH v. MARSHALL OIL CORPORATION
2004 OK 10
85 P.3d 830
Case Number: 96987
Decided: 02/10/2004

THE SUPREME COURT OF THE STATE OF OKLAHOMA

MAX SMITH, d/b/a SMITH OIL, Appellant,
v.
MARSHALL OIL CORPORATION, Appellee.

ON CERTIORARI TO THE COURT OF CIVIL APPEALS, DIVISION I

¶0 A former operator and lessee of certain oil and gas leases seeks to quiet title in his favor and against a successor in interest, and contends that ownership of certain equipment left on the leased premises did not vest in the surface owner. The Court of Civil Appeals, Division I, affirmed a judgment rendered by the trial court against the former operator and in favor of a successor in interest. On certiorari previously granted,

THE OPINION OF THE COURT OF CIVIL APPEALS,
DIVISION I, IS VACATED AND THE JUDGMENT
OF THE TRIAL COURT IS AFFIRMED.

Jack Mattingly, Sr., Jack Mattingly, Jr., Gary P. Snow, Mattingly, Snow & Mattingly, P.C., Seminole, Oklahoma, for Appellant.
James W. George, L. Mark Walker, Crowe & Dunlevy, A Professional Corporation, Oklahoma City, Oklahoma, for Appellee.

WINCHESTER, J.

¶1 The dispositive issues on certiorari are whether the subject leases terminated under the terms of their habendum clauses, and whether ownership of certain equipment left on the leased premises by appellant, Max Smith, d/b/a Smith Oil, vested in the surface owner. We answer these questions in the affirmative.

FACTS AND PROCEDURAL HISTORY

¶2 The operator, Max Smith d/b/a Smith Oil, acquired oil and gas leases for properties located in Seminole County, Oklahoma.

"7. In the event of cessation of production on said loud [land], Lessee agrees to remove all salvageable structures he then owns within six (6) months of cessation date, weather permitting. Failure of Lessee to do so shall vest ownership of said equipment to the surface owner."

¶3 The trial court rendered judgment against Smith in a quiet title action brought against Marshall Oil Corporation, appellee herein and a successor in interest to Smith. The trial court held that the oil and gas leases expired under the terms of their habendum clauses, and thus were no longer in force. The trial court also held that ownership of the structures and equipment Smith placed on the leased premises vested in the surface owner under ¶ 7 of the Exhibit "A" addendum quoted hereinabove. The Court of Civil Appeals, Division I, in an opinion released for publication, affirmed the judgment of the trial court. We granted certiorari.

¶4 Appellant Smith acquired a working interest in the oil and gas leasehold estate known as the Stacy-Paige lease pursuant to the above-mentioned leases covering the south half of the northeast quarter of section 22, township 10 north, range 7 east, in Seminole County, Oklahoma. Smith acquired the prior leasehold estate by sheriff's deeddated November 17, 1988, and filed December 9, 1993.

¶5 Marshall Oil's predecessors, West Consulting Company, Inc. and Energy Lease Brokers, Inc., purchased new oil and gas leases that covered the same properties as Smith's old leases on October 26, 1998, January 21, 1999, and April 8, 1999. They entered the premises and took possession of the Stacy and Paige wells. In February 2000, they top-leased the properties to Marshall Oil.

¶6 It is undisputed that the mineral owner lessor never made a verbal or written demand on Smith to comply with the implied covenant to market oil or gas from the wells, and did not give Smith reasonable time to comply with any such demand. It also is undisputed that the mineral owner lessor never brought an action to declare a forfeiture of the lease. Smith contends that the instant action arises from a claim of breach of the implied duty to market oil and gas. As such, he reasons that a demand must be made, and time granted with which to comply, prior to commencement of an action against him. Marshall Oil argues that the quiet title action before us is premised upon the theory that the Stacy-Paige lease expired under the terms contained in the habendum clause, and as such, no demand or time with which to comply, was necessary to prevent a forfeiture of Smith's estate in the leasehold.

¶7 This action to quiet title was tried on August 2, 2001. Marshall Oil moved for a directed verdict that the trial court granted, finding Smith's oil and gas leases expired by their own terms. The trial court denied Smith's Motion for New Trial and he appealed. The Court of Civil Appeals, Division I, affirmed the decision of the trial court in an opinion released for publication. On certiorari granted upon Smith's petition, we now vacate the Court of Civil Appeals' opinion, and sustain the judgment of the trial court, for the reasons set forth hereinbelow.

STANDARD OF REVIEW

¶8 The instant matter is an action to cancel an oil and gas lease. As such, it is one of equitable cognizance. Hininger v. Kaiser,

IMPACT OF LANGUAGE IN HABENDUM CLAUSE

¶9 In the state of Oklahoma, when the term "produced" is used in a "thereafter" provision of an habendum clause, its meaning is that of "production in paying quantities." Stewart v. Amerada Hess Corp.,

¶10 Smith, in his reply brief, contends that Danne v. Texaco Exploration and Production, Inc.,

EQUITABLE CONSIDERATIONS

¶11 We first conclude that the period employed by the trial court in the instant case, to measure the Stacy and Paige wells' profitability, was sufficient under all the facts and circumstances for a fair and reasonable determination. Since the Stacy and Paige wells commenced in the primary terms of the subject leases, the question then becomes whether the period of cessation of production and of failure to produce in paying quantities is reasonable, as well as the question of Smith's diligence, as operator. Voluntariness of the cessation is another factor to consider. Hunter v. Clarkson,

¶12 In determining whether a failure to produce in paying quantities suffices to terminate a lease, we examine the facts and circumstances of the cessation on a case-by-case basis. Barby v. Singer,

¶13 Smith relies heavily on our decision in Pack v. Santa Fe Minerals,

¶14 The evidence produced at trial establishes that the two leases in question failed to yield a return in excess of lifting expenses during years 1996 through 1998.

¶15 Smith testified at trial regarding this time period as follows: "I produced them when I felt like producing them. And I turned them off when I felt like turning them off."

"[t]he operator cannot . . . only produce oil when it suits his purposes. The landowner has an interest which must, and will, be protected when the operator ceases production for an unreasonable time, without cause, after the expiration of the primary term."

The facts in Hunter were disputed, but ultimately they revealed a voluntary cessation of production without any circumstances to justify a continuation of the lease.

¶16 The record supports the trial court's determination that while Smith produced these leases in their secondary terms, the production was not profitable for three years. At this juncture, all production ceased. No further production occurred until April 1999, when Marshall Oil 's predecessor commenced operations under the new leases. Smith quit using electricity in January 1998. His production records reflect that he terminated production at this time. Smith offered no compelling equitable concerns to justify this. Instead, Smith testified he deliberately ceased production, hoping oil and gas prices would rise. However, he had no factual support for this, and testified it was his mere "hope."

¶17 Smith also testified he did not want to produce the wells when prices of oil dropped to $8.00 a barrel, and that he decided to wait until they rose to $30.00 a barrel. However, the evidence presented shows that he sold oil for $16.25 per barrel on January 27, 1996, $22.50 a barrel on January 28, 1997, and $18.50 per barrel on February 28, 1997.

¶18 The evidence supports the trial court's finding that no extenuating circumstances occurred that would justify Smith's failure to produce in paying quantities for these years, and that the leases expired by the terms of their own habendum clauses. Smith continues to argue that they were at all times capable of producing in paying quantities, thus satisfying the habendum clauses of the leases. The trier of fact found to the contrary, based upon the evidence presented at the trial of this matter and upon appellate review, we cannot say that this finding was contrary to the clear weight of the evidence. Smith failed to produce any evidence to support his assertion that the wells were at all times capable of producing in paying quantities, other than his personal belief to that effect. The record establishes that Smith's lifting expenses, which by his own admission understate his actual costs due to insufficient record-keeping, far exceed any return, when the wells actually were producing. Evidence as to how this scenario could change vis- -vis a scenario in which the wells might be merely "capable of producing" was never presented by Smith. As stated hereinabove, Smith's argument as to a breach of an implied duty to market is inapplicable to the instant facts. None of the cases cited by Smith involve the evidence in this case. He cannot, under the terms of his leases, only produce oil and/or gas when it suits his purposes. The lessors have an interest that must be protected when Smith, as operator, ceases production for an unreasonable time, without cause or justifiable equitable considerations, after the primary terms of the leases have expired.

¶19 The remaining issue before us concerns the addendum to the November 30, 1987, lease, to-wit: whether ownership of certain equipment left on the premises vested in the surface owner because Smith failed to remove it. The record indicates that Smith was primarily concerned with possession of the Stacy-Paige lease, as opposed to any specific equipment left on the premises. Plaintiff's/Appellant's trial Exhibit 16 purports to be at least a partial list of Smith's salvageable structures and equipment, along with the values associated with each item left on the premises, the ownership of which Marshall Oil contends vested in the surface owner. Smith apparently did not maintain an equipment inventory for this lease. The handwritten list does not contain a total value. If we accept the values assigned by Smith to the equipment he listed, the value is $70,202.00. We note that Smith wrote this list on the back of an Oklahoma Corporation Commission division order for interests in Hughes County, Oklahoma. In any event, it would appear that if he were concerned with ownership of his equipment vesting in the surface owner, he would have maintained an equipment inventory complete with values of equipment that could be substantiated with purchase and depreciation documentation. No such evidence is contained in the record before us.

¶20 Overall, Smith's testimony reflects a lack of concern as to equipment ownership vesting in the surface owner. He testified that he did not remember whether the provision in the November 30, 1987, lease regarding ownership of equipment vesting in the surface owner, was his idea or the lessors. He further testified it was agreed that if there were a cessation of production, he had six months to recover his equipment. There was no confusion as to this provision, or its application in the event of a cessation of production. The only dispute was as to whether a cessation of production actually occurred. Smith testified he did not agree that there was a fifteen month cessation of production, stating: "Because I had proved I had produced the wells up to December of '98."

¶21 Smith testified he did not realize the leases had changed hands until a potential buyer called him and said that there were "some people out there using your equipment and trying to produce your well."

¶22 The record reveals that Marshall Oil was prepared to offer testimony as to the significant amount of money spent to rework the wells and return them to the capacity to produce in paying quantities, once Smith's successors in interest took over. Counsel for Marshall Oil stated in his opening statement to the trial court that his client completely reworked the wells and installed new equipment, spending in excess of over half a million dollars in reworking and re-equipping the wells so that they would be able to produce in paying quantities. Since the trial court granted a directed verdict at the end of appellant's evidence, it was unnecessary for appellee to call its witnesses who by all accounts would have so testified. Nonetheless, this fact alone suggests that the equipment Smith left on the premises had little industry value. Otherwise, significant expenditures would not have been required, and Smith would have attempted to recover his equipment. The evidence in the record does not show any efforts by Smith to recover the equipment he left on the leased premises at the time his successors in interest took over the leases, or at any time prior or subsequent to that time. When asked what he would have to do to produce the wells if he were to take them over again, Smith testified he had "no idea;" that he "didn't know what Marshall Oil ha[d] done."

CONCLUSION

¶23 Smith failed to present any equitable considerations to justify his failure to produce the Stacy-Paige lease, or to justify his failure to produce in paying quantities for the period of 1996-1998. In addition, Smith failed to produce any barrels of oil from the Stacy and Paige wells for the year 1999, and failed to present any equitable considerations to justify his failure to produce in 1999, as well. The evidence supports the trial court's rendering a directed verdict for Marshall. We hold that the evidence is sufficiently substantial to sustain the findings and determinations of the trial court, and to sustain its directed verdict in favor of Marshall Oil. We hold that the evidence did not constitute compelling equitable circumstances that would justify the continuation of the subject leases in the face of a cessation of production, and in the face of a cessation of production in paying quantities.

¶24 Smith failed to present any evidence at trial regarding inclement weather to preclude removal, or any other variable for equitable consideration, that might have precluded his removal of the structures, equipment and fixtures within the six months following cessation of production, as required under the Exhibit A to this lease. Therefore, we hold that the weight of the evidence clearly supports the judgment of the trial court in this regard. Since Smith failed to remove the structures, equipment and fixtures as required under the November 30, 1987, addendum to the lease, ownership of same vested in the surface owner, under the specific provisions of the lease.

¶25 On certiorari granted upon Smith's petition, the Court of Civil Appeals' opinion is vacated; the judgment of the trial court is affirmed.

CERTIORARI PREVIOUSLY GRANTED;
THE OPINION OF THE COURT OF CIVIL APPEALS,
DIVISION I, IS VACATED, THE JUDGMENT
OF THE TRIAL COURT IS AFFIRMED.

CONCUR: WATT, C.J., OPALA, V.C.J., HODGES, LAVENDER, KAUGER, BOUDREAU, WINCHESTER, EDMONDSON, JJ.

NOT PARTICIPATING: HARGRAVE, J.

FOOTNOTES

1 Identified herein are only those counsel for the parties whose names appear on the certiorari briefs.

2 The record reflects the following leases: November 12, 1987, lease with Scott as lessor and Goodnight as lessee (Exh. 1); November 30, 1987, lease with Scott as lessor and Smith as lessee (Exh. 2, that contains the Exhibit "A" attachment with the provision to remove structures or forfeit same, within six months of cessation of production); November 12, 1987, lease with Ratliff as lessor and Goodnight as lessee (Exh. 3); November 30, 1987, lease with Scott as lessor and Smith as lessee (Exh. 4); October 10, 1988, assignment of oil and gas leases, with Westoil Properties, Inc., assignor and Max Smith d/b/a Smith Oil, assignee (covering the Stacy and Paige lease in Seminole County, as well as the Brett lease that is not relevant to the instant matter)(Exh. 5); April 16, 1988, assignment of Overriding Royalty Interest with Max Smith d/b/a Smith Oil as assignor and Scott as assignee (covering the Stacy #1-22 and Paige #1-22 wells.)

3 See Plaintiff's exh. 12 and Defendant's exh. 1.

4 A top lease is "an oil and gas lease to take effect only if the pre-existing lease should expire or be terminated." Voiles v. Santa Fe Minerals, Inc., 1996 OK 13, ¶ 11, 911 P.2d 1205, 1207. The earlier leases are commonly referred to as base leases. Voiles, 1996 OK 1, ¶ 12, 911 P.2d 1205, 1208.

5 "Lifting expenses" include but are not limited to the following: costs of pump operation, pumper's salaries, costs of supervision, gross production taxes, royalties payable to the lessor, electricity, telephone repairs, depreciation, and other incidental lifting expenses. Hiniger v. Kaiser, 1987 OK 26, ¶ 5, n. 4, 738 P.2d 137, 139, n. 4.

6 As we determined in James Energy Company v. HCG Energy Corp., 1992 OK 117, 847 P.2d 333, two separate causes of action arise when it is claimed that a lessor violates an implied covenant to produce and market the product and when it is claimed that a lease expires under the terms of its habendum clause, for failure to produce in paying quantities. The former requires a demand that the lessee comply with the implied covenant, before a court of equity will grant a forfeiture, whereas the latter does not. Similarly, in Voiles v. Santa Fe Minerals, Inc., 1996 OK 13, 911 P.2d 1205, an action to quiet title in certain leasehold interests based upon the theory that a cessation of production clause controlled the habendum clause and terminated the base leases, we recognized the difference in an action filed by mineral owners to quiet title and cancel existing oil and gas leases, and a claim for breach of the implied covenant to market. In Voiles, we denied a party's request for remand to take testimony on a claim based upon breach of the implied covenant to market, because the issue was not raised previously.

7 Trial Transcript at p. 74, ll. 4-7., Smith testifying.

8 Plaintiff's Exhs. 17, 18 (cumulative production for years 1996-1999 was 740 barrels of oil and for years 1996 through March 1999, was 614 mcf of gas.)

9 Plaintiff's Exhs. 60-62, 70- 75.

10 Plaintiff's Exhs. 125-183.

11 Plaintiff's exhs. 60-62 and 70-75

12 Plaintiff's Exh. 16.

13 Trial Transcript at p.74, ll. 4-7, Smith testifying.

14 Trial Transcript. at pp. 74-77, Smith testifying.

15 Plaintiff's Exhibits 60-62.

16 Plaintiff's Exh. 77.

17 Trial transcript at. p. 57, ll. 8-9, Smith testifying.

18 Trial transcript at p. 50, ll. 18-23, Smith testifying.

19 Trial transcript at p. 50, l. 25, Smith testifying.

20 Trial transcript at p. 87, ll. 13-16, Smith testifying.