Transport Oil Co. v. Exeter Oil Co.Transport Oil Co. v. Exeter Oil Co.
This is an appeal by Transport Oil Company, herein called Transport, from a judgment denying it damages against Exeter Oil Company, Ltd., herein called Exeter. The action arose as a consequence of Exeter’s abandonment, in January 1942, of a certain oil leasehold located in the Signal Hill oil field at Long Beach, California, and of Exеter’s agreement to operate the property for Transport.
The basic lease to this property was executed in 1921 to one Stutts as lessee. It required the lessee to do certain drilling on the property, which has been done, and to pay a 16% per cent royalty to the lessor, based on gross returns. The
By means of successive assignments, Transport became the lessee. These various assignments reserved certain overriding royalties which Transport assumed.
On July 29, 1936, Transport entered into an operating agreement with Bacon and Bailes, who subsequently assigned to Exeter in 1937. Exeter assumеd the obligations of the agreement and operated the property until it was abandoned. Transport’s action is predicated upon a claimed breach of this operating agreement by Exeter.
The material provisions of the agreement are as follows: the operator was required to drill one new well, and to redrill оr otherwise recondition certain existing wells. This was done, and at the time of abandonment three wells, designated No. 1, No. 2, and No. 5 were in production. The agreement provided further than the operators “shall with reasonable diligence and in good faith pump and otherwise operate and care for all wells drilled by them upon the said lease at all times so long as they shall remain in possession of the same so that the full production thereof may be obtained,” etc. Finally, the agreement provided: “The parties of the second part (operators) hereby assume and agree to perform, each, every and all the duties, liabilities, covenants, agreements and obligations of the lessee under the lease hereinabove described, and of the party of the first part under said lease and the assignments thereof, ’ ’ etc. For the limited purposes of our decision Exeter should be deemed the lessee under the basic lease.
The royalty obligations assumed by Exeter as assignee of this oрerating agreement were the following: the 16% per cent royalty called for by the basic lease; the overriding royalties, by reason of the assignments of the basic le^se, amounting to 14 per cent, respectively, on wells No. 1 and No. 5, and 15 5/6 per cent on well No. 2; and the additional royalties
For many years prior to 1942, production of oil from the premises had been suffering an increasing and expеcted decline due to natural causes. In the latter part of 1941, Exeter sought unsuccessfully to negotiate a reduction in the amount of its royalty obligations. These efforts failing, in January, 1942, Exeter abandoned the property, moved off all the equipment, and plugged and cemented off the wells according to legal requirements. No noticе was ever given to Transport of intention to abandon the leasehold.
Under these circumstances, the abandonment by Exeter of performance under the operating agreement was also an abandonment of the lease, causing its forfeiture to Transport’s lessor. In addition to damages claimed for the loss of the lease, Transport seeks to recover the value of the equipment removed by Exeter and allegedly converted in violation of a liquidated damages provision of the operating agreement. Exeter’s defense, successful in the court below, is that the operation had become unprofitable, in that, oil or gas could no longer bе produced in paying quantities, and that therefore the lease had by its own terms expired prior to January, 1942. Thus, it is urged, Exeter acted squarely within its rights under the operating agreement in abandoning the leasehold and in removing the equipment for its own use. The question before the court is whether the abandonment was justified in view of Exeter’s obligations.
The oрerating agreement itself contains no provision for cessation of operations or abandonment in case the leasehold could no longer be operated profitably. However, the lease, as we have seen, obligated the lessee to hold and operate the property “for the period of twenty (20) years from and after the date hereof and as long thereafter as oil or gas is pro-< duced in paying quantities.” Since the lease was dated October 25, 1921, the fixed term had expired prior to the time of abandonment. The answer to the essential question of whether or not the lease had expired is thus seen to turn on whether or not produсtion was in paying quantities at the time Exeter terminated its operations.
The lease contains no definition of what would be considered a paying operation unless such definition can be found
There being no extrinsic evidence in aid of the construction of the instrument, this court is not bound by the trial court’s interpretation and will independently ascertain the meaning of the instrument’s provisions from the language thereof as a matter of law.
(Trubowitch
v.
Riverbank Canning Co.,
Exeter places reliance upon the introductory words of the quoted definition, “for all purposes herein contemplated.” Upon analysis, however, we are persuaded that these words referred solely to the development obligations of the lessee, and were not intended to operate as a limitation upon the habendum. The lease contemplated the drilling of one well on the north half of the property, with a privilege grantеd to the lessee of drilling a second one on the south half. The duty to drill the first well was limited to a depth of 3,500 feet, “unless oil, in paying quantities shall have been obtained at a lessor [sic] depth.” Furthermore, a cash bonus was to become payable only “in the event oil is obtained in paying quantities in the well so drilled on the north half of said Lot Three.” And finally, the lessee’s obligation to pay royalties was not to commence until “after the discovery and production of oil in paying quantities from said well.” It will be noted that all three of these provisions refer in terms to an individual well rather than to the leasehold as an entirety. Similarly, the express $15 per day definition sets forth the circumstances аs to production and expense of operation under which a single well is to be considered as producing in paying quantities, whereas the habendum clause defines the temporal duration of the lease as a whole. A grammatical reading would thus lead to the conclusion that the express
In the evolution of oil and gas leases, the paying quantities phrase has come to have two entirely different meanings. In the habendum it serves to perpetuate the lease beyond the fixed term for as long thereaftеr as it would be mutually profitable to the parties. (See 2 Summers, Oil and Gas (perm, ed.), §§ 287, 306;
Benedum-Trees Oil Co.
v.
Davis,
A simple illustration will demonstrate the unreasonableness of Exeter’s interpretation. Each well on the lease might hаve been producing a net revenue of $5,000 per year, rendering the lease extremely valuable, with no single well producing a net of $15 per day. Certainly the parties never contemplated that under such circumstances either the lessor or the lessee should have the right to terminate the lease. Again, the inclusion in the lease оf the provisions quoted above, obligating the lessee to continue operations, except in certain contingencies not here involved, provides support for our view that all producing wells, regardless of their individual profitability, were to be kept in continuous production as long as the operation, considered as a whole, was in paying quantities. The lessor would thereby be assured of receiving maximum royalties, which were to be computed on the basis of gross returns. In any event, the express definition must yield to the general intent of the contract. (Civ. Code, § 1650.) Accordingly, we hold that the effect to be given to the term, “paying quantities,” in the habendum is not governed by the $15 per day definition, but is to be determined by reference to the established legal meaning of the term.
Our next inquiry is whether the trial court correctly concluded that the leasehold was not producing in paying
Exeter’s contention, with which the trial court agreed, is that for the year 1941, the operation wаs conducted at a net loss of more than $100, and in the month preceding abandonment, at a net loss of more than $700. In computing operating costs, Exeter includes as part of cost all royalties, including those payable to Transport, and also all cost of maintenance of the three wells here involved. Transport, on the other hand, contends that the royalties payable to it should not be included as an operating expense, but apparently concedes that all other royalties should be taken into account.
■ A careful reading discloses that nowhere in the operating agreement is there to be found any provision that in determining whether the leаse has expired, overriding royalties, or any royalties other than the 16% per cent payable to the landowner, should be treated as an expense of operation, nor is there particular reference to the landowner’s royalty. However, each assignee of the lease assumed the lessee’s obligations to the landowner. Exeter assumed them, as we have seen. Neither the operating agreement nor the assignments purported to affect in any way the duration of the lease or the method of calculating its date of termination. It would seem clear, then, that the operation was to be considered profitable and the lease still operative as long as oil and gas could be produced in paying quantities by a lessee who was required to pay only the basic royalty of 16% per cent as an expense of operation.
Stated in a somewhat different fashion, we find Exeter carrying a dual set of obligations. (See 8 Cal.Jur. (Supp.) “Oil and Gas,” § 141.) In respect to Transport, it was, of course, required to comply with the terms of the operating agreement; in respect to the landowner, having assumed the leasehold obligations, it occupied the same position as the original lessee;
(Bessho
v.
General Petroleum Corp.,
Turning to Exeter’s own figures, which are stipulated by the parties to be correct, we find that when the overriding royalties, including those payable to Transport, are excluded as an operating expense, the total operation resulted in a profit, for 1941, of about $4,300, before reserves for depletion and depreciation, which were not shown. Regardless of the status of depletion in the calculation of taxable income
( Dakota-Montana Oil Co.
v.
United States,
Furthermore, Exeter’s alternative contention, that a substantial net loss incurred in December, 1941, the month preceding abandonment, had caused the lease to terminate, may not be sustained. It may be conceded that even when the ovеrriding royalties, including Transport’s, are disregarded as a cost of operation, the net loss amounted to more than $470 in this one month. This figure, however, is an insufficient basis for a finding that the leasehold was not producing in paying quantities. It is to be expected that a highly profitable lease may be operating at a loss temporarily. The present case amply illustrates the point, for the net loss in December, 1941, was chiefly due to unusually high maintenance costs in that month.
A
similar experience was had in several previous months. In the absence of compelling reasons to the
We hold therefore that the basic lease had not yet terminated in January, 1942, and the abandonment at that time by Exeter was in violation of the operating agreement and the lease.
The judgment is reversed for a retrial of the sole issue of damages, if any, suffered by plaintiff.
Wood, J., and Vallée, J. pro tem., concurred.