Case Title: State v. Pennzoil Co.

Citation: 

Docket Number: 

State: wyoming

Court: Wyoming Supreme Court

Date: 1988-04-05T00:00:00Z

Document:
State v. Pennzoil Co.1988 WY 51752 P.2d 975Case Number: 86-211Decided: 04/05/1988Supreme Court of Wyoming
THE STATE OF WYOMING, ED 
HERSCHLER, THYRA THOMSON, JAMES B. GRIFFITH, STAN SMITH AND LYNN SIMONS, AS 
MEMBERS OF THE BOARD OF LAND COMMISSIONERS, JAMES B. GRIFFITH, AS STATE AUDITOR 
AND HOWARD M. SCHRINAR, AS COMMISSIONER OF PUBLIC LANDS, APPELLANTS 
(DEFENDANTS),

v.

PENNZOIL COMPANY AND 
MARATHON OIL COMPANY, APPELLEES (PLAINTIFFS).

Appeal from the District 
Court, LaramieCounty, Gary P. Hartman, 
J.

A.G. McClintock, 
Atty. Gen., Michael L. Hubbard, Senior Asst. Atty. Gen., Vicci M. Colgan, and 
Clinton D. Beaver, Asst. Attys. Gen., for appellants.

William T. 
Schwartz, Schwartz, Bon, McCrary & Walker, Casper, Bruce F. Kiely and Thomas 
J. Eastment, Baker & Botts, Washington, D.C., Richard L. Edmonson, Houston, 
Tex., for appellee Pennzoil.

Morris R. 
Massey, Brown, Drew, Apostolos, Massey & Sullivan, Casper, Morris G. Gray 
and Kirby J. Iler, Casper, for appellee 
Marathon.

Before BROWN, C.J., and THOMAS, CARDINE, URBIGKIT and 
MACY, JJ.

THOMAS, 
Justice.

[¶1.]     The single issue to be 
resolved in this case is whether the State of Wyoming (State), the lessor of an 
oil and gas lease entered into through the Board of Land Commissioners (Board), 
is entitled to royalty on payments made by a purchaser from the lessee who was 
required to make minimum payments for gas even though the gas was not received. 
The district court held that royalties were not due on these payments which were 
attributable to what is described in the industry as a "take-or-pay" clause. We 
are in accord that royalties are not due on such payments, and we affirm the 
judgment of the trial court.

[¶2.]     Both parties articulate 
the issue in an argumentative way. The State, together with the individual 
members of the Board, the State Auditor, and the Commissioner of Public Lands, 
set forth the issue in their brief in this way:

"I. Did the district 
court err in its interpretation of the lease that royalties are not due on 
advance payments for gas?"

The appellees, 
Pennzoil Company (Pennzoil) and Marathon Oil Company (Marathon) assert this issue in their 
brief:

"I. Did the district 
court properly grant summary judgment to the appellees by declaring that the 
State of Wyoming, as lessor under the subject lease, has no royalty interest in 
take-or-pay obligations arising under gas sales contracts between the 
appellees/lessees and their gas purchaser?"

The crux of the 
matter is whether, under the oil and gas lease which was entered into, 
production of gas is essential to any requirement of royalty to the 
State.

[¶3.]     The parties agree that 
the facts are not in dispute. Marathon and 
Pennzoil each acquired, through assignment, a 50% working interest in an oil and 
gas lease executed by the State, through the Board, as lessor. Section 2 of that 
oil and gas lease provides, in pertinent part:

"(d) ROYALTIES. The 
royalties to be paid by lessee are: (i) on oil, one-eighth of that produced, 
saved, and sold from said land, the same to be delivered at the wells or to the 
credit of lessor into the pipe line to which the wells may be connected; (ii) on 
gas, including casinghead gas or other hydrocarbon substance, produced from said land saved and sold or 
used off the premises or in the manufacture of gasoline or other products 
therefrom, the market value at the well of one-eighth of the gas so sold or 
used, provided that on gas sold at the wells the royalty shall be one-eighth of 
the amount realized from such 
sale.

* * * * * 
*

"For royalty purposes on 
gas and natural gasoline the value shall be as approved by the lessor * * * and 
in no event shall the price for gas, or natural gasoline, be less than that 
received by the United States of America for its royalties from the same 
field.

* * * * * 
*

"(g) MONTHLY PAYMENTS AND 
STATEMENTS. Unless the time of payment is otherwise extended by the Commissioner 
of Public Lands, [the lessee agrees] to make payment on or before the twentieth 
(20) day of the calendar month succeeding 
the month of production and removal and sale of oil and gas from said land, 
and to furnish sworn monthly statements therewith showing in detail the quantity 
and quality of the production * * *." (Emphasis added.)1

[¶4.]     Marathon and Pennzoil drilled a well on the lands included 
in the lease which produces natural gas. The lessees have paid royalties to the 
State only on the gas produced and sold, based on the amounts realized from the 
sale of that gas.

[¶5.]     Colorado Interstate Gas 
(CIG) is a customer of Marathon and Pennzoil. 
CIG, pursuant to separate contracts with Marathon and Pennzoil, agreed to buy 
gas produced by Marathon and Pennzoil from the 
land included within the lease in issue. These respective contracts each contain 
a "take-or-pay" clause. Pursuant to the clause, CIG is required to receive a 
specified amount of gas each year.2 If CIG fails to receive the 
specified amount of gas each year, it is required to pay to Marathon and Pennzoil a sum which represents the 
difference between the specified amount of gas to be received and the amount 
actually received. The contracts, in addition, include a makeup provision,3 pursuant to which CIG receives 
credits for payments made under the take-or-pay clause with respect to any gas 
received in the succeeding five years, so long as the minimum amount has been 
received for any year in which the credit is claimed.4 On September 26, 1983, the Board 
sent an audit letter to Pennzoil and Marathon 
demanding unpaid royalties attributable to payments under the take-or-pay 
clause. Marathon agreed to pay the requested 
royalties, but Pennzoil refused and brought a declaratory judgment action 
against the Board. Then Marathon filed its own 
declaratory action against the Board seeking, as additional relief, the return 
of any monies it had paid to the Board as royalties for the take-or-pay 
payments. These actions were consolidated, and both sides moved for summary 
judgment on the sole question of whether or not the royalty payments were due. 
Briefs were filed; a hearing was held; and the district court granted the 
motions for summary judgment of Pennzoil and Marathon. It held that royalty payments were not due on 
the amounts realized from the take-or-pay payments. It is from that order 
granting judgment to Pennzoil and Marathon that 
the Board appeals.

[¶6.]     The Board argued to the 
district court, and maintains on appeal, that the pertinent lease provision is 
ambiguous and that an analysis of the intent of the parties results in a 
construction of the lease to the end that royalty payments should be made on 
payments received for future production as well as those received for actual 
production. The Board then contends that the take-or-pay payments which have 
been made or shall become due under the contract between CIG and Marathon and Pennzoil are made for future production of 
gas and that a royalty paid in advance is appropriate. Marathon and Pennzoil repeat their argument here, which 
was successful in the district court, that the pertinent provision in this lease 
entered into by the Board is clear, not subject to interpretation, and provides 
for royalty payments only in the event of actual 
production.

[¶7.]     An oil and gas lease is 
a contract, and the general principles invoked for the construction of contracts 
and their interpretation, if necessary, applies. Wolff v. Belco Development 
Corporation, Wyo., 736 P.2d 730 (1987); State 
v. Moncrief, Wyo., 720 P.2d 470 (1986). These general 
principles have been related a number of times, and we need allude to only those 
which are pertinent in this case. See e.g., State v. Moncrief, supra; Cheyenne 
Mining & Uranium Company v. Federal Resources Corporation, Wyo., 694 P.2d 65 
(1985); Amoco Production Company v. Stauffer Chemical Company of Wyoming, Wyo., 
612 P.2d 463 (1980). The purpose of interpretation or construction of any 
contract is to ascertain the true intent of the parties. Wolff v. Belco 
Development Corporation, supra; State v. Moncrief, supra; Cheyenne Mining & 
Uranium Company v. Federal Resources Corporation, supra. Unless the terms of the 
contract are ambiguous, the language used in the contract expresses and controls 
the intent of the parties. State v. Moncrief, supra; Amoco Production Company v. 
Stauffer Chemical Company of Wyoming, supra; 
Kuehne v. Samedan Oil Corporation, Wyo., 626 P.2d 1035 
(1981).

[¶8.]     It is correct, as the 
Board asserts, that the language of a contract is to be construed within the 
context in which it was written. In so doing, the court may look to the 
surrounding circumstances, the subject matter and the purpose of the contract. 
Cheyenne Mining & Uranium Company v. Federal Resources Corporation, supra; 
Dawson v. Meike, Wyo., 508 P.2d 15 (1973); Houghton v. Thompson, 57 Wyo. 196, 
115 P.2d 654 (1941); Pacific-Wyoming Oil Company v. Carter Oil Company, Wyo., 31 
Wyo. 314, 226 P. 193 (1924); Energy Oils, Inc. v. Montana Power Company, 626 F.2d 731 (9th Cir. 1980), quoting Liberty National Bank & Trust Company v. 
Bank of America Trust & Savings Association, 218 F.2d 831 (10th Cir. 1955). 
The purpose of examining the context within which the contract was drawn, 
however, is limited to ascertaining the intent of the parties at the time the 
agreement was made. The context cannot be invoked to contradict the clear 
meaning of the language used, and those extraneous circumstances do not justify 
a court in proceeding "to insert therein a provision other than or different 
from that which the language used clearly indicates, and thereby, in effect, 
make a contract for the parties." Snow v. Duxstad, 23 Wyo. 82, 147 P. 174, 184 
(1915). See also Arnold v. Mountain West Farm Bureau Mutual Insurance Company, 
Inc., Wyo., 707 P.2d 161 (1985); Adobe Oil & Gas Corporation v. Getter 
Trucking, Inc., Wyo., 676 P.2d 560 (1984); McCartney v. Malm, Wyo., 627 P.2d 1014 (1981).

[¶9.]     In order to justify 
examination of the contextual circumstances, the Board contends that the 
language of the lease is ambiguous and extrinsic evidence is necessary to 
determine the intention of the parties. Ambiguity in the lease would justify the 
examination of extrinsic evidence in order to arrive at the intention of the 
parties. State v. Moncrief, supra; Amoco Production Company v. Stauffer Chemical 
Company of Wyoming, supra. The ambiguity which justifies 
examining extrinsic evidence must exist, however, in the language of the 
document itself. It cannot be found in subsequent events or conduct of the 
parties, matters which are extrinsic evidence. State v. Moncrief, supra; Amoco 
Production Company v. Stauffer Chemical Company of Wyoming, supra. The 
suggestion that one should examine extrinsic evidence to determine whether 
extrinsic evidence may be examined is circuitous. Certainly, the proposition 
urged by the Board that we turn to the contracts entered into between CIG and 
Marathon and Pennzoil, respectively, to 
interpret the terms of the lease is inappropriate insofar as it is urged to 
structure an ambiguity.

[¶10.]  The district court in this case found 
that the lease was not ambiguous. Ambiguity in a document is a question of law 
which we must determine independently from the decision of the district court. 
Amoco Production Company v. Stauffer Chemical Company of Wyoming, supra. Our 
independent examination results in the same conclusion as that reached by the 
district court; this lease is not ambiguous with respect to when royalty 
payments are due.

[¶11.]  The language of the lease is that 
royalties are to be paid on gas "produced from said land saved and sold or used 
off the premises." In resolving ambiguity, we afford these terms their usual and 
accepted meaning unless it is clear that the parties intended some contrary 
meaning. Snow v. Duxstad, supra; Monsanto Company v. Tyrrell, Tex.Civ.App., 537 S.W.2d 135 (1976). The Board argues that both words, "produced" and "sold," are 
ambiguous in this lease and the Board's intent was that they should have a board 
construction which would include all proceeds relating to this gas whether or 
not actual production and sale had occurred. Pennzoil and Marathon do not concur in that assertion of 
intent.

[¶12.]  The parties to a contract are entitled to 
define its terms in a manner different from the common or established meaning. 
Snow v. Duxstad, supra. One court has invoked this proposition to determine that 
take-or-pay payments are within the federal statutory definition of production. 
See Diamond Shamrock Exploration Company, et al. v. Hodel, No. 86-537, decided 
January 23, 1987, U.S.D.C., E.D.La. (Opinion and Order not reported in F. Supp.) 
[Available on WESTLAW, 1987 WL 5986] (federal lease royalty payments due from 
take-or-pay payments under the definition of production provided in 43 U.S.C. § 
1331(m) (1986)). Cf. Mesa Petroleum Company v. United States Department of 
Interior, 647 F. Supp. 1350 (W.D.La. 1986) (determining that the same definition 
of production was not sufficient to include take-or-pay payments under a federal 
lease). Wyoming has no statutory definition of 
production, and the term is not specially defined in the lease. Consequently, we 
are satisfied that no meaning other than the common established meaning was 
intended pursuant to our examination of the entire lease. SeeState v. Moncrief, supra; Snow v. Duxstad, 
supra.

[¶13.]  The word "production" has an established 
legal meaning when used in a royalty or habendum clause of an oil and gas lease. 
"Production" requires severance of the mineral from the ground. Union Oil 
Company of California v. Touchet, 229 La. 316, 86 So. 2d 50 (1956); Monsanto 
Company v. Tyrrell, supra; Gulf Oil Corporation v. Reid, 161 Tex. 51, 337 S.W.2d 267 (1960); Saturn Oil and Gas Company v. Federal Power Commission, 250 F.2d 61, 
22 P.U.R.3d 123 (10th Cir. 1957), cert. denied 355 U.S. 956, 78 S. Ct. 542, 2 L. Ed. 2d 532 (1958); Mesa Petroleum Company v. United States Department of 
Interior, supra; Energy Oils Company, Inc. v. Montana Power Company, 
supra.

[¶14.]  Subsection 2(g) of the lease demonstrates 
that the parties intended the general meaning of "production." Pursuant to that 
provision, the lease royalty payments are not due until the twentieth day of the 
calendar month following the month of "production and removal and sale of oil 
and gas from said land * * *." This language manifests the proposition that 
royalties are due only upon physical extraction of the gas from the ground and 
its removal. The same clause continues with the provision that Marathon and Pennzoil are required to supply the Board 
with sworn monthly statements "showing in detail the quantity and quality of the 
production * * *." Such a statement cannot be furnished in the absence of the 
extraction of the gas from the land. Within the instrument, the term 
"production" has no use other than the established meaning requiring physical 
extraction of the mineral. There is nothing within this lease to manifest an 
ambiguity. If there were any arguable ambiguity in this aspect of the lease, any 
doubt would have to be resolved against the Board as the drafter of the lease. 
Kelliher v. Herman, Wyo., 701 P.2d 1157 (1985); Goodman v. Kelly, Wyo., 390 P.2d 244 
(1964); McGinnis v. General Petroleum Corporation, Wyo., 385 P.2d 198 
(1963).

[¶15.]  The Board attempts to find support for 
its argument by reliance upon language found in Cheyenne Mining & Uranium 
Company v. Federal Resources Corporation, supra, 694 P.2d  at 72. In that case, 
we said with respect to the phrase "mined and produced," that actual mining was 
immaterial so long as a promise to develop the mineral lease was present as well 
as sanctions for failure to develop. The only factual similarities between the 
lease found in Cheyenne Mining & Uranium Company v. Federal Resources 
Corporation, supra, and the lease presented in this case are in coincidental 
language. The unique situation presented in that case and the determination of 
the intent of the parties as expressed in the language of the lease examined in 
its entirety do not make it persuasive authority in this instance. The lease 
made by the Board manifests the intent of the parties that physical extraction 
of the gas from the leased tract is required before royalty payments can become 
due.

[¶16.]  The Board next argues that the 
requirement for the gas to be sold is an ambiguous term in the lease and that a 
proper interpretation would lead to the conclusion that this requirement is 
satisfied by the sale contracts between Marathon and Pennzoil and CIG. Usually, a "sale" is 
understood to require the passing of title manifesting the change in ownership. 
See § 34-21-206(a), W.S. 1977. In the absence of title to the property, one 
cannot lawfully sell it. In Wyoming, the right created by an oil and gas 
lease is a profit a prendre, connoting the right "to search for oil and gas and 
if either is found, to remove it from the land, * * *." Denver Joint Stock Land 
Bank of Denver v. Dixon, 57 Wyo. 523, 122 P.2d 842, 847, 140 A.L.R. 1270 (1942); Boatman v. Andre, 44 Wyo. 352, 12 P.2d 370, 
373 (1932). The Board does not contend that Marathon and Pennzoil attempted in any way to sell their 
interest in the lease. The only transaction that occurred between CIG and 
Marathon and Pennzoil, respectively, was an 
agreement to sell gas produced from the lease. Neither Pennzoil or Marathon could acquire any interest (title) in the gas 
which they could transfer to CIG until it was produced and severed from the 
land. It could not be produced and severed until it had been brought to the 
surface. Denver Joint Stock Land Bank of Denver 
v. Dixon, supra; Young v. Young, Wyo., 709 P.2d 1254 
(1985). The language of the lease, considered in its entirety, demonstrates that 
the intention of the parties was that royalty payments would be due only after 
the gas was sold or used, and no sale could be identified unless the gas was 
severed from the leased land.

[¶17.]  In presenting this argument, the Board 
again relies on statements from Cheyenne Mining & Uranium Company v. Federal 
Resources Corporation, supra, in an attempt to avoid the intent expressed in the 
language of the lease. We said in that case that the transfer of "`* * * the 
exclusive right to explore, develop, mine, extract and remove * * * and 
thereafter to retain all right, title and interest in and to all said severed 
minerals'" was a sale of the interest which, under the terms of the lease in 
that case, entitled the lessees to a portion of the profit derived from the 
sale. Cheyenne Mining & Uranium Company v. Federal Resources Corporation, 
supra, 694 P.2d  at 71. We do not perceive that the unique situation present in 
the facts of that earlier case is duplicated in this instance. The Board does 
not contend, indeed it could not, that in this instance there has occurred an 
actual sale of the leasehold interest such as was found in Cheyenne Mining & 
Uranium Company v. Federal Resources Corporation, supra. Reliance upon that 
authority does not lead to a conclusion that these parties intended that the 
royalties would be due before there was an actual sale or an actual use of this 
gas after physical extraction.

[¶18.]  The Board then urges, however, that there 
are other provisions manifesting an intent that royalty payments are due on any 
amount realized from any transaction relating to the oil and gas from the leased 
tract. The specific provisions suggested by the Board are the lessor approval 
clause and the federal floor clause, encompassed in this lease, which were 
construed in State v. Moncrief, supra. The Board claims that these clauses are 
relevant to a determination of whether royalty payments are due on take-or-pay 
payments. The pertinent part of the lessor approval clause is, "the value shall 
be as approved by the lessors." The Board contends that it would not approve any 
royalty which did not include take-or-pay payments. The federal floor clause 
relied upon says, "in no event shall the price for gas * * * be less than that 
received by the United States 
of America for its royalties from the same 
field." In invoking this provision, the Board contends that, since the federal 
government has required federal lessees to make royalty payments for take-or-pay 
payments under some federal leases, the same should be true under this lease. 
The Board has not provided any evidence in the record that the federal 
government was receiving royalties from take-or-pay payments relating to tracts 
in the same field as the lease involved in this case. More directly, the Board 
is straining the language of these two clauses to justify its position. As we 
said in State v. Moncrief, supra, these provisions are relevant to the 
determination of the value of the royalty to be paid. There is nothing to 
indicate that these provisions were intended by the parties to affect the time 
when royalty payments would be due. They do not contradict in any way the 
language of the royalty clause providing that payments are due only after 
production or sale or, alternatively, use of the gas.

[¶19.]  Next, the Board invokes a common sense 
and good faith premise for interpreting the lease. They urge that common sense 
requires a conclusion that the Board would not enter into a contract which 
permitted the lessees to receive proceeds in relation to the gas and foreclosed 
the lessor from any right to a portion of those proceeds. We accept the 
proposition that we are to interpret the contract in the light of common sense 
and good faith. Wolff v. Belco Development Corporation, supra; Marathon Oil 
Company v. Kleppe, 407 F. Supp. 1301 (D.Wyo. 1975), aff'd 556 F.2d 982 (10th 
Cir. 1977). Common sense and good faith do not demand a conclusion, however, 
that the Board would never enter into a contract which, in hindsight, is not the 
best arrangement that could have been made. The Board simply is requesting that 
this court rewrite the contract to encompass provisions that it would have 
included after learning of the take-or-pay payments. No rule of law justifies 
that resolution by this court.

[¶20.]  As a final argument, the Board invokes 
the proposition that the leased land is trust property dedicated to educational 
institutions in Wyoming. SeeState v. 
Moncrief, supra; Mayor v. Board of Land Commissioners, 64 Wyo. 409, 192 P.2d 403, 
reh. denied 64 Wyo. 430, 195 P.2d 752 (1948); 
State ex rel. Huckfeldt v. State Board of School Land Commissioners, 20 
Wyo. 162, 122 P. 94 (1912). As trustee, the Board reminds us of its duty to obtain the largest 
possible return from any leases entered into of the trust property. SeeState v. Moncrief, supra. The Board then 
urges that, in its role as trustee, it would not enter into any lease in which 
it did not receive full value for its interest. This contention also is a simple 
request to the court that the lease be rewritten to adjust to this proposition. 
As we have previously set forth, we cannot do that.

[¶21.]  As our precedent dictates, we have 
examined and interpreted this lease in accordance with the general principles 
applicable to the interpretation of contracts. We agree with the district court 
that this lease is not ambiguous. By its clear terms, it manifests the intention 
of the parties that royalty payments were to be made only in the event of 
production from the lease, that is, after physical extraction of the gas from 
the land and its sale or use. No argument is presented that either Marathon or Pennzoil have failed to develop the lease in a 
reasonably commercial manner. The appropriate remedy for such a claim would be 
an action for breach of the implied covenant of a reasonable development. See 
Wolff v. Belco Development Corporation, supra. Certainly, the Board could have 
included a provision requiring that the proceeds of take-or-pay payments be 
subject to its royalty clause. This lease does not contain a provision like 
that, and there is nothing else in the lease to indicate the intention that such 
royalty payments are required.

[¶22.]  The Board contends that take-or-pay 
payments are advance payments for gas. Pennzoil and Marathon argue that this essentially is a penalty 
provision in the gas sales contract. We recognize that those contracts between 
Marathon and Pennzoil and CIG encompass at 
least one scenario in which payments would be required and no gas would be 
received in exchange for those payments. It is not necessary for us to resolve 
this issue, however, in view of our conclusion that there has been no production 
and sale of this gas to trigger the requirement to pay 
royalties.

[¶23.]  The judgment of the district court is 
affirmed.

FOOTNOTES

1 This oil and gas lease 
has been reviewed by this court previously in State v. Moncrief, Wyo., 720 P.2d 470 (1986). In that case, the 
same royalty clause was in issue and required interpretation. The question 
concerned the value, under the terms of the lease, of gas actually produced and 
sold.

2 A take-or-pay contract 
is:

"A contract whereby a 
purchaser agrees to take a minimum quantity of oil or gas over a specified term 
at a fixed price (or at a fluctuating price which cannot be reduced below a 
specified level) or to make minimum periodic payments to the producer even 
though oil and gas is not being delivered to the purchaser." 8 H. Williams & 
C. Meyers, Oil and Gas Law at 979 (1987).

Such contracts 
are discussed in the same work at 4 H. Williams & C. Meyers, Oil and Gas Law 
§ 724.5 at 659-661 (1986).

3 Make-up gas 
is:

"(1) Gas that is taken in 
succeeding years having been paid for previously under a TAKE-OR-PAY CLAUSE in a 
GAS PURCHASE CONTRACT. The contract will normally specify the number of years 
after payment in which the purchaser can take delivery of make-up gas without 
paying a second time." 8 H. Williams & C. Meyers, Oil and Gas Law at 539 
(1987).

The function of 
this clause is discussed at 4 H. Williams & C. Meyers, Oil and Gas Law § 
724.5 at 665 (1985).

4 After the decision in 
this case by the district court, Marathon and 
Pennzoil negotiated with CIG with respect to the enforceability of the 
take-or-pay clauses. They agreed that CIG was relieved from any failure to take 
the specified amount in previous years. The dispute between CIG and Marathon and 
Pennzoil with respect to the enforceability of the take-or-pay clauses resulted 
in Marathon returning any payments made by CIG under Marathon's take-or-pay clause. Pennzoil advised that it 
had not received any payments from CIG under its take-or-pay clause.