Opinion ID: 2616229
Heading Depth: 1
Heading Rank: 5

Heading: impairment of contractual obligations

Text: We next address Amerada's contention that the Act impairs the obligations of contracts in violation of the Contract Clause of the federal and state constitutions. [25] In making this argument, Amerada maintains first that the Act creates a class of third party beneficiaries who benefit from existing gas purchase contracts contrary to the intention of the parties to the contract as required by 15 O.S. 1981 § 29. It points out that under the Act a non-contracting party benefits under the contract but has no apparent burdens. Consequently, in times of upward market price adjustment he would be free to sell his gas to another purchaser for a higher price than that provided in the contract from which he is benefitting, as his acreage would not be dedicated to the purchaser under the contract. As set forth in Part IV of this opinion, 15 O.S. 1981 § 29 does not support this argument. Nor does 52 O.S. Supp.1983 § 542 support this position. The non-contracting party may reject an offer presented by the operator to purchase the gas; or if the operator has failed to present an offer within 120 days, after the non-contracting party has elected to allow the operator to market the gas, the election may be rescinded in writing. A non-contracting party, who has accepted an offer to purchase gas is bound by the agreement. Furthermore, we do not believe the Act creates a third party beneficiary contract. On the contrary, it affords no right to a third party to sue on another's contract. The benefits to the non-contracting party arise incidentally to the performance of the contract due to the rights created by the Act. Accordingly, Amerada's challenge under 15 O.S. 1981 § 29 has no merit. Secondly, Amerada asserts the Act impairs the obligations under the royalty clause contained in many existing oil and gas leases which generally provide for allocation of production from a well on a unit basis for owners of royalty interests and an allocation on a tract basis for owners of working interests. Under this scheme of allocation pursuant to this Court's interpretation of 52 O.S. 1961 § 87.1 in Shell Oil Co. v. Corporation Commission, 389 P.2d 951 (Okla.1963), all burdens on the various working interests, other than the statutorily recognized one-eighth royalty paid proportionately by each working interest owner to each holder of a royalty interest in a well, were satisfied from the portion of production allocated to the working interest to which they were attached. In Shell Oil Co., supra, this Court interpreted the statutory scheme of allocation as superseding the terms of lease agreements as understood by the industry. Although the industry may have arranged its affairs in accordance with the Shell Oil Co. case, the current scheme is likewise subject to subsequent actions of the Legislature which may also have a disturbing effect. We simply cannot agree that parties have an accrued right to an allocation of proceeds of gas pursuant to Section 87.1 as interpreted in Shell Oil Co. The statutory allocation scheme which altered existing contract terms, like all legislation setting forth the terms on which private parties may execute contracts, is subject to revision or repeal. Moreover, the existence of an atmosphere of pervasive regulation of the natural gas industry [26] strongly suggests the parties had no legitimate expectation that the statutory scheme was a stable, unchanging one. Interest owners thus must hold their interests with the knowledge that the State retains substantial regulatory power over those interests. [27] Thirdly, Amerada asserts the Act unconstitutionally impairs contract rights because it modifies the terms of the standard operating agreement by converting the operator's right to sell gas on behalf of owners who do not have a contract into an obligation. In addition, it argues the Act eliminates the right of an interest owner to take gas in kind and separately dispose of his own share of production which owners generally had under the operating agreement. It notes Section 544 of the Act requires an owner taking in kind to share his market immediately with other owners in the unit and then argues this arbitrary across the board application, irrespective of particular circumstances, does not allow equitable balancing pursuant to long standing custom and practice in the industry. In connection with custom within the industry, we have stated: Custom or usage repugnant to expressed provisions of statute is void. [28] Accordingly, no amount of custom can be the basis for our decision herein. We therefore cannot conclude that the Legislature impaired a private contractual right simply by enacting legislation that was contrary to industry custom and practice. Moreover, Section 542(D) expressly provides: Nothing in this act shall be construed to prevent any owner or owners... from taking their share of production in kind or separately disposing of their share. The United States Supreme Court has addressed Contract Clause challenges to oil and gas state legislation in two recent opinions. In Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400, 103 S.Ct. 697, 74 L.Ed.2d 569 (1983), the Court upheld the constitutionality of a Kansas act which imposed price controls on the intrastate gas market with regard to contracts executed before April 20, 1977, and prohibited consideration either of ceiling prices set by federal authorities or of prices paid in Kansas under other contracts in the application of governmental price escalator and price redetermination clauses. In 1975, a natural gas producer had entered into intrastate gas sales contracts with a public utility which contained a governmental price escalator clause and a price redetermination clause. The Court rejected the public utility's argument that the Kansas act violated the Contract Clause because it diminished the effect of the indefinite escalator clause in the contracts by limiting the increases allowed under the Natural Gas Policy Act (NGPA). No sufficient impairment of the public utility's contract was found to give rise to a Contract Clause challenge. The two factors which influenced the Court's decision were, first, the finding that it was highly unlikely at the time of execution of the contracts that the public utility anticipated the deregulation of gas prices introduced by the NGPA and; thus, the public utility did not have a reasonable expectation to receive deregulated prices which would have been impaired by the Kansas act. And, second, the parties were operating in a heavily regulated industry; therefore, the public utility knew its contractual rights were subject to alteration by state price regulation. In Exxon Corp. v. Eagerton, 462 U.S. 176, 103 S.Ct. 2296, 76 L.Ed.2d 497 (1983), the Alabama statute under review increased the severance tax on oil and gas extracted from Alabama wells, exempted royalty owners from the increase and prohibited producers from passing on the increase to their purchasers. The Court held the royalty owner exemption and the pass-through prohibition did not impair the obligations of contracts in violation of the Contract Clause. Although the Court found the pass-through prohibition affected contractual obligations of which producers were beneficiaries, it concluded the prohibition did not offend the Contract Clause. The Court noted as the distinguishing factor in this case: [T]he pass-through prohibition did not prescribe a rule limited in effect to contractual obligations or remedies, but instead imposed a generally applicable rule of conduct designed to advance `a broad societal interest' protecting consumers from excessive prices. Exxon Corp., 462 U.S. at 191, 103 S.Ct. at 2306 (Citation omitted). In footnote the Court stated its conclusion was buttressed by the fact that appellants operate in industries that have been subject to heavy regulation. The essence of the appropriate Contract Clause standard articulated by the Court in these two cases is as follows: The threshold determination is whether the legislation has substantially impaired contractual rights. If no substantial impairment exists, the analysis is at an end and the legislation is upheld. If substantial impairment is found, it is justified only if the State's legislation is addressed to a significant and legitimate public purpose ... such as the remedying of a broad and general social or economic problem [29] and the means selected to achieve that end is based `upon reasonable conditions and [is] of a character appropriate to the public purpose justifying [the legislation's] adoption.' [30] The determination of the necessity and reasonableness of the means chosen is deferred to legislative judgment unless the state itself is a contracting party. Applying this standard to the present case, our initial determination is whether the Act has, in fact, operated as a substantial impairment of a contractual relationship. In determining the severity of the impairment consideration is given to the parties' reliance upon the contractual rights and obligations allegedly impaired. [31] Amerada asserts the Act substantially impairs existing contractual relationships in that it negates the right accorded by a joint operating agreement to every party to the agreement to take in kind or separately dispose of his share of production and retain the benefits, i.e., production revenues, of such right. It further contends that such parties possessed a legitimate contractual expectation that such right was secure and not subject to being abrogated by subsequent legislation. We disagree. The State of Oklahoma like the State of Kansas in Energy Reserves Group, Inc., has extensively and continuously regulated the natural gas industry. Although Oklahoma has not required a ratable sharing of proceeds specifically, it has regulated production and purchasing in the industry. Much of Amerada's assertions necessarily fall with our foregoing conclusion that the parties could not have reasonably expected that their contractual rights were immune from alteration by subsequent State regulation. We thus find Amerada's reasonable expectations have not been substantially impaired by the Act. Even if an impairment were found, the Act was enacted to protect a broad societal interest, i.e., the protection of correlative rights. We are not persuaded by Amerada's contention that the Act is nothing more than special interest legislation. To the contrary, the Act imposes a general rule of conduct for the natural gas industry.