Opinion ID: 1265995
Heading Depth: 1
Heading Rank: 9

Heading: the lease contracts

Text: It is fundamental that royalty due a lessor-landowner is controlled by the terms of the gas lease. Such leases are contracts. They are governed by the common law of this jurisdiction. I am not unmindful of the well-established rules for the interpretation and construction of contracts. The cardinal rule is to ascertain the intention of the parties at the time they entered into the contract and to give effect to that intention if it can be done consistent with legal principles. See, e.g., Mobile Acres, Inc. v. Kurata, 211 Kan. 833, 508 P.2d 889; First National Bank of Lawrence v. Methodist Home for the Aged, 181 Kan. 100, 309 P.2d 389. Courts first look to the language used by the parties to ascertain their intent. The language of an oil and gas lease contract will be given its ordinary and commonly understood meaning when no reason appears for doing otherwise. Skelly Oil Co. v. Savage, 202 Kan. 239, 447 P.2d 395, 38 ALR 3d 971; Collier v. Monger, 75 Kan. 550, 89 Pac. 1011. In my judgment, the fact that the FPC rate is totally unrelated to the commodity which serves as the basis for royalty provides ample reason for doing otherwise. In the face of the paradox created by using a cost basis utility rate as the measure of royalty for the gas produced, this court is fully warranted in construing these lease contracts to ascertain what the parties intended. The foregoing portions of this dissent clearly show these proceeds lease contracts may be understood to reach a meaning other than that ascribed by the majority. Where the language of a lease may be understood to reach two or more possible meanings, resort to rules of construction is proper. The circumstances and conditions existing when an agreement was made may sometimes aid the court in clarifying the real intentions of the parties. E.g., Amortibanc Investment Co. v. Jehan, 220 Kan. 33, 551 P.2d 918; Skelly Oil Co. v. Savage, supra. The proceeds leases in question were executed during the period of January 11, 1938, to November 18, 1942. The Natural Gas Act was enacted on June 21, 1938. 15 U.S.C. § 717 et seq. It was not until June 7, 1954, in the decision of Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672, 98 L.Ed. 1035, 74 S.Ct. 794, that the United States Supreme Court determined the Federal Power Commission was authorized under the Natural Gas Act to regulate the rates chargeable by the lessee now before this court. It is obvious that when the parties executed the leases, they intended the proceeds would result from a sale in an unregulated market. In the free market, it is the gas that commands the amount received by the producer, rather than an artificial rate based upon production cost factors and determined as a matter of utility rate setting for the benefit of the ultimate consumer. It seems clearly contrary to the intention of the parties to say that the measure of royalty under the proceeds leases should be the FPC regulated utility rate received for the gas produced. Instead, it may be said the parties intended the lessors' royalty share of production denominated as proceeds from the sale of gas would result from a sale in an unregulated market and be based on gas produced and related to the value of that gas. Another aid in construing provisions of a contract susceptible to more than one meaning is the conduct of the parties thereto subsequent to its execution. When such terms have been construed and acted upon by the parties themselves, such construction will be adopted, even though the language used may more strongly suggest another construction. Desbien v. Penokee Farmers Union Cooperative Association, 220 Kan. 358, 552 P.2d 917. The district court found the conduct of the parties reflected an intention that royalty be based on the value of the gas. That finding is supported by substantial evidence. From the time production on these leases started until June 30, 1953, the gathering system utilized for delivery of the gas to the pipeline purchaser was owned by the lessee-producer. Sales, therefore, were not at the wellhead, but off the leased premises. The price paid for the gas and the basis for royalty was the price established by contract between the lessee-producer and the pipeline purchaser. The contract price and measure for royalty were related to and determined by the value of the gas produced. On June 30, 1953, the producer and pipeline entered into a contract transferring the gathering system to the pipeline. Sales were thereafter at the wellhead. On that same date, the contracts governing the sale of gas from producer to pipeline were amended. The contract price was increased substantially. Royalty payments under the amended contracts were again based on the contract price which was determined by the market value of the gas. The foregoing conduct does not bear out the assertion the parties intended royalty payments be based on the producer's cost of production  the FPC rate. In transferring its gathering system to the pipeline, the producer decreased its costs. Yet the contract prices renegotiated at the same time were increased. It is clear that producer costs were not material to the basis for royalty payments. The history of royalty payments under the leases clearly shows a practice of measuring royalty against the value of the gas without reference to costs. Royalty payments were the same under all the leases, whatever the language of the royalty clause. Another rule of construction deserves consideration. In construing a contract, reasonable rather than unreasonable interpretations are favored by the law, and results which vitiate the purpose or reduce the terms of the contract to an absurdity should be avoided. Garvey Center, Inc. v. Food Specialties, Inc., 214 Kan. 224, 519 P.2d 646. It cannot be disputed the FPC rate in no way reflects the value of the commodity gas. Neither can it be disputed that the rate is paid for development and production costs and not for the gas itself. It is manifestly clear that to allow such a rate to serve as the basis for royalty totally divorces royalty from the commodity on which it is based. This is an absurdity. An equally unreasonable result is illustrated by the three leases in the Flower case. These three leases were made subject to a unitization agreement. Accordingly, all acreage burdened by those three leases is in a single unit, and gas produced from the three leases is from a single well. One of the leases is market value; the other two, proceeds. Under the majority opinion, the same gas from the same well will be subjected to two different measures for determining the royalty payments due lessors. To interpret these proceeds leases as calling for the FPC ceiling rate as the measure of proceeds is unreasonable for an even more basic reason. The federal courts have held the FPC has no jurisdiction over the lease contract between landowner and producer nor over the payment of royalty thereunder. These same courts have said that the FPC ceiling sets no limit on the measure of royalty under the leases. To say, as does the majority, that the FPC rate is the measure of royalty under these proceeds leases is to do by indirection what the federal courts did not do directly. The majority's interpretation of these lease contracts is restrictive, unwarranted and unwise. It renders the judicial and administrative proceedings culminating in Mobil Oil Corporation v. Federal Power Commission, supra, an exercise in futility. Royalty payments, at the FPC ceiling rate which were held inapplicable in Mobil for lack of jurisdiction, have now been reinstated by the majority of this court as the basis of proceeds royalty payments. One final rule of construction should be noted. The construction of an oil and gas lease subject to more than one interpretation is in favor of the lessor and against the lessee. Gilmore v. Superior Oil Co., 192 Kan. 388, 388 P.2d 602. The reason for this rule is simple. The lessor almost never has a part in the preparation of the lease; the lessee, who either prepared the lease or chose the form, has the opportunity to protect itself through the language employed in the lease. Construing these proceeds leases in favor of the lessors brings me back to where this dissent began. Royalty arises from the gas produced and its measure is related to the value of that gas. From the lessee's proceeds, the lessor's royalty share is to be paid on the basis of the market value at the well as evidenced by the arbitrated contract prices. Proceeds from the sale of gas must be construed to mean proceeds obtained or obtainable in the absence of cost-oriented regulation of the producer. Proceeds from the sale of gas must mean proceeds at the prevailing market value.