Opinion ID: 2633380
Heading Depth: 2
Heading Rank: 4

Heading: Jury Instruction Regarding Marketability

Text: We have defined marketability as requiring that the gas be in a physical condition acceptable to be exchanged in a commercial market, and also in a location, the commercial marketplace, where the gas is commercially saleable. Here, we consider the jury instructions given by the trial court, and the court of appeals' analysis of those instructions, including the portion of the instruction related to the lessors' claims of bad faith by the lessees. We review the instructions to determine whether the trial court adequately instructed the jury on the issue of marketability. We conclude that it did not. We commence our discussion of the jury instructions with the court of appeals' conclusions. The court of appeals analyzed the issue of marketability based on the jury instruction given by the trial court. [22] The court of appeals held that the jury instruction was erroneous, because it concluded that under Garman, marketability is to be determined solely based on the condition of the gas. Rogers, 986 P.2d at 973. Because the jury instruction included a reference to the good faith of the lessee, and to whether the actions of the parties were consistent with their reasonable expectations under the lease, the court of appeals concluded that it was in error. Accordingly, the court of appeals concluded that the instruction was erroneous because it combined the two issues related to marketability for consideration by the jury. Id. Notwithstanding its finding of error, however, the court of appeals considered the effect of this error on the lessors' claims. The court of appeals concluded that, with respect to sales at the wellhead, the erroneous instruction did not prejudice either party for two reasons. Id. at 974. First, the court of appeals reasoned that the lessors had not raised a valid claim that the gas was not marketable at the well because some of the gas was actually sold at the well. Thus, the court of appeals concluded that because the gas was sold, it must be marketable. Id. Second, the court of appeals concluded that the only valid claim that the lessors could assert with respect to sales at the well was that the lessees acted unreasonably or in bad faith in selling the gas at the well. Thus, the court of appeals suggested that the jury, by determining that the gas was marketable at the well based on the instruction given, implicitly found that the lessees had acted reasonably and in good faith. Thus, the court of appeals concluded that the instruction was not prejudicial to either party. Id. With respect to sales away from the well, however, the court of appeals determined that there was a more fundamental defect than the jury instruction itself. The court of appeals held that the trial court erred in submitting the issue of whether the gas was in a marketable condition to the jury with respect to sales away from the well, because the court of appeals concluded that the gas was marketable at the well as a matter of law. Id. Therefore, the court of appeals concluded that, because the gas was marketable at the well, all costs incurred subsequently were transportation costs, and thus, were deductible as a matter of law. Accordingly, the court of appeals held that because there was no issue of fact to be resolved, this question should not have been submitted to the jury. Id. at 974-75. We first address the court of appeals' conclusion that the gas was marketable at the well as a matter of law, and thus, its determination that the marketability issue should not have been submitted to the jury with respect to gas sold away from the well. We disagree with the court of appeals, and conclude that the court of appeals erred in several aspects of this holding. First, we disagree with the court of appeals' conclusion that the gas was marketable as a matter of law. As we have previously stated, the question of marketability is one of fact, not law. Garman, 886 P.2d at 661 n. 28; Anderson, Part 2, supra, at 642. Thus, we disagree with the court of appeals' further conclusion that the costs at issue were properly deducted from the royalty calculations as a matter of law. Moreover, we hold that because the issue of whether gas is marketable is a factual inquiry, it was properly submitted to the jury. Second, we disagree with the court of appeals' application of the first-marketable product theory. While it is true that Anderson suggests that the costs of compression should not always be borne by the lessee, and that transportation costs to a distant market should be shared by the lessor and the lessee, we have concluded, and Anderson agrees, that whether costs are deductible is based on whether a first-marketable product has been obtained, not on the label associated with any particular cost. See Anderson, Part 2, supra, at 640, 668-69, 682. Moreover, Anderson indicates that the determination of when gas is first-marketable is a question of fact, not a question of law, as suggested by the court of appeals. Id. at 642. Likewise, The dissent in Mittelstaedt advocates that Oklahoma should adopt the first-marketable product rule. Mittelstaedt, 954 P.2d at 1211 (Opala, J., dissenting), not a rule that suggests that certain costs are deductible as a matter of law. Thus, we disagree with the court of appeals' application of the first-marketable product rule and the inconsistent conclusion that certain costs are deductible as a matter of law. Finally, the court of appeals concluded that the gas was marketable at the physical location of the well, and as such, all costs incurred subsequently should be shared by the lessee and lessor. Such a conclusion was essentially an adoption of the reasoning followed in other states which contend that the point of marketability is at the physical location of the well. See generally Martin v. Glass, 571 F.Supp. 1406 (N.D.Tex.1983); Merritt v. Southwestern Elec. Power Co., 499 So.2d 210 (La.Ct.App.1986). In Garman, we rejected those cases and declined to follow the reasoning therein. Garman, 886 P.2d at 659-61. We confirm our reasoning in Garman here with respect to that line of cases, and as such, suggest that the court of appeals should not have adopted those cases in support of its analysis. Having confirmed that the issue of whether gas is marketable is a question of fact, and as such, was properly submitted to the jury with respect to all of the gas at issue in this case, we now analyze the actual instructions given to the jury regarding marketability. We first discuss the issue of whether the trial court's instruction to the jury was erroneous. The court of appeals suggested that the instruction was erroneous because it combined the issue of whether the gas was marketable with the issue of whether the lessees acted in good faith. We agree that this combination rendered the instruction erroneous. Whether the lessees acted in bad faith is a separate issue from the determination of marketability for the purposes of determining allocation of costs and calculating royalty payments. An analysis of marketability allows for a determination of the proper allocation of costs, and thus, defines the calculation of royalty payments. In contrast, the bad faith of a lessee implicates the sale price of certain gas, either for less than it was worth, or to a related party for an artificially low price. Thus, in determining whether a lessee acted in bad faith, the focus is on the sale price of the gas, and what a fair sale price would have been had the lessee acted in good faith. A bad faith claim raises the issue of improper receipt and distribution of royalty payments, not calculation of the allocation of costs. Thus, a bad faith claim does not implicate allocation of costs in the first instance. Instead, a bad faith claim raises the issue of determining what a fair price would have been had the gas been sold in good faith. A lessee's duty of good faith and fair dealing in performance of an oil and gas lease has developed through the law of implied covenants arising from contract law in general. See 5 Williams & Meyers, supra,  802.1, at 8-14. In Colorado, every contract contains an implied duty of good faith and fair dealing. Amoco Oil Co. v. Ervin, 908 P.2d 493, 498 (Colo.1995); see also Farmers Group, Inc., v. Trimble, 691 P.2d 1138, 1141 (Colo.1984)(insurer has duty to act in good faith and fair dealing under implied covenant in insurance contract). As previously noted, with respect to oil and gas leases, Colorado has adopted a prudent-operator standard for analysis of performance of implied lease covenants. Mountain States Oil Corp. v. Sandoval, 109 Colo. 401, 125 P.2d 964 (1942); 5 Williams & Meyers, supra,  806.3, at 37. Regardless of the characterization of the lessee's duty as one requiring good faith and fair dealing, or acting as a prudent operator, analysis of the lessee's duty in either context relates to whether the lessee has breached that duty. See Davis v. Cramer, 808 P.2d 358, 363 (Colo.1991)(discussing that the implied covenant to market requires the lessee to act with reasonable diligence, and remanding the case to the court of appeals for determination of whether covenant was breached by lessee). The issue that we are faced with on certiorari is not whether the lessees breached an implied covenant to market with respect to their conduct in selling the gas, and not whether the jury instruction was adequate with respect to any potential breach of duty. Rather, the issue here is whether the jury instruction adequately defined marketability, in order for the jury to determine whether the gas was, in fact, marketable, and ultimately for the jury to determine the proper royalty calculations. As we have discussed, the determination of whether gas is marketable is a question of fact, and must be determined based on a condition and location in a commercial market. The commercial market and the condition of the gas dictates the marketability of the gas, not the independent actions of a particular lessee. Thus, under the circumstances where bad faith of a lessee is at issue, it should be addressed and instructed separately from the issue of whether the gas is marketable. [23] In the event a jury found that a lessee had acted in bad faith, the focus would then become what a fair market price for the gas would have been, and also what the payment to the lessors should have been, had the lessee acted in good faith. The issue of proper allocation of costs is not implicated under the circumstances where bad faith of a lessee is raised. Thus, any bad faith issues regarding the lessees' conduct are separate and distinct from the issue of where and when the gas was marketable, and therefore, should not have been included in the jury instruction given in this case related to marketability. Instead, issues related to the bad faith of the lessees should have been addressed and instructed separately. [24] We conclude that the instructions were erroneous for other reasons as well. Under Colorado law, all of the trial court's instructions are to be considered as a whole when determining whether the necessary law has been properly stated to the jury. Montgomery Ward & Co. v. Kerns, 172 Colo. 59, 63, 470 P.2d 34, 36-37 (1970). However, the form and style of the instructions is within the trial court's discretion. Id. at 63-64, 470 P.2d at 37. A judgment will not be reversed for refusal of the trial court to give requested instructions where there was not resulting substantial, prejudicial error. Armentrout v. FMC Corp., 842 P.2d 175, 186 (Colo.1992). Review of the language of the jury instruction regarding marketability, in conjunction with the other instructions related to marketability, reveals that the jury was not properly instructed as to the necessary law. The language of the jury instruction at issue required the jury to evaluate marketability based on the condition of the gas. [25] The instruction stated that gas is marketable when it is fit to be offered for sale in a market. It defines fit to be offered for sale by indicating that it must be sufficiently free from impurities that it will be taken by a purchaser, and that it may be justly and lawfully bought and sold. The justly and lawfully bought and sold requirement looks to the actions of the lessees, and requires that they act in good faith and fair dealing, and in a manner so as to satisfy the lessors' reasonable expectations under the lease (hereinafter the good faith requirement). When read carefully, it becomes clear that the instruction requests the jury to consider whether the gas is marketable based on the condition that it be taken by a purchaser. This language suggests that a single purchaser may be sufficient to establish that the gas is marketable. This suggestion is further solidified by the inclusion of the good faith requirement in the instruction. The good faith requirement suggests that as long as the lessees find a purchaser, and act in good faith and fair dealing in selling the gas to such a purchaser, that the gas is marketable. Under this instruction, it appears that any purchaser will suffice, so long as the purchase agreement was made in good faith by the lessees. Thus, this instruction erroneously requires the jury to consider whether the gas is marketable based on whether a single purchaser exists, and whether the lessees acted in good faith in selling the gas to that purchaser. Moreover, as we have discussed, the instruction erroneously requires the jury to consider whether the lessees acted in good faith in selecting a purchaser. This instruction is too narrowly tailored, and is limited to the actions of the lessees. It fails to address the broader concept of marketability. In other words, the instruction should have required the jury to analyze whether the gas was marketable by looking at more than just the sale of the gas by the lessees in this case. Whether the gas is marketable or not is a much broader question of fact, to be resolved based on whether there is a commercially viable market for the gas. While we agree that a single purchaser, in a good faith purchase of gas, is evidence that there is a market for the gas, we do not agree that such a purchase conclusively establishes a market. The determination of whether a market exists is an issue of fact to be decided by a jury, based on the facts and circumstances, which may include factors other than a single purchase of gas. The jury instruction here erroneously implies that one sale to a purchaser in good faith establishes marketability. Instead, under our definition of marketability, the gas must be in such a physical condition and location that it is available for commercial exchange, in a viable market, i.e., a commercial marketplace. Moreover, if the instruction sufficiently advised the jury that in order to be marketable the gas must be available for sale in a commercial market, there would be no need for the good faith requirement. This is because the good faith notion is inherent in a commercial market. Thus, if the instruction were intended to define marketability in the context of a commercial market, the good faith requirement would be unnecessary. The interpretation that the instruction at issue failed to adequately define marketability is further supported by looking at the other instructions given to the jury related to marketability. See Montgomery Ward & Co., 172 Colo. at 63, 470 P.2d at 36-37. Specifically, Instruction 15 stated that gas can be marketable at more than one point in the field and in the production and distribution process. In general, we agree that this is an accurate statement. However, this instruction, in combination with the marketability instruction providing that gas is marketable when it is in a condition that it will be taken by a purchaser, suggests to the jury that the gas is marketable anywhere and anytime it is sold to a purchaser at any point in the field or process. Similarly, Instruction 17 provides that the jury, having heard evidence relating to both gas which was sold at the wells, and gas which was sold away from the wells, must apply the instructions to gas which has been sold in each place. By referring to gas being sold, this instruction, in combination with the others, suggests that gas may be marketable assuming it is sold to a purchaser in good faith. Gas is not marketable merely because it is sold. Moreover, this instruction further emphasizes that the single sale of gas at a particular location determines marketability. Thus, it adds to the notion that the jury was instructed that marketability can be established by a single sale to a purchaser in good faith. As we have discussed above, such a definition of marketability is erroneous. Accordingly, we conclude that the instruction was erroneous with respect to marketability and allocation of costs, and thus, the jury was not adequately instructed on the appropriate law. Having found the instruction was erroneous, we next discuss whether such error was substantial and prejudicial. We disagree with the court of appeals that the error was not prejudicial. Instead, we conclude that the error was both substantial and prejudicial, and thus requires reversal. We first address the court of appeals conclusion that the erroneous instruction was not prejudicial with respect to gas sold at the well because of the fact that the gas was sold meant that it was marketable. We disagree with this analysis. There is a difference between marketing and selling a product. California Co. v. Udall, 296 F.2d 384, 388 (C.A.D.C.1961). For marketing, there must be a market, which has been defined as an established demand for an identified product. Id. With respect to sales, almost anything can be sold, if the price is no consideration. Id. In Udall, the court found that the record suggested that there was no market for the gas as it emerged from the well, but instead, the only market was for gas at a certain pressure, and certain minimum water and hydrocarbon content. Id. Thus, the gas must be more than merely sold in order for the lessee to meet the duty to market the gas. Instead, as previously discussed, the gas must meet the standard of being suitable for a commercial market. Marketability of the product may be affected because the quality of the raw gas is impaired by the presence of impurities. In this instance, it should be necessary to determine if there is a commercial market for the raw gas. If there is a commercial market, then a marketable product has been produced and further processing to improve the product should be treated as refining to increase the value of the marketable product. If there is no commercial market for the raw gas, the lessee's responsibilities theoretically have not ended, and the lessee should bear the costs of making the gas marketable. 3 Kuntz, supra,  40.5 at 351. Moreover, as we have previously determined, marketability is a question of fact, not law. Thus, we disagree with the court of appeals' conclusion that the gas was marketable based solely on the fact that it was sold, and as such, disagree with the court of appeals' conclusion that the instruction was not prejudicial on this basis. The court of appeals also concluded that the instruction was not prejudicial with respect to the sale of the gas at the well because under the good faith requirement of the instruction, the jury must have found that the lessees acted both reasonably and in good faith regarding those sales. Accordingly, the court of appeals concluded that there was no prejudice to either party resulting from the instruction. Rogers, 986 P.2d at 974. We agree with the court of appeals that the trial court erred in including the lessors' bad faith claim in the instruction regarding marketability. However, we disagree with the court of appeals that there was no prejudice to either party with respect to the bad faith claim regarding this instruction. Although the instruction required the jury to consider the lessees' behavior in selling the gas, and make an assessment as to whether the lessees acted in good faith, it did not require the jury to consider the lessees' conduct apart from the issue of whether the gas was marketable. Instead, the marketability instruction combined the two claims, and thus, did not allow for either claim to be independently resolved by the jury. The jury was only allowed to consider the potential bad faith of the lessees in the context of whether the gas was marketable. As we have previously discussed, any claims of bad faith regarding the lessees' conduct are separate and distinct from the issue of whether the gas was marketable. It is possible, as the court of appeals suggested, that by finding that the gas was marketable both at the well and away from the well, the jury may have found that the lessees had not acted in bad faith. However, because the instructions did not address the claims raised by the lessors separately, it may also be possible that the jury did not fully consider the lessees' conduct. The language in the instruction did not refer to the claim that the gas was sold at an artificially low price, nor did it refer to the claim that the gas was sold to an affiliated purchaser. As such, it is unlikely that the jury considered whether the lessees acted in bad faith based on the actual allegations raised by the lessors in this litigation. Thus, the instruction was prejudicial and substantial with respect to the bad faith claim. Accordingly, we disagree with the court of appeals and conclude that the bad faith claim was not effectively resolved by the jury, since there was no separate instruction given to the jury addressing bad faith. Therefore, because the error in the jury instruction was both substantial and prejudicial with respect to the bad faith claim, the trial court judgment must be reversed. In addition, we believe that the error created by the jury instruction with respect to allocation of costs was both substantial and prejudicial. First, the instruction confused two separate claims at issue in this case. As we explained above, the instruction erroneously combined the issue of whether the gas was marketable with the issue of whether the lessees acted in bad faith. Resolution of whether the gas is marketable leads to the determination of the proper allocation of costs for the purposes of calculating royalties. Alternatively, the determination of whether the lessees acted in bad faith looks at the particular conduct of the lessee and requires an assessment of what actions the lessee should have taken. The bad faith of a lessee does not determine allocation of costs for a royalty calculation. Thus, the combination of the two concepts led to confusion and misunderstanding by the jury regarding the determination of whether the gas was marketable, [26] and was therefore substantial and prejudicial error. In addition, as we previously explained, the instructions as a whole focused the analysis of marketability on whether a single purchaser bought the gas in a good faith transaction, [27] not on whether there was a commercial market for the gas. Accordingly, the jury's determination of whether the gas was marketable was not based on correct law, and thus, resulted in inconsistent findings by the jury. The harm resulting from this instruction was both substantial, in that the jury reached two inconsistent conclusions, and prejudicial, in that it did not result in a determination of whether the gas was, in fact, marketable. Moreover, the instructions, when reviewed as a whole, may explain why the jury found that the same gas was both marketable at the well, and not marketable at the well. It appears that the jury reached its verdict by determining that the gas was in the condition that it could be taken by a purchaser both at the well and away from the well, and that the lessees sold the gas in good faith at both of those points. Thus, under these instructions, it is understandable why the jury reached two apparently inconsistent results. Moreover, the instructions collectively indicate, and the inconsistent jury verdicts suggest, that the trial court essentially instructed the jury that a good faith purchaser was all that was needed to establish marketability as a matter of law. Because the error in the jury instructions was both substantial and prejudicial, the trial court judgment must be reversed, and this case remanded for a new trial on both the issue of allocation of costs and the issue of the alleged bad faith of the lessees.