United States District Court, E.D. Kentucky, Central Division, Lexington
MEMORANDUM OPINION AND ORDER
M. Hood Senior U.S. District Judge
matter is before the Court upon Defendant Magnum Hunter
Production Company's Motion for Partial Summary Judgment
[DE 23] and Motion for Summary Judgment [DE 62], as well as
Plaintiff EQT Production Company's Motion for Partial
Summary Judgment [DE 63]. All Motions have been fully briefed
a nd are ripe for the Court's review. [DE 27, 28, 48, 52,
62, 63, 67, 68, 71, 72]. For the reasons stated herein, IT IS
ORDERED that Magnum Hunter's Motion for Partial Summary
Judgment is GRANTED, while the Motion for Summary Judgment is
GRANTED IN PART AND DENIED IN PART. EQT's Motion for
Partial Summary Judgment is GRANTED IN PART AND DENIED IN
FACTUAL AND PROCEDURAL BACKGROUND
Magnum Hunter are in the business of producing and selling
oil and natural gas. [DE 1, p. 1-2, ¶ 1-6]. Between 1996
and 2002, the predecessors in interest of both companies
entered into eleven Farmout Agreements (“FOAs”)
which allocated exploration and drilling rights on lands
situated in Eastern Kentucky. [Id. at p. 2-5, ¶
9]. Specifically, the FOAs allowed Magnum Hunter to drill
wells on lands owned or leased by EQT and sell oil and/or gas
produced from those wells. [DE 1-1, 1-2, 1-3, 1-4, 1-5, 1-6, 1-7,
1-8, 1-9, 1-10, 1-11]. In exchange, EQT would receive a
royalty, amounting to a percentage of “8/8 of the gross
proceeds received from the sale of oil and/or gas produced
from wells drilled hereunder without deductions of any
kind.” [DE 1-1, p. 6, ¶ 4A].
the general prohibition on deductions, eight of the FOAs
specifically authorized Magnum Hunter to deduct EQT's
“proportionate share of applicable severance tax”
from the royalty payments. [DE 1-1, p. 17; 1-2, p. 8-9, ¶ 4B;
1-3, p. 9, ¶ 4B; 1-4, p. 12, ¶ 4D; 1-5, p. 12,
¶ 4D; 1-6, p. 9, ¶ 4B; 1-7, p. 40; 1-8, p. 8,
¶ 4D]. Two of the FOAs provided for escalation of
overriding royalties “[u]pon the payout of the first
two (2) wells drilled and completed as a well capable of
production in paying quantities.” [DE 1-1, p. 6-7,
¶ 4A; 1-7, p. 7-8, ¶ 4A]. All of the FOAs required
Magnum Hunter to pay EQT a shut-in fee for each well capable
of production that it closed for an extended period of
time. [DE 1-1, p. 8-9, ¶ 7A; 1-2, p. 11,
¶ 7B; 1-3, p. 12, ¶ 7B; 1-4, p. 15, ¶ 7B; 1-5,
p. 15, ¶ 7B; 1-6, p. 10-11, ¶ 7B; 1-7, p. 9, ¶
7A; 1-8, p. 9-10, ¶ 7B; 1-9, p. 9, ¶ 7C; 1-10, p.
7, ¶ 9C; 1-11, p. 7, ¶ 9C].
the exception of the 7/21/04 FOA which only featured a
modified MOA [DE 1-10, p. 15-38], all of the FOAs attached
and incorporated by reference an Agreement and Assignment of
Operating Rights (“AAOR”), memorializing Magnum
Hunter's right to operate wells on the lands in question
and specifying that royalties must be paid to EQT on or
before the 28th day of the month.[7"
name="FN7" id="FN7">7] [DE 1-1, 1-2, p. 21-23; 1-3,
p. 24-26; 1-4, p. 29-31; 1-5, p. 29-31; 1-6, p. 22-24; 1-7,
p. 17-18; 1-8, p. 23-25; 1-9, p. 69-71; 1-11, p. 14-16]. Of
those ten FOAs, six incorporated by reference a Model Form
Operating Agreement (“MOA”), which the parties
modified to include specifics about Magnum Hunter's
operations. [DE 1-2, p. 24-46; 1-3, p. 27-49; 1-4, p.
36-58; 1-5, p. 36-58; 1-8, p. 32-53; 1-9, p. 23-46].
the FOAs had clauses indicating that, “[i]n the event
that there exists any conflict between the terms and
conditions of this Agreement and the provisions of any
Exhibit attached hereto, the terms and conditions of this
Agreement shall control.” [DE 1-2, p. 15, ¶ 15H;
1-3, p. 17, ¶ 15G; 1-4, p. 20, ¶ 15G; 1-5, p. 20,
¶ 15G; 1-6, p. 15, ¶ 15G; 1-7, p. 17; 1-8, p. 13,
¶ 15H; 1-9, p. 12, ¶ 16F; 1-10, p. 11, ¶ 20J;
1-11, p. 11, ¶ 20J]. The 4/12/96 FOA did not contain a
conflict clause. Nine of the FOAs also included the following
A failure by any party hereto to exercise any right or rights
or to take any authorized action shall in no way serve to
permanently amend or modify this Agreement, nor shall a
departure from the terms and conditions of the Agreement
establish a course of conduct of amending this Agreement.
This Agreement cannot be modified except in writing.
Activities of parties cannot be construed to modify the
[DE 1-2, p. 15, ¶ 15I; 1-3, p. 17, ¶ 15H; 1-4, p.
20, ¶ 15G; 1-5, p. 20, ¶ 15G; 1-6, p. 15, ¶
15H; 1-8, p. 13, ¶ 15G; 1-9, p. 12, ¶ 16G; 1-10, p.
10, ¶ 20F; 1-11, p. 10, ¶ 20F].
December 2008, Magnum Hunter built a processing plant and
began transporting gas from FOA wells to that facility, where
it was converted into NGLs. [DE 52-3 at 3-5]. This endeavor
was part of Magnum Hunter's effort to comply with new
requirements imposed by the Federal Energy Regulatory
Commission (“FERC”). [DE 23-4, 27-2 at 15-16].
Magnum Hunter deducted transportation and processing costs
from the NGL sales price, then used the difference as the
basis for calculating EQT's royalty on NGLs.
[Id.]. EQT maintains that Magnum Hunter's
executives made this decision internally, while Magnum Hunter
insists that it consulted with EQT before taking
post-production deductions. [Id.].
receiving payments for six years, EQT realized that it was
losing revenue and exercised its contractual right to audit
Magnum Hunter's production records related to the FOAs.
[Id. at p. 5, ¶ 10-12; 1-9; 1-14]. The Audit
Report, prepared by Mercadante and Company, PC, reported that
Magnum Hunter had failed to pay the full amount of shut-in
fees, royalties, and escalation fees due under the terms of
the FOAs. [DE 1-14]. It also indicated that Magnum Hunter had
made unauthorized deductions in calculating the royalties
owed to EQT. [Id.]. In sum, the Report identified
net exceptions totaling $2, 367, 307 for the audit period of
2011 to 2013. “Net exceptions in the amount of $3, 620,
661 … were identified” for the audit period of
2011 to 2013. [Id.]. EQT was entitled to $2, 367,
307 of that total. [Id.]. The remainder was
allocated to KRCC Oil & Gas, LLC, EQT's co-Farmor in
the 12/11/02 FOA. [Id.].
December 15, 2015, Magnum Hunter filed a Chapter 11
bankruptcy petition in the United States Bankruptcy Court for
the District of Delaware. [DE 1, p. 5, ¶ 15]. During
this proceeding, “EQT asserted a claim in the amount of
$5, 896, 907.00 for the unremitted shut-in fees, royalties,
overriding royalties; underpayment for the sale of natural
gas liquids; improper post-production deductions from
royalties; and other amounts related to the [FOAs].”
[Id. at p. 6, ¶ 19; DE 1-12]. In addition to
the $2, 367, 307 allegedly owed to EQT for 2011 to 2013, EQT
sought additional sums for 2002 to 2010 and 2013 to 2015
“based on production records from Magnum Hunter.”
[DE 1-14]. The parties ultimately agreed that Magnum Hunter
would pay EQT $1, 833, 780 for amounts owed for natural gas
between January 2011 and October 2013. [Id. at p.
6-7, ¶ 23-24]. Although EQT withdrew the remainder of
its claims from the bankruptcy petition, it reserved the
right to pursue them in a separate proceeding.
on May 19, 2016, EQT filed the instant action against Magnum
Hunter, asserting the following claims: (1) breach of
contract for failure to render payment for wells in
production; (2) breach of contract for failure to render
shut-in royalty payments; (3) breach of contract for failure
to escalate royalty or overriding royalty percentages after
the specified time period; (4) breach of contract for failure
to escalate royalty or overriding royalty percentages after
proceeds from production exceeded costs; (5) breach of
contract for improper royalty and overriding royalty
deductions; (6) prejudgment interest on the EQT cash payment;
(7) unjust enrichment; (8) accounting; (9) declaratory
relief; and (10) injunctive relief. [DE 1].
discovery closed, Magnum Hunter moved for partial summary
judgment on the claim for unauthorized deductions relating to
NGL royalties. In its Motion, Magnum Hunter argues that the
FOAs did not address the production of NGLs at all and that,
thus, they did not prohibit Magnum Hunter from taking
post-production deductions in calculating EQT's royalty
payments. In the alternative, Magnum Hunter asserts that it
was not required to pay royalties to EQT because it was
acting as a processor, rather than a lessee, with regard to
discovery closed, the parties contacted United States
Magistrate Judge Robert E. Wier, seeking assistance in
resolving a discovery dispute. [DE 41]. Magnum Hunter
complained that it had repeatedly asked EQT to provide
evidence relating to its damages calculations but received
only the Mercadante audit materials. [DE 43]. When Magnum
Hunter deposed John Bergonzi, EQT's corporate
representative, he could not explain how EQT had calculated
certain categories of damages that were not covered by the
audit, except to say that it had “brought
forward” production figures from its Enertia database.
[Id.]. EQT had not provided this data to Magnum
Wier provisionally “exclude[d] as a preclusive sanction
under Rule 37(c) and (d), from further proceedings in this
case any evidence on which EQT relied to make damages
calculations that EQT did not produce to Magnum
Hunter.” [DE 43]. EQT filed a Motion for
Reconsideration, which Judge Wier denied in a written
Memorandum Opinion and Order on May 25, 2017. [DE 49, 54, 55,
61]. EQT then submitted Objections to Judge Wier's
ruling, which this Court overruled in a separate Memorandum
Opinion and Order.
thereafter, Magnum Hunter moved for summary judgment on all
remaining claims, arguing that EQT could not prove its
damages in light of Judge Wier's ruling. [DE 62]. EQT
simultaneously moved for partial summary judgment on Count I
(Breach of Contract for Failure to Render Payment for Wells
in Production), “as it relates to royalty due and owing
from October, 2015-present.” [DE 63-1 at 3]. EQT also
sought summary judgment on Count V (Breach of Contract for
Improper Royalty and Overriding Royalty Deductions) and Count
VI (Prejudgment Interest), “as it relates to damages
for Counts I and V.” [Id.].
to EQT, “[t]he undisputed evidence demonstrates that
[Magnum Hunter] has breached the contracts by failing to make
full and complete payments for royalty.”
[Id.]. In support of this assertion, EQT notes that
it has not received a payment from Magnum Hunter in two
years. [Id.]. As for Count V, EQT reiterates
arguments made in responding to Magnum Hunter's Motion
for Partial Summary Judgment. [Id.]. Specifically,
EQT insists that the FOAs address the production of NGLs and
explicitly prohibit Magnum Hunter from taking any royalty
deductions, apart from severance taxes. [Id.].
Finally, EQT argues that prejudgment interest should be
awarded because it has not had the use of these sums for
several years now. [Id.]. The Court will address
each of these Motions, and the numerous arguments raised
therein, in turn.
courts sitting in diversity apply federal procedural law.
Hanna v. Plumer, 380 U.S. 460, 465 (1965). The
substantive law of the forum state governs the claims
asserted. Erie R. Co. v. Tompkins, 304 U.S. 64
(1938); Moore, Owen, Thomas & Co. v. Coffey, 992
F.2d 1439 (6th Cir. 1993). Accordingly, the Court will
evaluate the Motions in accordance with the Federal Rules of
Civil Procedure while applying substantive Kentucky law to
the underlying claims.
Standard of Review
judgment is appropriate when there is no genuine dispute as
to any material fact and the movant is entitled to judgment
as a matter of law. Fed.R.Civ.P. 56(a). If there is a dispute
over facts that might affect the outcome of the case under
governing law, then entry of summary judgment is precluded.
Anderson v. Liberty Lobby, Inc., 77 U.S. 242');">477 U.S. 242, 248
(1986). The moving party has the ultimate burden of
persuading the court that there are no disputed material
facts and that he is entitled to judgment as a matter of law.
party files a properly supported motion for summary judgment
by either affirmatively negating an essential element of the
non-moving party's claim or establishing an affirmative
defense, “the adverse party ‘must set forth
specific facts showing that there is a genuine issue for
trial.'” Id. at 250 (quoting Fed.R.Civ.P.
56(e)). “The mere existence of a scintilla of evidence
in support of the [non-moving party's] position will be
insufficient; there must be evidence on which the jury could
reasonably find for the [non-moving party].”
Id. at 252.
Magnum Hunter's Partial Motion for Summary
Interpretation of the FOAs
contract between parties dealing in oil and gas is subject to
the same rules of construction as any ordinary
contract.” Oliver v. Louisville Gas & Elec.
Co., 732 S.W.2d 509');">732 S.W.2d 509, 511 (Ky. Ct. App. 1987).
Interpretation of a contract “must begin with an
examination of the plain language of the instrument.”
Ky. Shakespeare Festival, Inc. v. Dunaway, 490
S.W.3d 691, 694 (Ky. 2016). “‘[I]n the absence of
ambiguity a written instrument will be enforced strictly
according to its terms, ' and a court will interpret the
contract's terms by assigning language its ordinary
meaning and without resort to extrinsic evidence.”
Frear v. P.T.A. Indus., Inc., 103 S.W.3d 99, 106
(Ky. 2003) (quoting O'Bryan v. Massey-Ferguson,
Inc., 413 S.W.2d 891, 893 (Ky. 1966)). “A contract
is ambiguous if a reasonable person would find it susceptible
to different or inconsistent interpretations.”
Hazard Coal Corp. v. Knight, 325 S.W.3d 290, 298
(Ky. 2010). In such instances, “the court's primary
objective is to effectuate the intentions of the
parties.” Dunaway, 490 S.W.3d at 695 (citing
Cantrell Supply, Inc. v. Liberty Mut. Ins. Co., 94
S.W.3d 381, 384 (Ky. Ct. App. 2002)).
FOAs state that EQT is entitled to royalties based on a
percentage of “8/8 of the gross proceeds received by
[Magnum Hunter] from the sale of oil and/or gas, without
deductions of any kind, produced from wells drilled
hereunder.” [See DE 1-1, p. 6, ¶ 4A].
This language indicates that Magnum Hunter only owes EQT
royalties from the sale of NGLs if they qualify as “oil
and/or gas, ” as that term is used in the FOAs.
none of the FOAs explicitly define “oil and/or gas,
” some of them provide more guidance as to the meaning
of this term than others. Accordingly, the Court will divide
the FOAs into three subsets: (1) FOAs that define “oil
well” and “gas well” and attach and
incorporate an MOA defining “oil and gas”; (2)
FOAs that define “oil well” and “gas
well” but do not attach and incorporate an MOA defining
“oil and gas”; and (3) FOAs that do not define
“oil well” and “gas well” and do not
attach and incorporate an MOA defining “oil and
gas.” The Court will then analyze each subset in turn.
FOAs that define “oil well” and “gas
well” and attach and incorporate an MOA defining
“oil and gas”
the FOAs include definitions for the terms “oil
well” and “gas well.” [See DE 1-2,
p. 2, ¶ 2M; 1-3; 1-4; 1-5; 1-8; 1-9; 1-10]. “Gas
Well” means “gas well as defined by Kentucky
Revised Statute Number 353.010, ” which provides as
well” means any well which:
(a) Produces natural gas not associated or blended with crude
petroleum oil any time ...