CHAPTER 10 THE RULES OF THE GAME: RECENT DEVELOPMENTS IN TAKE-OR-PAY LITIGATION

• Jurisdiction: United States

Natural Gas Marketing II
(Apr 1988)
CHAPTER 10
THE RULES OF THE GAME: RECENT DEVELOPMENTS IN TAKE-OR-PAY LITIGATION
PAUL STROHL
JOHNSON & SWANSON A PROFESSIONAL CORPORATION
DALLAS, TEXAS PAPER 10

TABLE OF CONTENTS

SYNOPSIS

I. INTRODUCTION

II. RECOVERY ON TAKE-OR-PAY CLAIMS

A. THEORIES OF RECOVERY

1. Anticipatory Repudiation

2. Drainage

3. Tortious Breach of Contract

4. Antitrust

5. RICO

6. Miscellaneous Claims

B. COMMON PIPELINE DEFENSES

1. Commercial Impracticability and Frustration of Purpose

2. Force Majeure

3. Take-or-Pay Provisions as Penalties

4. Unconscionability

5. Miscellaneous Contractual Defenses

6. Illegality Under the NGPA

7. FERC Primary Jurisdiction

8. Conservation Regulations

a. Waste

b. Ratable Taking

c. Analysis

III. REMEDIES

A. DAMAGES

B. INJUNCTIVE RELIEF

C. RESCISSION OF PRIOR CONTRACT AMENDMENTS

IV. SOME OBSERVATIONS ON ARBITRATION

A. THE DECISION TO ARBITRATE

1. Advantages

a. Expertise

b. Speed

c. Expense

2. Disadvantages

a. Discretion

b. Absence of Appeals

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c. Absence of Procedural Safeguards

B. AVOIDING ARBITRATION

C. ARBITRATING THE DISPUTE

1. Reach an Agreement on Ground Rules

2. Select the Arbitrators Carefully

3. Organize Your Presentation

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I. INTRODUCTION

One year ago, at the time of the Rocky Mountain Mineral Low Foundation last special institute on natural gas marketing, the courts had only just begun to address merits of the take-or-pay controversy. Strohl, Approaching the Day of Judgment: Recent Developments in Take-or-Pay Litigation 5 (paper delivered at the Institute on Natural Gas Marketing sponsored by the Rocky Mountain Mineral Law Foundation (May 14 & 15, 1987)) [hereinafter cited as Strohl]. Since that time, the take-or-pay literature—both published and unpublished — has grown at a phenomenal rate.¹ Obviously, it is difficult to summarize so much material. It is safest to say that producers and pipelines are continuing their high-stakes game to see who must bear the greatest part of the losses caused by the collapse of natural gas prices in the early 1980's. The part of the game being played in the courtroom has continued to favor producers, although the pipelines have made some noteworthy advances. However, the game is also being played before the Federal Energy Regulatory Commission ("FERC"), the various state regulatory commissions, and — above all — in the boardrooms and conference rooms of the nation's pipelines and producers. a sophisticated observers of the game must keep track of the score in all those arenas if he wants to find out whether the producers are truly in the lead.

This paper assumes a general familiarity with the origins of the take-or-pay controversy and the nature and purposes of the take-or-pay provisions generally.² Instead, the paper will

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discuss the legal theories used to justify recovery or take-or-pay claims, the most common defenses to those claims, and the remedies available for breach of take-or-pay provisions. The paper also includes some observations on arbitration as an alternative to litigating take-or-pay disputes.

II. RECOVERY ON TAKE-OR-PAY CLAIMS

A. THEORIES OF RECOVERY

A purchaser who fails to take gas from a seller as prescribed by a natural gas sales contract may be liable to the seller under a number of theories, depending upon the terms of the contract and the nature of the relationship between buyer and seller. The most straightforward of these theories is that of breach of contract, and it is this theory which will be emphasized.³ However, the existence of other causes of action deserve at least a brief mention.

1. Anticipatory Repudiation.

A producer may sue for anticipatory repudiation of the contract if his purchaser has taken any action or made any statement demonstrating a clear determination not to continue performance. UCC §2-610 clearly authorizes suit for anticipatory breach of contract where there has been "an overt communication

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of intention or an action which renders performance impossible or demonstrates a clear determination not to continue with performance." UCC §2-610, Comment 1. The aggrieved seller may obtain any remedy to which he is entitled under the other provisions of the UCC, including the right under UCC §2-708(1) to receive the difference between the market price at the time and place for tender and the unpaid contract price. This measure of damages, if applied, can subject a breaching purchaser to staggering liability, as one interstate pipeline recently discovered. El Paso Gas Co. v. G.H.R. Energy Corp., No. 85-09329 (Harris Cty. Dist. Ct., Tex.), as reported in Hunter, "$536.2 Million Verdict is a First," 4 Tex. Law. 1, 12 (Mar. 28, 1988) (jury verdict for producer in the amount of $536 million based on repudiation theory) [hereinafter El Paso v. G.H.R.].

However, asserting a repudiation claim is not without its hazards. The UCC does not specifically define "repudiation." As a result, the seller must be careful not to conclude prematurely that repudiation has occurred, lest he himself be held liable for anticipatory repudiation, or for breach of contract when performance comes due. See Columbia Gas Transmission Corp. v. Larry H. Wright, supra, at 23, n.5 (buyer's suspension of payments for gas where buyer had no evidence of meter tampering was held to be anticipatory repudiation); National Farmer's Organization v. Bartlett & Co., Grain, 560 F.2d 1350 (8th Cir. 1977); Harlow S. Jones, Inc. v. Advance Steel Co., 424 F. Supp. 770 (E.D. Mich. 1976). See generally, J. WHITE & R. SUMMERS, HANDBOOK OF THE LAW UNDER THE UNIFORM COMMERCIAL CODE 207 (2d ed. 1980) (hereinafter "White & Summers").

As a practical matter, the seller may be able to avoid this trap by asking for adequate assurance of performance under UCC §2-609. In order to do so, the seller must have reasonable grounds for insecurity, and he must demand adequate assurance of due performance in writing. The party receiving the request must provide the aggrieved party with adequate assurances within a reasonable time, not to exceed 30 days. Failure to provide such assurances is a repudiation of the contract. Commercial standards determine whether the grounds for insecurity and the adequacy of assurances offered are reasonable.

In Kaiser-Francis Oil Co. v. Producer's Gas Co., No. 83-C-400-B (N.D. Okla. June 19, 1986) (LEXIS Genfed Library, Dist. File), appealed docketed, No. 86-2382 (10th Cir. Sept. 18, 1986) (hereinafter Kaiser-Francis), Kaiser-Francis, the seller, requested adequate assurances under UCC §2-609 after the buyer, Producer's Gas Company ("PGC"), failed to comply with the take-or-pay provisions of certain gas sales contracts executed by the parties. PGC responded that no deficiency payments were due, arguing that the failure of PGC's markets was an event of force majeure, and Kaiser-Francis' gas did not meet contract specifications. Although PGC's defenses were ultimately

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rejected, the court concluded that PGC did not repudiate the contract because it raised defenses based on the force majeure and quality provisions of the contract in good faith. Kaiser-Francis, slip op. at 5. Notwithstanding Kaiser-Francis, the mere assertion of a contractual defense will not defeat a claim of repudiation. Westinghouse Elec. Corp. v. CX Processing Labs., Inc., 523 F.2d 668 (9th Cir. 1975) (defendant claimed performance not due because contract unenforceable, but refusal to perform was found to be repudiation); Lubrication & Maintenance, Inc. v. Union Resources Co., Inc., 522 F. Supp. 1078 (S.D.N.Y. 1981) (defendant's refusal to perform held to be repudiation, notwithstanding alleged contractual right of renegotiation); Missouri Pub. Serv. Co. v. Peabody Coal Co., 583 S.W.2d 721 (Mo. App. 1979), cert. denied, 444 U.S. 865 (1979) (defendant's refusal to perform held to be repudiation, notwithstanding asserted defense of commercial impracticability).

Another pitfall for the producer seeking to assert anticipatory repudiation is continued dealing with the pipeline. Very few producers can afford to shut in their wells pending the outcome of a repudiation claim, and it would make little commercial sense for them to do so. Indeed, they may be legally precluded from doing so by virtue of implied lease covenants to market production and to prevent drainage.⁴ The producer must continue to sell to his current pipeline purchaser, possibly waiving his repudiation claim, unless he can find a new purchaser and have gas transported to him by the pipeline.

However, it seems unreasonable to argue that, in effect, the producer's commercially reasonable behavior can waive an otherwise valid repudiation claim. Unlike virtually all other commodities, natural gas cannot be stored at atmospheric pressures and temperatures. Thus, sellers of natural gas are uniquely dependent on pipelines for access to markets: one sells to a pipeline, or not at all. Yet this circumstance should not deprive sellers of natural gas of an opportunity available to sellers of other commodities. It seems that UCC §2-703 and §2-704(2) should operate to preserve the producer's rights in this

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situation. UCC §2-703 precludes seller's election of remedies, and UCC §2-704(2) allows the seller to complete the manufacture of unfinished goods, identify the goods to the contract and resell them "or proceed in any other reasonable manner." By analogy, a producer should be able to continue production and to sell on a spot-market basis to his pipeline pending the outcome of any litigation. Cf. Northern Natural Gas Co. v. Grounds, 292 F. Supp. 619, 686 (D. Kan. 1968) (producers' continued sales did not bar claims to payment for helium delivered to purchasers). Such a result would be consistent with the well-established UCC policies which favor minimization of...