CHAPTER 14 SPECIAL ROYALTY LITIGATION ISSUES: FRAUD, FIDUCIARY RELATIONSHIPS, AND PUNITIVE DAMAGES
| Jurisdiction | United States |
(Sept 2003)
SPECIAL ROYALTY LITIGATION ISSUES: FRAUD, FIDUCIARY RELATIONSHIPS, AND PUNITIVE DAMAGES
Holland & Hart LLP
Denver, Colorado
I. INTRODUCTION
II. A ROYALTY CLAIM IS A BREACH OF CONTRACT CLAIM
A. No Punitive Damages for Breach of Contract
B. The Economic Loss Rule
III. INTENTIONAL TORT CLAIMS
A. Fraud
1. Elements of the claim
2. Fraud in the inducement vs. fraud in the performance
3. Royalty cases addressing fraud claims
4. The detrimental reliance requirement
B. Fiduciary Duty
1. Elements of the claim
2. Fiduciary duty based on "facts and circumstances"
3. The superior position of the oil and gas lessee
4. What does a fiduciary duty require?
C. Conversion
1. Elements of the claim
2. Whether conversion will lie in a royalty case
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SYNOPSIS
D. Tortious Breach of Contract/Breach of Implied Duty of Good Faith
IV. STATUTORY CLAIMS
A. Consumer Protection Act
1. Elements of the claim
2. Why the CCPA should not apply to royalty claims
3. Courts have rejected CCPA claims in royalty cases
B. Organized Crime Act
1. Elements of the claim
2. Why the Act should not apply to royalty claims
C. Civil Theft
1. Elements of the claim
2. Why the statute should not apply to royalty claims
D. Checkstubs laws
V. CONCLUSION
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1. Application of economic loss rule to intentional tort claims (page 14-7, n. 35):
In Grynberg v. Questar Pipeline Co., 70 P.3d 1, 10-14 (Utah 2003), the Utah Supreme Court applied the economic loss rule to bar intentional tort claims growing out of a gas purchase contract dispute.
2. Update to cases:
On August 22, 2003, the Oklahoma Court of Appeals issued an opinion affirming the trial court's judgment in Bridenstine v. Kaiser-Francis Oil Co., No. CJ-2000- 1 (Texas County, Okla.). The opinion was not designated for official publication. On September 11, 2003, a petition for writ of certiorari was filed in the Oklahoma Supreme Court.
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I. INTRODUCTION1
When the lessor-royalty owner and the lessee-oil and gas company end up in court in a dispute over whether the company paid royalties properly, Claim One for the royalty owner will be for breach of contract. The claim will allege that the company failed to pay in accordance with the royalty clause provisions of the oil and gas lease (e.g., royalty on 1/8 of "market value," etc.) and/or in accordance with the implied covenant to market. But it is unlikely the complaint will stop there.
It is becoming de rigueur for the royalty owner to include, as Claims Two, Three, Four, and Five, tort claims for fraud, breach of fiduciary duty, conversion, and tortious or bad faith breach of contract. The reason is obvious: The chance for a lottery-ticket punitive damage award, as well as to put pressure on the oil company to settle in order to avoid the risk of a punitive damage award.2 And the complaint may not even stop with tort claims. Claims Six, Seven, and so on may allege statutory claims under the Consumer Protection Act, Organized Crime Act, Checkstub laws, and the like, in an effort to recover treble damages or other statutory penalties, plus attorney fees.
Royalty owners assert these tort and statutory claims knowing that, if they can survive motions to dismiss or for summary judgment, they will get to a jury that is likely to be sympathetic to their side. Not many royalty cases have gone to a jury trial, but in three that have, juries found fraud and awarded large damages: the SEECO case in Arkansas,3 the Bridenstine case in Oklahoma,4 and the Exxon case in
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Alabama.5 It is the rare royalty case in which these tort and statutory treble damage claims should be allowed to go to a jury, but faced sometimes with confusing case law and vague legal standards, some courts have been reluctant to dispose of the claims before trial.6
This paper addresses the inclusion of tort and statutory treble damage claims in a royalty dispute and discusses the results in royalty cases thus far. Along the way, it identifies key areas of disagreement among the courts, as well as issues where litigants should focus attention in current and future cases.
II. A ROYALTY CLAIM IS A BREACH OF CONTRACT CLAIM
A. No Punitive Damages for Breach of Contract
A claim for additional royalties is a breach of contract claim. As discussed in other papers for this program, there are express provisions in the oil and gas lease that govern the payment of royalties.7 A claim for additional royalties is a claim that the lessee failed to comply with these lease provisions and therefore breached the contract. Courts also have implied a "covenant to market" in oil and gas leases, which essentially supplements the express lease terms on the proper determination of royalties due (e.g., costs allowable in determining market value "at the well").8 Breach of this implied covenant is likewise a contract claim.9
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The remedy for breach of contract is traditionally an award of damages to compensate the non-breaching party for his loss.10 In most jurisdictions, punitive damages are not recoverable for breach of contract, even where the breach is intentional or done with malicious intent.11
The principle that punitive damages are not available for breach of contract is a fundamental one. A famous formulation of the principle is Oliver Wendell Holmes' oft-quoted statement that, "[t]he duty to keep a contract in law means a prediction that you must pay damages if you do not keep it, -- and nothing else.' 12 Important public policies underlie this principle. First, contracts are formed when private parties voluntarily enter into a bargained-for agreement. Thus, breach of contract is generally viewed as a private injury, for which the parties are free to provide their own remedies.13 A tort, by contrast, is viewed as a public injury to be remedied by the state, for it arises out of a duty "imposed on all individuals to restrain the exercise of freedom so as to avoid damage to others."14 Second, contract law allows "economically efficient" breaches of contract - that is, when it costs less for one party to breach a contract and to pay the other party compensatory damages than it would to perform the contract. An award of punitive damages for such an intentional breach of contract would effectively prevent economically efficient breaches.15 Third, the threat of punitive damages for breach of contract would "create uncertainty and apprehension in the marketplace."16
Thus, most courts follow the rule set forth in the Restatement (Second) of Contracts § 355: "Punitive damages are not recoverable for a breach of contract unless the conduct constituting the breach is also a tort for which punitive damages are recoverable." Phrased a little differently, punitive damages cannot be recovered
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for breach of contract; to recover punitive damages, one must show an "independent tort."17
Not surprisingly, the rule that an "independent tort" must be shown to support a request for punitive damages leads royalty owners to allege tort claims on top of their contract claims. The question is whether these tort claims can be asserted when the relationship between the parties is based on the lease contract and the royalty obligation is contained in the lease itself, either within the express terms of the royalty clause or through the implied covenant to market.
B. The Economic Loss Rule
Closely related to the principle that punitive damages can be recovered only if there is an independent tort is the "economic loss rule." This rule is designed "to maintain the boundary between contract law and tort law."18 It developed in the 1960s in products liability litigation, where courts were allowing strict liability tort claims in cases involving defective products.19 Courts became concerned that strict liability tort claims were being pursued to recover for economic loss instead of physical injury, and thus began limiting those tort claims to physical injuries.20 Ultimately, in 1986 the U.S. Supreme Court applied the economic loss rule in a case involving tort claims against a manufacturer of turbines for oil supertankers.21 The damages claimed were solely economic; yet, because of a statute of limitations defense to the contract claims, the case proceeded only with the tort claims. The
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Supreme Court held that there is no cause of action in tort, either for negligence or strict liability, when a product malfunctions and causes purely economic loss.22 The Court explained that "contract law ... is well suited to commercial controversies of the sort involved in this case because the parties may set the terms of their own agreements ... : Since a commercial situation generally does not involve large disparities in bargaining power, we see no reason to intrude into the parties' allocation of the risk.23
The economic loss rule soon spread beyond products liability cases. Courts found the rationale underlying the rule - "to maintain a distinction between contract and tort law"24 - persuasive in other cases, too. Courts observed that limiting the availability of tort remedies in contract disputes would help hold parties to the terms of their bargain and "ensure predictability in commercial transactions."25 As the economic loss rule developed, courts focused not on the type of loss suffered (economic or physical injury), but instead on the "source of the duty alleged to have been violated."26 Courts then allowed certain tort claims to remedy economic loss, and called them "independent of a breach of contract claim."27 A good statement of the rule is this: "a party suffering only economic loss from the breach of an express or implied contractual duty may not assert a tort claim for such a breach absent an independent duty...
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