CHAPTER 9 RECENT CASES AFFECTING PIPELINES
| Jurisdiction | United States |
(Jan 1995)
RECENT CASES AFFECTING PIPELINES
Colorado Interstate Gas Company
Colorado Springs, Colorado
INSTITUTE ON OIL AND NATURAL GAS PIPELINES: WELLHEAD TO END USER
I. INTRODUCTION
Recent cases affecting natural gas pipelines cover several diverse areas including contract dispute litigation, developments in the right of royalty owners to share in the proceeds from contract reformation, tax litigation, recent developments in employment litigation and environmental litigation and regulations.
II. CONTRACT DISPUTES
A. Take-or-Pay Damages
There is general agreement among the courts of various jurisdictions that natural gas contracts are contracts for the sale of goods and are thus governed by Article II of the Uniform Commercial Code ("UCC").2 Jurisdictions are, however, split on the proper application of the UCC in calculating take-or-pay damages. The divisive issue is whether the seller is obligated to mitigate the damages resulting from a breach of the take-or-pay gas purchase contract by deducting the market price of the gas from the contract price when computing damages.
[Page 9-2]
In Prenalta Corp. v. Colorado Interstate Gas Co., the Tenth Circuit Court of Appeals reversed the District Court's opinion that the proper measure of damages in a take-or-pay case is the UCC formula of contract price minus market price. The Appellate Court decided that the seller was entitled to the full payment for gas without deducting the market value of the gas.3 The court predicated its decision on the conclusion that the take-or-pay provision in the gas purchase agreement:
clearly provides the contract remedy for breach, and that the measure of damages under the [take-or-pay] provision is the value of the "quantity of gas which is equal to the difference between the Contract Quantity and Buyer's actual takes" for each year [Buyer] has been in breach of the contracts.4
Notwithstanding the court's conclusion that the take-or-pay language was an additional remedy under Wyoming's UCC, the court refused to determine whether the remedy constituted an unenforceable penalty, or otherwise test the remedy for reasonableness under UCC §§ 2-718 and 2-719. The court reasoned that "[b]ecause one of the alternative performances in a take-or-pay contract is the payment of money, courts have distinguished the 'pay' provision from a liquidated damages provision."5
The court distinguished the "pay" remedy from an unenforceable penalty on the basis that the contract provided the buyer with an alternative means of performance. Citing Professor Corbin's treatise on contract law, the court concluded that the take-or-pay contract is an alternative contract which limits the:
power of the promisor to discharge his contractual duty by performing one of the alternatives to a definite period of time, after the expiration of which only the other alternative is available to him. After expiration of the specific period, the obligation of the promisor becomes single and the contract is no longer alternative. In cases like this, the promisee must always estimate his damages on the basis of the second alternative....6
[Page 9-3]
In Roye Realty & Developing, Inc. V. ARKLA, Inc., the Oklahoma Supreme Court declined to adopt the position of the Tenth Circuit in Prenalta.7 The Oklahoma Supreme Court held that the proper measure of damages in a take-or-pay case is the UCC measure of contract price minus the market price.8 The Oklahoma court disagreed that the deficiency payment was an agreed contract remedy. The court concluded that "the deficiency payment obligation is neither a remedy for breach of the first alternative performance nor a clause which alters or limits the measure of damage...."9 Rather, the court found that the take-or-pay clause was simply an obligation which the seller alleged that the buyer had breached.10
The court stated that:
[a]lthough we agree that take-or-pay contracts were designed to allocate the risks involved in gas production and marketing, we cannot accede to the view that such allocation of risk is determinative of the measure of damages for anticipatory repudiation of the contracts. The deficiency payment obligation is merely a promise from [the buyer] to compensate [the seller] for [the seller's] promise to take gas off the public market and sell the gas produced from the designated wells exclusively to [the buyer]. [Buyer's] refusal to make the deficiency payment is nothing more than reneging on its promise to compensate. The fact that [the buyer] took a risk that the market might become depressed when [the buyer] made the promise does not result in damages for repudiation being measured according to the promise. Rather the Legislature has provided a specific statutory measure of damages for anticipatory repudiation of the take-or-pay obligation.11
Turning to the statutory remedy, the court assessed damages under § 2-708(1) of the UCC as the difference between contract price and the market value of the gas. The court reasoned that "by selling the gas on the open market and utilizing the § 2-708(1) measure of damages to get the difference between the market price and the
[Page 9-4]
contract price, [the seller] will obtain the same price for its gas as if [the buyer] would have fully performed."12
In applying § 2-708(1) in assessing damages, the Oklahoma court rejected what it viewed as the Tenth Circuit's misreading of the comments of Professor Corbin. The court stated that "Professor Corbin concludes that contrary to the general measure of damages for breach of an alternative contract, there is no reason for laying down a rule which requires damages for failure to elect performance between the alternatives to be estimated according to the sum of money."13 In the case of take-or-pay, where the second alternative is the breach of an obligation to pay money "the more appropriate measure of damages should be in accordance with the less valuable of the two alternatives which is usually the market value of the specific alternative."14
In a blend of the two approaches, a court-appointed claims mediator in the Columbia Transmission Corporation bankruptcy proceeding engaged in an in-depth analysis of the question in his report submitted on October 13, 1994.15 The mediator's task was to establish a claims resolution procedure concerning 14 billion dollars in producer damage claims arising out of Columbia's rejection of approximately 4,100 gas purchase contracts. All non-Louisiana production was controlled by Article 2 of the UCC. Drawing from both Prenalta and Roye, the mediator concluded that prior to repudiation, the measure of damages is the deficiency payment.16 As to the damages occurring after repudiation, a mitigation price is to be deducted from the contract price.
The cornerstone of the mediator's analysis is the fundamental UCC concept of cover which dictates that the seller's basic remedy after repudiation should reflect the seller's obligation to mitigate damages by selling the gas subject to the contract to another buyer. After establishing this basic rule, the mediator focused the balance of his extensive discussion on establishing the proper contract and mitigation price, the contract volumes, and discount rate which apply in computing damages under the following basic damage formula:
[Page 9-5]
Damages=Average Contract Price in a given year (weighted by volume), less the Average Mitigation Price in that year (weighted by volume), times the Contract Volume, all reduced to present value.
As to the fundamental dispute over the mitigation requirement, the mediator's basic treatment of repudiation damages is both consistent with the Code and fair to the buyer and seller. It is consistent with the principles stated in the Code prohibiting the aggrieved party to the sales contract from engaging in strategic and speculative behavior. Once the contract has been repudiated, the aggrieved party (in this case the seller) must sell the contract gas to another buyer.17 As noted by the Roye court, this result will place the seller in the same position it would have been in had the buyer performed.
Pipeline buyers would perhaps take issue with the mediator on that aspect of his decision concerning pre-repudiation damages. As noted, the mediator concluded that prior to repudiation, the measure of damages is the deficiency payment. The basis for this decision appears to be that, prior to repudiation the seller would not be free to sell the gas to third parties due to the dedication of reserves under the contract.18 Buyers would argue that the UCC itself gives the seller the necessary authority to sell the gas under the seller's remedy provisions outlined in UCC 2-703. Under these circumstances, no basis arguably exists for different pre-and post-repudiation damages, and certainly none can be found in the UCC.
B. Market-Out Clauses
In Columbia Gas Transmission Corp. v. New Ulm Gas, Ltd., the question addressed was whether or not the market out pricing provision in the gas purchase contract was the exclusive pricing provision, or whether the base contract price could still be invoked by the seller.19 The Court held that the contract was ambiguous on this point, in spite of contract language stating that the alternate price "shall remain in effect thereafter until Seller requests a different alternate price." The question of the intent of the parties went to the jury, which determined that Columbia not only breached the contract, but committed fraud in paying the market out price. The Court reversed the trial court decision, however, on an evidentiary question, ruling that evidence of
[Page 9-6]
Columbia's other similar contracts and performance under those contracts of marketing out without objection from the other producers should have been admitted. This case tells business lawyers representing a...
To continue reading
Request your trial