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No. 101,566 IN THE COURT OF APPEALS OF THE STATE OF KANSAS DEAN D. WELSCH, Appellant, v. TRIVESTCO ENERGY COMPANY, et al., Appellees.

SYLLABUS BY THE COURT

1. The concept underlying shut-in royalty clauses within oil and gas leases is to enable a lessee, under appropriate circumstances, to keep a nonproducing lease in force by the payment of the shut-in royalty, which payment is considered constructive production. In this manner, the clause can modify and become an integral part of the habendum clause, or extension clause, of the lease.

2. The rights and obligations of those operating in the Kansas oil patch are governed by the terms and conditions of specialized contracts, and each dispute arising in this context can and should usually be resolved by the construction and application of such contracts. This is particularly true in construing a shut-in royalty clause.

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3. Reliable authorities recognize that an option to pay shut in gas royalties--in contrast to an obligation to do so--can support cancellation where the optional royalties are not timely paid.

4. The phrase "may pay or tender" generally does not express any language of obligation, but rather it expresses an option or permissive choice.

5. Cherokee Resources, Inc. v. Gold Energy Corp., 11 Kan. App. 2d 436, 724 P.2d 695 (1986), is discussed and distinguished.

6. Under the facts of this case, the oil and gas lease provided to the lessee an option to pay shut-in royalty payments in order to allow the only well on the leased acreage to be "considered" to produce gas in paying quantities sufficient to satisfy the habendum clause and extend the lease in full effect, but because the lessee did not exercise this option and pay the shut-in royalties, the result is that the lease expired by its own terms.

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7. The doctrine of temporary cessation of production has been recognized in Kansas as dictating that a mere temporary cessation of production from wells on an oil and gas lease because of necessary developments or operations does not result in the termination of the oil and gas lease, despite the requirement of production to satisfy the habendum clause. So long as the cessation is temporary, the doctrine allows the lessee a reasonable time to recommence production in paying quantities.

8. The lessee of an oil and gas lease cannot invoke the doctrine of temporary cessation to avoid complying with a specific provision in the lease that addresses temporary cessation of production and requires the lessee to recommence production within a specified period of time. The express provision, as a contractual agreement of the parties, supersedes application of the more general doctrine.

9. The constructive production achieved by the payment of shut-in gas royalty is not the production to which the cessation of production clause applies and thus the clause does not apply to a cessation of constructive production that results from a failure to make payment of the shut-in gas royalty.

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10. The bankruptcy of a purchaser is generally covered by the shut-in royalty clause, not the force majeure clause of an oil and gas lease, because a lessee seldom has control over the demand for production from a well, and this is why the shut-in royalty clause was devised. Generally courts refuse to excuse performance under the force majeure clause of an oil and gas lease provision when financial issues have caused a cessation of production that could have been replaced by constructive production upon payment of shut-in royalties.

11. Under the facts of this case, and given a force majeure clause that required for its application that some default was due to a force majeure event, the default (failure to pay shut-in royalties) was not due to the unavailability of purchasing and transporting services. Therefore, the force majeure clause in this lease was not triggered.

12. Under the facts of this case, the oil and gas lease expired by its own terms when production from the only producing well on the acreage ceased due to financial failure of the gas purchaser, the well was shut in, production was not recommenced nor was additional drilling achieved within the 60 days required under the lease, shut-in royalty payments were not paid when they would have been due had lessee exercised this option,

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and the failure to pay or tender such shut-in royalty payments was not due to any force majeure event.

Appeal from Edwards District Court; BRUCE T. GATTERMAN, judge. Opinion filed December 18, 2009. Reversed and remanded with directions.

Michael K. Johnston, of Johnston & Eisenhauer, of Pratt, and Larry E. Keenan, of Keenan Law Firm, P.A., of Great Bend, for appellant.

Michael P. Womack, of Riggs, Abney, Neal, Turpen, Orbison & Lewis, P.C., of Tulsa, Oklahoma, and Gordon B. Stull, of Stull Law Office, P.A., of Pratt, for appellees.

Gregory J. Stucky, of Fleeson, Gooing, Coulson & Kitch, L.L.C., of Wichita, and David G. Seely, of the same firm, for amici curiae The Southwest Kansas Royalty Owners Association and The Eastern Kansas Royalty Owners Association.

Before GREENE, P.J., MALONE, J., and KNUDSON, S.J.

GREENE, J.: Dean D. Welsch, successor in interest to the lessors in an oil and gas lease, appeals the district court's refusal to grant summary judgment cancelling the lease, as well as the court's award of summary judgment to Trivestco Energy Company, the successor in interest to the lessee in that lease, thus preserving the lease on the basis
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that the shut-in royalty provisions of the lease created a covenant with entitlement to money damages rather than a condition with entitlement to lease termination. As alternate bases for its decision, the district court relied on a construction and application of the force majeure clause in the lease and the doctrine of temporary cessation of production. Welsch argues that the failure of Trivestco to pay shut-in gas royalty payments caused the lease to expire by its own terms and that neither the force majeure clause nor the doctrine of temporary cessation of production apply to save the lease. We agree with Welsch, reverse the district court, and remand with directions to cancel the lease in favor of lessor Welsch.

Factual and Procedural Background

The subject of this oil and gas lease cancellation action is a lease covering the northeast quarter and the north 80 acres of the east half of the west half of section 6, township 26 south, range 17 west, in Edwards County. The lease was entered into on May 23, 1975, and contained the following material provisions:

"2. Subject to the provisions herein contained, this lease shall remain in force for a term of three (3) years from this date (called the 'primary term') and as long thereafter as oil, liquid hydrocarbons, gas or other respective constituent products, or any of them, is produced from said land or land with which said land is pooled.

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"3. The royalties to be paid by lessee are: (a) on oil, and other liquid hydrocarbons saved at the well, one-eighth of that produced and saved from said land . . . (b) on gas, including casinghead gas and all gaseous substances, produced from said land and sold or used off the premises or in the manufacture of gasoline or other products therefrom, the market value at the mouth of the well of one-eighth of the gas so sold or used . . . and (c) at any time either before or after the expiration of the primary term of this lease, if there is a gas well or wells on the above land . . . and such well or wells are shut in before or after production therefrom, lessee or any assignee hereunder may pay or tender annually at the end of each yearly period during which such gas well or gas wells are shut in, as substitute gas royalty, a sum equal to the amount of delay rentals provided for in this lease for the acreage then held under this lease by the party making such payments or tenders, and if such payments or tenders are made it shall be considered under all provisions of this lease that gas is being produced from the leased premises in paying quantities. . . . .... "6. If, . . . after discovery of oil, liquid hydrocarbons, gas or their respective constituent products, or any of them, the production thereof should cease from any cause, this lease shall not terminate if lessee commences reworking or additional drilling operations within sixty (60) days thereafter. . . . .... "9. Lessee shall not be liable for delays or defaults in its performance of any agreement or covenant hereunder due to force majeure. The term 'force majeure' as employed herein shall mean: any act of God . . .; exhaustion or unavailability or delays in delivery of any product, labor, service, or material."

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By declaration of unitization dated June 26, 1978, and pursuant to an express provision in the lease, the lease acreage was unitized with adjoining leases to create a unit of approximately 682.4 acres. The only producing well on the unitized acreage was the gas well at issue herein.

In late August 2004, Trivestco shut in the gas well because the gas purchaser for this well ceased making payments for produced gas. The well remained shut in until late March 2007. In the interim, bankruptcy proceedings ensued involving the gas purchaser and related entities. At no time during this 2 and 1/2-year period did Trivestco pay or tender shut-in royalties to Welsch, nor did it attempt to recommence production or to commence additional drilling activities at any time thereafter.

After Welsch made demand for release of the lease and negotiations between the parties failed, Welsch brought this action to declare the lease terminated. After discovery was concluded, both parties filed opposing summary judgment motions. The district court denied Welsch's motion but sustained Trivestco's motion, thus resulting in the preservation of the lease.

The district court justified its decision on multiple bases. First, it held that the difficulties experienced by Trivestco with its gas purchaser "triggered the force majeure clause in the lease, thereby suspending any provision of the lease which would otherwise terminate it." The court also held that the "obligation to pay royalty is a covenant of a
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lease, not a condition," that "a forfeiture under the facts would represent a windfall to [Welsch]," and that the lease therefore should not be terminated for failure to pay shut-in royalties. Finally, the court held that because the cessation of production was temporary, never intended to be permanent, and occurred for only a reasonable time, the cessation did not warrant termination of the lease, applying the doctrine of temporary cessation of production rather than the specific lease provision governing cessation of production. Although the court refused to cancel the lease, the court granted judgment to Welsch for payment of shut-in royalties of $706.

Welsch timely appeals.

Standards of Review

When the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law, summary judgment is appropriate. The district court is required to resolve all facts and inferences which may reasonably be drawn from the evidence in favor of the party against whom the ruling is sought. When opposing a motion for summary judgment, an adverse party must come forward with evidence to establish a dispute as to a material fact. In order to preclude summary judgment, the facts subject to the dispute must be material to the conclusive issues in the case. On appeal, the same rules apply; summary judgment must
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be denied if reasonable minds could differ as to the conclusions drawn from the evidence. Miller v. Westport Ins. Corp., 288 Kan. 27, 32, 200 P.3d 419 (2009). Where there is no factual dispute, appellate review of an order regarding summary judgment is de novo. Central Natural Resources v. Davis Operating Co., 288 Kan. 234, 240, 201 P.3d 680 (2009).

The interpretation and legal effect of a written contract are matters of law over which an appellate court has unlimited review. Conner v. Occidental Fire & Cas. Co., 281 Kan. 875, 881, 135 P.3d 1230 (2006). Regardless of the district court's construction of a written contract, an appellate court may construe a written contract and determine its legal effect. City of Arkansas City v. Bruton, 284 Kan. 815, 828-29, 166 P.3d 992 (2007). These standards have application to the interpretation of oil and gas leases. Lauck Oil Co. v. Breitenbach, 20 Kan. App. 2d 877, 878, 893 P.2d 286 (1995).

Did the District Court Err in Holding the Shut-in Royalty Provision of the Lease to be a Covenant that Limited Welsch to a Judgment for Unpaid Royalties Instead of Lease Cancellation?

At the outset of our analysis, it is critical to recognize that oil and gas law is not so much a unique body of law as it is a specialized application of contract law. The rights and obligations of those operating in the Kansas oil patch are governed by the terms and conditions of specialized contracts, and each dispute arising in this context can and should usually be resolved by the construction and application of such contracts.
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Although parties to such disputes often seek to rely on and argue the application of case law, we must decline to blindly apply what may appear to be legal principles within such precedent without a preliminary determination whether the contract provisions at issue in the cited authority are identical to those before us. This is particularly true in construing a shut-in royalty clause. See Pray v. Premier Petroleum, Inc., 233 Kan. 351, 662 P.2d 255 (1983).

Notwithstanding the importance of the particular lease terms and conditions, certain general characteristics of shut-in royalty clauses should be noted. The concept underlying such clauses is to enable a lessee, under appropriate circumstances, to keep a nonproducing lease in force by the payment of the shut-in royalty and that such a clause by agreement of the parties creates constructive production. In this manner, the clause can modify and become an integral part of the habendum clause, or extension clause, of the lease. See Pray, 233 Kan. at 353. Our Supreme Court has provided a more detailed history and use of such clauses in Tucker v. Hugoton Energy Corp., 253 Kan. 373, 38082, 855 P.2d 929 (1993).

Here, we begin our analysis by analyzing the shut-in royalty provisions of the subject lease. First, we note that the provisions are not a part of the habendum clause but rather are contained within the royalty clause. Second, we note that the provisions are stated in language indicating that such payments are optional; that is, the lease provides that the lessee "may" pay or tender such royalties rather than employing language of
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obligation. Third, we note that the provisions contain the saving clause that if such royalties are paid, "it shall be considered under all provisions of this lease that gas is being produced from the leased premises in paying quantities"; that is, payment of such royalties--if elected by the lessee--is obviously intended to relate to the habendum clause that preserves the lease in effect "as long thereafter as" production is achieved. Finally, we note that production from the lease was achieved during the primary term, and its cessation occurred well into the secondary term of the lease, where the habendum clause required production for the term of the lease to continue. These unique features of the shut-in royalty provisions are paramount to our construction and application of those provisions to the factual circumstances here.

Generally, reliable authorities recognize that an option to pay shut-in gas royalties--in contrast to an obligation to do so--can support cancellation where the optional royalties are not paid. Generally, such an option is considered to create a special limitation on the lease, and the failure to pay the shut-in royalties will terminate the lease. See Pierce, Incorporating a Century of Oil and Gas Jurisprudence Into the "Modern" Oil and Gas Lease, 33 Washburn L.J. 786, 811 (1994). According to the foremost treatise authority, Williams & Meyers,

"[a]t first glance it might appear that lessees would prefer the optional to the obligatory form of this clause. However where the optional form is employed, the lease will provide, expressly or by implication, that
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the lease shall expire under the prescribed circumstances unless such optional payment is made. In a number of cases lessees have lost valuable leaseholds by reason of failure to make timely payment of the optional shut-in royalty payment. It is for this reason that many such clauses provide that a lease shall be preserved even though there is no production or operations on the premises if a well capable of producing is shut-in; such clauses impose a duty to pay shut-in royalty. " 3 Williams & Meyers, Oil and Gas Law

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