JULIE A. ROBINSON, District Judge.
Plaintiffs in this case are seeking equitable reformation and declaratory judgment with respect to the annual payment required to exercise annual options in the natural gas storage leases under which Plaintiffs are lessors and Defendant Southern Star is lessee. This matter is before the Court on Defendant's Motion for Summary Judgment (Doc. 110). The motion is fully briefed and the Court is prepared to rule. As described more fully below, the Court grants Defendant's motion for summary judgment.
Plaintiffs seek leave to file a surreply to the motion for summary judgment, arguing that Southern Star's reply brief raised two new arguments: 1) that the factual basis for reformation does not show a present hardship; and 2) that Plaintiffs' reformation theory violates public policy. Southern Star did allege in its memorandum in support of summary judgment a lack of hardship factors in the present
The following facts are either uncontroverted, stipulated to, or viewed in the light most favorable to Plaintiffs.
Defendant Southern Star ("Southern Star") owns and operates a natural gas storage field located in Rice County, Kansas ("the Alden Field"), as authorized by Certificates of Public Convenience and Necessity issued by the Federal Energy Regulatory Commission ("FERC"). The Alden Field encompasses all of Sections 15, 21, and 22, and portions of Sections 9, 10, 16, 27, and 28 in Township 21 South, Range 9 West, Rice County, Kansas. There are currently thirty-three gas storage leases for this acreage in the Alden Field. Southern Star is the current "Lessee" and operator of the gas storage leases located within the certificated boundaries of the Alden Field. Plaintiffs are owners of mineral and/or surface rights in some of the acreage within the Alden Field and are "Lessors" of the seventeen Alden Field gas storage leases that are the subject of this case (the "gas storage leases"). Over the term of the gas storage leases, Southern Star and its predecessors have always used the subject properties for gas storage, and their use of the subject properties has not changed over time.
All of the gas storage leases provide for the lease by Southern Star of the land described therein "lying above the top of the Viola lime," or comparable subsurface geological formations, exclusively for the purpose of natural gas storage and associated activities. All but one of Plaintiffs' natural gas storage leases gave Southern Star the right to store natural gas during a primary term of fifty years. The one exception was a ten year primary term, which expired in 1983.
Each of the seventeen leases contained language that gave a "repeated annual option to extend and continue this lease for and during each repeated annual period, after the expiration of said primary term, upon the same terms and provisions applicable for and during said primary term, including each repeated annual option." The amount provided in the leases to be paid during the primary term and for the exercise of subsequent annual options was $1 per acre per year. The yearly rental in each lease is referred to as an "annual payment." The paragraph of each lease that provides for an annual payment to exercise the yearly option contains the following language:
None of the Plaintiffs' leases contain any provision for upward adjustments for inflation or on any other basis. Under the subject leases, the only basis for exercising the annual option is by making a $1 per acre per year "annual payment" and "being engaged in any one of the purposes of the lease upon said land or upon land in the vicinity thereof."
All of the gas storage leases provide that Southern Star will, at the landowner's request, deliver free and/or reduced-price natural gas to the principal dwelling on the leased property ("Domestic Gas"), under conditions specified in the leases — either the existence of an observation well on the premises or upon circumstances that might exist "until a well exists on the premises." For purposes of this Memorandum and Order, "Domestic Gas" is defined as free and/or reduced-price natural gas to the principal dwellings on the properties subject to Plaintiffs' gas storage leases. All of the gas storage leases at issue in this case contain provisions obligating Southern Star to deliver some quantity of Domestic Gas, provided that terms and conditions specified in the gas storage leases are met. Some of the leases provide for 250,000 Mcf
Plaintiffs make no claim that there was fraud, coercion or duress in the negotiation, acquisition, or execution of the gas storage leases. Plaintiffs make no claim that the negotiation, acquisition, or execution of the gas storage leases was based on a mutual mistake of fact between the parties.
Plaintiffs seek reformation of the gas storage leases "in a manner which requires Southern Star to tender payments to exercise its annual option in an amount determined to be fair and reasonable at current market value rates for underground natural gas storage." Plaintiffs assert further that the "current market value for gas storage leases is multiple times the one dollar an acre being currently paid by Southern Star." Plaintiffs also seek a declaratory judgment holding that the storage leases should be reformed "to require Southern Star to tender payments to exercise the annual option in an amount determined to be fair and reasonable at current market value rates for underground natural gas storage."
Plaintiffs seek relief because of numerous changes in the natural gas business that "were neither anticipated nor reasonably foreseeable" ... and because "[t]he Storage Leases as written drive too hard of a bargain to be enforced and are unconscionable and inequitable." Among the changes alleged to have been neither anticipated nor reasonably foreseeable were:
a. "dramatic and marked changes in the natural gas business, including but not limited to deregulation and unbundling of services as mandated by FERC Order 436 in 1985 and Order 636 in 1992, the growth and development of marketing subsidiaries, the direct sale of natural gas from
b. "dramatic and unexpected changes in the energy industry generally, the value of energy and the value of natural gas"; and
c. "dramatic increases in the price of natural gas and the value of amounts paid for rentals of natural gas storage."
With respect to the Domestic Gas provisions in the gas storage leases that give Plaintiffs the right to free and/or reduced-price natural gas to their principal dwellings on the leased properties, Plaintiffs contend: "The free house gas clause is an independent clause and a separate contractual obligation of the lessee and lessee cannot avoid its express duty under the contract to provide free house gas."
One of Plaintiffs' experts is S. Wesley Haun, who describes himself as "an independent natural gas consultant with experience in the natural gas industry since 1977."
Plaintiffs have also retained William A. Henry, a consultant "for midstream operations, management, storage, regulatory and permit services."
The average annual residential natural gas rate in Kansas in 1967 (the first year for which the Energy Information Administration ("EIA") posted rates) was $1.04 per Mcf, and would have been even lower than that in 1959. The average annual residential natural gas rate in Kansas rose to as high as $13.89 per Mcf in 2008 and the EIA's most current (June 2012) rate is approximately $14.23 per Mcf.
Plaintiffs Howard Partington and Shirley Fair admit they own property that received Domestic Gas from Southern Star and its predecessors from approximately 1959 until 1999. Almost all of the gas received was delivered free of charge (the free gas maximum volume was only exceeded in two years; $.50 per Mcf was paid for the excess volume).
Plaintiffs Wendell and Sheryl Carter own three properties that are currently receiving Domestic Gas from Southern Star (Lease #32593 since October 2001; Lease #32594 since November 2007; and Lease #32639 since October 1993). The Domestic Gas delivered to Lease #32639 is reduced-price gas at $.50 per Mcf. The rest of the Domestic Gas is delivered free of charge. To date, all three properties continue to receive Domestic Gas.
The total market value (applying EIA rates) of the Domestic Gas that Southern Star or its predecessors would have been obligated to supply free of charge to the Plaintiffs and their predecessors, if each of them had complied with the conditions for and demanded the maximum free gas quantity specified in their respective gas storage lease from the date of execution, until December 31, 2011 is $1,111,558.
At the time the leases were executed, Southern Star's predecessor, Cities Service Gas Company, was a wholly regulated utility, exercising a merchant function in which its rates included the costs for gas, gathering, treating, processing, storage, transporting, etc., plus a reasonable rate of return.
Mr. Haun's opinion is that the natural gas industry has been completely restructured in substantial ways by federal regulatory changes ordered by the FERC, and that the "changes took the natural gas pipeline industry from a regulated, utility model of bundled rates and services, to a market priced commodity...."
Among the many things which happened in the years after 1959 were the passage of the NGPA of 1978, issuance of orders by the FERC numbered 380, 436, 500 and FERC order 636 in 1992 which "totally restructured the natural gas industry."
Plaintiffs served a Deposition Notice pursuant to Fed.R.Civ.P. 30(b)(6) on Southern Star which, inter alia, requested that Southern Star produce a witness who was able to testify to the manner in which certain risks associated with the operation of the Alden Storage Field have changed during the life of the field and Southern Star's ability to foresee such risks in the past or in the future.
Southern Star has identified one expert in this case, Bernie Shaner, an appraiser. He offers no opinion on whether or not substantial changes occurred that would affect fair value or whether such changes were foreseeable at the time the leases were entered.
Southern Star's Sr. Vice President Operations and Technical Services stated in a sworn affidavit filed in this case that:
The $1 per acre per year flat rental rate established in the Plaintiffs' leases in 1959 and anticipated to be in effect for another fifty years, currently has the buying power of $0.13 in 1959 Dollars.
Prior to 1978, Southern Star and its predecessor were a simple regulated chain, "vertically integrated, fully regulated providers of fully bundled sales, storage and transportation service to utilities at a cost of service rate approved at the federal level."
The dramatic and unforeseen changes in the entire structure of the natural gas storage industry have resulted in substantial economic advantages for the storage operator as follows:
a. The change allows profits for buying, selling, storing, trading, and transportation of natural gas while maintaining FERC regulations on the interstate pipeline operations;
b. Customers are utilizing storage capacity to make additional profits from price movements and seasonal price volatility;
c. Companies such as Southern Star are allowed to charge market based rates that reflect what the market will bear and not what the actual services cost, allowing them to earn more money for storage service;
e. The volume of a storage field, as part of the overall system, is a significant factor in the economics of the company;
f. Changes in the structure of the entire system allow Southern Star to use its entire system which is "reticulated" ... i.e. one that includes many different, often interconnected line segments, to meet market demands from a number of different sources;
g. The traditional utility model allowed a storage field operator to recover all of its costs in his rates;
h. Southern Star however, is not restricted to compensation for its costs in amounts in place in 1959, but rather, files periodic rate cases before the FERC to account for changes in costs and expenses. The last rate case was filed by Southern Star in 2008 and they expect to file another case in December 2013;
I. Southern Star routinely injects and withdraws more gas into the Alden Storage field than its certificated capacity. This is possible because it does so throughout the year on multiple, often daily, occasions. The volumes of storage capacity are a significant component of the economics of the company.
The current fair rental value for gas storage in the Alden Field would result in an annual payment to exercise the annual renewal option in varying amounts (based on the volumes of injections and withdrawals from the field), which in the past ten years would have fluctuated from a low of $17.57 per acre per year, to a high of $44.80 per acre per year.
Summary judgment is appropriate if the moving party demonstrates "that there is no genuine dispute as to any material fact" and that it is "entitled to judgment as a matter of law."
Once the movant has met the initial burden of showing the absence of a genuine issue of material fact, the burden shifts to the nonmoving party to "set forth specific facts showing that there is a genuine issue for trial."
Finally, summary judgment is not a "disfavored procedural shortcut"; on the contrary, it is an important procedure "designed to secure the just, speedy and inexpensive determination of every action."
The facts in this case are generally uncontested by the parties. Although Plaintiffs argue that they are entitled to a factual review at trial, Southern Star has not contested Plaintiffs' factual allegations for purposes of summary judgment, and the Court is accepting Plaintiffs' factual assertions as true for purposes of summary judgment. The parties agree that this case is governed by Kansas law.
Courts have traditionally taken the view that "competent adults may make contracts on their own terms, provided they are neither illegal nor contrary to public policy, and that in the absence of fraud, mistake or duress a party who fairly and voluntarily entered into such a contract is bound thereby, notwithstanding it was unwise or disadvantageous to him."
The Wille factors are not particularly helpful in this case. Plaintiffs concede that there was no duress, coercion or mistake in the negotiation and execution of the gas storage leases. Nor do they allege fraud, breach of contract, bad faith, improper self-dealing, or any kind of illegal activity or misconduct on the part of Southern Star or its predecessors. Plaintiffs do not allege that the annual rental rate in the gas storage leases was below market value at the time the leases were executed.
Rather, Plaintiffs argue that the market for gas storage leases has changed dramatically over the years due to factors unforeseeable at the time the leases were entered into, rendering the rent payable under the leases well below current fair market rent. Plaintiffs argue that these unforeseen changes have dramatically changed the entire industry so as to alter the equitable balance between lessor and lessee and render the annual option payment unconscionable.
Southern Star argues that unconscionability is judged at the time a contract is executed, and market changes that occur later are not sufficient grounds for equitable reformation. However, Kansas courts have held that:
The courts have relied on the rules concerning specific performance as well as the Uniform Commercial Code in making an unconscionability determination.
Plaintiffs thus set forth the unforeseeable changes in the entire structure of the natural gas storage industry and rely on the court's rulings in Jensen
In Kansas Baptist Convention, the landowner plaintiff, Kansas Baptist Convention ("KBC") sued to avoid or reform their 1952 unitization contract with the defendant, oil and gas operator, Mesa.
Although this arrangement worked when the first two wells were drilled on the gas unit, when Mesa decided to drill a third well on the gas unit the drilling costs had increased so significantly that Mesa knew KBC's share of the operating expenses, drilling expenses and interest would never be recovered by the $.10 per Mcf gas purchase price provided in the contract.
The court concluded that Mesa had breached its contract with KBC, when it elected to drill the third well.
In Jensen, the landowner-plaintiffs wanted to sell their 2,040 acre ranch, but the property was subject to a recorded mineral deed that gave the mineral interest owner the option to purchase the surface of 880 acres of the ranch for a payment of only $70 or $75 per acre.
In Wirtz, the Kansas Court of Appeals considered the decision in Jensen but reached a "contrary conclusion."
The court in Wirtz, found that "no real hardship or injustice would result from the enforcement of the lease."
These cases all focused on the presence of or lack of undue hardship. Therefore, the Court must consider whether this case presents a situation involving undue hardship. Courts will not relieve a party from a "bad bargain," therefore "undue hardship" must encompass more than loss of value over time. Plaintiffs argue that:
The crux of Plaintiffs' argument is that those industry changes have allowed Southern Star to make more money from its customers, not that the changes have caused an undue hardship on Plaintiff. The court in Wille distinguished between a situation where a party stands to lose everything they have invested, and a situation where a party is no worse off than if they had made no contract at all.
Plaintiffs ask the Court, in equity, to remedy this alleged "equitable imbalance" by reforming Plaintiffs' leases to require Southern Star to share the alleged increased profits with Plaintiffs, in spite of their agreement for a fixed-rate rent. In any long-term lease, the passage of time is likely to make it more favorable to one of the parties. Thus, each party takes the risk that future events will disadvantage the party's economic position. The Court cannot allow a party to enforce a lease when it is economically productive and repudiate or reform it when the assumed risks make it less productive. This is especially true in this case, where Plaintiffs seek to reform the provision that has become disadvantageous, while leaving intact the provision that has proved to be beneficial with the passage of time.
Southern Star argues that Plaintiffs' unconscionability argument fails to take into account the gas storage leases in their entirety, including valuable compensation in addition to the $1/acre rent.
Plaintiffs respond by arguing that the free gas clause was not part of the annual base rental for the lease for the gas storage, and is more like rental for the location of a well on the land. However, the Domestic Gas element of compensation encompasses two paragraphs of Plaintiffs' gas storage leases dealing with the right to gas at the principal dwelling on the leased properties. The gas storage leases provide specifically for (a) free gas (which in some cases is available only if a well is placed on the property); and/or (b) reduced-price
Pursuant to this provision, all Plaintiffs have the right to receive gas to the principal dwelling on their leased property at a price of only $.50 per Mcf and this right is not contingent upon Southern Star drilling a well on their property.
The right to receive gas at $.50 per Mcf is a right of compensation that all Plaintiffs have, in addition to their annual rental payment. This is a very valuable right, as average residential natural gas rates in Kansas over time have been many multiples greater than $.50 per Mcf.
Plaintiffs also argue that Domestic Gas cannot be additional consideration for Plaintiffs' leases because it is not mentioned in the paragraph of the leases specifically addressing consideration, as follows: "the consideration recited in paragraph 1 hereof, together with the herein provided annual payment, shall operate, cover and be held to be full consideration and compensation to Lessor for all privileges, rights and each option granted Lessee under this lease, except only as otherwise provided in this lease."
The Court finds that it cannot look at the provision dealing with the annual rental payment in isolation. In this case, equity requires the Court to look at the contract as a whole when determining unconscionability and whether an undue hardship exists. The Supreme Court of Kansas has stated:
The Court finds that the unforeseeable market changes present in this case, without some other factor creating an undue hardship, are insufficient to render the gas storage leases unconscionable. This conclusion is further supported by the fact that Plaintiffs have the right, which some Plaintiffs have taken advantage of, to receive free and/or reduced-price gas from Southern Star. Plaintiffs cannot argue for equitable reformation of one term in the lease that has proved disadvantageous to them, while arguing against reformation of another term that has proved beneficial by virtue of the same changes in market conditions.
Plaintiffs maintain that summary judgment is inappropriate and that they are entitled to present evidence on their claim of unconscionability. However, as stated earlier, the Court accepted all of Plaintiffs' factual assertions as true for purposes summary judgment. Where the party asserting unconscionability fails to show any facts that would tend to show unconscionability, summary judgment is proper. Plaintiffs had the opportunity in summary judgment briefing to present sufficient evidence of unconscionability but failed to do so.
