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Energy & the Law

Contracts – It’s More About the Drafting Than the Suing

Posted in Contract Disputes
compressorCo-author Brooke Sizer

It’s been said that your most important decisions are made when you write your contract, not when you have to sue on it. Kachina Pipeline Company v. Lillis agrees.

In a gas-purchase agreement, can the pipeline operator (Kachina) deduct costs of compression from its payments to the producer (Lillis).

“No”, said the Texas Supreme Court. Kachina could not charge Lillis for compression costs incurred after it received the gas in order to sell the gas to the third-party processing facility.

Why? Because according to the words of the contract that was the intention of the parties. This is even if, as the dissent argues, given the way things work in the business the parties couldn’t have meant what the words say.

The case construed the following provision:

Seller shall deliver the gas deliverable hereunder, … at a pressure sufficient to enter Buyer’s pipeline against the working pressure maintained therein from time to time. … neither party … shall be obligated to compress any gas … . If Buyer installs compression to effect delivery of Seller’s gas, Buyer will deduct from proceeds payable to Seller hereunder a value equal to Buyer’s actual costs to install, repair, maintain and operate compression, plus 20% … .

Sequence of Events

2001 – Lillis begins selling gas to Kachina (maybe earlier)

2003 – Kachina installs the Barker Central Compression Station

2007 – Kachina installs additional compression

2005 – The contract is made

2005 to 2008 – Kachina buys, transports, and resells Lillis’s gas according to the contract, deducting marketing fees, which include compression costs.

2008 – Lillis enters into a purchase agreement directly with Davis, constructs his own pipeline to its plant, and objects to Kachina’s deductions.

Lillis would transfer gas from his wells into Kachina’s gathering system and Kachina would pay Lillis a percentage of the proceeds from resale to Davis.

Alternative Readings

If the provision authorized deductions for any compression that aids in the final delivery of gas to Davis, then Kachina had been rightfully deducting Lillis’s share of costs.

If the provision only allowed deductions for compression that Kachina installed post-contract. If Lillis failed to deliver at pressures that overcame Kachina’s working pressure at the point of transfer, no deductions were allowed.

The Result

The contract allowed Kachina to deduct only the costs of compression installed during the term of the Agreement if required to overcome the working pressure in Kachina’s system.  In order to discern the intention of the parties the court relied on the four pretty-much standard rules of construction. We’ve stated them in this blog before and don’t need to repeat them. See page 6 of the opinion.

The Dissent
Three justices dissented. It was illogical for Lillis to pay compression costs prior to 2005, but then no longer have to pay them under the 2005 agreement. The believe the parties really didn’t intend the meaning ascribed to them by the majority. Further, “Lillis testified that, under the 2005 GPA, he expected to keep paying compression costs. And though Lillis’ expectations do not determine the meaning of the agreement … they certainly reflect his perspective on the facts: … Kachina’s compression had been and would be effecting delivery of his gas. [We] would not reward Lillis’ efforts to avoid his acknowledged obligation under the GPA.”

Today’s musical interlude is dedicated to Mr. Lillis, whose testimony almost blew his case.