Northern Oil and Gas, Inc. v. Carol Kay Moen

United States Court of Appeals
For the Eighth Circuit
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No. 14-3836
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Northern Oil and Gas, Inc.
lllllllllllllllllllll Plaintiff - Appellee
v.
Carol Kay Moen; Orville A. Moen
lllllllllllllllllllll Defendant Third Party Plaintiffs - Appellants
v.
Limsco Limited Partnership
lllllllllllllllllllllThird Party Defendant - Appellee
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Appeal from United States District Court
for the District of North Dakota - Bismarck
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Submitted: September 10, 2015
Filed: December 10, 2015
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Before LOKEN, MELLOY, and GRUENDER, Circuit Judges.
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GRUENDER, Circuit Judge.
The parties in this case dispute the continued validity of an oil and gas lease
covering land in Williams County, North Dakota. Northern Oil and Gas, Inc.,
(“Northern Oil”) and Limsco Limited Partnership (“Limsco”) sought judgment
declaring that the lease remained valid and quieting title in their respective interests
in the lease. Carol Kay Moen and Orville A. Moen (collectively, “the Moens”)
sought declaratory judgment finding that the lease had expired as to the disputed land.
The district court1 granted Northern Oil’s and Limsco’s motions for summary
judgment, and the Moens appealed. We affirm.
I.
In 1984, the Moens’ predecessors in interest entered into an agreement to lease
oil and gas interests to Northern Oil and Limsco’s predecessor. The lease applies to
five sections of land in Williams County, North Dakota, described as follows:
Township 155 North, Range 99 West
Section 2: Lots 3 (39.99), 4 (39.91), S/2NW/4
Section 3: Lots 1 (39.89) . . . 3 (39.95), 4 (39.99), S1/2N1/2, SW1/4
Section 4: E1/2SE1/4, SW1/4SE1/2, SE1/2SW1/2
Section 9: E1/2NE1/3 . . .
Section 10: SW1/4NE1/4 . . .
The lease describes the land using the Public Land Survey System (“PLSS”), a
rectangular survey system used to subdivide and describe public land in the western
United States. The Public Land Survey System, U.S. Geological Survey,
http://nationalatlas.gov/articles/boundaries/a_plss.html (last visited Dec. 4, 2015).
1
The Honorable Daniel L. Hovland, United States District Judge for the
District of North Dakota, adopting the report and recommendation of the Honorable
Karen K. Klein, United States Magistrate Judge for the District of North Dakota.
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The PLSS divides land into six-square-mile townships. Id. These townships are
further divided into thirty-six sections, which each span one square mile. Id. Each
township is assigned a number, based on how far north or south the township is
located from the survey’s starting point, and a range, based on the township’s
distance east or west of that same point. Id. Each section within the township is also
assigned a number, one through thirty-six. Id. Thus, the PLSS assigns a unique
three-number combination—township, range, and section—to describe the exact
location of every one-square-mile section of land under the survey. This dispute
involves a 160-acre plot of land constituting the southwest quarter of Section 3,
Township 155 North, Range 99 West.
Interpreting the lease requires understanding the concepts of spacing and
pooling. A spacing unit is an administratively created boundary used “to prevent
waste, to avoid the drilling of unnecessary wells, [and] to protect correlative rights.”
N.D.C.C. § 38-08-07(1). The North Dakota Industrial Commission (“NDIC”) assigns
a spacing unit to each well “for drilling, producing, and proration purposes.” See id.
(granting the NDIC authority to set spacing units); N.D. Admin. Code § 43-02-03-
01(46) (defining spacing units). When multiple parties own land within a spacing
unit, they must combine, or “pool,” their separate interests in the land and divide
between them all profits from production within the spacing unit. See N.D.C.C. § 38-
08-08(1).
The lease at issue provides for a primary term of five years, beginning on July
5, 1984, and extends “thereafter as long as oil and gas is [sic] produced from said land
or Lessee is engaged in drilling or reworking operations thereon.” Under this clause,
production from any land under the lease would be sufficient to continue the lease
beyond its primary term with respect to all land covered by the lease. However, the
lease also contains a “Pugh clause,” a special provision designed to “protect the lessor
from the anomaly of having the entire property held under a lease by production from
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a very small portion.” Sandefer Oil & Gas, Inc. v. Duhon, 961 F.2d 1207, 1209 (5th
Cir. 1992). The Pugh clause here provides, in relevant part:
This lease shall terminate at the end of the primary term as to all of the
leased lands except those lands located within the same section of a
production unit or spacing unit2 prescribed by law or administrative
authority on which is located a well producing or capable of producing
oil or gas in commercial quantities . . . .
At the end of the lease’s primary term, Section 3 contained two active wells:
one well was assigned a 160-acre spacing unit comprised of the northwest quarter of
Section 3, and the other well was assigned a 160-acre spacing unit comprised of the
northeast quarter of Section 3. However, the southwest quarter, the land at issue here,
was not included within any spacing unit with an active well at that time.
The parties dispute whether the Pugh clause divides the lease at spacing-unit
boundaries or section boundaries. The Moens claim that the Pugh clause divides the
lease at spacing-unit boundaries such that the lease expired as to the disputed land
because the land did not fall within a spacing unit with an active well at the end of the
lease’s primary term. Under their interpretation, the wells on the northeast and
northwest quarters of Section 3 maintained the lease only as to those quarter sections.
In turn, Northern Oil and Limsco claim that the Pugh clause divides the lease at
section boundaries such that production anywhere within a one-square-mile section
of land maintains the lease as to that entire section. Under their reading, production
elsewhere on Section 3 maintained the lease as to the disputed land.
Northern Oil filed its complaint in this matter, and the Moens filed an answer,
a counterclaim against Northern Oil, and a third-party complaint against Limsco.
2
The terms “spacing unit” and “production unit” are used interchangeably in
the lease.
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After all parties moved for summary judgment, the district court referred each of the
summary-judgment motions to the magistrate judge for a report and recommendation.
The magistrate judge recommended that the lease be found valid and enforceable as
to the southwest quarter of Section 3, that Northern Oil’s and Limsco’s motions for
summary judgment be granted, and that the Moens’ motion for summary judgment
be denied. The district court issued an order adopting the magistrate judge’s report
and recommendation, granting Northern Oil’s and Limsco’s motions for summary
judgment, and denying the Moens’ motion for summary judgment. The Moens timely
appealed.
II.
We review the district court’s grant of summary judgment de novo. Hackett
v. Standard Ins. Co., 559 F.3d 825, 829 (8th Cir. 2009). Summary judgment is
appropriate only when there is no genuine issue of material fact and the moving party
is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c); Celotex Corp. v.
Catrett, 477 U.S. 317, 322 (1986).
In a diversity suit, this court applies the substantive law of the forum state, here
North Dakota. See Urban Hotel Dev. Co., Inc. v. President Dev. Group, L.C., 535
F.3d 874, 877 (8th Cir. 2008). Under North Dakota law, a contract’s language will
“govern its interpretation if the language is clear and explicit and does not involve an
absurdity.” Deckert v. McCormick, 857 N.W.2d 355, 359 (N.D. 2014) (quoting
N.D.C.C. § 9-07-02). North Dakota courts construe words in their ordinary and
popular sense unless the parties use them in a technical sense. Grynberg v. Dome
Petroleum Corp., 599 N.W.2d 261, 265 (N.D. 1999) (citing N.D.C.C. § 9-07-09). “A
contract must be construed as a whole to give effect to each provision, if reasonably
possible.” Johnson v. Shield, 868 N.W.2d 368, 371 (N.D. 2015) (citing N.D.C.C. § 9-
07-06).
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North Dakota courts presume that oil and gas leases are indivisible such that
production on any part of the land will maintain the lease beyond the primary term
for all land covered by the lease. Tank v. Citation Oil & Gas Corp., 848 N.W.2d 691,
696 (N.D. 2014) (citing Egeland v. Cont’l Res, Inc., 616 N.W.2d 861, 866 (N.D.
2000)). “A Pugh clause generally provides for a severance of the lease where less
than all of the leasehold is included in a single [spacing] unit, but it can vary widely
in form.” Id. at 697. In order to overcome the presumption that an oil and gas lease
is indivisible, a Pugh clause must “clearly and explicitly direct a division of the lease
into several parts.” Egeland, 616 N.W.2d at 867.
The parties in this case dispute the meaning of the phrase “the same section of”
in the lease’s Pugh clause, which states, in relevant part:
This lease shall terminate at the end of the primary term as to all of the
leased lands except those lands located within the same section of a
production unit or spacing unit prescribed by law or administrative
authority on which is located a well producing or capable of producing
oil or gas in commercial quantities . . . .
Northern Oil and Limsco argue that the term “section” in the Pugh clause refers to the
PLSS definition, i.e., a one-square-mile tract of land. They claim that the Pugh clause
severs the lease at section boundaries such that production from any part of a one-
square-mile section extends the lease as to that entire section. The Moens, in
contrast, claim that the Pugh clause divides the lease at spacing-unit boundaries, not
section boundaries. They argue that the definition of the term “section” is irrelevant,
and they instead focus on the preposition—the same section “of” a spacing unit.
Since the Pugh clause uses “of,” the Moens assert that whatever “section” means, the
“section” must be part “of” the spacing unit. Thus, because the disputed land did not
fall within any spacing unit, the Moens argue that the land could not have fallen
within a “section” of a spacing unit, either.
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At the outset, we note that neither side has proposed an interpretation of the
Pugh clause that gives meaning to both of the disputed terms, “section” and “of.” The
Moens’ reading ignores the term “section.” They do not propose any definition or
explain how their interpretation makes use of the term. While Northern Oil and
Limsco’s interpretation makes use of the term “section,” their reading requires us to
redefine the relevant preposition so that the Pugh clause extends the lease as to all
land in the same section “as” a spacing unit with a producing well. However, for the
reasons explained below, we find Northern Oil and Limsco’s interpretation more
persuasive and thus adopt their position that the Pugh clause divides the lease at
PLSS-section boundaries.
A.
As an initial matter, we agree with Northen Oil and Limsco that the term
“section” refers to a one-square-mile tract of land under the PLSS. When interpreting
and defining terms in oil and gas agreements, the North Dakota Supreme Court has
consistently relied on the Williams & Meyers Oil and Gas Law Manual of Terms.
See, e.g., Egeland, 616 N.W.2d at 866; Tank, 848 N.W.2d at 696. Williams & Meyers
contains one definition for the word “section”: “An area of one square mile (640
acres). There are 36 sections in a township.” 8 P. Martin & B. Kramer, Williams &
Meyers Oil and Gas Law Manual of Terms 952 (2013). The manual is consistent
with other legal resources routinely used by this court. See, e.g., Northland Cas. Co.
v. Meeks, 540 F.3d 869, 875 (8th Cir. 2008) (using Black’s Law Dictionary to define
the word “furnish” in an insurance policy). These volumes uniformly define
“section” in the real-estate context as a plot of land containing one square mile. See,
e.g., Black’s Law Dictionary 1557 (10th ed. 2014) (defining “section” as “[a] piece
of land containing 640 acres, or one square mile. Traditionally, public lands in the
United States were divided into 640-acre squares, each one called a ‘section.’”);
Webster’s New College Dictionary 1022 (3d ed. 2008) (defining “section” as “a land
unit of 640 acres or one square mile, equal to 1/36 of a township”); New Oxford
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American Dictionary 1578 (3d ed. 2010) (defining “section” as “a piece of land one
square mile in area forming one of the 36 subdivisions of a township”).
In addition to the term’s ordinary meaning, we also find telling the original
contracting parties’ use of the term “section” in other parts of the lease to refer to
PLSS sections. While the lease does not specifically reference the PLSS, it describes
the land under the lease using the PLSS three-number model by assigning a number
to the township, range, and section of each plot of land to provide its exact location.
The parties do not dispute that “Township 155 North, Range 99 West, . . . Section 3,”
refers to a one-square-mile tract of land.
The Moens contend that the meaning of the term “section” outside of the Pugh
clause does not dictate its meaning within the Pugh clause. The Moens note that the
original contracting parties did not capitalize the word “section” in the Pugh clause,
but they did capitalize the term throughout the rest of the lease when referring to
specific PLSS sections. The Moens suggest that the parties intentionally capitalized
“Section” when using its specialized meaning, i.e., a one-square-mile tract of land,
but did not capitalize the term when using it in its ordinary sense. However, a likelier
explanation for the discrepancy is that all uses of the word “section” outside of the
Pugh clause refer to particular sections of land covered by the lease—which should
be capitalized as proper nouns—whereas the Pugh clause refers to sections generally.
We see no reason to give the term “section” in the Pugh clause a different meaning
from its use elsewhere in the lease. Thus, we conclude that the term “section” as used
in the Pugh clause refers to one-square-mile tracts of land, consistent with the PLSS.
B.
Our inquiry does not end by defining “section” under the Pugh clause because
the Moens assert that the definition of “section” is irrelevant. They argue that the use
of the preposition “of” in the phrase “the same section ‘of’ a [spacing] unit”
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establishes that production maintains the lease only as to land within a spacing unit.
Because the disputed land is not contained within a spacing unit, they assert that
production from other wells in Section 3 does not maintain the lease and therefore the
lease expired as to that land.
We are tasked with choosing between two interpretations that each ignore parts
of the Pugh clause. Though we agree with their proposed definition of “section,” we
recognize that Northern Oil and Limsco’s reading is nonetheless flawed because their
interpretation construes “the same section ‘of’ a spacing unit” instead to mean “the
same section [as] a spacing unit.” However, even recognizing this flaw, we find their
reading more persuasive.
The Moens’ reading does more damage to the plain language of the Pugh
clause because they ignore the term “section,” an important word used
repeatedly—and, as explained above, consistently—throughout the lease. Further,
their interpretation renders meaningless the entire phrase “the same section of” in the
Pugh clause: if the original contracting parties had intended to divide the lease at
spacing-unit boundaries, the Pugh clause should have stated that the lease terminates
“except as to those lands located within the same section of a production unit or
spacing unit.” See, e.g., Anderson v. Hess, 733 F. Supp. 2d 1100, 1102 (D.N.D.
2010) (interpreting Pugh clause providing that “this lease shall terminate . . . as to all
of the leased lands except those within a producing or spacing unit”). We find it
unlikely that the original contracting parties inadvertently added a four-word phrase
containing a key term used repeatedly throughout the lease; in contrast, it seems
considerably more likely that the parties misused a single preposition when drafting
the Pugh clause. See Freidig v. Weed, 868 N.W.2d 546, 549 (N.D. 2015) (“A court
interprets a written contract to give effect to the mutual intention of the parties as it
existed at the time of contracting.”) (citing N.D.C.C. 9-07-03); Egeland, 616 N.W.2d
at 864 (noting that a court must interpret a contract so as “to determine the true intent
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of the parties”). Thus we adopt Northern Oil and Limsco’s interpretation of the Pugh
clause as dividing the lease at section boundaries.
The Moens attempt to overcome this conclusion by emphasizing the history
and purpose of Pugh clauses. They rely primarily on Tank v. Citation Oil & Gas,
Corp. for the proposition that Pugh clauses must be read to protect the lessor. 848
N.W.2d at 700. But Tank represents a straightforward case of contract interpretation
that focused on the plain language of the Pugh clause. In Tank, the lease at issue
contained a drilling-operations clause that conflicted with a Pugh clause; the drilling
clause, if read broadly, would have superceded the Pugh clause and rendered it
inoperative. Id. The Court sensibly interpreted the lease to give effect to both
clauses. Id. To the extent that the Court invoked the history and purpose of Pugh
clauses, it did so to determine whether the Pugh clause or drilling-operations clause
should prevail when the clauses were in conflict. See id.
Neither factor that the Tank court relied upon is present here. First, the Pugh
clause does not conflict with any other clause; rather, the issue here is whether the
language in the Pugh clause severs the lease at section boundaries or spacing-unit
boundaries. Second, adopting Northern Oil and Limsco’s interpretation of the Pugh
clause does not render the clause inoperative because the lease presumably terminated
as to any of the other four sections if they did not contain spacing units with
producing wells at the end of the primary term.
The Moens’ remaining arguments lack merit. First, they argue that Northern
Oil and Limsco’s interpretation violates a provision of the Lease that limits the right
to pool because their reading “effectively pool[s]” the southwest quarter of Section
3 with the existing spacing units within the section. Pooling involves the division of
profits between owners of land within a single spacing unit, see N.D.C.C. § 38-08-
08(1), but does not implicate the validity of an underlying lease. Second, they assert
that the inclusion of a Pugh clause in a lease creates a presumption that the lease will
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expire at the end of the primary term and that the burden is on the lessee to establish
that the lease should not expire. They cite no authority to support this claim, which
directly contradicts Egeland. See 616 N.W.2d at 866-67 (holding that in order to
overcome presumption that oil and gas leases are indivisible, a Pugh clause must
divide the lease “clearly and explicitly”).
Accordingly, we agree with the district court that the lease remains valid
because production from other areas in Section 3 maintains the lease as to the entire
section.
III.
For the foregoing reasons, we affirm.
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