Kraynak v. Whitacre

[Cite as Kraynak v. Whitacre, 2018-Ohio-2784.]
IN THE COURT OF APPEALS OF OHIO
SEVENTH APPELLATE DISTRICT
MONROE COUNTY
KENNETH R. KRAYNAK, ET AL.,
Plaintiffs-Appellees,
v.
KOY L. WHITACRE, ET AL.,
Defendants-Appellants.
OPINION AND JUDGMENT ENTRY
Case No. 17 MO 0014
Civil Appeal from the
Court of Common Pleas of Monroe County, Ohio
Case No. 2015-203
BEFORE:
Gene Donofrio, Carol Ann Robb, Kathleen Bartlett, Judges.
JUDGMENT:
Affirmed.
Atty. Timothy Pettorini, and Atty. Sara Fanning, Roetzel & Andress, LPA, 41 South High
Street, Huntington Center, 21st Floor, Columbus, Ohio 43215, for Plaintiffs-Appellees,
and
Atty. Daniel Gibson, Atty. Christine Schirra, Atty. Kara Herrnstein, Atty. Matthew
Warnock, Bricker & Eckler LLP, 100 South Third Street, Columbus, Ohio 43215, and
Atty. Kevin Colosimo, Atty. Christopher Rogers, Frost Brown Todd LLC, Union Trust
Building, 501 Grant Street, Suite 800, Pittsburgh, Pennsylvania 15219, and
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Atty. Richard Yoss, Atty. Ryan Regel, Yoss Law Office, 122 North Main Street,
Woodsfield, Ohio 43793, and Atty. Zachary Simpson, Gulfport Energy Corporation,
14313 North May Avenue, Suite 100, Oklahoma City, Oklahoma 73134, for Defendants-
Appellants.
Dated:
July 3, 2018
Donofrio, J.
{¶1} Defendants-appellants, Koy L. Whitacre, KL.J., Inc., Gulfport Energy
Corporation, Buckeye Oil Company, Clearfork Oil Company, Whitacre Oil Company,
Whitacre Enterprises, Inc., and American Energy-Utica Minerals, LLC, appeal from a
Monroe County Common Pleas Court judgment, resulting from a bench trial, that a
certain oil and gas lease terminated due to the failure of the well at issue to produce in
paying quantities.
{¶2} Plaintiff-Appellee, Kenneth Kraynak, is the owner of 99.18 acres of real
property located in Wayne Township (the property). On August 21, 2006, appellee
entered into an oil and gas lease with Whitacre Enterprises, Inc. (Whitacre Enterprises).
During this transaction, Whitacre Enterprises was represented by its sole owner, Koy
Whitacre (Whitacre).
{¶3} The lease contained two duration terms under its habendum clause. The
primary term provided that the lease would last for fifteen months. The secondary term
provided that the lease would continue “as much longer as oil or gas is found in paying
quantities.” Throughout the duration of this lease, Whitacre operated one well on
appellee’s property, the K. Kraynak No. 1 well (the well).
{¶4} In addition to Whitacre Enterprises, Whitacre wholly owns and operates
Whitacre Store, LLC (Whitacre Store). While Whitacre Enterprises negotiated the
original lease with appellee, Whitacre Store was responsible for servicing the well. All of
Whitacre’s employees and equipment are housed under Whitacre Store. Whitacre
Enterprises has no employees and owns no equipment. Whitacre Enterprises
transferred $300.00 a month every month to Whitacre store as operating expenses for
the well. According to Whitacre, this business and transaction structure was done for
accounting simplicity purposes and did not reflect the actual operating costs of the well.
Case No. 17 MO 0014
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{¶5} The oil and gas lease between Kraynak and Whitacre also contained a
sublease agreement which allowed Whitacre to sublet the well. Appellant Gulfport
Energy Corporation is a sub-lessee of the deep rights to the well and appellant
American Energy – Utica Minerals owns an overriding royalty interest in the well.
{¶6} On July 10, 2015, appellee filed this action in the Monroe County Common
Pleas Court. Appellee sought, among other things, declaratory judgment that the well
was no longer producing in paying quantities and an order quieting appellee’s title to all
oil and gas rights in and under the property against all appellants.
{¶7} The years at issue concerning the well’s profitability are the years 2012
through 2015. Under an analysis performed by Whitacre, which did not include the
$300.00 a month Whitacre Enterprises transferred to Whitacre Store, the well resulted
in a net profit each year. Under an analysis performed by Kraynak, which did include the
$300.00 a month Whitacre Enterprises sent to Whitacre Store, the well resulted in a net
loss each year. The only fact disputed in this case is what expenses the $300.00 a
month payment from Whitacre Enterprises to Whitacre Store paid for.
{¶8} The matter proceeded to a bench trial. At trial, appellee produced
Whitacre’s business records which showed the amount of gas produced by the well for
the years 2012 through 2015. (Tr. Ex. 4-7). Also introduced were Whitacre’s business
records showing the amount of operating expenses Whitacre incurred in operating the
well for those same years. (Tr. Ex. 17-20). One of those expenses was the $300.00 a
month Whitacre Enterprises paid Whitacre Store. Those expenses were labeled as
“operating expenses.” (Tr. 36). The records showed that for each month between 2012
through 2015, the well resulted in a net loss. Moreover, Whitacre’s responses to
appellee’s requests for admissions were admitted into evidence. These responses show
that Whitacre admitted that the well’s revenue did not exceed the operating expenses
for the years 2012 through 2014. (Tr. 83-84, Ex 15).
{¶9} Appellants presented testimony which showed that the $300.00 a month
Whitacre Enterprises sent to Whitacre Store were blanket expenses that had no impact
on the well’s ability to produce in paying quantities. (Tr. 102-103). Appellants argued
that the $300.00 a month did not accurately reflect the operating costs associated the
well.
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{¶10} In a judgment entry dated May 31, 2017, the trial court ruled that the
revenue from the well was not sufficient to offset the costs of operating the well. The
trial court specifically pointed out the $300.00 a month Whitacre Enterprises transferred
to Whitacre Store for operating costs, which amounted to $3,600.00 a year. The
$300.00 a month was greater than any revenue the well generated for the years 2012
through 2015. The trial court ruled that the $300.00 a month payment combined with the
other expenses in operating the well that Whitacre Enterprises reported rendered the
well’s revenue less than its expenses. The trial court ruled in favor of appellee on his
quiet title action and deemed the lease terminated due to the well’s failure to produce in
paying quantities. Appellants timely filed this appeal on June 29, 2017. Appellants now
raise two assignments of error.
{¶11} Appellants’ two assignments of error will be analyzed together.
{¶12} Appellants’ first assignment of error states:
THE TRIAL COURT ERRED IN ENTERING JUDGMENT IN
FAVOR OF PLAINTIFF-APPELLEE.
{¶13} Appellants’ second assignment of error states:
THE TRIAL COURT ERRED IN NOT GRANTING JUDGMENT IN
FAVOR OF DEFENDANTS-APPELLANTS.
{¶14} In an action seeking declaratory judgment, legal questions are subject to a
de novo standard of review. Paulus v. Beck Energy Corporation, 7th Dist. No 16 MO
0008, 2017-Ohio-5716, ¶ 15 citing Arnott v. Arnott, 132 Ohio St.3d 401, 2012-Ohio-
3208, 972 N.E.2d 586. But where the final decision involves factual issues, R.C.
2721.10 provides: “that issue may be tried and determined in the same manner as
issues of fact are tried and determined in other civil actions in the court in which the
action or proceeding is pending.” Id.{¶15} When reviewing civil appeals from bench trials, an appellate court applies
a manifest weight standard of review. Revilo Tyluka, L.L.C. v. Simon Roofing & Sheet
Metal Corp., 193 Ohio App.3d 535, 2011-Ohio-1922, 952 N.E.2d 1181 (8th Dist.),
citing App.R. 12(C), Seasons Coal v. Cleveland, 10 Ohio St.3d 77, 461 N.E.2d 1273Case No. 17 MO 0014
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(1984). Judgments supported by some competent, credible evidence going to all the
material elements of the case must not be reversed as being against the manifest
weight of the evidence. C.E. Morris Co. v. Foley Constr. Co., 54 Ohio St.2d 279, 376
N.E.2d 578, syllabus (1978). See, also, Gerijo, Inc. v. Fairfield, 70 Ohio St.3d 223, 226,
638 N.E.2d 533 (1994). Reviewing courts must oblige every reasonable presumption in
favor of the lower court's judgment and finding of facts. Gerijo, 70 Ohio St.3d at 226,
638 N.E.2d 533 (citing Seasons Coal Co., supra). In the event the evidence is
susceptible to more than one interpretation, we must construe it consistently with the
lower court's judgment. Id. In addition, the weight to be given the evidence and the
credibility of the witnesses are primarily for the trier of the facts. Kalain v. Smith, 25 Ohio
St.3d 157, 162, 495 N.E.2d 572 (1986). “A finding of an error of law is a legitimate
ground for reversal, but a difference of opinion on credibility of witnesses and evidence
is not.” Seasons Coal, 10 Ohio St.3d at 81, 461 N.E.2d 1273.
{¶16} The relevant issue in this case is whether the well was producing in paying
quantities. The term “paying quantities” is defined as production of “quantities of oil or
gas sufficient to yield a profit, even small, to the lessee over operating expenses, even
though the drilling costs, or equipping costs, are not recovered, and even though the
undertaking as a whole may thus result in a loss.” Blausey v. Stein, 61 Ohio St.2d 264,
265-266, 400 N.E.2d 408 (1980). Whether the production is in paying quantities is left to
the good faith judgment of the lessee. See Hupp v. Beck Energy Corp., 7th Dist. Nos 12
MO 6, 13 MO 2, 13 MO 3, 13 MO 11, 2014-Ohio-4255, ¶ 102–103. The party who
asserts the claim that the well is not producing in paying quantities carries the burden of
proof. Positron Energy Resources, Inc. v. Weckbacher, 4th Dist. No. 07CA59, 2009-
Ohio-1208, ¶ 19, see also Weisant v. Follett, 17 Ohio App. 371 (7th Dist. 1922). In a
paying quantities analysis, the reviewing court looks to the direct operating costs and
excludes any indirect operating costs that do not contribute to the production of oil or
gas. Hogue v. Whitacre, 7th Dist. No. 16 MO 0015, 2017-Ohio-9377, ¶ 27.
{¶17} Appellants raise four issues regarding their assignments of error. The
issues will be analyzed separately.
The trial court incorrectly concluded that Whitacre Enterprise’s business records
established the Well’s failure to produce in paying quantities.
Case No. 17 MO 0014
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{¶18} Appellants argue that the trial court erred when it classified “operating
costs” in Whitacre Enterprises’ business records as being the true costs in operating the
well. Appellants also argues that the trial court erred when it concluded that no
admissible evidence contradicted appellee’s interpretation of the business record.
{¶19} In its judgment entry dated May 31, 2017, the trial court ruled that all of
Whitacre Enterprises’ records kept in the ordinary course of business for the years 2012
through 2015 showed that the well’s production was less than the expenses incurred to
operate the well. The trial court also ruled that the testimony from Whitacre and Lisa
Jones, an employee for Oil Haulers, LLC and Whitacre’s daughter, related to indirect
expenses was self-serving, irrelevant, and not persuasive.
{¶20} At trial, Whitacre Enterprises’ “detail by lease” records for the well were
admitted into evidence. (Tr. 37-41, Ex. 10-13). These records show that every month
from December of 2011 until August of 2015, the well resulted in a net loss. (Tr. 37-41,
Ex. 10-13). The loss from 2012 was $1,854.37, the loss from 2013 was $2,281.73, the
loss from 2014 was $2,035.80, and the loss from 2015 was $2,277.38. (Ex. 10-13). The
expenses for each of these months include the $300.00 payment Whitacre Enterprises
made to Whitacre Store. The only exception is August of 2015 where the payment was
$225.00. For each year, this expense is only labeled as “operating.”
{¶21} Appellants contend that the $300.00 a month payment should not have
been included because appellee did not satisfy his burden to show that this payment
reflected the direct costs of operating the well. Whitacre testified that this amount was
chosen because “it was simpler just to pay Whitacre Store X number of dollars.” (Tr.
141). Whitacre also testified that this amount was based on “the price of oil and gas at
the time.” (Tr. 154). Similarly, Lisa Jones testified that some of the operating expenses
would be unaffected if the well did not exist. (Tr. 102-103).
{¶22} There is no other evidence in the record of exactly what operating costs
the $300.00 a month from Whitacre Enterprises to Whitacre Store paid for. The 2012
through 2015 “expenses – original source documents” only identify this $300.00 a
month as “operating.” (Ex. 17-20). It is also only identified as an “operating” expense in
the detail by lease records. (Ex. 10-13).
Case No. 17 MO 0014
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{¶23} Equally important, Whitacre’s responses to appellee’s requests for
admissions were admitted at trial. (Ex. 15). In these responses, Whitacre admitted that
“after deducting [the] landowner royalty, revenue from production and sale of oil and gas
from the K. Kraynak No. 1 Well did not exceed operating expenses between January 1,
2012 and December 31, 2012.” (Tr. 150-151, Ex. 15). Whitacre admitted the same for
the years 2013 and 2014. (Ex. 15). Based on all of these exhibits, appellee satisfied his
burden and put forth evidence that the well was not producing in paying quantities.
{¶24} At trial, there was a factual dispute as to whether the $300.00 a month
from Whitacre Enterprises to Whitacre Store constituted a direct or an indirect operating
expense. Whitacre’s business records were ambiguous and did not itemize the
operating expenses the $300.00 paid for. As such, the trial court made a conclusion of
fact based on the testimony and exhibits presented at trial that the $300.00 a month
constituted a direct operating expense. The only evidence that countered this
conclusion was testimony from Whitacre and Jones. In its May 31, 2017 judgment entry,
the trial court found this testimony self-serving, irrelevant, and not persuasive.
The trial court errantly based its “Production in Paying Quantities” conclusion on
Investment or Tax Profit or Loss.
{¶25} Appellants argue that the trial court erred when it relied on investment or
tax profits or losses in its paying quantities analysis. Appellants essentially argue that
even though the well overall was not profitable, including the working interest owner-
investors not seeing a profit, this is irrelevant under a paying quantities analysis as the
only thing that matters is whether the operating costs exceed the revenue of the well.
{¶26} In its May 31, 2017 judgment entry, the trial court found that the working
interest owners of the well each suffered a loss and did not see a profit from their
ownership interest in the well during the years 2012 through 2015.
{¶27} We do not reach a general conclusion on whether the working interest
owners’ profits or losses affect a paying quantities analysis. Even if the record lacked
any evidence of such profits or losses, there are still multiple pieces of evidence in the
record which show that the well’s operating expenses exceeded its revenue.
Case No. 17 MO 0014
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{¶28} Whitacre and Jones admitted at trial that the well was not profitable
overall. (Tr. 101, 106-112, 153-154). Multiple exhibits at trial also showed that the well’s
production did not exceed the operating costs. (Ex. 10-13, 17-20). Whitacre even
admitted in requests for admissions that the well’s operating costs exceeded the well’s
revenue. (Ex. 15). In short, even if this evidence should not have been considered by
the trial court, the trial court still had sufficient evidence to conclude that the well’s
profits did not exceed its operating costs. Any error by the trial court in considering the
working interest owners’ profits or losses is harmless error and disregarded pursuant to
R.C. 2309.59.
Whitacre Enterprise’s Monthly Payments to Whitacre Store are not Operating Expenses
{¶29} Appellants argue that the $300.00 a month payment from Whitacre
Enterprises to Whitacre Store should not have been considered an operating expense
as it was a blanket payment Whitacre Enterprises made to Whitacre Store.
{¶30} Appellants make four arguments regarding this issue. First, appellants
argue that it was undisputed that the $300.00 a month payment had no relation to the
actual costs of production. Appellants point to the testimony of Whitacre to support this
argument. (Tr. 141, 154). But Whitacre testified that while this payment was a “catch-all”
payment, “some of that $300 represents the direct costs of production[.]” (Tr. 141).
Whitacre also testified that the $300.00 per month payment was so Whitacre Store
could operate the well. (Tr. 118). Moreover, Whitacre’s business records themselves
classify this $300.00 a month payment as “operating.” (Ex. 10-13, 17-20).
{¶31} Second, appellants argue that because Whitacre Store was a third party
operator and not the actual lessee, the trial court erred in concluding that the $300.00 a
month payment represented operating costs. In response, appellee argues that
appellants’ argument would allow lessees to outsource all well operations to a third
party and claim that the operating costs are zero because they are done by a third
party. (Brief of Appellee 15).
{¶32} In support of their argument, appellants cite this Court’s decision in Paulus
v. Beck Energy Corporation, 7th Dist. No. 16 MO 0008, 2017-Ohio-5716. Appellants rely
on Paulus for the notion that Ohio case law emphasizes that the “law is concerned with
Case No. 17 MO 0014
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the actual costs of operation, not the identity of who incurs those costs.” (Brief of
Appellants 15). But the portions of Paulus appellants cite do not help or hinder their
arguments. Specifically, costs associated with the pumping of a well are treated as a
direct expense attributable to production of the well, “just as it would have been if an
independent contractor performed the service.” Id. at ¶ 64. But this particular section of
Paulus was addressing how the lessee artificially deflated its operation expenses and
such artificial deflation was appropriate for a court to consider when performing a paying
quantities analysis. Id. at ¶ 62-64.
{¶33} Third, appellants argue that affirming the trial court would encourage
lessees to establish arbitrarily low operating costs in order to perpetually preserve
leases. Appellants argue that if the $300.00 a month payment from Whitacre
Enterprises to Whitacre Store could be used as evidence in a paying quantities
analysis, then people in Whitacre’s position could easily create a separate entity to
operate the well and pay the operating entity nominal amounts of money or no money at
all.
{¶34} This argument does not affect the trial court’s paying quantities analysis.
The trial court had competent and credible evidence that the $300.00 a month Whitacre
Enterprises paid to Whitacre Store was for operating costs associated with the well.
Moreover, if a lessee does attempt to artificially deflate its operating costs for purposes
of perpetually preserving a lease, it stands to reason that evidence of such deflation will
exist as it did in Paulus.
{¶35} Fourth, appellants argue that the well was in fact producing in paying
quantities for all four years at issue. Appellants argue that the testimony and underlying
documents admitted at trial show that the well was producing in paying quantities for the
years 2012 through 2015.
{¶36} At trial, Jones testified that she personally reviewed Whitacre Enterprises’
records associated with the well. (Tr. 97). Jones also testified that the accounting
system used by Whitacre does not distinguish between direct and indirect expenses.
(Tr. 109). Jones testified from documents she prepared that the well overall was
profitable. (Tr. 110-112). But in a judgment entry dated March 29, 2017, the trial court
excluded the exhibits Jones was testifying to on the basis that they were inadmissible
Case No. 17 MO 0014
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hearsay. One of those excluded exhibits, D-C, purported to illustrate the direct cost of
operating the well. (Tr. 98). But appellee objected to this exhibit on the basis that it was
prepared either in anticipation of litigation or during litigation and therefore did not
constitute a business record pursuant to Evid.R. 803(6). (Tr. 167). Jones testified that
this proposed exhibit was prepared after this action was filed. (Tr. 98).
{¶37} With several admitted exhibits showing that the well was not profitable
while the testimony of Whitacre and Jones was that the well was profitable, there was
an issue of fact that needed to be resolved regarding the profitability of the well. The
trial court resolved the issue finding that the exhibits at trial showed the well was not
profitable and finding the testimony of Whitacre and Jones to be self-serving and not
persuasive.
{¶38} Furthermore, appellants and appellee agree that the well’s revenue from
the years 2012 through 2015 were $2,271.57, $1,869.87, $2,138.27, and $866.28
respectively (Brief of Appellants 19, Brief of Appellee 2). Applying only the $300.00 a
month payment, which is $3,600.00 per year, the well’s expenses surpassed the well’s
revenue for the years 2012 through 2015.
Koy Whitacre’s Reponses to the Requests for Admission Do Not Change the Result
{¶39} Appellants argue that Whitacre’s admissions that revenue from the well
did not exceed the operating costs for the years 2012, through 2014 does not change
the fact that the well was still producing in paying quantities. Appellants also argue that
Whitacre’s admissions do not bind other appellants, specifically Gulfport.
{¶40} We do not agree with appellants’ argument that Whitacre’s responses to
the requests for admissions have no effect on the trial. These responses show Whitacre
admitted that for the years 2012 through 2014, the well’s operating costs did not exceed
its revenue. (Ex. 15). In its judgment entry dated May 31, 2017, the trial court noted that
these responses conclusively established that the revenue from production and sale of
gas from the well did not exceed operating expenses during 2012 through 2014.
{¶41} Appellants also argue that Whitacre did not know exactly what he was
admitting to when he admitted that the well’s operating costs did not exceed its revenue.
Whitacre testified at trial that he did not know the legal distinction between direct and
Case No. 17 MO 0014
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indirect operating costs and therefore included all operating costs. (Tr. 151-152).
Additionally, Whitacre denied all requests for admissions which asked him to admit that
the well was not producing “in paying quantities” for the relevant years. (Ex. 15).
{¶42} Appellee argues that under this Court’s decision in Paulus, the formula for
determining if a well is profitable is income minus operating expenses. Paulus at ¶ 68.
The requests for admissions that Whitacre admitted state:
Admit that, after deducting the landowner royalty, revenue from the
production and sale of oil and gas from the K. Kraynak #1 Well did not
exceed operating expenses between January 1, 2012 and December 31,
2012.
Ex. 15.
{¶43} This same request for admission was repeated for the years 2013 and
2014 with Whitacre admitting both of them. (Ex. 15). This is the same formula this Court
established in Paulus.
{¶44} The trial court also found that Whitacre Enterprises’ business records for
the years 2012 through 2015 showed that the revenue generated from the well was less
than the expenses incurred to operate the well. This was shown in several exhibits
admitted at trial. (Ex. 10-13, 17-20, 27-30).
{¶45} Addressing Whitacre’s discovery responses applying to other parties,
appellants cite the Tenth District’s decision in Chickey v. Watts, 10th Dist. No. 04AP-
1269, 2005-Ohio-4974. In Chickey, the Tenth District held that one party’s responses to
requests for admissions cannot be binding on another party. See Id. at ¶ 24.
{¶46} This argument does not have merit for two reasons. First, there is no
evidence that the trial court bound other parties to Whitacre’s admissions. No such
ruling is found in the record. Second, whether Whitacre’s admissions are binding on
another party is irrelevant to a paying quantities analysis. These admissions were
relevant to the sole issue at trial, which was whether the well was producing in paying
quantities. After a review of the record, the trial court’s judgment that the lease was
terminated due to the well’s failure to produce in paying quantities is supported by
competent and credible evidence.
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{¶47} Accordingly, appellants’ first and second assignments of error lack merit
and are overruled.
{¶48} For the reasons stated above, the trial court’s judgment is hereby affirmed.
Robb, P. J, concurs
Bartlett, J., concurs
Case No. 17 MO 0014
[Cite as Kraynak v. Whitacre, 2018-Ohio-2784.]
For the reasons stated in the Opinion rendered herein, the two assignments of
error are overruled and it is the final judgment and order of this Court that the judgment
of the Court of Common Pleas of Monroe County, Ohio, is affirmed. Costs to be taxed
against the Appellant.
A certified copy of this opinion and judgment entry shall constitute the mandate in
this case pursuant to Rule 27 of the Rules of Appellate Procedure. It is ordered that a
certified copy be sent by the clerk to the trial court to carry this judgment into execution.
NOTICE TO COUNSEL
This document constitutes a final judgment entry.