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November 25, 1981

James I. MOORE, Paul L. Meaders and Lorna P. O'Brien, as tenants in common, Donald K. Lourie, on his own behalf and on behalf of Cynthia Janeway, Edward N. Cogen, George F. Fisher, Jr. and Martha C. Fisher, as tenants in common, Brad Hvolbeck and Marian Hvolbeck, as tenants in common, Donald C. Alexander on his own behalf and on behalf of Hiram D. Black and C. Benson Wigton, Jr., Plaintiffs,
TRISTAR OIL AND GAS CORPORATION, Bryant Oil & Gas Corporation, Sheldon J. Dubow, James B. Lundquist and Clayton Brokerage Co. of St. Louis, Inc., Defendants

The opinion of the court was delivered by: CANNELLA

After a trial on the merits of plaintiffs' amended complaint, the Court finds for defendants. The amended complaint is dismissed.

The Court reserves decision on defendants' counterclaim *fn1" pending further proceedings consistent with this Opinion.



 Plaintiffs bring this diversity action for breach of contract and breach of fiduciary duty against Tristar Oil and Gas Corp. ("Tristar") and Bryant Petroleum Corp. ("Bryant"), *fn2" the two former general partners of the Tristar Thermoil Oil Income Program (the "partnership"), a California limited partnership, Sheldon J. Dubow and James B. Lundquist, the presidents, chief executive officers and sole shareholders of Tristar and Bryant respectively, and Clayton Brokerage Co. of St. Louis, Inc. ("Clayton"). *fn3" Throughout this Opinion, the Court will refer to Tristar, Bryant, Dubow and Lundquist as the Tristar defendants.

 Each of the plaintiffs invested in the partnership as limited partners, holding collectively 7-1/2 of the 40-1/2 limited partnership units. In brief, plaintiffs allege that the Tristar defendants improperly divided among the limited and general partners the proceeds from (1) the sale of the limited partnership's primary asset, a leasehold interest in certain oil-bearing property in California, and (2) the concurrent sale of interests in the leasehold held by the general partners. *fn4" Plaintiffs claim that this division of proceeds violated the terms of the limited partnership agreement in that the general partners received a larger portion of the proceeds than that to which they were entitled, thereby decreasing the share of each limited partner. Plaintiffs also charge that defendants breached their fiduciary duties owed to the limited partners, by acting in concert in furtherance of their own interests to the exclusion of plaintiffs' interests.

 The Offering Period

 The following are the Court's findings of fact: Prior to July 1979, the Thermoil Company ("Thermoil"), a wholly-owned subsidiary of Bryant, held an 80% net leasehold in the property at issue, known as the Kern River field. Bryant thus had the right to explore for and extract oil and gas from the property. The lessor of the property, Tenneco West, Inc. ("Tenneco"), retained a 20% interest in the lease, known as a landowner royalty, which entitled it to 20% of the production and sale of oil and gas. Under the lease, Tenneco could demand its payment either in oil and gas or in money and its interest was not subject to the lessee's production expenses. *fn5" The lease was to expire in July 1983, although it could be renewed for so long as the lessee determined that oil and gas could be produced in paying quantities. *fn6" The lease also prohibited the drilling of new oil wells after July 25, 1983. *fn7" The first wells were drilled on the property in 1964, and by July 1979 forty-nine wells were in place on the property's 110 acres. *fn8" Over time, however, it had become clear that artificial means of stimulating production were necessary to recover oil in commercial quantities. Bryant decided that a "steam flooding" process would be required to reduce the viscosity of the oil and to increase its flow to the wells. But between December 1977, when Bryant acquired Thermoil, and early 1979, Bryant was unable to raise sufficient funds to engage in a large-scale enhanced recovery program through steam flooding. *fn9"

 To meet its capital requirements, Bryant decided to organize a limited partnership. Its plan was to raise $ 2 million by arranging in conjunction with Tristar, which was in the business of organizing oil and gas investor participation programs, an offering of fifty units of the limited partnership, at a cost of $ 40,000 per unit. *fn10" Bryant and Tristar determined, however, that the operation could commence with as little as.$ 1.2 million although they also determined that the recovery program might be adversely affected if less than $ 1.7 million was raised. *fn11" Upon the completion of the offering and the formation of the partnership, Bryant planned to convey its interest in the lease to the partnership *fn12" for $ 600,000 in cash and the assumption by the partnership of $ 186,000 in notes. *fn13" This amount approximated Bryant's original cost in acquiring the lease through its acquisition of Thermoil as well as the cost of subsequent improvements on the property. *fn14"

 In July 1979, the general partners retained Clayton to act as underwriter on their behalf in the sale of the fifty units. Clayton agreed to use its best efforts to find buyers for the units during a sixty-day offering period in return for 10% of the initial capital raised. The underwriting agreement gave the general partners the sole power to extend the offering period. *fn15" Because the minimum thirty units had not been sold by September 1979, the general partners extended the offering period. *fn16"

 In October 1979, Lundquist advised Stephen C. Holmes, who was Clayton's syndication manager on this offering, that in September the Getty Oil Corporation had offered.$ 1.8 million to purchase Bryant's interest in the Kern River lease and that in October Santa Fe Industries, Inc. had offered $ 3.5 million toward the same end. *fn17" After consulting his superiors at Clayton, Holmes asked Lundquist if the general partners would give Clayton another extension and refrain from selling the property. The general partners decided not to exercise their right to withdraw from the offering and granted the requested extension. *fn18" By mid-November, Clayton had achieved the minimum capitalization, *fn19" and by late-November, 40-1/2 units had been sold to thirty-one persons for a total sum of $ 1,620,000. *fn20"

 The limited partnership offering was made through the use of a Private Placement Memorandum (the "Memorandum"). *fn21" Each investor, including plaintiffs, signed a subscription agreement certifying that he had read the Memorandum and the Certificate and Agreement of Limited Partnership (the "Partnership Agreement"), *fn22" and, in making his investment, had relied on the information contained therein. *fn23" By signing the subscription agreement, each investor also agreed to be bound by the terms of the Partnership Agreement. *fn24" During the offering, Clayton undertook to ascertain whether each subscriber met the offering criteria, namely, that the subscriber was a wealthy and sophisticated investor and capable of bearing the economic risks of an investment in the limited partnership. All of the plaintiffs met the offering criteria. *fn25"

 The Memorandum is a fifty-one page document, plus appendices, and contains a detailed description of the limited partnership, its purpose and goals, and the rights and obligations of the general and limited partners. The Memorandum also contains a copy of the Partnership Agreement. The Memorandum and Partnership Agreement state that upon formation of the partnership the general partners would receive a one-time fee of 5% of the initial capital to cover their expenses in organizing the partnership. *fn26" These documents also reveal that as compensation for organizing and promoting the limited partnership, the general partners would receive 1% of the partnership's net income. *fn27" The general partners would also receive an annual overhead reimbursement fee of $ 20,000, *fn28" and, upon dissolution, 10% of the distributable assets of the partnership. *fn29"

 Of particular import to this litigation are the Memorandum and Partnership Agreement's provisions relating to the general partners' so-called "overriding royalty" and "working interest." Both documents explain that the general partners would receive, as consideration for managing the partnership, a 5% overriding royalty in the revenues from the property until the limited partners recovered 100% of their initial capital contributions at "payout," and, after payout, a 10% overriding royalty and a 10% working interest in all the limited partnership's property. *fn30" Thus, as explained in the Memorandum, after Bryant conveyed its interest in the lease to the partnership, the partnership would hold a 100% working interest in a 75% net leasehold, Tenneco would retain its 20% net leasehold by virtue of its landowner royalty, and the general partners would own a 5% net leasehold by virtue of their 5% overriding royalty. *fn31" After payout, the partnership would hold a 90% working interest in a 70% net leasehold, Tenneco would continue to hold its 20% landowner royalty, and the general partners would hold a 10% net leasehold through their stepped-up overriding royalty, as well as a 10% working interest in the partnership's 70% net leasehold. *fn32"

 An overriding royalty is defined in the Partnership Agreement as "an interest in the oil and gas produced pursuant to a specified oil and gas lease or leases, or the proceeds from the sale thereof, carved out of the working interest, to be received free and clear of all costs of development, operation, or maintenance." *fn33" The Memorandum defines overriding royalty as "(an) interest in oil and gas produced free of the expenses of production, and which is in addition to the royalty reserved by the lessor of the land." *fn34" The term working interest is defined in the Partnership Agreement as "an interest in an oil and gas leasehold which is subject to some portion of the expense of development, operation, or maintenance." *fn35" In the Memorandum, a working interest is defined as

(an) operating interest under an oil lease covering a specific tract or tracts of land. The owner of a working interest has the right to explore for, drill and produce the oil covered by such lease, and to bear a proportionate share of the expense of development, operation or maintenance. In the situation of a lessor who executes a lease, reserving a 20% royalty, to a lessee who creates no additional burdens on such lease, the working interest receives 80% of production therefrom subject to all costs of exploration, operation and development and the lessor receives its 20% of production free of such costs. *fn36"
The Memorandum states that the partnership would assign to the general partners their overriding royalty, *fn37" and it is a customary practice in the oil and gas industry to assign both overriding royalty interests and working interests. *fn38" These terms will be discussed more fully below.
In a document entitled "Schedules of Projected Program Cash Flow, Projected Cash Flow From Operations and Projected Taxable Income *fn39" the partnership's independent accounting firm, Elmer Fox, Westheimer & Co. ("Fox"), calculated the prospective economic consequences of the various interests. Using figures supplied by the general partners concerning the estimated amount of recoverable oil on the lease property and its estimated selling price per barrel, *fn40" Fox projected that over the fifteen-year expected life of the limited partnership, the property would generate gross sales of $ 35,802,000. *fn41" Of this amount, $ 7,160,400, or 20%, would be paid to Tenneco as its landowner royalty, and $ 3,085,200 would be paid to the general partners as an overriding royalty, taking into consideration the step-up from 5% to 10% at payout. *fn42" The remaining $ 25,556,400 would be paid to the working interests. *fn43" Of the latter amount, the partnership would receive $ 23,728,264, representing a 100% working interest before payout and a 90% working interest after payout, and the general partners would receive $ 1,828,136, representing a 10% working interest after payout. *fn44" After subtracting each party's share of expenses, the partnership would have net income of $ 6,439,464, *fn45" and the general partners would have net income of $ 518,000. *fn46" Of the partnership's net income, the general partners would receive $ 64,395, or 1%, and the limited partners would receive $ 6,375,069, or 99%. *fn47"
In sum, according to the projections in the Schedules, over the life of the program the general partners would receive $ 3,667,595 and the limited partners would receive $ 6,375,069. Thus, the general partners would receive 36.5% of the net revenues and the limited partners would receive 63.5% of the net revenues.
On November 29, 1979, Dennis G. Strauch, a reservoir engineer associated with the Petro-Lewis Corporation ("PLC"), telephoned Stephen K. Burch, a Clayton employee, to express PLC's interest in acquiring the Kern River lease. *fn48" In a confirmation letter of that date, Strauch stated that "the preliminary value of this property appears to be in the neighborhood of $ 12 to $ 15 million," although he noted that PLC would not make a formal offer until a thorough petroleum engineering evaluation had been completed. *fn49" Strauch explained that PLC had become interested in the Kern River lease because it was also considering acquiring an adjacent oil field and believed that it was commercially advantageous to acquire the two properties together. Burch and Stephen Anthony, a Clayton vice-president, advised Holmes of this development on November 30. *fn50" The same day, Clayton likewise informed Dubow and Lundquist, but did not identify PLC as the interested party. *fn51" Clayton also halted all sales of limited partnership units at that time. *fn52"
On December 4, 1979, Clayton sent a Mailgram to the subscribers advising them that (1) the price of crude oil had nearly doubled since the date of the Memorandum, which would have the effect of substantially increasing the partnership's projected revenues and expenses, although the additional revenues were expected to far exceed the additional expenses; (2) the State of California had proposed stringent new air quality regulations that might delay the implementation of the partnership's enhanced recovery program by forcing alterations of the two steam generators contemplated for the Kern River field; (3) Clayton had received a letter from a party interested in purchasing the lease; and (4) the closing of the sale of limited partnership units was scheduled for December 10, 1979. *fn53" In the Mailgram, Clayton asked each investor to notify Clayton by December 7 if he wished to rescind his subscription in light of the reported developments. None of the investors withdrew from the program. *fn54"
On December 10, 1979, the sale of the limited partnership units closed and the partnership was formed. *fn55" Also on that date, certain assignments were made. First, Thermoil assigned its interests in the lease to Bryant *fn56" and Bryant in turn assigned its interests to the partnership in exchange for $ 786,000. *fn57" The partnership then assigned to the general partners the latter's overriding royalty and working interest. *fn58" Finally, each of these assignments were recorded in the office of the Kern County Recorder. *fn59"
During the offering period, and prior to the formation of the limited partnership, Bryant incurred expenses totalling $ 75,963 for maintenance and rehabilitation of the leasehold property. *fn60" In February 1980, after the partnership was formed, the partnership reimbursed Bryant for this amount *fn61" because, based on what they had been told by Clayton, the general partners believed that such pre-formation expenses were reimbursable. *fn62" During a routine audit conducted by Fox for the first quarter of 1980, however, Fox discovered that the Memorandum did not provide for the reimbursement of such expenses and so informed the general partners. *fn63" The general partners then advised the limited partners of these facts and, on July 17, 1980, the general partners repaid the partnership in full for the $ 75,963 paid to Bryant. *fn64"
The Sale to PLC
On December 10, after the partnership closed, Clayton informed the general partners that PLC was the party interested in purchasing the lease. *fn65" PLC had made it clear to Clayton that it intended to acquire all the various interests in the lease, with the exception of Tenneco's landowner royalty, and did not wish to have any such interests continue as burdens on the lease after the sale. *fn66"
A few days earlier, and prior to Clayton's identifying PLC as the prospective purchaser, Holmes and Dubow had first discussed the valuation of the general partners' overriding royalty and working interests, anticipating that the buyer would want to acquire those interests as well as the partnership's interests. Dubow first suggested that if the general partners sold their interests along with the partnership's interests, they should receive one-third of the total proceeds. Holmes responded initially that the general partners' interests would be worth 20%, but, after reviewing the Schedules and determining that the general partners could realize 36.5% of the projected net revenues over the life of the partnership, he agreed with Dubow that one-third was a more appropriate valuation. *fn67" Holmes nevertheless insisted that the fairness of such an allocation would have to be confirmed by independent accountants who would make revised projections if an agreement to sell was reached. *fn68"
Immediately after the partnership closed on December 10, negotiations with PLC commenced. At the first meeting, attended by Holmes, Burch, Lundquist, Dubow, Simm, counsel to the partnership, and representatives of PLC, PLC asked for data to assist its own geologists in their evaluation of the property. *fn69" ...

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