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ENVIROGAS INC. v. WALKER ENERGY PTNRS.

August 13, 1986

ENVIROGAS INC., Plaintiff, -and- WILLIAM B. YEOMANS and YEOMANS ENERGY PROGRAM, INC., Plaintiff-Intervenors,
v.
WALKER ENERGY PARTNERS and WALKER ENERGY OPERATING, LTD., Defendants



The opinion of the court was delivered by: CURTIN

JOHN T. CURTIN, United States District Judge

Plaintiff Envirogas, Inc., a New York corporation, is in the business of drilling gas wells and operating those wells on behalf of various limited partnerships or joint ventures which own an interest in the gas and oil produced from the wells. Defendants Walker Energy Partners and Walker Energy Operating, Ltd. [Walker], both of Texas, have a partnership interest in many of the wells operated by Envirogas. Plaintiff-intervenors William B. Yeomans and Yeomans Energy Program, Inc., also have a partnership interest in some of the wells.

Plaintiff commenced this action on March 21, 1986, seeking a declaratory judgment of the rights and obligations of the parties under several agreements. Plaintiff also sought a preliminary injunction preventing Walker from taking any steps to 1) collect any revenues directly from the gas purchasers, 2) audit Envirogas, or 3) dismiss Envirogas as the operator of any wells. Jurisdiction is premised on the diversity of the parties. 28 U.S.C. § 1332(a)(1).

 On May 7, 1986, Walker sent a letter of termination to Envirogas, advising Envirogas that it would be removed as the operator of the wells in which Walker had a majority interest effective May 22, 1986. The letter also noted that Walker was informing gas purchasers of the change in operations (Item 9, Exh. F).

 Envirogas has drilled approximately 1,400 wells. Of these wells, defendants have a partnership interest in approximately 1,130 wells (Item 5). Of this 1,130, Walker has a majority interest of the working-interest ownership (greater than 50 percent) in about 940 wells. These are the wells in which Walker is seeking to remove Envirogas as the operator. The approximately 200 remaining wells in which Walker has a minority interest are not at issue at the present time.

 Envirogas produces a varying quantity of gas each month. It sells the gas primarily to two utility companies, National Fuel Gas [National Fuel] and Columbia Gas Transmission Corporation [Columbia], which make the payment directly to Envirogas. The gas companies make a payment each month for the gas used the previous month. For example, for gas taken by the utilities from mid-March through mid-April (April production), the gas company would pay Envirogas in mid or late May (Item 18, pp.37-39). Envirogas would pay the partnership for this gas at the end of June. According to this schedule, the partnerships receive their share of the revenues about 2 1/2 months after the gas is taken from the wells (Item 18, pp.40-46). When the gas companies received notice of the planned termination of Envirogas as the operator of many of the Walker wells, they were uncertain whether to make their monthly payments to Walker or Envirogas. Arrangements for the April, May, and June production payments were eventually made.

 On May 15, Envirogas sought a temporary restraining order and preliminary injunction preventing the termination. The application for a restraining order was denied, and a hearing was held on plaintiff's motion for a preliminary injunction. At the conclusion of the hearing, the parties were given an opportunity to submit proposed findings and legal conclusions. Oral argument was held July 23, 1986. For the following reasons, plaintiff's motion for a preliminary injunction is denied.

 A basic understanding of the operation of the business and the relationships of the various parties is essential. Many of these facts are undisputed (see Items 36 and 37). Envirogas engages in exploration, drilling, development, and production of gas and oil wells. To finance the drilling of the wells and the costs of their operation, Envirogas entered into agreements with either limited partnerships or joint ventures. A limited partnership consists of individuals or companies looking to invest in gas wells. The affairs of the limited partnership are handled by the general partners (Exh. 7).

 Under the agreements with Envirogas, a partnership acquires all or some percentage of the "working interest" of a gas and oil lease. The working interest entitles a partnership to drill wells and produce gas at its expense and, in turn, to receive the net revenues from these operations (Exh. 7, p.10). Under the agreements, the partnership paid a fee, known as the "turnkey price," to Envirogas for the drilling and completion of the well (Exh. 7, pp.17-18). Included in the turnkey price was the connection of the well to the purchaser's pipeline (see Exh. 2, Vol. II, #3, p.2; and Vol. IV, Exh. 119, p.3).

 Each month, Envirogas, as the operator of the wells, collects a payment from all purchasers of the gas produced the previous month. These monthly revenues are substantial. For instance, the June 1986 production payment from Columbia amounted to $1,545,952.13. Walker's share of this was $323,669.99 (Item 35, Letter to Columbia). Only a portion of the monthly revenue attributable to gas produced from a given well is paid to the working interest owners of the well. A share of each month's revenues from each well is also paid to the holders of a royalty interest in the well.

 In some cases, before drilling a well, Envirogas obtains a lease directly from the owner of the land on which the well is to be drilled. Envirogas pays a landowner a set percentage of the monthly revenues earned by that well. This is the landowner royalty payment, which usually comes to 12.5 percent of the monthly revenues. For its efforts in acquiring the lease, Envirogas receives its own "overriding royalty," usually totaling 12.5 percent of monthly payments.

 In many instances, however, Envirogas is not the first party to acquire a lease. Instead, it may have been assigned by the landowner to a utility company, which in turn "farms out" the lease to Envirogas. Under this arrangement, Envirogas still pays the landowner royalty, and the utility company is entitled to a share of Envirogas's overriding royalty. On the average, Envirogas is left with an overriding royalty of 7 or 8 percent of the monthly production revenues for each well (Item 19, pp.94-95).

 After the royalties are paid, Envirogas deducts its monthly operating fee and any extraordinary expenses from the monthly revenues. "Extraordinary expenses" are not incurred on a monthly basis, but are for occasional services such as "tubing." The partnerships must pay for these expenses, in addition to paying their monthly operating fee. The classification of certain items as "extraordinary expenses," the need for those items, and who determines when the expense is to be incurred are hotly debated by the parties. The money remaining after deduction of the fee and extraordinary expenses is divided among the partnerships according to their interest in the gas sold.

 Several different entities may each own a percentage of the working interest of a well (Item 5, Exhs. A and E). As the operator, Envirogas markets the gas, entering into purchase agreements on behalf of the partnerships. Columbia and National Fuel pay Envirogas based on the amount of gas passing through a "tap" into their pipelines. The gas at any given tap point comes from several different wells, all connected to the tap through a system of collection pipelines. At the tap point, if the gas must be compressed to increase its pressure, the working-interest owners must bear the cost (Item 19, pp.18, et seq.). Envirogas allocates the amount of revenue owing to each well, and this money is eventually distributed to the working-interest owners.

 In November of 1985, the Walker defendants were assigned the working-interest ownerships of 175 limited partnerships (which, altogether, had an interest in the 1,130 wells) and succeeded to the agreements these partnerships had with Envirogas. A single master limited partnership was formed, headed by the Walker defendants (Item 11, Walker affidavit). Shortly thereafter, Walker began a review and examination of its wells and became concerned about Envirogas's performance as an operator (see discussion below).

 Apparently fearing that Walker would attempt to remove Envirogas as the operator as a result of their disagreements, plaintiff filed this lawsuit. Walker's notice of termination of plaintiff as operator for all wells in which Walker has a majority interest (see Item 5, Exh. A) resulted in Envirogas's current application for a preliminary injunction.

 The standards for granting a preliminary injunction are well established in this circuit. The movant must show:

 (1) irreparable harm and (2) either (a) likelihood of success on the merits or (b) sufficiently serious questions going to the merits to make them a fair ground for litigation and a balance of hardships tipping decidedly toward the [movant].

 Jackson Dairy, Inc. v. H. P. Hood & Sons, Inc., 596 F.2d 70, 72 (2d Cir. 1979).

 1. Irreparable Harm

 Envirogas claims that, if Walker were permitted to terminate the wells as planned, it would suffer harm which money damages could not compensate. As part of its asserted irreparable harm, Envirogas urges that the business will be "decimated" if an injunction is not granted. Envirogas predicts that more than 50 percent of its staff would be laid off, equipment would be sold at distress prices, wells would be "shut-in" and possibly damaged during the period in which they are kept inactive, and landowners and other working-interest owners would not receive prompt or accurate payment.

 A careful review of the record, however, reveals that much of this harm would not come from the removal of Envirogas as the operator of Walker's wells, but from Walker's retention of the production revenues from those wells. In his initial affidavit in support of a temporary restraining order, John M. Clarey, President of Envirogas, makes this clear:

 43. The gross amounts paid to Envirogas for the gas it markets for all wells and all programs is currently at a monthly level of $2,500,000 to $4,000,000. Of this, Columbia pays approximately $1,600,000 to $2,500,000 and National (including end-user sales), approximately $400,000 to $500,000, with the balance paid by several other purchasers. The wells in which Walker claims an interest are responsible for producing approximately 35%-40% of these sales before expenses.

 44. . . . If Walker follows through in its announced intention to interfere with the payments of the gas purchasers and the purchasers hold the money or do not pay it to Envirogas, this will cause significant irreparable harm. The purchasers could well assert the right to hold up all dollar payments of any amount for gas for beyond any amounts in which Walker could claim an interest.

 Clarey goes on to state that the Walker take-over of operations and "interruption of cash flow from the gas purchasers" will cause layoffs (P46). During the hearing, Mr. Clarey testified that certain expenses for the operation of the wells are paid a couple of months in advance so that, if the relationship were cut off at any given point, Walker would owe Envirogas money. (Item 18, pp.46-47) ...


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