Face Challenges Confidently

115 Northern Natural Gas Co. v. Conoco, Inc

Thursday, September 3rd, 2015

Richard F. Brown
The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
Northern Natural Gas Company v. Conoco, Inc., 986 S.W.2d 603 (Tex. 1998), construes a natural gas transportation and processing agreement as to the intent behind the dedication of reserves and whether a gas purchaser can unilaterally terminate gas purchase contracts and escape the obligation to deliver gas. Northern purchased gas from producers for delivery into Conoco’s gas processing and gathering facilities. Northern agreed to deliver and Conoco agreed to accept “all of the gas [that] Northern purchases and receives, in accordance with Northern’s gas purchase contracts with producers . . . in keeping with all the quantity and other provisions of [Northern’s] various gas purchase contracts in effect from time to time.” The agreement was to continue “for so long as the various Gas Purchase Contracts dedicated hereunder remain in effect, but not less than twenty (20) years, unless terminated pursuant to the terms herein.” There was also a supplemental amendment to the agreement which added new wells and recited that the agreement would apply to both the original and the new wells “for the productive life of the wells.”
As the Federal Energy Regulatory Commission proceeded with the deregulation of gas marketing, Northern began canceling and buying out its contractual obligations to purchase gas from producers. By 1994, Northern was no longer purchasing gas from producers and was acting only as a gas transporter. Conoco contended that Northern was obligated to continue purchasing all of the gas produced from the wells listed in Conoco’s agreement with Northern and to deliver that gas to Conoco for the productive life of the wells. The jury found that Northern had breached its agreement with Conoco and awarded Conoco $20,000,000.00 in damages for lost gas processing profits. The court of appeals and the Texas Supreme Court reversed, holding that Northern was obligated to deliver for processing all gas that it bought under the dedicated gas purchase contracts for twenty years, and as long thereafter as purchases continued under those contract, but Northern was never obligated to perpetuate the gas purchase contracts or to deliver any gas for processing if no gas was purchased.
The remaining issues in the case centered around whether there was a duty of “good faith” and whether that duty was breached Conoco contended that Northern’s contract cancellations were contrary to the general good faith standards of Tex. Bus. & Com. Code Ann. §1.203 and §2.306 (Vernon 1994). Tex. Bus. & Com. Code Ann. §1.203 states the general rule that “[e]very contract or duty within this title imposes an obligation of good faith in its performance or enforcement.” The Supreme Court concluded that this provision does not support an independent cause of action for failure to perform or enforce in good faith. It means that a failure to perform or enforce, in good faith, a specific duty or obligation under the contract, constitutes a breach of that contract. Northern, however, had no duty imposed upon it to maintain the gas purchase contracts. Therefore, Section 1.203 would not support Conoco’s claim for damages.
Although the agreement stated that it “shall be interpreted in accordance with the rules of construction and interpretation set forth in the Texas Uniform Commercial Code,” the Supreme Court also refused to apply the good faith provision applicable to sales found in Section 2.306. The court noted that this was a service contract, not a sales contract, and that Article Two was not applicable.
However, the Court found that in an output/requirements contract there is a common law duty of good faith, and that a party who seeks to avoid performance of an output contract by having no output — or of a requirements contract by having no requirements — may not do so in bad faith. The Supreme Court remanded this case to the trial court for a new trial for Conoco to attempt to prove that Northern canceled its gas purchase contracts without a valid business reason and in bad faith. This is a relatively easy standard to meet, because Northern obviously had a valid business reason (getting out of everything but transportation) and presumably was not motivated by an intent to hurt Conoco.
This case is significant for gas processors who had similar output contracts with other pipeline purchasers and re-sellers of natural gas whose contracts were unilaterally terminated by the purchasers because of a failure to purchase gas. It is instructive as to the method of dedicating gas and is definitive on some of the issues pertaining to the applicability of the “good faith” standard to such contracts.