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Naylor Farms, Inc. v. Chaparral Energy, LLC

United States Court of Appeals, Tenth Circuit

May 3, 2019

NAYLOR FARMS, INC.; HARREL'S LLC, Plaintiffs - Appellees,

          Appeal from the United States District Court for the Western District of Oklahoma (D.C. No. 5:11-CV-00634-HE)

          Anthony J. Shaheen, Holland & Hart LLP, Denver, Colorado (Christopher A. Chrisman and Jessica M. Schmidt, Holland & Hart LLP, Denver, Colorado; Linda J. Byford, Chaparral Energy, LLC, Oklahoma City, Oklahoma; John J. Griffin, Jr., Harvey D. Ellis, Jr., and Charles V. Knutter, Crowe & Dunlevy, Oklahoma City, Oklahoma, with him on the briefs), for Defendant-Appellant Chaparral Energy, LLC.

          Conner L. Helms (Gary R. Underwood and Erin M. Moore, with him on the brief), Helms Underwood & Cook, Oklahoma City, Oklahoma, for Plaintiffs-Appellees Naylor Farms, Inc. and Harrel's LLC.

          Daniel H. Charest and Warren T. Burns, Burns Charest LLP, Dallas, Texas, filed an amicus curiae brief for Black Stone Minerals Company, L.P. in support of Plaintiffs-Appellees Naylor Farms, Inc. and Harrel's L.L.C.

          Before MORITZ, MURPHY, and EID, Circuit Judges.


         Defendant Chaparral Energy, L.L.C. (Chaparral) operates approximately 2, 500 oil and gas wells in Oklahoma. Plaintiffs Naylor Farms, Inc. and Harrel's, L.L.C. (collectively, Naylor Farms) have royalty interests in some of those wells. As a result, Naylor Farms receives a portion of the proceeds those wells generate. But according to Naylor Farms, Chaparral systematically underpaid Naylor Farms and other similarly situated royalty owners by improperly deducting from their royalty payments certain gas-treatment costs-costs that Naylor Farms says Chaparral was required to shoulder under Oklahoma law. Thus, Naylor Farms brought a putative class-action lawsuit against Chaparral and moved to certify the class under Rule 23 of the Federal Rules of Civil Procedure. The district court granted Naylor Farms' motion to certify, and Chaparral now appeals the district court's certification order. For the reasons discussed below, we affirm.


         Under Oklahoma law, lessees like Chaparral are subject to an implied duty of marketability (IDM).[1] The IDM imposes upon lessees "a duty to provide a marketable product available to market." Mittelstaedt v. Santa Fe Minerals, Inc., 954 P.2d 1203, 1206 (Okla. 1998). Consistent with this duty, lessees are generally precluded from passing along to royalty owners any costs the lessees incur in making a product marketable. See id. at 1208. And because "raw or unprocessed gas" must typically "undergo[] certain field processes"-such as gathering, compressing, dehydrating, transporting, and producing (GCDTP services)-to make the gas marketable, lessees generally bear the costs associated with performing such services. Id. at 1205, 1208.

         Citing the IDM, Naylor Farms brought a putative class-action lawsuit against Chaparral, asserting claims for breach of contract, breach of fiduciary duty, fraud, unjust enrichment, and failure to produce in paying quantities. As relevant here, Naylor Farms' complaint alleges that Chaparral breached the IDM by improperly deducting GCDTP-service costs from the royalty payments Chaparral made to Naylor Farms and to other similarly-situated royalty owners. More specifically, Naylor Farms contends that in an attempt to circumvent the IDM, Chaparral enters into wellhead sales contracts with midstream processing companies. Under the terms of those contracts, the midstream companies acquire title or possession of unprocessed gas at or near the wellhead.[2] Yet according to Naylor Farms, the midstream companies don't actually pay Chaparral for the gas at this time. Instead, the midstream companies first perform certain GCDTP services and then sell the treated gas to downstream purchasers.

         At that point, Naylor Farms asserts, the midstream companies (1) take the gross proceeds they receive from the downstream sales; (2) deduct from those gross proceeds the costs and fees associated with performing the GCDTP services;[3] and (3) pay Chaparral for the gas they previously acquired at the wellhead by giving Chaparral the resulting net proceeds. Chaparral then calculates royalty payments based on the net proceeds it receives from the midstream companies, rather than calculating royalty payments based on the gross proceeds the midstream companies receive from the downstream sales. And in doing so, Naylor Farms alleges, Chaparral impermissibly "requires royalty owners to bear the costs of transforming unprocessed gas into a marketable product," thus violating the IDM. Id. at 13.

         Based on this theory of liability, Naylor Farms moved to certify a class comprising it and other similarly situated royalty owners.[4] In relevant part, Naylor Farms argued that certification was appropriate under Rule 23 because (1) whether Chaparral breached the IDM is a common question, see Fed. R. Civ. P. 23(a)(2); and (2) this and other common questions predominate over any individual ones, see Fed. R. Civ. P. 23(b)(3).

         In response, Chaparral asserted that whether it breached the IDM isn't a common question because a jury won't be able to answer it without first assessing "individualized issues, including the obligation created by each" individual lease "and the gas produced from each" individual well. App. vol. 2, 410. Further, Chaparral asserted, these individual questions about lease language and gas quality, as well as individual questions about damages, predominate over any common questions Naylor Farms might identify. Thus, Chaparral argued, Naylor Farms cannot satisfy Rule 23's certification requirements.

         The district court disagreed and concluded that certification was appropriate. As an initial matter, the court ruled that Naylor Farms identified at least one common question: whether Chaparral breached the IDM. The district court then rejected Chaparral's arguments that answering this common question will require an individualized assessment of either the language that appears in each lease or the quality of the gas that comes from each well. Next, the district court ruled that common questions, including whether Chaparral breached the IDM, predominate over any individual ones. Ultimately, after addressing Rule 23's remaining requirements, the district court granted Naylor Farms' motion to certify.[5] Chaparral now appeals the district court's class-certification order.


         According to Chaparral, the district court erred in certifying the class under Rule 23. In support, Chaparral advances three discrete arguments. It first asserts the district court erred in failing to recognize that marketability constitutes an individual question-one that necessarily predominates over any common ones in this litigation. It next contends the district court erred in rejecting Chaparral's argument that distinctions in lease language also give rise to individual questions, and that those individual questions likewise predominate. Finally, it insists the district court erred in failing to recognize that in the absence of evidence indicating Chaparral employs a uniform payment methodology, certification is inappropriate. We address each of these arguments in turn.

         I. Marketability

         As discussed above, the cornerstone of Naylor Farms' class-action lawsuit is its allegation that Chaparral breached the IDM by improperly saddling Naylor Farms and other similarly situated royalty owners with certain gas-treatment costs.

         The parties agree that the success of this allegation turns in large part on when the gas at issue became marketable. But they disagree about whether, in assessing marketability, a jury will need to individually analyze the quality of gas that each well produced. And by extension, they also disagree about whether the attendant need to conduct such an individualized assessment renders class certification inappropriate.

         To resolve the parties' disagreement on this point, we begin with an overview of Oklahoma state law. We then discuss Rule 23's certification requirements. Next, we explain how the district court applied Rule 23 in the context of Naylor Farms' state-law claims. Finally, we set forth the applicable standard of review and discuss whether, considering that deferential standard, Chaparral's marketability arguments require us to reverse the district court's class-certification order.

         A. Oklahoma Law

         As discussed in more detail below, the ultimate issue before us in this appeal is whether the district court abused its discretion in concluding that Naylor Farms satisfied Rule 23's certification requirements. See Vallario v. Vandehey, 554 F.3d 1259, 1264 (10th Cir. 2009). And this ultimate issue presents a question of federal law. But that doesn't doom Oklahoma law to irrelevancy. On the contrary, at the heart of the parties' Rule 23 dispute lies an intermediate state-law question: When is gas marketable under Oklahoma law? Thus, we begin our discussion with an overview of that law. Cf. Wal-Mart Stores, Inc. v. Dukes, 564 U.S. 338, 351 (2011) (noting that Rule 23 analysis will often "overlap with the merits of the plaintiff's underlying claim"); CGC Holding Co., LLC v. Broad & Cassel, 773 F.3d 1076, 1087 (10th Cir. 2014) (explaining that Rule 23 inquiry requires "consideration of how the class intends to answer factual and legal questions to prove its claim" and thus "will frequently entail some discussion of the claim itself").

         To the extent we "are called upon to interpret state law" in resolving this appeal, we begin by "look[ing] to the rulings of [Oklahoma's] highest state court." Stickley v. State Farm Mut. Auto. Ins. Co., 505 F.3d 1070, 1077 (10th Cir. 2007) (quoting Johnson v. Riddle, 305 F.3d 1107, 1118 (10th Cir. 2002)). It has been more than two decades since the Oklahoma Supreme Court (OSC) has said anything meaningful about marketability. See Mittelstaedt, 954 P.2d 1203. And neither party suggests Mittelstaedt involved (or even contemplated, for that matter) the type of wellhead sales contracts that Chaparral allegedly utilized here. Thus, in the absence of any guidance from the OSC on the specific marketability questions before us in this appeal, our task is "to predict how [the OSC] would rule" if it were to answer those questions. Stickley, 505 F.3d at 1077 (quoting Johnson, 305 F.3d at 1118). In undertaking that task, we find certain aspects of Mittelstaedt relevant to, albeit not dispositive of, the issues before us.

         In Mittelstaedt, the OSC began by explaining that the IDM imparts upon lessees like Chaparral a duty "to provide a marketable product available to market." 954 P.2d at 1208. And as the OSC noted, "[i]t is common knowledge that raw or unprocessed gas" must usually undergo one or more GCDTP services to make that gas marketable.[6] Id. Thus, because the costs of such GCDTP services are often "associated with" making gas marketable, the OSC explained that the IDM typically precludes a lessee from "deducting a proportionate share" of those costs from royalty payments. Id. at 1205. But the OSC then recognized that a lessee may sometimes be able to demonstrate that gas is "in a marketable form at the well[head]." Id. at 1208. In that scenario, GCDTP services aren't "necessary" to transform the already-marketable gas into a marketable product. Id. at 1208. Yet a lessee may nevertheless opt to perform such services with an eye toward "enhancing" the value of the "already[-]marketable" gas. Id. at 1210. And when it does so, the OSC explained, the cost of performing such GCDTP services "may be allocated to the royalty interests" if the lessee can make certain additional showings. Id.

         We derive two controlling principles from Mittelstaedt. First, Mittelstaedt resolved that when unmarketable gas undergoes GCDTP services for the purpose of transforming that unmarketable gas into a marketable product, the lessee must bear the cost of the GCDTP services. Second, Mittelstaedt resolved that when marketable gas undergoes GCDTP services to enhance the value of gas that is already marketable, the lessee may, under certain circumstances, allocate the cost of the GCDTP services to royalty holders.

         Yet Mittelstaedt left unresolved a whole host of other questions. The most obvious are these: What does the term "marketable" mean, and what factors determine when, where, and if gas became marketable for purposes of applying Mittelstaedt's marketable-product rule?

         Notably, the OSC has declined at least two recent invitations to address these questions. See Order Denying Certiorari, Whisenant v. Strat Land Expl. Co., No. 115, 660 (Okla. Oct. 1, 2018); Order Denying Certiorari, Pummill v. Hancock Expl. LLC, No. 114, 703 (Okla. May 21, 2018). Further, the OSC declined one of these invitations over the dissenting voices of two of its own members. See Dissent from Order Denying Certiorari, Pummill, No. 114, 703 (May 21, 2018) (Winchester, J.) (noting that OSC "should grant certiorari to refine what constitutes a 'marketable product' as that term is used in [Mittelstaedt]").

         Nevertheless, the Oklahoma Court of Civil Appeals (OCOCA) has attempted to fill the resulting legal vacuum, albeit with somewhat inconsistent outcomes. See Whisenant v. Strat Land Expl. Co., 429 P.3d 703, 707, 708-10 (Okla.Civ.App. 2018) (recognizing that term "marketable product" isn't susceptible to and has no uniform definition, but then implicitly suggesting marketability always turns, at least in part, on individual characteristics of gas at issue); Pummill v. Hancock Expl. LLC, 419 P.3d 1268, 1278 (Oka. Civ. App. 2018) (indicating that in some cases, it may be possible to answer marketability question based on characteristics of relevant market, thus rendering individualized gas-quality assessment unnecessary).

         In Whisenant, for instance, the OCOCA held that the state trial court erred when, in proceeding under Okla. Stat. Ann. tit. 12, § 2023(B)(3), it certified a class of Oklahoma royalty owners who brought claims similar to those Naylor Farms advances here.[7] See 429 P.3d at 706-07. Specifically, those royalty owners alleged that the defendant, who operated several Oklahoma gas wells, breached the IDM by calculating "royalties based on what it received from" a midstream processing company, "rather than based on what" that midstream processing company "received for the gas at the interstate (or intrastate) pipeline inlet." Id. at 706.

         In reversing the district court's certification order, the Whisenant court initially expressed its view that the OSC has, "for good reasons," declined to "define the meaning of 'marketable product, '" opting instead to leave the marketability question "open to resolution on a case-by-case basis." Whisenant 429 P.3d at 708 (quoting Mittelstaedt, 954 P.2d at 1208). Nevertheless, immediately after suggesting that the concept of marketability isn't susceptible to any uniform definition or test, the Whisenant court indicated that the answer to the marketability question will always turn, at least in part, on "the quality of [the] gas" at issue. Id. at 710-12. Thus, the Whisenant court reasoned, a "highly individualized and fact-intensive review of each [class member's] claim," as informed by the quality of the gas at each individual well, "would be ...

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