U.S. Energy Exploration Corp. v. Directional Drilling Systems ( 2023 )

NOT DESIGNATED FOR PUBLICATION
No. 123,885
IN THE COURT OF APPEALS OF THE STATE OF KANSAS
U.S. ENERGY EXPLORATION CORP.,
Appellant,
v.
DIRECTIONAL DRILLING SYSTEMS LLC,
Appellee.
MEMORANDUM OPINION
Appeal from Butler District Court; KRISTIN H. HUTCHISON and CHAD M. CRUM, judges. Opinion
filed January 13, 2023. Reversed and remanded.
Ryan M. Peck, Jeffery L. Carmichael, and Jonathan A. Schlatter, of Morris, Laing, Evans, Brock
& Kennedy, Chartered, of Wichita, for appellant.
David E. Bengtson and Frank W. Basgall, of Stinson LLP, of Wichita, for appellee.
Before SCHROEDER, P.J., MALONE, J., and TIMOTHY G. LAHEY, S.J.
PER CURIAM: In 2016, U.S. Energy Exploration Corporation (U.S. Energy) sued
Directional Drilling Systems, LLC (DDS) for breach of contract involving assets in an oil
and gas development project in Butler County (the Project). After more than a year of
litigation, the parties agreed to settle. After signing a negotiated settlement agreement, the
parties filed a stipulation of dismissal pursuant to K.S.A. 2021 Supp. 60-241(a)(1)(A)(ii).
Less than a year later, U.S. Energy filed a motion to set aside the stipulation claiming
DDS procured the settlement agreement through fraud or misconduct under K.S.A. 2021
Supp. 60-260(b)(2) and (b)(3). An evidentiary hearing was scheduled, but following the
assignment of a new presiding judge, the district court cancelled the hearing and denied
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the motion. U.S. Energy now challenges both the procedure and result of that decision.
Because we find the district court erred by denying the motion without conducting an
evidentiary hearing, we reverse the district court's judgment and remand for a hearing on
U.S. Energy's motion.
FACTUAL AND PROCEDURAL BACKGROUND
Introduction to Parties and Overview of 2016 Purchase Agreement
In 2015, two companies—DDS and Empire Energy, Midcon, LLC (Empire)—
agreed to purchase various assets necessary to initiate the Project from Source Energy
LLC (Source Energy) for $2,437,027. The Project assets included producing and
nonproducing oil and gas leases; saltwater disposal wells and pipelines; well logs; and
land, seismic, and other geological data. According to the terms of the parties' Purchase
and Sale Agreement (PSA), Empire would pay for and acquire an undivided 60% interest
in the Project assets, and DDS would cover the remaining 40%.
Due to financial difficulties, DDS and Empire agreed to postpone the original
closing date of their purchase by several months. They also amended the terms of the
PSA to allow DDS the option of reassigning Empire's 60% interest to itself or a third-
party buyer in the event that Empire failed to meet its financial obligations.
Per the terms of the amended PSA, DDS paid and closed on its portion of the PSA.
Empire gave Source Energy a $25,000 promissory note to continue its contractual
relationship with DDS and Source Energy. Source Energy then assigned 100% of the
producing leases to DDS and held the assignments of the nonproducing leases in escrow
pending Empire's payment. This agreement contemplated that after paying its portion of
the amended PSA, DDS would assign Empire 60% of the producing leases, and Source
Energy would transfer 60% of the nonproducing leases to Empire and 40% to DDS.
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In the meantime, Empire assumed operations of the producing leases according to
the terms of an operating agreement it entered with DDS, which the parties referred to as
an "Exploration and Development Agreement" (E&D Agreement). The terms of the E&D
Agreement governed DDS and Empire's joint ownership, development, and exploration
of the leases, and any future leases acquired in the Project.
However, Empire was ultimately unable to fulfill its financial obligations, so DDS
exercised its right to reassign Empire's 60% interest to another buyer. DDS offered U.S.
Energy those interests and the option to "step into Empire's shoes," and U.S. Energy
assumed Empire's role as provided in the amended PSA.
2016 Lawsuit Between DDS and U.S. Energy
At some point, DDS insisted that U.S. Energy sign an E&D Agreement.
Throughout the underlying proceedings, DDS has maintained that its offer was
contingent on U.S. Energy signing an E&D Agreement. U.S. Energy, on the other hand,
adamantly denies it was required to sign an E&D Agreement and did not sign one.
DDS sent U.S. Energy a letter essentially stating that U.S. Energy's failure to sign
an E&D Agreement prevented the companies from forming a contractual relationship.
This dispute eventually culminated in U.S. Energy suing DDS and claiming, among other
things, that U.S. Energy and DDS were parties to a joint venture or mining partnership. In
addition to its joint venture claim, U.S. Energy claimed that DDS agreed to the creation
of an area of mutual interest (AMI), under which the parties agreed to give each other an
option to share any oil and gas leases that the other party acquired within a defined
geographic area. U.S. Energy contended that DDS acquired oil and gas leases in the
alleged AMI without telling U.S. Energy or allowing it to participate in the leases. U.S.
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Energy also raised a breach of contract claim, arguing DDS wrongfully withheld the
interpretation of the seismic data information.
DDS denied the existence of a joint venture, mining partnership, enforceable
contract, or contractual duties. DDS also filed several counterclaims, arguing that because
U.S. Energy failed to sign an E&D Agreement, it never obtained any right to participate
in the Project. DDS also raised an alternative breach of contract claim, alleging that if the
district court found U.S. Energy accepted its offer to assume Empire's interest in the
Project, U.S. Energy's failure to sign an E&D Agreement constituted a breach of contract.
The parties litigated these matters for over a year, and the district court made
numerous rulings throughout those proceedings. The district court denied U.S. Energy's
request for summary judgment on its joint venture claim, finding it involved issues of
disputed facts. And the district court also denied DDS summary judgment on its claim
that the parties completely lacked an agreement regarding the ownership of the oil and
gas leases, finding the parties were, at the very least, tenants in common.
Two days before trial was scheduled to begin the parties notified the district court
that they reached a settlement agreement. The district court therefore canceled the
scheduled trial. It still, however, filed a final amended pretrial conference order on April
25, 2018.
Settlement Agreement and Stipulation of Dismissal
DDS sent U.S. Energy an email detailing the terms of a proposed settlement
agreement, which the parties eventually adopted. The email stated that "[a]ny oil and gas
lease[s] purchased by either party, whether a new lease or an extension or renewal of an
existing jointly owned undeveloped lease, will be owned 100% by the party that
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purchased that lease free and clear of all claims of the other party." The settlement
agreement also included the following provisions:
• The jointly owned producing leases would continue to be jointly owned and
operated by U.S. Energy pursuant to the terms of a joint operating agreement;
• DDS would assign its 40% undivided interest in all of the unexpired jointly
owned, nonproducing leases to U.S. Energy;
• DDS and U.S. Energy were each entitled to acquire, own, explore, develop, and
operate leases in Butler County, free and clear of any and all claims by the other
party; and
• Both DDS and U.S. Energy would waive and release each other from any and all
liabilities, actions, claims, demands, or lawsuits, which either party may have had
or have against the other party arising from or relating to the Project.
The settlement agreement also contained an integration clause, which provided the
agreement was the "entire agreement" and that "no other understandings, representations,
inducements, promises or warranties, verbal or otherwise, may be relied upon other than
those set forth in this Agreement." The agreement lacked any representations or
warranties regarding any of the parties' previously purchased leases.
U.S. Energy and DDS's representatives finalized the settlement agreement and did
not seek the district court's approval of the agreement. The stipulation of dismissal
succinctly provided, "As authorized by Kansas Rule of Civil Procedure § 60-
241(a)(1)(A)(ii), Plaintiff U.S. Energy Exploration Corp. and Defendant Directional
Drilling Systems, LLC stipulate to the dismissal of all claims in the above-captioned
action with prejudice, with each of the parties to bear its own costs."
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New Lawsuit and Motion to Set Aside Dismissal
Three months after the stipulation of dismissal was filed, U.S. Energy filed a new
lawsuit with multiple allegations against DDS and Hiram W. Lewis III, including a claim
that it was fraudulently induced to enter into the settlement agreement with DDS. Lewis
was the Manager of Oil & Gas Operations for DDS. In that action, the district court
initially granted summary judgment in favor of DDS on the U.S. Energy claim related to
the AMI because there was no written contract supporting the claim. After a subsequent
motion by DDS, the district court dismissed the entire action without prejudice, ruling
that U.S. Energy first had to set aside the joint stipulation of dismissal before the court
could address any of U.S. Energy's remaining claims.
Motion Proceedings in Original Lawsuit
After dismissal of the second lawsuit, U.S. Energy filed its motion to set aside the
stipulation of dismissal in the original lawsuit. Relying on K.S.A. 2021 Supp. 60-
260(b)(3), U.S. Energy argued that the stipulation was induced by fraud or misconduct
because DDS engaged in fraud or misconduct detailed in U.S. Energy's motion:
• "DDS acquired at least 21 leases, what have been referred to herein as numerous
'Secret Leases,' between March 2017 and June 2017, all within the NW Butler
County Project, and in total covering 3,277 acres of the Project."
• "At least 17 of the Secret Leases were acquired by DDS prior to the Settlement
Agreement. . . . 18 of the Secret Leases are top leases or replacement leases
covering approximately 2,598 acres of land covered by the jointly-owned
undeveloped leases."
• "DDS and Mr. Lewis began negotiating to acquire many, if not all of the Secret
Leases, prior to the date the Settlement Agreement was entered into."
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• "US Energy did not know about or have any reason to know about the Secret
Leases prior to entering into the Settlement Agreement."
• "DDS and Mr. Lewis concealed the Secret Leases from US Energy by not
recording them (in some cases, for more than a year) or otherwise disclosing their
existence to US Energy."
• "Many of the Secret Leases cover the same acreage as the Undeveloped Leases
that US Energy was supposed to receive pursuant to the Settlement Agreement. . .
. As a result of the Secret Leases, the undeveloped leases that US Energy was
supposed to receive pursuant to the Settlement Agreement have lost value or are
worthless."
• "The top leases were negotiated for and taken in breach of the right of first refusal
owned by US Energy."
• "US Energy and DDS utilized and exploited the jointly-owned 3-D seismic data
to identify areas and acreage to lease in the course of the scheme to acquire the
Secret Leases, thereby secretly exploiting a [sic] valuable jointly-owned assets to
the direct detriment of US Energy."
U.S. Energy alleges:
"This lengthy course of misconduct and fraud was deceptive, did not represent
good faith in the performance of the parties' purported settlement, and it undermined the
very essence of the purported settlement going forward. US Energy was not aware, nor
could it reasonably have become aware, of this course of misconduct prior to the
settlement and stipulation. When it became aware of the misconduct, it sought first to
pursue claims in the 2018 Case and now to set aside the stipulation in the 2016 Case."
DDS contended that it did not have any duty to disclose any information regarding
the leases while negotiating the settlement agreement because the parties were merely
litigants in an adversarial proceeding. And DDS also argued that Lewis' testimony
regarding other leases DDS purchased put U.S. Energy on notice that it needed to make
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additional inquiries into the matter. DDS acknowledges it objected to discovery requests
for the actual leases but faults U.S. Energy for failing to follow up in discovery to compel
disclosure of those leases, or to make disclosure a condition of the settlement.
The district court held two preliminary hearings to, in part, determine whether
U.S. Energy's claim warranted an evidentiary hearing. Following the lengthy oral
arguments, the district court determined an evidentiary hearing was warranted. The
district court acknowledged that U.S. Energy was requesting an extreme remedy. The
district court also determined that U.S. Energy's motion was timely, and that fraud
needed to be proved by clear and convincing evidence. Although the court found U.S.
Energy had not yet provided sufficient evidence to establish fraud, it scheduled the matter
for an evidentiary hearing to allow U.S. Energy the chance to make the showing but
denied U.S. Energy's request for additional discovery.
Motion for a Prehearing Ruling and Judgment Rendered
Before this case proceeded to the scheduled evidentiary hearing on U.S. Energy's
motion to set aside the stipulation, Judge Kristin Hutchinson replaced Judge Mike Ward
as the presiding judge in this case. Around the time of this transition, DDS filed a motion
requesting a prehearing ruling on U.S. Energy's motion as a matter of law.
In its motion, DDS argued that the district court could decide U.S. Energy's claim
of fraud without conducting an evidentiary hearing because the record established that
DDS did not have a confidential relationship with U.S. Energy or a duty to disclose any
information:
"The nature of the relationship between DDS and US Energy is undisputed—
adversaries engaged in protracted litigation negotiating a settlement agreement to resolve
that litigation. As a result, the Court can and should find as a matter of law that DDS had
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no duty to disclose any information to US Energy in conjunction with the negotiation of
the Settlement Agreement. Since there was no duty, there can be no fraud and US
Energy's motion fails as a matter of law."
U.S. Energy contended that this argument ignored the facts of the case and the
clear language of K.S.A. 2021 Supp. 60-260(b)(3), which provides three grounds for
granting relief: fraud, misrepresentation, and misconduct.
After considering the parties' arguments, the district court announced its findings
with very little explanation. The district court stated that it decided "to grant DDS'[s]
motion on the duty to disclose" and "to overrule U.S. Energy's motion to set aside." The
district court directed DDS to prepare a proposed journal entry of judgment. Judge Crum,
who replaced Judge Hutchinson after her retirement, ultimately settled the parties'
disagreement over the journal entry. The journal entry included the following findings:
• "DDS's Motion for Prehearing Ruling is granted."
• "US Energy's Motion to Set Aside Joint Stipulation of Dismissal is denied."
• "During the pendency of this case there was extensive discovery between DDS
and US Energy and the parties ultimately negotiated and agreed to a settlement
agreement and, pursuant to that agreement, the parties agreed to dismiss this
lawsuit with prejudice."
• "Both US Energy and DDS were represented by counsel throughout this lawsuit."
• "The Settlement Agreement expressly provides that it constituted the entire
agreement between the parties and that there were no other understandings,
representations, inducements, promises or warranties, verbal or otherwise, that
may be relied upon by either party."
• "US Energy knew, or reasonably should have known, all of the information that it
wanted and needed to know when the Settlement Agreement was signed and that
case was dismissed with prejudice."
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• "The Settlement Agreement expressly provided that US Energy fully, finally and
forever waived, released, and discharged DDS from any and all claims, liabilities,
actions, demands or lawsuits under any theory."
• "This case was settled and dismissed with prejudice and this case is closed and
will remain closed."
• "The Court does not express any position on whether US Energy has a viable
claim for breach of the Settlement Agreement."
Appeal
U.S. Energy timely appeals the district court's order denying its motion to set aside
the stipulation of dismissal.
ANALYSIS
I. Abandoned Claim
In its motion to set aside the stipulation of dismissal, U.S. Energy argued that
relief was warranted under K.S.A. 2021 Supp. 60-260(b)(2) and (b)(3). On appeal,
however, U.S. Energy does not brief any argument under K.S.A. 2021 Supp. 60-
260(b)(2) and thus abandons or waives such a claim. See State v. Davis, 313 Kan. 244,
248, 485 P.3d 174 (2021).
K.S.A. 2021 Supp. 60-241(a)(1)(A)(ii) and K.S.A. 2021 Supp. 60-260(b)(3) and Standard
of Review
K.S.A. 2021 Supp. 60-241(a)(1)(A)(ii) permits the parties to a lawsuit to dismiss
the lawsuit without a court order. And the district court here was not called upon to make
any findings or conduct any review of the underlying settlement agreement. When the
stipulation of dismissal was filed, the court had not made any factual findings whether
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DDS owed any legal duty because there was no presentation of evidence to establish the
relationship between the parties. That remains true to this day. No evidence has been
presented establishing the nature and extent of the relationship between the parties.
K.S.A. 2021 Supp. 60-260(b)(3) permits a party, "[o]n motion and just terms" to
obtain relief from a final judgment for "fraud, whether previously called intrinsic or
extrinsic, misrepresentation or misconduct by an opposing party." U.S. Energy argues it
is entitled to relief because the settlement agreement and stipulation of dismissal were
"procured by blatant misconduct, fraud and material misrepresentations of DDS and Mr.
Lewis."
This court reviews a trial court's decision on a K.S.A. 60-260(b) motion for abuse
of discretion. Northern Natural Gas Co. v. ONEOK Field Services Co., 296 Kan. 906,
937, 296 P.3d 1106 (2013). Such an abuse occurs when judicial action is arbitrary,
fanciful, or unreasonable; based on an error of law; or based on an error of fact. Biglow v.
Eidenberg, 308 Kan. 873, 893, 424 P.3d 515 (2018). "An appeal from an order denying a
motion under K.S.A. 60-260(b) brings up for review only the order of denial itself and
not the underlying judgment." Ellis v. Whittaker, 10 Kan. App. 2d 676, 677, 709 P.2d 991(1985).
"A settlement agreement is a type of contract and is governed by contract law."
Farm Bureau Mut. Ins. Co. v. Progressive Direct Ins. Co., 40 Kan. App. 2d 123, Syl. ¶ 7,
190 P.3d 989 (2008). Ordinarily, whether a contract exists is a question of fact. U.S.D.
No. 446 v. Sandoval, 295 Kan. 278, 282, 286 P.3d 542 (2012); see also Waste
Connections of Kansas, Inc. v. Ritchie Corp., 296 Kan. 943, 964-65, 298 P.3d 250 (2013)
(whether party defaulted on contractual obligations—including inherent duty of good
faith and fair dealing—is question of fact). The existence of fraud is also generally a
question of fact. So appellate courts review these findings for substantial competent
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evidence. See Price v. Grimes, 234 Kan. 898, 904, 677 P.2d 969 (1984) (contract); In re
Estate of Hessenflow, 21 Kan. App. 2d 761, 774, 909 P.2d 662 (1995) (fraud).
The existence of a duty in a claim of fraud is a question of law upon which our
review is unlimited. See In re Estate of Pritchard, 37 Kan. App. 2d 260, 272, 154 P.3d 24(2007). Similarly, to the extent this analysis requires statutory interpretation, this court's
review is unlimited. Nauheim v. City of Topeka, 309 Kan. 145, 149, 432 P.3d 647 (2019).
The law favors compromise and settlement of disputes, so absent a showing of bad faith
or fraud, a party to "an agreement settling and adjusting a dispute" will be precluded from
repudiating the agreement. In re Estate of Thompson, 226 Kan. 437, 440, 601 P.2d 1105(1979). However, "[f]raud vitiates whatever it touches including final judgments and final
orders as well as contracts." Stegman v. Professional & Business Men's Life Ins. Co., 173
Kan. 744, 751, 252 P.2d 1074 (1953).
The district court erred by overruling U.S. Energy’s Motion without an evidentiary
hearing.
DDS asked the district court to overrule U.S. Energy's motion on the basis that
there could be no fraud because DDS did not have any duty to disclose information to
U.S. Energy. To prove constructive fraud, a party must show the existence of a
confidential relationship and a betrayal of that confidence, or a breach of duty imposed
by that relationship. A confidential relationship is not presumed, and the party asserting
that such a relationship exists bears the burden of proving it. Kampschroeder v.
Kampschroeder, 20 Kan. App. 2d 361, 364-65, 887 P.2d 1152 (1995). In DDS's view, the
parties were simply opposing litigants. But the exact nature of the business relationship
between the parties is not clear in the record and is disputed by the parties. There is no
doubt the parties were engaged in some form of joint business pursuit, the nature of
which was never determined, and that was the reason Judge Ward scheduled an
evidentiary hearing. While DDS correctly describes, in part, the parties as opposing
litigants, DDS's status as an opposing litigant does not empower it to engage in fraud or
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misconduct. To the contrary, K.S.A. 2021 Supp. 60-260(b)(3) provides relief to an
opposing litigant who is subjected to fraud or misconduct.
The district court did not hold an evidentiary hearing, yet the district court made a
plainly factual finding that "US Energy knew, or reasonably should have known, all of
the information that it wanted and needed to know when the Settlement Agreement was
signed." Not only does this finding contradict U.S. Energy's express assertions, it also
lacks any factual support in the record—because no evidence was presented. Given the
allegations of fraud and misconduct detailed by U.S. Energy, and refuted by DDS, an
evidentiary hearing is both necessary and unavoidable. In other words, under the facts
alleged here, it is not possible for the court to determine as a matter of law what duty
DDS may have owed U.S. Energy without evidence which establishes the nature and
context of the parties' relationship.
The district court found that the settlement agreement "expressly provide[d] that it
constituted the entire agreement between the parties and that there were no other
understandings, representations, inducements, promises or warranties, verbal or
otherwise, that may be relied upon by either party." DDS contends the integration clause
prohibits U.S. Energy from now claiming it lacked necessary information or relied on
DDS to provide additional information. However, "[f]raud vitiates whatever it touches
including final judgments and final orders as well as contracts." Stegman, 173 Kan. at
751. The law favors compromise and settlement of disputes, so absent a showing of bad
faith or fraud, a party to "an agreement settling and adjusting a dispute" will be precluded
from repudiating the agreement. In re Estate of Thompson, 226 Kan. at 440. Although an
integration clause generally provides that the written contract constitutes the entire
agreement between the parties, a contractual waiver does not necessarily bar claims such
as fraud. See Osterhaus v. Toth, 291 Kan. 759, 776, 249 P.3d 888 (2011).
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Finally, DDS's argument to the district court focused primarily on whether there
was fraud. K.S.A. 2021 Supp. 60-260(b)(3) plainly allows relief even when fraud is not
found, as relief may be granted in cases where there is "misrepresentation or misconduct
by an opposing party." Relying on McKnab-Bess Oil Co. v. Commonwealth O. & G. Co.,
142 Kan. 739, 52 P.2d 363 (1935), DDS asserts that the settlement agreement was a
contract, so it could only be set aside based on a successful showing of fraud, "not mere
misconduct." But McKnab-Bess Oil Co. did not make that ruling. That case simply held
that the appellant failed to plead sufficient facts of "fraud, mistake, or omission" to
warrant relief from the settlement judgment. See 142 Kan. 739, Syl. ¶ 2.
The district court here failed to address almost any portion of U.S. Energy's claim
despite its sufficient pleading of fraud and misconduct and the existence of disputed or
unresolved facts. Smith v. Amazon.com Services LLC, No. 21-CV-2260-JAR-TJJ, 2022
WL 179465, at *3 (D. Kan. 2022) (unpublished opinion) ("Where material facts
concerning the existence or terms of an agreement to settle are in dispute, the parties must
be allowed an evidentiary hearing."). The court did not make any findings regarding the
parties' specific actions, relationship, actual knowledge, or possible contractual or
fiduciary obligations, so this matter must be remanded for additional proceedings. Cf. In
re Deepwater Horizon, 786 F.3d 344, 364 (5th Cir. 2015) (finding unresolved factual
issues should have prevented lower court from "discounting . . . substantial evidence of
fraud without holding an evidentiary hearing").
The record shows that U.S. Energy sufficiently raised claims of fraud,
misrepresentation, or misconduct in connection with the settlement agreement and
stipulation of dismissal to warrant an evidentiary hearing. We find the district court
abused its discretion by denying U.S. Energy's K.S.A. 2021 Supp. 60-260(b)(3) claim
without first conducting that hearing. Thus, we reverse and remand the case to the district
court.
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Reversed and remanded.
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