Eastern Air Lines, Inc. v. Gulf Oil Corporation

OPINION BY: KING

Eastern Air Lines, Inc., hereafter Eastern, and Gulf Oil Corporation, hereafter Gulf, have enjoyed a mutually advantageous business relationship involving the sale and purchase of aviation fuel for several decades.

This controversy involves the threatened disruption of that historic relationship and the attempt, by Eastern, to enforce the most recent contract between the parties. On March 8, 1974 the correspondence and telex communications between the corporate entities culminated in a demand by Gulf that Eastern must meet its demand for a price increase or Gulf would shut off Eastern's supply of jet fuel within fifteen days.

Eastern responded by filing its complaint with this court, alleging that Gulf had breached its contract n1 and requesting preliminary and permanent mandatory injunctions requiring Gulf to perform the contract in accordance with its terms. By agreement of the parties, a preliminary injunction preserving the status quo was entered on March 20, 1974, requiring Gulf to perform its contract and directing Eastern to pay in accordance with the contract terms, pending final disposition of the case.

Gulf answered Eastern's complaint, alleging that the contract was not a binding requirements contract, was void for want of mutuality, and, furthermore, was "commercially impracticable" within the meaning of Uniform Commercial Code § 2-615.

The extraordinarily able advocacy by the experienced lawyers for both parties produced testimony at the trial from internationally respected experts who described in depth economic events that have, in recent months, profoundly affected the lives of every American.

THE CONTRACT

On June 27, 1972, an agreement was signed by the parties which, as amended, was to provide the basis upon which Gulf was to furnish jet fuel to Eastern at certain specific cities in the Eastern system. Said agreement supplemented an existing contract between Gulf and Eastern which, on June 27, 1972, had approximately one year remaining prior to its expiration.

The contract is Gulf's standard form aviation fuel contract and is identical in all material particulars with the first contract for jet fuel, dated 1959, between Eastern and Gulf and, indeed, with aviation fuel contracts antedating the jet age. It is similar to contracts in general use in the aviation fuel trade. The contract was drafted by Gulf after substantial arm's length negotiation between the parties. Gulf approached Eastern more than a year before the expiration of the then-existing contracts between Gulf and Eastern, seeking to preserve its historic relationship with Eastern. Following several months of negotiation, the contract, consolidating and extending the terms of several existing contracts, was executed by the parties in June, 1972, to expire January 31, 1977.

The parties agreed that this contract, as its predecessor, should provide a reference to reflect changes in the price of the raw material from which jet fuel is processed, i.e., crude oil, in direct proportion to the cost per gallon of jet fuel.

Both parties regarded the instant agreement as favorable, Eastern, in part, because it offered immediate savings in projected escalations under the existing agreement through reduced base prices at the contract cities; while Gulf found a long term outlet for a capacity of jet fuel coming on stream from a newly completed refinery, as well as a means to relate anticipated increased cost of raw material (crude oil) directly to the price of the refined product sold. The previous Eastern/Gulf contracts contained a price index clause which operated to pass on to Eastern only one-half of any increase in the price of crude oil. Both parties knew at the time of contract negotiations that increases in crude oil prices would be expected, were "a way of life", and intended that those increases be borne by Eastern in a direct proportional relationship of crude oil cost per barrel to jet fuel cost per gallon.

Accordingly, the parties selected an indicator (West Texas Sour); a crude which is bought and sold in large volume and was thus a reliable indicator of the market value of crude oil. From June 27, 1972 to the fall of 1973, there were in effect various forms of U.S. government imposed price controls which at once controlled the price of crude oil generally, West Texas Sour specifically, and hence the price of jet fuel. As the government authorized increased prices of crude those increases were in turn reflected in the cost of jet fuel. Eastern has paid a per gallon increase under the contract from 11 cents to 15 cents (or some 40%).

The indicator selected by the parties was "the average of the posted prices for West Texas sour crude, 30.0-30.9 gravity of Gulf Oil Corporation, Shell Oil Company, and Pan American Petroleum Corporation". The posting of crude prices under the contract "shall be as listed for these companies in Platts Oilgram Service -- Crude Oil Supplement . . ."

"Posting" has long been a practice in the oil industry. It involves the physical placement at a public location of a price bulletin reflecting the current price at which an oil company will pay for a given barrel of a specific type of crude oil. Those posted price bulletins historically have, in addition to being displayed publicly, been mailed to those persons evincing interest therein, including sellers of crude oil, customers whose price of product may be based thereon, and, among others, Platts Oilgram, publishers of a periodical of interest to those related to the oil industry.

In recent years, the United States has become increasingly dependent upon foreign crude oil, particularly from the "OPEC" nations n3 most of which are in the Middle East. OPEC was formed in 1970 for the avowed purpose of raising oil prices, and has become an increasingly cohesive and potent organization as its member nations have steadily enhanced their equity positions and their control over their oil production facilities. Nationalization of crude oil resources and shutdowns of production and distribution have become a way of life for oil companies operating in OPEC nations, particularly in the volatile Middle East. The closing of the Suez Canal and the concomitant interruption of the flow of Mid-East oil during the 1967 "Six-Day War", and Libya's nationalization of its oil industry during the same period, are only some of the more dramatic examples of a trend that began years ago. By 1969 "the handwriting was on the wall" in the words of Gulf's foreign oil expert witness, Mr. Blackledge.

During 1970 domestic United States oil production "peaked"; since then it has declined while the percentage of imported crude oil has been steadily increasing. Unlike domestic crude oil, which has been subject to price control since August 15, 1971, foreign crude oil has never been subject to price control by the United States Government. Foreign crude oil prices, uncontrolled by the Federal Government, were generally lower than domestic crude oil prices in 1971 and 1972; during 1973 foreign prices "crossed" domestic prices; by late 1973 foreign prices were generally several dollars per barrel higher than controlled domestic prices. It was during late 1973 that the Mid-East exploded in another war, accompanied by an embargo (at least officially) by the Arab oil-producing nations against the United States and certain of its allies. World prices for oil and oil products increased.

Mindful of that situation and for various other reasons concerning the nation's economy, the United States government began a series of controls affecting the oil industry culminating, in the fall of 1973, with the implementation of price controls known as "two-tier". In practice "two-tier" can be described as follows: taking as the bench mark the number of barrels produced from a given well in May of 1972, that number of barrels is deemed "old" oil. The price of "old" oil then is frozen by the government at a fixed level. To the extent that the productivity of a given well can be increased over the May, 1972, production, that increased production is deemed "new" oil. For each barrel of "new" oil produced, the government authorized the release from price controls of an equivalent number of barrels from those theretofore designated "old" oil. For example, from a well which in May of 1972, produced 100 barrels of oil; all of the production of that well would, since the imposition of "two-tier" in August of 1973, be "old" oil. Increased productivity to 150 barrels would result in 50 barrels of "new" oil and 50 barrels of "released" oil; with the result that 100 barrels of the 150 barrels produced from the well would be uncontrolled by the "two-tier" pricing system, while the 50 remaining barrels of "old" would remain government price controlled.

The implementation of "two-tier" was completely without precedent in the history of government price control action. Its impact, however, was nominal, until the imposition of an embargo upon the exportation of crude oil by certain Arab countries in October, 1973. Those countries deemed sympathetic to Israel were embargoed from receiving oil from the Arab oil producing countries. The United States was among the principal countries affected by that embargo, with the result that it experienced an immediate "energy crises".

Following closely after the embargo, OPEC (Oil Producing Export Countries) unilaterally increased the price of their crude to the world market some 400% between September, 1973, and January 15, 1974. Since the United States domestic production was at capacity, it was dependent upon foreign crude to meet its requirements. New and released oil (uncontrolled) soon reached parity with the price of foreign crude, moving from approximately $5 to $11 a barrel from September, 1974 to January 15, 1974.

Since imposition of "two-tier", the price of "old oil" has remained fixed by government action, with the oil companies resorting to postings reflecting prices they will pay for the new and released oil, not subject to government controls. Those prices, known as "premiums", are the subject of supplemental bulletins which are likewise posted by the oil companies and furnished to interested parties, including Platts Oilgram.

Platts, since the institution of "two-tier" has not published the posted prices of any of the premiums offered by the oil companies in the United States, including those of Gulf Oil Corporation, Shell Oil Company and Pan American Petroleum, the companies designated in the agreement. The information which has appeared in Platts since the implementation of "two-tier" with respect to the price of West Texas Sour crude oil has been the price of "old" oil subject to government control.

Under the court's restraining order, entered in this cause by agreement of the parties, Eastern has been paying for jet fuel from Gulf on the basis of the price of "old" West Texas Sour crude oil as fixed by government price control action, i.e., $5 a barrel. Approximately 40 gallons of finished jet fuel product can be refined from a barrel of crude.

Against this factual background we turn to a consideration of the legal issues.

THE "REQUIREMENTS" CONTRACT

Gulf has taken the position in this case that the contract between it and Eastern is not a valid document in that it lacks mutuality of obligation; it is vague and indefinite; and that it renders Gulf subject to Eastern's whims respecting the volume of jet fuel Gulf would be required to deliver to the purchaser Eastern.

The contract talks in terms of fuel "requirements." The parties have interpreted this provision to mean that any aviation fuel purchased by Eastern at one of the cities covered by the contract, must be bought from Gulf. Conversely, Gulf must make the necessary arrangements to supply Eastern's reasonable good faith demands at those same locations. This is the construction the parties themselves have placed on the contract and it has governed their conduct over many years and several contracts.

In early cases, requirements contracts were found invalid for want of the requisite definiteness, or on the grounds of lack of mutuality. Many such cases are collected and annotated at 14 A.L.R. 1300.

As reflected in the foregoing annotation, there developed rather quickly in the law the view that a requirements contract could be binding where the purchaser had an operating business. The "lack of mutuality" and "indefiniteness" were resolved since the court could determine the volume of goods provided for under the contract by reference to objective evidence of the volume of goods required to operate the specified business. Therefore, well prior to the adoption of the Uniform Commercial Code, case law generally held requirements contracts binding.

The Uniform Commercial Code, adopted in Florida in 1965, specifically approves requirements contracts in F.S. 672.306 (U.C.C. Sec. 2-306(1)).

"(1) A term which measures the quantity by the output of the seller or the requirements of the buyer means such actual output or requirements as may occur in good faith, except that no quantity unreasonably disproportionate to any stated estimate or in the absence of a stated estimate to any normal or otherwise comparable prior output or requirements may be tendered or demanded."

The Uniform Commercial Code Official Comment interprets Sec. 2-306(1) as follows:

"2. Under this Article, a contract for output or requirements is not too indefinite since it is held to mean the actual good faith output or requirements of the particular party. Nor does such a contract lack mutuality of obligation since, under this section, the party who will determine quantity is required to operate his plant or conduct his business in good faith and according to commercial standards of fair dealing in the trade so that his output or requirements will approximate a reasonably foreseeable figure. Reasonable elasticity in the requirements is expressly envisaged by this section and good faith variations from prior requirements are permitted even when the variation may be such as to result in discontinuance. A shut-down by a requirements buyer for lack of orders might be permissible when a shut-down merely to curtail losses would not. The essential test is whether the party is acting in good faith. Similarly, a sudden expansion of the plant by which requirements are to be measured would not be included within the scope of the contract as made but normal expansion undertaken in good faith would be within the scope of this section. One of the factors in an expansion situation would be whether the market price has risen greatly in a case in which the requirements contract contained a fixed price.

Some of the prior Gulf-Eastern contracts have included the estimated fuel requirements for some cities covered by the contract while others have none. The particular contract contains an estimate for Gainesville, Florida requirement.

The parties have consistently over the years relied upon each other to act in good faith in the purchase and sale of the required quantities of aviation fuel specified in the contract. During the course of the contract, various estimates have been exchanged from time to time, and, since the advent of the petroleum allocations programs, discussions of estimated requirements have been on a monthly (or more frequent) basis.

The court concludes that the document is a binding and enforceable requirements contract.

BREACH OF CONTRACT

The court however, finds that Eastern's performance under the contract does not constitute a breach of its agreement with Gulf and is consistent with good faith and established commercial practices as required by U.C.C. Sec. 2-306.

COMMERCIAL IMPRACTICABILITY

In like manner, the "per barrel" cost calculations which Gulf introduced at trial reflect "in house" profits from Gulf's domestic production. During the discovery process, Gulf developed for Eastern certain "cost" figures. Those data show that a Gulf-produced barrel of domestic crude oil is reflected on Gulf's books at a cost of approximately $2.44 for the nine-month period ending September 30, 1974.Yet, for purposes of computing an overall average "cost" to Gulf of a barrel of crude oil for trial purposes (estimated by Gulf's economist witness Davis on the stand at about $9.50 for that period), Gulf used, not the $2.44 actual booked cost, but a "transfer" price, equal to "postings" and including intra-company profit. To the extent "old oil" postings are reflected in the domestic oil "transfer price", the intra-company profit would be on the order of $2.76 per barrel, measured against the $5.20 posting listed in Platt's for West Texas Sour Crude; "new" oil "transfer prices" would include an even larger profit margin. Gulf estimated that some 70 percent of domestic oil going into Gulf's refineries was its own proprietary production.

Again, these are not the kinds of "costs" against which to measure hardship, real or imagined, under the Uniform Commercial Code. Under no theory of law can it be held that Gulf is guaranteed preservation of its intra-company profits, moving from the left-hand to the right-hand, as one Gulf witness so aptly put it. The burden is upon Gulf to show what its real costs are, not its "costs" inflated by its internal profits at various levels of the manufacturing process and located in various foreign countries.

No criticism is implied of Gulf's rational desire to maximize its profits and take every advantage available to it under the laws. However, these factors cannot be ignored in approaching Gulf's contention that it has been unduly burdened by crude oil price increases.

No such hardship has been established. On the contrary, the record clearly establishes that 1973, the year in which the energy crises began, was Gulf's best year ever, in which it recorded some $800 million in net profits after taxes. Gulf's 1974 year was more than 25% better than 1973's record $1,065,000,000 profits were booked by Gulf in 1974 after paying all taxes.

For the foregoing reasons, Gulf's claim of hardship giving rise to "commercial impracticability" fails.

But even if Gulf had established great hardship under U.C.C. Sec. 2-615, which it has not, Gulf would not prevail because the events associated with the so-called energy crises were reasonably foreseeable at the time the contract was executed. If a contingency is foreseeable, it and its consequences are taken outside the scope of U.C.C. § 2-615, because the party disadvantaged by fruition of the contingency might have protected himself in his contract.

REMEDY

Having found and concluded that the contract is a valid one, should be enforced, and that no defenses have been established against it, there remains for consideration the proper remedy.

The Uniform Commercial Code provides that in an appropriate case specific performance may be decreed. This case is a particularly appropriate one for specific performance. The parties have been operating for more than a year pursuant to a preliminary injunction requiring specific performance of the contract and Gulf has stipulated that it is able to perform. Gulf presently supplies Eastern with 100,000,000 gallons of fuel annually or 10 percent of Eastern's total requirements. If Gulf ceases to supply this fuel, the result will be chaos and irreparable damage.

Under the U.C.C. a more liberal test in determining entitlement to specific performance has been established than the test one must meet for classic equitable relief.

It has previously been found and concluded that Eastern is entitled to Gulf's fuel at the prices agreed upon in the contract. In the circumstances, a decree of specific performance becomes the ordinary and natural relief rather than the extraordinary one. The parties are before the court, the issues are squarely framed, they have been clearly resolved in Eastern's favor, and it would be a vain, useless and potentially harmful exercise to declare that Eastern has a valid contract, but leave the parties to their own devices. Accordingly, the preliminary injunction heretofore entered is made a permanent injunction and the order of this court herein.