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United States Bankruptcy Court,
D. Arizona.

In re KRYSTAL ENERGY CO. INC., Debtor.
Krystal Energy Co. Inc., Plaintiff,
v.
The Navajo Nation, Defendant.

Bankruptcy No. 2:01–00166–GBN.
Adversary No. 01–ap–00171–GBN.
Jan. 6, 2012.
Adam B. Nach, Lisa Perry Banen, Lane & Nach, P.C., Phoenix, AZ, for Plaintiff.

Marcelino R. Gomez, Assistant Attorney General, Window Rock, AZ, for Defendant.

PROPOSED FINDINGS OF FACT, CONCLUSIONS OF LAW AND ORDER

GEORGE B. NIELSEN, Bankruptcy Judge.

*1This adversary proceeding seeks, inter alia, to adjudicate a demand for damages by the Chapter 11 bankruptcy estate of Krystal Energy Co., Inc. against the Navajo Nation, a sovereign Indian tribe .FN1 Plaintiff filed a Chapter 11 bankruptcy case in the District of Arizona on January 5, 2001. On April 8, 2003, the case was dismissed by stipulated order between the Chapter 11 bankruptcy trustee and the United States Trustee, effective as of February 14, 2003 and reserving to this court jurisdiction over this adversary proceeding.

FN1. The Ninth Circuit Court of Appeals has expressly ruled that Congress has abrogated the tribe's sovereign immunity in regard to this litigation. Krystal Energy Co. v. Navajo Nation (In re Krystal Energy Co.) 375 F.3rd 1055, 1056–61 (9th Cir.2004).

After the defendant tribe (“Nation”) answered the amended complaint, plaintiff sought approval for filing a second amended complaint and request for injunctive relief. Adversary docket items (“dkt.”) 38 and 39. The court granted the motion to further amend the complaint. Injunctive relief was granted in part and denied in part. The court authorized plaintiff's agents to visit two oil well sites located on the Nation's reservation upon notice, but would not authorize resumption of oil producing activities by plaintiff. Dkt. 50 at p. 2; Order at dkt. 54. After briefing of a motion to dismiss, the court dismissed without prejudice second amended complaint counts one (Breach of Contract), two (unjust enrichment) and three (violation of due process). See Dkts. 52, 65.

Following briefing and oral argument, the court on January 8, 2008, granted summary judgment to plaintiff on complaint count four (turnover of property) and reserved ruling on count five (violation of the automatic stay). Dkts. 76–78, 81–86, 88. Transcript at dkt. 106. The court ruled in part that Krystal had obtained assignments of oil leases near Aneth, Utah and Farmington, New Mexico with the knowledge of the Nation and made substantial investments to acquire operating equipment. The Bureau of Indian Affairs never approved the oil lease assignments to Krystal. Through the declarations of an eye witness and a principal of Krystal, plaintiff established that defendant's employees appeared at the Utah site in 1999, escorted Krystal's employee off the premises, locked it, removed oil from storage tanks and warned the employee not to return. Defendant's physical ejectment and exclusion of Krystal from both sites without the opportunity to remove its equipment was found to create liability for return of the property or its value. Dkts. 86, 88 at p. 2.

The court stated in part: “The problem I'm having is that there was an ejectment. The Nation had some role in that ejectment. There might be other parties liable, but the Nation has not sought to bring them into this proceeding.... I don't have a clear explanation why ... the Nation believes that the debtor didn't own this personal property.... I don't have a clear explanation from the Nation why it didn't have an obligation to see that some opportunity be given for the safe keeping of that equipment.... [A]s long as it's proper you can eject someone from your property, but that doesn't mean you get to keep the property that ... person has brought onto the property. That's the explanation that seems to be lacking in the response.” Dkt. 106 at p. 7.

*2The United States District Court for the District of Arizona has affirmed the liability ruling. The Navajo Nation v. Krystal Energy Co., Inc. Civ. 08–0178–Phx–MHM. Dkt. 123. An evidentiary hearing on damages concluded with post trial briefing and closing argument. The court has considered sworn witness testimony, admitted exhibits, briefs and the facts and conclusions of this case. An interim order was issued on December 20, 2011, advising the parties of court's decision. Dkt. 223. The following findings and conclusions are now proposed to the district court:

FINDINGS OF FACT

1. Johnny Bennett, Jr. is a college educated New Mexico crude oil loader who worked for approximately eight years as an oil and gas inspector for the Nation in Arizona, Utah and New Mexico. He was required by the Nation to inspect at least annually, all well sites located on the reservation, including Krystal's sites near Farmington, New Mexico and Aneth, Utah. The witness has a clear recollection of the Aneth lease. Debtor's predecessor as leaseholder in Utah was an entity known as Cross Creek. Approximately 11 years ago, the Aneth well was operated by Krystal, but the formal transfer of the lease from Cross Creek was still in transition. Mr. Bennett issued non compliance notices regarding signage and leakage at the site. The signage citation was issued because a posted sign listed Cross Creek as operator. Bennett knew Krystal was really the operator. Nonetheless, the signage citation had to be issued to Cross Creek as the lease assignment was delayed at the Bureau of Indian Affairs. This was not an unusual violation, but had the citation been issued to Krystal, it would have been rejected by the Nation's administrative process, since the Krystal assignment was still pending. Oil leakage was also a common citation. The witness has no memory of Krystal not addressing the citations. He had an obligation to follow up on them.

From 1997 through 1999 Krystal operated a well in Utah that appeared to be producing. He witnessed Krystal make both repairs and improvements to the sites. He doesn't have a specific recollection whether New Mexico produced oil. The Utah site was a mile deep and New Mexico was shallower. Utah had three pumping jacks while New Mexico had one. There were also large water and oil storage tanks. During this time he worked with a number of Krystal's representatives, but never himself was a Krystal employee. In his experience, it would take “forever” for the federal government to approve lease assignments.

2. His Navajo Nation employment occurred between 1990 or 1991 and 2000, with a break for a few months to work on pipe line operations. His recollection of the New Mexico Krystal lease is more vague, but he does recall the New Mexico equipment, such as flow lines and tanks was not new. The Nation was aware Krystal was operating the wells through Bennett himself and his reports to Nation petroleum engineers, Tribal Committees, the Director of the Minerals Department and to other inspectors. While the witness does not recall directly speaking to the Director, this officer would receive the witness' written reports.

*33. The federal approval delay occurred just as to the Utah lease. The Nation's practice was to allow operation during the delay, but the witness can't recall if the interim operation was normally by the assignor or assignee. He can't recall the last time he was physically present at either site. Although he was aware of some dispute between the Nation and Krystal, he did not pay attention to it. He would just inspect the equipment. The Utah equipment was adequate for operational purposes and Mr. Bennett saw it operating. He wrote citations for both of Krystal's sites. The witness cannot recall how often he would inspect the Krystal sites, but he would revisit within 30 days of issuing a citation. The court finds witness Bennett to be a knowledgeable, impartial and credible witness. June 27, 2011 testimony (“test.”) of Johnny Bennett, Jr.

4. Carl Padilla has been an oil equipment manufacturer in Farmington, New Mexico since 1990 or 1991. He has been a certified oil pipe welder since 1977 and has extensive experience working with a large variety of oil production equipment. He has a number of competitors and is often required to submit competitive equipment bids. He holds master mechanic and licensed contractor designations. Although he has never before qualified as an expert witness in a judicial proceeding, the court overruled an objection and accepted his tender as an expert in oil equipment valuation for this case.

5. He recalls being on the Utah site in the late 1990's to assess a leaking oil tube. At the time the site equipment included tank batteries, gas separators, a pump house, pump jacks and a heat treater used to separate water from the oil. Debtor's site also included equipment to separate natural gas from oil. The witness believes Krystal utilized the natural gas to power on site machinery. Mr. Padilla was contacted in 2009 and requested to do a market valuation of the equipment. His appraisal consists of a four-page letter, utilizing current values rather than 1999 values, which he understands to be the year Krystal was evicted. Exhibit (“Ex.”) 1 at p. 2. Page one identifies his experience in Utah, his company and client information. It indicates he works with many large producers throughout the San Juan Basin, which is essentially the “Four Corners” area. Page two discusses a 42,000 gallon tank, approximately 21 feet in diameter and 20 feet tall located at the Utah site. His company manufactures such equipment. He has never before submitted a report for use in litigation or such a valuation report. He did not consult with anyone, but just obtained prices from the vendors he works with and estimated the labor costs of originally installing the items onto the site.

6. In 2009, he traveled to Krystal's former site near Farmington, New Mexico for purposes of the valuation. He had not previously been on this property. Certain items absolutely have to be located at an oil drilling site to allow operations. The New Mexico equipment appeared to not have been recently used and was in a fair to poor condition. His valuation represents what it would cost to put the Farmington site into operation. He has engaged in the manufacture or re manufacture of surface oil pumping equipment since 1991. Before starting his own company, he was the employee of others in the industry since 1976, principally his father. He holds no formal appraisal certifications and essentially appraised equipment he never saw. His values are for new or nearly new equipment. He received information verbally from Krystal's representative, such as well depth. He did not previously know Krystal's representative.

*47. Transportation and installation costs were added to equipment values. No written documents or list of property was provided by Krystal. The witness had not visited the Utah site when Cross Creek was the lessee. He has never before worked for Krystal. He has experience in purchasing used equipment from a plugged or abandoned well. He wouldn't pay the prices he quotes for market value since he is in business to make money and must acquire property at less than normal market value. He doesn't consider his letter to be an appraisal and is not familiar with professional appraisal practices. Instead, he believes his four page letter is a proposal from him to sell equipment to a buyer. He did not consider the costs of abandoning the site, plugging the well or environmental clean up costs.

8. The costs of new, as compared to nearly new equipment is within ten to fifteen per cent of each other. Customers don't request old or equipment that “sort of” works. Instead, Padilla used values for equipment that meets established operating requirements. He obtained the well depth for the Farmington site during his visit, as it was listed on signage. The Utah depth was provided verbally by Krystal. No other information was provided verbally. All other information, other than the Utah well depth was acquired by the witness personally. He didn't travel to Utah. The witness provided the New Mexico values based on what he recalled seeing on site or what would be needed for operations.

9. While he has not previously done business directly with Krystal, he has had business dealings previously with Krystal's principal owners, the Nicholson brothers. In the mid 1990's he moved equipment for the brothers and built oil tanks for them. He last did business with the Nicholson brothers two to three years ago. He did not receive compensation for his four page letter. Padilla will be paid his out of pocket travel expenses and $50 per hour for his time in testifying. If he was attempting to purchase the New Mexico equipment he valued for resale, he would agree to pay more than salvage value, perhaps $100 to $150 per ton. A single tank weighs 9,000 pounds. He would personally pay approximately the same values for the Utah items. His proposal letter represents replacement values.

10. His prior work for the Nicholson brothers in the 1990's involved repairing a fire box, disassembling and reassembling a Lupton, Arizona plant and a 60–day maintenance job that cost $12,000 to $15,000. He has never been involved in plugging a well and provided no-cost information on such action. He considers that cost a property owner expense. Currently Padilla's Farmington business, CIP, Inc. is trending downward. When business is better, his company's gross revenues run between two to three million dollars per year. In slow times, he feels fortunate to gross a million dollars yearly. Test. of Carl Padilla, Ex. 1. The fact finder's assessment is that Mr. Padilla is a credible, experienced and fair witness who admits when he lacks knowledge. The court finds his testimony and opinions credible, but they do not rise to the level of an experienced, licenced appraiser.

*511. George Cunningham is a certified appraiser who owns his own firm and has done two to four appraisals a week since the 1990's. He visited the New Mexico site on March 16, 2007 to make an inspection and take photographs. Mr. Cunningham also visited the Utah site on the same day for an inspection and photographs. He contacted two suppliers to the New Mexico site and appraised the assets he could view. He didn't calculate the exact pipeline dimensions, but based his estimate on a supplier's information. He used equipment valuations from 2009, but adjusted for an assumed better condition earlier. He estimates approximately the same well depth for each location. He concedes he erred by using an incorrect figure for tubing values. Mr. Cunningham learned what had been on the Utah site by interviewing others. According to Mr. Nicholson, Padilla had erred by assuming one too many pump jacks. He adjusted for this error by reducing value by $12,000. At the time he testified, his estimated hypothetical fair market value for the missing equipment was 4.25 million dollars.

12. The witness cannot recall if he previously has appraised oil and gas equipment. While he appraised the equipment he actually saw in New Mexico, his hypothetical valuations for missing machinery would not qualify as a formal appraisal. For purposes of the valuations, he assumed a valid lease was in effect and that the equipment was operating and producing income. For the New Mexico valuation, he assumed the equipment would be in better condition that what he observed. His assumption of equipment condition was based on an equipment list provided by John Deets, which the witness verified through two vendors. He was told there were three pump jacks operating in Utah with another about to be placed into service. It would be a significant factor had he received definitive information that the jacks had actually been in place for 30 years. The appraisal's effective date was December of 1999. It reflects fair market value for equipment in continuous use.

13. Cunningham reviewed no financial documents, except for the drilling leases. If operational leases were not in place, the items would have received a lower valuation. His instructions were to value the equipment at fair market value in continuous operation at its present location. If some of the machinery was actually 30 years old and operating, it would have to have received appropriate maintenance including newer replacement parts. His total appraised value, including $75,000 for the New Mexico machinery and installation costs is 4.25 million dollars. He didn't inquire regarding what Krystal originally paid for the equipment. This would not be relevant. This valuation reflects what it would cost to replace the missing property and does not necessarily require all new items. Hypothetical valuations are not considered a formal appraisal, but are commonly utilized in loss situations, such as an insurance fire loss. Such valuations are approximately five to ten per cent of the witness' work. Test. of George Cunningham, Ex. 2. The court finds this witness' testimony and opinions to be direct, honest, credible and professional.

*614. Bruce Nicholson is Krystal's vice president. The Gallup, New Mexico family business consisted of retail gasoline stations, including some located on the Nation's reservation land. He was raised on the Monument Valley reservation and spent most of his life there. His girl friend, an enrolled member of the Nation, signed the debtor's bankruptcy filings. The witness attended a 1997 meeting with officials of the Bureau of Indian Affairs (“BIA”), the Amoco Production Company and officials of the Nation. The meeting was driven by Amoco's desire to obtain assurances from the Nation for approval of the transfer of operating rights from the Cross Creek Corporation to Krystal. The Nation did not want Cross Creek to continue on the reservation. Mr. Nicholson's father handled negotiations for the family business. Debtor paid Cross Creek more than $300,000 for the Utah rights and $100,000 for the New Mexico rights. The witness is unsure why his father wanted to enter the drilling business. Neither he nor his father knew much about gas and oil production. The Cross Creek application for assignment of the Utah well is dated May 28, 1997. Krystal felt it was appropriate to start operations, as they believed the Nation had approved the transfer. No difficulties occurred with the Tribe until 1999.

15. A report was generated for the Utah site, listing Krystal as operator. Other paperwork and a bond were also created for the transfer. This included a tax document submitted to the Nation by Krystal. The Utah well was operating at this time. A $150 receipt to pay for the public filing of the Utah and New Mexico leases reflects the public nature of the transfer. Both locations operated in 1997 through 1998 by Krystal, using its employees. However, the family retail store office employees administered Krystal employee records.

16. In April or May of 1999, business operations were greatly disrupted by an FBI seizure of essentially all business records. While the debtor was never indicted, other business were prosecuted concerning non payment of government fuel taxes. The State of Texas shut down the family stores. Mr. Nicholson, whose father was Navajo, made the mistake of not paying fuel taxes. Following plea bargaining in September or October of 2001, the witness plead guilty and was sent to prison for two years. He also agreed to stay out of the service station business. His brother received a one year sentence. The seized business records were sent to a location in Lubbock, Texas, where they remained for years. The witness was released in 2004 and has completed his probation obligations. Attempts were made to locate the documents through correspondence with the United States Attorney for the Northern District of Texas and the State of Texas, to no avail. Although on some date the records were made available, no one from the family obtained them. Once the records were seized, all operations stopped. In a December 8, 1999 letter, the BIA advised Nicholson that at the Nation's request, the federal government would not approve transfer of the Cross Creek leases to Krystal, due to Krystal's ineligibility under Navajo law “... and due to other concerns of the Navajo Nation.” Unlike Cross Creek, debtor was directed to stop all drilling operations and immediately leave the reservation. The witness complained that Cross Creek was allowed to remain in possession and transfer its leases when it ran into difficulty with the Nation.

*717. Amoco was instructed to immediately take over operation of the lease. The witness was informed the Nation would not approve future lease transfers to his family members. Nicholson did not return to see the Utah site again until 2007. By then, all machinery had been removed. He estimates he visited the Utah location 30 to 40 times prior to the ejectment and verified that the Utah equipment listed on page two of Mr. Padilla's valuation was actually installed there. The Utah well had a depth of between 5,000 and 6,000 feet. Less of an investment was made in the Farmington, New Mexico lease, but the witness saw the Farmington equipment installed and operating between 1997 and 1999. Krystal obtained a 1998 bond for the Utah leasehold which the BIA did not sign. The Nation and BIA did not sign the oil and gas lease assignments that the witness signed on May 28, 1997. Nicholson was not concerned about the delay as he had been advised formal approval took time. Test. of Bruce Nicholson, exs. 1, 4–9, 11–12, 16, 26, 34–36, 38. The court finds the witness to be credible on the subject of his company's dealings with the Nation.

18. Donald E. Ross is a geologist and certified general appraiser with 40 years experience with expertise in mines and minerals. His assignment was to determine the forced liquidation value of the equipment as of March 6, 2008 for the Nation, “as is” and “where is.” His final value estimate is $8,300 with a 12 month marketing period for the Farmington equipment. He did a field visit, talked with individuals and examined comparable values. One of the people he consulted was Barbara Padilla, the wife of plaintiff's witness Carl Padilla. A tribal official informed Ross that the property contained a 210–barrel tank. He denied that he is mistaken and Farmington had a 380–barrel tank, although he did not see signage indicating a 210–barrel tank. The witness doubts the tank size would impact his opinion. His report does not discuss underground piping as he was unable to view it. The well had been abandoned and plugged. He has previously worked for the Nation and hopes to receive future assignments from them. His valuation is not a fair market valuation, which values property on an ongoing producing basis. He did not do a hypothetical valuation regarding missing machinery. He summarized that the appraised items were “... old idle equipment sitting out on the desert.” Ross' appraisal contemplates disposition by auction or for salvage. He has no opinion regarding the value as of December of 1999. Test. of Donald E. Ross, ex. QQ at p. ii and at pgs. 17, 25. The court finds the witness knowledgeable, but argumentative on cross examination. Since this expert witness did not key his value opinion to the date of plaintiff's exclusion from the sites, his opinion is of limited value to the fact finder.

19. To the extent any of the following conclusions of law should be considered findings of fact, they are hereby incorporated by reference.

CONCLUSIONS OF LAW

*81. To the extent that any of the above findings of fact should be considered conclusions of law, they are hereby incorporated by reference.

2. Jurisdiction of the Chapter 11 bankruptcy case to which this adversary proceeding is related is vested in the United States District Court for the District of Arizona. 28 U.S.C. § 1334(a) . That court has referred all cases under Title 11 of the United States Code, all adversary proceedings and all contested matters arising under Title 11 or related to a bankruptcy case to the United States Bankruptcy Court for the District of Arizona. 28 U.S.C. § 157(a) , District General Order 01–15(1). The Nation has denied this court has core bankruptcy jurisdiction to resolve this proceeding by entering a final order or judgment. Answer to second amended complaint at ¶ 4, dkt. 64. The Nation was scheduled as a disputed unsecured creditor, but did not file a bankruptcy claim against the estate. Schedule F at p. 2.

3. While plaintiff alleges this court has core bankruptcy jurisdiction to liquidate the damages claim as an estate asset FN2 , see 28 U.S.C. § 157(b)(2)(O) , care should be taken to not transgress the limits of bankruptcy court jurisdiction. Northern Pipeline Constr. Co. v. Marathon Pipe Line Co. 102 S.Ct. 2858,2862–80 (1982) (Unconstitutional for bankruptcy court to decide a state law contract claim against an entity not otherwise part of the bankruptcy case), Stern v. Marshall, 131 S.Ct. 2594, 2611–13 (2011) (Bankruptcy Court lacks Constitutional authority to enter a final judgment on estate's state law counterclaim to bankruptcy claim). Accordingly, the court will enter proposed findings and conclusions. § 157 (C)(1).

FN2. Second amended complaint at p. 2.

4. This court has not adjudicated whether the Nation's refusal to approve the lease transfer was wrongful. Rather, this court is determining what damages are to be awarded for the Nation's refusal to return or allow plaintiff to retrieve its equipment from the terminated leaseholds. Navajo Nation v. Krystal Energy Co. Inc. 2008 WL 2477084 at pgs. 2–3 (D.Az.2008)(Partially granting leave to appeal). This court's ruling, finding the Nation liable has been affirmed. Navajo Nation v. Krystal Energy Co., Inc. 2008 WL 4446703 at p. 6 (D.Az.2008) (“In contrast, the uncontroverted facts, as set forth in the record through depositions by eye witnesses, establish that in December 1999, Navajo Nation officials evicted Krystal employees from the well sites, took equipment that belonged to Krystal for transport from the site, and chained and locked the well sites, telling Krystal's employees that they could not return.”).

5. It is troubling that plaintiff could not produce its own internal records to establish exactly what equipment was located on which site, its condition and dates and costs of acquisition. However, the uncontroverted testimony is that the entirety of plaintiff's business records were removed by law enforcement. Given the incarceration of two family members, it is understandable that no one else apparently followed up on the records' return, given that the family entities ceased operation by the combination of the Nation's exclusion and criminal prosecution of officers FN3. Efforts years later to locate the documents were unsuccessful. Exs. 34–38. Accordingly, the court will accept credible testimony regarding missing assets and their hypothetical valuation by recognized experts. Nonetheless, plaintiff ultimately bears the risk of non persuasion through uncertainty.

FN3. Apparently, family member Brian L. Nicholson received contact regarding the record's return but either never followed up or did not retain them. Nicholson test., Ex. 35.

*96. This court's conclusions of law are reviewed de novo. California Franchise Tax Board v. Kendall ( In re Jones), 657 F.3d 921, 924 (9th Cir.2011) . Its factual findings are reviewed for clear error. Hanf v. Summers (In re Summers), 332 F.3d 1240, 1242 (9th Cir.2003) . Findings of fact, whether based on oral or documentary evidence will not be set aside unless clearly erroneous. Due regard is given to the bankruptcy court's opportunity to judge the credibility of witnesses. Rule 8013, F.R.B.P . The appellate court accepts the bankruptcy court findings, unless upon review, it has the definite, firm conviction a mistake was committed. Ganis Credit Corp. v. Anderson ( In re Jan Weilert RV, Inc.), 315 F.3d 1192, 1196 (9th Cir.) , amended by 326 F.3d 1028 (9th Cir.2003) . The appellate court may affirm on any ground supported by the record. Jones, Id., Stevens v. NW Nat'l Ins. Co. ( In re Siriani), 967 F.2d 302, 304 (9th Cir.1992) .

7. Defendant's expert appraisal is of lesser utility, as it has an effective date years after defendants' forced shut down of two operating well sites. Further, it is calculated at salvage value, based on equipment that sat for years unused in the desert. Those are not the facts of this case. Plaintiff's experts appraised for replacement value equipment that until December of 1999 was actively utilized in two producing sites. Had the Nation accepted its responsibility and either let the operating equipment be removed or sold in place, precisely the way plaintiff originally acquired its interests, value would have been maximized. This the Nation did not do. It should not benefit for this failure through a valuation technique.

8. Plaintiff's Cunningham appraisal, prepared by an independent professional, supported by the extensive personal industry experience of Carl Padilla, is far more valuable in establishing the value for the operating assets as existing in place during December of 1999. Given the uncertainty caused by a necessary hypothetical appraisal for missing assets and plaintiff's complete failure to produce contemporaneous business records to document the loss, the appraised value for both locations will be reduced to four million dollars.

ORDER

The court will recommend that the United States District Court issue a final judgment, supported by these proposed findings and conclusions of four million dollars in favor of plaintiff and against defendant. Plaintiff may apply to the Bankruptcy Court Clerk for an award of costs and, if appropriate, apply to this court for an award of attorneys fees.

Bkrtcy.D.Ariz.,2012.
In re Krystal Energy Co. Inc.
Slip Copy, 2012 WL 32636 (Bkrtcy.D.Ariz.)
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