A sharp MDN reader, John S., emailed MDN to remind us of how PA landowners ended up in the quagmire they are now in with regard to royalties with drillers (like Chesapeake) deducting post-production expenses from what they pay to landowners. We had forgotten about the Kilmer v ElexCo Land Services case from March 2010 in which the PA Supreme Court ruled that drillers could indeed deduct certain post-production expenses without violating the law that says landowners must be paid a 12.5% minimum royalty (see Breaking News: PA Supreme Court Rules Against Landowner Seeking to Invalidate Lease).
PA Gov. Tom Corbett wrote a letter to Doug “the ax” Lawler at Chesapeake telling him the company’s royalty calculations were unfair at best, and perhaps illegal. Doug just has to point to the 2010 PA Supreme Court case. Here’s more information about the 2010 case and what the decision means, and doesn’t mean:
Last year, Susquehanna County landowner Herbert Kilmer sued ElexCo Land Services Inc. and Southwestern Energy Production to invalidate his lease. The reason? He said that by deducting drilling costs from his royalty payments, his payments fell below Pennsylvania’s law that a minimum one-eighth share of royalties are guaranteed to the landowner. A Susquehanna County judge ruled against the landowner and in favor of the energy companies. Other people started filing lawsuits, so the energy companies asked the PA Supreme Court to take up the matter. The Supremes did, and today they also ruled in favor of the energy companies:
Pennsylvania’s high court sided Wednesday with the natural gas industry in a dispute with landowners who had sought to invalidate the leases they signed before the Marcellus Shale rush intensified and drove up land values.
In a 6-0 decision, the Supreme Court upheld a Susquehanna County judge’s ruling that validated lease agreements that subtract drilling costs from the calculation of landowners’ natural gas royalties.
Justice Max Baer, who wrote the court’s decision, noted that the term “royalty” and the method of calculating a one-eighth share is not defined by the state’s Guaranteed Minimum Royalty Act. However, he cited various texts on the industry that say a royalty is paid from the net amount remaining after deduction of certain production and well development costs.*
This case will now force similar pending cases to be settled or dismissed. Landowners beware: (1) There is no such thing as a “standard” contract, and (2) Always have an attorney review a lease agreement first.
*BND.com (Mar 24) – Pa. justices side with gas industry over landowner
An informative article with a lot of background on the issue of gas royalty payments and the practice of deducting post-production expenses from those payments is published in today’s The State Journal. The article covers in detail the case of Tawney v. Columbia Natural Resources that was settled by the West Virginia Supreme Court in 2006. That decision said, in essence:
[G]as producers cannot deduct “post-production” expenses — those incurred between the wellhead and market, such as dehydration, compression and transportation — from royalty payments unless explicitly spelled out in the lease.*
West Virginia is in the minority of states that have ruled against post-production expenses. Other states disallowing post-production expenses (unless specifically spelled out in the lease) include Arkansas, Colorado, Kansas and Oklahoma.
However, because gas “at the wellhead” is not in “marketable condition,” a number of other states do allow deduction of post-production expenses from royalty payments in cases where it’s not specifically enumerated in the lease. Those states include Louisiana, Mississippi, Texas, California, Montana, New Mexico and some others.
Kentucky and Pennsylvania have not yet ruled on the matter, although the Pennsylvania Supreme Court is due to rule soon in Kilmer v. Elexco Land Services Inc.
The lesson for landowners: Make sure the language in your lease is spelled out in detail about what kinds of post-production expenses can and cannot be deducted from your royalty checks. And if you have a contract that is not specific, get legal advice and be sure you’re receiving the money you’re owed.
*The State Journal (Mar 11) – State Courts Continue to Evaluate Gas Royalties