On August 24, 2017, the United States District Court for the Northern District of West Virginia granted summary judgment to producers in a class action lawsuit concerning the deduction of flat-rate post-production costs.

In Kinney v. CNX Gas Company, LLC, et al., the parties’ leases provided that the lessors would receive a percentage of the oil and gas produced and sold from the leased premises less:

an amount equal to $1.20 per MMBtu with respect to heating, sweetening, gathering, dehydrating, compressing, processing, manufacturing, transporting, trucking, marketing, blending, and other costs and expenses incurred by Lessee in marketing said oil and gas and all excise depletion, severance, privilege and production taxes that are now or hereafter levied, or assessed or charged on oil and gas owned by Lessor and produced from the Premises, which amount the parties are agreed will be presumed to be actually incurred and reasonable. [Emphasis is ours].

The lessors claimed that such flat-rate post-production cost deductions were prohibited under West Virginia law under the decisions of Wellman v. Energy Resources, Inc. and Estate of Tawney v. Columbia Natural Resources, LLC.

The court disagreed, noting first that although Wellman found that a West Virginia lessee has an implied duty to market oil and gas and therefore, that lessees generally cannot take post-production cost deductions, Wellman recognized an exception whereby post-production costs may be deducted where the lease expressly allows it, and the deductions taken are “actually incurred and reasonable.” And the Tawney decision clarified that lessees could take post-production cost deductions so long as certain requirements were met—i.e., (1) the lease expressly provides that the lessor will bear post-production costs; (2) the lease identifies with particularity the specific deductions taken; and (3) the lease indicates the method for calculating the amounts deducted.

Here, the court found that the requirements of Wellman and Tawney were met. The lease royalty clause satisfied the three factors in Tawney, and it stipulated that the deductions are “actually incurred and reasonable” under Wellman. The parties freely contracted for that stipulation and the court honored that language.  Additionally, the lease contained a disclaimer of implied covenants, reinforcing the notion that the parties intended to abrogate the lessee’s implied duty to market production.

Click here to read the decision.