Tawney Stopped at the Ohio Border

Posted on June 18, 2010 by Vorys

Building on the royalty-interest owners' success in Estate of Garrison G. Tawney v. Columbia Natural Resources, LLC (West Virginia), plaintiffs filed a nearly-identical suit in Ohio asserting class-action claims for the deliberate and fraudulent underpayment of natural gas royalties by CNR and its successors.  See Lutz v. Chesapeake Appalachia, LLC, Case No. 4:09CV2256 (United States District Court, Northern District of Ohio).  Today, the District Court issued its decision dismissing those claims - based largely on Ohio's new 4-year statute of limitations.

Effective April 6, 2007, Ohio changed its statute of limitations for breaches of oil and gas leases from 15 years (i.e., the limitations period ordinarily applicable to breach of contract claims) to 4 years (i.e., the period applicable to UCC sales of goods).  See Rev. Code Section 2305.041.  Notably under the new statute, the "cause of action accrues when the breach occurs, regardless of the aggrieved party's lack of knowledge of the breach."  See Rev. Code Section 1302.98.  To overcome the fact that they had alleged royalty claims beginning in 1993 and 2000, plaintiffs argued the new statute of limitations should not be applied because it would retroactively extinguish an accrued substantive right.  The court disagreed.

Because the retroactive application of the new limitations period would eliminate the right to sue on their contract claims, the court found that plaintiffs must be permitted a "reasonable time" to assert those claims to avoid offending the Ohio Constitution's retroactivity clause.  The issue therefore was:  "[W]hat is a 'reasonable time' under the new statute made effective in 2007 for plaintiffs to assert claims that accrued in 1993 and 2000."  The answer:  2 years, following the Ohio Supreme Court's decision in Groch v. Gen. Motors Corp., 117 Ohio St. 3d 192 (2008).  Because plaintiffs filed suit outside that 2-year period (i.e., after April 6, 2009), they were too late.

Plaintiffs sought to save their claims by arguing continuing breach! - i.e., by asserting that each monthly royalty payment was a separate breach of the parties' leases triggering a new claim accrual period.  Unfortunately for the plaintiffs, on the very day that the District Court held its hearing on the issue, the Ohio Supreme Court issued its decision in State ex rel. Nickoli v. Erie Metroparks, 124 Ohio St. 3d 449 (2010), distinguishing between continuing violations and the continuing effects of prior violations.  The District Court found that the same reasoning applied to plaintiffs' claims here.

As the first test of Ohio's new statute of limitations, this is a good result for Ohio producers!
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PA Royalty Decision

Posted on March 24, 2010 by Vorys

The Pennsylvania Supreme Court recently upheld the lower court's decision in Kilmer v. Elexco Land Services, Inc., Docket No. 63-MAP-2009, which found that the net-back method for calculating natural gas royalties did not violate the state's Guaranteed Minimum Royalty Act (GMRA) (which requires that leases guarantee a landowner-lessor at least a 1/8th royalty).  See here (go to Supreme Court Opinions).  After going through the parties' arguments in detail, the Court reasoned, in part, that the term royalty must be construed according to its industry meaning, and that:

The term royalty has been defined in the oil and gas industry as “[t]he landowner's share of production, free of expenses of production.” *** In the industry, as referenced above, the “expenses of production” relate to the costs of drilling the well and getting the product to the surface, but do not encompass the costs of getting the product from the wellhead to the point of sale, as those costs are termed “post-production costs.” “Although the royalty is not subject to costs of production, usually it is subject to costs incurred after production, e.g., production or gathering taxes, costs of treatment of the product to render it marketable, costs of transportation to market.” Id.; see also George A. Bikikos and Jeffrey C. King, A Primer on Oil and Gas Law in the Marcellus Shale States, 4 TEX. J. OIL, GAS, & ENERGY L. 155, 168-69 (2008-2009) (explaining post-production costs and noting that a majority of jurisdictions authorize the deduction of post-production costs in the calculation of royalties).

This, bolstered by the fact that the GMRA was intended to apply to both natural gas and oil royalties, and that oil royalties can be taken in-kind, persuaded the court to agree with the lower court that the GMRA should be read to permit the calculation of royalties at the wellhead, consistent with the net-back method in the lease at issue.

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ND Royalty Opinion

Posted on July 11, 2009 by Vorys

The North Dakota Supreme Court held this week that deductions for natural gas processing of sour gas made by Petro-Hunt, LLC, were properly deducted from royalty payments in Bice v. Petro-Hunt, L.L.C. (Case No. 20080265).  The leases at issue paid royalties based on the market-value of the gas "at the well," and the court found that the majority rule in oil and gas producing states in the country allowed a lessee to deduct post-production costs related to improving gas-quality or transporting the gas to market under this type of lease language.  Adopting that rule, the court therefore rejected  claims made by royalty owners that the producer had an obligation to pay all costs incurred to turn unmarketable gas into a marketable product - i.e., rejecting the first marketable product rule.

[Note:  Also interesting, the court addressed issues involving the royalty-free use of residue gas and deductions made for risk-capital and depreciation.]

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Deepwater Lease Royalty Case

Posted on January 14, 2009 by Vorys

The U.S. Court of Appeals for the Fifth Circuit recently upheld a lower court decision finding that the federal government could not collect royalties on certain deepwater leases held by Anadarko in the Gulf of Mexico.  The issue involved whether the Department of Interior had the authority to suspend royalty relief established by Congress under the Outer Continental Shelf Deep Water Royalty Relief Act for production volumes that were less than the volume thresholds established in the Act itself.  The court held that it did not.

A copy of the court's decision can be found here.

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Devon Loses Appeal

Posted on January 3, 2009 by Vorys

In Devon Energy Corp. v. Kempthorne, Devon challenged an order of the Department of the Interior requiring it to retroactively recalculate royalties owed to the United States under a coalbed methane lease in Wyoming's Powder River Basin.  At issue were certain deductions taken by Devon for compression and dehydration-related costs when calculating royalties under the agency's marketable condition rule, which requires a federal lessee to put production into a marketable condition at no cost to the United States.  Interior had found that the marketable condition rule precluded those deductions where compression and dehydration were necessary to meet the transporting pipeline's gas quality specifications (and thus make the gas deliverable to the purchaser).

Devon argued that Interior's order was inconsistent with the rule's plain meaning, as well as the agency's own prior interpretations of its rule.  The court disagreed:  First, it held that Interior's interpretation of the rule was reasonable and not at odds with its plain language.  The court was therefore required to defer to the agency's interpretation (even while acknowledging that Devon's interpretation was "not unreasonable").  Second, the court found that the guidance documents previously distributed by agency personnel could not be used to support Devon's claim that the agency's order was inconsistent with its prior interpretations of the marketable condition rule.  The agency personnel issuing those documents had no authority to amend the marketable condition rule or to issue authoritative guidelines on the agency's behalf.
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