WV Supreme Court Favors the Gas Industry on Post-Production Costs

WV Supreme Court reverses itself on gas royalties of post-production expenses

From an Article by Ken Ward, Jr., Charleston Gazette – Mail, May 26, 2017

In a ruling that was expected by most industry observers, the West Virginia Supreme Court on Friday reversed its own decision from just last year and ruled that natural gas drillers can deduct post-production costs from the royalties paid to certain types of mineral owners.

In the decision, the court ruled 4-1 in favor of EQT Corp. to allow deduction of such expenses — for things like gathering, transporting or treating gas after it is extracted — when checks are sent to a group of mineral royalty owners covered by a state law meant to update and reform decades-old natural gas industry payment practices in West Virginia.

Chief Justice Allen H. Loughry II wrote the 47-page majority opinion, in which he was joined by Justices Menis E. Ketchum II and Beth Walker. Justice Margaret Workman sided with the majority, but wrote a concurring opinion. Justice Robin Jean Davis dissented and reserved the right to issue a dissenting opinion at a later date.

In a new point of law, Loughry’s opinion stated that royalty payments under that state law “may be subject to pro-rata deduction or allocation of all reasonable post-production expenses actually incurred by the lessee.”

It said that oil and gas companies may use “net-back” or “work-back” methods to calculate royalties owed but that the “reasonableness” of those expenses in specific instances may be decided by future court cases.

The court’s reversal of its November 2016 ruling in the case, called Leggett v. EQT Production, comes after last year’s election, in which Walker defeated Justice Brent Benjamin, who had written that earlier court opinion.

Walker’s involvement in the case generated controversy, because her husband had previously owned significant stock in a long list of natural gas and other energy companies that would be affected by the court’s decision. In the new ruling, Workman also went from ruling with what was then a 3-2 majority opposed to allowing post-production costs to being with the majority that was in favor of allowing such deductions.

Last year’s ruling found that West Virginia’s 1982 law to update old “flat-rate” leases requires that companies like EQT not deduct from royalties they pay to mineral owners any expenses for gathering, transporting or treating gas after it is initially extracted from the ground. The court had ruled a decade ago, in a case called “Tawney v. Columbia Natural Resources,” that deducting these sorts of post-production costs from royalties to gas owners was illegal unless doing so was specifically outlined in the lease.

The case decided Friday, brought on behalf of Patrick Leggett and other mineral owners against EQT, focused on whether the same legal requirements from Tawney also applied to drilling operations that work under the 1982 law.

Legislators passed that law to reform what they said was “wholly inadequate compensation” for mineral owners covered by leases that dated back, in many instances, to the turn of the 20th century. Those leases often paid a flat rate, such as $300 a year, regardless of how much gas was being produced and how much profit drillers were making. Basically, the law said that, to put a new well on a site covered by one of those flat-rate leases, the driller had to agree to pay royalties amounting to a one-eighth — 12.5 percent — royalty.

The Leggett case plaintiffs argued — and the previous court ruling agreed — that EQT has been wrongly deducting post-production expenses before paying owners their one-eighth royalty on a tract that had been covered by a 1906 lease that was updated according to the 1982 law.

In Friday’s majority opinion, Loughry wrote that, “Upon rehearing, with all due regard to the previous majority’s consideration of the admittedly complex and subversively entangled issues implicated in this case, we conclude that it did, in fact, misapprehend the applicability of certain common law principles and exceeded its charge in its interpretation of the subject statute.”

Specifically, Loughry wrote that the earlier majority wrongly concluded that the 1982 law contained an ambiguity that needed to be interpreted to “right past wrongs” by prohibiting dilution of royalty payments by post-production costs.

Just before an oral argument in May, attorneys for the royalty owners had sought to stop the rehearing of the case. They argued that Walker should not have taken part in the vote to grant that rehearing and that she should have disqualified herself from any consideration of the issue because her husband, Michael Walker, owned stock in natural gas and energy companies.

Michael Walker loaned his wife’s campaign $525,000 during last year’s election. After information about that motion by the royalty owners was publicized, Walker released an updated decision not to disqualify herself, saying her husband had sold all of his energy stocks.

Friday’s ruling defended the decision to rehear the case.

“While an admittedly uncommon occurrence, rehearing exists expressly for the purpose of ensuring that opinions which are not well-founded due to misapprehension of the issues, the law, or the facts are rectified,” the new ruling said. “Justice demands this procedural remedy, which this Court has judiciously utilized when the issues or outcome demand it.

“When a petition for rehearing compels the Court to conclude that the law may have been misapprehended, neither hubris nor sanctimony should give the Court pause in granting rehearing to correct any such error of law or fact,” it said.

The majority decision and Workman’s concurring opinion acknowledge a difference between the way royalty owners are treated under the court’s rulings in the Leggett and Tawney decisions, and they urge the Legislature to take action to resolve that conflict.

Workman, for example, wrote, “Where the Legislature’s inaction in the face of such significant changes in the industry leaves this Court to intuit its intentions and/or retrofit outdated statutory language to evolving factual scenarios, the will of the people is improperly disregarded.”

Workman also said she wrote a separate opinion to emphasize that the majority decision to allow cost deductions “may not be abuses to the detriment of lessors who are chargeable with pro-rata costs and to urge the Legislature to enact specific protections to assure fairness and reasonableness in the calculation of post-production costs.

“As the majority’s new syllabus point states, only such costs as are reasonable and actually incurred are properly deductible,” Workman wrote. “Accordingly, to the extent that a lessor alleges that cost deductions are artificially inflated or are otherwise not commercially reasonable, he or she may clearly maintain an action against the lessee pending sufficient proof thereof.”

The Leggett case was a major point of discussion during the legislative debate over potential passage of a forced-pooling natural gas bill this session. Various parties were looking for lawmakers to either codify Tawney and the earlier Leggett decision — or to overturn them, depending on which side those parties were on.

Tagged as: horizontal drilling, Leggett case, marcellus shale, natural gas, post-production costs, slick water fracking, WV Supreme Court