Editor’s note: This is the sixth article in an occasional series.
When the state Supreme Court issued its decision last year on how to properly calculate royalties owed by gas companies to landowners, attorneys representing the industry couldn’t oversell its importance.
Some 70 cases on the issue were pending in state and federal courts at the time, they said, and a contrary ruling could have crippled natural gas exploration in Pennsylvania as landowners and gas companies would have been forced back to the negotiating table.
That, of course, didn’t happen.
The high court, ruling 6-0 in Kilmer v. Elexco Land Services Inc. , held that factoring post-production expenses into royalty calculations did not violate the Guaranteed Minimum Royalty Act — a win for natural gas drillers. It also allowed for several cases to be quickly resolved, attorneys said.
“We’ve seen the first wave of litigation pretty much over,” said Kevin Abbot, an attorney at Reed Smith in Pittsburgh. “Their ruling had an immediate impact on reducing the number of cases. They clarified the law on what that act meant. Since then, there have been a number of follow-up decisions in state and federal court.”
Kilmer , though, remains the sole drilling-related decision reached by the high court during the explosion of the Marcellus Shale exploration. And while the Superior Court has also reached rulings on novel issues related to the natural gas play, the sole state Supreme Court ruling is one that most attorneys point to when discussing the impact of the law on development in the shale.
That specifically goes for Kermit Rader, co-chair of the environmental law practice at Hamburg Rubin Mullin Maxwell & Lupin in Lansdale, Pa.
Rader, who has developed a practice negotiating gas leases, said he’s now able to request limiting language be included in leases.
Previously, Rader said, gas companies would fight such inclusion and it still doesn’t appear on their “usual form.”
“But if you ask for the language, you’ll get it,” he said. “I don’t get a whole lot of resistance now. There’s not really any discussion.”
A recent Superior Court case — Hite v. Falcon Industries — has also aided Rader when it comes to negotiations, he said.
That case addressed the payment of delay rentals and was favorable to landowners “who have old leases where there’s a question as to whether or not the lease is going to renew at the end of the term,” Rader said.
“There are lots and lots of people who have leases that come right up to the 11th hour and sometimes past the 11th hour and you wonder if you have an argument to make that the lease hasn’t automatically renewed and you have to negotiate,” Rader said. “That case has been very helpful to argue to gas companies.”
Plenty of questions remain, though.
In the last month, questions that were shaped, in part, by the court’s ruling in Kilmer have been resolved in two federal court cases.
For instance, a recent class action suit in the U.S. District Court for the Western District of Pennsylvania, Frederick v. Range Resources , settled last month when landowners and the drilling company agreed to an initial damages payment and a restructured lease that would benefit the class by an estimated $20 million.
It only came about, however, because the plaintiffs were forced to alter their legal argument in light of the Kilmer ruling.
Initially challenging the validity of the leases under the Guaranteed Minimum Royalty Act, the class amended its complaint after the ruling to challenge the propriety of the amounts deducted by Range Resources.
The plaintiffs argued the gas company had reduced the amounts of their royalty payments by improperly using the point-of-sale volume of gas, rather than the volume of gas collected at the well head, to calculate the gross royalty.
The suit also challenged deductions for marketing costs and management fees, as well as the lack of royalties for liquid hydrocarbons, a product extracted from the gas and sold separately by Range Resources.
The move seemed to take the advice of Justice Max Baer, who wrote in the court’s Kilmer opinion that “if a landowner suspects that a gas company is charging higher costs than the gas company is actually paying, then the landowner can seek a court ordered accounting.”
In Lauchle v. The Keeton Group LLC , however, U.S. District Court Judge for the Middle District of Pennsylvania John E. Jones III was only able to rely on Kilmer once.
Though he cited the case to uphold a group of leases being challenged by the plaintiffs in Lauchle , Jones couldn’t use the decision to guide him in considering whether those leases could be extended by the amount of time the suit was pending.
According to Jones, the gas companies in the case had stopped exploration on the landowners’ properties when the litigation began in 2008. After the high court’s decision in Kilmer , the companies filed a counterclaim against the landowners in Lauchle , seeking to have the court rule that the landowners, by their actions, had repudiated the leases and that they were entitled to equitable extensions of them.
It was an issue that had not yet been considered by the high court, Jones wrote.
In his March 8 opinion, however, Jones did find guidance in a 1982 Superior Court case cited by the landowners — Derrickheim Co. v. Brown .
In that case, Jones wrote, the Superior Court ruled that taking a gas company’s “prudent” action of suspending exploration while sorting out a title question did not justify “disregarding the express language of the lease.”
It was a persuasive ruling, Jones wrote. Further, he ruled, it mattered not whether the litigation was initiated by a landowner or a gas company.
Such a distinction was “too fine a point” and would “discourage lessors from bringing actions to determine the validity of their leases,” Jones ruled.
“In making this determination we are mindful of the fact that oil companies, like the chief defendants, wield significant, if not exclusive power in the drafting of oil and gas leases,” Jones wrote. “A determination that plaintiffs had repudiated their leases via the filing of these actions further tips the balance in favor of the oil companies. Moreover, it would likely dissuade lessors from bringing potentially meritorious actions, which the case sub judice unquestionably was at its inception, in the future.”
To attorneys, it’s likely that more cases will play out like Frederick and Lauchle than those cases where Kilmer was quickly applied and the issue resolved.
Questions, nuances and alternative arguments will be borne out of varying fact patterns, attorneys said, and the organic process of building case law on the issue will take root.
And though such a process can be slow, many attorneys said the courts have moved quickly on issuing opinions. Add to that an increase in litigation, said Joel Burcat of Saul Ewing in Harrisburg, and that will speed the process even more.
“Hopefully, we get to a point where there are fewer disputes, but you are dealing with a lot of money,” said John Carroll, an attorney at Pepper Hamilton in Harrisburg and the secretary of the Pennsylvania Bar Association’s environmental and energy law section. “What we’re dealing with right now is a lot of leasing activity. Many of those leases were three- to five-year leases. There will be another round of leasing if those leases are not carried on by active production.”
By that time, said Burcat, other issues may be fleshed out for guidance.
Already, state appellate courts and federal courts have increased their output of reported opinions this year.
According to Burcat, the courts have been issuing anywhere between 10 and 12 reported opinions per year on Marcellus Shale issues. Through April of this year, Burcat said, the courts have already issued 10 such opinions.
Questions have included whether royalty calculations have to go to arbitration, whether theories of strict liability can apply to gas wells for personal injury and property damage claims and how to resolve certain property disputes.
As that happens, the case law will take care of itself.
“I think the cases are there,” Burcat said of the high court’s ability to impact Marcellus Shale development. “And as we see more cases, there will be more novel issues that come up, issues that we thought, perhaps, were settled, we’ll find out that they weren’t all that settled or that a nuance of an issue suddenly becomes important.” •