Oil & Gas Alert
March 25, 2010
Author:
David R. Fine
david.fine@klgates.com
+1.717.231.5820
K&L Gates includes lawyers practicing out
of 36 offices located in North America,
Europe, Asia and the Middle East, and
represents numerous GLOBAL 500,
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corporations, in addition to growth and
middle market companies, entrepreneurs,
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sector entities. For more information,
visit www.klgates.com.
Pennsylvania Supreme Court Unanimously
Holds that the Minimum Royalty Act Allows
Post-Production Deductions
The Pennsylvania Supreme Court has interpreted Pennsylvania’s Minimum Royalty
Act (“MRA”), 58 P.S. § 33, to allow natural-gas producers to calculate royalties by
subtracting post-production expenses from sales prices. On March 24, 2010, the
court handed down its much-anticipated decision in Kilmer v. Elexco Land Services
Company, 63 MAP 2009, and it held that the royalty required by the MRA may be
measured at the wellhead.
Kilmer is one of more than 70 cases filed in state and federal courts across
Pennsylvania in which hundreds of landowners sought to invalidate their existing
leases by arguing that the MRA’s requirement that a lease allow at least a one-eighth
royalty was violated by lease provisions that allowed such a royalty but also allowed
deduction of post-production expenses such as dehydration, compression and
transportation.
In Kilmer, the landowners brought suit in the Court of Common Pleas of
Susquehanna County, Pennsylvania, against the leasing company, Elexco Land
Services Company, and the producer that took an assignment of the lease,
Southwestern Energy Production Company (collectively, “Southwestern”).
Southwestern argued in response that proper interpretation of the MRA required
consideration of where royalties were generally measured in 1979 when the
Pennsylvania General Assembly enacted the statute, and the vast majority of
jurisdictions at that time used a wellhead measurement. The trial judge granted
summary judgment to Southwestern, and the landowners appealed to the
Pennsylvania Superior Court, one of the Commonwealth’s intermediate appellate
courts.
Southwestern, represented by a K&L Gates team that included David R. Fine,
George A. Bibikos, Amy L. Groff and Patricia C. Shea, petitioned the Pennsylvania
Supreme Court to take the case immediately under its extraordinary jurisdiction
rather than waiting for the Superior Court to complete its review. The Supreme
Court granted the petition and ordered expedited briefing and argument.
The Supreme Court’s 6-0 decision in Kilmer agreed with Southwestern’s analysis
that the General Assembly’s intention regarding royalty measurement had to be
determined based on the prevailing industry and legal customs in 1979. Because
almost every jurisdiction measured royalties at the wellhead at that time, the Court
agreed that the General Assembly must have intended the one-eighth royalty to be
measured there.
Oil & Gas Alert
Because of the difficulty in assessing the value of
raw gas at the wellhead, producers developed a netback method to calculate royalties that subtracted
from the downstream sales price the expense
associated with moving the gas from the wellhead to
the market. In Kilmer, the Supreme Court held that
a lease that incorporates such a net-back calculation
meets the requirements of the MRA.
This result is particularly important to the ongoing
development of the Marcellus Shale because the
landowners in Kilmer and dozens of other, similar
cases sought to invalidate their leases, and a
decision in their favor would have affected not only
their leases but potentially thousands more with
similar royalty provisions. The Supreme Court’s
decision is also critical because a number of
producers were understandably reluctant to drill
wells on land under challenged leases.
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March 25, 2010
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