Each of the leases at issue contained a separate royalty provision, with some being gross proceeds provisions and others being market value provisions. The leases were amended by a settlement agreement between Antero and some of the plaintiffs from previous years. Included in this modification of the leases was a “market enhancement clause,” which provided:

It is agreed between the Lessor and Lessee that notwithstanding any language herein to the contrary, all oil, gas or other proceeds accruing to the Lessor under this lease or by state law shall be without deduction, directly or indirectly, for the cost of producing, gathering, storing, separating, treating, dehydrating, compressing, processing, transporting, and marketing the oil, gas and other products produced hereunder to transform the product into marketable form; however, any such costs which result in enhancing the value of the marketable oil, gas or other products to receive a better price may be deducted from Lessor’s share of production so long as they are based on Lessee’s actual cost of such enhancements. However, in no event shall Lessor receive a price that is less than, or more than, the price received by Lessee.

The court explained that the market enhancement clause included two distinct provisions: first, referred to as the “gross proceeds provision,” it “prohibits Antero from deducting any costs incurred to ‘transform [oil, gas, and other products] into marketable form’” and second, referred to as the “enhancement provision,” it “permits Antero to deduct costs for enhancing a product already in marketable form.” The court ultimately found that taken together, “these two provisions unambiguously distinguish between costs arising from actions taken to transform the product into marketable form, which are not deductible, and costs resulting in enhancing the value of the gas to receive a better price, which are deductible.” However, the court found that the market enhancement clause was “ambiguous in material aspects” as it failed to indicate what the parties intended to include as “oil, gas, and other products,” and when they became marketable.

The court held that two landmark West Virginia cases, Wellman v. Energy Resources, Inc., 557 S.E.2d 254 (W. Va. 2001), and Tawney v. Columbia Natural Resources, LLC, 633 S.E.2d 22 (W. Va. 2006), applied to the leases at issue in Corder v. Antero, notwithstanding Antero’s argument that Wellman and Tawney do not apply to the market value leases. The court concluded that “the ‘market value’ provisions” were “not sufficient to escape the dictates of Wellman and Tawney.”

Under Wellman, in order for the lessee “to deduct any post-production costs from a lessor’s royalty payments, the lease must expressly allocate such costs to the lessor and the lessee must prove that the costs were actually incurred and reasonable.” Under Tawney, in order to “rebut the presumption that the lessee bears all post-production costs,” the lease must (1) “expressly provide that the lessor shall bear some part of the costs incurred between the wellhead and the point of sale”; (2) “identify with particularity the specific deductions that the lessee intends to take from the lessor’s royalty”; and (3) “indicate the method of calculating the amount to be deducted from the royalty for such post-production costs.”

The court found that the market enhancement clause satisfied the first prong “by providing that costs incurred by Antero to enhance the products extracted from the Plaintiffs’ property to receive a better price ‘may be deducted’ from the Plaintiffs’ royalty payments.” As to the third prong, Antero asserted that its enhancement deductions were calculated using the “work-back method,” as permitted under the Fourth Circuit’s opinion in Young v. Equinor USA Onshore Properties, Inc., 982 F.3d 201 (4thCir. 2020), so this prong was met. The court agreed that the market enhancement clause satisfied the third prong, “as it states that enhancement costs ‘may be deducted’ from Lessor’s share of production so long as they are based on Lessee’s actual cost of such enhancements.” However, the court found that Tawney’s second prong was not satisfied by the clause “because it does not identify with particularity the costs that Antero may deduct” from plaintiffs’ royalty payments. The court reasoned that “[a]lthough the Market Enhancement Clause enumerates types of post-production costs, it does not unambiguously identify the products from which those costs may be deducted.” Therefore, the court held that the “key terms of the parties’ contract are ambiguous,” which “preclude[s] a finding that the enhancement costs to be deducted have been stated with sufficient specificity” as required under Tawney. The court explained that it is “unclear whether they intended to include [natural gas liquids] as ‘other products,’ or what efforts must be undertaken to get oil, gas, and other products into their ‘marketable form.’” As a result, the court granted summary judgment to the plaintiffs as to their claim that certain leases are subject to Wellman and Tawney “because the language of the Market Enhancement Clause is insufficient to permit Antero to take post-production or market enhancement deductions from their royalty payments.”

In addition, the court adjudicated claims relating to the plaintiffs who were not parties to the settlement agreement that included the market enhancement clause and had to determine whether the unmodified leases allowed Antero to allocate post-production or market enhancement costs to these plaintiffs under Wellman and Tawney. The court held that the unmodified leases that do not reference post-production costs “fail to satisfy Tawney’s first prong and do not permit Antero to deduct any post-production costs” from the royalties. Thus, Antero was denied summary judgment as to its royalty obligations under those unmodified leases.

Lastly, the court ruled on the sole flat rate lease at issue. The court reasoned that “[u]nder West Virginia law, flat rate leases are not subject to Wellman’s presumption and Tawney’s heightened specificity requirements” but rather are subject to West Virginia Code section 22-6-8, which was amended in 2018 per Leggett v. EQT Production Co., 800 S.E.2d 850 (W. Va. 2017). This 2018 amendment provided that a permit for the drilling of a new oil or gas well or other certain activities shall not be issued “if the right to extract, produce or market the oil or gas is based upon a lease...providing for flat well royalty.” The plaintiffs to this lease argue that the 2018 amendment applies retroactively to prohibit Antero from taking post-production deductions from their royalties. The court disagreed, reasoning that the statute neither clearly stated that it applies retroactively nor specified any intent by the legislature to clarify the current case law on flat rate leases. The court noted that the record did not indicate if Antero altered any of its activities on the properties at issue that would require a new permit. The court ultimately found that it “cannot determine whether Leggett or the 2018 amendment to § 22-6-8 governs Antero’s royalty obligations” under the flat rate lease because it could not “ascertain whether, post-2018, Antero was required to obtain a new permit.”

Questions of material fact remained as to damages.

Bankruptcy

Chesapeake Energy filed for Chapter 11 bankruptcy in June 2020. The company recently reached a settlement agreement with 139 parties who had named Chesapeake as a defendant in various lawsuits in Texas state court. Most of the matters made claims for breach of contract due to drilling operations in the Eagle Ford basin and for underpayment of royalties. On May 11, 2021, a Texas bankruptcy judge approved the settlement deal, resolving about $150 million in claims.

Key takeaways

1. The Western District of Pennsylvania found that when a lease calls for the calculation of royalties at the wellhead, the net-back method may be used for calculation under Kilmer.
2. The Northern District of West Virginia applied Wellman and Tawney to the oil and gas leases before it.
3. The U.S. Bankruptcy Court for the Southern District of Texas approved a settlement agreement reached by Chesapeake Energy, resolving about $150 million in claims.

In-depth 2021-145