The West Virginia Supreme Court held that the above clauses were ambiguous, construed them in favor of the royalty owner, and held that, without additional express language, the clauses did not permit the lessee to deduct production costs. In particular, the Court stated that if a lease is to allocate production costs between the lessor and the lessee, the lease “must expressly provide that the lessor shall bear some part of the costs incurred between the wellhead and the point of sale, identify with particularity the specific deduction the lessee intends to take from the lessor’s royalty, and indicate the method of calculating the amount to be deducted.” Estate of Tawney v. Columbia Natural Resources, L.L.C., 633 S.E.2d 22, 24 (W. Va. 2006) (syllabus ¶ 10).5 The Plaintiffs also argued that CNR wrongfully sold gas at less than market value. At the crux of this argument was the so-called “Mahonia deal.” Under this transaction, CNR entered into two forward or futures contracts, which provided for the sale of gas in advance to Mahonia for a fixed price over a five-year period. CNR received $400 million in advance payments because of the Mahonia contracts. CNR blended the Mahonia contracts with other gas sales, and royalty owners received royalties based on an average sales price. Ultimately, Judge Evans ruled as a matter of law, based on the Supreme Court’s ruling, (i) that CNR was not entitled to deduct production and marketing costs, (ii) that the Plaintiffs were entitled to recover for royalties lost as a result of CNR’s volume deductions, and (iii) that CNR was required to pay a 1/8 royalty6 on all wells, metered and non-metered. As a result, the principal questions left for the jury to determine were: (i) whether CNR could properly consider the lower Mahonia sales numbers when calculating royalties and (ii) whether CNR was liable for punitive damages. The jury answered these questions in favor of the Plaintiff class. Justification for Punitive Damages Perhaps the most remarkable factor in Tawney is the trial court’s allowance of punitive damages. In Tawney, the Plaintiffs successfully argued that punitive damages were warranted because CNR had acted fraudulently in two ways:
CNR countered that the Mahonia contracts were negotiated for record-high prices and allowed CNR to have immediate cash to expand drilling and conduct further exploration. CNR further contended that it should not be penalized because the price of natural gas rose even further during the contract period and that it had no duty to disclose the contracts to the royalty owners. The jury evidently was not convinced by CNR’s arguments, however, because it assessed the punitive damage award. Conclusion Undoubtedly hoping to benefit from the favorable certified question opinion, at least four more class action royalty owner suits have been filed in West Virginia, and other royalty class actions continue to be filed in other states. This increase in royalty litigation serves to remind oil and gas companies that class action litigation remains a significant concern. Because of the variety of often-aged lease forms that govern royalty payments and the multi-state nature of many oil and gas companies’ operations, this is an intricate area of the law. Companies, therefore, may be well advised to consult with experienced counsel who can assist them in assessing the risk posed by royalty-owner class actions and in defending against any claims that may be asserted.
2. Judge Evans also denied the Plaintiffs’ motion for post-trial relief, which requested that the Defendants pay Plaintiffs’ attorneys’ fees in excess of $1 million.
3. Specifically, CNR allegedly (i) assessed fees for CNR’s delivery of gas from the well to the transmission line, (ii) assessed fees for the processing of gas to make it suitable for delivery, (iii) adjusted production volumes to account for losses due to leaks in gathering system and (iv) adjusted production volumes for other volume losses incurred in transmission.
4. At issue in Tawney were 1,382 separate leases.
5. For a discussion of other jurisdictions’ approach to the deductibility of production and marketing costs from royalties, see, e.g., Annotation, Sufficiency of “At the Well” Language in Oil and Gas Leases to Allocate Costs, 99 A.L.R. 5th 415 (2002).
6. By statute in West Virginia, a lessee is entitled to a 1/8 royalty.
This alert was also published in the September/October 2007 issue of Landman magazine.
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