Co-author Trevor Lawhorn

*Kind of; this is a federal court predicting what the Ohio Supreme Court would do.

In Ohio, in calculating royalties in a market-value-at-the-well lease (as distinguished from a “proceeds” lease), post-production costs are to be shared proportionately by the working interest and royalty owners. The lessee’s duty to market does not extend to expenses incurred in sales not at the well-head. This is consistent with other producing states such as Texas and Pennsylvania. 

In Lutz v. Defendant-Who-Appears-Most-Often-in-This-Blog, et al, the lessors sued under leases where royalty is paid:

…” on gas, . . . produced from said land and sold or used off the premises . . . the market value at the well of one-eighth of the gas so sold or used, provided that on gas sold at the wells the royalty shall be one-eighth of the amount realized from such sale. . . .”

The class-action lessors alleged that defendants underpaid them by deducting post-production costs, calculating payments using a price that was less than the market price at the time of production, and using volumes less than volumes actually produced (that is, deducting for “line loss”).

When gas is sold downstream of the wellhead, Defendant-Appearing-the–Most pays lessors a pro rata share of downstream sales and, depending on circumstances, may deduct a share of post-production costs (the “net-back” or “work-back” method).

Prior to this round in the litigation, the Ohio Supreme Court had declined to answer a certified question: Does Ohio follow the “at the well rule”? The court ruled instead that Ohio oil and gas leases are to be construed under traditional rules of contract construction. (Translation: Follow the words in the lease.)

The federal court framed the issue this way: Given this lease language, how should royalties be paid when gas is sold downstream and not “at the well.”

The court decides

Based on the unambiguous language of the royalty clauses, the Ohio Supreme Court would adopt the “at the well” rule in these leases because that rule simply identifies the location at which the gas is valued for purposes of calculating royalties. There are no proceeds at the wellhead, so it would be meaningless to apply the language in isolation.

The court also held that because royalties are based on volume at the well, line loss was irrelevant.

Tolling of limitations?

The court rejected the lessors’ claim that limitations should be tolled because of the defendants’ fraudulent concealment. The lessors admitted that they only looked at the money amount listed on the check stubs and no other information. There was no evidence that the check stubs were inaccurate or that there was no way for the lessors to check their accuracy. The lessors failed to exercise appropriate due diligence to determine if they had a claim.

Holiday pushback

Weary of Christmas trees before Halloween, seasonal retail overload, and your grandmother’s fruitcake? Me too. Remembering what the season is about, we offer an early and, apparently counter-cultural, musical interlude.