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Ohio Supreme Court Finds Post-Production Royalty Disputes Should Be Decided Individually

The Ohio Supreme Court has decided that landowners that challenge natural gas producers about post-production costs deducted from royalty checks will have to keep heading to trial courts to resolve the issues on a case-by-case basis.

The high court's long-awaited decision came on Wednesday after it accepted a certified question last year about whether the state follows the "at the well" rule, which allows post-production deductions, or if it follows some version of the "marketable product" rule, which limits post-production deductions, such as those for compression, dehydration and transmission.

"Under Ohio law, an oil and gas lease is a contract that is subject to the traditional rules of contract construction," the court wrote in its opinion. "Because the rights and remedies of the parties are controlled by the specific language of their lease agreement, we decline to answer the certified question."

While neighboring states have addressed the issue, the opinion was the first on the matter by the Ohio Supreme Court (see Shale DailyApril 15). By choosing not to answer the question, the justices leave the trial courts to decide.

In 2009, a group of landowners filed a class action lawsuit against Chesapeake Energy Corp. affiliate Chesapeake Appalachia LLC in the U.S. District Court for the Northern District of Ohio. The landowners alleged that Chesapeake and nonaffiliated predecessor companies had underpaid gas royalties due to them under the terms of their leases by deducting post-production costs. The case dragged on until the federal court certified the question to the Ohio Supreme Court.

Chesapeake, which has settled or is fighting similar cases in other states including Pennsylvania, argued that Ohio contract law makes clear that the state should follow the "at the well" rule and allow the netback method to calculate deductions from royalties. The landowners in the case argued that the court should ignore the "at the well" language in a lease because there are no more true sales of natural gas at the wellhead in today's industry (Regis F. Lutz et al, v Chesapeake Appalachia, No. 2015-0545).

The trial courts will likely continue to weigh-in on the issue. A similar case was decided in Pennsylvania in 2010. In Kilmer v Elexco Land Services and Southwestern Energy Production Co., the Pennsylvania Supreme Court ruled in favor of producers, saying the netback method of calculating royalties did not violate state law (see Shale DailyMarch 29, 2010). A spate of lawsuits have been filed and/or settled in other states against producers for deducting post-production costs (see Shale Daily, May 23Dec. 9, 2015).

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