The Pennsylvania Supreme Court in an expedited case on Wednesday rejected an attempt by Marcellus Shale landowners to receive higher royalty payments from natural gas operators.

The court, in a unanimous opinion, upheld the validity of the original leases signed by property owners, who had claimed the transactions violated state law (J-78-2009, Supreme Court of Pennsylvania, Middle District, on appeal from the Order of the Susquehanna County Court of Common Pleas, Civil Division, No. 2008-57, in Herbert Kilmer, Elsie Kilmer, Jacqueline Frantz, Jeffrey Kilmer, Diane Kilmer, Kenneth Kilmer and Thomas Kilmer vs. Elexco Land Services Inc. and Southwestern Energy Production Co.).

“The court could have invalidated tens of thousands of leases,” said attorney David R. Fine, who represented Elexco and Southwestern Energy. “It would have been catastrophic, really.”

Justice Max Baer wrote the court’s opinion, which resolved several cases pending in state and federal courts in Pennsylvania that challenged the leases signed in the early stages of Marcellus exploration a few years ago. The landowners then received smaller payments compared with some of the more recent lucrative agreements.

The plaintiffs had argued that the original leases violated Pennsylvania’s 1979 royalty law, which provides that landowners receive at least one-eighth shares of natural gas recovered from their properties. They had claimed that the energy industry’s practice to charge landowners for a share of the post-production costs had reduced their royalty payments below the state minimum.

However, the state’s high court agreed with the operators that the netback method to calculate royalties did not violate Pennsylvania law.

Baer noted that the “critical term ‘royalty’ is not defined by the statute” as it is used in the Pennsylvania’s Guaranteed Minimum Royalty Act (GMRA), but “many leases in the Commonwealth, including the lease at issue before this Court, calculate the royalties as one-eighth of the sale price of the gas minus one-eighth of the post-production costs of bringing the gas to market.

“This calculation is called the ‘netback method,’ as its goal is to determine the value of the gas when it leaves the ground (hereinafter ‘at the wellhead’) by deducting from the sales price the costs of getting the natural gas from the wellhead to the market. The landowners in this case filed for declaratory judgment seeking to void their leases, arguing that the netback method of calculating royalties violates the GMRA. The trial court rejected this argument and granted summary judgment to the gas companies.”

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