kentucky royalty litigation update
TRANSCRIPT
KENTUCKY ROYALTY LITIGATION
UPDATE
Karen J. Greenwell
Wyatt, Tarrant & Combs, LLP
250 West Main Street
Suite 1600
Lexington, Kentucky 40507
Royalties
Royalty Calculation Issue Created When Product is Sold
Away From The Well
Mostly a Gas Issue
Common Lease Terms:
“Market Price at the Well”
“Proceeds at the Well”
How do you Determine the Price or Proceeds “at the
well”?
Royalties
Can You Deduct Post-production Costs From
The Sales Price To “Net-back” To “Market Price”
Or “Proceeds” “At The Well”?
Can gas severance taxes be deducted in that
calculation?
ROYALTY LITIGATION
Appalachian Land Company v. EQT
Production Company (Federal Ct.)
Baker v. Magnum Hunter Production,
Inc. (Ky State Ct.)(Pending)
Court SystemsKentucky State Courts
Kentucky Supreme
Court
Kentucky Court of
Appeals
County Circuit Courts
County District Courts
Federal Courts for KY
U.S. Supreme Court
6th Circuit Court of Appeals
US District Court, Eastern
and Western Districts of
Kentucky
Federal Court
Federal Courts Apply The Substantive
Law Of The Applicable State On State
Issues
If The State Appellate Courts Have Not
Decided A Point Of Law, The Federal
Courts Must “Guess” What The State
Courts Will Do
Or
Federal Court
The Federal Court Can Ask The State Court By
“Certifying” The Question To The State Court.
The Federal Court’s “Guess” Is Not Binding On
Kentucky State Courts, And They The State
Courts Are Free To Come To The Opposite
Conclusion.
POPLAR CREEK
In Poplar Creek, The Federal Courts Made Their Own Guess About What Kentucky Law Would Be On The Deductibility Of Post-Production Costs
Trial Court – July 2, 2009
KY Courts Would Interpret “At The Well” To Mean Producer Pays On Value Of Gas “Before It Has Been Gathered, Treated Or Compressed”
Appellate Court (6th Circuit)
Affirmed
“We Hold That Kentucky Follows The “At-the-well” Rule, Which Allows For The Deduction Of Post-production Costs Before Paying Appropriate Royalties.”
Severance Taxes Were Not An Issue
APPALACHIAN LAND (Federal Ct.)
Addressed Deductibility Of Post Production Costs And
Gas Severance Taxes In Calculating Gas Royalty.
Held In Abeyance Until 6TH Circuit Ruled In Poplar Creek
Trial Court – Judgment On The Pleadings:
Adopted 6TH Circuit’s Poplar Creek Ruling That Costs
Are Deductible
Ruled That Severance Taxes Are Deductible As Post-
production Costs
6TH Circuit
Certified Deductibility Of Severance Taxes To The
Kentucky Supreme Court
APPALACHIAN LAND (Ky Sup. Ct.)
6TH Circuit
Certified Deductibility Of Severance Taxes To The
Kentucky Supreme Court
The Kentucky Supreme Court answered saying:
“[W]e conclude that in the absence of a specific lease
provision apportioning severance taxes, lessees may not
deduct severance taxes or any portion thereof prior to
calculating a royalty value.”
APPALACHIAN LAND (Ky Sup. Ct.)
The Kentucky Supreme Court Found That:
The Gas Severance Tax (KRS 143A.060) Is Imposed
For The Privilege Of Producing Gas.
The Tax Is Not A Post-Production Cost.
The Opinion Does Not Specifically Address The Oil
Severance Tax. (KRS 137.120)
APPALACHIAN LAND (Ky. Sup Ct.)
Although The Ky. Sup. Ct. Opinion Was A
Response To A Certified Question, It Is Now A
Published, Final Declaration Of Kentucky Law
And Will Be Binding On All Kentucky Courts.
What Now?
APPALACHIAN LAND (Ky. Sup Ct.)Severance Taxes Should Not Be Deducted In
Calculating Gas Royalties At The Well, Unless The
Lease Permits It.
The 6th Circuit Will Send The Case Back To The
District Court To Decide Damages For Improperly
Deducted Severance Taxes.
The District Court Will Have To Address The Practical
Questions Of Who Is Entitled To Recover, For What
Periods, From Whom, And How Much.
APPALACHIAN LAND (Ky. Sup Ct.)
What Is The Period Of Possible Recovery?
If The Ruling Is Viewed As Purely Prospective, There
Might Be No Recovery Allowed For Periods Prior To
The Ruling.
KRS 413.120 (4) Establishes A 5-year Statute Of
Limitations For An Actions For Profits Or Damages
For Withholding Real Or Personal Property.
APPALACHIAN LAND (Ky. Sup Ct.)
KRS 413.120(11) establishes a 5-year statute of
limitations for an action based on fraud or mistake.
Punitive damages may be available on a fraud
claim.
KRS 413.090(2) establishes a 15-year statute of
limitations for an action on a written contract executed
before July 15, 2014. The statute of limitations is 10
years for those later contracts (KRS 413.160).
APPALACHIAN LAND (Ky. Sup Ct.)
Who Can Recover? That Will Depend On
Circumstances Of Each Lease.
Generally, The Claim Belongs To The Lessor At The
Time The Claim Accrued, As It Accrued, And Does Not
Go To A Successor Lessor.
Has A Lessor Died During The Damages Period?
With A Will: The Claim May Have Been Expressly Conveyed Or
It May Have Passed In The Residuary.
Without A Will: The Claim Will Pass As Personal Property Under
The Laws Of Descent And Distribution.
APPALACHIAN LAND (Ky. Sup Ct.)
Has the lessor assigned the lease or transferred
the property?
Did the assignment or deed specifically
include accrued claims?
If not, those claims may still belong to the
assignor/grantor.
APPALACHIAN LAND (Ky. Sup Ct.)
Did Claims Accrue During The Tenure Of A Prior
Lessee?
Did The Successor Lessee Specifically
Assume Any Accrued Claims?
Are There Contractual Rights Of Indemnity
Against The Prior Lessee?
APPALACHIAN LAND (Ky. Sup Ct.)
Does App. Land Apply To Oil Severance Taxes?
Possibly/Probably Not.
KRS 137.120 says: “The tax … shall be imposed
ratably upon all persons owning any interest in such
oil.”
If The Oil Is Deemed To Have Been Taken In Kind
And Sold By The Lessor At The Wellhead, Then The
Lessor Would Be An “Owner” And Subject To The
Tax.
This Would Be Particularly Applicable If The Jobber
Pays The Lessor Directly.
APPALACHIAN LAND (Ky. Sup Ct.)
Regardless Of What The Federal District Court
Decides, There Will Likely Be Appeals.
When These Issues Are Taken Up By The State
Courts, They May Have Different Answers.
BAKER (Pending)
State Court Case
Addressed the Deductibility Of Post-Production
Costs To Arrive at Price “at-the-well”
Severance Taxes Not An Issue
Harlan Circuit Court
“Kentucky follows the “at-the-well” rule that
permits a lessee to deduct its post-production
costs before the royalty payment to the lessor
is calculated.”
Ky Court of Appeals agreed.
BAKER
Kentucky Supreme Court
“[U]nder standard ‘market price (value) at the
well’ royalty clauses, the lessee is solely
responsible for the costs of production – of
bringing the gas to the well – but post-
production costs for such marketing-related
enhancements as accumulating,
compressing, processing, and transporting
the gas may be deducted from gross receipts
before the calculation of the royalty share.”
BAKER
The landowners filed a petition for rehearing on
9/9/15.
MHP Has 20 days to respond.
Since the Ky Supreme Court’s opinion was
unanimous, it seems unlikely there will be a
substantial change in response to the petition.
BAKER
Once Baker Becomes Final And We Know That
Post-production Costs Are Deductible, The
Focus, In State And Federal Court, Will Turn To
Questions About The Amount, Nature,
Reasonableness And Proof Of The Deductible
Costs.
KENTUCKY ROYALTY LITIGATION
UPDATE
Karen J. Greenwell
Wyatt, Tarrant & Combs, LLP
250 West Main Street
Suite 1600
Lexington, Kentucky 40507