Francis Kaess v. BB Land, LLC ( 2024 )

FILED
No. 23-522, Francis Kaess v. BB Land, LLC
November 14, 2024
released at 3:00 p.m.
Walker, Justice, dissenting, and joined by Justice Bunn: C. CASEY FORBES, CLERK
SUPREME COURT OF APPEALS
OF WEST VIRGINIA
In this certified question proceeding, the majority opinion applies an implied
duty to market to an oil and gas lease that contains an in-kind royalty provision. It goes on
to hold that the requirements for the deductions of post-production expenses from
Wellman1 and Tawney2 apply to the lease. With respect for my colleagues in the majority,
I dissent. As explained below, the majority’s analysis does not withstand scrutiny primarily
because it muddles the distinction between different types of leases. As a result, the
majority effectively rewrites the leases to take money from the producers to give it to the
royalty owners. But it is not the province of this Court to rewrite an oil and gas lease to
1
See Syl. Pt. 4, Wellman v. Energy Res., Inc., 210 W. Va. 200, 557 S.E.2d 254(2001) (“If an oil and gas lease provides for a royalty based on proceeds received by the
lessee, unless the lease provides otherwise, the lessee must bear all costs incurred in
exploring for, producing, marketing, and transporting the product to the point of sale.”).
2
See Syl. Pt. 10, Estate of Tawney v. Columbia Natural Res., 219 W. Va. 266, 633
S.E.2d 22 (2006) (“Language in an oil and gas lease that is intended to allocate between
the lessor and lessee the costs of marketing the product and transporting it to the point of
sale 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
deductions the lessee intends to take from the lessor’s royalty (usually 1/8), and indicate
the method of calculating the amount to be deducted from the royalty for such post-
production costs.”).
1
reflect the Court’s view of a fair bargain. We certainly would not go to such extreme
measures to rewrite contracts in any other context.3
I would have held that for leases that contain an in-kind royalty provision,
there is no implied duty to market and the requirements of Wellman and Tawney for the
deductions of post-production expenses are inapplicable. As explained below, the duty to
market is only triggered when a royalty owner does not or cannot take physical possession
of its royalty share of the production; when that occurs, the producer must market and sell
the royalty owner’s share of the production to avoid waste and loss, and the producer may
properly charge the royalty owner his share of any post-production costs.
One of the most contentious legal issues in the oil and gas industry is the
dispute concerning the deductibility of post-production costs from royalty payments owed
to lessors.4 At the risk of oversimplification, most royalty clauses generally fall into one
3
When examining a contract in an employment dispute, this Court stated that: “Our
task is not to rewrite the terms of contract between the parties; instead, we are to enforce it
as written.” Fraternal Ord. of Police, Lodge No. 69 v. City of Fairmont, 196 W. Va. 97,
101, 468 S.E.2d 712, 716 (1996). In the same fashion, we have held parties to a contract
dispute involving an insurance policy to the plain language in the policy and noted that:
“‘We will not rewrite the terms of the policy; instead, we enforce it as written.’” Auto Club
Prop. Cas. Ins. Co. v. Moser, 246 W. Va. 493, 500, 874 S.E.2d 295, 302 (2022) (quoting
Payne v. Weston, 195 W. Va. 502, 507, 466 S.E.2d 161, 166 (1995)).
4
See William T. Silvia, Slouching Toward Babel: Oklahoma’s First Marketable
Product Problem, 49 Tulsa L. Rev. 583 (Winter, 2013) (outlining the “minefield of judicial
interpretations among the major oil and gas-bearing states[,]” including West Virginia);
Scott Lansdown, The Marketable Condition Rule, 44 S. Tex. L. Rev. 667, 668-69 (2003)
2
of two broad categories: “proceeds” royalty provisions, which provide for the mineral
owner to receive a royalty consisting of a monetary share of the proceeds the producer
receives from the sale of the oil and gas produced under the lease, and “in-kind” royalty
provisions, which provide for the mineral owner to receive a royalty consisting of a portion
of the physical oil and gas produced, tendered at the wellhead.
This Court has stated that an oil and gas lease is both a conveyance and a
contract because it contains “traditional conveyancing portions and the usually separate
contractual portions.”5 The contractual portions of an oil and gas lease govern the rights
and responsibilities of the parties.6
The majority begins on the wrong foot when it states that “this Court is ‘once
again asked to wade into the waters of postproduction costs[,]’ an expedition that by
(recognizing the deductibility of post-production costs is a widely litigated issue in the oil
and gas industry).
5
McCullough Oil, Inc. v. Rezek, 176 W. Va. 638, 642, 346 S.E.2d 788, 792-93
(1986); see also Teller v. McCoy, 162 W. Va. 367, 383, 253 S.E.2d 114, 124 (1978) (“The
authorities agree today that the modern lease is both a conveyance and a contract.”).
6
Ascent Res. - Marcellus, LLC v. Huffman, 244 W. Va. 119, 125, 851 S.E.2d 782,
788 (2020); see also Phillip T. Glyptis, Viability of Arbitration Clauses in West Virginia
Oil and Gas Leases: It Is All About the Lease!!!, 115 W. Va. L. Rev. 1005, 1007 (2013)
(“[A] lease is by definition a contract. All rights and protections are controlled by the
principles of contract law and depend on the proper construction.”).
3
necessity begins with a review of our relevant precedents.”7 But the cause of action that
prompted the certified questions is Mr. Kaess’s claim that BB Land breached their contract
by improperly deducting post-production costs from his royalties. A breach of contract
analysis in any context should not begin with industry-specific precedent, but with the
language of the contract itself. In failing to observe that very basic starting point, what the
parties actually agreed to is dwarfed into insignificance at the outset.
When the oil and gas lease is not ambiguous and plainly expresses the intent
of the parties, then it must be enforced according to that intent. This Court has held that:
“An oil and gas lease which is clear in its provisions and free from ambiguity, either latent
or patent, should be considered on the basis of its express provisions and is not subject to
a practical construction by the parties.”8 As we said in Syllabus Points 1 and 3 of Cotiga
Development Company v. United Fuel Gas Company,9
[a] valid written instrument which expresses the intent
of the parties in plain and unambiguous language is not subject
to judicial construction or interpretation but will be applied and
enforced according to such intent.
It is not the right or province of a court to alter, pervert
or destroy the clear meaning and intent of the parties as
7
Quoting SWN Prod. Co., LLC v. Kellam, 247 W. Va. 78, 84, 875 S.E.2d 216, 222
(2022).
8
Syl. Pt. 3, Little Coal Land Co. v. Owens-Illinois Glass Co., 135 W. Va. 277, 63
S.E.2d 528 (1951).
9
147 W. Va. 484, 128 S.E.2d 626 (1962).
4
expressed in unambiguous language in their written contract or
to make a new or different contract for them.
Under an oil and gas lease that contains an in-kind royalty clause, the lessor
owns a share of the actual production at the wellhead. “Where the royalty owner has the
necessary infrastructure to take physical possession of its royalty share of the production,
a lessee may discharge its royalty obligations under an in-kind royalty clause by delivering
the royalty owner’s share of the production directly to the royalty owner.”10 But if the
royalty owner decides to monetize its royalty, “it may make its own arrangements—on its
own terms and at its own risk—to sell its share of the production to a third-party
purchaser.”11 For these reasons, the implied duty to market does not apply to an in-kind
royalty provision lease and the majority should have answered the first certified question
in the negative.
Obviously, not all royalty owners have the infrastructure (wells or tanks or
pipelines) to store and market their one-eighth share of the oil and gas produced. But the
majority wrongly concludes that Mr. Kaess’s inability to take his share of the oil and gas
produced creates an inherent ambiguity in an otherwise straightforward in-kind lease. As
10
Byron C. Keeling, Fundamentals of Oil and Gas Royalty Calculation, 54 St.
Mary’s L.J. 705, 711 (2023) (footnotes omitted).
11
Id.5
commentator Byron C. Keeling has described, when Mr. Kaess could not take his one-
eighth share of the oil and gas in kind, BB Land had three possible courses of action:
If, for whatever reason, a royalty owner does not or
cannot take physical possession of its royalty share of the
production under an in-kind royalty clause, then the lessee or
producer may discharge its royalty obligation to the royalty
owner in one of several ways:
(1) The producer may deliver the royalty owner’s share
of the production to a pipeline purchaser or other third-party
purchaser near the wellhead—free of cost, and to the royalty
owner’s credit—under the terms of a division order or other
contract in which the purchaser pays the royalty owner directly
for its share of the production.
(2) The producer may buy the royalty owner’s share of
the production from the royalty owner on terms that the
producer negotiates with the royalty owner.
(3) Or, if the producer does not either buy the royalty
owner’s share of the production or deliver the royalty owner’s
share of the production to a purchaser free of cost, then under
the implied marketing covenant, the producer must market and
sell the royalty owner’s share of the production—on the royalty
owners behalf—along with the producer's own share of the
production.[12]
Under this commentator’s scenario three, an implied duty to market is
triggered—to avoid waste and loss—when the producer does not either buy the royalty
owner’s share of the production or deliver it to a purchaser free of cost. The majority cites
that portion of Mr. Keeling’s article. But the majority omits the very next paragraph of the
12
Id. at 711-12.
6
article, which states that the producer may properly charge the royalty owner his share of
any post-production costs in this scenario:
If, under the third of these options, the producer sells the
royalty owner’s share of the oil and gas production, the
producer must pay the royalty owner the net proceeds that the
producer received for the royalty owner’s share of the
production—or, in other words, the producer must pay the
royalty owner its share of the actual sales price for the oil and
gas production, minus the royalty owner’s share of the costs
that the producer incurred to make the production marketable
and deliver it to the downstream point of sale. Because any
such sale arises from the implied marketing covenant, the
producer must market the production in a way that mutually
benefits both the producer and the royalty owner—typically by
selling the production for the “best price . . . reasonably
available.” Nonetheless, the producer may properly charge the
royalty owner with the royalty owner’s share of any post-
production costs on the theory that those post-production costs
enhance the value of the production for the mutual benefit of
both the producer and the royalty owner.[13]
Turning to the second certified question—whether the requirements for the
deductions of postproduction expenses from Wellman and Tawney apply to leases
containing an in-kind royalty provision—it is unnecessary for me to give an exhaustive
overview of our caselaw because the majority has done so. It is sufficient to recognize that
in the landmark ruling of Wellman, this Court examined a proceeds royalty lease that was
silent on what party would bear post-production costs.14 In Wellman, we established the
13
Id. at 711-12 (footnotes omitted and emphasis added).
14
210 W. Va. at 211, 557 S.E.2d at 265.
7
presumption that unless the lease provides otherwise, the lessee bears post-production
costs, and when we articulated that presumption, we referred specifically to “proceeds”
leases.15 In Tawney, this Court expanded on Wellman by clarifying the type of language
that must be included in a lease that contains a proceeds royalty clause before a lessor could
allocate some, or all, of the post-production expenses to the lessor.16
As explained above, the contract dispute before the district court in this
case—unlike Wellman and Tawney—involves a lease that contains an in-kind royalty
provision.17 For this reason, the requirements for the deductions of postproduction
expenses from Wellman and Tawney do not apply here and the majority should have
answered the second certified question in the negative.
By proclaiming that that Wellman and Tawney apply to all oil and gas leases
in West Virginia, the majority has lost sight of the fact that the language of the in-kind
royalty lease controls. Words in the contract matter; when the terms are clear there is no
reason to resort to an implied covenant. This principle of law applies to oil and gas leases
just like any other contract. The terms of the lease, including its royalty clause, are freely
15
See note 1.
16
See note 2.
17
As the majority notes, the district court held that by virtue of Mr. Kaess’s failure
to respond to a request for admission, the court deemed admitted “that the LEASE entitles
YOU to receive YOUR royalty in-kind, as opposed to a percentage of proceeds received
by [BB LAND] from the sale of any OIL, GAS, or NGLs.”
8
negotiable.18 So, the parties to an oil and gas lease may, if they wish, agree to shift some
of the costs of production to the lessor in exchange for an increase in the royalty interest
that he is entitled to receive on production.19
The majority goes further off course when it devotes pages to its fascination
with Leggett’s20 criticism of Wellman and Tawney—as well as Kellam’s21 criticism of
Leggett—along with the legislative history of West Virginia Code § 22-6-8 (a statute that
deals with flat-rate leases22). This discussion offers nothing useful to the questions
presented. And this walk down memory lane reveals the majority’s motive for engaging
in this endeavor when it grasps ahold of this controversy to declare, by judicial fiat, that
“the Legislature’s extension of Wellman and Tawney to leases containing flat-rate royalty
provisions [is] a persuasive indicator that those precedents should govern leases containing
in-kind royalty provisions as well.” Indeed, the majority “discern[s] no principled basis on
which to hold that in-kind leases are somehow different[,]” to flat-rate leases. But if the
18
See Jeff King, Natural Gas Royalties: Lessors vs. Lessee and the Implied
Covenant to Market, 63 Tex. Bar J. 854 (2000) (“Oil and gas leases are negotiated
contracts.”).
19
Id. (“As to the royalty amount, the parties to the lease are free to decide and define
the type, basis, or standard for the royalties to be paid.”) (citations omitted).
20
Leggett v. EQT Prod. Co., 239 W. Va. 264, 800 S.E.2d 850 (2017).
21
SWN Prod. Co., LLC v. Kellam, 247 W. Va. 78, 875 S.E.2d 216 (2022).
22
Flat-rate leases require the producer to pay the royalty owner a set royalty per
well, per year, whether that well produces oil and gas or not.
9
Legislature intended West Virginia Code § 22-6-8’s protections to include freely
negotiated in-kind royalty provision leases, it certainly would have said so.
The majority’s sweeping holding is audacious—three members of the
majority have now commandeered thousands of leases across the State for judicial
revision—and its damaging impact on this institution’s legitimacy will be felt for years to
come. Its decision cannot be justified by the parties’ written agreement. It cannot be
justified by our case law. Nor is there any authority for extending the Legislature’s
statutory protections for royalty owners who hold flat-rate leases to those who hold in-kind
royalty leases. Because I find no authority for the invasion into the right to contract that
the majority now commits, I dissent. I am authorized to state that Justice Bunn joins in this
dissent.
10