Dressler Family v. PennEnergy Resources

J-A08033-22
2022 PA Super 77DRESSLER FAMILY, LP : IN THE SUPERIOR COURT OF
: PENNSYLVANIA
Appellant :
:
:
v. :
:
:
PENNENERGY RESOURCES, LLC, AS :
SUCCESSOR IN INTEREST TO R.E. :
GAS DEVELOPMENT, LLC : No. 635 WDA 2021
Appeal from the Order Entered April 28, 2021
In the Court of Common Pleas of Butler County Civil Division
at No(s): 2017-10357
BEFORE: BENDER, P.J.E., LAZARUS, J., and McCAFFERY, J.
OPINION BY McCAFFERY, J.: FILED: APRIL 29, 2022
In this oil and gas lease/breach of contract matter, Dressler Family, LP
(Appellant) appeals from the order entered in the Butler County Court of
Common Pleas, granting summary judgment in favor of PennEnergy
Resources, LLC, as Successor in Interest to R.E. Gas Development, LLC
(Appellee).1 The issue before the trial court, as well as this Court on appeal,
is whether a lease provision — setting royalties to be one-eighth (1/8th) of
“gross proceeds received from the sale of [gas] at the prevailing price for gas
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1The trial court granted Appellee’s motion for summary judgment, as well as
denied Appellant’s motion for partial summary judgment.
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sold at the well”2 — permits Appellee to deduct post-production costs from the
royalties. The parties agree that gas is not, in fact, “sold at the well.” The
trial court concluded the royalty provision was plain and unambiguous, and it
permitted the deduction of post-production costs. On appeal, Appellant
argues the trial court erred in this interpretation, and in the alternative, that
the lease was ambiguous.3 We conclude the lease terms are ambiguous and
thus reverse and remand.
I. Lease Royalty Provision
The trial court summarized the following. Jacob Dressler, III, and
Charlotte Dressler (collectively, the Dresslers) owned real property (the
Property) in Connoquenessing Township and Lancaster Township, Butler
County. In March 2007, the Dresslers
entered into an Oil and Gas Lease (the Lease) with William
McIntire Coal, Oil and Gas (WMCOG). The Lease permitted
WMCOG to engage in oil and gas exploration and production
operations on the Dresslers’ property . . . in return for an annual
payment and monthly royalties for oil and gas extracted from the
Property. . . .
Trial Ct. Op., 4/28/21, at 3 (quotation marks & record citations omitted).
Paragraph 2(b) of the Lease governs the royalty payment and states:
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2 See Oil & Gas Lease, 3/14/17, at 1, Exh. 1 to Appellant’s Complaint,
6/30/17.
3 The American Petroleum Institute and the Marcellus Shale Coalition have
filed a joint amicus curiae brief in support of affirming the summary judgment
order.
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Lessee covenants and agrees to pay Lessor as a royalty
for the native gas from each and every well drilled on
said premises producing native gas, an amount equal to
one-eighth (1/8) of the gross proceeds received from
the sale of same at the prevailing price for gas sold at
the well, for all native gas saved and marketed for the
said premises, payable monthly.
Oil & Gas Lease at 1.
The emphasized terms above, “gross proceeds” and “sold at the well,”
are not defined in the Lease. The parties agree that gas is not, in fact, sold
“at the well.”4 Additionally, the parties do not “dispute that the Lease requires
[Appellee] to bear all production costs, which are the costs of producing the
gas from below the ground and getting it to the wellhead.” Trial Ct. Op. at 5
(emphasis added). However, as stated above, the parties disagree as to
whether the royalty provision permits Appellee to deduct post-production
costs, which are “the costs incurred after the gas is produced at the wellhead
and before it is sold.” Id.II. Facts & Procedural History
“Oil and gas production operations have been continuously conducted
on the Property since the execution of the Lease in 2007.” Trial Ct. Op. at 4.
In 2009, R.E. Gas Development, LLC (Rex), became the second successor in
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4 Appellant’s Brief in Support of Motion for Partial Summary Judgment
(Appellant’s SJ Brief), 7/17/20, at 1; Appellee’s Combined Brief in Support of
its Cross-Motion for Summary Judgment & Opposition to Appellant’s Motion
for Partial Summary Judgment (Appellee’s SJ Brief), 10/6/20, at 10.
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interest to WMCOG.5 In 2011, the Dresslers assigned the subsurface rights
on the Property to Dressler Family, LP (Appellant).
For a four-year period,
[f]rom January 2012 through December 2015, Rex issued monthly
royalty payments . . . averaging . . . $35,000 for oil and gas
production from the Property.
[However, i]n May 2015, Rex informed [Appellant] that it
[would] retroactively . . . collect[,] through offsets from future
royalty payments, certain electric charges that Rex incurred prior
to April 2014 while processing the oil and gas at a processing
plant. In addition[,] Rex has been deducting all post-production
costs incurred. Deductions for post-production costs have
reduced [Appellant’s] monthly royalty from an average of . . .
$35,000 to . . . $7,800.
Trial Ct. Op. at 4 (record citations omitted and paragraph break added).
Appellant commenced the instant action by filing a praecipe for a writ of
summons on April 18, 2017.6 On June 30th, it filed a complaint against Rex,
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5 The trial court and Appellant refer to R.E. Gas Development, LLC,
respectively, as “Rex” and “Rex Energy.” See Trial Ct. Op. at 4; Appellant’s
Complaint, 6/30/17, at 3. For ease of review, we adopt the same shorthand
reference, “Rex.” Furthermore, we note the trial court summarized:
[In] 2008, WMCOG assigned its interest in the Lease to Gastar
Exploration USA, Inc. (Gastar). [Rex] obtained its interest in the
Lease in 2009 when it entered into a Pooling and Unitization
Agreement with Gastar, pursuant to which Gastar agreed to pool
the Lease with other oil and gas leases owned by Gastar and Rex.
Trial Ct. Op. at 4 (quotation marks and record citations omitted).
6This case was initially assigned to the Honorable Michael Yeager. In January
of 2021, after the parties filed cross motions for summary judgment but before
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alleging breach of contract and unjust enrichment, and seeking a declaratory
judgment. Rex filed an answer and new matter, and subsequently a motion
for judgment on the pleadings, which was denied on March 28, 2018, following
oral argument.
Subsequently, as a part of Rex’s 2018 federal bankruptcy action,
Appellee assumed the Lease, as well as “Rex’s liabilities relating to or arising
out of this case.” Trial Ct. Op. at 4-5 (record citations omitted). Appellee was
accordingly substituted, in the above caption, as successor in interest to Rex.
III. Cross Motions for Summary Judgment
On July 17, 2020, Appellant filed a motion, along with a supporting brief,
for partial summary judgment.7 It argued: (1) there was no provision in the
Lease allowing Appellee to deduct, from royalty payments, “any costs incurred
after the gas leaves the well;” and (2) the clear language of the phrase, “gross
proceeds” means that “royalties should be calculated using the gross sales
price for the gas.” Appellant’s SJ Brief at 1, 6; Appellant’s Motion for Partial
Summary Judgment (Appellant’s SJ Motion), 7/17/20, at 4-5. Appellant also
pointed out that although the Lease referred to “gas sold at the well,” gas was
not in fact sold at the well. Appellant’s SJ Brief at 1, 6. Appellant cited other
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oral argument was held thereon, Judge Yeager recused, and the case was
reassigned to the Honorable Thomas Doerr, President Judge.
7 Appellant averred it was entitled to judgment as a matter of law as to the
interpretation of the Lease, but reserved the issue of damages.
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jurisdictions — the Texas, West Virginia, and North Dakota state courts —
which have interpreted “similar or nearly identical royalty language [and]
determined that the term ‘gross proceeds’, even if accompanied by ‘at the
well’ language, prohibited the deduction of post-production costs.” Appellant’s
SJ Motion at 4. At this juncture, we note that some of these decisions
contemplated the “first-marketable product” doctrine or “marketable product”
rule. This rule “provides that because the lessee-gas company has a duty to
market the natural gas, [it is] responsible for all post-production expenses
until the product arrives at a downstream location where it can be marketed.”
See Kilmer v. Elexco Land Services, Inc., 990 A.2d 1147, 1155 (Pa. 2010).
On October 6, 2020, Appellee filed a cross motion and a brief for
summary judgment. It relied on the Pennsylvania Supreme Court’s decision
in Kilmer, which Appellee summarized to have “addressed in detail” “[t]he
established meaning of common oil and gas royalty terms and the manner in
which . . . production costs are allocated[.]” Appellee’s SJ Brief at 2. Appellee
averred
the clear and unambiguous meaning of “royalty” and “at the well”
in the oil and natural gas industry [permitted deduction of post-
production] costs to transform the gas from the point it leaves the
ground (i.e. “at the well”) in its unprocessed state into a
marketable and usable product. . . .
Appellee’s Cross-Motion for Summary Judgment (Appellee’s SJ Motion),
10/6/20, at 2. Appellee stated that Kilmer permitted oil and gas companies
to practice the “net-back method,” under which the post-production costs, of
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bringing the gas from the wellhead to market, are deducted from the royalties.
Appellee’s SJ Brief at 3-4. Appellee also averred: (1) “[i]t is generally
impractical for natural gas to be sold at the location where it leaves the
ground, [i.e.] the ‘wellhead[;]’” and (2) “post-production costs add significant
value for both the lessor and operator by enabling the gas to be sold for a
higher price[.]” Id. at 2-3. Appellee reasoned, “To [allow] otherwise would
improperly award an enhanced royalty without requiring [Appellant] to share
in the expenses [Appellee] has undertaken to increase the sale price of gas.”
Appellee’s SJ Motion at 2-3.
Appellant disputed Appellee’s contention that the royalty should be
based on the value of the gas “at the downstream point of sale.” Appellant’s
SJ Brief at 11. Appellant reasoned instead that such a calculation would: (1)
contemplate “a fictional” sale price at the well; and (2) ignore “the true point
of sale,” as well as the lease language, “gross proceeds.” Id.
The trial court heard oral argument on March 15, 2021, via
videoconference.8 On April 28th, the court entered the underlying order,
granting Appellee’s motion for summary judgment and denying Appellant’s
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8 The transcript to this hearing was not included in the certified record
transmitted on appeal. Upon informal inquiry, the trial court advised that no
transcript was produced. We remind Appellant’s counsel the appellant bears
the “responsibility to ensure that a complete record is produced for appeal.”
See Kessler v. Broder, 851 A.2d 944, 950 (Pa. Super. 2004) (citation
omitted).
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motion for partial summary judgment. In so ruling, the court found the royalty
provision of the Lease and clear and unambiguous, and it provided for the
deduction of post-production costs.
Appellant timely appealed, and has complied with the court’s order to
file a Pa.R.A.P. 1925(b) statement of errors complained of on appeal.
IV. Statement of Questions Involved
Appellant presents five issues for our review:
1. Whether the trial court erred by entering summary judgment
in favor of Appellee and finding, pursuant to Kilmer v. Elexco
Land Services, Inc., 990 A.2d 1147 (Pa. 2010), Appellee is
permitted to deduct post-production costs from Appellant’s
royalties.
2. Whether the trial court erred by entering summary judgment
in favor of Appellee and finding that the lease at issue is subject
to only one interpretation, specifically that the prevailing price for
gas must be determined by deducting post-production costs from
Appellant’s royalties.
3. Whether the trial court erred by entering summary judgment
in favor of Appellee and finding that Appellant’s interpretation of
the lease would essentially adopt the “first-marketable product”
doctrine in Pennsylvania.
4: Whether the trial court erred by denying Appellant’s motion for
summary judgment and finding that the “gross proceeds”
language in Paragraph 2(b) of the lease does not prevent Appellee
from deducting post-production costs from Appellant’s royalty
payments.
5: Whether the trial court erred by entering summary judgment
in favor of Appellee because, at a minimum, the lease is
ambiguous and subject to multiple interpretations necessitating
further factual determinations.
Appellant’s Brief at 5.
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V. Standards of Review
We first consider our standard of review of an order granting summary
judgment:
A reviewing court may disturb the order of the trial court only
where it is established that the court committed an error of law or
abused its discretion. As with all questions of law, our review is
plenary.
We view the record in the light most favorable to the non-
moving party, and all doubts as to the existence of a genuine issue
of material fact must be resolved against the moving party. Only
where there is no genuine issue as to any material fact and it is
clear that the moving party is entitled to a judgment as a matter
of law will summary judgment be entered.
Mitch v. XTO Energy, Inc., 212 A.3d 1135, 1138 (Pa. Super. 2019)
(citations omitted). See also Pa.R.C.P. 1035.2(1) (party may move for
summary judgment in whole or in part “whenever there is no genuine issue of
any material fact as to a necessary element of the cause of action or defense
which could be established by additional or expert report”).
“[O]il and gas leases are subject to the same contract law principles that
apply to contract interpretation generally.”9 Mitch, 212 A.3d at 1139 (citation
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9This Court has observed that despite the use of the term “lease,” an oil and
gas lease actually involves
a conveyance of property rights within a highly technical and well-
developed industry[. T]hus certain aspects of property law as
refined by and utilized within the industry are necessarily brought
into play.
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omitted). “[B]ecause contract interpretation is a question of law, our review
of the trial court’s decision is de novo and our scope of review plenary.” Id.
VI. Appellant’s Argument
While Appellant sets forth five issues in its statement of questions
involved, its argument section is divided into three main arguments.10 We
review each seriatim.
First, Appellant maintains: (1) no terms in the Lease permit the
deduction of post-production costs from royalties; and (2) the term “gross
proceeds,” “as opposed to the term ‘net proceeds,’” contemplates the gross
amount Appellee receives from the sale of gas, without any deduction for post-
production costs. Appellant’s Brief at 14.
Under this same section, Appellant also avers that while there is little
Pennsylvania appellate court guidance on this issue, its position “has been
adopted by courts in jurisdictions analyzing nearly identical language to the
terms found in the [instant] Lease.” Appellant’s Brief at 16-22. However, in
support Appellant cites decisions that have found such leases to be ambiguous
or not clear: (1) Judice v. Mewbourne Oil Co., 939 S.W.2d 133, 136 (Tex.
1996) (the phrase, “[s]ettlement for gas sold shall be based on the gross
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Nolt v. TS Calkins & Assocs., LP, 96 A.3d 1042, 1046 (Pa. Super. 2014)
(citations omitted).
We remind Appellant’s counsel that “[t]he argument shall be divided into as
10
many parts as there are questions to be argued[.]” See Pa.R.A.P. 2119(a).
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proceeds realized at the well,” was ambiguous because “[t]he term ‘gross
proceeds’ means . . . the gross price received by” the oil company, while “value
at the well means the value of the gas before it has been compressed and
before other value is added in preparing and transporting the gas to market”);
(2) BlueStone Nat. Res. II, LLC v. Randle, 601 S.W.3d 848, 857, 860 (Tex.
App.-Ft. Worth. 2019) (Bluestone) (while the phrase “market value at the
well” “has a commonly accepted meaning” that lessor will pay post-production
costs, that phrase is “is at odds with” the term “gross proceeds,” which “means
that the royalty is to be based on the gross price received by” the lessee),
aff’d in part & rev’d in part, 620 S.W.3d 380 (Tex. 2021);11 and (3) Estate of
Tawney v. Columbia Natural Resources, L.L.C., 633 S.E.2d 22, 28 (W.V.
2006) (holding: (1) the “‘wellhead’-type language” is ambiguous and
imprecise because it “does not indicate how or why what method the royalty
is to be calculated;” and (2) the phrase “ “gross proceeds at the wellhead”
“could be read to create an inherent conflict [as] the lessees generally do not
receive proceeds for the gas at the wellhead,” and “the phrase ‘market price
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11 While Appellant cites the 2019 decision by the Texas Second Court of
Appeals, Appellant’s Brief at 18-19, this decision was affirmed in part and
reversed in part by the Texas Supreme Court in 2021. See BlueStone, 620
S.W.3d 380. Nevertheless, the Texas Supreme Court’s decision did not
disturb the portion of the Court of Appeals that we set forth above. See id.
at 391 (rejecting lessee’s argument that the lease term, “gross value
received,” “can be melded with an ‘at the well’ valuation point to produce a
net-proceeds calculation,” and instead concluding “‘gross’ and ‘net’ terms do
not peaceably coexist”).
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at the wellhead’ is unclear since it contemplates the actual sale of gas at the
physical location of the wellhead, although the gas generally is not sold at the
wellhead”).
Second, Appellant argues the Pennsylvania Supreme Court’s decision in
Kilmer does not apply to the instant matter, where: (1) the lease in Kilmer
explicitly permitted the deduction of certain post-production costs from
royalties; and (2) the Kilmer “Court did not establish a rule that all royalties
are subject to deductions for post-production costs[,]” nor “hold that the term
‘royalty’ has universal meaning within the context of oil and gas leases.”
Appellant’s Brief at 22-24 citing Kilmer, 990 A.2d at 1150. Furthermore,
Appellant contends, Kilmer engaged in statutory interpretation, specifically of
the definition of “royalty” within the then-in effect Guaranteed Minimum
Royalty Act (GMRA),12 whereas the instant matter concerns a different issue —
an alleged breach of contract. Appellant’s Brief at 23-24.
Finally, Appellant alleges in the alternative that the trial court erred in
not finding the royalty provision ambiguous. Appellant asserts the drafter of
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12 The GMRA, 58 P.S. § 33, governed “leases between Pennsylvania
landowners and gas companies seeking to drill natural gas wells into
Pennsylvania’s Marcellus Shale deposits.” Kilmer, 990 A.2d at 1149. It
provided that a lease must guarantee the lessor at least 1/8th royalty of all
oil or gas removed from the property. Id. The GMRA was repealed in 2013
and replaced with the Oil and Gas Lease Act, 58 P.S. §§ 33.1 to 35.4. See
2013, July 9, P.L. 473, No. 66, § 1, eff. in 60 days (Sept. 9, 2013). An almost
identical statute to the GMRA now appears at 58 P.S. § 33.3.
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the Lease could have included specific and clear language as to “how the gas
royalties would be calculated and what deductions would be taken[.]”
Appellant’s Brief at 25. Appellant also reasons the trial court was inconsistent
in denying Appellee’s motion for judgment on the pleadings but then, without
any new facts, granting Appellee’s motion for summary judgment. We
conclude that relief is due to Appellant.
VII. Contract Interpretation Principles
This Court has stated:
The fundamental rule in interpreting the meaning of a contract is
to ascertain and give effect to the intent of the contracting parties.
The intent of the parties to a written agreement is to be regarded
as being embodied in the writing itself. The whole instrument
must be taken together in arriving at contractual intent. Courts
do not assume that a contract’s language was chosen carelessly,
nor do they assume that the parties were ignorant of the meaning
of the language they employed. . . .
Mitch, 212 A.3d at 1138-39 (citation omitted). “In construing a contract, we
must give effect to all of the provisions therein. An interpretation will not be
given to one part of the contract which will annul another part of it.” Id. at
1139 (citation omitted).
“[W]hen the language of a contract is clear and unequivocal, courts
interpret its meaning by its content alone, within the four corners of the
document,” and “this Court need only examine the writing itself to give effect
to the parties’ understanding. [We] must construe the contract only as written
and may not modify the plain meaning under the guise of interpretation.”
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Stephan v. Waldron Elec. Heating & Cooling LLC, 100 A.3d 660, 665 (Pa.
Super. 2014) (citation omitted). Finally, our Supreme Court has stated:
In the law of contracts, custom in the industry or usage in the
trade is always relevant and admissible in construing commercial
contracts and does not depend on any obvious ambiguity in the
words of the contract. If words have a special meaning or usage
in a particular industry, then members of that industry are
presumed to use the words in that special way, whatever the
words mean in common usage and regardless of whether there
appears to be any ambiguity in the words.
Sunbeam Corp. v. Liberty Mut. Ins. Co., 781 A.2d 1189, 1193 (Pa. 2001).
On the other hand,
[a] contract is ambiguous if it is reasonably susceptible of different
constructions and capable of being understood in more than one
sense. The “reasonably” qualifier is important: there is no
ambiguity if one of the two proffered meanings is unreasonable.
Furthermore, reviewing courts will not distort the meaning of the
language or resort to a strained contrivance in order to find an
ambiguity. . . .
Mitch, 212 A.3d at 1139 (citation omitted).
“When . . . an ambiguity exists, parol evidence is admissible to explain
or clarify or resolve the ambiguity, irrespective of whether the ambiguity is
patent, created by the language of the instrument, or latent, created by
extrinsic or collateral circumstances.” Kripp v. Kripp, 849 A.2d 1159, 1163
(Pa. 2004) (citation omitted). “While unambiguous contracts are interpreted
by the court as a matter of law, ambiguous writings are interpreted by the
finder of fact.” Id.- 14 -
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VIII. Kilmer Decision
At this juncture, we consider the Pennsylvania Supreme Court’s 2010
decision in Kilmer, on which Appellee relied in the proceedings below. In that
case, the parties’ oil and gas lease stated:
. . . Lessor shall receive as its royalty one eighth (1/8th) of the
sales proceeds actually received by Lessee from the sale of such
production, less this same percentage share of all Post
Production Costs . . . .
Kilmer, 990 A.2d at 1150 (some emphasis omitted). As Appellant points out,
this lease specified that post-production costs were to be deducted from
royalties. See id.; Appellant’s Brief at 22.
The issue before the Supreme Court was “the proper [statutory]
construction of the term ‘royalty’ as it is used in the” Guaranteed Minimum
Royalty Act. Kilmer, 990 A.2d at 1149. The GMRA required an oil and gas
agreement to “guarantee the lessor at least [1/8th] royalty of all oil[ or gas]
removed or recovered from the subject real property.” Id. at 1150. The Court
stated:
[M]any leases in the Commonwealth, including the lease at issue
before this Court, calculate the royalties as [1/8th] of the sale
price of the gas minus [1/8th] of the post-production costs of
bringing the gas to market.[ ] This calculation is called the “net-
back 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.
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Id. The landowners argued, inter alia, the lease violated the 1/8th royalty
requirement of the GMRA, “given that royalties under the Lease are calculated
after deducting post-production costs.”13 Id. at 1153.
The Supreme Court affirmed the summary judgment in favor of the gas
companies. Kilmer, 990 A.2d at 1157-58. In so holding, the Court
considered, inter alia, several treatises addressing the terms “royalty” and
“expenses of production” as they are commonly used in the oil and gas
industry: “Although the royalty is not subject to costs of production, usually it
is subject to” post-production costs, including “costs of treatment of the
product to render it marketable[ and] costs of transportation to market.” See
id. at 1157, quoting Howard R. Williams & Charles J. Meyers, Manual of Oil
and Gas Terms § R (Patrick H. Martin & Bruce M. Kramer eds., 2009). The
Court reasoned that “[c]onsistent with this definition, the lease . . . provides
for the lessor to share in the post-production costs.” Kilmer, 990 A.2d at
1158. Accordingly, the Court held “the GMRA should be read to permit the
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13 The landowners had filed a complaint for a declaratory judgment, asserting
the same — that “the lease violated the [1/8th] royalty requirement of the
GMRA because the net-back method resulted in a royalty less than [1/8th] of
the value of the gas.” Kilmer, 990 A.2d at 1150. The trial court granted
summary judgment in favor of the gas companies, and the landowners
appealed. Id. at 1150-51. Our Supreme Court exercised extraordinary
jurisdiction, under 42 Pa.C.S. §726, “to consider whether the GMRA precludes
parties from contracting to use the net-back method to determine the royalties
payable under an oil or natural gas lease.” Kilmer, 990 A.2d at 1151.
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calculation of royalties at the wellhead, as provided by the net-back method
in the Lease.” Id.
Appellee relied on Kilmer in the proceedings below, as well as in the
instant appeal, to argue: (1) Pennsylvania practices the net-back method; (2)
the terms “royalty” and “at the well” have a particular meaning in the oil and
gas industry; and (3) these specialized meanings should apply when
interpreting the instant Lease. See Appellee’s Brief at 13-14. Amici advance
the same argument. See Amici Brief at 10-11 (“[T]he Court should interpret
the words in the oil and gas lease . . . not in a vacuum but in the context of
the oil and gas business[,]” and “the general rule [in the industry] is that
royalties are subject to post-production costs[.]”).
While Appellant argues the trial court erred in applying Kilmer to reach
its decision, we point out the court rejected Appellee’s arguments relying on
Kilmer:
Although Kilmer determined that the GMRA permits the
calculation of royalties at the wellhead using the net-back method,
Kilmer does not stand for the proposition that royalties at the
wellhead must be calculated in such a manner. When defining
the term “royalty” as it relates to the GMRA, the Kilmer [C]ourt
relied in part upon treatises which stated that generally the
royalty is not payable from gross profit but from the net amount
remaining after post-production costs. Kilmer, 990 A.2d at 1158.
Parties are not prevented from entering an agreement which
provides that the royalty will be based upon the gross profit.
Trial Ct. Op. at 16. The trial court then reviewed the Lease terms independent
of Kilmer (discussed infra).
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IX. Trial Court Opinion
Next, the trial court considered Appellant’s arguments concerning
Kilmer, including its contention that “Kilmer did not establish a rule that all
royalties are subject to deductions for post-production costs, but merely held
that the GMRA does not preclude parties from contracting to use the net-back
method to determine royalties[.]” Trial Ct. Op. at 8. The court noted that
“other jurisdictions are split on the issue.” Id. It then devoted almost half of
its 18-page opinion to reviewing decisions of our sister states (some of which
were cited by Appellant) and the federal courts, which have addressed similar
language in oil and gas leases. We summarize that the court reviewed cases
that did find terms, similar to “gross proceeds” and “at the well,” were in
conflict or ambiguous: (1) the Texas decisions in Judice, 939 S.W.2d 133,
and BlueStone, 601 S.W.3d 848 (same);14 and (2) the West Virginia decision
in Estate of Tawney, 633 S.E.2d 22. The trial court also reviewed decision
that concluded such leases allowed or even required the deduction of post-
production costs: Schroeder v. Terra Energy, 565 N.W.2d 887 (Mi. 1997);
EQT Prod. Co. v. Magnum Hunter Prod., Inc., 768 Fed. Appx. 459 (6th
Cir. 2019); and Bounty Minerals, LLC v. Chesapeake Exploration, LLC,
2019 WL 7171353 (N.D.Ohio 2019). Finally, the trial court considered
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14 The trial court discussed the Texas Supreme Court’s 2021 decision in
Bluestone, unlike Appellant, who cited the Texas Court of Appeal’s 2019
decision. See n.11, supra.
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decisions that found post-production costs were not permitted: Newfield
Exploration Co. v. State ex rel. N.D. Bd. of Univ. & Sch. Lands, 931
N.W.2d 478 (N.D. 2019); and Rogers v. Westerman Farm Co., 29 P.3d 887(Co. 2001). We note the decisions in these cases hinged on the particular
definition of “at the well” accepted in those jurisdictions. Finally, the trial court
observed that “[a] minority of jurisdictions have adopted the First Marketable
Product Doctrine, under which the lessee is held responsible for all post-
production expenses[.]” Trial Ct. Op. at 8-9.
Returning to the Lease in the case sub judice, the trial court concluded
the Lease was plain and clear, and it permitted Appellee to deduct post-
production costs from royalties. First, it reasoned:
It may first appear that the phrasing in Section 2(b) of the Lease
causes a contradiction because the term “gross proceeds” means
an amount without deductions for costs, whereas “at the well”
contemplates deductions. . . .
Trial Ct. Op. at 16. The court set forth its reasoning for this last statement —
that “‘at the well’ contemplates deductions” — as follows:
Since the gas is not actually sold at the well, the only logical
way to determine the prevailing price for gas sold at the well is to
base the price on the market value at the well. [“]Market value
at the well[”] is defined as [“]the value of oil or gas at the place
where it is sold, minus the reasonable cost of transporting it and
processing it to make it marketable.[”] BLACK’S LAW DICTIONARY
(8th ed. 2004). In other words, it is the value of the gas at the
wellhead and excludes the additional value added through
preparing and transporting the gas to market. Thus it is necessary
to make adjustments to the sales price of the gas by deducting
post-production costs to establish the prevailing price for gas sold
at the well.
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Id.Although initially acknowledging the Lease terms “gross proceeds” and
“at the well” may be contradictory, the trial court then reasoned:
However, upon close review of the language utilized, the royalty
provision of the Lease is subject to only one reasonable
construction. The prevailing price for gas sold at the well must be
determined first, and then that full amount, without any
further deductions, is the amount used to calculate the one-
eighth (1/8) portion paid to [Appellant] as a royalty.
Trial Ct. Op. at 16 (emphasis added). This discussion indicates, in contrast to
the above, that post-production costs are not to be deducted from royalties.
See id.Next, the trial court rejected Appellant’s contention that royalties should
be based “on the gross price at the point of sale,” and in so holding, rejected
any argument that Pennsylvania should adopt the first-marketable product
doctrine:15
Basing the royalty on the gross price at the point of sale, as
[Appellant] proposes, would be contrary to the terms of Section
2(b) of the Lease because it would disregard the phrase “at the
prevailing price for gas sold at the well” and use the downstream
price instead. The present case is distinguishable from [other
jurisdictions’ cases, cited by Appellant,] in which the value of the
royalty is based simply upon “gross proceeds of sale.”
____________________________________________
15Appellant’s third issue, in its statement of questions involved, is “[w]hether
the trial court erred by . . . finding that Appellant’s interpretation of the lease
would essentially adopt the ‘first-marketable product’ doctrine in
Pennsylvania.” Appellant’s Brief at 5. However, Appellant does not present
any argument on this claim in its argument, and thus it is waived. See
Lackner v. Glosser, 892 A.2d 21, 29 (Pa. Super. 2006) (“[A]rguments which
are not appropriately developed are waived.”).
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Accepting [Appellant’s] position that the royalty should be
based upon the gross amount that [Appellee] receives from the
sale of the gas without deductions for post-production costs would
be essentially adopting the first-marketable product doctrine.
Pennsylvania Courts have not adopted the first-marketable
product doctrine. . . . Hence, outcomes from jurisdictions which
rely upon the first-marketable product doctrine, such as West
Virginia and Colorado, have limited applicability to this case.
Moreover, the plain language of the Lease does not suggest that
it was the intent of the parties for the royalty calculation to be
based in the manner of the first marketable product doctrine.
There is no implication of any kind that the Lease intended for the
royalty to be calculated at a downstream location. Instead, the
Lease specifically identifies that the calculation of the royalty is to
be based upon the prevailing price for gas sold at the well.
Trial Ct. Op. at 17-18.
X. Analysis
Foremost, we observe that while both parties and the trial court aver
the Lease terms are clear and unambiguous, they cite, as support, extrinsic
matters. For example, Appellant extensively cites other jurisdictions’
decisional authority, which hold, contra its position, that similar lease terms
are ambiguous. Appellant’s Brief at 16-19. The trial court went to great
lengths to review how other jurisdictions struggled to discern the meaning of
an industry term of art, applying different doctrines to resolve the disputes
before them. The court also pointed out the jurisdictions’ different
approaches: finding ambiguity, no ambiguity and permitting post-production
costs, and no ambiguity but prohibiting post-production costs. See Trial Ct.
Op. at 9-15. Meanwhile, Appellee and the trial court rely on Kilmer and
specialized industry meanings to argue what “gross” and “at the well” should
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mean. See Trial Ct. Op. at 16; Appellee’s Brief at 14. Additionally, Appellee
cites policy considerations (consistent with net-back method): (1) “[t]he oil
and gas industry has changed over time such that, in more recent times, there
is generally not a market to sell natural gas at the wellhead[;]” (2) “[t]he
activities that generate post-production costs add significant value for both
the operator and the lessor by enabling the gas to be sold for a higher price[;]”
and (3) operators and lessors should “fairly share the expenses of bringing
raw gas from the wellhead to the point of sale[.]” Appellee’s Brief at 2-4.
We do not, at this juncture, opine on the merits of the parties’
arguments or the trial court’s reasoning, but emphasize that they go outside
the four corners of the Lease and cite multiple sources to conclude the Lease
is clear and unambiguous. A finding that a contract is clear and
unequivocable, however, must be made on the contents of the contract
“alone, within the four corners of the document.” See Stephan, 100 A.3d at
665 (emphasis added).
We conclude the royalty provision contains a latent ambiguity, as “it is
reasonably susceptible of different constructions and capable of being
understood in more than one sense.” See Mitch, 212 A.3d at 1139. As stated
above, the Lease provides that royalties are “equal to [1/8th] of the gross
proceeds received from the sale of same at the prevailing price for gas sold at
the well.” Oil & Gas Lease at 1. While the lease specifically refers to the “sale”
of gas “at the well,” both parties agree that gas is not, in fact, sold at the well.
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See Kripp, 849 A.2d at 1163 (latent ambiguity latent is created by extrinsic
or collateral circumstances).
Appellee maintains the oil and gas industry has evolved such that there
is generally no market to sell natural gas at the wellhead. Appellee’s Brief at
2; see also Amici Brief at 6, 7 (“Before deregulation of the natural gas
industry [following the Natural Gas Policy Act of 197816], production
companies generally sold natural gas . . . in the field at or near the
wellhead[,]” but subsequently, “pipeline companies would perform all post-
production activities . . . after the point of production at the wellhead to sell
natural gas downstream of the well.”). Appellee and the trial court both
reason that we may look to the industry usage of the terms “royalty” and “at
the well” to reconcile this conflict.
We acknowledge the trial court and Appellee’s rationale that industry
terms can comprise the plain language and meaning of a contract. We agree
with Appellee that “‘custom in the industry or usage in the trade is . . . relevant
and admissible’ in construing a contract and does not depend on an ambiguity
in the agreement.” See Appellee’s Brief at 12, quoting Sunbeam Corp., 781
A.2d at 1193. However, we disagree that this rule can so neatly apply to the
case sub judice.
____________________________________________
16 15 U.S.C. §§ 3301–3432.
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In Sunbeam, the case cited by Appellee, commercial “insurance policies
cover[ed] pollution if it was ‘sudden and accidental.’” Sunbeam Corp., 781
A.2d at 1192. The policy holders argued that according to industry usage,
“‘sudden and accidental” meant “unexpected and unintended.” Id. The trial
court disagreed, as it was bound by Superior Court precedent, “which held
‘the plain meaning of [the phrase ‘sudden and accidental] requires that
damages resulting from gradual releases of pollution are excluded from
coverage.’” Id. at 1194. On appeal, our Supreme Court held the trial court
could take into account the special industry usage of the term, and remanded
for the court to reexamine the policy language. Sunbeam Corp., 781 A.2d
at 1195.
With respect to the Lease in the case sub judice, we note the common,
ordinary meaning of the word “gross” is “[e]xclusive of deductions.” See
AMERICAN HERITAGE COLLEGE DICTIONARY (3d. ed. 2000). As Appellant points out,
the royalty provision does not specifically address post-production costs. The
trial court and Appellee, however, argue, that consistent with the specialized
industry meanings of “royalties” and “at the well,” “gross” has the opposite
meaning: it includes the deduction of certain costs. Trial Ct. Op. at 16;
Appellee’s Brief at 13. Likewise, the phrase “price for gas sold at the well”
has a common sense meaning — the price of gas as it is sold from the
wellhead. The trial court and Appellee again advance a contrary meaning: the
value of gas sold after it leaves the well, with an additional caveat that “the
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reasonable cost of transporting it and processing it to make it marketable”
should be deducted. See Trial Ct. Op. at 16.
We offer no opinion on the veracity of Appellee’s and amici’s contentions
that these terms have the specialized industry meanings discussed above.
Instead, we disagree that such industry meanings are comparable to those in
Sunbeam Corp., such that they may so easily be interchanged with the
original Lease terms. As stated above, in Sunbeam Corp., the question was
whether the insurance policy phrase, “sudden and accidental,” could have a
nuanced, industry meaning of “unexpected and unintended.” Sunbeam
Corp., 781 A.2d at 1192. Here the trial court and Appellee interpret “gross”
and “price for gas sold at the well” to each have the very opposite meaning.
Such interpretations support a finding that the royalty provisions are not clear
and are ambiguous.
Furthermore, the trial court’s own discussion of Kilmer and the net-
back method does not support a finding that these terms “are known and
understood by a particular class of persons in a certain special or peculiar
sense.” See Sunbeam Corp., 781 A.2d at 1195. The trial court specifically
found “Kilmer does not stand for the proposition that royalties at the wellhead
must be calculated in” the net-back method. Trial Ct. Op. at 16, 17.
We appreciate the complexity of the issues presented and the parties’
and amici’s advocacy in this appeal. However, in sum, we disagree with the
trial court’s finding that the royalty provision terms are plain and unambiguous
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with regard to whether Appellee may deduct post-production costs from
royalties. Instead, under our de novo standard of review, we conclude the
royalty provision is ambiguous. See Mitch, 212 A.3d at 1139.
Accordingly, we reverse the order of the trial court granting Appellee’s
motion for summary judgment and denying Appellee’s motion for partial
summary judgment. Furthermore, as “ambiguous writings are [to be]
interpreted by the finder of fact,” we remand this case to the trial court for
further proceedings. See Kripp, 849 A.2d at 1163. We note that on remand,
the trial court may consider, inter alia: whether it should apply the accepted
meanings, in the oil and gas industry, of “gross proceeds” and “at the well;”
the contractual intent of the original Lease parties who executed the Lease in
2007;17 whether gas was ever sold at the wellhead under this Lease; the
subsequent conduct or course of performance of WCMOG and its successors
in not deducting post-production costs for eight years, from 2007 to 2015;
and any other factors advocated by the parties or found to be relevant by the
trial court.18 Again, we characterize these issues to be parol evidence, outside
the four corners of the Lease, and relevant only after we have determined the
Lease is ambiguous.
____________________________________________
17It is not apparent from the record whether the original lessors, Jacob
Dressler, III, and Charlotte Dressler, play a role in the operation of Appellant,
Dressler Family LP.
18 We offer no opinion as to the merits of these potential factors.
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Finally, we observe amici has urged this Court to endorse the net-back
method, and to reject the “flawed” first-marketable product doctrine. See
Amici Brief at 22. They reason that if we accept Appellant’s interpretation of
the Lease, we “would be endorsing all the hallmarks of the marketable-product
doctrine without saying so[,]” and “may disrupt the legal framework for
royalties in Pennsylvania on which parties to an oil and gas leave have relied.”
Id. at 9, 25. We enter no conclusion as to the proper meaning of the royalties
provision of the Lease, but instead conclude the provision is ambiguous and
remand to the trial court to determine the proper meaning.
XI. Conclusion
For the reasons set forth above, we reverse the order of the trial court
granting Appellee’s motion for summary judgment and denying Appellee’s
motion for partial summary judgment. We remand this case to the trial court
for proceedings consistent with this opinion. We again emphasize that we
offer no opinion as to the merit of the parties’ various arguments regarding
the meanings of the Lease terms.
Order reversed. Case remanded. Jurisdiction relinquished.
Judgment Entered.
Joseph D. Seletyn, Esq.
Prothonotary
Date: 04/29/2022
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