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Federal District Court Applies the “At the Well” Rule to Ohio Leases in a Decision for the Producer

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On October 25, 2017, in Regis F. Lutz v. Chesapeake Appalachia, LLC, Case No. 4:09-cv-2256, the United States District Court for the Northern District of Ohio applied the “at the well” rule in granting partial summary judgment to the producer.  The Plaintiffs in this putative class action alleged improper calculation of royalties through post-production cost deductions, line loss, and below-market gas prices.  Chesapeake argued that the “at the well” lease language requires payment of royalties based upon the value of natural gas at the wellhead.  Therefore, Chesapeake argued that it was proper to use the “net back” or “work back” method to deduct the lessors’ pro-rata share of post-production costs incurred as the gas was moved downstream to the point of sale.  Plaintiffs countered that the “marketable product” rule adopted in Tawney v. Columbia Natural Resources, L.L.C., 633 S.E.2d 22 (W. Va. 2006), should apply because “at the well” language is ambiguous and does not address post-production cost deductions. 

Earlier in this litigation, the Supreme Court of Ohio declined to answer the District Court’s certified question as to whether the “at the well” rule or the “marketable product” rule applies in Ohio.  The Supreme Court stated that the parties’ rights and remedies are controlled by the specific language of their leases, which are governed by contract law.  It noted that courts should apply clear lease language, but extrinsic evidence can be used to give effect to the parties’ intent when the circumstances impart a special meaning to the language.

Based upon the express language of the leases at issue, the District Court concluded that the Supreme Court of Ohio would apply the “at the well” rule in this case.  The District Court rejected Plaintiffs’ argument for the “marketable product” rule because it ignores the “market value at the well” lease language.  Therefore, the parties intended “that the location for valuing the gas for purposes of computing the royalty was ‘at the well’” (emphasis in original).

The District Court further granted summary judgment to Chesapeake on Plaintiffs’ claim regarding “line loss.”  Despite their assertion that line loss is akin to post-production costs, the Plaintiffs did not present evidence to support their allegations.  Chesapeake argued that royalties should be calculated based upon the volume of gas actually sold.  Agreeing with Chesapeake, the District Court held that computing royalties “at the well” renders any subsequent line loss irrelevant.

Finally, the District Court held that the Plaintiffs were not entitled to equitable tolling of the statute of limitations for their claim of fraudulent concealment because they presented no evidence that their royalty statements or check stubs contained inaccurate information.  The record did not reflect any attempt by the Plaintiffs to verify the accuracy of royalty information, which could have been accomplished by comparing the gas price on the statement with that found in a publicly available price index. 

Although the Supreme Court of Ohio has not clarified which competing rule – “at the well” or “marketable product” – should be applied to leases in this state, the Lutz opinion illustrates the process the Supreme Court envisioned: unambiguous lease language is dispositive as to how royalties should be calculated.

 

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