Publication Date: 4/29/2009
Author: William H. Smith
Contact: bill.smith@steptoe-johnson.com
Whether Pennsylvania's Minimum Royalty Act ("MRA") permits deductions of "post production" costs from a one-eighth royalty payment under an oil and gas lease remains unclear. In separate decisions, the Court of Common Pleas in Susquehanna County, Pennsylvania ruled that lease provisions providing for post-production deductions did not violate the relevant statute, while the United States District Court for the Middle District of Pennsylvania found that the issue raised questions of fact on the definition of the term "royalty."
The statute at issue is 58 P.S. § 33 which provides that an oil and gas lease "...shall not be valid if such lease does not guarantee the lessor at least one-eighth royalty of all oil, natural gas or gas of other designations removed or recovered from the subject real property."
On March 16, 2009, the Court of Common Pleas for Susquehanna County, Pennsylvania, in Kilmer v. Elexco; No. 2008-57 ("Kilmer"), granted summary judgment in favor of the operator. The Kilmers sought to void their lease based on a claim that the subtraction of "post-production" costs reduced their royalty to less than the requisite one-eighth required by statute. The court found that inclusion of "post-production" costs in calculating royalty is customary within the oil and gas industry throughout the country and concluded that the statute does not preclude parties from negotiating how royalty will be calculated "so long as the net result is not less than one-eighth." The Kilmers appealed the Order of the Common Pleas Court to the Superior Court of Pennsylvania, and subsequently, the Defendants petitioned the Supreme Court of Pennsylvania, asking it to exercise extraordinary jurisdiction to review the case and provide guidance to other courts because a number of pending cases hinge on the same ultimate issue. To date, no action has been taken by either appellate level court.
In an order entered on April 17, 2009, the United States District Court for the Middle District of Pennsylvania, in Kropa v. Cabot Oil & Gas Corporation, WL 1044610 ("Kropa"), did not follow the Kilmer decision and declined to grant Cabot Oil & Gas Corporation's ("Cabot")motion to dismiss stating "we are not convinced that merely because the statute is silent on whether post-production costs can be deducted means that such costs can in fact be legally deducted from the royalty." Kropa asserted that the royalty provision of the lease violated the MRA; and Cabot moved the court to dismiss the claim under the same logic that prevailed in Kilmer. In denying Cabot's motion to dismiss, the court found that the definition of "royalty" is subject to more than one meaning, and therefore a finding of fact as to the definition of the term must be made before a final decision can be reached. Thus, the Kropa Court left open the possibility that it may invalidate or reform leases that include certain post production costs.