Poplar Creek Dev. Co. v. Appalachia

Decision Date07 March 2011
Docket NumberNos. 09–5914,10–5373.,s. 09–5914
Citation636 F.3d 235
PartiesPOPLAR CREEK DEVELOPMENT COMPANY, on behalf of itself and all others similarly situated, Plaintiff–Appellant,v.CHESAPEAKE APPALACHIA, L.L.C., Defendant–Appellee.John Thacker, individually and on behalf of all others similarly situated; Jackson Rowe, Inc., individually and on behalf of all others similarly situated, Plaintiffs–Appellees,Poplar Creek Development Company; Alma Land Company; Appalachian Land Company, Claimants–Appellants,v.Chesapeake Appalachia, L.L.C.; NiSource, Inc.; Columbia Energy Group, Defendants–Appellees.
CourtU.S. Court of Appeals — Sixth Circuit

636 F.3d 235

POPLAR CREEK DEVELOPMENT COMPANY, on behalf of itself and all others similarly situated, Plaintiff–Appellant,
v.
CHESAPEAKE APPALACHIA, L.L.C., Defendant–Appellee.John Thacker, individually and on behalf of all others similarly situated; Jackson Rowe, Inc., individually and on behalf of all others similarly situated, Plaintiffs–Appellees,Poplar Creek Development Company; Alma Land Company; Appalachian Land Company, Claimants–Appellants,
v.
Chesapeake Appalachia, L.L.C.; NiSource, Inc.; Columbia Energy Group, Defendants–Appellees.

Nos. 09–5914

10–5373.

United States Court of Appeals, Sixth Circuit.

Argued: Dec. 9, 2010.Decided and Filed: Feb. 17, 2011.Rehearing Denied March 7, 2011.


[636 F.3d 237]

ARGUED: George E. Stigger, St. Marys, Georgia, Gary E. Mason, Mason LLP, Washington, D.C., for Appellants. Barbara B. Edelman, Dinsmore & Shohl LLP, Lexington, Kentucky, Anne A. Chesnut, Greenebaum Doll & McDonald PLLC, Lexington, Kentucky, Clark C. Johnson, Stites & Harbison, PLLC, Louisville, Kentucky, for Appellees. ON BRIEF: George E. Stigger, St. Marys, Georgia, Gary E. Mason, Donna F. Solen, Mason LLP, Washington, D.C., John C. Whitfield, Whitfield & Cox, P.S.C., Madisonville, Kentucky, for Appellants. Barbara B. Edelman, Whitney Howard Mendiondo, Dinsmore & Shohl LLP, Lexington, Kentucky, Anne A. Chesnut, Joseph A. Tarantelli, Greenebaum Doll & McDonald PLLC, Lexington, Kentucky, Clark C. Johnson, Marjorie A. Farris, Stites & Harbison, PLLC, Louisville, Kentucky, John Famularo, Thomas E. Meng, Daniel E. Danford, Stites & Harbison, Lexington, Kentucky, for Appellees.Before: GILMAN and GRIFFIN, Circuit Judges; COLLIER, Chief District Judge.*

OPINION
GRIFFIN, Circuit Judge.

These cases arise out of a dispute over the respective rights of lessors and lessees under Kentucky oil and gas leases. Both actions are resolved by determining whether Kentucky law allows lessees, in calculating gas royalty payments, to take into account certain post-production costs as an offset against the value or proceeds upon which royalty payments are based. Because the two appeals involve the same or similar leases, have some parties in common, and raise similar legal questions, we have consolidated these two cases for decision.

In case number 09–5914 (the “ Poplar Creek action”), plaintiff Poplar Creek Development Company (“Poplar Creek”)

[636 F.3d 238]

brought a proposed class action for breach of contract, breach of the implied covenant to market gas, and for declaratory judgment, claiming that defendant Chesapeake Appalachia, L.L.C. (“Chesapeake”) is liable to all lessors in Kentucky from whom it leases gas rights because of improperly deducted costs incurred in bringing natural gas to a marketable condition. In response, Chesapeake moved for judgment on the pleadings, which the district court granted.

Following our thorough review, we affirm. In doing so, we hold that Kentucky follows the “at-the-well” rule, which allows for the deduction of post-production costs before paying appropriate royalties.

In case number 10–5373 (the “ Thacker action”), named plaintiffs John Thacker and Jackson Rowe, Inc. filed the instant class action on February 6, 2007, against defendants Chesapeake, NiSource, Inc. (“NiSource”), and Columbia Energy Group (“Energy Group”) (collectively “defendants”), on behalf of a class consisting of Kentucky landowners who are lessors under natural gas leases with the defendants. This diversity class action was resolved by a settlement approved by the district court on March 3, 2010. Claimants Poplar Creek, Alma Land Company, and Appalachian Land Company (collectively the “Poplar Creek Objectors”), objectors to the settlement, appeal the March 3 order on grounds similar to those raised in the Poplar Creek action.

At oral argument, the Poplar Creek Objectors conceded that their challenge to the approved settlement fails should this court affirm the district court in the Poplar Creek action. Having concluded that the judgment in the former case must be affirmed, we affirm the settlement order in the companion case.

I.

We begin by reviewing the factual and procedural history in the Poplar Creek action.

A.

Poplar Creek is the current lessor and fee simple owner of gas interests located in Pike County, Kentucky, as set forth in the November 23, 1951, oil and gas lease originally entered into between Majestic Collieries Company (predecessor in title to Poplar Creek) and Hurricane Mineral Corporation (as lessors), and United Fuel Gas Company. Chesapeake is the successor-in-interest to the lessee, United Fuel Gas Company. Chesapeake has produced gas from wells it owns and operates on the leasehold, and it has paid and continues to pay royalties to Poplar Creek on that gas.

The parties' lease contains the following provision concerning the payment of gas royalties:

IN CONSIDERATION OF THE PREMISES, the said Lessee covenants and agrees,

* * *

2nd. To pay to the Lessor a royalty for the gas produced and marketed from any gas well on the leased premises at the rate of one-eighth (1/8) part of the wholesale market value of such gas at the well based on the usual price paid therefor in the general locality of said leased premises....

Chesapeake sells the gas at a market away from the well, which results in increased expenses, including gathering,1

[636 F.3d 239]

compression,2 and treatment 3 costs. See Schroeder v. Terra Energy, Ltd., 223 Mich.App. 176, 565 N.W.2d 887, 891 (1997) (noting that “natural gas is not typically sold at the wellhead”). Poplar Creek refers to these costs as “production costs,” but they are more appropriately labeled post-production costs because these expenses are incurred after the gas leaves the wellhead. As Chesapeake notes, “[p]roduction costs, like those incurred drilling, operating and maintaining a well, as well as other costs incurred in order to extract gas from the earth and bring it up to the wellhead, are borne entirely by Chesapeake, according to the Lease.” Additionally, Kentucky imposes a 4.5% tax for the privilege of severing and/or processing natural resources. See Ky.Rev.Stat. § 143A.020.

Chesapeake deducts these post-production costs from the price at which it sells the gas away from the well in order to calculate the market value of the gas “at the well.” Poplar Creek alleges that these deductions are improper, and that the terms of the lease and Kentucky law require Chesapeake to bear all such costs itself. The district court agreed with Chesapeake and ruled that “Kentucky courts would interpret the lease provision in this case, requiring Chesapeake to pay royalties based on the gas's value ‘at the well,’ to unambiguously mean just that—that Chesapeake must pay royalties on the value of the gas at the well, before it has been gathered, treated, or compressed.”

Poplar Creek now timely appeals.

B.

In the Thacker action, John Thacker and Jackson Rowe, Inc. asserted breach-of-contract and fraud claims on behalf of a class consisting of Kentucky landowners who are lessors under natural gas leases with the defendants. Similar to the Poplar Creek action, the Thacker complaint alleged that it was a breach of contract for the lessees to deduct certain post-production expenses from the calculation of the royalty payments.

The class was certified and a proposed settlement preliminarily approved in August 2009. Under the terms of the settlement agreement and plan of allocation, defendants agreed to contribute $28,750,000 to a settlement fund. Notice was sent to the 8,185 eligible class members, and 68 class members opted out of the settlement. Twelve class members, including the Poplar Creek Objectors, filed objections. Relevant here, the Poplar Creek Objectors argued that the settlement was unfair because it permitted the defendants to continue to deduct post-production expenses from royalty payments. In response, the district court noted that an action by Poplar Creek, i.e. the Poplar Creek action, raising this claim had been

[636 F.3d 240]

dismissed by the court based on a finding that the manner in which royalties were calculated under the leases was consistent with Kentucky law. The court subsequently overruled this objection, and others raised by the Poplar Creek Objectors, and approved the settlement.

The Poplar Creek Objectors now timely appeal.

II.

Because the Thacker action appeal is explicitly premised upon Poplar Creek prevailing in its appeal in the Poplar Creek action, we shall consider the merits of the appeal in case number 09–5914 first.

A.

We review a district court's grant of judgment on the pleadings under Rule 12(c) using the same de novo standard of review applicable to orders of dismissal under Rule 12(b)(6). Tucker v. Middleburg–Legacy Place, 539 F.3d 545, 549 (6th Cir.2008). “For purposes of a motion for judgment on the pleadings, all well-pleaded material allegations of the pleadings of the opposing party must be taken as true, and the motion may be granted only if the moving party is nevertheless clearly entitled to judgment.” Id. (citation and internal quotation marks omitted).

The parties do not dispute that Kentucky law is the applicable law governing this dispute. A federal court sitting in diversity must apply the law of the highest state court if that court has ruled on the matter in dispute; otherwise, the court may rely on case law from lower state courts. See Westfield Ins. Co. v. Tech Dry, Inc., 336 F.3d 503, 506 (6th Cir.2003); Hayes v. Equitable Energy Res. Co., 266 F.3d 560, 566 (6th Cir.2001); Talley v. State Farm Fire & Cas. Co., 223 F.3d 323, 326 (6th Cir.2000) (citing Meridian Mut. Ins. Co. v. Kellman, 197 F.3d 1178, 1181 (6th Cir.1999)). Because Kentucky law determines that the construction of a contract is a legal question, the terms of the contract are reviewed de novo. See Morganfield Nat'l Bank v. Damien Elder & Sons, 836 S.W.2d 893, 895 (Ky.1992); Cantrell Supply, Inc. v. Liberty Mut. Ins. Co., 94 S.W.3d 381, 385 (Ky.Ct.App.2002).

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