Kilmer v. Elexco Land Services, Inc.

• Citation: 990 A.2d 1147
• Decision Date: 24 March 2010
• Docket Number: No. 63 MAP 2009.,63 MAP 2009.
• Parties: Herbert KILMER, Elsie Kilmer, Jacqueline Frantz, Jeffrey Kilmer, Diane Kilmer, Kenneth Kilmer, and Thomas Kilmer, Appellants v. ELEXCO LAND SERVICES, INC. and Southwestern Energy Production Company, Appellees.
• Court: United States State Supreme Court of Pennsylvania

990 A.2d 1147

Herbert KILMER, Elsie Kilmer, Jacqueline Frantz, Jeffrey Kilmer, Diane Kilmer, Kenneth Kilmer, and Thomas Kilmer, Appellants v. ELEXCO LAND SERVICES, INC. and Southwestern Energy Production Company, Appellees.

No. 63 MAP 2009.

Supreme Court of Pennsylvania.

Argued September 16, 2009.

Decided March 24, 2010.

Michael James Gathany, Hallstead, Laurence M. Kelly, Kelly & Kelly, Montrose, for H. Kilmer, E. Kilmer, J. Frantz, J. Kilmer, D. Kilmer, K. Kilmer, & T. Kilmer.

Michael Anthony Dinges, Elion, Wayne, Grieco, Carlucci, Shipman & Irwin, P.C., Williamsport, for Amicus Curiae Andrew Hooker.

Kenneth Scott Kornacki, Steven Michael Petrikis, Brian Thornton Must, Metz Lewis, L.L.C., Pittsburgh, for Amici Curiae Curtis R. Lauchie, Terri, Lauchie, Gary K. Beach & Carolyn J. Beach.

Thomas Waffenschmidt, Rieders, Travis, Humphrey, Harris, Waters & Waffenschmidt, Williamsport, for Amici Curiae Samuel Belcher, Cheryl Belcher, Douglas Blessing, et al.

George A. Bibikos, Amy L. Groff, David R. Fine, Patricia Carol Shea, K & L Gates, L.L.P., Harrisburg, for Elexco Land Services, Inc. and Southwestern Energy Production Company.

Alfred Hettinger, Hettinger Law Office, Allentown, for Amici Curiae Charles S. Snyder, Jr. and Township of Middletown.

Joseph Thomas Wright, Jr., Danielle Marie Mulcahey, Dixon Wright & Associates, Scranton, for Amicus Curiae Huntley & Huntley, Inc.

Bruce M. Kramer, for Amicus Curiae Bruce M. Kramer.

Nicolle Renee Snyder Bagnell, Kevin Charles Abbott, Reed Smith, L.L.P., Pittsburgh, for Amici Curiae PA Oil & Gas Association & Independent Oil & Gas Association & Chesapeake Appalachia.

CASTILLE, C.J., SAYLOR, EAKIN, BAER, TODD, McCAFFERY, GREENSPAN, JJ.

OPINION

Justice BAER.

The case at bar concerns the proper construction of the term "royalty" as it is used in the Guaranteed Minimum Royalty Act ("GMRA"), 58 P.S. § 33, which governs, inter alia, leases between Pennsylvania landowners and gas companies seeking to drill natural gas wells into Pennsylvania's Marcellus Shale deposits. As developed below, the GMRA requires that leases guarantee the landowner-lessor "at least one-eighth royalty of all oil, natural gas or gas of other designations removed or recovered from the subject real property." 58 P.S. § 33.¹ Although the critical term "royalty" is not defined by the statute, many leases in the Commonwealth, including the lease at issue before this Court, calculate the royalties as one-eighth of the sale price of the gas minus one-eighth of the post-production costs of bringing the gas to market.² 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.³ The landowners in this case filed for declaratory judgment seeking to void their lease, arguing that the net-back method of calculating royalties violates the GMRA. The trial court rejected this argument and granted summary judgment to the gas companies. After exercising extraordinary jurisdiction, we affirm the decision below.

The Marcellus Formation is a region of natural gas-rich shale extending from New York to West Virginia, including large portions of Pennsylvania. See generally Timothy Considine, et al., Pennsylvania State University, An Emerging Giant: Prospects and Economic Impacts of Developing the Marcellus Shale Natural Gas Play (2009). While the existence of the gas deposits in the area have been known for a long time, recent developments in drilling techniques have allowed for the potential recovery of dramatically larger quantities of natural gas. Estimates suggest that the area could contain over 489 trillion cubic feet of recoverable gas, enough to supply the natural gas needs of the United States for fourteen years. The developments in recovery techniques and the proximity of the formation to the energy markets of the east coast cities has created a surge of interest in drilling in the area. Consequently, gas companies in the past few years have offered landowners much more lucrative lease terms than were present in older leases, given the increased competition for drilling rights. This has caused some landowners to review their older leases and question whether the terms provided therein comply with the GMRA.

In January 2008, Landowners⁴ in the present case filed a complaint for declaratory judgment in the Court of Common Pleas of Susquehanna County seeking to invalidate their 2007 lease, asserting that the lease violated the one-eighth royalty requirement of the GMRA because the net-back method resulted in a royalty less than one-eighth of the value of the gas. The relevant provision of the lease provided for the calculation of royalties as follows:

3. Royalty Payment. For all Oil and Gas Substances that are produced and sold from the leased premises. 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, as defined below, and this same percentage share of all production, severance and ad valorem taxes. As used in this provision, Post Production Costs shall mean (i) all losses of produced volumes (whether by use as fuel, line loss, flaring, venting or otherwise) and (ii) all costs actually incurred by Lessee from and after the wellhead to the point of sale, including, without limitation, all gathering, dehydration, compression, treatment, processing, marketing and transportation costs incurred in connection with the sale of such production. For royalty calculation purposes, Lessee shall never be required to adjust the sales proceeds to account for the purchaser's costs or charges downstream from the point of sale.

Lease between Kilmer et al. and Elexco Land Services, Inc, dated October 15, 2007 ("Lease") (emphasis added).⁵ Similar royalty provisions are present in many other leases across the Commonwealth. According to Landowners, this provision violates the GMRA, which provides in full:

§ 33. Guarantee of minimum royalties

A lease or other such agreement conveying the right to remove or recover oil, natural gas or gas of any other designation from lessor to lessee 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.

58 P.S. § 33.

As the case presented the trial court with a pure question of law regarding the requirements of the GMRA, both parties filed motions for summary judgment.⁶ In March 2009, the trial court granted summary judgment in favor of the Gas Companies and denied Landowners' motion for summary judgment. The court concluded that there were no issues of material fact and that the GMRA does not preclude the parties from utilizing the net-back method of royalty calculation. The Gas Companies discontinued their other claims and praeciped for the entry of judgment. Landowners timely appealed to the Superior Court.

In a very brief opinion in support of its decision, the trial court observed that no Pennsylvania appellate court had yet spoken to the question of whether the net-back method of royalty calculation violated the GMRA, despite the numerous cases then pending in Pennsylvania trial courts involving the same question. The trial court acknowledged, but did not rely upon, the Gas Companies' argument that the term "royalty" had acquired a meaning in the industry that was consistent with the use of the net-back method. The court, however, ultimately held that the lease did not violate the GMRA because "the statute in question does not prohibit the inclusion of `post-production' costs to calculate the one-eighth royalty. The parties are, therefore, free to negotiate how that royalty shall be calculated, so long as the net result is not less than one-eighth." Tr. Ct. Op. at 3.

Recognizing that more than seventy suits were currently on hold pending the appellate litigation in this case and fearing that uncertainty would stymie economic development, the Gas Companies filed a petition asking this Court to exercise extraordinary jurisdiction to speed the resolution of this pure legal question of first impression. The Landowners did not oppose the petition. We granted extraordinary jurisdiction pursuant to 42 Pa.C.S. § 726⁷ 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. As the question presented involves a pure question of law, our scope of review is plenary and our standard of review is de novo. See Merlini ex rel. Merlini v. Gallitzin Water Authority, 980 A.2d 502, 506 (Pa.2009).

Before this Court, Landowners seek to invalidate their leases, claiming that the Gas Companies are attempting to evade the GMRA's requirement of a one-eighth royalty. Landowners argue that the plain language of the statute does not provide for the net-back method through which post-production costs are subtracted from the sale price at market. Likewise, Landowners assert that the plain language does not state that royalties should be calculated at the wellhead as argued by the Gas Companies. Landowners reject the Gas Companies' contention that the word "royalty" has developed a technical meaning in the oil and gas industry. Instead, they maintain that the ordinary meaning of the term royalty should be binding in this case. Relying upon standard dictionary definitions, Landowners argue that the term "royalty" is ordinarily defined as "a compensation or portion of the proceeds paid to the owner of a right, as a patent or oil or mineral right." Landowners' Brief at 19 (emphasis in original). They note that "proceeds" are defined as the "total amount derived from a sale or other transaction." Landowners' Brief at 20....