West Virginia Tawney Apple Case
Post-production deductions are a hot topic in the Appalachian Basin. If you practice or operate in West Virginia, you know that over the past 20 years, West Virginia has charted its own course and strayed from the majority of states when it comes to the law governing payouts. royalties and, in particular, post-production deductions. However, that could all change. September 13, 2021, in the case Kellam v. SWN Production Co.,1 the United States District Court for the Northern District of West Virginia has certified matters referred to the West Virginia Supreme Court of Appeal (the “Supreme Court”) that could have a significant impact on payments royalty and related litigation in the state. In particular, the Supreme Court can finally and directly examine whether Estate of Tawney v. Columbia Natural Resources, LLC2 is still good law in West Virginia. The certified questions are:
Is Tawney Still Good Law in West Virginia?
What is meant by “method of calculation” of the amount of post-production costs to be deducted?
Is a simple list of the types of fees that can be deducted enough to satisfy Tawney?
If post-production costs are to be deducted, are they limited to direct costs or can they also be deducted from indirect costs?
Under Tawney, a lessee must generally bear “all costs incurred in the exploration, production, marketing and transportation” of oil and gas to its point of sale.3 In other words, post-production deductions were not allowed unless (1) were expressly authorized by the lease and (2) actually incurred by the tenant.4 Tawney acknowledged that the parties may contractually agree to deviate from the general rule that the lessee bears post-production costs, but considered that in order to allow deductions a lease must (1) “expressly provide that the lessor will bear part of the costs “(2)” indicate with precision the specific deductions that the tenant intends to take “and (3)” indicate the method of calculating the amount to be deducted “.5
The day after Tawney, state and federal courts have considered how the Tawney factors must be applied and consider whether current West Virginia law is applicable given the realities of the modern oil and gas industry.6 In Leggett c. EQT Production Co., the Supreme Court did everything possible to discuss “the defective legs on which [Tawney] and its iteration of the salable product rule is supposed to be valid ”,7 and instead noted that “the most logical way to determine the wellhead price is, in fact, to deduct post-production costs from the downstream price of ‘value added'”,8 although the court stopped before overthrowing Tawney. Following the example of the Supreme Court, the fourth circuit, in Young v. Equinor USA Onshore Properties, Inc., ruled that West Virginia “does not require an oil and gas lease to establish Einsteinian proof for calculating post-production costs”9 and instead, the “return work method” is sufficient, as long as post-production deductions are “reasonable” and “actually incurred”.ten It now appears that Kellam gives the Supreme Court the opportunity to review its decision in Tawney. Kellam is a putative class action lawsuit, in which the plaintiffs allege that their leases do not allow post-production deductions and, as a result, various tenants improperly deducted post-production costs when calculating royalties. The Kellam Court recognized that “the Supreme Court has cast a veil on Tawney when he criticized it is [sic] own participation in Leggett, “11 and, therefore, the state of the law is “so uncertain that this Court cannot accurately and reliably predict how these questions of law would be determined under West Virginia law.”12 If the Supreme Court accepts the case, it has the potential to clarify existing West Virginia law or overturn West Virginia post-production deduction law.
1No.5: 20-CV-85 (NDW Va.).
2633 SE2d 22 (W. Va. 2006).
3Syl. pt. 1, Tawney, 633 SE 2d-23 (citing Syl. Pt. 4, Wellman v. Energy Res., Inc., 557 SE2d 254, 256 (W. Va. 2001)).
4Syl. pt. 2, Tawney, 633 SE 2d to 23 (citing Syl. Pt. 5, Wellman, 557 SE2d to 256). 5Tawney, 633 SE2d at 24 years old.
6See Leggett v. EQT Prod. Co., 800 SE2d 850, 863, 867 (W. Va. 2017); Young v. Equinor USA Onshore Properties, Inc., 982 F.3d 201, 207 (4th Cir. 2020).
7Leggett c. EQT Prod. Co., 800 SE2d to 862.
8Identifier. to 866.
9Young, 982 F.3d to 208.
tenIdentifier. to 209.
11Kellam, # 5: 20-CV-85, at 25.
12Identifier. to 1.