Zehentbauer Family Land, LP v. TotalEnergies E&P USA, Inc.

• Court: Court of Appeals for the Sixth Circuit
• Decided: February 1, 2022
• Docket: 20-3469
• Status: Unpublished

Opinion

NOT RECOMMENDED FOR PUBLICATION File Name: 22a0059n.06

No. 20-3469

UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT

) FILED ZEHENTBAUER FAMILY LAND, LP; Feb 01, 2022 ) HANOVER FARMS, LP; EVELYN FRANCES DEBORAH S. HUNT, Clerk ) YOUNG, Successor Trustee of Robert Milton Young ) Trust, ) ) Plaintiffs-Appellants, ON APPEAL FROM THE ) ) UNITED STATES DISTRICT v. COURT FOR THE ) NORTHERN DISTRICT OF TOTALENERGIES E&P USA, INC., fka Total E&P ) OHIO USA, Inc.; PELICAN ENERGY, LLC; ) ) JAMESTOWN RESOURCES, LLC, ) ) Defendants-Appellees.

Before: SUHRHEINRICH, STRANCH, and MURPHY, Circuit Judges.

SUHRHEINRICH, Circuit Judge. Plaintiffs, a class of landowners in Ohio’s Utica Shale

Formation, claim that Defendants, oil-and-gas exploration companies, miscalculated their royalty

payments by basing them on the “at the wellhead” price rather than on the downstream value of

refined oil and gas products. The district court sided with Defendants and so must we.

I.

Plaintiffs entered into oil and gas lease agreements with a predecessor of Defendants

between 2010 and 2012. See Zehentbauer Fam. Land, LP v. Chesapeake Expl., L.L.C., 935 F.3d

496, 499–501 (6th Cir. 2019). These agreements allow the defendant production companies to

extract oil and gas from the landowners’ properties; in exchange, the landowners receive royalty No. 20-3469, Zehentbauer Family Land, LP, et al. v. TotalEnergies E&P USA, Inc., et al.

payments “based upon the gross proceeds paid to Lessee for the gas marketed and used off the

leased premises, including casinghead gas or other gaseous substance . . . computed at the wellhead

from the sale of such gas substances so sold by Lessee.” R. 1-1, PID 46 ¶ 5(b) (emphasis added).

“Gross proceeds” are defined as “the total consideration paid for oil, gas, associated hydrocarbons,

and marketable by-products produced from the leased premises.” Id. And gross proceeds are

derived from sales either to (1) an unaffiliated bona fide purchaser in an “arms-length transaction,”

or (2) an “affiliate of Lessee,” for a comparable sales price “and without any deductions or

expenses.” Id.

Defendants Chesapeake Exploration, LLC and CHK Utica, LLC (collectively

“Chesapeake”) sell their oil and gas at the wellhead to midstream affiliate Chesapeake Energy

Marketing, LLC (“CEMLLC”).1 See R. 114-1, PID 3724. Defendant TotalEnergies E&P USA,

Inc. (“Total”)2 sells its oil and gas at the wellhead to midstream affiliate Total Gas & Power North

America, Inc. (“TGPNA”). See R. 112-1, PID 3606. CEMLLC and TGPNA process the raw

products and transport them for sale to unaffiliated downstream companies. Zehentbauer, 935

F.3d at 501. These midstream affiliates pay for the gas using the netback method, which “takes a

weighted average of prices at which the midstream affiliates sell the oil and gas at various

downstream locations and adjusts for the midstream company’s costs of compression, dehydration,

treating, gathering, processing, fractionation, and transportation to move the raw oil and gas from

the wellhead to downstream resale locations.” Id. The netback method accounts for these

midstream, or post-production, costs. Id. The midstream affiliates pay this reduced amount to the

1 Chesapeake Exploration or CHK Utica, LLC is the named lessee or the successor in interests in the leases. R. 92, PID 1020 ¶ 4. Total, Jamestown Resources, LLC, and Pelican Energy LLC own working interests in Plaintiffs’ leases. Id. at 1020 ¶ 5; see also R. 109-1, PID 3540–41, ¶¶ 26-27. 2 Chesapeake assigned some of its rights as lessee to Total. Total has a working interest in many of the leases at issue. Appellees’ Br. at 10–11.

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defendant producers, who use this netback price as the base for calculating Plaintiffs’ royalty

payments. Id.

Plaintiffs felt that their royalties should be based on a different set of gross proceeds—the

gross proceeds received by affiliates of Defendants further downstream after the product is refined

and moved to market. In 2015 they sued Defendant Lessees on behalf of themselves and 224 other

lessors complaining that Defendants had breached their lease obligations by “failing to pay the full

royalties due under the leases” to the class members. R. 1-1, PID 36 ¶ 85.

The district court granted summary judgment to Defendants, holding that the plain and

unambiguous language of the contract required that the “royalties are to be valued based on the

wellhead value of the oil, gas, and [natural gas liquids] and, therefore, the deduction of post-

production costs are authorized.” Zehentbauer Fam. Land LP v. Chesapeake Expl., LLC,

450 F. Supp. 3d 790, 811 (N.D. Ohio 2020).

Plaintiffs appealed. Plaintiffs and the Chesapeake Defendants jointly moved to dismiss the

case as to those defendants only, see ECF No. 43, which the Clerk of Court granted, ECF No. 46.

The remaining defendants on appeal are Total, Jamestown Resources, LLC, and Pelican Energy,

LLC.

II.

Summary judgment is proper where “there is no genuine dispute as to any material fact and

the movant is entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(a). We review the

district court’s grant of summary judgment de novo. Laster v. City of Kalamazoo, 746 F.3d 714,

726 (6th Cir. 2014).

The parties agree that Ohio law applies. R. 92, PID 1021. In Ohio, an oil and gas lease is

a contract governed by “the traditional rules of contract construction.” Lutz v. Chesapeake

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Appalachia, LLC, 71 N.E.3d 1010, 1011 (Ohio 2016); see Henceroth v. Chesapeake Expl., LLC,

814 F. App’x 67, 69 (6th Cir. 2020). “If the lease language is unambiguous, then courts should

interpret the lease ‘so as to carry out the intent of the parties, as that intent is evidenced by the

contractual language.’” Zehentbauer, 935 F.3d at 505 (quoting Lutz, 71 N.E.3d at 1012).

Defendants’ royalty calculations follow the lease language. Defendants sell oil and gas at the well

to their affiliates, CEMLLC and TGPNA, and calculate the landowners’ royalty payments based

on the amount received from those sales. Cf. Henceroth, 814 F. App’x at 69.

This conclusion follows from a textual analysis. The leases provide that gas royalties3 are

calculated “based upon the gross proceeds paid to Lessee for the gas marketed and used off the

leased premises . . . computed at the wellhead from the sale of such gas substance so sold by

Lessee.” R. 1-1, PID 46 ¶ 5(b) (emphasis added). Thus, the royalty calculation is based on (1) the

“gross” (or total) proceeds, (2) “paid to Lessee[s]”, i.e., Defendants themselves; (3) on gas

marketed, i.e., sold, see id. at 71; (5) at the wellhead, see id. (noting that “[t]he key language is

‘produced and marketed from the Leasehold,’ and it shows that the first sale price is the proper

royalty base”); (6) using the netback method, see id. at 70 (stating that “[i]t is standard practice in

the industry to calculate the wellhead sales price using the netback method and to use the netback

price to calculate landowners’ royalties”). Thus, Plaintiffs’ royalties are based on the wellhead

value of the gas sold. In fact, there’s no deduction at all. Stated differently, though the Lessees

are receiving an amount that is “net” as to the downstream affiliate, it is not “net” from the Lessees’

perspective, but simply the actual cost of the raw product produced by the Lessee production

company without any deductions (production or post-production) by the Lessee for its production

3 Plaintiffs do not develop a distinct argument for the oil leases, so we treat them similarly. In any event, the oil leases provide that Defendants pay royalties on the gross proceeds “from the sale of oil recovered from the leased premises” near the wellhead, where the “oil is run into transporter trucks or pipelines.” R. 1-1, PID 46 ¶ 5(a).

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costs. See id. And Plaintiffs’ royalties are based on those gross proceeds paid to the Lessee. This

reading not only squares with the “without any deductions or expenses” language in the affiliate

clause, but it also reaches a fair result by “avoid[ing] a windfall to landowners.” See id.; see also

Schroeder v. Terra Energy, Ltd., 565 N.W.2d 887, 894 (Mich. Ct. App. 1997).

Plaintiffs’ arguments for a different reading of the leases fail.4 First, defining “gross

proceeds” as including “marketable by-products” does not require that the royalties be based on

downstream sales of finished by-products. A marketable product is one that is “capable of” being

marketed; it is not a “finished” by-product. See -able, Merriam-Webster.com Dictionary (2021),

https://www.merriam-webster.com/dictionary/able. Instead, the leases require that Plaintiffs

receive royalties on the sale of all products and by-products that are capable of being marketed,

i.e., sold. See Henceroth, 814 F. App’x at 71.

Second, Plaintiffs’ suggestion that the phrase “at the wellhead” refers to “volume” or

“amount” and modifies the words “gas marketed and used” instead of “gross proceeds” doesn’t

work either because the terms “volume” or “amount” do not appear in the royalty clauses. To read

them in would be to rewrite the contract, something courts are not authorized to do. See Porter v.

Columbus Bd. of Indus. Rels., 675 N.E.2d 1329, 1331 (Ohio Ct. App. 1996). The omission of the

“at the wellhead” verbiage from the oil leases is understandable because oil is not measured at the

wellhead but stored in tanks and transported by trucks. Thus, the valuation point for the oil royalty

calculation is “based upon the gross proceeds paid to Lessee from the sale of oil recovered from

the leased premises valued at the purchase price received for oil prevailing on the date such oil is

run into transporter trucks or pipelines.” R. 1-1, PID 46 ¶ 5(a). Our reading of “at the wellhead”

4 Plaintiffs’ assertion that the district court defaulted to the “at the well” rule deserves little comment. The court held that the contract language reflected the parties’ intent to adopt that rule. Zehentbauer, 450 F. Supp. 3d at 805–09, 811. Thus, the court did precisely what Ohio law requires—it looked to the lease language to ascertain the parties’ intent. See Lutz, 71 N.E.3d at 1012.

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fills another hole in Plaintiffs’ argument—it provides a valuation point. Because gas is processed

at various downstream sales points, R. 109-1, PID 3541 ¶ 28, it would be difficult to set a valuation

point for the gas royalty calculation under Plaintiffs’ reading of the leases.

Third, even if, as Plaintiffs say, “computed at the wellhead” modifies “gas marketed and

used off the leased premises,” it also necessarily modifies “gross proceeds” because “gas marketed

and used” modifies “gross proceeds.” The district court read the phrase in a similar way: “[T]he

words ‘computed at the wellhead’ appear in the sentence ‘computed at the wellhead from the sale

of such gas substances so sold by Lessee[.]’ What is ‘computed . . . from the sale’ must be the

proceeds of those sales.” Zehentbauer, 450 F. Supp. 3d at 809 (first alteration added) (emphasis

in original) (citations omitted).

Plaintiffs have one case in their camp: BlueStone Natural Resources II, LLC v. Randle, 620

S.W.3d 380 (Tex. 2021). There, the Texas Supreme Court held that the phrases “gross proceeds”

and “at the wellhead” in a gas lease conflicted because the latter term envisions a net-proceeds

calculation. Id. at 391. But, as Defendants point out, a critical fact distinguishes BlueStone from

this case: there the lessor did not actually sell gas until after paying to have it processed and then

sold to a downstream third party. Thus, under those circumstances, “gross value received” for the

refined gas was at the point of sale, which was not “at the wellhead,” where the gas was in a raw,

less valuable state. See Opening Br. on the Merits 21-22, BlueStone Nat. Res., 2021 WL 936175

(Tex. Mar. 12, 2021) (No. 19-0459), 2019 WL 7466291. In this case, the gas was sold at the

wellhead, so the “gross value received” by Defendants was the wellhead price.

III.

We affirm the judgment of the district court.

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