Court Opinion

ID: 3192418
Source: CourtListenerOpinion
Date Created: 2016-04-07 22:07:24.590912+00
Date Added: 2024-06-11T14:28:48.685130
License: Public Domain

J-A27013-15

                               2016 Pa. Super. 80

EARL D. HALL SR.; BETTY JANE HALL;              IN THE SUPERIOR COURT OF
AND EARL D. HALL, JR., ON BEHALF OF                   PENNSYLVANIA
THEMSELVES AND ALL OTHERS
SIMILARLY SITUATED,

                          Appellants

                     v.

CNX GAS COMPANY, LLC, IN ITS OWN
RIGHT AND AS SUCCESSOR-IN
INTEREST TO CONSOL GAS COMPANY,
LLC

                          Appellee                   No. 1703 WDA 2014

                  Appeal from the Order October 7, 2014
            In the Court of Common Pleas of Allegheny County
                    Civil Division at No(s): GD 10-21633

BEFORE: BOWES, OLSON, AND STABILE, JJ.

OPINION BY BOWES, J.:                                 FILED APRIL 07, 2016

     Earl D. Hall, Sr., Betty Jane Hall, and Earl D. Hall, Jr. (hereinafter “the

Halls” or “Lessors”) appeal from the October 7, 2014 order entered by the

trial court that granted summary judgment in favor of CNX Gas Company

(hereinafter “CNX” or “Lessee”) and dismissed their claims. After thorough

review, we affirm.

     The instant appeal involves the interpretation of an oil and gas lease.

In March 1998, Earl Hall, Jr., leased the oil and gas rights on his Fayette

County property to a predecessor company of CNX. Earl, Sr. and Betty Hall

leased the same rights in their real estate in October 2002.        The leases
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contain nearly identical language throughout and specifically utilize the same

royalty clause at issue in this matter. That provision reads:

       3. Royalties The royalties to be paid by the Lessee are:

              ....

       (b) on gas, including casinghead gas or other gaseous
       substance, produced from said land and sold or used beyond the
       well or for the extraction of gasoline or other product, an amount
       equal to one-eighth of the net amount realized by Lessee
       computed at the wellhead from the sale of such substances. On
       gas sold at the well, the royalty shall be one-eighth of the
       amount realized by Lessee from such sale.

Lease, Earl, Sr. and Betty Hall (“the Hall lease”), 10/23/02, at ¶ 3.1

       As the provision states, when gas is sold at the Lessor’s wellhead,

Lessee pays one-eighth of the amount realized from that sale as royalty.

However, the bulk of the gas is not sold at the wellhead but is transported

via pipeline downstream2 to the point of sale. The Hall lease provides that,

for gas sold or used beyond the well, Lessor is entitled to a royalty of one-

eighth of the net amount realized from the sale. This is generally referred to

as a proceeds lease, and the parties agree that royalties are payable only on

the gas sold. See Appellant’s Reply Brief at 1.

____________________________________________

1
  The fraction one-eighth is in compliance with Pennsylvania’s Oil and Gas
Lease Act. 59 P.S. § 33.3.
2
  The “downstream” segment refers to the final portion of the distribution
chain, which typically begins after gathering and processing and concludes
with the distribution or sale of the gas.

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      The two Hall properties are part of a system of wellheads and pipelines

that feed into a gathering system. At various points along that pipeline, gas

produced from other lessors’ wells is commingled with that of the Halls and

transported to the point of sale. The Hall lease conferred upon CNX the right

to drill and operate the Halls’ wells in conjunction with the wells on

neighboring properties. See Hall lease at 1 ¶1(b)(granting to CNX “any and

all other rights and privileges necessary, incident to, or convenient for the

economical operation of the lands, alone or conjointly with neighboring lands

for these purposes”). Significantly, the lease also gave Lessee the right “to

use, free of cost, oil, gas and water produced on said land for its

operations.” Id. at ¶13.

      It is undisputed that the Hall lease requires CNX to pay a one-eighth

royalty to the Halls and the other lessors calculated upon the net amount

realized at the point of sale.   CNX allocates royalties among the lessors

based on each lessor’s proportionate contribution to the volume of gas as

measured at the wellhead by the well meter. CNX succinctly described the

calculation as follows:

      The royalty payment to each [lessor] is computed by dividing the
      volume of gas as measured at each well head by the total
      volume of gas measured at all of the wellheads that feed into the
      sales point. This value is multiplied by the amount realized on
      the sale by CNX to compute each well’s proportionate share of
      the amount realized from the sale.

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Appellant’s brief at 8 n.1 (quoting CNX’s Answer to Interrogatory No. 3,

Plaintiff’s Motion for Partial Summary Judgment as to Liability on Counts I

and II of the Second Amended Complaint, Exhibit 1 at 2-3 ). Thus, if there

are multiple lessors contributing gas to the system, CNX measures the

volume of gas at each wellhead, and totals the volumes.       For purposes of

illustration, we assume that the total volume produced is 10,000 units. If

Earl, Sr. and Betty Jane’s well contributed 2000 units, which is twenty per

cent of the aggregate, they would receive a royalty of twenty percent of

one-eighth royalty computed on the net amount realized from the sale.

Assuming Earl, Jr.’s, well contributed 1000 units, he would be entitled to ten

percent of the one-eighth royalty. The other lessors would receive royalties

based upon the proportion of their volumetric contribution of gas to the

aggregate as measured at the wellhead.

       The Halls filed this multi-count contract action on behalf of themselves

and others similarly situated seeking an accounting and asserting that CNX

breached the lease in its allocation of the post-production costs, lost gas,

and used gas.3 The trial court sustained preliminary objections to the Halls’

claim that they were entitled to royalties on the volume of gas produced and

measured at their wells and that this included gas lost or used prior to the
____________________________________________

3
  The Halls also presented a breach of contract cause of action based on
nonpayment of oil royalties that was dismissed pursuant to preliminary
objections, and which is not at issue herein.

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point of sale.     Since the lease provided for calculating royalty payments

based on the amount of gas sold, the court reasoned that the missing gas

was obviously not part of that equation. Trial Court Opinion, 7/29/11, at 3.

The Halls do not challenge that ruling herein. We agree with the trial court’s

reasoning and we utilize it in our disposition of the instant appeal.

        The Halls subsequently amended their complaint to allege, inter alia,

that CNX’s allocation of the lost and used gas among the lessors was

unauthorized under the lease.4 Lost gas is a reduction in the volume of gas

due to evaporation or leakage as it is transported through a pipeline. Used

gas refers to volumes of gas that are used along the pipeline for

compression,      flaring,   venting,    and   other   operations   associated   with

processing raw gas into a marketable gas and transporting it to the point of

sale.

        The Halls moved for summary judgment as to counts I and II of their

complaint alleging breach of contract based on the allocation of lost and

used gas. They contended that since the lease did not authorize the pro rata

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4
   The Halls also alleged that the allocation of post-production costs was not
permitted by the lease. They subsequently withdrew that claim, however, in
light of the Pennsylvania Supreme Court’s decision in Kilmer v. Elexco
Land Servs., Inc., 990 A.2d 1147 (Pa. 2010), which held that a lease that
utilized the net-back method to allocate post-production costs for purposes
of calculating royalties did not violate GMRA, the Guaranteed Minimum
Royalty Act, 58 P.S. § 33.

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allocation of lost and used gas among the lessors, CNX was limited to

deducting only actual volumes of lost and used gas from each lessor’s share

of the royalty. As CNX does not measure the volume of gas from each well

just prior to the point of commingling, and therefore cannot attribute to an

individual well the precise amount of gas lost or used from that well, the

Halls contended that CNX was obligated to pay royalties based on the

volume of gas measured at each wellhead.

      CNX sought summary judgment in its favor.        In support thereof, it

maintained that, due to the fungible nature of the compound and the

physical impossibility of independently tracking each molecule from its

source, it was impossible to attribute any specific amount of gas lost or used

to any one of the individual wells along the pipeline.      CNX renewed its

argument that no royalty was due on gas that was lost or used prior to the

point of sale.   It also steadfastly maintained that it did not deduct an

allocated amount of lost and used gas from the royalty payable on each well.

      The trial court entered summary judgment in favor of CNX and

adopted its opinion in Lawrence v. Atlas Resources, Inc., GD-10-011904

(Alleg.Co. 2012) as the basis for its decision.   The Halls appealed to this

Court and they present one issue for our consideration:

      Whether a natural gas producer may allocate lost and used gas
      even without a provision in the lease authorizing it to do so
      when, under established Pennsylvania law, oil and gas leases are
      to be narrowly construed and the rights not directly conferred by
      the lease language are to be considered withheld by the lessor?

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Appellant’s brief at 2.

      We follow a well-established standard of review in evaluating a trial

court’s grant or denial of summary judgment:

      We view the record in the light most favorable to the nonmoving
      party, and all doubts as to the existence of a genuine issue of
      material fact must be resolved against the moving party. Only
      where there is no genuine issue as to any material fact and it is
      clear that the moving party is entitled to a judgment as a matter
      of law will summary judgment be entered. Our scope of review
      of a trial court's order granting or denying summary judgment is
      plenary, and our standard of review is clear: the trial court's
      order will be reversed only where it is established that the court
      committed an error of law or abused its discretion.

Daley v. A.W. Chesterton, Inc., 37 A.3d 1175, 1179 (Pa. 2012) (citation

omitted). Instantly, there is no dispute between the parties regarding the

facts underlying this appeal; therefore, we confine our review to the trial

court's legal conclusions.

      Our Supreme Court has recognized that an oil and gas lease “is in the

nature of a contract and is controlled by principles of contract law.”     T.W.

Phillips Gas and Oil Co. v. Jedlicka, 42 A.3d 261, 267 (Pa. 2012).           It

must be construed in accordance with the terms of the agreement as

manifestly expressed, and "[t]he accepted and plain meaning of the

language used, rather than the silent intentions of the contracting parties,

determines the construction to be given the agreement." J.K. Willison v.

Consol. Coal Co., 637 A.2d 979, 982 (Pa. 1994) (citations omitted). The

interpretation of any contract is a question of law and this Court's scope of

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review is plenary. Id. Moreover, "[w]e need not defer to the conclusions of

the trial court and are free to draw our own inferences.             In interpreting a

contract, the ultimate goal is to ascertain and give effect to the intent of the

parties   as   reasonably     manifested       by   the   language   of   their   written

agreement."      Humberston v. Chevron U.S.A., Inc., 75 A.3d 504, 509

(Pa.Super. 2013).

       No one disputes that the Hall lease is silent as to the allocation of

royalties generally among the Halls and other lessors.5 However, that is not

the issue before us.       The Halls have not assailed CNX’s right to pro rata

allocate royalties generally.        Rather, their challenge is limited to CNX’s

proportionate allocation of lost and used gas, absent a provision authorizing

such allocation. The issue is one of first impression for this Court.

       The Halls contend that, without language permitting a proportionate

allocation of lost and used gas, CNX can deduct from their royalties only the
____________________________________________

5
  Section 34.1 of The Oil and Gas Lease Act, entitled Apportionment, was
approved on July 9, 2013, effective in sixty days. It provides:

       Where an operator has the right to develop multiple contiguous
       leases separately, the operator may develop those leases jointly
       by horizontal drilling unless expressly prohibited by a lease. In
       determining the royalty where multiple contiguous leases
       are developed, in the absence of an agreement by all
       affected royalty owners, the production shall be allocated
       to each lease in such proportion as the operator
       reasonably determines to be attributable to each lease.

58 P.S. § 34.1 (emphasis added).

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amount of gas actually lost and/or used as measured from each well. The

Halls rely upon this Court’s decision in Pomposini v. T.W. Phillips Gas &

Oil Co., 580 A.2d 776, 778 (Pa.Super. 1990), for the proposition that “all

rights claimed by the Lessee that are not conferred in direct terms or by fair

implication . . . are to be construed as being withheld by the Lessor.” Since

the lessors did not confer the right to allocate lost and used gas “in direct

terms or by fair implication,” Appellant’s brief at 18, the Halls argue that

“[t]he fairer implication is that the parties deliberately excluded an allocation

clause.” Appellants’ reply brief at 5.

      In Pomposini, this Court examined whether a lease for the rights to

extract oil and gas from a lessor’s property permitted the lessee company to

use the well as an underground reservoir to store gas. The lease, which was

“for the sole and only purpose of drilling and operating for natural gas,” was

effective for 20 years or for as long as the lessor’s well produced natural gas

in paying quantities. Id. at 777. The lessor accepted quarterly payments

from the lessee for twenty-five years, believing them to be payment for gas

produced on his land.      Instead, the property was being used solely for

storage and not production of gas. The lessor filed suit against the lessee

alleging that the use of his well for the storage of gas was fraudulent and

unauthorized, and was awarded compensatory damages based on the fair

rental value of the well for that period.

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      Both parties appealed.   This Court pointedly noted that the lease to

which both parties agreed did not expressly authorize the storage of gas,

that it did not establish a rent to be paid for storage purposes, and that it

did not “disclose an implied intent” to allow the same.           Id. at 778.

Accordingly, we concluded that the parties did not contemplate that the

leased premises would be used for gas storage.        Since the lease did not

expressly authorize or fairly imply that the lessee was permitted to use the

property to store gas, the right to such storage was not conferred to the

company and was instead retained by the lessors. Id. at 779 (“Because the

lessee did not acquire an estate in the caverns and was not authorized to

store gas on plaintiff's land, . . . the lessee was liable for the unauthorized

storage of gas on Pomposini's land.”).

      The Halls contend that, under the reasoning in Pomposini, since CNX

can deduct from royalties only the actual amount of gas actually lost and/or

used from each well, and CNX has no means to measure that amount at the

point of commingling, the lessors retain the right to all of the royalties on

the lost and used gas.    Accordingly, the Halls argue they are entitled to

royalties based on the volume of gas as measured at each wellhead, despite

the lease provision calculating the royalty on the volumes of gas sold.

      CNX counters that the trial court ruled, and the Halls concede, that the

lease provides for the payment of a one-eighth royalty on the amounts

realized from the sale of gas. See Appellant’s brief at 6. It also cites the

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trial court’s earlier ruling on preliminary objections that the Halls were not

entitled to a royalty on gas that was lost or used prior to the point of sale

since the Hall lease only provides for royalties on the net amount realized

from the sale of gas. According to CNX, “if the gas does not reach the point

of sale and there are no proceeds, there is no royalty due.” Appellee’s brief

at 10. Consequently, lost and used gas is not allocated as part of the royalty

allocation.

       CNX also takes issue with the Halls’ assertion that it deducted some

value from the royalty payable for lost and used gas.6      Rather, the one-

eighth royalty was calculated when the gas was sold, and at that point, the

lost and used gas was not in existence. In short, royalties were not due on

lost and used gas as it did not reach the point of sale. CNX contends that

the foregoing analysis is dispositive of the issue. It alleges that the Halls’

argument based on Pomposini is misplaced and nothing more than an

____________________________________________

6
 Unlike the lease herein, the royalty provision in the lease in Lawrence v.
Atlas Resources, Inc., GD-10-011904 (Alleg.Co. 2012), provided for a
deduction for the cost of transportation and compression. The lessee agreed

       (b) to pay to the Lessor, as royalty for the gas marketed and
       used off the premises and produced from each well drilled
       thereon, the sum of one-eighth (1/8) of the price paid to Lessee
       per thousand cubic feet of such gas so marketed and used . . .
       less any charges for transportation or compression paid by
       Lessee to deliver the gas for sale . . .

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attempt to circumvent clear language in the lease that royalties are to be

calculated at the point of sale.

       Although CNX consistently maintains that there is no missing allocation

term vis ‘a vis lost and used gas, it argues in the alternative that, even

assuming a term is missing, the trial court properly supplied that term. CNX

contends that either the Restatement (Second) of Contracts § 204, utilized

by the trial court below and in Lawrence, or custom and practice in the

industry as employed by the district court in Pollock v. Energy Corp. of

Am., 2013 WL 275327 (W.D.Pa. 2013), can remedy any deficiency.

       In Lawrence, the gas lease provided for a one-eighth royalty

computed at the point of sale, minus a deduction of charges                for

transportation and compression. The lessee apportioned pro rata the royalty

among the landowners based upon each well’s percentage of the overall

production.     The landowners argued that, as a result of the allocation

method used, some property owners did not receive what was promised,

i.e., a royalty of at least one-eighth of the sale value of his gas less the

deduction for transportation and compression.7 The court concluded that the

lease unambiguously provided for royalties to be based on the volume of gas

____________________________________________

7
  The landowners also argued that the pro rata deduction of transportation
and compression costs resulted in some landowners receiving a royalty that
was less than the agreed-upon royalty.

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sold, not the volume of gas produced at the wellhead.          See Lawrence

Opinion, 12/12/12, at 7. (“There is no language that provides for royalties

to be based on the volume of gas recorded at any location other than the

point of sale.”). The court found, however, that the lease was silent on the

method of allocation of the one-eighth royalty among the landowners.         It

relied upon the Restatement (Second) of Contracts § 204 (1981), to supply

“a term which is reasonable” and which comports with community standards

of fairness and policy. Comment d. In doing so, the trial court explained:

      I find that the use of the pro rata method allows each party to
      receive what the party expected to receive.       [The lessee]
      intended to expend seven-eighths of the transportation costs
      and receive seven-eighths of the purchase price. By using the
      pro rata method for calculating what each property owner will
      receive, [the lessee] will receive the share described in the
      lease.

Trial Court Opinion, Lawrence, supra, at 8.      The method, the trial court

opined, was consistent with the expectations of both sophisticated and

unsophisticated sellers and community standards of fairness.

      In Pollock, the landowners advanced an argument similar to the one

proffered herein regarding the allocation of lost and used gas.     Since the

lease did not contain a provision for allocating lost and used gas, the lessor

argued that the lessee could only deduct the value of the volumes of gas

that it could establish were actually sustained at a particular well.     The

Pollock Court found that, pursuant to the terms of the lease, the

landowners agreed to a royalty calculated on the net proceeds from the sale

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of gas. In the absence of a clear indication from the parties regarding the

allocation of those royalties, the court looked to industry custom and

practice. It credited the opinion of the gas company’s expert witness that,

although leases have historically been silent on the issue of allocation, it has

long been the custom in the industry to combine gas production from several

wells and then use a reasonable method of allocation to calculate the

royalties for the individual wells.

      We observe preliminarily that the Halls’ position is predicated on the

assumption that lost and used gas is part of the royalty, a premise that CNX

disputes and the trial court rejected.           See Appellant’s brief at 8 (“CNX

allocates lost and used gas when calculating gas royalties.”). CNX maintains

that it “allocates pro rata the amounts realized from the volumes of gas sold

back to the various wells and lessors that contribute to the sold volumes,”

and “pays a royalty based on those amounts.”                Appellee’s brief at 7

(emphasis added). According to CNX, there is no volume of lost and used

gas at the point of sale to allocate.

      We agree with CNX.         Its argument highlights a critical distinction

between the lease in Lawrence and the Hall lease that the trial court did

not appreciate. See Trial Court Opinion, 10/27/14, at 1 (stating “there are

no material factual differences between the present case and Lawrence”).

The argument in Lawrence was that there was no lease term authorizing

the allocation of royalties.    The Halls argue here that there is no term

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allocating the royalties on lost and used gas.        Admittedly, both leases

state that royalties are to be based on the net amount realized at the point

of sale.   However, as the trial court properly concluded when it sustained

preliminary objections to the Halls’ claim of breach of contract for non-

payment of royalties for lost and used gas, the volume of lost and used gas

is not part of the royalty calculation in this case.        Despite the Halls’

insistence that CNX deducts the volume of lost or used gas from the one-

eighth royalty computed at the point of sale, the record does not support

that contention. Gas lost or used on the way to the point of sale is simply

not part of the royalty computation. It necessarily follows that lost and used

gas is not allocated when the royalty is allocated among the various lessors.8

       Hence, with regard to the lost and used gas specifically, we find no

ambiguity or missing allocation term in the Hall lease.          The language

providing for royalties to be calculated on the net amount realized at the

point of sale obviates the need for a term allocating lost and used gas.9

Accordingly, for purposes of our disposition herein, we need not engage in
____________________________________________

8
   The Halls rely upon CNX’s answers to two interrogatories as the basis for
their contention that CNX deducts an allocated amount of lost and used gas
from each lessor’s royalty. See CNX’s Answers to Interrogatories, Nos. 3
and 8. Neither answer supports that interpretation.
9
  In effect, CNX bears seven-eighths of any lost revenue attributable to lost
and used gas; the lessors bear one-eighth of the lost revenue. That
allocation is dictated by the provision in the lease that the one-eighth royalty
is based on the net amount realized at the point of sale.

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the debate whether our Supreme Court has adopted or sanctioned the

Restatement (Second) of Contracts § 204, that would permit us to supply an

essential missing term into the lease. See Lawrence, supra; see Banks

Engineering Co. v. Polons, 752 A.2d 883 (Pa. 2000). Moreover, we need

not consider the wisdom of importing industry custom and practice to supply

missing contract terms. See Pollock, supra.

     Order affirmed.

Judgment Entered.

Joseph D. Seletyn, Esq.
Prothonotary

Date: 4/7/2016

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