Great Opinion on Gas Leases from the Sixth Circuit’s Chief Judge Sutton

I have now lived in Oklahoma for five years, and still, I know next to nothing of the law pertaining to the oil and gas industry. It comes up from time to time, and I have to rely on students to explain how things work . This is a genuine liability, but my students indulge me. As Sid DeLong explains here, in order to understand a contracts case, one must understand the underlying transaction. In The Grissoms, LLC v. Antero Reesources Corporation, Chief Judge Sutton (below) explains the transaction succinctly and with crystalline clarity. The opinion is a marvel of explanatory virtuosity.

The opinion begins, charmingly, with the story of the first oil-and-gas lease case in U.S. history. It’s a banger, involving shocking pollution, a river on fire, and the invention of the kerosene lamp. You have my attention, Chief Judge Sutton.

The Grissoms, LLC filed a class action on behalf of 370 Ohio landowners that entered into leases with Antero Resources Corporation (Antero). Judge Sutton then describes in detail the nature of Antero’s operations. It is concise, but I won’t replicate it here. The key element is that Antero pays landowners a 21% royalty on “gross proceeds.” Antero gets to deduct some costs, but Antero may not deduct the costs of “transform[ing] the product into marketable form.” And yet, The Grissoms alleged, Antero deducted the “processing” costs of separating purified natural gas from the non-methane gas mixture, as well as the “fractionation” costs of isolating each discrete gas from that mixture.

The District Court certified the class, granted the landowners’ motion for summary judgment on liability, and entered judgment in the amount that the parties had stipulated as damages — $10 million. The issue on appeal was whether Antero was entitled to deduct processing and fractionation costs from the royalty payments. The lease provides a long list of costs that may not be deducted. However, there is an exception for “any such costs which result in enhancing the value of the any such costs which result in enhancing the value of the marketable oil, gas or other products to receive a better price oil, gas or other products to receive a better price.” (emphasis added)

The trial court determined, and the Sixth Circuit agreed, that the challenged processing and fractionation costs did not enhance the value of any marketable products. Rather, they were necessary to render non-marketable products marketable. The Fourth Circuit reached the same conclusion in another case involving Antero. Judge Sutton then proceeds to explain why Antero’s interpretive arguments, while seemingly sensible in the abstract, do not make sense in the context of the lease agreement taken as a whole. He weighs Antero’s appeals to the commercial reasonableness canon but finds that Antero’s alternative is less reasonable than the landowners’ understanding of the agreement. Any doubts as to the meaning of the lease are to be resolved, under Ohio law, against the drafter. All evidence suggests that Antero drafted the language in question.

All in all, it is a great opinion. It explains a complex set of transactions in plain language and in twelve pages. It provides a great example of contract interpretation, informed by a few canons of construction. I might not use this as a teaching case in a contracts course, because we would have to spend a lot of time unpacking the transaction, but it would be great for an oil and gas course.