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ND Justices Say Lease Lets Oil Producers Deduct Costs

The North Dakota Supreme Court has ruled in a question of first impression that a lease provision at issue in five pending federal proposed class actions allows for post-production expenses to be deducted from oil royalty payments.

Answering a certified question from a North Dakota federal court, the court held in a 4-1 decision Thursday that leases entered by royalty owners David and Pauli Blasi provide that oil and gas producers can deduct from royalty payments the cost of bringing oil to market.

The Blasis have brought five putative class actions against Continental Resources Inc., EOG Resources, Lime Rock Resources Operating Co. Inc., Bruin E&P Partners LLC and Kraken Development III LLC in North Dakota federal court, claiming they were underpaid royalties because the companies overcharged them for post-production costs.

The court said the royalty language in the lease — "free of cost, in the pipeline to which lessee may connect wells on said land" — can be unambiguously interpreted to value oil produced under the lease at the wellhead. Because the valuation point is where the oil comes out of the ground, the companies producing that oil can deduct post-production expenses from the royalties they pay to the Blasis.

"We conclude, as a matter of law, that the royalty provision in this case establishes a valuation point that is at the well," Chief Justice Jon J. Jensen wrote for the majority.

The state's high court had not previously weighed in on how to interpret that royalty language. U.S. District Judge Peter D. Welte certified a question of how to interpret the language to the state high court, and said when he did so that a valuation point at the wellhead would mean the Blasis' unpaid royalty claim would "likely be subject to dismissal."

Stinson LLP, the law firm representing Bruin and Kraken, said in a statement Friday that the oil royalty provision at issue in the opinion exists in "virtually every standard-form oil and gas lease" throughout the country. The firm said the state high court's ruling is expected to end somewhere between 15 and 20 pending class actions in North Dakota federal court that involve the provision and said the effects of the ruling will likely be felt nationwide.

The Blasis had urged the high court not to take up the question at all, arguing discovery was needed to determine what the term "pipeline" meant in the royalty provision of the lease. They cautioned that a premature answer to the certified question could have far-reaching and unexpected consequences.

But the majority, which acknowledged that the implications of the dispute are "of some magnitude," said it didn't need to consider outside evidence to properly interpret the lease.

"The exact meaning of the word 'pipeline,' and whether any specific pipe constitutes a 'pipeline,' is not dispositive of the issue," the court said. "Nor is it necessary to know exactly which costs were deducted to interpret the royalty provision. No matter which costs were deducted, the valuation point will remain the same, and whether deduction of a certain cost was permissible can only be determined after a valuation point is established."

The Blasis had argued that under the lease, the valuation point is not reliant on the well's location but is rather when it reaches a specific pipeline that will transport the oil to a refinery.

In a dissent, Judge David W. Nelson said he would have declined to answer the certified question until more information was available. Judge Nelson is a retired state court judge sitting in on the case by designation because Justice Gerald W. VandeWalle recused.

"Allowing the parties to conduct discovery would permit the court to actually find out what representations were made by those who created the leases and what the lessors understood those provisions to mean," Judge Nelson wrote. "Discovery might also reveal whether any defendants have taken any positions contrary to their interpretation of the oil royalty provision presently put forth. While this is a very important question, I am left with many questions as to the history and actual practice in the industry."

The Blasis brought the federal proposed class actions in May 2020, accusing the five companies of shorting them on royalties by deducting post-production costs from the sales price of the oil.

"We are satisfied with the conclusion and the answer of this North Dakota Supreme Court," Daniel T. Donovan of Kirkland & Ellis LLP, an attorney for Lime Rock, told Law360 on Friday.

Counsel for Bruin and Kraken declined to comment beyond the statement on Stinson's website. Representatives for the plaintiffs, Continental Resources and EOG Resources didn't immediately respond to requests for comment.

The royalty owners are represented by Mike Montgomery and Kyle G. Pender of Montgomery & Pender PC and Rex A. Sharp, Isaac L. Diel, Charles T. Schimmel and Gregory M. Bentz of Sharp Law LLP.

Bruin E&P Partners LLC and Kraken Development III LLC are represented by Robin Wade Forward and Matthew J. Salzman of Stinson LLP and Paul J. Forster of Crowley Fleck PLLP.

Lime Rock Resources Operating Co. Inc. is represented by Daniel T. Donovan, Ragan Naresh and Katherine Canning of Kirkland & Ellis LLP and Paul J. Forster of Crowley Fleck PLLP.

Continental Resources Inc. is represented by Ronald H. McLean and Kasey D. McNary of Serkland Law Firm and Jeffrey C. King and Elizabeth L. Tiblets of K&L Gates LLP.

EOG Resources is represented by Daniel M. McClure and Rebecca J. Cole of Norton Rose Fulbright and Paul J. Forster and Zachary R. Eiken of Crowley Fleck PLLP.

The consolidated suits are Blasi v. Bruin E&P Partners LLC et al., case number 20200327; Blasi v. Lime Rock Resources Operating Co. Inc. et al., case number 20200328; Blasi v. Kraken Development III LLC, case number 20200329; Blasi v. Continental Resources Inc., case number 20200330; Blasi v. EOG Resources Inc., case number 20200331; all in the Supreme Court for the State of North Dakota.