WVDEP Moves to Dismiss Gas Producer Lawsuit Claiming "Flat Rate Statute" is Unconstitutional
June 6, 2018
We have previously written about a gas producer’s suit against WVDEP claiming that West Virginia’s “Flat Rate Statute” unconstitutionally impairs flat rate gas leases. In a flat rate lease, the producer pays a regular, often annual fee to the mineral owner rather than paying a royalty based on the amount of oil and gas that is produced. The history of flat rate leases in West Virginia is explained in detail in our earlier post and is briefly summarized below.
The West Virginia Legislature effectively barred the continued use of flat rate leases in 1982, reasoning that technological advances had rendered such leases unfair to mineral owners. See W.Va. Code §22-6-8. Specifically, the legislation prohibited WVDEP from issuing new well permits to oil and gas operators under flat rate leases unless the operator agreed to pay at least a 1/8 royalty of the working interest “at the wellhead.” W.Va. Code §22-6-8(e).
The 1982 legislation ultimately created confusion with respect to “post-production” expenses – i.e., costs related to severance taxes, pipelines, surface facilities, transportation, manufacturing, or marketing oil and gas. With the legislation silent on the issue, producers began deducting these post-production expenses from royalty payments. In the 2000s the West Virginia Supreme Court took on the issue of the extent to which producers could deduct post-production costs. While those cases limited the ability of producers to deduct these costs, it did not discuss whether post-production costs could be deducted if the royalty was based solely on the 1982 statute that converted flat rate leases to production based leases. Rather, these cases evaluated the term “at the wellhead” using contract principles.
In 2017, the State Supreme Court addressed whether post-production costs were deductible for royalty payments that were invoked under the “Flat Rate Statute.” The Court ultimately ruled that the Flat Rate Statute unambiguously authorized lessees to deduct post-production costs that had actually been incurred.
In response to the Court’s ruling, the West Virginia Legislature amended W.Va. Code §22-6-8(e) to prohibit lessees from deducting post-production costs for older flat rate leases. See W.Va. Senate Bill 360.
In April of this year EQT Production Company filed a federal suit against WVDEP claiming that the application of West Virginia’s Flat Rate Statute as amended by Senate Bill 360 violated the Contract Clause of the United States Constitution. Specifically, EQT’s Complaint asserted that the Contract Clause requires states to demonstrate a significant and legitimate purpose and that contractual adjustments they make must be reasonable and appropriate to serve those purposes. The Flat Rate Statute, EQT argued, fails the test because it “shift[s] the benefits of private parties” and “is not in any way related to any conceivable state interest in effecting the permitting regime.”
On May 31, the day that Senate Bill 360 became effective, WVDEP filed a motion to dismiss EQT’s Complaint. WVDEP argues that EQT may not file a federal Constitutional challenge for monetary damages against West Virginia since the State had not waived its sovereign immunity under the Eleventh Amendment. WVDEP also argues that Senate Bill 360 does not “substantially” impair EQT because it simply modifies how lease royalties will be paid instead of preventing EQT from recovering and marketing gas altogether.