Appalachian Land Company v. EQT Production Company

Filing

Per Curiam OPINION filed: In view of the decision by the Kentucky Supreme Court, we must REVERSE the judgment of the district court in EQT s favor and REMAND the case for further proceedings consistent with the state court s holding. Decision not for publication. Martha Craig Daughtrey, Circuit Judge; Karen Nelson Moore, Circuit Judge and Jane Branstetter Stranch, Circuit Judge.

Case: 12-5589

Document: 60-2

Filed: 10/27/2015

Page: 1

NOT RECOMMENDED FOR FULL-TEXT PUBLICATION
File Name: 15a0719n.06
No. 12-5589

UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
APPALACHIAN LAND COMPANY,
Plaintiff-Appellant,
v.
EQT PRODUCTION COMPANY,
Defendant-Appellee.

BEFORE:

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FILED
Oct 27, 2015
DEBORAH S. HUNT, Clerk

ON APPEAL FROM THE UNITED
STATES DISTRICT COURT FOR THE
EASTERN DISTRICT OF KENTUCKY

DAUGHTREY, MOORE, and STRANCH, Circuit Judges.

PER CURIAM. In this diversity-jurisdiction case, we certified a question of Kentucky
law to the Kentucky Supreme Court, after concluding that it was “determinative of the cause then
pending before the originating court and as to which it appears . . . that there is no controlling
precedent in the decisions of the Supreme Court and the Court of Appeals of [Kentucky].”
Ky. R. Civ. P. (CR) 76.37(1). The Kentucky Supreme Court graciously accepted certification
and has provided us with an interpretation of a state tax statute that resolves the dispositive issue
in this case. See Appalachian Land Co. v. EQT Prod. Co., ___ S.W.3d ___, No. 2013-SC000598-CL, 2015 WL 4972511 (Ky. Aug. 20, 2015) (construing Section 143A.020(1) of the
Kentucky Revised Statutes, under which the Commonwealth levies a severance tax on the gross
value of natural resources that are extracted or processed within Kentucky).

Case: 12-5589

Document: 60-2

Filed: 10/27/2015

Page: 2

No. 12-5589
Appalachian Land Company v. EQT Production Company
The dispute concerns whether, under Kentucky’s “at-the-well” rule, defendant EQT
Production Company, a natural gas-processor, could deduct the amount of the severance tax it
paid on natural gas extracted under a lease with Appalachian Land Company when calculating
the royalties owed to Appalachian. Because natural gas is not typically sold at the wellhead, an
extractor such as EQT incurs certain post-production costs prior to the sale of the gas at a site
away from the well itself, for collection, processing, and transmission to the point of sale. See
Poplar Creek Dev. Co. v. Chesapeake Appalachia, LLC, 636 F.3d 235, 238–39 (6th Cir. 2011).
Because these costs increase the value of the product at the time it is sold, they are deducted
from the final sales price before calculating the royalties payable to the lessor based on the
market price of gas at the well. See id.
In this case, EQT also deducted the full amount of the severance tax paid pursuant to
Section 143A.020(1). That tax is levied “[f]or the privilege of severing or processing natural
resources . . . at the rate of four and one-half percent (4.5%) on natural gas . . ., such rates to
apply to the gross value of the natural resource severed or processed . . . .” Ky. Rev. Stat.
' 143A.020(1). The “gross value of natural resources severed or processed” is further defined by
statute as “the amount received or receivable by the taxpayer” or “the fair market value for that
grade and quality of the natural resource.” Ky. Rev. Stat. ' 143A.010(5)(a) and (b).
Appalachian sued EQT, claiming that EQT’s deduction was improper because it resulted
in an underpayment of royalties. Appalachian argued in the district court that the royalty
payments due under the lease “at the rate of one-eighth (1/8) of the market price of gas at the
well” should have been based upon the value of the gas after deducting the post-production costs
but without deducting the severance taxes paid pursuant to Section 143A.020(1).

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Case: 12-5589

Document: 60-2

Filed: 10/27/2015

Page: 3

No. 12-5589
Appalachian Land Company v. EQT Production Company
The district court disagreed and entered judgment on the pleadings in favor of EQT. On
appeal, we determined that the issue was an unresolved matter of Kentucky state law that was
better left to the judgment of the state courts. In the absence of clear guidance from the
Kentucky courts, we certified the following question:
Does Kentucky=s Aat-the-well@ rule allow a natural-gas processor to deduct all
severance taxes paid at market prior to calculating a contractual royalty payment
based on “the market price of gas at the well,” or does the resource=s at-the-well
price include a proportionate share of the severance taxes owed such that a
processor may deduct only that portion of the severance taxes attributable to the
gathering, compression, and treatment of the resource prior to calculating the
appropriate royalty payment?
Appalachian Land Co. ___ S.W.3d at ___, 2015 WL 4972511 at *1.
The Kentucky Supreme Court reformulated the dispositive issue and held that “the
producer severing natural gas from the earth [here, EQT] is solely responsible for the payment of
the severance tax” due under Section 143A.020(1). Id. (emphasis added). In reaching this
conclusion, the court first noted that:
This tax applies to “all taxpayers severing and/or processing natural resources in
this state . . . .” KRS 143A.020(2). “Severing” is defined as “the physical
removal of the natural resource from the earth or waters of this state by any
means.” KRS 143A.010(3). “‘Processing’ includes but is not limited to breaking,
crushing, cleaning, drying, sizing, or loading or unloading for any purpose.” KRS
143A.010(6).
Id. at *2. The Kentucky Supreme Court then observed that Appalachian was “not engaged in the
business of producing natural gas” and that EQT was “the only party to the lease that engage[d]
in severing the gas” and also “the only party to the lease involved in bringing the gas to market
and, thus, processing the gas.” Id. at *3. Finally, the court said:
[I]t is critical to our analysis that the natural gas tax is assessed for the “privilege
of severing or processing” the gas. This is a privilege [Appalachian’s predecessor]
surrendered over seventy years ago. Absent a clear legislative directive to the
contrary, the privilege to deplete this non-renewable resource and bring it to
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Case: 12-5589

Document: 60-2

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No. 12-5589
Appalachian Land Company v. EQT Production Company
market is most logically bestowed upon the producer—not the passive lessor from
whose land the resource is being severed.
Id. As a result, the court held, “royalty owners are not statutorily liable for the severance tax
assessed under KRS Chapter 143A,” and “absent a specific contractual provision apportioning
severance taxes, lessees may not deduct severance taxes or any portion thereof prior to
calculating a royalty value.” Id. at *7.
In view of this decision by the Kentucky Supreme Court, we must REVERSE the
judgment of the district court in EQT’s favor and REMAND the case for further proceedings
consistent with the state court’s holding.

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