Implied Duty to Market and Free-of-Cost Royalties: Extending Wellman & Tawney to In-Kind Oil & Gas Leases

Introduction

In Francis Kaess v. BB Land, LLC, the Supreme Court of Appeals of West Virginia confronted two certified questions from the U.S. District Court for the Northern District of West Virginia. The dispute arose under a 1979 “in-kind” oil and gas lease covering mineral interests in Pleasants County, West Virginia. The lessor, Francis Kaess, declined to take his one-eighth share of production physically “in-kind,” so the lessee, BB Land, sold his share and deducted post-production costs from his royalty payments. Kaess sued, relying on this Court’s precedents in Wellman v. Energy Resources, Inc. (2001) and Estate of Tawney v. Columbia Natural Res., LLC (2006), which prohibit deductions of marketing and transportation expenses from royalties absent clear lease language. The key issues certified were:

1. Whether an implied duty to market arises in leases containing an in-kind royalty provision when the lessor does not take production in-kind; and
2. Whether the prohibitions against post-production cost deductions under Wellman and Tawney extend to in-kind royalty leases.

Summary of the Judgment

On June 6, 2025, Chief Justice Wooton, writing for a majority, answered both certified questions in the affirmative:

• Implied Marketing Duty: Except as contractually altered, every oil and gas lease—whether proceeds-based, flat-rate, or in-kind—carries an implied covenant that the lessee must market and sell royalty owners’ share if the owners do not take it in-kind.
• Post-Production Cost Rules Apply: When a lease contains an in-kind royalty clause and the lessor fails to take physical production, the lessee must tender the lessor’s share of the gross proceeds, free of any deductions for post-production marketing or transportation costs, at the first point of sale to an unaffiliated third party.

The Court remanded for further proceedings consistent with these principles.

Analysis

1. Precedents Cited and Their Influence

• Light v. Allstate Ins. Co., Aikens v. Debow, Harper v. Jackson Hewitt, Inc. (1998–2010)
  Established that certified questions of state law are reviewed de novo by this Court.
• Wellman v. Energy Resources, Inc. (2001)
  Held that, in a proceeds-based royalty lease, the lessee bears all costs of exploring, producing, marketing, and transporting produced gas or oil to the point of sale, unless the lease unambiguously shifts costs to the lessor. Syllabus Pt. 4.
• Estate of Tawney v. Columbia Natural Res., LLC (2006)
  Clarified that lease language such as “royalty at the wellhead” or “net of all costs beyond the wellhead” is ambiguous and insufficient to permit post-production cost deductions. Syllabus Pts. 10–11.
• Leggett v. EQT Production Co. (2017)
  Interpreted the flat-rate royalty statute and initially held that “at the wellhead” in a statutory affidavit allowed cost deductions—an interpretation subsequently overruled by legislative amendment.
• Kellam v. SWN Production Co., LLC (2022)
  Reaffirmed Wellman and Tawney as West Virginia common law, refused to overrule them, and reiterated their three-part requirements for cost-shifting language:
  1. Express indication that lessor will bear some costs;
  2. Specific identification of the deductions;
  3. Method of calculating deductions.
• West Virginia Code § 22-6-8(e) (2018 amendment)
  Statutorily adopted the “first point of sale” / “free from post-production expenses” formula of Wellman and Tawney for flat-rate leases, thereby overruling Leggett.

2. Legal Reasoning of the Court

The Court’s decision rests on three pillars:

1. Stare Decisis and Legislative Endorsement: Kellam reaffirmed Wellman and Tawney, and the Legislature’s prompt amendment of § 22-6-8(e) to adopt those decisions signals the State’s commitment to prohibit post-production cost deductions absent clear lease language.
2. Implied Covenant to Market: In the absence of an express provision to the contrary, every lease carries an implied duty on the lessee to prevent waste by marketing production. If a lessor fails to take in-kind and the lessee does not purchase the share or deliver it pipeline-free, the only way to fulfill the royalty covenant is to market the lessor’s share alongside the lessee’s own production.
3. Extension of Post-Production Cost Rules to In-Kind Leases: Once the lessee markets the lessor’s in-kind share, the royalty becomes a monetary share of proceeds. Under Wellman and Tawney, that share must be calculated “free from any deductions for post-production expenses” at the first point of sale, absent “express, unambiguous” cost-shifting language.

3. Potential Impact on Future Cases and the Oil & Gas Industry

• Uniform royalty recovery rules will apply to proceeds, flat-rate, and in-kind leases, reducing litigation over what type of lease is at issue.
• Lease negotiators will draft more detailed cost-allocation clauses if they intend to shift any post-production expenses to lessors.
• Producers must track and document post-production costs meticulously, since any attempt to deduct such costs from royalties will be scrutinized for express lease authority, reasonable incurrence, and actual expenditure.
• Greater royalty income predictability for mineral owners may spur increased investment in West Virginia’s natural resources.

Complex Concepts Simplified

• In-Kind Royalty: Lessor receives a physical share of production (e.g., one-eighth of the gas), rather than a cash amount.
• Proceeds Royalty: Lessor receives a fraction of the money the producer actually receives when it sells the product.
• Flat-Rate Royalty: Lessor receives a fixed monetary payment per well per year.
• Implied Covenant to Market: Even if not spelled out in a lease, the law assumes the producer must sell production for the lessor if the lessor cannot or does not take it in-kind.
• Post-Production Costs: Expenses incurred after drilling and extraction—such as gathering, treating, compressing, processing, marketing, and transporting hydrocarbons to sale points.
• First Point of Sale: The place where the producer’s product first enters an arm’s-length transaction with an unaffiliated buyer.
• “Free from Any Deductions”: The royalty calculation must be based on gross proceeds without subtracting post-production costs, unless the lease clearly and unambiguously says otherwise.

Conclusion

Francis Kaess v. BB Land, LLC marks a significant extension of West Virginia’s anti-deduction framework for post-production costs into the realm of in-kind leases. By recognizing an implied duty to market and applying the well-settled rules of Wellman and Tawney to any lease requiring the sale of lessor production, the Court has unified royalty protections across all lease types. Going forward, lessors may confidently anticipate royalties calculated on gross proceeds at the first point of sale, and lessees must negotiate explicit cost-sharing terms if they wish to allocate any marketing or transportation expenses to their counterparties.