Richlands lawyer challenges Virginia Gas and Oil Act

A Richlands, Va., attorney is challenging the constitutionality of the Virginia Gas and Oil Act, arguing that it deprives mineral owners of their property without due process and without guaranteeing them just compensation, according to a lawsuit filed last week in Tazewell County Circuit Court.

T. Shea Cook, a personal injury and criminal defense lawyer, brought the suit on behalf of a Texas resident who was forced by the Virginia Gas and Oil Board in 2007 to lease his mineral interests in Buchanan County, Va., to a private energy corporation. The lawsuit names as defendants Stephen Walz, director of the Virginia Department of Mines, Minerals and Energy; and Bradley Lambert, chairman of the Virginia Gas and Oil Board.

In a wide-ranging argument, Cook contends that the 1990 Virginia Gas and Oil Act fails to protect the interests of people forced by the state to lease their natural gas rights. He charges that the regulatory framework has improperly allowed gas producers to deduct expenses from royalty payments to mineral owners, and created a “cartel” of a few dominant corporations that has removed competition from the state’s gas market.

Aggravating these factors, Cook argues, is a lack of meaningful state oversight to ensure that energy corporations accurately report production and make the legally required royalty payments. He incorporates as evidence the findings of a recent Bristol Herald Courier investigation that revealed scant oversight and irregularities in a state-run escrow fund that holds $25 million of gas royalties in limbo.

Cook, 43, has two goals in challenging the law: invalidating it and spurring state lawmakers to cure what he views as its defects.

“What I hope is that the legislature will begin acting in a positive way that creates real oversight and real protection for gas owners in Southwest Virginia,” Cook said in a telephone interview.

Among the chief aims of the 1990 statute was to create a way to economically develop the commonwealth’s reserves of coalbed methane – a gas that clings weakly to coal seams and now accounts for 80 percent of all gas produced in the state.

By allowing private companies to “pool” 100 percent of the coalbed methane interests in a state-defined gas unit, the law dramatically expanded gas production in Southwest Virginia. The practice of forced pooling is common in states across the country, but lingering disputes over coalbed methane ownership has led the Virginia Gas and Oil Board to funnel into escrow millions of dollars that belong to thousands of mineral owners. Extracting those royalties requires owners to sue to prove their rights, or else agree to split with another party that claims them.

Cook’s client, John Sheffield, is the sole proprietor of an independent grocery store in Kerrville, Texas. He inherited a mineral interest in about 3,000 acres in Buchanan County from his grandmother, a onetime resident of Bluefield, Va.

“I’m just a simple guy from Texas who sees a problem,” Sheffield said by phone.

Cook and Sheffield are not the first to question the constitutionality of Virginia’s gas and oil statute. And the state’s attorney general already has issued what may or may not foreshadow the state’s formal response.

The state’s defense
In March 2009, at a hearing of the Virginia Gas and Oil Board in Abingdon, Delegate Bud Phillips surveyed the room packed with angry landowners, gas industry representatives and their attorneys.

Phillips was fresh from a defeat at the recently concluded General Assembly, where he ultimately killed his legislation – designed to stop gas producers from deducting transportation-related costs from royalties owed to people who had been forced to lease – after amendments to it drastically changed the content.

“Landowners feel like they’ve been wronged,” Phillips, a Castlewood Democrat, told board members. “I strongly suspect that’s correct – that their money, that their royalties, have been taken away from them without due process by the state.”

An attorney, Phillips had opposed the passage of the Virginia Gas and Oil Act in 1990, and now he raised questions about its constitutionality and whether the board had overstepped its authority by allowing gas companies to make deductions not specifically allowed in the statute.

Phillips called on the board to request an opinion from the Virginia Attorney General about the legality of the practice of forced pooling and of deducting post-production costs from royalties owed to force-pooled owners.

In June 2009, Virginia Attorney General William Mims responded, defending the Gas and Oil Act and the board’s orders as an appropriate use of “police powers” reserved to the state.

In separate opinions addressed to Phillips and to Lambert, the Gas and Oil Board chairman, Mims wrote that forcing people to lease their mineral rights was not an unconstitutional taking – even when it “imposes some economic burden or loss of property.”

In cases where the board’s action “results in substantial diminution of property values, an owner has no right to compensation for legislation which, in the judgment of the legislature, was of greater value to the public.”

To be clear, Mims wrote, “There has been no taking or damage to private property for public use.”

But Mims won’t be in charge of responding to Cook’s challenge. That job will transfer to Attorney General-Elect Ken Cuccinelli, a former Republican state senator and staunch defender of private property rights, who in 2007 drafted a reform of the state’s eminent domain statute to strengthen protections for property owners.

Cook’s challenge
What drives a lawyer with negligible experience in the highly specialized arena of Virginia mineral law to take aim at its legal framework?

For Cook, it began with a steady stream of clients asking for his help in reading gas leases. Many Southwest Virginians, he noticed, were splitting their gas royalties with coal companies in an effort to dislodge them from escrow.

“Those individuals, but for their poverty, should have no interest in giving away what they own to a coal company,” Cook said. Their limited means, combined with the onerous burden of proving ownership established by the state law, “financially coerced” them into splitting royalties, Cook said.

Asked what prompted him to file his challenge, he said, “I didn’t see anybody else doing anything about it.”

There is no reference in Cook’s 42-page petition to Mims’ defenses of the statute, but he is nonetheless familiar with them. In fact, he said, the opinions further motivated him to pursue legal action.

“The interpretation that the post-production charges were permissible: I found that to be unacceptable,” Cook said.

Few practices of the gas industry have sparked as much controversy as charging people – forced to lease – a fee for getting their gas to market.

The industry argues that companies enhance the value of an owner’s gas by treating it, compressing it and moving it along a pipeline to the market that offers the highest price, and that owners should bear a portion of those costs.

Many force-pooled owners, though, view such deductions as adding insult to injury – whittling away at the royalty they receive when they didn’t want to lease in the first place.

The Virginia Gas and Oil Act does not specifically authorize companies to take such deductions, but the Gas and Oil Board has allowed the practice in its regulations – which Mims defended as within the scope of the board’s power to interpret the law.

Cook argues that allowing deductions “constitutes a further taking and devaluing of property by the Commonwealth for private gain” – and without state oversight to determine whether the deductions are reasonable.

But in Cook’s view, the devaluation of individuals' mineral property begins even before their gas is produced.

Just compensation?
The Virginia Gas and Oil Act allows energy corporations to pool the interests of all mineral owners in a coalbed methane unit – generally 60-80 acres – and pay them a one-eighth royalty from the proceeds, based on their interest in the unit. Because a handful of corporations dominate gas production in Southwest Virginia, Cook argues, the one-eighth royalty established by law “eliminates any ability for the owners of the gas to effectively negotiate” with gas well operators, which he dubs “the cartel.”

These operators know that in most cases they can force individuals to lease at the one-eighth royalty, and so have little incentive to offer to lease their property at a higher rate. Because a few companies control the rights to produce gas in most of the region, they can maneuver to prevent would-be competitors from outbidding them, Cook argues, resulting in artificially low royalty payments.

In 2008, two corporations – CNX Gas Co. and EQT Corp. – produced 97 percent of all coalbed methane in the state, according to Virginia Division of Gas and Oil records.

State law gives three options to mineral owners forced to lease: They can choose to participate in a well by footing their proportion of the costs up-front, and fully share in the risk and proceeds; choose to receive nothing until the well has paid for itself twice, and then share fully in the proceeds; or accept a payment of $1 to $5 per acre for their mineral acreage, and a one-eighth royalty according to their interest in the well.

If mineral owners make no choice – and many do not – they are leased according to the third option by default.

What a gas owner cannot choose, Cook asserts, is “who he wants to develop the [coalbed methane] reserves, how he wants to develop it, or when he wants to develop it.”

Aggravating these factors, according to Cook, is a general lack of state oversight that stretches from accuracy checks on gas meters to compliance checks on gas corporations required to pay royalties into escrow.

Noting that the Herald Courier found cases of royalties that should have been paid years ago, Cook wrote, “The inadequacy and inaccuracy of the financial accounting of the escrow accounts constitutes a due process violation of the rights of those individuals whose funds are escrowed.

“The violation is aggravated by the refusal of the board to take meaningful steps to conduct a forensic audit, despite repeated requests from the public” – including himself in September 2009.

Though the Gas and Oil Board last month voted to authorize the first audit of the escrow fund in a decade, Cook was nonplussed.

“Even what has been voted on recently doesn’t provide accountability that ensures what is being put into those escrow accounts is what should be there,” he said.

Cook also blames state legislators for failing to provide the Division of Gas and Oil with the funding and resources necessary to meet its statutory obligations.

“It is inconceivable that a director with such few employees can adequately carry out the statutory mandate of the 1990 Act or provide the necessary regulatory oversight,” he wrote.

dgilbert@bristolnews.com | (276) 645-2558