The Top 5 Chesapeake Royalty Litigation Trends to Watch

By Keith Mauck

Over the last few years litigation arising from Chesapeake Energy’s royalty practices, has reached a tipping point with a number of new suits being filed in the last year and stretching into new legal theories of liability. The origins of this litigation boom against Chesapeake stems from changes in the company’s royalty calculation, which saw them reinterpreting thousands of royalty agreements beginning in 2012. Among industry observers, this strategy was an attempt partially to mitigate a massive debt burden and cash shortfalls arising out of the 2012 drop in gas prices. Although some experts indicate that, the foundation for this move was rooted in the financial collapse of 2008.

As reported previously, the initial wave of litigation saw the company fighting or settling royalty underpayment lawsuits in Texas, Oklahoma, Louisiana, Arkansas, Kentucky, New York, Virginia and Pennsylvania, areas where Chesapeake leased vast swaths of acreage in the early days of the shale boom. The first wave of lawsuits saw mixed results, with some litigants failing to advance their claims against the company while others were largely successful.

One case that illustrates the potential shift toward decisions favoring royalty owners. In the Demchak litigation (Demchak Partners Limited Partnership, et al. v. Chesapeake Appalachia, L.L.C.), Chesapeake has agreed in principle, although still pending Court approval, to pay $7.5 million as part of a settlement with over 1,000 Pennsylvania landowners claiming an underpayment due to the company deducting post-production costs from royalty checks.[1] The case involved a class action suit involving several thousand leaseholders and prompted the Pennsylvania legislature to pass an amendment to the “Guaranteed Minimum Royalty Act” signed by the Governor requiring royalty check transparency. According to the law listed as Senate Bill 259, royalty check statements must provide a more thorough accounting of payments and deductions.

The second wave of litigation appears to have been spurred on by the success of the Demchak case. In the last year, class action litigation against Chesapeake appeared to be gaining traction. In addition to small leaseholders filing as a plaintiff class, a number of large leaseholders have also advanced litigation with some of the large leaseholders’ cases filed during the first wave of litigation being resolved.  It has also seen litigants expanding their theories of liability to include new claims against the company arising from improper deductions from royalty payments. Lastly, Chesapeake has also drawn the attention of Federal Authorities with criminal enforcement measures being launched in Michigan by the Department of Justice.  This second wave of royalty litigation marks a new phase in which there will likely be more leaseholder litigants advancing claims and most likely case law in a number of state and federal jurisdictions will likely be shaped by this uptick in litigation. 

For royalty owners observing litigation trends against Chesapeake Energy, the following cases could be influential on future royalty dealings with Chesapeake and may shape legal doctrine concerning leaseholder rights. Further, as Demchak illustrated this wave of litigation may act as a potential driver behind new legislation at the state level aimed at how royalties are calculated and disclosed to leaseholders.

The following list represents five recent trends in royalty litigation against Chesapeake to watch in the next year.

5. More Small Leaseholders in Filing Single Cases: The Demchak settlement may act as a trigger point for small leaseholders to advance their claims. However, some firms have elected to employ the strategy of filing individual royalty claims rather than navigate the procedural requirements of establishing a class action suit. For example, the Texas-based McDonald law firm has reportedly been retained by around 4,000 with the hope of 10,000 signing up by Christmas. These suits against Chesapeake in Texas will likely result in a flood of litigation against Chesapeake, which could prove logistically difficult to defend.

4. New Theories of Recovery: In June 2014 a group of Pennsylvania royalty owners have filed suit seeking $5 Million in damages in Federal Court alleging Chesapeake and Access Midstream Partners LP violated the federal Racketeering Influenced and Corrupt Organizations (RICO) Act. This argument takes the traditional royalty claim beyond a matter of contract interpretation to include the allegation that the companies have engaged in a scheme to raise capital by reducing payouts to royalty owners.

3. Potential Criminal Cases: On September 10, 2014 a Michigan State Court judge has ordered that sufficient probable cause existed for the company to stand trial on a racketeering charge and 20 counts of false pretenses charges brought by the Michigan Attorney General. The allegations of the case state that the company allegedly defrauded Michigan property owners by cancelling nearly all of its lease agreements when competition dried up.

2. Developments in Federal Case Law: Two recent federal court decisions this summer coming from the Fifth U.S. Circuit Court of Appeals in New Orleans ruled that Chesapeake could charge royalty owners for post-production costs despite lease provisions, which appeared to state otherwise. This Federal Circuit's jurisdiction includes Louisiana, Texas and Mississippi, potentially affecting Federal and State royalty litigation in these areas.

1. Large Leaseholders Suits: Large leaseholders have brought improper royalty deduction claims against Chesapeake recently with a number of these suits being settled for significant sums of money. For example, the cities of Fort Worth and Arlington sued Chesapeake in 2013 settling their claims this August for over $1 Million. The Hyder family, the leaseholder, owns approximately 1,000 acres, brought a claim against Chesapeake in a San Antonio Court winning an award of $1 Million. Billionaire Ed Bass, Trinity Valley School and Texas Health Harris Methodist Hospital Southwest Fort Worth among others have sued Chesapeake over leases covering 3,290 acres in the Northern District of Texas Federal Court. The case is still pending at this time.

 

 

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Replies to This Discussion

Permalink Reply by jim weyland on October 1, 2014 at 13:42

the only party that won't gripe about a check/reference meter is the party to which it belongs.

Permalink Reply by Larry G Smith P.E. on October 3, 2014 at 6:54

They were taking LA Tax out of the Royalty Checks for the 1st year, while the production was high and keeping that money instead of paying the State. That first year is TAX free income on Royalty. I had been fighting them for a long time about that. If you will look back at your statements for that first year, you can add the State Tax deductions and it should be what you were paid on that check, plus the last month that was due.

Permalink Reply by 30 yr-landman on October 3, 2014 at 8:28

Chesapeake was deducting for LA Tax they weren't paying to the State of LA?  That's fraud!

Frankly....having to pay a state tax on producing hydrocarbons is fraudulent too.  Nowadays, taxes are paid to Feds, State (Ad Valorem, Severance and  Sales) Taxes, County Taxes, school taxes (both on production and on equipment values).  Match that up with State Taxes accessed operators for road, highway and bridge taxes, transportation permits, fuel surcharges and regulatory oil and gas permitting fees, what else can they find......well States have now started to increase their filing and permit fees by a factor of 2-4 times and increased their red tape / confusing regulations with huge penalties.   Wonder all the fees total a year!  Its past time to convene a Constitutional Convention and change things back to reasonable fees or we can kiss the good ole USA Good Bye! (or its it "Bye To God"?)  Can't keep up.  Are you sure it's Tax Free!  These days State's change the rules....retroactively!   (ALWAYS NEED MORE MONEY TO WASTE)

Permalink Reply by Larry G Smith P.E. on October 3, 2014 at 9:27

Better do some research 30 yr-landman.

Permalink Reply by jim weyland on October 3, 2014 at 12:38

lgs- pe,

with apologies to all, i'm sometimes slow to pick up on the tin foil helmet crowd.

jim weyland

Permalink Reply by Steve P on October 4, 2014 at 16:08

I agree that if Chesapeake was deducting severance taxes from royalties when, in reality, they weren't paying those taxes to the State, then that is fraud.  My agreement with you pretty much ends there.

Taxes should be paid by those entities that are making use of public resources.  I no longer live in Louisiana, but when I did, I used the local roads.  I paid gasoline taxes, property taxes, and Louisiana income taxes.  I think I can safely say my car or pickup (or minivan, back in the day) did not provide much wear and tear on the road.  The same can not be said for timber companies or oil and gas producers.  Big trucks wear out road - far in excess of the amount of fuel taxes they pay when they fill up.  Similarly, well permits are a great idea, and the ones asking for those permits should be the ones to pay for them.  While I am a fairly conservative guy, and always vote for conservative candidates, industries that "tax" the local infrastructure of a town or parish should pay fees and taxes that cover the increased costs. 

Occasionally, states or parishes may offer tax incentives to some particular industry to locate in their jurisdiction.  That's a part of competition and free enterprise.  Otherwise, my belief is that industries that consume a great deal of resources should pay a commensurate amount of taxes.  This should not be done in the name of enlarging government expenditures just for the sake of creating jobs, but should be done in the name of offsetting burdens created by that particular industry.

 

Permalink Reply by 30 yr-landman on October 6, 2014 at 1:25

Re: Steve P. comments.......Actually I agree with your comments relative to the payment of taxes commensurate with industry consumption and use....... but what I don't think you see is how these increased fees and taxes many times have filled the State and local tax coffers with so much money that many State, County and City governments are looking to spend, spend and spend more.  (Example....a few weeks ago I was in Laredo, Texas at a high school ball game and needed to find a men's restroom so I went into their "sports facility" only to find a high school workout facility that was clearly "extravagant"......as large and expensive as any that college athletes enjoy at UT, A&M, etc.  It was a prime example of extravagant spending. (also....it took 10 minutes to find a person who even spoke English)  Lastly, what happens when the local oil & gas activity slows down (and it always does), do you think the taxing entities will timely reduce their tax rates and fees.....or their spending?  What about the small independent operator that continues to operate older producing properties in Counties where shale drilling activity has gone crazy.....with no increase in his/her activity......how do you justify increasing taxes and fees on that small operator who has not increased his/her activity???  If you are going to rely upon government to create jobs....say good bye to "competition and free enterprise", government can't create jobs.....government feeds off private business....24 hours a day, 7 days a week.  A very good example is PEMEX who owns and operates all the minerals in Mexico....because of over spending, graft and under the table payoffs.....it takes PEMEX six months to drill/complete a well that takes private industry in the USA 14-20 days to drill/complete??  But the same cry is heard.....Oh but PEMEX creates jobs.  Difference is when a government entity spends more than it takes in....it just increases taxes and fees.  Private business can't do this....not for long (example Chesapeake)......so they start to pinch pennies and cut corners (out of their royalty owners' pockets) and everyone thinks their "scum bags" (for trying to survive).  My best example of government spending.....remember in past years when government employees who drove government vehicles, many of those vehicles were "fleet' vehicles sometimes look alike Dodges with no radios....all the same.....nothing fancy.....just enough for required transportation.  Today, go check those government entity "fleet" vehicle lots today.....SUVs or nice crew cab trucks (some with different luxury packages/options) or Mustang/Camero type sport vehicles.  Just an observation that tells a lot of how government has changed.  One might also ask the local private charities and churches how government taxation / over spending has affected their coffers in recent years?  Are they getting any help from local.State government?          

Permalink Reply by William C. Morrison on October 5, 2014 at 5:17

This is why we use attorneys in our lease dealing now days.  We  have had Chesapeake leases in the past,  but that was almost 20 years ago.  They generally have not come knocking on our door, more recent contenders are Anadarko (which inherited the old T&P bunch out of Fort Worth, TX).  At any rate our last leaser was a front company out of Lafayette and we had the attorneys clean up the lease.  That is the only way to go.

Permalink Reply by Skip Peel - Mineral Consultant on October 5, 2014 at 5:51

Major and mid-major E&P companies leasing for modern (read, "unconventional") plays do not have the manpower required to lease large areal extents themselves.  The energy company land department designs the lease program and the company landmen oversee one or more independent, contract "land companies" to acquire the leasehold in a timely fashion and on budget, if possible.  The energy companies that we primarily discuss are "operators", meaning they want to drill wells and hope to develop the resource for the long term. The operating companies attempt to control costs and maintain flexibility by using contract land companies.  In the age of the Internet, few leasing programs fly below the radar for long. Operating companies  attempt to hide their intentions from their operating competitors and from individuals and companies that attempt to buy leases for speculative investment wherever a major prospect is being leased.   In the trade those companies and individuals are called "block busters", "corner shooters" and other colorful names unfit to post.  The operator hopes, and plans, to acquire the targeted leasehold before the word spreads too far.  There is nothing inherently illegal or unethical about an operating company offering leases through a land company.  A lot of names get used in our GHS discussions. It is important for mineral owners to recognize the difference between a land company working on behalf of an operator leasing with intent to develop and a company representing a non-operating client or a company seeking to speculate in leases for themselves. 

Permalink Reply by William C. Morrison on October 5, 2014 at 7:10

Of course they are ethical.  But leases often contain things more friendly to the leasing combine than the land owner.  Thus it is necessary sometimes to modify or remove such onerous clauses.  The clause that most comes to mind is the "Pugh" clause, a clause we added to our lease.   There are other little tid bits added or removed to make the lease a more fair deal.  If you do not, then you may get screwed on issues other than royalty payments, etc.

Permalink Reply by Skip Peel - Mineral Consultant on October 5, 2014 at 7:25

William, my post above is not about lease language. which I agree is important.  And I agree with you regarding the services of an experienced O&G attorney.  My post is about the confusion created by terms such as "flipper", "front company", "speculator", etc.  For the purposes of GHS members there are only two categories of lessee in the major plays we discuss: the land company or companies in the employ of the operating companies and the lessee that is not.  Their business models are different.  And understanding that difference is critical to negotiating a lease.

Permalink Reply by 30 yr-landman on October 6, 2014 at 1:42

Re: Reply to William C. Morrison

There are several lease provisions that need to be placed in an oil & gas lease to better protect the land/mineral owner.  A good "Pugh Clause" protects the Lessor from a company who wishes to hold all the land covered by a lease where only part of the lands are pooled into a producing unit and the remaining (unpooled) lands (without a Pugh Clause") can be held as long as the pooled lands are producing.  There needs to be a "failure to timely pay lease royalties" causes lease termination provision in every oil & gas lease.  The use of a knowledgeable and reasonable oil & gas attorney is fine but it would be better if the industry/AAPL would just improve its "Producers 88 form" oil and gas lease to include a few of these updated lease provisions.  Again, people need to be reasonable but fair in their dealings.  Many times oil & gas lawyers these days go to far in their demands on the oil companies and what they charge for their services.      

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