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Chesapeake Lawsuit Involves 4,000 PA Landowners; Other Operators Could Face Charges

The Pennsylvania Attorney General's (AG) office said Thursday that its lawsuit against Chesapeake Energy Corp. and its affiliates, including Williams Partners LP, could involve at least 4,000 landowners, a number that could grow exponentially as the case unfolds and if the state takes action against other operators.

The lawsuit, which came after what the office called an "extensive investigation" that took more than a year to complete, might not be the only result of those efforts. On Thursday, a day after it filed the complaint against Chesapeake in the Bradford County Court of Common Pleas, the AG's office did not rule out the possibility of legal action against other operators in the state.

"We really can't get into what may be coming in the future in regard to other companies," said spokesman Jeffrey Johnson. "At the moment, this lawsuit is what we're prepared to discuss." He added that the AG made a "very extensive review" of the oil and gas industry "as a whole" and said the office was already receiving phone calls from landowners it had not spoken to.

Just days before the office filed the lawsuit, a source with knowledge of the investigation, who agreed to speak on the condition of anonymity because they were not authorized to share information publicly, said the investigation would likely uncover "excessive" and "improper" royalty deductions made by Chesapeake and some other operators. The source said the AG's investigation became "much more complicated than the office ever expected it was going to be," adding that it was forced to conduct in-depth auditing of royalty payments and other records.

The complaint accuses Chesapeake of unfairly deducting post-production costs from royalty checks to cover marketing costs, including compression, dehydration and transmission (see Shale DailyDec. 9). It is seeking restitution for thousands of landowners, as well as civil penalties and legal costs, adding to Chesapeake's legal problems in the state and elsewhere where it has been accused in various courts of underpaying royalties. In addition to Williams, which moves and processes gas for the company, the state's lawsuit names as defendants Chesapeake Appalachia LLC, Chesapeake Operating Inc. and Chesapeake Energy Marketing Inc.

The AG is seeking restitution for all persons affected, civil penalties of $1,000 each and $3,000 for each violation involving people 60 years of age and older. Taken together, Johnson said, the office has conservatively estimated that Chesapeake could be forced to pay "tens of millions" of dollars in damages if the lawsuit is successful. It also comes ahead of a Feb. 2, 2016 hearing in federal court at which a judge is expected to approve a class action lawsuit against Chesapeake (see Shale DailyDec. 8). Known as the Demchak settlement, involving more than 15,000 landowners, that case has taken years to resolve.

When Chesapeake first agreed to settle in 2013, they offered $7.5 million to resolve claims about post-production deductions, but the Demchak settlement has since swelled to more than $17 million.

The AG's investigation began in early 2014. Former Republican Gov. Tom Corbett and state legislators called for an investigation into Chesapeake after receiving complaints from landowners (see Shale DailyMarch 14, 2014Feb. 18, 2014). Later that year, the office expanded the investigation and was said to have sent administrative subpoenas -- or judicially enforceable requests for records -- to operators throughout the industry (see Shale DailyAug. 29, 2014). It remains unclear when, or even if the AG will act against other operators, but some still expect it.

"I thought it was possible that more operators were going to be included," said Jackie Root, President of the Pennsylvania Chapter of the National Association of Royalty Owners, referring to similar complaints about other operators her organization has received over the years. "It doesn't surprise me that it was only Chesapeake, I guess. The [AG] seems to be honing in on their practices. As far as I'm concerned, Chesapeake has led the way on this kind of stuff and hopefully the [AG] is successful, Chesapeake pays up and others pay attention. We're pleased. It has to be viewed as a start."

The state Supreme Court, however, recently suspended Pennsylvania Attorney General Kathleen Kane's law license. She's been charged with obstruction of justice, official oppression and two felony counts of perjury for her alleged role in the leak of grand jury information to a Philadelphia newspaper. On Wednesday, the state Senate voted unanimously to schedule a Jan. 12 hearing on whether Kane can continue to serve as the state's top prosecutor. While those charges were filed after the royalties investigation began, it's unclear how the proceedings could affect potential action against other operators.

Landowners in the region have sued other producers to recover underpaid royalties in recent years (see Shale DailyOct. 4, 2013). Most leasehold contracts include standard provisions to deduct some expenses from royalties. Deductions for transportation and marketing are typically set at the discretion of operators. Chesapeake, which said Wednesday when the lawsuit was filed that it would fight the allegations, has previously argued that its deductions were allowed under Pennsylvania's Guaranteed Minimum Royalty Act of 1979.

A bill last year to clarify that law by addressing marketing costs stalled in the state legislature after it met opposition from producers, their allies and ambivalent lawmakers (see Shale DailyJan. 20, 2014). It has since been reintroduced and referred to the House Environmental Resources and Energy Committee (see Shale DailyJune 26)

"Mineral owners are feeling the pinch of persistently low commodity prices..." said the Marcellus Shale Coalition in a statement. "It's important to recognize that post-production related issues -- which have been extremely localized and not widespread -- are being actively addressed in the courts where contract matters should be addressed."

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