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Chesapeake Energy Corp. improperly deducted drilling expenses from Barnett Shale natural gas royalty payments and violated some terms of a lease agreement, a Texas appeals court has affirmed.
The Fourth Court of Appeals, comprised of seven judges, upheld a Tarrant County, TX, lower court ruling in 2012 that found Chesapeake breached a lease agreement with Martha Rowan Hyder, who is representing the estate of husband Elton M. Hyder Jr. and their children. The Tarrant County court had awarded the estate close to $1 million, including $700,000 in unpaid royalties, interest and attorney fees.
The Hyders in 2004 signed a minerals rights lease on about 1,000 acres in Tarrant and Johnson counties with Four Sevens Oil Co., which assigned the lease in 2006 to Chesapeake. They filed a lawsuit in 2010 [Chesapeake Exploration LLC et al, v Martha Rowan Hyder et al, No. 04-12-00769-CV].
The lease agreement with the Hyder family included a 25% royalty and another 5% override for production from other leases if the wells were drilled on Hyder property. The agreement did not allow post-production expense deductions. It also required royalties to be calculated on the sale of gas to a third party, not a Chesapeake affiliate.
As the Hyder lease was written, the language expressly rejected using a Texas court precedent, Heritage Resources vs. NationsBank, which allows producers to deduct some costs even when a lease as written barred such deductions. Accepting a no-cost lease on override royalties could set a precedent, according to attorney David Drez of Wick Phillips, which represented the Hyder family.
Chesapeake declined to comment on the case, but it may appeal the ruling. The Oklahoma City-based operator has been the subject of numerous royalty-related lawsuits, many of which concern predecessor lease agreements that Chesapeake acquired. It's also not the only producer to face inquiries into its royalty deductions.
In February, the Department of Interior's Office of Natural Resources Revenue slapped Chesapeake with a civil penalty of $428,400 for underreporting royalties on a tribal leasehold in Oklahoma. Chesapeake had a "knowing or willful submission" of inaccurate reports for several months in 2005 regarding leases from the Cheyenne and Arapaho tribes in Custer County, federal officials said. Auditors had found the inaccurate reports and notified Chesapeake, but proper corrections never were paid.
"It is simply unacceptable that a company continues to file inaccurate reports after an audit order instructed the company to make the necessary corrections," the revenue office said. Chesapeake may request a hearing. The federal office in 2013 had fined Chesapeake $765,000 for incorrectly reporting royalties on federal land from May 2011 to July 2012. Chesapeake paid the fine and the case is closed.
Millions already have been paid out by Chesapeake to settle other royalty-related lawsuits.
In September 2012 the producer agreed to pay Dallas/Fort Worth International Airport $5 million to settle a lawsuit on how gas royalties were calculated. The airport board said Chesapeake had shortchanged payments from wells drilled on the property for about four years. Under terms of the agreement, Chesapeake was to pay the airport $5 million for production through June 2013, and the airport was to drop any claims for additional royalties.
Chesapeake last year agreed to pay $7.5 million to settle a class action lawsuit regarding underpaid royalties in Pennsylvania (see Shale Daily, Sept. 4, 2013). However, Chesapeake's problems in Pennsylvania may not be over after state lawmakers in February called for another investigation into post-production cost reductions from royalties (see Shale Daily, Feb. 18). In Ohio, a federal appeals court last May remanded to a Youngstown, OH, district court a similar class action lawsuit (see Shale Daily, May 30, 2013).
Texas lawsuits regarding underpaid royalties that are pending include filings by the cities of Fort Worth and Arlington, TX, the Arlington school district, another by Hyder interests and residents, and one by renowned Fort Worth billionaires the Bass family. The Bass lawsuit, scheduled to go to trial in 2015, is similar to the Hyder case, accusing Chesapeake of selling Barnett-produced gas to an affiliate for a reduced price and basing royalty payments on those sales, violating the lease agreements (see Shale Daily, March 22, 2013).