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Chesapeake Allegedly Underpaid Royalties on Barnett Shale Natural Gas

A lawsuit filed by a several Barnett Shale mineral owners accuses Chesapeake Energy Corp. of selling natural gas to an affiliate for a reduced price and basing royalty payments on those sales, which violates the terms of the lease agreements.

Fort Worth, TX billionaire brothers Ed and Robert Bass are leading a group of Barnett landowners in the lawsuit, which was filed earlier this month in U.S. District Court, Northern District of Texas (Trinity Valley School et al v. Chesapeake Operating Inc. et al, No. 3:13-cv-01082-K).

The Bass brothers have royalty or other interests in all of the disputed land, including the Winscott Ranch, which is at the Tarrant and Johnson counties' boundary. All together the plaintiffs own 3,952 acres, which include the 74-acre Trinity Valley School, as well as the 660-acre Rall Ranch.

According to the lawsuit, the plaintiffs leased mineral rights to Chesapeake beginning in about 2005 to 2007. However, once Chesapeake began to develop the leases, it allegedly underpaid royalties, improperly passed along production costs and made up "sham transactions" with affiliate companies. The affiliate transactions apparently allowed Chesapeake to set the price on which royalties were paid, which breached the terms of the leases.

The plaintiffs are seeking "complete production, pricing, sales and services information" to "quantify the full extent of Chesapeake's underpayments and to recover the deficiency in royalty and override payments.

"In violation of its express and/or implied duties to plaintiffs, Chesapeake, acting as lessee and operator, has underpaid royalty and override payments whether by basing its payments on below-agreed prices or by effectively deducting from plaintiffs' royalties and overrides contractually forbidden production and post-production costs, such as well maintenance, gas gathering and transportation, separation and treating, and other services," the lawsuit states.

Under the lease terms, Chesapeake was not allowed to pass along "any part of the costs or expenses" for producing and transporting the natural gas, the lawsuit contends. In addition, Chesapeake "did not actually incur" any post-production expenses, yet it passed 75 cents/Mcf in costs to the leaseholders.

"The Winscott leases, the Rall properties lease, and the Trinity Valley lease each require the lessee to separate natural gas liquids, whether by processing plant or by field separator, from gas produced from the relevant lands," the lawsuit notes. The lease agreements "obligate the lessee to provide the processing/separation services 'free of all costs' to the relevant lessor."

Chesapeake has paid the landowners "less than the lessor's full royalty share," which was 25% on the minerals, according to the court documents.

With regard to selling the gas at the wellhead, the plaintiffs contend that Chesapeake sold gas to affiliates Chesapeake Energy Marketing Inc., which sells the gas to third parties, and Chesapeake Midstream Partners, which provides gas gathering services, to "suppress" the prices on which it paid royalties. "Chesapeake's payment of royalties and overrides on the basis of this artificial market value measurement breaches the relevant leases and assignments," the lawsuit states.

Last September, Chesapeake 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 royalty payments from wells drilled on the property for about four years. Under terms of the agreement, Chesapeake is to pay the airport $5 million for production through June, and the airport is to drop any claims for additional royalties.

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