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Producers Decry $400 Million Dollar WV Royalty Verdict

A more than $400 million jury verdict issued Saturday against two producers in an Appalachia royalty case "is clearly excessive" and "would have far-reaching negative implications for all gas producers in West Virginia" if allowed to stand, said NiSource Inc. and Chesapeake Energy Corp.

A jury in Spencer, WV, imposed approximately $134.3 million in compensatory damages and $270 million in punitive damages against defendants in the case of Tawney, et al. v. Columbia Natural Resources (CNR) et al. in Roane County Circuit Court.

CNR is a former NiSource Inc. subsidiary, which was sold in 2003 to Triana Acquisition LLC (see Daily GPI, Sept. 2, 2003). NiSource, Columbia Energy Group (CEG) and Chesapeake Appalachia LLC, a Chesapeake Energy subsidiary, are named as defendants in the lawsuit. CEG is a NiSource subsidiary. Chesapeake Appalachia is the successor to CNR. The case was filed in 2003 and inherited by Chesapeake when it acquired CNR in November 2005 from Triana Energy Holdings LLC, which is not named in the case (see Daily GPI, Nov. 17, 2005).

Class action plaintiffs are natural gas royalty owners who allege that CNR underpaid royalties by deducting a portion of post-production costs incurred in order to gather and transport gas to interstate pipelines and by not paying market value for gas produced under all leases, even those providing for payment based on actual proceeds received for the gas. Plaintiffs sought the alleged royalty underpayment and punitive damages. The defendants believe CNR operated in good faith and that there is no valid basis for any award of punitive damages, let alone the "unwarranted and unreasonable levels" granted.

One aspect of the case is a determination that post-production costs are not deductible from payments to royalty owners, Henry Hood, Chesapeake general counsel and senior vice president for land and legal, told NGI. "Every major producer in the state [of West Virginia] is subject to a similar lawsuit," he said. "Everyone kind of assumed that reasonable post-production costs were deductible [from royalty payments]."

One of the consequences of the case, if the verdict is allowed to stand, Hood said, is that West Virginia wells will be plugged sooner since producers will be forced to bear more of the production costs, causing wells to become uneconomic earlier.

NiSource said it believes the verdict is "clearly excessive and should be set aside by the trial court or overturned on appeal." If left to stand, NiSource said the award would set a precedent that is contrary to existing law and could undermine the legal underpinnings of nearly every natural gas royalty contract in West Virginia.

The defendants also maintain they were prevented from presenting key evidence at trial.

The jury's verdict and its award of damages are subject to review by the trial court, which could result in the verdict being set aside or reduced. The defendants will appeal any adverse judgment.

Although NiSource sold CNR in 2003, the company is a defendant in the case and remains primarily responsible for any damages following appeal. NiSource has already recorded a reserve for the litigation and is assessing whether to adjust the level of that accrual based on the verdict, it said.

The case involves facts and conduct that occurred before Chesapeake's acquisition of the company and the vast majority of the liability for the case was reserved by CEG/NiSource in the purchase and sale agreement conveying the stock of CNR to the predecessor owner of CNR before Chesapeake. However, Chesapeake has set aside a legal reserve, which it believes will be adequate to cover its share of any final judgment. When judgment is entered, Chesapeake said it will analyze the judgment and decide the proper course of action including any appeal.

Monday, Standard & Poor's Ratings Services said if the verdict is not set aside or overturned it would have adverse credit implications for NiSource; however, the company's rating is not immediately affected. "Although NiSource has capacity under its bank facilities to fund the imposed damages, such a large cash outlay would harm the company's already subpar financial parameters."

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