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.