Arlington sues Chesapeake Exploration over underpaid royalties

Posted Tuesday, Aug. 06, 2013  comments  Print Reprints
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The city is suing Chesapeake Exploration, saying the company underpaid royalties on natural gas pumped from about 1,908 acres of public land.

The lawsuit, filed Monday in a civil District Court in Tarrant County, alleges that the Oklahoma City-based energy company has deducted post-production costs from the city’s royalty payments that are not only unauthorized under the lease agreements but also appear to be “excessive and unreasonable.”

The company has also failed to reasonably market the produced gases from the leases and obtain the best price possible by selling to subsidiaries or affiliates in violation of the lease agreements, the lawsuit alleges.

Arlington said it has not been able to quantify its monetary damages for the contract breach because Chesapeake has withheld lease documents. But the city said in the suit that it expects to seek monetary relief in excess of $1 million.

Neither Arlington City Attorney Jay Doegey nor Chesapeake spokeswoman Leah King could be reached for comment late Monday.

The city’s lease agreements “prohibit or significantly limit deductions,” such as transportation and production costs and taxes, and “provide for cost-free royalties,” according to the lawsuit.

However, Arlington said it found in a recent audit that Chesapeake appears to be basing its royalty payments to the city on proceeds received from sales to affiliates after production costs have already been taken out.

The suit also alleges that these deductions are not apparent from the information that Chesapeake has provided to the city, saying that those statements “misleadingly reflect” that no deductions are being taken.

The city sent a letter to the company in April raising concerns about underpaid royalties and the improper deduction of costs. The company did not respond, according to the suit.

“Instead, Chesapeake continues to engage in a scheme of affiliated transactions aimed at hiding or embedding impermissible cost deductions and suppressing the royalties it pays to the city,” the suit says.

Disagreements between producers and mineral-rights owners are fairly common, experts say. But the sharp decline in natural gas prices seen since 2008, bottoming out at a 10-year low at about $1.90 per cubic feet in April 2012, sent producers scrambling to hang on to narrowing profit margins, leaving royalty owners to scrutinize their statements.

Arlington’s suit is similar to one filed against Chesapeake in federal court this year by Fort Worth investor Ed Bass and more than a dozen other landowners in far south Tarrant County. That lawsuit claims that Chesapeake has cheated them out of potentially millions of dollars in royalties for leases on 3,952 acres at the Tarrant-Johnson County line, south of Benbrook Lake.

Last year, Chesapeake Energy agreed to pay Dallas/Fort Worth Airport $5.3 million to settle a similar lawsuit after the airport alleged it had been shortchanged on royalty money from wells Chesapeake drilled on its property. The airport used its gas money to help pay for capital projects including the $1.9 billion terminal renovation.

Joining these large entities in suing Chesapeake are individual landowners. In 2012, Charles and Robert Warren, along with another couple in Johnson County, were seeking class action status in a lawsuit filed in federal court, a rarity in a Texas oil and gas royalty dispute. The case was dismissed by U.S. District Judge Barbara Lynn in May and is currently on appeal.

In its response to the Warrens’ lawsuit, Chesapeake asked Judge Lynn to dismiss the claim, saying the lease allows the cost deductions. The company’s November filing cites a number of precedents for its position, including a 1996 Texas Supreme Court decision called Heritage Resources v. NationsBank. That ruling found that some deductions are allowed even if one clause in the lease prohibits them, depending on what other lease terms say about how the value of the gas or oil will be set.

The suit against Chesapeake isn’t Arlington’s only legal battle with the natural gas drilling industry.

Last year, the Texas Oil & Gas Association and the Texas Independent Producers & Royalty Owners Association sued Arlington over the creation of a gas well fee.

The fee was expected to generate about $800,000 a year so that Arlington, which has 300-plus gas wells, could hire six more firefighters and to train and equip 42 current firefighters for the creation of two gas well emergency response teams.

Arlington has not charged the fee while the lawsuit is pending.

This report includes material from the Star-Telegram archives.

Susan Schrock, 817-390-7639 Twitter: @susanschrock

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