Lessors Sue Chesapeake Energy for $5 Billion
HARRISBURG, Pa. (CN) - Chesapeake Energy Corp. and its subsidiary Access Midstream Partners cheated Pennsylvania landowners of more than $5 billion in gas and oil royalties through inflated and unreasonable fees, a RICO class action claims in Federal Court.
Lead plaintiff, the Suessenbach Family Limited Partnership, seeks damages for racketeering, unjust enrichment, mail fraud, wire fraud, honest services fraud, conversion and civil conspiracy.
Chesapeake is the nation's second-largest producer of natural gas.
The complaint states: "Since at least 2010 Chesapeake engaged in unlawful conduct to improperly extract billions of dollars in royalties owed to plaintiffs and other lessors by artificially manipulating and deducting from royalty payments the cost of 'marketing,' 'gathering,' and 'transporting' natural gas. The marketing, gathering and transportation deductions at issue in this action were both unreasonable and inflated."
The Suessenbachs claim that "Chesapeake's subsidiaries have paid fees, which are then charged to lessors, for gas pipeline transport to Access Midstream that are many multiples of Access Midstream's actual costs."
In one case, the family claims, the markup was more than 3,000 percent.
"These deductions were inflated, improper, completely unrelated to the 'cost of services,' did not serve to enhance the marketability of gas, and instead, merely served to enrich the co-conspirators who devised the scheme," the complaint states.
It continues: "The benefit to Access Midstream is clear. Access Midstream's predominant source of revenue is gathering fees and Chesapeake accounts for approximately 84 percent of Access Midstream's business."
Under the Guaranteed Minimum Royalty Act, the complaint states, there are two kinds of land leases entered into for natural gas extraction with landowners that promise a royalty to the landowners based on oil and gas price realized by Chesapeake's subsidiaries. By law, the leases allow search and extraction of natural gas with royalty deductions for production, transport, treatment and process of gas, "but nowhere does either lease permit deductions in excess of actual cost or which are unreasonable."
Through the leases, companies purchase or lease mineral rights to gain access to natural deposits of gas and build profitable wells. Once gas is accessed, it is moved from well through gathering pipes and transported through an interstate transmission pipeline which connects to major interstate transmission pipelines and transports natural gas throughout the United States.
According to the complaint, "While federal rules limit fees that can be charged on the interstate pipelines to prevent gouging, drilling companies levy fees on local pipelines known as gathering lines. However, even where such fees are deducted, they must be reasonable and actual."
While processing can include certain services to make gas suitable for entry into the interstate pipeline system, such as dehydration when the natural gas has a high water content, the Suessenbachs say that Access Midstream conceded, "[i]n general, the natural gas in the northern Marcellus Shale is lean and typically requires little to no treatment to remove contaminants."
The Suessenbachs claim that "defendants, under the guise of Chesapeake's subsidiaries' agreements with lessors, exploited deductions language from the lease agreements to, among other things, shift repayment of Chesapeake's off-balance sheet loan from Access Midstream to the lessors."
According to the complaint, Chesapeake got into money trouble almost five years ago when "Despite their dominant role in natural gas extraction in the United States, Chesapeake was experiencing severe financial difficulty, including funding gaps, reportedly due to major capital expenditures and lower natural gas prices and cash flow. As a result, Chesapeake needed cash quickly to service its outstanding debt and fund its operations.
"On Aug. 3, 2010, Chesapeake formed Access Midstream and began spinning off its midstream assets, which included its natural gas gathering and intrastate pipeline operations, through a series of sales to Access Midstream in order to fund its ongoing operations. During this time, Chesapeake was using its subsidiaries to artificially inflate deductions charged to lessors."
In seeking to spin off its gathering operations, Chesapeake sold a couple of its subsidiaries and their assets the following year. Included in the transactions were "post-spinoff agreements between Chesapeake and Access Midstream [to] guarantee that Chesapeake and certain of its subsidiaries and affiliates get a rebate of some of the monies they will pay out to Access Midstream in the form of payments for services and additional assets," according to the complaint.
"Notably, Access Midstream is managed and directed by former and current Chesapeake officers, has made extensive use of other Chesapeake employees in conducting its operations, and continues to pay Chesapeake and other affiliates and subsidiaries for a variety of services," the complaint states.
Once Access Midstream acquired Chesapeake's operating assets, it replaced Chesapeake as the beneficiary of certain contractual obligations and entered into gas gathering agreements with several Chesapeake subsidiaries who agreed to pay Access Midstream for natural gas gathering and transportation services, including intrastate transport.
These fees for services are misleading, according to the complaint, as they are "intended to provide Access Midstream with a guaranteed, above-market return as an incentive and consideration for the payments it made to Chesapeake."
According to ProPublica, an independent, nonprofit news source cited in the complaint, a rival company executive described the gas-gathering agreements this way: "Chesapeake had found a way to make the landowners pay the principal and interest on what amounts to a multi-billion loan to the company from Access Midstream."
The Suessenbachs claim that Chesapeake "pledged to pay Access enough in fees to repay the $5 billion plus a 15 percent return on its pipelines."
"Chesapeake's ability to follow through on its promise to lock in Access Midstream's rate of return relies on continued inflation of gathering costs and other services paid to Access Midstream and deducted from oil and gas lessors' royalty payments," according to the complaint.
"Fully aware of the true market rates of such services, Chesapeake and its subsidiaries agreed to this above-market rate of return and then Chesapeake agreed to pay Access Midstream supra-competitive prices for natural gas gathering and transportation services, as part of the renewed agreement with Access Midstream and to repay the off-balance sheet loan provided by Access Midstream to Chesapeake's subsidiaries, such as Chesapeake Appalachia, have, in turn, passed the costs of the services along to Pennsylvania oil and gas lessors, such as plaintiffs, by deducting the inflated expenses built into the Marcellus fee from lessor's royalty payments," the complaint states.
ProPublica, reported in March this year that "Chesapeake executed an adroit escape, raising nearly $5 billion ... [b]y gouging many rural landowners out of royalty payments they were supposed to receive."
According to the complaint, "Chesapeake conspired with Access Midstream to continue its scheme to extract inflated royalty deductions from lessors ... in order to ... satisfy an off-balance-sheet loan from Access Midstream that was disguised as asset sales. The purpose of the off-balance sheet loan was to hide Chesapeake's need to 'raise billions of dollars quickly' without alerting the market to its financial troubles when it was already saddled with billions of dollars in debt."
Confused by the answers he received after writing to Chesapeake CEO Robert Lawler, Gov. Tom Corbett asked Attorney General Kathleen Kane to investigate Chesapeake's deductions from royalty payments. State Senator Gene Yaw also wrote to Kane about Chesapeake, describing its royalty deductions as "cheating," "stealing," and "fraud," the complaint states.
The Suessenbachs claim that "Access Midstream, Chesapeake's co-conspirator, was more than eager to participate in the scheme. In return for 'purchasing' $4.76 billion in gas transportation lines from Chesapeake, Access Midstream was guaranteed to recover $5 billion plus a 15 percent return on its pipelines over the next decade - all of which would be shouldered by inflated expenses charged to the class."
The Suessenbachs seek class certification, an injunction, disgorgement of ill-gotten gains and damages.
Their lead counsel is Robert Schaub with Rosenn Jenkins & Greenwald, of Wilkes-Barre, assisted by Joseph Meltzer, with Kessler Topaz Meltzer & Check, of Radnor.
CORRECTION: Because of an error in editing, the original version of this article incorrectly stated that Chesapeake did not reply to the questions it received from Gov. Tom Corbett. Courthouse News regrets the error.