The state high court’s 5-4 decision in Chesapeake Exploration, LLC v. Hyder clarifies when post-production costs may be exempted from overriding royalty interests. The court stated that generally, an overriding royalty on production of gas and oil is not burdened by production costs, but must carry a share of post-production costs, unless there is an agreement that states otherwise. The court stated that the only question to be decided in the lawsuit was whether there was an agreement allocating post-production costs, and the court concluded that there was.

The Texas Supreme Court agreed with San Antonio’s Fourth Court of Appeals, which in turn had sided with a court in Tarrant County, Texas, which awarded the Hyder family about $1 million.

In the Hyder case, the state high court revisited its 1996 ruling in Heritage Resources Inc. v. NationsBank. Before Hyder, the default rule had been that royalty interests were subject to post-production costs, which may include taxes and expenses for transportation and treatment. While case law recognized that post-production costs could be allocated by agreement, the court’s ruling in Heritage Resources made it difficult in practice. The “default rule” that post-production costs may be charged to royalty owners has now been significantly weakened.

Gregory D. Jordan is an Oil and Gas lawyer in Austin. To learn more, visit http://www.theaustintriallawyer.com or call 512-419-0684.

The Arlington City Council approved the settlement August 19 by a vote of 8-0, with Mayor Robert Cluck absent while recovering from surgery. The deal was reached between the city, Chesapeake and Total E&P USA, a French company that owns a 25 percent share of Chesapeake’s holdings in the Barnett Shale.

The lawsuit had accused Chesapeake of improperly deducting post-production costs from royalties paid to the city and of basing payments on gas prices below the actual sales price. 

Chesapeake holds leases on approximately 1,900 acres of public property.

The settlement agreement provides that in the future, the royalty rate paid to the city will be based either on the highest sales price received by Chesapeake or on a price established by a formula. Also, post-production costs will no longer be subtracted from royalty payments.

Attorneys for the city initially said they thought damages would exceed $1 million, but the city settled for a lower payment. City Attorney Jay Doegey said that the settlement was fair and that it clarified the methodology for calculating royalties.

Chesapeake did not admit fault in the settlement, and it maintained, in court documents, that Texas law permits the deduction of post-production costs.

The settlement covers 25 separate leases of varying size. 

Chesapeake still faces numerous additional lawsuits filed by other property owners alleging underpayment of royalties. The Arlington school district, which joined the city’s lawsuit, is still negotiating with Chesapeake regarding its claims.

The lawsuit by the city of Arlington made claims similar to those made in other lawsuits against Chesapeake: that in addition to improperly deducting post-production costs from royalty payments, the company used a system of “sham transactions,” such as selling gas to its own affiliates, in order to calculate royalties based on a price lower than the actual sales price.

Gregory D. Jordan is an Oil and Gas lawyer in Austin. To learn more, visit http://www.theaustintriallawyer.com or call 512-419-0684.

Charles and Robert Warren, along with a Johnson County couple, filed the lawsuit against Chesapeake Energy after they claim they saw significant reductions in their royalty payments.

Chesapeake had informed royalty owners in August 2011 that it would begin subtracting “post-production costs” from the sales prices for natural gas that it used to determine royalty payments. The company said then that if a royalty owner’s lease prohibited such charges – for expenses such as compressing and treating gas to ready it for sale – then the costs would not be deducted. However, the Warrens allege they saw such deductions even though their lease does contain a provision prohibiting charges for post-production costs.

Post-production costs can amount sometimes to between 80 cents and $1 per 1,000 cubic feet (mcf), which is significant when gas prices are around $2 per mcf, as they were last year. The Warrens claim that by March 2012 they were being paid as low as 42.4 cents per mcf for natural gas from the eight wells operated by Chesapeake. According to Charles Warren, the difference in payments ran to six figures.

The Warrens’ lawsuit joins several others against the company over reduced royalty payments, including a suit filed by Tarrant County landowners. The Warrens’ suit is now before Judge Barbara Lynn in U.S. District Court in Dallas. The fact that class action status is being sought is unusual for a Texas gas royalty lawsuit.

Chesapeake’s action in reducing royalty payments came at a time of extremely low natural gas prices. Prices began falling in 2008 and reached $1.90 per mcf in April 2012, a 10-year-low.

Some landowners have achieved results without legal action. A neighborhood association in Arlington, Texas questioned Chesapeake’s reduced royalty payments to residents, pointing out that their lease had a strong clause prohibiting the deduction of post-production costs. In that case, Chesapeake adjusted the royalty checks and residents have seen their payments more than doubled. Debbie Moore, the president of the neighborhood association, said that the group had insisted on the clause during the 2008 leasing process, upon the advice of another neighborhood group.

Chesapeake Energy is the second-largest natural gas producer in the Barnett Shale. The company has experienced cash flow and debt problems in recent years and has sold approximately $2 billion in assets. Chesapeake also recently dismissed its former CEO and Chairman Aubrey McClendon.

Gregory D. Jordan is an Oil and Gas lawyer in Austin. To learn more, visit http://www.theaustintriallawyer.com or call 512-419-0684.