$7.5 million settlement reached in Pennsylvania class action regarding deductions of post-production costs from royalty payments

In October 2012, the class action plaintiffs confronted Chesapeake Appalachia LLC  with allegations that Chesapeake violated leases by deducting from their royalty checks post-production costs for gathering, dehydration and compression of the gas taken from their property.  Plaintiffs argued that their leases contained a “Market Enhancement Clause,” which expressly  precluded Chesapeake from charging them for transforming the gas into its “marketable” form or make the gas ready for sale or use, but would allow Chesapeake to deduct a pro-rata share of  these costs after the gas had been placed in a marketable form or is ready for sale or use.  Plaintiffs contended that the gas is not actually “marketable” until it meets the quality and pressure specifications of the interstate pipeline into which it is delivered; and that, by deducting costs that were incurred prior to the gas entering the transmission pipeline, Chesapeake underpaid the royalties due under the lease.  In opposition, Chesapeake contended  that the gas produced or to be produced under plaintiffs’ leases was marketable at the wellhead and thus was entitled to make the deductions.

With an arbitration clause in the leases, the parties hired retired Judge Edward N. Cahn, a mediator with Blank Room LLP, to help settle the questions raised.  Judge Cahn met with the parties on June 18, 2013, and then for more than two months negotiated with each side to reach the proposed $7.5 million settlement.  On August 30, 2013, the plaintiffs filed their Class Action Complaint (attached) and the Unopposed Motion for Preliminary Approval of Class Action Settlement.  The proposed settlement agreement (attached) requires Chesapeake to pay the class action plaintiffs 55% of post-production costs for gathering, dehydration and compression prior to September 1, 2013 and 27.5% of post-production costs until the effective date of the settlement.  After the settlement is approved, Chesapeake will implement a revised royalty calculation methodology that provides a 27.5% reduction in costs for gathering, dehydration, and compression borne by the class action plaintiffs.  These plaintiffs will continue to bear 100%, on a pro-rata basis, of the transportation costs that are incurred after the gas has entered the interconnect point of a transmission pipeline.

Note that, after many discussions in the Pennsylvania legislature, on July 9, 2013,  Governor Tom Corbett signed into law S.B.259 which requires royalty check “transparency.”  Royalty check statements must provide a range of details, including well identification information, the price received per barrel, Mcf or gallon, the net value of total sales after deductions, the owners’ percent of interest  in production and share of the total value of the sales prior to deductions, and the total amount of taxes and deductions permitted under the lease.