Chesapeake Energy Corp. (CHK:US), facing suits by hundreds of mineral rights holders over canceled oil and gas lease offers, asked appeals judges in New Orleans to reverse a $19.7 million judgment to a Texas lease owner.
U.S. District Judge John Ward in Marshall, Texas, ruled in 2011 that Chesapeake officials wrongfully canceled an agreement to buy energy rights held by the family-owned Peak Energy Corp., based in Plano, Texas. Chesapeake breached a contract and abandoned the deal as gas prices plummeted, Peak claimed.
Lawyers for Chesapeake, claiming the deal was uncompleted and the offer nonbinding, asked judges today to reverse the lower court and rule a letter of intent wasn’t a valid contract. The letter of intent couldn’t be a completed contract because it didn’t describe which leases were being sold, Chesapeake lawyer Jesse Pierce told the appeals court today.
“There is no description whatsoever of what certain oil and gas leases are to be conveyed,” Pierce said. “They never figured out what they were selling and what my client was buying.”
The company is also asking the court to cancel an order telling it to pay the $12,000-an-acre difference between the offer price and the lease value when the bid was withdrawn. Chesapeake argues that Peak didn’t have rights to nearly two- thirds of the 5,405 acres covered in the agreement.
“They’re trying to find strained readings of the contract to make the contract unenforceable,” Peak lawyer W. Scott Hastings told the appeals court judges. Hastings asked the panel to uphold the lower court’s judgment.
A map of the property shared by the companies shows “where all the leases are located,” Hastings said. “This is a clearly valid property description that needs to be enforced as Judge Ward correctly did.”
The appeals court reached no decision.
Chesapeake fell $1.29 to $18.69 or 6.5 percent, in New York Stock Exchange composite trading.
Winning may be an uphill battle for Chesapeake, said Anthony Sabino, a law professor at St. John’s University in New York who specializes in complex litigation and oil-and-gas law.
“It’s quite possible that the judge overlooked some sort of contingency,” he said by phone. “But just as the trial judge made short shrift of this, I think the Fifth Circuit will as well. As they like to say in Texas, a deal is a deal.”
Falling Prices, Shares
Chesapeake, the second-largest U.S. gas producer, lost 39 percent of its market value (CHK:US) in the past year as the effect of tumbling energy prices was compounded by questions about Chief Executive Officer Aubrey McClendon. The CEO led a costly push to expand the firm’s gas holdings during the past decade. He was replaced as chairman June 21 by Archie Dunham.
McClendon has been under fire for using personal stakes in the company’s oil and gas wells to borrow privately more than $800 million last year from some of the company’s biggest financiers.
He also has been criticized for a wrong-way bet in natural- gas prices that damaged the Oklahoma City-based company’s cash flow, increased its borrowing costs and spurred its biggest investors to replace more than half the board.
The Peak suit is among similar claims filed in federal and state courts in states including Pennsylvania, Michigan and Texas alleging that Chesapeake breached contracts to buy oil and gas leases.
Change of Plans
Those suing typically claim Chesapeake offered top prices, including sign-up bonuses, then walked away from agreements when gas prices dropped or shale formations proved less profitable to develop than originally projected.
Peak officials sued Chesapeake in 2009, alleging that its executives began a “land grab” in eastern Texas and western Louisiana in early 2008, seeking to acquire the rights to large swaths of the Haynesville Shale area. Chesapeake relied on an “army of landmen” to acquire leases, Peak’s attorneys said in court filings.
Peak officials contend that McClendon was personally involved in their deal, approving a landman’s offer of $15,000 an acre and pushing to speed negotiations.
Upon learning Peak officials wanted the offer in writing, McClendon sent his negotiator an e-mail urging him to complete the deal promptly. “Sooner the better of course!” McClendon said in the July 1, 2008, e-mail, according to court filings.
McClendon described the push to acquire rights to the Haynesville Shale formation in a July 2008 call with investors, saying he was trying to make Chesapeake “the only game in town for a lot of owners of smaller tracts of land out there.”
“We especially understand the value in today’s world of having a huge land machine that can devour big chunks of land across these massive new unconventional plays,” McClendon said, according to a transcript. “In these plays, if you snooze, you lose. And with over 4,000 landmen in the field every day buying new leases, I can assure you that Chesapeake is not snoozing.”
Four months later, McClendon and other Chesapeake officials weren’t as eager to complete the deal as gas prices continued to fall, Peak’s lawyers said.
“The transaction failed to close because market conditions had changed, Chesapeake ran into cash flow problems and Chesapeake was looking for excuses to back out of its pending deals for Haynesville Shale properties,” the Texas company’s lawyers said in February appeals court filing.
The price of natural gas had dropped in 2008 by about 50 percent from June to September, Peak’s lawyer Clint Schumacher said in the company’s complaint.
“Because of the falling price of natural gas and tightening credit markets, the agreement between Chesapeake and sellers was no longer economically advantageous for Chesapeake in October 2008,” Schumacher said. “Rather than suffering the ill-effect of the changing market by fulfilling its contractual obligations to sellers, Chesapeake chose to repudiate the agreement.”
Chesapeake’s lawyers countered that the “letter of intent” between the two companies over the oil and gas leases didn’t amount to a final contract and Peak officials failed to come up with a final list of leases to be covered.
“The letter of intent was simply the beginning of a negotiation,” Chesapeake’s lawyers said in court papers in June 2010. A final agreement was never reached, the lawyers said.
“Peak cannot enforce a sale and assignment between the parties because, as a matter of law, Peak cannot demonstrate that it performed its obligations,” Chesapeake said. “In tendering only 1,645 acres, Peak failed to perform under the letter of intent.”
Ruling on Letter
Ward, the trial judge, disagreed, finding that the letter of intent was a contract, that Chesapeake breached it, and that the company must pay for the acres Peak tendered.
“The letter was certainly meant to bind the parties to the transaction,” Ward said in his March 25, 2011, order.
The additional acres covered in the letter of intent were irrelevant, Ward said. Chesapeake still had to pay for those acres Peak tendered, he said.
Chesapeake was seeking to acquire all the acreage it could and continued to negotiate with Peak after learning of the true extent of Peak’s holdings, Ward said in his 33-page opinion.
“Chesapeake continued working on the deal and extending out the time of closing, making it clear that Chesapeake did not view the difference in acreage to be material to their deal,” Ward wrote. “Accordingly, the discrepancy in the acreage of land simply does not excuse Chesapeake from having to perform under the letter.”
Eric N. Smith, assistant director of the Tulane Energy Institute and a finance professor with an oil and gas background, said the outcome of the case “will not have a material effect on the stock price because it is part of the normal cost of doing business.”
“That said, Chesapeake does not need any more bad news right now,” Smith said yesterday in an e-mail. “Chesapeake needs prices for natural gas and gas liquids to improve significantly for them to be able to produce the profits that existing investors are expecting. Realistically, that price turn is several months if not a year or more in the future.”
The lower-court case is Coe v. Chesapeake Exploration LLC, 2:09-cv-00290, U.S. District Court, Eastern District of Texas (Marshall). The appeal is Coe v. Chesapeake Exploration LLC, 11- 41003, U.S. Court of Appeals for the Fifth Circuit (New Orleans).
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