Face Challenges Confidently

589 Flanagan v. Chesapeake Exploration, LLC No. 3:15-CV-0222-B, 2015 WL 6736648 (N.D. Tex. Nov. 4, 2015)

Monday, June 19th, 2017

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.

Flanagan v. Chesapeake Exploration, LLC No. 3:15-CV-0222-B, 2015 WL 6736648 (N.D. Tex. Nov. 4, 2015) (mem. op.) (Implied duty to reasonably market) described the proper pleading for breach of the implied duty to market when there is an alleged sham sale at the wellhead. This case is a class action for underpayment of oil and gas royalties payable by the lessee, Chesapeake Exploration, LLC (“CEX”), under leases requiring a 25% royalty on proceeds computed at the point of sale. CEX sold the gas at the wellhead to its wholly-owned subsidiary Chesapeake Energy Marketing, Inc. (“CEM”), and CEM then sold the gas on the open market to unaffiliated purchasers for a much higher price. Lessors asserted a claim for breach of the implied duty to reasonably market oil and gas.

The implied duty to reasonably market “is two-pronged: (1) ‘the lessee must market the production with due diligence,’ and (2) must ‘obtain the best price reasonably possible.’” In their Original Complaint, Lessors alleged that CEX sold the production at less than the best price reasonably possible, but failed to allege that CEX could have obtained a higher price from another company for the production at the wellhead. After amendment, Lessors asserted that there was no market at the wellhead, that the market could only be accessed after processing, and that if CEX had done so, it would have obtained a higher price. The court held that this was sufficient to plead a cause of action, because the allegation is that a reasonably prudent operator would have taken the gas to the market, rather than sell to an affiliate at the wellhead. For there to be a market, it must be open and competitive. “Thus the duty to market the production with due diligence would have been implicated and possibly violated at the point of sale (the wellhead).”

The case describes the pleading necessary to assert a breach of the implied duty to market, when the issue is the failure to obtain the best price reasonably possible at the wellhead, but there is no market at the wellhead, except the lessee’s affiliate.