Court upholds $19 million verdict against Chesapeake Energy for contract breach over east Texas natural gas lease

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by John Chapman

The Haynesville Shale is a stratographic rock formation in East Texas, Northwest Louisiana and Southwest Arkansas that lies beneath the Cotton Valley formation and contains large quantities of natural gas. In 2008, when natural gas prices were soaring, Chesapeake Exploration, LLC (a subsidiary of Chesapeake Energy Corporation) attempted to acquire as much producing acreage as it could.

On June 30, 2008, Chesapeake contacted Peak Energy Corporation and expressed interest in acquiring all of the deep rights that Peak owned in Harrison County, Texas, where part of the Haynesville Shale is located.

A Peak representative stated that he did not know how many acres Peak had in the area and that Peak might be willing to sell its holdings for $15,000 per acre for a net revenue interest of 75%.

On July 2, 2008, Chesapeake e-mailed a letter entitled “Offer to Purchase” to Peak that stated:

Chesapeake Exploration, L.L.C. (“Chesapeake”) hereby submits a cash offer of Eighty One Million Seventy One Thousand Two Hundred Fifty and No/100ths Dollars ($81,071,250.00) (“Purchase Price”) to Peak Energy Corporation (“Seller”), effective July 2, 2008 (the “Effective Date”), for all the Seller’s right, title and interest in certain oil and gas leases located in Harrison County, Texas (and only those located in Harrison County, Texas), such leases being shown in the map attached hereto as Exhibit “A”, excepting and reserving unto the Seller all right, title and interest in and to the formations, intervals, strata and depths found between from the surface of the Earth and the stratographic equivalent of the base of Cotton Valley formation and further reserving an overriding royalty interest described below (the “Leases”).

The “terms and conditions” section specified that “[t]he leases to be conveyed … shall include approximately 5,404.75 net acres,” and “[a]djustments to the Purchase Price based on the Seller delivering more or less than 5,404.75 net acres shall be made in accordance with the allocated value of $15,000 per net acre.” It further provided that “[t]his offer will be considered void if not accepted by 5:00 PM CDT on July 3, 2008,” was a “valid and binding agreement,” and that the transaction’s closing date was August 31, 2008. At Peak’s request, an asterisk was added after “Peak Energy Corporation” to indicate that “Seller” included “affiliated entities for which Peak Energy Corporation or its officers have the authority to act as agent or principal.” Attached to the letter was Exhibit A, a letter-sized map showing Harrison County and parts of neighboring counties. Several areas in Harrison County were highlighted and had “PEAK” written next to them. The letter was signed and agreed to by representatives for Chesapeake and Peak.

Weeks after the July Agreement had been signed, Chesapeake asked Peak to prepare a final list of leases to be conveyed. As they worked to complete the lease list and other closing documents, both parties requested and obtained extensions beyond the original closing date. Chesapeake repeatedly expressed its intent to complete the transaction and Peak, believing itself bound by the July Agreement, did not solicit or entertain any offers for its holdings in Harrison County.

Meanwhile, a significant decrease in natural gas prices made the deal much less desirable for Chesapeake. Prices began falling shortly after the July Agreement was signed and by October, prices had fallen approximately 50% from their high in early July. The fair market value of deep right leases in Harrison County had decreased to $3,000 per acre.

On October 9, Chesapeake requested that closing be postponed until January 2009. Then, six days later, Chesapeake informed Peak that it would not be completing the transaction.

Peak filed suit to enforce the agreement. Chesapeake responded by arguing the July Agreement was simply an agreement to negotiate, or letter of intent, and not binding. It claimed the agreement did not meet the requirements of the Texas statute of frauds and was too indefinite to be enforced.

Following a bench trial, the district court ruled the July Agreement was enforceable and entered judgment in favor of Peak. It awarded damages to Peak in the amount of $19,751,004, as well as pre-judgment and post-judgment interest. Damages were determined by multiplying the number of acres subject to the agreement (1,645.917) by $12,000, which was the contract price ($15,000 per acre) minus the market price on the date of breach ($3,000 per acre). Peak also received $434,951.80 in attorneys’ fees and $19,851.92 in costs. Chesapeake appealed the judgment and, this month, the Fifth Circuit Court of Appeals affirmed the district court.

Chesapeake’s first argument on appeal was that the parties’ July Agreement was unenforceable under the Texas statute of frauds because it did not adequately identify the property to be conveyed. The Fifth Circuit noted that one method of identification that may provide a sufficient “nucleus of description” under the statute of frauds is a “recital of ownership.” This is a means of identifying the property to be conveyed by identifying the person who owns the property, and is usually indicated by such words as “my property,” “my land,” or “owned by me.”

Because such a recital of ownership eliminates the risk of the property being misidentified, so long as the owner is conveying all of the property that he owns in the area described by the agreement, it fulfills the demands of the statute of frauds. The July Agreement conveyed all of Peak’s rights, interest and title in oil and gas leases in the areas shown on Exhibit A, which outlined several tracts of land in Harrison County. Thus, the Fifth Circuit determined that the description was similar to other agreements enforced by Texas courts in which an owner conveyed all the property he owned in a specified state, county or survey.

Chesapeake next argued that the July Agreement was too indefinite to be enforced because it lacked essential terms. Generally, essential terms include the time of performance, the price to be paid and the service to be rendered. The Court of Appeals found that the July Agreement contained these key elements, as it identified the property to be conveyed, its price, the closing and delivery dates, and the purchaser’s interest in the property. It also provided that Chesapeake would have an opportunity to examine title and review any contracts and agreements affecting the lease to ensure they were “reasonably acceptable.”

To prevail on a claim for breach of contract, the plaintiff must prove that it performed or tendered performance. Chesapeake contended the July Agreement was unenforceable because Peak could not perform its obligations under that agreement. The July Agreement stated that “[t]he Leases to be conveyed to Chesapeake by the Seller shall include approximately 5,404.75 net acres” and, at trial, Peak conceded that it could only deliver 1,645.917 acres meeting the agreement’s specifications.

Texas courts may decline to enforce a contract when there is an excessive discrepancy between the amount of acreage listed in the contract and the amount of acres actually delivered. Thus, Chesapeake contended that Peak could not adequately perform under the agreement. The Fifth Circuit disagreed and pointed out that the July Agreement included an adjustment clause expressly addressing this very issue: “[a]djustments to the Purchase Price based on the Seller delivering more or less than 5,404.75 net acres shall be made in accordance with the allocated value of $15,000 per net acre.” Because the agreement acknowledged uncertainty about the number of acres Peak could deliver and the parties inserted an adjustment clause in the contract to provide for a change in sale price based on the number of acres actually conveyed, the Fifth Circuit concluded the district court did not err in finding Peak was willing and able to tender performance on the July Agreement.

The full opinion in Coe v. Chesapeake Exploration, L.L.C., — F.3d —- (5th Cir. September 12, 2012) is available online here: http://www.ca5.uscourts.gov/opinions/pub/11/11-41003-CV0.wpd.pdf

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