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Back v. Chesapeake Operating, LLC

United States District Court, E.D. Kentucky, Southern Division, Pikeville

February 6, 2018

THOMAS R. BACK, Individually and on behalf of all other similarly situated states, Plaintiff,
v.
CHESAPEAKE OPERATING, LLC and CHESAPEAKE APPALACHIA, LLC, Defendant.

          OPINION AND ORDER

          KAREN K. CALDWELL, CHIEF JUDGE.

         The defendants move (DE 41) to dismiss the plaintiff's complaint. For the following reasons, the motion will be granted in part and denied in part.

         I. Background

         On a motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6), like the one filed by the defendants here, the Afactual allegations in the complaint must be regarded as true.” Scheid v. Fanny Farms Candy Shops, Inc., 859 F.2d 434, 436 (6th Cir. 1988) (quoting Windsor v. The Tennessean, 719 F.2d 155, 158 (6th Cir. 1983)).

         According to the complaint, the plaintiff, Thomas Back, owns an interest in the oil and gas estate of property located in Knott County, Kentucky. (DE 40, Complaint ¶ 2.) He leases that estate to the defendants (collectively, “Chesapeake”), which grants Chesapeake the right to produce and sell the oil and gas. In return, Chesapeake agrees to pay royalties to Back.

         In the complaint, Back asserts Chesapeake has paid him fewer royalties than the parties agreed to. He asserts that Chesapeake has done this in two ways. First, he asserts the leases require Chesapeake to “pay royalties based on the sales price of gas at the time it is sold.” (DE 40, Complaint ¶ 14.) Back alleges that Chesapeake calculated his royalties “based on a sales price that is materially less than the price at which Chesapeake sold the gas.” (DE 40, Complaint ¶ 3.) More specifically, Back asserts that, in late 2007, Chesapeake sold a large amount of natural gas (208 billion cubic feet) to affiliates of certain investment banks at a sales price of approximately $1.1 billion or $5.27 per thousand cubic feet. (DE 40, Complaint ¶¶ 17, 18.)

         Nevertheless, Back alleges, even after the sale, Chesapeake calculated the royalties it paid to him “as if no such sale had ever occurred.” (DE 40, Complaint ¶¶ 15, 16.) Later, Back alleges, Chesapeake paid him royalties on the gas sold to the banks but calculated the royalties based on a lower sales price than what the banks paid it. (DE 40, Complaint ¶ 18.)

         The second way that Back alleges Chesapeake paid him fewer royalties than he was entitled to was by deducting more expenses from the sales price than it was permitted to under the leases. Back asserts that the leases permit Chesapeake to deduct “the reasonable expenses that it actually incurred in preparing the oil and gas for sale.” (DE 40, Complaint ¶ 19.) Back alleges that Chesapeake has, however, deducted unreasonable expenses or expenses that it did not actually incur from the royalties it paid him. (DE 40, Complaint ¶ 4.)

         Back asserts claims of breach of contract, breach of the implied covenant of good faith and fair dealing, and fraud. In addition, he seeks an accounting from Chesapeake of the manner by which his royalty payments were calculated. Chesapeake moves to dismiss all of these claims.

         II. Analysis

         A. Breach of Contract

         As to Back's breach-of-contract claim, Chesapeake argues it must be dismissed because there are two relevant leases between it and Back and neither requires it to pay royalties based on sales price at all. Nor, Chesapeake argues, do the leases allow it to deduct expenses from the royalties owed. Instead, Chesapeake argues, the leases require it to pay a flat royalty rate of 12 cents per 1, 000 cubic feet for 1/8 of the gas produced from the wells. Chesapeake attaches two leases - one dated 1940; the other dated 1954 - that support its assertions. (DE 41-2, Leases.)

         In response, Back concedes that the written leases require Chesapeake to pay a flat royalty rate. He argues, however, that the parties have modified the agreement by their conduct over the years. Back asserts that, from the date Chesapeake became lessee, it has paid royalties equal to 1/8 of the sales price it receives for the natural gas, minus expenses incurred. He states that Chesapeake became the lessee more than a decade ago, when it purchased the original lessee, and that it has consistently represented in its statements to him that it calculated the royalties based on the sales price minus expenses, not at a flat rate.

         Under Kentucky law, “[a] written contract can be modified or abandoned by a subsequent oral agreement, [but] the proof to support such an assertion must be clear and convincing.” Dalton v. Mullins, 293 S.W.2d 470, 475 (Ky.1956). In his complaint, however, Back does not allege that the leases have been modified by the conduct of the parties. Instead, he alleges “Under [the] leases, Chesapeake is to pay royalties based on the sales price of the gas at the time it is sold.” (DE 40, Complaint ¶ 14.) Likewise, he alleges “Under the leases, ...


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