Antitrust Law Daily Wrap Up, RICO—N.D. Ohio: Racketeering claims against natural gas producer survive motion to dismiss, (Mar 25, 2016)

By Michael Menzhuber, J.D., LL.M.

A motion to dismiss Racketeer Influenced and Corrupt Organizations (RICO) Act claims that a natural gas producer, and the company it created to purchase its midstream assets, inflated deductions at the expense of mineral rights owners was denied by the federal district court in Akron, Ohio (Kovach v. Access Midstream Partners, L.P., March 23, 2016, Lioi, S.)

Chesapeake Energy Corporation, a producer of natural gas, entered in two types of leases with the owners of mineral rights to land in Ohio that is situated over large shale formations from which natural gas can be extracted. Each lease provided that the owners would receive a royalty, which represented a percentage of the proceeds from the sale of the oil. However, one lease provided royalties based on the price the subsidiaries actually realized for the sale of the gas and oil while the other allowed deductions for the cost to transport, treat and process the gas. Neither lease permitted deductions in excess of actual cost or which were unreasonable.

After experiences financial difficulties, Chesapeake created Access Midstream (AM) and began selling its midstream assets to it. Former and current Chesapeake officers managed and directed AM, extensive use was made of Chesapeake employees in conducting AM operations, and AM paid Chesapeake and other affiliates and subsidiaries for a variety of services. AM received a guaranteed “above market” return under gathering agreements with Chesapeake subsidiaries and allowed Chesapeake subsidiaries a recovery of some of the monies payed out to them. Chesapeake subsequently reported to investors that both its expenses and revenue doubled after it sold its pipelines.

The plaintiffs claimed that Chesapeake’s asset transfer to AM as a way to reverse its financial trouble by dipping into royalties owed to them and, in the process, also benefit AM. They subsequently brought suit against Chesapeake and AM, alleging, in part, a civil RICO violation and a conspiracy to violate RICO.

RICO. Chesapeake argued that the plaintiffs’ claims rested almost entirely on a 2014 Internet article about the plight of mineral owners in Pennsylvania who leased property to Chesapeake for gas and oil exploration. However, the court found that the plaintiffs sufficiently stated a cause of action because the plaintiffs could rely on: (1) facts contained in the article relating to business arrangements between defendants and Chesapeake subsidiaries; and (2) facts involving nonpublic dealings, as they represented matters that were within the defendants’ control.

The court determined that the plaintiffs established the required elements for a RICO violation. The plaintiffs alleged: (1) the existence of two or more predicate offenses by setting forth sufficient factual allegations to support their claims of mail and wire fraud; (2) the existence of an enterprise by setting forth an “association-in-fact” enterprise and clearly pleading the fraudulent scheme behind it; and (3) a pattern of racketeering, and the nexus between it and the enterprise, by pleading that the royalty checks they received each month were fraudulent misrepresentations and products of the defendants’ fraudulent scheme.

Additionally, the plaintiffs sufficiently alleged a conspiracy to violate the provisions of RICO because they alleged all the elements of a substantive RICO violation and that Chesapeake devised a conspiracy which AM participated in, the court concluded.

The case is No: 5:15-cv-616.

Attorneys: Daniel E. Smolen (Smolen Smolen & Roytman) for Linda Kovach. Michael J. Gibbens (Crowe & Dunlevy) and Roy A. Powell (Jones Day) for Access Midstream Partners, L.P. Seamus C. Duffy (Drinker Biddle & Reath) and Jessica Knopp Cunning (Vorys, Sater, Seymour & Pease) for Chesapeake Energy Corp.

Companies: Access Midstream Partners, L.P.; Chesapeake Energy Corp.

Cases: RICO OhioNews