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Will Chesapeake Energy Corporation’s Legal Woes Doom Its Stock?

Photo credit: Chesapeake Energy 

Chesapeake Energy (NYSE: CHK  ) received some very good legal news last week. Unfortunately, it also received some disappointing legal news as well. While in this case the good news appears to outweigh the bad, the fact of the matter is that Chesapeake Energy's legal woes aren't yet all in the rear view mirror. That makes it tough for investors as its remaining legal risks could end up costing them a lot of money. But is it enough to doom the stock?

The good news
Chesapeake Energy, along with Encana (NYSE: ECA  ) , received letters of closure from the Department of Justice last week, which ended the government's criminal review of alleged violations of the Sherman Anti-Trust Law. The companies had been accused of colluding together in the state of Michigan to push lease prices down. The closure of the criminal antitrust probe puts to rest one of the big skeletons that had been hiding in Chesapeake Energy's closet.

Photo credit: Copyright © Encana Corporation, all rights reserved 

Encana and Chesapeake Energy had held talks about forming a joint venture in Michigan during 2010, however, no deal was ever reached. It ensured no wrongdoing occurred, the boards of both companies conducted internal investigations and neither found evidence of collusion. But that didn't stop the Department of Justice from looking into the matter. The good news is the fact that the Justice Department didn't find any wrong doing either so Chesapeake Energy investors can breathe a sigh of relief.

The bad news
That said, it wasn't all good legal news for Chesapeake Energy investors last week. The company lost a U.S. appeals court ruling in Texas. The court upheld a previous ruling requiring the company to pay $121 million to leaseholders after it had backed out of a deal with them.

This legal battle started in 2008 when Chesapeake Energy had agreed to buy 500 oil and gas leases. But the company backed out of the deal after gas prices plunged. Chesapeake Energy actually won the first court case in 2012, but a subsequent appeal sided with the lease owners. It was that appeal that was held up by the U.S. Court of Appeals last week, which said Chesapeake Energy must uphold its end of the deal to pay for the leases. While not an enormous sum of money by Chesapeake Energy's standards, its still is money that's not likely to earn much of a return for investors. 

What's left?
Chesapeake Energy still faces hundreds of additional landowner claims in state and federal courts. The company is facing suits in Texas, Pennsylvania, and Michigan for allegedly breaking oil and gas lease contracts like the Texas case it lost last week.

On top of that the company has been accused of shortchanging landowners in Pennsylvania on royalties. The company is accused of taking advantage of its ability to charge landowners "post-production costs" for transporting and processing natural gas. The Wall Street Journal found that in one well in Pennsylvania, for example, Chesapeake Energy deducted 37% of the royalty payment for these postproduction expenses. Meanwhile, one of the well's owners, Anadarko Petroleum (NYSE: APC  ) , only deducted 13% of the royalty payment for postproduction costs while another interest owner in the well didn't deduct any postproduction costs.

Photo credit: Anadarko Petroleum 

Meanwhile, even though the federal antitrust allegations against Chesapeake Energy and Encana have been dropped, both companies still face state charges in Michigan. The state's Attorney General charged both companies with one count each of antitrust violations and one count each of attempted antitrust violations. While these charges aren't as serious as the federal charges, it still represents a big legal liability for the company.

Investor takeaway
Needless to say Chesapeake Energy still faces a number of legal battles, which could still impact the company's stock price. That makes it really tough for investors to know exactly how big the company's future legal tally will be, meaning the company's stock still could face a lot more volatility while it sorts out these legacy legal issues. While its legal woes aren't likely to doom the stock, its an added risk that make it tough to be a buyer here as the downside is still unknown. 

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  • Report this Comment On May 07, 2014, at 8:15 PM, Hansen wrote:

    Chesapeake Energy beat revenues and earnings estimates for the quarter and also raised its production outlook for fiscal year 2014 as the stock went up 2%

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Matt DiLallo

Matthew is a Senior Energy and Materials Specialist with The Motley Fool. He graduated from the Liberty University with a degree in Biblical Studies and a Masters of Business Administration. You can follow him on Twitter for the latest news and analysis of the energy and materials industries:

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