Chesapeake Energy's Legal Woes in Michigan Just Won't Go Away

Chesapeake Energy is now being charged with felony racketeering and fraud in Michigan on top of previous charges that it colluded with EnCana to keep lease prices in the state low.

Jun 6, 2014 at 4:37PM
  Drilling Mast With Flag

Source: Chesapeake Energy.

Chesapeake Energy's (NYSE:CHK) legal issues in Michigan just took a turn for the worse. The state, which had already charged Chesapeake Energy and Encana (NYSE:ECA) with collusion, is now charging Chesapeake Energy with racketeering and fraud. Let's take a close look at what these new charges mean for Chesapeake Energy and its investors.

Latest charges
According to Michigan Attorney General Bill Schuette, Chesapeake Energy told landowners in 2010 that existing mortgages on their properties weren't a barrier to signing a lease with Chesapeake Energy for the property. However, after competition for leases ceased as the price of natural gas plunged, the company allegedly cited those same mortgages as justification for canceling nearly all of the leases. According to the state, this enabled Chesapeake Energy to obtain uncompensated land options from these landowners under false pretenses, which prevented the landowners from leasing their land to a competitor.

These charges come with stiff penalties. The company was charged with one count of racketeering, which is a felony punishable by a fine of as much as $100,000. In addition to that, the company faces eight counts of false pretenses, each of which is subject to a fine of $10,000, or three times the value of the money or property involved, whichever amount is greater. That's on top of the antitrust charge, which carries a penalty as high as a million dollars.

What's at stake
While the potential fines represent less than the cost of one well, these legal woes come at a higher cost than most investors might realize. These allegations make it seem like Chesapeake Energy doesn't look after all of its stakeholders equally. It's an image that could hurt the company in the future when it's negotiating for new leases in emerging areas like the Rockies. A landowner could opt to accept a lower lease term with a competitor of Chesapeake Energy as these past issues have eroded the company's trustworthiness. 

Further, the earlier collusion allegations could hurt its ability to work with industry peers like Encana in the future. In that case, Encana chose to settle its collusion charges with Michigan by agreeing to pay $5 million while not contesting the charge that it tried to collude with Chesapeake Energy. The fact that those collusion charges stemmed from Encana and Chesapeake Energy talking about forming a joint venture in Michigan could make a future potential joint venture partner wary about ever engaging in similar talks with Chesapeake Energy. It's an image problem that will be tough to shed.

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Investor takeaway
The hope for investors is that Chesapeake Energy is found to be without fault and that the charges are eventually dropped. However, until there is resolution to the company's legal woes in Michigan, investors need to realize that it's an additional risk that could have a negative impact on the company's stock if these allegations prove to be true. 

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