Liquidated Damages and Penalties

Originally published by John McFarland.

Lawyers for royalty owners have filed multiple suits against Chesapeake Energy in Dimmit County seeking damages for breach of Chesapeake’s leases. These cases were consolidated for discovery and case-management purposes into a single matter, In re: Chesapeake Eagle Ford Royalty Litigation, Cause No. 2016CI22098, in the 224th District Court in San Antonio.

In addition to claims for underpayment of royalties, the plaintiffs in the Dimmit County cases allege that Chesapeake has breached clauses in the leases requiring the lessee to protect the lease against drainage from adjacent wells – sometimes called an express offset clause. Chesapeake has filed a motion for summary judgment arguing that these clauses are unenforceable because they impose a “penalty.”

One of the implied covenants in all oil and gas leases is the covenant to protect the lease against drainage from wells on adjacent tracts. The implied covenant requires the lessee to drill an “offset well” to the draining well if a reasonable and prudent operator would do so. Damages for breach of the implied covenant are the value of the royalty lost to the lessor, based on the amount of drainage that would have been prevented by the drilling of the offset well. Liability and damages for breach of the implied covenant are difficult to prove, so lessors have come up with an alternative – the express offset clause.
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