Promises made, but not kept, and it’s all legal
By Joshua Schneyer and Brian Grow, REUTERS

TRAVERSE CITY, Michigan  — Hundreds of farmers had signed leases with local brokers permitting drillers to tap natural gas and oil beneath their land. All were demanding thousands of dollars in bonuses they had been promised in exchange. But none knew for certain whom to go after.

That’s because the company rejecting their leases hadn’t signed them to begin with. In fact, the company issuing the rejections wasn’t much of a business at all. It was a shell company – a paper-only firm with no real operations – called Northern Michigan Exploration LLC.

One jilted land owner, Eric Boyer-Lashuay, called to complain to the broker who had handled his lease. Northern, he recalls saying, is “a shell company … a blank door with no one behind it.”

Northern has voided hundreds of land deals, and was indeed a facade – a shell company created so that one of America’s largest energy companies could conceal its role in the leasing spree, a Reuters investigation has found. Oklahoma-based Chesapeake Energy Corp., the nation’s second-largest gas driller, was behind the entire operation.

Chesapeake had created one shell company that set up another, Northern Michigan Exploration. Next, Northern hired brokers who signed leases with residents such as Boyer-Lashuay. And those brokers were under strict orders not to divulge Chesapeake’s role, records reviewed by Reuters show.

In fact, the effort in Michigan was directed from the very top – by Chesapeake’s CEO, Aubrey McClendon. In corporate filings that Chesapeake made public earlier this year – nine months after McClendon’s agents began signing Michigan land leases – McClendon is named as the chief executive officer of Northern, the shell company that voided hundreds of those leases.

Chesapeake’s effort to hide its involvement isn’t illegal. To the contrary, the company’s maneuvering exemplifies how U.S. corporations routinely can conceal financial and corporate transactions through the use of shell companies.

In America, privately held businesses aren’t required to disclose the individuals or companies who really own them.

Chesapeake’s own website advises land owners that their “main consideration” before leasing should be “to discover who will ultimately be producing your minerals.” But Chesapeake’s strategy made that extremely difficult for the Michigan land owners.

The tactics “raise moral and ethical questions about how entities can be used,” says Joshua Fershee, a contract law professor at the University of North Dakota.

Others, including Chesapeake, defend the need to use shell companies and front companies – contractors with local ties who do business on behalf of a larger corporation. John Lowe, a professor of energy law at Southern Methodist University, calls it “business as usual.”

“Shells aren’t just a device to pull the wool over land owners’ eyes,” Lowe says. “You have to weigh some of the unfortunate cases against the fact that these companies can facilitate doing business, making it easier and probably cheaper to obtain leases. If I were a regulator, I’m not sure I’d change anything or try to limit the use of shells.”

At least one lawmaker, Rep. Raul Grijalva, a Democrat from Arizona, says he will be “arguing for some intervention” to control the use of shell companies in such deals.

“Private property owners who enter into these transactions with good faith shouldn’t be getting duped by a front company,” says Grijalva, a member of the House Committee for Natural Resources. “It’s deception and you can’t call it anything else. It’s a good example where the intervention of government to require disclosure and binding contracts is needed.”

Intent to renege?
The effort to secure leasing rights in Michigan was part of Chesapeake’s national “land grab,” a term the company has used in its filings with the U.S. Securities and Exchange Commission.

But Chesapeake’s Michigan land rush quickly ended. In court this month, lawyers for land owners alleged that lease agreements were voided after Chesapeake learned a well it drilled in the state had come up dry.

Bonuses promised to land owners went unpaid, according to court documents submitted by lawyers for the land owners. Northern Michigan Exploration, the Chesapeake-affiliated shell company, rejected more than 97 percent of the leases its Michigan agents had signed with farmers and other land owners, the documents allege.

More than 800 Michigan land owners – many of them elderly farmers – had their leases terminated by Northern, Reuters found.

As a consequence, owners missed opportunities to lease their land to other oil firms. At least 115 have sued, alleging that Chesapeake breached their contracts and defrauded them. On average, they each had been expecting $95,000 in bonuses, those lawsuits show.

The near-blanket cancellation of the contracts raises the question of whether Chesapeake ever intended to pay if it failed to find oil or gas immediately, says Mark Gergen, a contract law professor at the University of California-Berkeley law school.

“It suggests they might have had a strategy going in of not honoring their agreements,” he says. “The shells would have facilitated that” because Chesapeake could blame the shells for the cancellations, suffering no damage to its reputation.