Records reviewed by Reuters show that Oklahoma-based Chesapeake Energy Corp., the nation’s second-largest gas driller, created a shell company, Northern Michigan Exploration LLC, that scammed hundreds of farmers in northern Michigan.
The farmers had signed leases with local brokers permitting drillers to tap natural gas and oil beneath their land. They were owed thousands of dollars in bonuses that 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 paper-only firm with no real operations.
One 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.”
Today, he puts it this way: “It was all a fake, all a scam.”
Reuters investigation has found that Northern voided hundreds of land deals, and was indeed a facade created so that one of America’s largest energy companies could conceal its role in the entire operation.
Chesapeake 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.
The orders in Michigan came directly from the top, 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.
President Barack Obama has called on other nations to improve corporate transparency, but under state laws governing corporate formation 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.
Legal scholars say the operation serves as an intriguing test case of the use of shell companies.
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.
Chesapeake, defends 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.”
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.”
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.
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.
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. More than 800 Michigan land owners, many of them elderly farmers, had their leases terminated.
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.
If land owners prove that they should have been paid, at issue is who will be held accountable: Chesapeake, a corporation with $37 billion in assets, or Northern, a shell company with no publicly documented assets.