Unassociated Document
UNITED STATES
 
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


Form 10-QSB

x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

o
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to _________
 
Commission file number 000-30219
 
Chancellor Group, Inc.
(Name of small business issuer in its charter)

Nevada
  
87-0438647
(State or other jurisdiction of
  
(I.R.S. Employer
incorporation or organization)
  
 Identification No.)
 
216 South Price Road, Pampa, TX 79065
(Address of principal executive offices)

(806-688-9697)
(Issuer's telephone number)
 
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. xYes  oNo

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes  x No

APPLICABLE ONLY TO CORPORATE ISSUERS
 
The number of shares outstanding the issuer's common stock, $.001 par value, was 64,802,781 as of November 1, 2007. Transitional Small Business Disclosure Format (Check one):
Yes o No x

 
Table of Contents

Item 1.
  
Financial Statements
1
       
Item 2.
  
Management's Discussion and Analysis or Plan of Operation
14
 
      
Item 4.
  
Controls and Procedures
19
       
PART II
      
       
Item 1.
  
Legal Proceedings
20
       
Item 6.
  
Exhibits
20
       
   
Signatures
21
       
EXHIBIT INDEX
22
 
ii
 
Item 1. Financial Statements

Chancellor Group, Inc.

I N D E X

 
Page No.
Balance Sheet as at September 30, 2007 (Unaudited)
2
   
Statements of Operations For the Three and Nine Months Ended September 30, 2007 and 2006 (Unaudited)
4
   
Statements of Cash Flows For the Nine Months Ended September 30, 2007 and 2006 (Unaudited)
5
   
Notes to Financial Statements (Unaudited)
6
 
1
 
ITEM 1.
 
CHANCELLOR GROUP, INC.
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2007
(UNAUDITED)
ASSETS
      
Current Assets
      
Cash in Bank
  
$
66,510
  
Revenue Receivable
    
246,675
  
Total Current Assets
    
313,185
  
         
Fixed Assets
        
Leasehold Costs - Developed
    
4,938,564
  
Office Building and Equipment
    
126,073
  
Fleet-Road
    
40,476
  
Heavy Field Equipment& Tools
    
402,707
  
Accumulated Depreciation
    
(273,921
 ) 
Total Fixed Assets
    
5,233,899
  
         
Other Assets
        
Unamortized Debt Expense
    
85,018
  
Prepaid Long Term Hedge
    
66,600
  
Total Other Assets
    
151,618
  
         
Total Assets
  
$
5,698,702
  

2
 

LIABILITIES AND STOCKHOLDERS' EQUITY
      
Current liabilities
      
Accounts Payable - Chancellor
  
$
109,828
  
Accounts Payable - Gryphon Production
    
130,471
  
Stock Subscription Payable
    
1,602
  
Misc. Accounts Payable & Suspense
    
6,746
  
         
Current portion of Long Term Debt
        
Note Payable - Senior Debt
    
603,803
  
Installment Loan - Equipment
    
11,065
  
Total Current Liabilities
    
863,515
  
         
Long Term Liabilities
        
Note Payable - Investors
    
5,100
  
Note Payable - Senior Debt
    
1,552,446
  
Note Payable - Subordinated Debt
    
3,797,345
  
Installment Loan - Equipment
    
53,453
  
Total Long Term Liabilities
    
5,408,344
  
         
Stockholders' equity
        
Common stock: $.001 par
        
value, 250,000,000 shares
        
authorized, 64,802,781
        
shares issued & outstanding
    
60,755
  
Preferred Series B stock:
        
$1,000 par value,
        
250,000 shares authorized,
        
-0- issued and outstanding
        
         
Paid in capital
    
3,199,583
  
         
Accumulated deficit
    
(3,323,438
)
Net Income (Loss)
    
(510,056
)
Total Stockholders' Equity
    
(628,911
)
         
Total Liabilities And
             
Stockholders' Equity
  
$
5,698,702
  
         
See Notes to Consolidated Financial Statements
 
3
 
CHANCELLOR GROUP, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)

   
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
 
 
2007
 
2006
 
2007
 
2006
  
Sales- Net of Royalties
                  
Oil
  
$
1,156,335
  
$
-
  
$
887,862
  
$
-
  
Natural Gas
    
192,536
          
170,624
        
Other Incomes
    
2,165
    
-
    
2,165
    
-
  
     
1,351,036
          
1,060,651
        
Severance Taxes
    
66,762
          
52,881
        
Marketing Fees
    
8,669
          
7,194
        
Royalties Paid
    
10,454
          
10,454
        
Net Revenues
    
1,265,151
    
-
    
988,647
    
-
  
                           
Operating expenses
                          
Lease Operating Exp
    
268,803
          
180,646
        
Other Operating
    
653,762
          
299,365
        
General& Admin
    
165,298
    
35,145
    
77,213
    
17,612
  
Depreciation, Depletion,
                          
and Amortization
    
273,922
          
137,109
    
-
  
Total Operating
                          
Expenses
    
1,361,785
    
35,145
    
694,333
    
17,612
  
Income (loss) from
                          
Operations
    
( 96,634
)
  
(35,145
)
  
(295,789
)
  
(17,612
)
                           
Other Income (Expenses)
                          
Organization Costs
    
(49,299
)
        
-
        
Hedge Cost
                          
Amortization
    
(22,200
)
        
(11,100
)
      
Total Other Inc.(Exp.)
    
(71,499
)
        
(11,100
)
      
Financing Charges
                          
Interest
    
313,584
          
274,271
        
Bank Fees Amortization
    
28,339
          
14,170
        
Total Financing Cost
    
341,923
    
-
    
288,441
    
-
  
                           
Income (loss) before
                          
provision for income
                          
taxes
    
(510,056
)
  
(35,145
)
  
(3,752
)
  
(17,612
)
                           
Provision for income tax
    
-
    
-
    
-
    
-
  
Net income (loss)
  
($510,056
 ) $
(35,145
 ) ($3,752
)
 ($17,612
)
Net income (loss)per share (Basic and fully diluted)
 
$
(*
)
$
(*
)
$
(*
)
$
(*
)
Weighted average
                          
number of common
                          
shares outstanding
    63,016,406    
57,513,748
    64,577,781    
59,105,030
  
 
*less than $.01 per share
 
See Notes to Consolidated Financial Statements
 
4
 
CHANCELLOR GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
 
   
Nine Months Ended
 
 
 
September 30,
  
   
2007
 
2006
  
Cash Flows from Operating
          
Activities:
          
Net Income (Loss)
    
($510,056
)
  
(35,145
)
               
Adjustments to Reconcile Net Income (Loss) to Net Cash Flow from Operating Activities:
              
Depreciation and Amortization
    
273,922
        
Decrease(Increase) in Operating Assets
    
(398,293
)
      
Increase(Decrease) in Operating Liabilities
    
137,217
        
Accounts Payable & Other
                        
29,083
  
Total Adjustments
    
12,846
    
29,083
  
               
Net Cash Provided by (Used  in) Operating Activities
    
(497,210
)
  
(6,062
)
               
Cash Flows for Investing Activities Capital Expenditures
    
(5,507,821
)
           
               
Net Cash Provided(Used) by Investing Activities
    
(5,507,821
)
  
-
  
               
Cash Flows from Financing Notes Payable Borrowings
    
6,023,212
    
-
  
Paid in Capital
    
47,500
    
27,450
  
               
Net Cash Provided by Financing
    
6,070,712
    
27,450
  
               
             
Net Increase (Decrease) in Cash
    
65,680
    
21,388
  
Cash Beginning
    
829
        
               
Cash Ending
  
$
66,510
    
21,388
  

See Notes to Consolidated Financial Statements
 
5

Chancellor Group, Inc.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2007
(Unaudited)
 
NOTE 1. ORGANIZATION, OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Chancellor Group, Inc. (the "Company") was incorporated in the state of Utah on May 2, 1986, and then, on December 31, dissolved as a Utah corporation and reincorporated as a Nevada corporation. The Company's primary business purpose is to engage in the exploration and production of oil and gas. In 1996 the Company's corporate name was changed from Nighthawk Capital, Inc. to Chancellor Group, Inc.

On April 16, 2007, the Company closed the acquisition of assets from Caldwell Production Company, Inc., consisting of 48 mineral leases with 631 wells, of which approximately 100 were believed to be producing wells and 531 inactive well bores equipped with necessary production equipment, and related operating facilities and equipment including an office warehouse facility, ten pickup trucks, two pulling rigs, a backhoe, a winch truck and a water truck. The purchase price for such oil field equipment was $291,500. The purchase price for the mineral leases and an existing office building, including an attached warehouse/shop building valued at $81,630, was $5,000,000. The oil and natural gas leases purchased are on approximately 8,000 acres in Gray and Carson Counties, Texas, with a well spacing of 10 acres, and are in the Panhandle Field, discovered in 1920. After closing the acquisition, the Company has opened corporate offices for our production and oil field service subsidiaries at the purchased facilities in Pampa, Texas. After the initial acquisition, the Gryphon Production Company subsidiary has acquired additional trucks, including an electrical repair “bucket” truck, which is needed to restore electric power to several previously non-producing wells. The cost of this additional equipment was $34,000, and associated tools and equipment was $6,422. The Company has also acquired a replacement backhoe machine for $67,000. Subsequently, additional field equipment and tools were purchased for $31,184.
 
The plan is to operate our properties and to restore 10-20 wells per month to production. A typical well restoration is estimated to cost $2,500 to $5,000.
 
Soon after April 16, 2007, the number of producing wells was determined to be 84. As of September 30, 2007, 166 wells are producing - an increase of 82 wells. Productive capacity on April 16 was estimated to be 70 bopd and 90 mcfd. Productive capacity at September 30 is estimated to be 101 bopd and 263 mcfd gas.” The oil is light sweet crude and the natural gas has very high heat content, 1600 to 2600 btu/scf.

As set forth in Note 8 below, on October 30, 2007, we filed for reorganization under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court, District of Northern District of Texas.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Chancellor Group, Inc., and will include its newly formed, wholly owned subsidiaries: Gryphon Production Company, LLC, and Gryphon Field Services, LLC. These entities are collectively hereinafter referred to as "the Company". Any inter-company accounts and transactions have been eliminated. Former subsidiaries, Radly Petroleum, Inc., Lichfield Petroleum America, Inc. , and Getty Petroleum, Inc., no longer exist.
 
6
 
NOTE 1. ORGANIZATION, OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):
 
Oil and Gas Properties

The Company follows the successful efforts method of accounting for its oil and gas activities. Under this accounting method, costs associated with the acquisition, drilling and equipping of successful exploratory and development wells are capitalized. Geological and geophysical costs, delay rentals and drilling costs of unsuccessful exploratory wells are charged to expense as incurred. The carrying value of mineral leases is depleted over the minimum estimated productive life of the leases, or ten years. Undeveloped properties are periodically assessed for possible impairment due to un-recoverability of costs invested. Cash received for partial conveyances of property interests is treated as a recovery of cost and no gain or loss is recognized.

Income Tax

Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less as cash equivalents.

Accounting Year

The Company employs a calendar accounting year. The Company recognizes income and expenses based on the accrual method of accounting.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Net Income (loss) per share

The net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of common outstanding. Warrants, stock options, and common stock issuable upon the conversion of the Company's preferred stock (if any), are not included in the computation if the effect would be anti-dilutive and would increase the earnings or decrease loss per share.
 
7

NOTE 1. ORGANIZATION, OPERATIONS, AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):

Property and Equipment

Property and equipment are recorded at cost and depreciated under the straight line method over the estimated useful life of the equipment. This life is estimated to be five years. The useful life of the office building and warehouse is estimated to be 20 years.

Depletion

The carrying value of the mineral leases is depleted over the minimum estimated productive life of the leases, or ten years.

Accounts Receivable

The Company reviews accounts receivable periodically for collectibles and establishes an allowance for doubtful accounts and records bad debt expense when deemed necessary.

Products and Services, Geographic Areas and Major Customers

The Company plans to develop its domestic oil and gas properties, located in Gray and Carson counties, Texas, and possibly to acquire additional producing oil and gas properties. The Company’s major customers are Shell Trading Company, Valero Marketing, DCP Midstream, and Eagle Rock Energy.

Revenue Recognition

The Company recognizes revenue when a product is sold to a customer, either for cash or as evidenced by an obligation on the part of the customer to pay.

Financial Instruments

The carrying value of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and long term debt, as reported in the accompanying balance sheet, approximates fair value.

Employee Stock-Based Compensation

The Company uses the intrinsic value method of accounting for employee stock-based compensation.

Recent Accounting Pronouncements

In March 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 155, "Accounting for Certain Hybrid Financial Instruments." SFAS 155 resolves certain accounting issues related to various hybrid financial instruments. The Company has adopted the provisions of SFAS No. 155 which are effective for fiscal years beginning
after September 15, 2006. The adoption did not have a material effect on the results of operations of the Company.

In March 2006, the FASB issued SFAS No. 156 "Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". This statement requires all separately recognized servicing  assets and servicing liabilities be initially measured at fair value, if practicable, and permits for subsequent measurement using either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of Statement No. 140. The Company has adopted the provisions of SFAS No. 156, which are effective in general for an entity's fiscal year beginning after September 15, 2006. The adoption did not have a material effect on the results of operations of the Company.
 
8
 
NOTE 1. ORGANIZATION, OPERATIONS, AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):

In December 2006, the FASB issued SFAS No. 157 "Fair Value Measurements", to improve consistency and comparability in fair value measurements, and to expand related disclosures. The Company has adopted the provisions of SFAS No. 157, which are effective for financial statements for fiscal years beginning after November 15, 2007. The adoption did not have a material effect on the results of operations of the Company.

In September 2006 the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans”. SFAS No. 158 requires the Company to recognize the funded status of its post retirement plans on the balance sheet and recognize as a component of accumulated other comprehensive income the gains and losses, prior service costs or credits that occur during the financial year but are not recognized as components of the Company’s pension costs This Statement is effective as of the beginning of its first fiscal year that begins after December 15, 2008. The Company does not expect application of SFAS No. 156 to have a material affect on its financial statements.

In February 2007 the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115”. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The amendment to SFAS No. 115 applies to all entities with investments in available-for-sale or trading securities. The statement is effective for fiscal years beginning after November 15, 2007. The Company does not expect application of SFAS No. 159 to have a material affect on its financial statements.

NOTE 2. RELATED PARTY TRANSACTIONS

In the second quarter of 2007, ending June 30, 2007, a Director purchased 300,000 shares of Chancellor common stock for $15,000. Also in the second quarter of 2007, we paid $40,000 in consulting fees to a Director. In addition during the second quarter of 2007, US Consultancy and Services, LLC, owned by the son-in-law of the President and CEO, was paid $6,000 for consulting services.

In the third quarter of 2007, ending September 30, a Director was paid $6,000 in consulting fees. Also in the third quarter of 2007, US Consultancy and Services, LLC, owned by the son-in-law of the President and CEO, was paid $29,018.57 for consulting services.
 
9
 
NOTE 3. INCOME TAXES

Deferred income taxes arise from the temporary differences between financial statement and income tax recognition of net operating losses. These loss carryovers are limited under the Internal Revenue Code should a significant change in ownership occur. The Company accounts for income taxes pursuant to SFAS 109.

At December 31, 2006 the Company had approximately $3,315,000 in unused federal net operating loss carry-forwards, which begin to expire principally in the year 2011. A deferred tax asset of approximately $660,000 resulting from the loss carry-forward has been offset by a 100% valuation allowance. The increase in the valuation allowance from 2005 to 2006 was approximately $12,000.

At September 30, 2007, the Company had approximately $3,833,000 in unused federal net operating loss carry-forwards, which begin to expire principally in the year 2011. A deferred tax asset of approximately $875,000 resulting from the loss carry-forward has been offset by a 100% valuation allowance. The increase in the valuation allowance from year end 2006 to third quarter 2007 was approximately $215,000. The net operating loss carry-forwards may be limited under the Change of Control provisions of the Internal Revenue Code section 382.

NOTE 4. STOCKHOLDERS' EQUITY

Common Stock

The Company has 250,000,000 authorized shares of common stock, par value $.001, with 64,802,781 shares issued and outstanding as of September 30, 2007.

Preferred Stock

Preferred Series B Stock - The Company has provided for the issuance of 250,000 shares, par value $1,000 per share, of convertible Preferred Series B stock ("Series B"). Each Series B share is convertible into 166.667 shares of the Company's common stock upon election by the shareholder, with dates and terms set by the Board. 48,000 Series B shares have been issued and converted in prior years.

Stock Options

Non-employee Stock Options

The Company accounts for non-employee stock options under SFAS 123 (as amended by SFAS 148), whereby options costs are recorded based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. During the years ended December 31, 2005 and 2006, no options were issued, exercised or cancelled.

The Company currently has stock options outstanding to various individuals in the following amounts: 2,000,000 options exercisable for one share of common stock at an exercise price of $0.025 per share, currently exercisable, expiring December 31, 2009, and 4,000,000 options exercisable for one share of common stock at an exercise price of $0.02 per share, currently exercisable, expiring December 31, 2009. In addition, At the closing of the purchase of the Caldwell Assets, pursuant to an Agreement to Issue Warrants, dated April 13, 2007 (the “CapWest Warrant Agreement”), we also issued CapWest a warrant to purchase 2,000,000 shares of our common stock, at a purchase price of $0.001 per share, which warrant is exercisable at any time up to April 13, 2012. CapWest has a put option (the “Put Option”) during the period beginning on the first to occur of the following dates (a) the second anniversary of the CapWest Loan Agreement; or (b) the date when the Company shall have paid CapWest’s loan in full to put the CapWest Warrants to the Company for repurchase at an exercise price of $1,000,000.
 
10

NOTE 4. STOCKHOLDERS' EQUITY (Continued):

Employee Stock Options

The Company accounts for non-employee stock options under SFAS 123 (as Amended by SFAS 148). The Company issued no employee stock options and had none outstanding at the end of 2005, 2006 or as of the close of the quarter ending June 30, 2007.
 
NOTE 5. GOING CONCERN UNCERTAINTY

These financial statements are presented assuming the Company will continue as a going concern. The Company has had recurring losses from operations, negative working capital, and stockholders' equity deficiency. This raises substantial doubt about its ability to continue as a going concern. Management's plan in regard to these matters includes restoring sufficient production capacity from the recently acquired properties so as to achieve positive cash flow, as well as raising working capital to assure the Company's viability, through private or public equity offerings and/or debt financing; and acquiring and developing profitable oil and gas properties. There can be no assurance that either operating or capital market transactions will be successful.

NOTE 6. CONTINGENT LIABILITY

On August 4, 2007, the Company received a letter from David L. Kagel, a former attorney for the Company, indicating his intention to initiate an arbitration proceeding or to file a lawsuit for recovery of $50,489 (including interest) for services rendered over several years under prior management. The Company believes the claim is without merit and that it has a number of counterclaims against Mr. Kagel. No further action has occurred regarding this issue.

NOTE 7. DEBT

To finance the acquisition of the assets purchased from Caldwell Production Company, Inc., on April 13, 2007, we closed on a Loan Agreement with Western National Bank (“WNB”), Midland, Texas, for a senior loan facility (the “WNB Loan Agreement”). At the closing of the purchase of the Caldwell Assets, we drew down $2.3 million under the WNB Loan Agreement The interest rate under the WNB Loan Agreement is a variable rate equal to the prime rate as defined in this Agreement plus 2%, but in no event to be less than 9.25%.

April 13, 2007, we also entered into a Loan On Agreement with CapWest Resources, Inc., Midland, Texas, for an advancing line of credit/term loan facility, under which we drew down at closing $2,700,000 for the balance of the purchase price of the leases, $291,500 for the equipment, $111,000 for bank fees, legal expenses and associated costs, and $130,000 for initial working capital. The interest rate under the CapWest Loan Agreement is a variable rate equal to the prime rate as defined in this Agreement plus 4%. Under the CapWest loan agreement, CapWest has a 2% overriding royalty interest in the Leases.
 
11

NOTE 7. DEBT (Continued):

After the payout of CapWest’s loan, or in the event that the Company is sold, this overriding royalty interest will convert to a 15% net revenue interest in the Leases. This interest may be purchased by us under a formula specified in this Agreement. The CapWest Loan Agreement has now been fully drawn to the initially agreed amount of $3,700,000.
  
On August 2, 2007, that Company and CapWest Resources, Inc., our subordinated debt lender, agreed in principle, subject to definitive documentation, to amend the Subordinated Loan Agreement in order to increase the loan by $250,000. The terms of the agreement in principle were: a) The Company must pay accrued interest thru July 30, by August 20, 2007. The Company has paid $42,000 in August, and must pay an additional $85,000 by that date; b) CapWest agreed to require monthly interest only thereafter, until December 31, 2007; c) The Company agreed to raise $250,000 in common equity by October 31,2007; d) The Company agreed to reduce administrative salaries by $25,000 per month; e) The net revenue interest after payout provided in the CapWest loan was increased from 15% to 20%.

NOTE 8. SUBSEQUENT EVENTS

On October 15, 2007 Mr. Bradley W. Fischer resigned as the Chief Executive Officer and as a director. Under the separation agreement with the Company, Mr. Fischer has released the Company for any claims of unpaid salary and unreimbursed expenses, and is returning the 3,037,751 shares of common stock issued to him for cancellation.

Effective October 16, 2007, Thomas H. Grantham was appointed as the President and Chief Financial Officer of the Company.

Due to the resignation of Mr. Bradley W. Fischer as Chief Executive Officer of the Company the primary lenders (Western National Bank of Midland, Texas and CapWest Resources, Inc.) have taken the position the Company is in default with regard certain loan covenants that related to changes in management and borrowers. An extension of time to correct these technical defaults was provided to the Company until October 31, 2007. Additionally, another loan covenant regarding a debt ratio was deemed to have been in default and the Company was given until November 15, 2007 to remedy that problem.

On October 25, 2007, the lenders presented to the Company three agreements, that upon their execution, the lenders would extend the default provisions until December 15, 2007 at which date the lenders expected the debt to be paid in its entirety. One of the agreements was that a fully executed deed in trust would be placed into an escrow account that would allow the lenders to immediately proceed to foreclosure if the Company was unable to retire its debt by the December 15, 2007 deadline.

Due to the unreasonable time frame that was placed upon the Company by the lenders to restructure its liabilities to the lenders and the impending default date of October 31, 2007, the management of the Company made the decision to seek the protection of the United States Bankruptcy Court, District of Northern District of Texas. The applicable filings were made for Gryphon Operating Co., LLC on October 29, 2007. Subsequent filings were made for Chancellor Group, Inc. and Gryphon Field Services Co., LLC on October 30, 2007. The Company is currently operating as a debtor in possession under those court filings.
 
12
 
Note 9. ACCUMULATED COMPENSATED ABSENCES

It is the Company’s policy to permit employees to accumulate a limited amount of earned by unused vacation and sick leave, which will be paid to employees upon separation from the Company’s service. The cost of vacation and sick leave is recognized when payments are made to employees. These amounts are immaterial at this time and no amounts have been recorded in the financial statements.
 
13
 
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN of OPERATION
 
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
 
Throughout this report, we make statements that may be deemed "forward-looking" statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, that address activities, events, outcomes and other matters that Chancellor plans, expects, intends, assumes, believes, budgets, predicts, forecasts, projects, estimates or anticipates (and other similar expressions) will, should or may occur in the future are forward-looking statements. These forward-looking statements are based on management's current belief, based on currently available information, as to the outcome and timing of future events. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this report.

We caution you that these forward-looking statements are subject to all of the risks and uncertainties, many of which are beyond our control, incident to the exploration for and development, production and sale of oil and gas. These risks include, but are not limited to, commodity price volatility, inflation, lack of availability of goods and services, environmental risks, operating risks, regulatory changes, the uncertainty inherent in estimating proved oil and natural gas reserves and in projecting future rates of production and timing of development expenditures and other risks described herein.
 
BACKGROUND

Chancellor Group, Inc., a Nevada corporation (“we”, “us”, “Chancellor” or the “Company”), is in the business of acquisition, exploration, and development of natural gas and oil properties. In 1997, we had purchased oil, gas and mineral leases in Pecos County, Texas. All such leases have since lapsed. Following the appointment in 2002 of a new Board by the Court in a derivative action brought against us in 2001, the Company has applied itself to reorganizing management, providing up to date accounting information and seeking new business opportunities. Funds provided by several investor-shareholders enabled the process to proceed and the Company's audits and filings with the Securities and Exchange Commission to be brought up to date.

Since that time, we actively sought an acquisition of petroleum producing assets, and have completed an initial acquisition of oil and gas leases and related facilities and equipment as described below under “Plan of Operation.” As set forth in detail below, on October 30, 2007, we filed for reorganization under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court, District of Northern District of Texas.

Our common stock is quoted on the Over-The-Counter market and trades under the symbol CHAG.PK. As of November 1, 2007, there were 64,802,781 shares of our common stock issued and outstanding.
 
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Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006
 
We had no production operations in calendar year 2006. Our oil production operations began April 16th, 2007 with an effective date of April 1st, 2007. During the three month period ending September 30th, 2007 we produced and sold 9,131 barrels of oil and produced and sold 23,689 mcf gas, generating $1,048,032 revenues after royalties, with a one month lag in receipt of revenues for the prior months sales. Start up expenditures, included debt origination expenditures, and the required prepaid hedge were $251,456. We had 84 wells actually producing oil and gas on April 16th and restored an additional 82 wells by September 30th.

Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006
 
We had no production operations in calendar year 2006. Our oil production operations began April 16th, 2007 with an effective date of April 1st, 2007. During the period ending September 30th, 2007 we produced and sold 17,099 barrels of oil and produced and sold 33,630 mcf gas, generating $1,348,871 revenues after royalties, with a one month lag in receipt of revenues for the prior months sales. Start up expenditures, included debt origination expenditures, and the required prepaid hedge were $251,456. We had 84 wells actually producing oil and gas on April 16th and restored an additional 82 wells by September 30th. The terms of our loan agreement required us to hedge initial oil production; we purchased two 1000 barrel hedge contracts covering the first 24 months production at a cost of $88,900. We also experienced non-recurring expenses related to start-up. In aggregate, the delays in revenue, hedge expense, and non-recurring expenses amounted to approximately $490,000 of reduced income and $666,000 of reduced cash flow.
 
We have a stockholders' deficiency in the amount of $628,911 at September 30, 2007.
 
PLAN OF OPERATION

On April 16, 2007, we closed the acquisition of assets from Caldwell Production Company, Inc., consisting of 48 mineral leases with 621 wells, of which approximately 100 were considered to be producing wells and 531 inactive well bores equipped with necessary production equipment, and related operating facilities and equipment including an office warehouse facility, ten pickup trucks, two pulling rigs, a backhoe, a winch truck and a water truck. The purchase price for the mineral leases and an existing office building including an attached warehouse/shop building valued at $81,630, was $5,000,000, and for the equipment $291,500. The oil and natural gas leases purchased are on approximately 8,000 acres in Gray and Carson Counties, Texas, with a well spacing of 10 acres, and are in the Panhandle Field, discovered in 1920. After closing the acquisition, we has opened corporate offices for our production and oil field service subsidiaries at the purchased facilities in Pampa, Texas. After the initial acquisition, the Gryphon Production Company subsidiary we have acquired additional trucks, including an electrical repair “bucket” truck, which is needed to restore electric power to several previously non-producing wells. The cost of this additional equipment was $34,000 and associated tools and equipment was $6,422. We have also acquired a replacement backhoe machine for $67,000. Subsequently, additional Field equipment and tools were purchased for $31,184. We were also required to invest $38,949 in the rehabilitation and restoration of the office building.
 
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We commenced operations on April 16 with what were 84 actually producing wells. As of September 30, 2007, 166 wells are producing. Productive capacity on April 16 was estimated to be 70 bopd and 90 mcfd. Productive capacity at September 30 is estimated to be 101 bopd and 163 mcfd gas. The oil is light sweet crude and the natural gas has very high heat content, 1600 to 2600 btu/scf.

On October 30, 2007, as discussed in more detail under “Liquidity and Capital Resources” below, due to notices of default received from Western National Bank and CapWest Resources, Inc., we filed a bankruptcy petition under Chapter 11 of the United States Bankruptcy Code, and our operating subsidiaries, Gryphon Production Company, LLC and Gryphon Field Services, LLC, filed bankruptcy petitions under Chapter 11 of the Code on October 29 and October 30, 2007, respectively. At this time, the Company is managing its operations and those of its two subsidiaries as a debtor in possession. Our intention making in the Chapter 11 filings is to continue operations of the Company through the Chapter 11 bankruptcy process and to emerge from the Chapter 11 reorganization as an operating company, with our financial structure reorganized, and where all of our creditors would receive the full amounts owed. However, there is no assurance that we will be able successfully to reorganize our company in this bankruptcy proceeding.
 
The following table is for the three months ended:

 
  
September 30, 2007
  
 
  
September 30, 2006
  
 
  
Oil and Gas Sales
                  
Oil Sales(Bbl)
    
9131
          
0
        
Natural Gas (Mcf)
    
23689
          
0
        
                           
Average Sales Price:
                  
Oil, per Bbl:
  
$
76.59
        
0
      
Gas, per MMCF:
  
$
6.80
        
0
      
 
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The following table is for the Nine months ended:

 
  
September 30, 2007
  
 
  
September 30, 2006
  
 
  
Oil and Gas Sales
                  
Oil Sales(Bbl)
    
17098
          
0
        
Natural Gas Sales (Mcf)
    
38041
          
0
        
                           
Average Sales Price:
                  
Oil, per Bbl:
  
$
70.15
        
0
      
Gas, per MMCF:
  
$
7.31
        
0
      
 
Generally, in managing our business we must deal with many factors inherent in our industry. First and foremost is wide fluctuation of oil and gas prices. Oil and gas markets are cyclical and volatile, with future price movements difficult to predict. While our revenues are a function of both production and prices, wide swings in prices often have the greatest impact on our results of operations.
 
Our operations entail significant complexities. Advanced technologies requiring highly trained personnel are utilized in restoration of wells and production. The oil and gas industry is highly competitive. We compete with major and diversified energy companies, independent oil and gas companies, and individual operators. In addition, the industry as a whole competes with other businesses that supply energy to industrial, commercial, and residential end users. Our ability to recruit and retain experienced personnel is vital to the success of our endeavors.

Liquidity & Capital Resources

As of September 30, 2007 the Company had $66,510 of cash on hand. We have an accumulated deficit of $3,833,494 and have a stockholders' deficiency of $628,911 at September 30, 2007.

Loan Agreements with Western National Bank and CapWest Resources, Inc.

To finance the acquisition of the assets purchased from Caldwell Production Company, Inc., on April 13, 2007, we closed on a Loan Agreement with Western National Bank (“WNB”), Midland, Texas, for a senior loan facility (the “WNB Loan Agreement”). At the closing of the purchase of the Caldwell Assets, we drew down $2.3 million under the WNB Loan Agreement The interest rate under the WNB Loan Agreement is a variable rate equal to the prime rate as defined in this Agreement plus 2%, but in no event to be less than 9.25%.

On April 13, 2007, we also entered into a Loan Agreement with CapWest Resources, Inc., Midland, Texas (“CapWest”), for an advancing line of credit/term loan facility, under which we drew down at closing $2,700,000 for the balance of the purchase price of the leases, $291,500 for the equipment, $111,000 for bank fees, legal expenses and associated costs, and $130,000 for initial working capital. The interest rate under the CapWest Loan Agreement is a variable rate equal to the prime rate as defined in this Agreement plus 4%. Under the CapWest loan agreement, CapWest has a 2% overriding royalty interest in the Leases. After the payout of CapWest’s loan, or in the event that the Company is sold, this overriding royalty interest will convert to a 15% net revenue interest in the Leases. This interest may be purchased by us under a formula specified in this Agreement.
 
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On April 26, 2007 we drew $75,000 for additional working capital and start-up expenses. On May 6, 2007 we drew $88,800 to purchase a hedge floor for a portion of our oil production, as required by the loan agreements. On May 7, 2007 we drew $203,000 to fund lease operating expenses and well restorations. On June 14, 2007 we drew $98,000 for the same purposes. The CapWest Loan Agreement has now been fully drawn to the initially agreed amount of $3,700,000.

Effective July 12, 2007, we executed an agreement ("Modification'), amending the WNB Term Note issued pursuant to the WNB Loan Agreement. The Modification changes the monthly payment date from the 15th to the 25th of each month and extended the maturity date of the loan to April 25, 2010.

Pursuant to the terms of the CapWest Loan Agreement, we have previously executed an assignment of overriding royalty interest under which we conveyed to CapWest a 2% overriding royalty interest ("ORRI") in our leases, proportionately reduced to our net revenue interest. In addition to the aforementioned 2% ORRI, after payout of Cap West's loan (as defined in the CapWest Loan Agreement), CapWest will "back-in" for 15% of our gross oil and gas proceeds, conveyed in a Bill of Sale and Assignment of Contractual Rights dated April 13, 2007. We may repurchase this interest based upon a formula specified in the Cap West Loan Agreement. As of August 2, 2007, we entered into a new Bill of Sale and Assignment of Contractual Rights with CapWest that provides for an additional 5% interest for Cap West in the gross oil and gas proceeds from our leases after payout of Cap West's loan, effectively resulting in an increase of the back-in from 15% to 20% of our gross oil and gas proceeds.

We received a notice of defaults dated September 7, 2007 from counsel for WNB and CapWest stating that we were in default of two financial covenants relating to our consolidated debt service coverage ratio under the WNB and CapWest loan documents. We subsequently received letters from WNB and CapWest, both dated September 12, 2007, waiving the previously stated events of default until October 15, 2007. Following the resignation of Bradley W. Fischer as our Chief Executive Officer effective October 16, 2007, we received notices dated that date from WNB and CapWest as to the existence of an event of default regarding our consolidated debt service coverage ratio, which had been waived by both financial institutions through October 15, 2007, and an event of default relating to the departure of Mr. Fischer as our Chief Executive Officer. As to the noticed default regarding our consolidated debt service coverage ratio, the October 16 notices from the lenders provided us until November 15, 2007 to take appropriate curative action. With regard to the management change, both lenders expressed a willingness to meet with Thomas Grantham, Mr. Fischer’s successor as our President and did, in fact, meet with Mr. Grantham. On October 22, 2007, we received an oral communication from a representative of one the lenders to the effect that the lenders would not waive this event of default and that they would not extend the November 15, 2007 compliance deadline for the debt service coverage ratio covenants. In continuing negotiations, on October 25, 2007, the lenders further advised that the banks would not foreclose on the Company’s assets if the Company agreed to pay the lenders in full by December 15, 2007, execute a release of the banks from liability, and deliver into escrow a deed in trust on all our properties and assets that would be released from escrow and delivered to the banks on December 15, 2007 if all loans were not paid in full.

Bankruptcy Filing under Chapter 11 of the Bankruptcy Code

Due to the potential for an immediate event of default under the WNB and CapWest loan agreements, unless we signed additional documents with the banks with the required payoff of their loans by December 15, 2007, on October 30, 2007, we filed a bankruptcy petition under Chapter 11 of the United States Bankruptcy Code (the “Code”) with the United States Bankruptcy Court, Northern District of Texas. Our operating subsidiaries, Gryphon Production Company, LLC and Gryphon Field Services, LLC filed bankruptcy petitions under Chapter 11 of the Code on October 29 and October 30, 2007, respectively, with the same Court. At this time, the Company is managing its operations and those of its two subsidiaries as a debtor in possession.
 
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Our intention making in the Chapter 11 filings is to continue operations of the Company through the Chapter 11 bankruptcy process and to emerge from the Chapter 11 reorganization as an operating company, with our financial structure reorganized, and where all of our creditors would receive the full amounts owed. In the context of our reorganization under Chapter 11 of the Code, we may be required to raise equity capital to fully rework wells that are currently not in production in the next 12 months and to finance our planned business operations. There are no assurances that we will be able to raise additional equity capital. In the event we are unable to obtain additional capital or funding we may be unable to reorganize successfully under Chapter 11 of the Code.

CRITICAL ACCOUNTING POLICIES

The Securities and Exchange Commission recently issued "Financial Reporting Release No. 60 Cautionary Advice Regarding Disclosure About Critical Accounting Policies" ("FRR 60"), suggesting companies provide additional disclosures, discussion and commentary on those accounting policies considered most critical to its business and financial reporting requirements. FRR 60 considers an accounting policy to be critical if it is important to the Company's financial condition and results of operations, and requires significant judgment and estimates on the part of management in the application of the policy. For a summary of the Company's significant accounting policies, including the critical accounting policies discussed below, please refer to the accompanying notes to the financial statements.
 
The Company assesses potential impairment of its long-lived assets, which include its property and equipment and its identifiable intangibles such as deferred charges under the guidance of SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets". The Company must continually determine if a permanent impairment of its long-lived assets has occurred and write down the assets to their fair values and charge current operations for the measured impairment.
 
ITEM 3. CONTROLS AND PROCEDURES

The Company's President and Chief Financial Officer is primarily responsible for the accuracy of the financial information that is presented in this quarterly Report. This officers has as of the close of the period covered by this Quarterly Report, evaluated the Company's disclosure controls and procedures (as defined in Rules 13a-4c and 15d-14c promulgated under the Securities Exchange Act of 1934 and determined that such controls and procedures were effective in ensuring that material information relating to the Company was made known to him during the period covered by this Quarterly Report. Since his evaluation, no changes were made to the Company's internal controls or in other factors that could significantly affect these controls.
 
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PART II—OTHER INFORMATION

ITEM 1. Legal Proceedings

On August 4, 2007, the Company received a letter from David L. Kagel, a former attorney for the Company, indicating his intention to initiate an arbitration proceeding or to file a lawsuit for recovery of $50,489 (including interest) for services rendered over several years under prior management. The Company believes the claim is without merit and that it has a number of counterclaims against Mr. Kagel.
 
ITEM 6. Exhibits.

No.   Description
     
31   Certification of President and Chief Financial Officer Pursuant to Section 302 of The Sarbanes Oxley Act of 2002.
     
32
  Certification of President and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Oxley Act of 2002.
 
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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
     
 
Chancellor Group, Inc.  
(Registrant)
 
 		  
 		  
 
By:   /s/ Thomas H. Grantham
 
Thomas H. Grantham, President and
Chief Financial Officer
   
Dated: November 15, 2007
  
 
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EXHIBIT INDEX

Exhibit
Number
  
Description
31
  
Certification of President and Chief Financial Officer Pursuant to Section 302 of The Sarbanes Oxley Act of 2002.
     
32
  
Certification of President and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes- Oxley Oxley Act of 2002.
 
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