CHAPTER 12 AN ANALYSIS OF STATE OIL AND GAS ROYALTY PAYMENT LAWS: THE POLITICAL PROCESS CROSSES WITH THE COMMON LAW

• Jurisdiction: United States

PRIVATE OIL & GAS ROYALTIES
(Sept 2003)
CHAPTER 12
AN ANALYSIS OF STATE OIL AND GAS ROYALTY PAYMENT LAWS: THE POLITICAL PROCESS CROSSES WITH THE COMMON LAW
By Dante L. Zarlengo
Zarlengo & Kimmell, LLC
Denver, Colorado

TABLE OF CONTENTS

SYNOPSIS

I. INTRODUCTION

II. PAYMENT AND REPORTING UNDER ROYALTY PAYMENT LAWS

A. Timeliness Of Payment

B. Payment Suspension Provisions

C. Interest On Royalty Payments

D. Royalty Reporting Provisions

1. Information Required To Be Disclosed

E. Penalties And Attorneys' Fees

III. STATUTORY PROVISIONS AFFECTING PRODUCTION VALUATION AND CALCULATION OF PAYMENTS

1. Applicable Statutory Provisions

2. Issues Pertaining To Statutory Applicability

3. Issues Pertaining To Statutory Construction

IV. ENFORCEMENT

A. Standing

B. Jurisdiction

C. Effective Date Of Statutory Provisions And Modification Of Existing Contract Issues

D. Applicable Statute Of Limitations

E. Responsible Party

V. EFFECT OF DIVISION ORDERS AND PRIVATE CONTRACT PROVISIONS

A. Effect Of Division Orders On Statutory Provisions

B. Contracts Which Modify The Statutory Provisions

VI. CONSIDERATIONS FOR A LEGISLATIVE SOLUTION

A. Payment And Reporting Provisions

B. Legislating Royalty Valuation And Calculation Issues

VII. CONCLUSION

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I. INTRODUCTION

Through the years, legislatures in many states, and all states with significant oil and gas production, have passed laws which address the manner in which royalties are to be paid on oil and gas produced in that state.¹ Most of these laws are the product of political processes being brought to bear on long time established practices of oil and gas producers and production purchasers. Usually, these laws, at least in their original conception, are designed to change existing practices which were found to be in some way unfair to royalty owners. Therefore, most such laws are considered remedial in nature.²

However, it is evident that the various legislative bodies desired to balance the advantages of large and continuing investment in oil and gas drilling and production in their state with the need for reform in the manner in which royalties on oil and gas production are calculated and paid. In some cases, the laws simply specify a time by which royalty payments must be made. In other cases, a statute directly affects calculation of royalty payments, arguably in derogation of common law, and even as to oil and gas leases long since in effect at the time the statute was passed. Most such statutes purport to do some or all of that, with varying degrees of success.

The degree to which royalty payment laws in the various states can change from one jurisdiction to the next cannot be overemphasized. There is little, if any, uniformity in the provisions contained in the various statutes. It is incumbent upon the practitioner to carefully investigate the specific statutory provisions related to the particular jurisdiction from which the production at issue comes. Having said that, this paper will attempt to identify the main issues associated with royalty payment laws, and the manner in which the courts have dealt with these issues to this point. Comment will be made on an appropriate resolution of such issues. Obviously, it is not possible to anticipate every single issue and source of dispute that can arise under a particular royalty payment act.

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However, some general principles will be articulated related to statutory construction and legislative intent that may be applied to resolve or determine disputes arising under royalty payment laws.

The propriety and effectiveness of the legislative process upon an area of law long left for judicial determination and resolution in the first instance is, of course, subject to debate. As in most things, a person's point of view on that subject will depend upon the statutory terms in question, the person's own vested interest, and the person's view of the judicial system and the legislative process as a whole. One must also recognize the emotional baggage the issues associated with royalty payments on oil and gas production can carry. Nevertheless, this paper will also attempt to present objective comment on some motivations and conflicting political pressures that have affected adoption of oil and gas royalty payment laws in the past.

It should be mentioned that royalty payment issues raised by pooling and unitization statutes are beyond the scope of this paper, as are statutes which pertain to trusts and estates which address allocation of royalty payments between income and principal.

II. PAYMENT AND REPORTING UNDER ROYALTY PAYMENT LAWS

A. Timeliness Of Payment

Tradition and common law generally did not require payment of royalty at any particular time, but only within a reasonable period of time.

The first issue commonly addressed by royalty payment laws is to require payment to be made to a royalty owner within a specified period of time. For example, in Colorado, royalty payments must be made within six months after the end the first month in which production is sold. Payments are then to be made within sixty days for oil and ninety days for gas following the end of the month in which production is sold.³ Annual payments for production are typically allowed for various diminimus amounts.

The penalty for failure to timely pay the amounts due royalty owners vary from each jurisdiction. In some cases, the payor party is only required to pay interest to the owner at a rate reflecting the reasonable time value of money. In other cases, interest is required at a higher, although hardly punitive rate.⁴ Other states impose significant penalties for failure to timely make royalty payments. In some states, lease cancellation may be a specified remedy.⁵ In still other states, a lien is provided against production to secure timely and proper payment of royalty.⁶

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For these reasons, and others discussed more fully below, one should assume that the consequences of failure to timely make royalty payments are significant and undesirable. It is incumbent upon payor systems and division order departments to become intimately familiar with the law in each particular state in which production is located, and to verify that royalty payments are timely made.

B. Payment Suspension Provisions

At common law, suspension of proceeds was done whenever the payor party believed that a reason existed to do so.⁷ Now, each state requiring royalty payments to be made within a particular time period will also apply a statutory provision allowing for suspension of payment under certain defined circumstances. If the circumstances set forth are not met, no suspension of payment is allowed, and additional interest or penalty may be due.

For example, and as one would suspect, the payor is not required to assume the risk of improper or double payment. In cases where a reasonable question exists as to the party entitled to payment of royalty, a payor party may suspend proceeds until a resolution of the potential dispute is had.⁸ In some instances, the provisions under which royalty payments may be suspended are broad.⁹ In other cases, such provision are narrow in scope.¹⁰ In any event, since the statutory provisions are remedial in nature and designed to remedy circumstances where producers would suspend funds for reasons perceived as unjustified, the circumstances under which suspension is allowed should be narrowly construed.¹¹

In some states, suspended amounts must be paid into a segregated escrow account, separate from the general funds otherwise held by the Payor. For example, Wyoming law requires that suspended funds be deposited into an interest bearing escrow account at an institution in Wyoming.¹² Other states provide that suspended payments be interpleaded into a court of competent jurisdiction.¹³ In still other states, notice must be given if an interest is placed in suspense.¹⁴

An argument exists that only the specific interest or portion of production proceeds with respect to which the impairment requiring suspension exists should be suspended, and not the remaining interests not subject to a title or location of person problems. For example, a portion of a royalty owner's interest may have a different title chain than the remainder of his or her interest. If an issue exists as to marketable title, only that

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portion of the royalty owner's interest that is subject to question should be placed in suspense. As another example, if a royalty owner can demonstrate that it does own an interest in production proceeds, and that its interest is not in any event less than a certain decimal, the owner should be paid for that decimal, even if the remainder of its interest is suspended. Some states specifically require partial suspension by law. ¹⁵ Other states are not as specific. However, given the general principle that royalty payment laws should be given liberal construction, the same conclusion can be reached in jurisdictions which do not allow for specific suspension of only the disputed portion of an owner's interest.

C. Interest On Royalty Payments

Typically, when suspension of funds occurred, no interest was due to the royalty on the money suspended. Suspension was viewed as the right of the payor party to avoid the risk of improper or double payments. The payor simply retained the use of the royalty owner money interest free.

States with royalty payment laws typically require payment of interest to the royalty owner on suspended funds. In some states, interest is required to be paid only when suspension is not justified, and royalty is improperly delayed beyond the statutory payment period.¹⁶ In other cases, interest is required to be paid on unpaid funds whether or not suspension is justified.¹⁷ As discussed above, interest is sometimes required at a punitive rate, while other statutes only require payment of interest at rates...