CHAPTER 12 FEDERAL ROYALTY COLLECTION AND ENFORCEMENT ISSUES

• Jurisdiction: United States

Royalty Valuation and Management
(Mar 1988)
CHAPTER 12
FEDERAL ROYALTY COLLECTION AND ENFORCEMENT ISSUES
Salvatore J. Casamassima
Exxon Company, U.S.A.
Houston, Texas

I. Background

One of the most nagging problems that has haunted the Minerals Management Service and federal and Indian lessees during this decade has been the question of royalty collection. Allegations in the press and on Capitol Hill are continually surfacing regarding huge undercollections of federal and Indian royalties amounting to several hundred million dollars. Although many of the allegations are either false or misleading, they have nonetheless caused the MMS to be very aggressive in enforcing royalty payments. This paper will look at the royalty collection problems of the MMS, both real and perceived, and will also deal with the related topic of enforcement. The object is to look at the problem from all sides and to make some recommendations along the way on how the system can be improved. From a practitioner's standpoint, the paper will also discuss some of the more important legal and accounting issues that will confront royalty payors in the context of royalty collection and enforcement.

A. Linowes Commission Report

The most logical starting point for this topic is the Linowes Commission Report.¹ The Linowes Commission was formed in 1981 to investigate several oil field thefts occurring in 1980 from a few federal and Indian leases and allegations of the federal government's mismanagement of its royalty collection and accounting responsibilities. The Commission formally entitled "Commission on Fiscal Accountability of the Nation's Energy Resources" and chaired by David F. Linowes issued a report in 1982 which was highly critical of the government's handling of royalty management. The report outlined numerous deficiencies in the government's royalty collection and recordkeeping practices and made sixty specific recommendations for improvement.²

The Commission concluded that there were, in some cases, substantial underpayments and undercollections of royalties and recommended a thorough overhaul of the government's royalty management system. The main message of the Commission was accountability. It cautioned lessees that they had primary responsibility for the detailed recordkeeping needed to assure royalty compliance and urged the federal government to develop systematic cross-checks of royalty payments and reporting. The Commission also recommended that meaningful penalties be imposed

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for false statements or gross errors on the part of lessees. Overall, the Commission painted a picture of poor internal controls and weak enforcement which generated a myriad of systemic problems in managing the nation's energy resources.

B. Federal Oil and Gas Royalty Management Act (FOGRMA)

A number of the recommendations of the Linowes Commission necessitated legislative action and the Congress responded quickly. On the heels of the Commission report Congress enacted the Federal Oil and Gas Royalty Management Act of 1982 ("FOGRMA").³ FOGRMA established the framework for a more effective and uniform royalty management program to be administered by the Secretary of the Interior and the newly formed Minerals Management Service. In addition, the Act established specific recordkeeping requirements for royalty payors and broadened the government's inspection, audit, enforcement, and penalty assessment authorities. Regulations implementing duties and responsibilities under FOGRMA were issued by the MMS in September, 1984.⁴

It is interesting to look at the Congressional statement of findings and purposes which opens FOGRMA.⁵ Section 1701(a) states that the federal and Indian system of accounting for oil and gas leases "is archaic and inadequate" and it calls for the Secretary to initiate procedures to improve methods of accounting for royalties. The statement also calls for the Secretary to effectively enforce existing regulations. To give the Secretary the powers to implement the purposes of the Act, FOGRMA clarified, reaffirmed and expanded the authorities and responsibilities of the Secretary and the responsibilities and obligations of lessees. It specifically required the lessee to develop enforcement practices that "ensure the prompt and proper collection and disbursement of oil and gas revenues...."

Under FOGRMA the Secretary is mandated to establish a comprehensive inspection, collection and fiscal production accounting and auditing system to provide the capability to accurately determine oil and gas royalties, interest, fines and penalties.⁶ On the enforcement side, FOGRMA provides for both civil and criminal penalties that can get very stiff. For failure to correct a violation within twenty days of notice, the penalty is up to $500 per violation per day. This can escalate to $5,000 per violation per day if corrective action is not taken within forty days. A knowing or willful failure to pay royalties can result in a $10,000 penalty and the knowing or willful submission of false or inaccurate reports, records and other information can carry a $25,000 per violation per day penalty. On top of this, FOGRMA provides for criminal penalties which can reach $50,000 in fines and imprisonment for up to two years.

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In addition to the penalty provisions, FOGRMA specifically provides for interest assessments on royalty payment deficiencies and late payments.⁸ Interest is limited only to the amount of the deficiency and only to the number of days the payment is past due. The interest rate to be assessed is established as being the IRS interest rate.

As far as the regulations implementing FOGRMA are concerned, I will not address those parts of the regulations dealing with record retention, auditing, or MMS-state and MMS-Indian delegations of authority and cooperative agreements. I will limit myself to 30 CFR Parts 218 and 241 dealing with royalty collection and enforcement. Under Part 218, the MMS requires payment of royalty at the end of the month following the month during which the oil and gas was produced and sold.⁹ Payments made on Bills for Collection are due as specified in the Bill and payments are not deferred by reason of the filing of an appeal.

In addition to interest assessments on late payments at the IRS rate, Part 218 also provides for assessments for incorrect or late reports.¹⁰ The MMS may assess an amount not to exceed $10.00 per day for incorrectly completed reports. Keep in mind that for purposes of the Auditing and Financial System (AFS), a "report" is defined as each individual required transaction code for each Accounting Identification Number, Product Code and Selling Arrangement. Because AFS submittals can contain hundreds or even thousands of line item entries, each constituting a report, such assessments can easily exceed several thousand dollars for a computer generated error that appears repeatedly in an AFS submittal. In many cases the $10.00 per line item penalty became excessive in relationship to the administrative burden associated with correcting the errors. In response to numerous complaints of excessive penalties by payors, the MMS modified the language in § 218.40 to its present form, thereby giving the agency discretion in assessing penalties of less than $10.00 per reporting error. Originally, the FOGRMA regulations gave the MMS no flexibility and the MMS had to assess a $10.00 per line penalty.

The FOGRMA regulations also implement the penalty provisions of the Act. The regulations follow the statute quite precisely and set forth both civil and criminal penalties for noncompliance. Enforcement commences with service of a notice of noncompliance. Service can only be achieved in two ways—personal service by an authorized MMS representative or by registered mail. The penalty provisions previously discussed are imposed after a twenty-day period (or longer time as specified in the notice) expires. What is noteworthy are the appeal procedures specified in the regulations which differ depending upon whether the twenty-day compliance period has lapsed.

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For a person who has passed the twenty-day period, a hearing on the record is obtained by filing a written request with the Office of Hearings and Appeals.¹³ If the violation is corrected within twenty days, no hearing is permitted and the person may only resort to the normal MMS appeal procedures afforded by 30 CFR Part 243.¹⁴ Appeals from a notice of noncompliance for intentional violations must be taken within twenty days from the date of service. Any decisions rendered by an OHA administrative law judge are appealable to the IBLA.

Even if a hearing is requested, penalties will continue to accrue at the assessed rate until the violations are corrected.¹⁵ The Director may suspend the requirement to correct the violations pending completion of the hearing if he determines that the suspension will not be detrimental to the lessor. There also must be the submission and acceptance of a bond adequate to cover any disputed amounts plus accrued penalties and interest. If no hearing is requested, the MMS must issue an order assessing the penalty and the penalty assessment must be paid within thirty days.¹⁶

Closely related to the MMS enforcement authorities under FOGRMA are the record retention requirements and authority to request data and information. All records pertaining to offshore and onshore Federal and Indian leases shall be maintained for six years after the records are generated unless the recordholder is notified, in writing, that records must be maintained for a longer period.¹⁷ When an audit is underway, records are to be maintained unless the recordholder is released by written notice of the obligation to maintain them.

The lessee is also obligated to make and retain accurate records necessary to demonstrate that payments of royalties, rentals, etc. are in compliance with the regulations, lease...