CHAPTER 5 ROYALTY ISSUES ON LANDS OWNED BY STATE OR LOCAL GOVERNMENTS
| Jurisdiction | United States |
(Apr 1993)
ROYALTY ISSUES ON LANDS OWNED BY STATE OR LOCAL GOVERNMENTS
Louisiana State University Law Center
Baton Rouge, Louisiana
TABLE OF CONTENTS
I. Introduction—The Dual Capacity of the State Lessor
A. The State as Proprietor
B. The State as Sovereign
II. Royalty: Amounts and Calculation
A. Federal Floor Clauses
1) Tax Reimbursements
2) Amount Realized
3) Coal—Prevailing Royalty
B. Take-or-Pay
C. Interest
1) Interest—Unjust Enrichment?
2) Is Interest Royalty?
3) "Total Proceeds"—Includes Interest?
III. Royalty: Post-Production Costs and Taxas
A. "At the well"
B. "At the well" part 2—A Vestigial Remnant?
C. Severance Tax Treatment
IV. Payment and Nonpayment of Royalty and Rental
A. In General
B. Failure to Pay Advance Rental
C. Cancellation for Failure to Pay Rental
V. Some Procedural Topics
A. Surrender & Refile Procedure
B. Alaska Hard Rock Leasing
C. Use of Audit To Resolve Lease Interpretation Problems
D. Royalty Reduction
VI. Texas Relinquishment Act
A. Is the Landowner a Fiduciary?
B. Surface Sharing in State Settlement?
VII. Conclusion
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I. Introduction — The Dual Capacity of the State Lessor
Government acts in two capacities with respect to its lessees: it is both proprietor and regulator. As a proprietor or landowner, it has the same interests and concerns as other landowners, with a primary interest in maximizing return. It also has limits on its authority similar to other landowners; i.e. it is bound by its own contracts.1 As a regulator, the government is possessed of other powers, including the power to tax and the police power. Pursuant to these powers, government (state, federal and Indian tribes) can impose regulations or requirements that were not in existence when a lease was first issued.2 The modern oil and gas lease granted by a government body is a property interest, but it also has the appearance of a permit which is governed as much by statute and regulation as by the terms of the document creating the interest. In some countries there is a concept of certain contracts with state entities as being "administrative contracts" that vest the government with power to modify the
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terms of the agreement to satisfy public needs."3 We are not yet at that point, I am happy to report, but it is a model to keep in mind.
In contrast to the extensive writings on the federal government as lessor of oil and gas leases, there is relatively little writing on state leasing.4 This is in large measure because it is difficult to make very broad statements about state leasing that cuts across state lines. In writing on state leasing one must focus on individual states and the special constitutional provisions, statutes, administrative programs, and leasing transactions within that state. Even within a single state there may be multiple public bodies responsible for leasing under several different statutes. Even when the inquiry is narrowed to a single agency and a single statute, it may turn out that the agency has employed differing lease forms over the years, and the rights and duties of the parties will vary according to those leases. In short, generalizations about state leasing are both difficult and misleading. It would be impossible to give a comprehensive guide to state leasing in a single state in one hour much less say cover all or even the principal producing states. What I will do in this paper is generalize about the dual status of state lessors and then describe some recent controversies that have developed in regard to some state leasing activities. From these developments we may obtain some guidance as to what other controversies may develop in the future.
.A. The State as Proprietor
The collection of bonus, rent and royalty by producing states amounts to a significant source of revenue. State receipts from mineral leases grew from approximately $.5 billion in 1972 to $3.3 billion in fiscal 1980 (the most recent reliable statistics I could find). Eighty percent of these receipts were from activities on state-owned land. The remaining was from lease receipts shared with the federal government.5 The extent of state owned land will depend on the state under consideration, but to suggest the possible magnitude of the subject we can note that one study said that sixteen percent of natural gas and five percent of oil in Texas was produced from state property, excluding the university lands.6
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The first aspect of this proprietary role that we should note is that government is the biggest landowner around. No private landowners come even near to the magnitude of governmental holdings. This means that government has strong bargaining power. State lessors can include in their leases terms that are much more favorable to the state than one can even dream of with private owners, who often must accept the lessee's terms or have no lease at all. States have so much land that they can hold public auctions for their leases that will bring top dollar in bonus, rental and royalty amounts. They can include multiple royalty provisions that allow them to insist on the highest method of royalty calculation. The states' resources are such that they can have full time staffs to monitor royalty collection and audit payments. These qualities flow simply from government's size and extent of holdings, not from the status of sovereign.
In its functions as a proprietor, the state may have some latitude it might not have in its sovereign capacity. The Supreme Court has recognized a "market participant" doctrine that may allow a state to undertake actions regarding its own property interests that might be invalid under the Commerce Clause of the United States Constitution as discriminatory if it attempted to do the same thing over property as to which it acted only in a sovereign capacity. Thus in Reeves Inc. v. Stake,7 the Court upheld a South Dakota restriction that allowed a state-owned cement plant to sell only to South Dakota purchasers in times of cement shortage. The majority opinion spoke of the right of a trader in private business "freely to exercise his own independent discretion as to parties with whom he will deal."8 Would this decision and doctrine allow a state to restrict its own share of production from state lands such as in-kind royalty oil or gas to be used exclusively for its own citizens? Some producing states have such provisions.9 But the market participant doctrine has enjoyed only limited support on the court10 and there are many academic critics of the doctrine.11
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The state acts in several capacities even when it functions as proprietor. It may be leasing land of the state; but the agency then is trustee for its people. Or it may be leasing on behalf of other entities of the state such as school boards or levee districts. Here it may have special responsibilities. Such responsibilities have been influential in several of the cases to be noted below.
.B. The State as Sovereign
The state does exempt itself from some limitations that apply to other owners of contract and property rights. Private lessors and other royalty owners generally are subject to statutes of limitations or prescriptive periods that prevent them from bringing claims for royalty after some period of time. Statutes or constitutional provisions often exempt the state from operation of such time limitations on claims of nonpayment.12
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Another aspect of the sovereign capacity of the state is that it is often held that equitable estoppel does not apply to governmental bodies.13 Unlike the actions and representations of private lessors, a government official generally cannot bind the state by his or her representations if they are contrary to the underlying statute or rules of the government.
Still another difference between private lessors and governmental lessors is that the state has enforcement powers not available to the private party. The sovereign has investigative powers such as the right to inspect books (in addition to audit authority that may be part of the lease). Violation of statute or regulations that concern leases may lead to criminal treatment of the lessee. Enforcement of criminal and civil provisions can include the subpoena power. Such features can get the lessee's attention far more quickly than the threat of a lawsuit from a private owner. I suspect this is why we see far less litigation over royalty payments owed to the state than we see in relation to other royalty owners.
Lest it appear that I am attributing a monolithic power to government that is sometimes not reflected in reality, let me hasten to add that yet another feature of the state's role as sovereign is that state leasing can be quite political in nature. Some highly placed officials may regard the state's mineral assets as a perk of office whose bounty they can share. We have had considerable experience with this in Louisiana where it is not unheard of to discover that leading political figures have somehow acquired overriding royalties on lands owned by the public14 and where members of the State Mineral Board have been known to have contractual relations with the very
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parties holding state leases.15 Having less familiarity with other producing states I cannot say whether such experiences are common elsewhere.
We can observe that the diligence of individual public officials and boards can have a significant impact on royalty collection, and politics can affect their ability to carry out their responsibilities. A little insight into this is provided in an interesting footnote on a severance tax case from Wyoming. In Union Pacific Resources Co. v. State16 the Wyoming Supreme Court made the following observations:
Not so fully documented in research or comment is the historical status of the ad valorem...
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