ROYALTY VALUATION PROCEDURES
| Jurisdiction | United States |
(Jan 1992)
ROYALTY VALUATION PROCEDURES
Liskow & Lewis
New Orleans, Louisiana
TABLE OF CONTENTS
Page
INTRODUCTION
I. Limits on the DOI's Authority to Establish Value
A. The Standard of Judicial Review—How Much Deference is Due?
B. Statutory, Regulatory and Contractual Constraints on the DOI's Valuation Authority
II. Additional Limits on the Agency's Authority to Retroactively Establish Value
A. The Standard of Judicial Review Applicable to the Agency's Decision To Retroactively Establish Value
B. Limits on the DOI's Authority to Retroactively Establish Value
III. Effect on Burden of Proof and Other Ramifications of Retroactive Value Determinations
A. Who Bears the Burden of Proof?
B. When Do the Applicable Statutes of Limitation Begin to Run?
C. Does the DOI Have the Authority to Require Its Lessees to Perform "Restructured Royalty Accountings?"
CONCLUSION
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INTRODUCTION
The United States Department of the Interior ("DOI") unquestionably has the authority to audit a federal lessee's royalty payments to determine whether or not, in making the payments, the lessee complied with all applicable statutes, regulations and lease provisions. Indeed, not only is the DOI authorized to conduct audits to determine whether or not the proper amount of royalties was paid, it is statutorily required to do so by the Federal Oil and Gas Royalty Management Act of 1982 ("FOGRMA"), which provides as follows regarding the duties of the Secretary of the DOI:
The Secretary shall audit and reconcile, to the extent practicable, all current and past lease accounts for leases of oil or gas and take appropriate actions to make additional collections or refunds as warranted.
30 U.S.C. § 1711(c)(1). Auditing to determine if a lessee has complied with its royalty obligation, however, is quite different from auditing to determine the extent of the obligation with which the lessee must comply.1
As is discussed more fully below, federal oil and gas royalties, if not taken in kind, are owed on the value of the production saved, removed, or sold from the leased premises. Therefore, to the extent that the DOI has the unilateral authority to establish value, it effectively has the unilateral right to determine the royalty obligation of its lessees. This is an extraordinary right. Indeed, for this reason, the Ninth Circuit rejected a claim by the DOI that it had the implicit authority to establish the value of royalty oil. The Court explained:
[Federal oil and gas leases] are predicated upon large expenditures of money, time and effort in making the required discoveries and
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in bringing these properties into production. The rights of the lessees are valuable property rights. A contract provision authorizing one party to a contract to fix the obligation of the other party by unilateral action, is so foreign to ordinary contracts and so drastic in its operation that we think it should not be implied in the manner for which the Government is here contending. We think that such a right cannot have been within the contemplation of the parties in the absence of an express reservation to that effect.
Continental Oil Co. v. United States, 184 F.2d 802, 810 (9th Cir. 1950) (emphasis added).
Nevertheless, it is clear that, under certain circumstances, the DOI does have the authority to establish value for royalty purposes. First, although the Mineral Lands Leasing Act ("MLLA") and the Outer Continental Shelf Lands Act ("OCSLA") require federal oil and gas leases to provide for a royalty of a percentage "in amount of value of the production saved, removed or sold" from the leased premises,2 these terms are not defined in the statutes.3 Therefore, since the DOI is the agency charged with administering the statutes, its interpretation of the statutory terms is entitled to a certain amount of deference.4
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Additionally, the statutes expressly authorize the DOI to promulgate implementing rules and regulations.5 Pursuant to this statutory authority, the DOI promulgated regulations that, prior to March 1, 1988, expressly stated that the value of production for royalty purposes would be as established by the DOI. After March 1, 1988, the DOI regulations more particularly defined the manner in which the value of production is to be determined.6
Many federal leases contain an express contractual provision wherein the parties agree that the Secretary of the DOI, under certain circumstances, can establish minimum values for the purpose of computing royalties. Moreover, most federal leases provide that they are subject to valid rules and regulations promulgated by the DOI. In some cases, this would include the regulations that authorize the DOI to establish royalty values.7
These sources of the DOI's authority are fully discussed in Mr. Schaumberg's paper. The purpose of this paper is not to repeat that discussion, but rather to test the limits of the DOI's valuation authority. Many of the topics that will be discussed are the subject of pending litigation in which the authors of this paper are involved.8 Therefore, be forewarned that even though we
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have striven for objectivity, a certain amount of bias could not be avoided.
I. Limits on the DOI's Authority to Establish Value
Certain limitations on the DOI's authority to establish value are applicable regardless of whether the agency is acting prospectively or retroactively, that is, regardless of whether it is attempting to establish the value of future or past production. In both cases, the agency is constrained by the traditional limits on administrative agency discretion. More particularly, in establishing royalty values, the DOI's discretion is limited by the Administrative Procedure Act of 1946, 5 U.S.C. §§ 551 et seq. (as amended) ("APA"). The APA prohibits agencies from acting in a manner that is arbitrary, capricious, an abuse of discretion, or not in accordance with law. Further, the APA prohibits agencies from violating constitutional safeguards, and from exceeding the limits of their statutory authority. Finally, agencies must follow proper procedures in adjudicating or promulgating rules, they must conform to their own regulations and internal guidelines, and are bound by the language of leases and contracts.9
A. The Standard of Judicial Review — How Much Deference is Due?
The ultimate arbiters of the DOI's authority are the courts. Therefore, as a threshold matter, it is important to understand the concept of deference. As summarized by the United States Supreme Court in Chevron v. Natural Resources Defense Council, 467 U.S. 837, 104 S. Ct. 2778 (1984), a federal court should defer to an administrative agency's interpretation of the statute it administers if (1) the intent of Congress is unclear on
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the particular question at issue and (2) the agency's interpretation of the statute is a "permissible" one.
The court in Chevron was interpreting regulations promulgated by the Environmental Protection Agency ("EPA") under the authority of the 1977 Amendments to the Clean Air Act, Pub. L. 95-95, 91 Stat. 685. The EPA had issued regulations that required states to establish a permit program regulating "stationary sources" of air pollution. The agency had approved an interpretation of the regulations that would allow permit holders to modify one or more pieces of pollution-emitting equipment within an existing permitted plant without applying for a new permit, so long as the alterations did not increase total emissions from the plant as a whole. Because the EPA interpretation allowed permit holders to modify their plants without reducing net emissions, the Natural Resources Defense Council ("NRDC") attacked the regulations as being contrary to the purposes of the statutory scheme. The D.C. Circuit agreed with NRDC. NRDC v. Gorsuch, 685 F.2d 718 (D.C. Cir. 1982). The Supreme Court reversed.
Declaring deference to be a principle of long standing, the Court summarized as follows the analysis that should be followed by courts in reviewing administrative agency decisions. First, the reviewing court must determine whether Congress has specifically addressed the question with legislation. If so, then both the agency and the court "must give effect to the unambiguously expressed intent of Congress." 104 S. Ct. at 2781. If Congress has not addressed itself specifically to the precise question at issue, as is likely to be the case in most instances, then the reviewing court must decide whether the agency's decision is based on a "permissible construction of the statute". Id. at 2782. If the agency's interpretation is reasonable, particularly where the question at issue requires specialized knowledge or requires balancing of competing policy interests, the reviewing court should not substitute its judgment for that of the agency. Applying these principles, the Supreme Court found that the EPA's rules were a "reasonable accommodation of manifestly competing interests ... entitled to deference: the regulatory scheme is technical and complex, the agency considered the matter in a detailed and reasoned fashion, and the decision involves reconciling conflicting policies."10 Id. at 2792-93.
Chevron notwithstanding, however, the courts have continued to recognize that they are under no obligation to defer to an administrative agency's legal conclusions. See, e.g., Pennzoil v. FERC, 789 F.2d 1128, 1135 (5th Cir. 1986). Moreover, as the Supreme Court itself recently reiterated in EEOC v. Arabian American Oil Co., 111 S. Ct. 1227, 1237 (1991):
... deference is not abdication, ... it requires us to accept only those agency interpretations that are reasonable in light of the principles of construction courts normally employ.
These seemingly inconsistent statements are...
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