UPDATE ON FEDERAL AND INDIAN ROYALTY DECISIONS
| Jurisdiction | United States |
(Feb 1998)
UPDATE ON FEDERAL AND INDIAN ROYALTY DECISIONS
Jackson & Kelly
Washington, D.C.
Federal royalty litigation proceeds in two forums: the federal courts and the Interior Board of Land Appeals ("IBLA" or "the Board"). Papers 16A and 16B summarize the most significant decisions issued by the courts and the Board within the last 6 years in federal and Indian royalty cases.
The IBLA's jurisdiction in royalty matters is to review appeals taken from decisions or orders of the Directors of the Minerals Management Service ("MMS") or, in the case of Indian lands, of the Commissioner of Indian Affairs. IBLA's review is essentially de novo, reviewing the case as fully as the Secretary of the Interior might; and its review ordinarily is on a documentary record often assembled without strict adherence — or any adherence — to rules of evidence. Accordingly, though there are occasional exceptions, procedural decisions are generally not to be found in the Board's decisions. This update mentions one.
The jurisdiction of the federal courts, on the other hand, is limited. Restraints on where and when the Department may be sued are the stock-in-trade of royalty litigation in the courts. Lessees have also urged the courts to find limits on certain of MMS's enforcement activities by challenging orders to produce documents as unlawful, orders to pay as untimely, and the withholding of refunds and credits for future offset as unconstitutional. MMS, in turn, has challenged the right of lessees to seek judicial review of royalty orders under the "citizens' suit" provisions of the Outer Continental Shelf Lands Act, 43 U.S.C. § 1349(a).
In both forums, of course, lessees have also challenged some of MMS's positions on the substantive requirements of royalty law. The most prominent issues concern whether royalties are owed on take-or-pay settlements, the extent of obligations under the duty to place production in marketable condition, and the existence and extent of obligations on the part of lessees to market production at no cost to the lessor.
In Paper 16A, Howard Chalker discusses, among other things, appeals and litigation involving (1) the statute of limitations, 28 U.S.C. § 2415, (2) MMS's power to order restructured accounting by lessees (so-called "self-audit" orders), (3) MMS's power to require royalty payments from non-lessees, (4) the finality or lack of finality of a "Dear Payor" letter, (5) MMS's power to obtain documents from affiliates of lessees which have purchased production and resold it, (6) whether federal lessees can challenge royalty orders by filing citizens' suits, (7) the duty to place production in marketable condition; and (8) MMS's power to withhold refunds or credits for future offset.
In Paper 16B, Poe Leggette discusses (1) the take-or-pay settlement litigation, and (2) the problem of "final" agency action.
[Page 16B-1]
ROYALTIES ON TAKE-OR-PAY SETTLEMENTS
Ask a royalty lawyer the Biblical question "What is the greatest commandment?" There can be little doubt what the answer would be. "Under no circumstances shall the value of production for royalty purposes be less than the gross proceeds accruing to the lessee for lease production...." 30 C.F.R. § 206.152(h) .
More ink has been spilled and hours billed over the application of this "gross proceeds" rule to various transactions and kinds of payment than have been spilled and billed on any other valuation issue. When the Interior Department or a sympathetic court describes the gross proceeds rule, it typically speaks of how "broad" the rule is. See, e.g., United States v. Century Offshore Management Corp., 111 F.3d 443, 446 (6th Cir. 1997), pet. cert. filed (Oct. 23, 1997). But calling the rule "broad" does not answer the fundamental question posed by the rule: What makes a payment "proceeds ... for lease production?"
The gross proceeds rule has been applied with the greatest difficulty to a payment which is calculated in some sense by reference to a volume of a mineral, but is paid before that volume is produced. Take-or-pay payments are the best-known example.1 Under the typical take-or-pay clause, a buyer agrees to pay each month or year for a certain minimum volume of production, whether the buyer takes delivery of that volume or not. The payment may be nonrecoupable, meaning that the lessee-seller keeps the payment no matter what, or recoupable, meaning that the buyer may later apply the payment as a credit when it later takes the production. Some contracts required the lessee-seller to refund recoupable payments if they were unrecouped after five years; other allowed the lessee-seller to keep them if unrecouped within that time. See IPAA v. Babbitt, 92 F.3d 1248, 1251 (D.C. Cir. 1996) (briefly summarizing take-or-pay clauses).
In the early 1980s, the Department's position was that royalties were due on take-or-pay payments under natural gas sales contracts when the lessee received them. It also held that royalties were due on take-or-pay settlements when the settlement payment was received. The royalties were subject to refund if the lessee had to refund the payment.
[Page 16B-2]
But if unrefunded, the payments were treated as part of the "total consideration" received for the sale of gas under the contract. Interior's position was codified in substantive rules adopted on January 15, 1988, which stated that "gross proceeds" included "take-or-pay payments." 53 Fed. Reg. 1230, 1273 (1988). The preamble to the rule clarified that the term "take-or-pay payment" was not limited to payments received under the take-or-pay clause of a natural gas sales contract, but extended to "all types of payments which fall within the concept of take-or-pay payments...." 53 Fed. Reg. 1245 (1988).
Diamond Shamrock Exploration Co. v. Hodel, 853 F.2d 1159 (5th Cir. 1988), rejected the Department's position as inconsistent with the Outer Continential Shelf Lands Act. Diamond Shamrock first rejected the notion that royalties were owed when a take-or-pay payment was received, ruling that "royalties are not owed unless and until actual production, the severance of minerals from the formation, occurs." Id. at 1165. It then determined that a take-or-pay payment becomes subject to royalty only if it is later used as a credit to pay for so-called make-up gas under the contract. If the payment is forfeited to the lessee, i.e., is unrecouped, the payment is not for production but is instead "for the pipeline-purchaser's failure to purchase (take) gas." Id. at 1167. See also id. at 1168 (take-or-pay payments "forfeited by the purchaser" never become "part of the price of gas" subject to royalty).
After electing not to seek a writ of certiorari, the Department responded to Diamond Shamrock by adopting its reasoning. On October 14, 1988, the Assistant Secretary for Land and Minerals Management issued a final decision in Santa Fe Energy Co., MMS-85-0046-OCS (Oct. 14, 1988), 5 GOWER FEDERAL SERVICE, ROYALTY VALUATION & MGMT. in which the Department ruled, in light of Diamond Shamrock, that royalties on take-or-pay payments and take-or-pay settlements "only become due if and when make-up gas is taken by the pipeline." Id. at 4. On November 8, 1988, Interior amended its gross proceeds rule to eliminate, among other things, the phrase "take-or-pay payments." 53 Fed. Reg. 45082, 45083 (1988). The Department explained that royalties would only be due if the payment was used as a credit "when make-up gas is taken." Id. Subsequent decisions in agency appeals in 1989-90 applied this revised position and held royalties were due on take-or-pay settlement payments "to the extent credited against future production." Blackwood & Nichols Co., Ltd., MMS-88-0008-O&G (Apr. 20, 1989), 10 GOWER FEDERAL SERVICE, ROYALTY VALUATION & MGMT. See also Wolverine Exploration Co., MMS-88-0052-IND (May 2, 1990), 10 GOWER FEDERAL SERVICE, ROYALTY VALUATION & MGMT.
Encouraged by audit officials of states sharing in federal lease revenues, in 1992 MMS officials began to reexamine whether it might be possible to fashion a legal theory to claim royalties on at least some portion of proceeds in nonrecoupable take-or-pay settlements. Having received encouragement to go forward from new Secretary of the Interior Babbitt, MMS issued a "Dear Payor" letter on May 3, 1993, explaining its "interpretation" of how the...
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