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SHELL OFFSHORE, INC. v. DOI

February 13, 1998

SHELL OFFSHORE, INC., SHELL OIL COMPANY, and SHELL WESTERN E & P, INC., Plaintiffs,
v.
DEPARTMENT OF THE INTERIOR, BRUCE BABBITT, Secretary of the Interior, and BOB ARMSTRONG, Assistant Secretary, Defendants.



The opinion of the court was delivered by: LAMBERTH

 This matter comes before the court on defendants' motion to dismiss plaintiffs' complaint pursuant to Fed. R. Civ. P. 12(b)(1) and 12(b)(6). For the reasons stated below, defendants' motion is granted.

 I. BACKGROUND AND PRIOR CASES

 In these cases, *fn1" three Shell affiliates -- Shell Offshore, Inc., Shell Oil Company and Shell Western E & P, Inc. (hereinafter "Shell") seek declaratory and injunctive relief as they challenge ten orders issued by auditors of the Department of Interior ("DOI"), Mineral Management Service ("MMS"), on April 14 and 30, 1997, which require Shell to pay royalties on lump sum gas contract settlement payments. In the first count ("Unlawful Royalty Assessment"), Shell alleges that DOI's interpretation of the gross proceeds rule as applied against Shell is in excess of defendants' authority under the applicable federal statutes, is arbitrary and capricious, and constitutes an abuse of authority. In the second count ("Collateral Estoppel"), plaintiffs allege that the final judgment in Independent Petroleum Association of America v. Babbitt, 320 U.S. App. D.C. 107, 92 F.3d 1248 (D.C. Cir. 1996) ("IPAA I ") bars the defendants from pursuing their claims against plaintiffs because they were for all practical purposes a party to that case. In the third count, plaintiffs claim that exhaustion of administrative remedies is unnecessary as there is no statute requiring exhaustion, and, that to the extent that DOI's rules require exhaustion, the rules are unlawful and arbitrary as applied to Shell.

 The storied history of the natural gas industry and long term gas contracts, federal and Indian mineral leasing, and royalties on take-or-pay settlements have previously been addressed in great detail, see IPAA II, 92 F.3d at 1251-53, and that history will be discussed in this opinion only to the extent it illuminates the issues under consideration. However, before addressing the substance of defendants' Motion to Dismiss, this court will briefly summarize the relevant portions of the holdings in IPAA I, In re Century Offshore Management Corp., 111 F.3d 443 (6th Cir. 1997) ("Century Offshore") and IPAA II, as these cases frame the issues that must be addressed in the instant matter.

 A. IPAA I.

 In IPAA I, the D.C. Circuit addressed, among other issues, the challenge of IPAA as to whether MMS' decision to assess a $ 20,000 royalty against Samedan Oil Company was arbitrary and capricious under the APA, 5 U.S.C. § 706(2)(A). Specifically, the court had to decide whether DOI's determination that non-recoupable take-or-pay settlement payments from Southern Natural Gas Co. (the purchaser) to Samedan Oil Company (the lessee) were royalty bearing was supportable, given that pursuant to MMS's amending of its regulations to comport with Diamond Shamrock Exploration Co. v. Hodel, 853 F.2d 1159, 1164 (5th Cir. 1988), royalties do not accrue on take-or-pay payments until those payments are specifically allocated to gas that is physically severed from the ground. IPAA I, 92 F.3d at 1258-59. "Neither take-or-pay payments nor take or pay settlements are royalty bearing unless and until they are credited toward the purchase of make-up gas." Id. at 1260. The court held that the assessment of royalties against Samedan Oil Company was arbitrary and capricious in light of DOI's adoption of the Diamond Shamrock holding. Id. at 1260.

 In reaching this conclusion, the court noted the Fifth Circuit's heavy emphasis on the link between royalty assessment and the actual removal, or "physical severance," of gas from the ground. Id. at 1259 (explaining that under Diamond Shamrock royalties are not due on value or even market value, but only on "the value of production saved, removed or sold from the leased property") (emphasis in original). The court noted that "a nonrecoupable settlement payment is never credited as payment for any gas actually severed from the ground," and, therefore, the vital link between removal and payment that triggers the royalty obligation was missing in the Samedan Oil order. Id. at 1259-60. Significantly, Samedan Oil and Southern Natural Gas Company agreed to a complete "buyout," in which the contract was terminated in exchange for a nonrecoverable and nonrefundable payment "in resolution and full and final settlement of any and all obligations and liabilities that Southern has or may have under the Contract." Id. at 1254. Even more significantly, on the same day as the settlement, Samedan contracted to sell the gas formerly allocated to Southern to another company at the market price, and none of the gas subject to the settlement was ever sold to Southern. Id. Therefore, in IPAA I, it was not disputed that the settlement payment at issue was never credited toward make-up gas.

 B. Century Offshore.

 Century Offshore, a lessee of federal lands, had an agreement to sell gas to Enron Gas Marketing, Inc. under a series of fixed price contracts that included take-or-pay provisions. Enron eventually made a lump-sum payment of $ 12,250,000 to Century in return for being relieved of all obligations under the base contracts. Enron subsequently entered into replacement contracts with Century Offshore based on the current floating market price of gas. Under these replacement contracts, Enron ultimately purchased virtually all of the gas identified in the original agreements, within the same time period. Century Offshore, 111 F.3d at 446-47. Again, the issue before the court was whether the lump-sum settlement payment was "properly attributable to 'the amount or value of the production [of natural gas] saved, removed or sold' under § 1337 of the Outer Continental Shelf Lands Act, 43 U.S.C. §§ 1331-1356 (1996)." Century Offshore, 111 F.3d at 445.

 In this case, the court did find that the challenged settlement payment was linked to gas production saved, removed or sold, and that the royalties were therefore properly assessed by the MMS auditors. Id. at 449. The court determined that the replacement contracts were best characterized as "substituted contracts," in that they were, by their very terms, intended to "replace and supercede" the terminated contracts. Id. at 448. Equally important was the fact that Enron purchased virtually all of the gas identified in the earlier contracts. The court noted that "though this gas was not make-up gas, it is analogous to make-up gas in the sense that though it is paid after the payment at issue, it provides a link to production." Id. at 449-50 (also remarking that "the lump sum payment contemplated and was the cause of new gas sales to be delivered in the future.") Therefore, "the lump sum payment behaved as an advance payment under a substituted requirements contract. As a result, the payment was for production sold under the statute, and the royalty was payable when the gas was produced." Id. at 449. To the extent that the lump-sum payment was allocable to gas taken, royalty payments were due on the lump-sum payment.

 Finally, the Sixth Circuit noted that IPAA I did not compel a different result because in that case, the gas in the original contract was sold to a third party. Consequently, the dispositive "nexus with production did not exist." Id. at 451.

 C. IPAA II.

 IPAA II involved implementation of the mandate of the court of appeals from IPAA I. Three aspects of this court's holding are noteworthy in light of the issues under consideration here. First, this court agreed with the Sixth Circuit that there was no conflict between the holdings in IPAA I and Century Offshore, finding that the factual circumstances underlying the two transactions were sufficiently distinct such that determining that royalties were not owed in the former yet were properly assessed in the latter was not inconsistent. See IPAA II, 971 F. Supp. at 32-33. Second, this court held that plaintiff IPAA had no jurisdictional basis on which to sue. This court determined that because the court of appeals held that the May 3, 1993 "Dear Payor" letter was not an agency statement with binding effect, IPAA was not appealing from any final agency action. Furthermore, this court concluded that the mere futility of pursuing administrative remedies could not, without more, create "final agency action," as finality is distinct from exhaustion, and the former is a jurisdictional requirement. See id. at 26-30.

 Finally, this court addressed whether the court of appeals' mandate as applied to Samedan Oil was broader than simply overturning the single challenged order to pay; namely, whether it covered present or future attempts to assess royalties against Samedan in this circuit or elsewhere. IPAA II, 971 F. Supp. at 31-35. This court held that as to the other pending (and therefore non-final) Samedan administrative appeals, defendants were collaterally estopped from pursuing the royalty claims, and Samedan's motion for a permanent injunction was granted. In reaching this conclusion, this court noted that "it appears that the court of appeals meant to include other circumstances -- other than simple buyouts -- where logic would dictate the exact same result." Id. at 32. The court noted that all four pending Samedan appeals appeared to deal with buyouts -- in which the purchaser of the gas completely and permanently walks away from the contract and never receives any gas -- and therefore, the challenged transactions "clearly fall under the shadow of IPAA." Id. at 32. However, in granting the permanent injunction, this court did not conclude that there was no possible contractual arrangement or device under which settlement payments could be royalty bearing, only that such a contractual arrangement did not appear to be presented in the four Samedan appeals. See id. at 32-33. Rather, permanent injunctive relief was demanded under collateral estoppel principles on account of the government' express intent to relitigate the same issue on virtually identical facts in various circuits around the country. Id. at 33-34 (citing United States v. Stauffer Chemical Co., 464 U.S. 165, 78 L. Ed. 2d 388, 104 S. Ct. 575 (1984).

 II. ANALYSIS

 A. Plaintiffs Must Exhaust Administrative Remedies Before Challenging the Administrative Action in Court

 In its complaint, Shell challenges the ten royalty assessment orders issued by the Houston Compliance Division (HCD) of MMS in April 1997. Shell has filed administrative appeals of these orders and these appeals are currently pending. Defendants' Motion to Dismiss as to counts one and two of the ten suits asserts that because the appeals have not been ruled upon, there is no "final agency action" such that this court may exert jurisdiction over these cases.

 Shell's complaints acknowledge that jurisdiction over this matter arises under the Administrative Procedure Act, 5 U.S.C. §§ 701-06. When a party seeks to challenge an agency policy or practice by which they are adversely affected or aggrieved in the courts, that party may seek judicial review under section 10(a) of the APA. See 5 U.S.C. § 702. When review is not sought pursuant to specific authorization in a substantive statute, but only under the general review provisions of the APA, the action in question must be "final agency action." See 5 U.S.C. § 704; Lujan v. National Wildlife Federation, 497 U.S. 871, 881-84, 111 L. Ed. 2d 695, 110 S. Ct. 3177 (1990). When a party seeks judicial review under section 10(c) of the APA, that party is required to exhaust all administrative remedies mandated either by statute or agency rule. See Darby v. Cisneros, 509 U.S. 137, 147, 153, 125 L. Ed. 2d 113, 113 S. Ct. 2539 (1993) (requiring exhaustion of available administrative appeals prior to judicial review if that remedy is required by statute or agency rule and the effect of the initial decision is inoperative during the period of appeal).

 With regard to the issuance of orders to pay royalties by DOI under the Outer Continental Shelf Lands Act ("OCSLA"), the administrative process operates in the following manner. The Federal Oil and Gas Royalty Management Act of 1982, 30 U.S.C. § 1701 et seq., directs DOI to ensure the "prompt and proper collection and disbursement of oil and gas revenues owed to the United States and Indian lessors . . . ." 30 U.S.C. § 1701(b)(3). When auditors find royalties to be due and unpaid, MMS Regional Compliance Divisions issue orders to pay or to recalculate royalties pursuant to specified instructions. These orders to pay are appealable to the MMS director, see 30 C.F.R. § 290; in fact, DOI rules specifically require that lessees permit the agency to adjudicate all royalty valuation issues prior to seeking judicial review.

 
"In order to exhaust administrative remedies, a decision or order of MMS's Royalty Management Program must be appealed pursuant to 30 CFR part 290 to the Director . . . and subsequently to the Interior Board of Land Appeals under 30 CFR part 290.7 and 43 CFR part 4 . . .

 30 C.F.R. § 243.3 (emphasis added). During the period of administrative review, the obligation to pay or comply is suspended. 30 C.F.R. 243.2 ("Compliance with any orders or decisions issued by . . . [MMS] . . . including orders for payment of royalty deficiencies . . . shall be suspended by reason of an appeal having been taken pursuant to 30 CFR part 290."). The decision of the IBLA constitutes judicially reviewable "final agency action" under the APA, 5 U.S.C. § 704. See 43 C.F.R. §§ 4.403, 4.21(c). Also, an MMS Director's decision may be reviewed and affirmed, reversed or modified by an Assistant Secretary; those decisions are not reviewable in the IBLA and are final agency action subject to judicial review. The Secretary retains reserved authority to act in any matter before the agency. 43 C.F.R. § 4.5.


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