Century Offshore Management Corp., In re

• Decision Date: 23 July 1997
• Docket Number: No. 95-6320,95-6320
• Citation: 111 F.3d 443
• Parties: 136 Oil & Gas Rep. 40 In re CENTURY OFFSHORE MANAGEMENT CORPORATION, Debtor. UNITED STATES of America, Plaintiff-Appellant, v. CENTURY OFFSHORE MANAGEMENT CORPORATION, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 443

111 F.3d 443

136 Oil & Gas Rep. 40

In re CENTURY OFFSHORE MANAGEMENT CORPORATION, Debtor.

UNITED STATES of America, Plaintiff-Appellant, v. CENTURY OFFSHORE MANAGEMENT CORPORATION, Defendant-Appellee.

No. 95-6320.

United States Court of Appeals,

Sixth Circuit.

Argued Oct. 17, 1996.

Decided April 14, 1997.

Rehearing and Suggestion for Rehearing En Banc Denied July 23, 1997.

Robert L. Klarquist, William B. Lazarus (argued and briefed), U.S. Department of Justice, Land & Natural Resources Division, Washington, DC, J. Christopher Kohn, Tracy J. Whitaker, Sidney P. Levinson, Office of the Department of Justice, Civil Division, Washington, DC, for Plaintiff-Appellant.

Solomon L. Van Meter, Wyatt, Tarrant & Combs, Lexington, KY, Jerry E. Rothrock (argued and briefed), Akin, Gump, Strauss, Hauer & Feld, Washington, DC, H. Rey Stroube, III, Akin, Gump, Strauss, Hauer & Feld, Houston, TX, for Defendant-Appellee.

Kelly S. Brooks (briefed), New Mexico State Land Office, Santa Fe, NM, for Amicus Curiae Commissioner of Public Lands for the State of New Mexico.

Frederick C. Whitrock, Asst. Atty, General (briefed), Louisiana Department of Natural Resources, Civil Division, Baton Rouge, LA, for amici curiae State of Louisiana, Louisiana Department of Natural Resources.

Before: MERRITT, JONES, and COLE, Circuit Judges.

MERRITT, Circuit Judge.

SUMMARY

This case arises from the bankruptcy of Century Offshore Management Corporation, a natural gas producer and the lessee of federally-owned submerged lands in the Gulf of Mexico. Century sold gas to Enron Gas Marketing, Inc. under five- and five-and-a-half-year, fixed price contracts. The Minerals Management Service of the United States Department of the Interior seeks to obtain $1,855,004 in royalties on a $12,250,000 lump sum payment Enron made to Century to terminate these contracts and replace them with new contracts based on current, floating market prices. The bankruptcy and district courts denied the government's royalty claim because they concluded that the lump sum payment was not a payment for the "production" of gas but merely a settlement payment designed simply to terminate the original contracts. The issue of statutory interpretation before us is whether this lump sum payment is 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). We conclude that the transaction, viewed as a whole, was clearly linked to gas "production saved, removed or sold," and we therefore reverse the decision of the courts below. An up-front payment made in exchange for a substituted contract that changes the price of the old contract, followed by new purchases, is a sufficient cause of new production of gas to qualify as "production sold" under the Act.

I.

In the Outer Continental Shelf Lands Act (OCSLA), 43 U.S.C. §§ 1331-1356 (1996), Congress authorized the Department of the Interior to issue leases providing for the development of federal oil and gas resources on submerged lands on the outer continental shelf and gave the Department the authority to prescribe rules and regulations necessary to carry out the Act's leasing provisions. 43 U.S.C. § 1334(a) (1996). Since 1982, the Secretary of the Interior has delegated the administrative responsibility for outer continental shelf leases to the Minerals Management Service.

The Act authorizes the Department of the Interior to grant oil and gas leases to "the highest responsible qualified bidder" and presents a menu of payment approaches The Department of the Interior has the sole authority to prescribe regulations necessary to carry out the provisions of the Act. Id. § 1334(a). As part of its administration of the Act, the Department has adopted the "gross proceeds" rule, a broad view of "the amount or value of ... production." Under the Department's interpretation, "under no circumstances shall the value of production for royalty purposes be less than the gross proceeds accruing to the lessee for lease production, less applicable allowances." 30 C.F.R. § 206.152(h) (1996). The Department has applied the "gross proceeds" rule to offshore leases since its initial implementation of the Act. It has also, in turn, adopted a broad definition of "gross proceeds": "Gross proceeds ... means the total monies and other consideration accruing to an oil and gas lessee for the disposition of the oil [or gas] produced." 30 C.F.R. § 206.151 (1996) (emphasis added).

from which the Department may choose before the bidding begins. Id. § 1337(a)(1). The first of these options--the one used in the instant case--provides for a royalty of a fixed percentage of "the amount or value of the production saved, removed, or sold" by the lessee. Id. § 1337(a)(1)(A).

Century, the debtor in this case, acquired working interests in the leases at issue in this litigation--known as West Cameron Block 368, South Timbalier Block 107, and Breton Sound Block 53--in 1987, 1989, and 1990. All are located in the Gulf of Mexico off the coast of Louisiana. All of these leases incorporate the "amount or value of production saved, removed or sold" language of the statute. ST 107 Lease at 2 (J.A. at 60); WC 368 Lease at 2 (J.A. at 67); BS 53 Lease at 1 (J.A. at 72). Two of the leases--South Timbalier Block 107 and West Cameron Block 368--expressly invoke the "gross proceeds" language of the regulation, stating that the amount of production "shall not be deemed to be less than the gross proceeds accruing to the Lessee from the sale thereof." ST 107 Lease at 2 (J.A. at 60); WC 368 Lease at 2 (J.A. at 67).

In 1989 and 1990, Century entered into production contracts with Enron Gas Marketing, Inc., under which Enron agreed to purchase gas produced from these leases. First, Enron and Century entered into "base contracts" covering an initial quantity of gas. For the purposes of this case, the base contracts had two important features: They were fixed price contracts, under which Enron agreed to purchase certain minimum quantities of gas for a fixed price; and they contained "take-or-pay" provisions. In other words, Enron was required to pay Century the price of the minimum purchase quantity, even if it did not choose to take any gas. ¹ Unlike some standard take-or-pay provisions, these payments for gas not taken were nonrecoupable: If Enron were to make a payment for gas not taken one month, and then take more gas than the minimum purchase quantity the next month, the excess gas would not entitle Enron to a refund of a portion of the previous month's payment. In other words, once made, Enron's payments under the take-or-pay clause were gone for good.

The base contracts covered a certain minimum quantity of gas. At the same time, Century and Enron entered into "excess contracts" for additional gas produced from the leases in question. In contrast to the base contracts, the excess contracts provided for floating prices tied to the spot price of natural gas. They did not contain take-or-pay provisions.

In late 1991, Enron approached Century with a proposal to purchase the 1989 and 1990 contracts. On February 12, 1992, Enron and Century entered into the agreement that has given rise to the current dispute. Enron agreed to make a lump sum payment to Century of $12,250,000, in return for which Enron was relieved of its obligation to make further payments under the base contracts. At the time of the agreement, Enron did not owe Century any accrued "pay" payments under the take-or-pay clause. Century did not pay royalties to the federal government on any portion of the lump sum payment. But after receiving warnings from its bank about possible royalty liability, Century required Enron to agree to loan Century up to $1.5 million in case the government demanded royalties.

Simultaneously, Enron and Century entered into new contracts, which have become known as the "replacement contracts." These replacement contracts provided for floating prices, fixed to the spot price for natural gas. They did not provide for any minimum quantity, and lacked take-or-pay provisions. The preamble to these contracts expressly noted the parties' "desire to replace and supercede" the previous agreements. E.g., Gas Purchase Contract, Breton Sound Blocks 45 and 52, at 1 (J.A. at 183). Under the replacement contracts, Enron purchased virtually all of the gas identified in the original agreements, within the same time period.

In August of 1992, Hurricane Andrew caused extensive damage to Century's platforms in the Gulf. A year later, it filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. The United States then filed a proof of claim for $1,855,004, the full royalty that would be due on production worth $12,250,000, the amount of Enron's lump sum payment. In this adversary proceeding, the United States and Century each filed motions for summary judgment. The bankruptcy court ruled in Century's favor across the board, holding that the government's royalty claim exceeded its statutory authority, and that the government's interpretation of the gross proceeds rule was arbitrary and capricious, unlawfully retroactive, and adopted in violation of the Administrative Procedure Act's notice and comment requirement. The district court affirmed on all grounds except the last.

The government makes several arguments in support of its position that Century owes royalties on the lump sum payment. First, the government notes that courts must defer to an agency's reasonable interpretation of the statutes which it is entrusted to enforce. See Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43, 104 S.Ct. 2778, 2781-82, 81 L.Ed.2d 694 (1984). Within this context, it asserts that Enron made the lump sum payment to obtain a reduced price for future gas purchases. Such an advance payment for future gas, it concludes, would be...