98 F.3d 1222 (10th Cir. 1996), 95-2214, Harvey E. Yates Co. v. Powell

Docket Nº:95-2214.
Citation:98 F.3d 1222
Party Name:HARVEY E. YATES COMPANY, a New Mexico corporation; New Mexico Oil & Gas Association, Plaintiffs-Appellees, v. Ray POWELL, Commissioner of Public Lands for the State of New Mexico, Defendant-Appellant.
Case Date:October 16, 1996
Court:United States Courts of Appeals, Court of Appeals for the Tenth Circuit

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98 F.3d 1222 (10th Cir. 1996)

HARVEY E. YATES COMPANY, a New Mexico corporation; New

Mexico Oil & Gas Association, Plaintiffs-Appellees,


Ray POWELL, Commissioner of Public Lands for the State of

New Mexico, Defendant-Appellant.

No. 95-2214.

United States Court of Appeals, Tenth Circuit

October 16, 1996

Rehearing Denied Nov. 13, 1996.

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Jan Unna, Special Assistant Attorney General, Santa Fe, New Mexico (Kelly Brooks, Special Assistant Attorney General, with her on the brief), for Defendant-Appellant.

Andrew J. Cloutier of Hinkle, Cox, Eaton, Coffield & Hensley, Roswell, New Mexico (Harold L. Hensley, Jr., with him on the brief), for Plaintiffs-Appellees.

Before SEYMOUR, Chief Judge, TACHA and EBEL, Circuit Judges.

EBEL, Circuit Judge.

Appellees Harvey E. Yates, Co. ("HEYCO") and the New Mexico Oil and Gas Association ("NMOGA") filed this declaratory judgment action in state district court in Chaves County, New Mexico against the New Mexico Commissioner of Public Lands. Appellees sought a judgment declaring invalid a revised New Mexico State Land Office regulation governing the calculation and payment of royalties under state oil and gas leases ("Rule 1.059"). The Commissioner removed the action to federal district court pursuant to 28 U.S.C. §§ 1441, 1446 (1994) and asserted various counterclaims against Appellee HEYCO. The Commissioner's counterclaims sought royalty payments or corresponding damages from HEYCO arising out of HEYCO's acceptance of cash payments in settlement of certain take-or-pay disputes. The federal district court granted summary judgment to HEYCO on the Commissioner's counterclaims, holding that no royalty was due on the settlement proceeds received by HEYCO. In a separate ruling, the district court also granted summary judgment to Appellees on their claim for declaratory relief and apparently held Rule 1.059 invalid in its entirety. The Commissioner now appeals both summary judgment rulings. We exercise jurisdiction pursuant to 28 U.S.C. § 1291 and affirm in part, reverse in part, and remand for further proceedings.


The New Mexico Commissioner of Public Lands is the executive officer of the New Mexico State Land Office ("SLO"), which holds over thirteen million acres of state land in trust for various specified beneficiaries, including schools and institutions of higher learning. See N.M. Stat. Ann. §§ 19-1-1, 19-1-2, 19-1-17 (Michie 1994). Revenues to support these beneficiaries are obtained in primary part from oil and gas producers, who lease oil and gas interests in the SLO lands and pay a royalty to the state pursuant to statutory leases. Although the Commissioner is authorized by statute to execute and issue oil and gas leases on SLO lands, N.M. Stat. Ann. § 19-10-1 (Michie 1994), the state legislature sets the terms and conditions of the oil and gas leases, and directs the Commissioner to use the form leases as set forth in the New Mexico Public Land Code. See N.M. Stat. Ann. § 19-10-4 (Michie 1994) (directing commissioner to use legislative form leases); see also N.M. Stat. Ann. §§ 19-10-4.1 to -4.3 (Michie 1994) (containing actual form leases).

Appellee NMOGA is an unincorporated trade association made up of various individuals and entities involved in oil and gas exploration,

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development and production in New Mexico. Many members of NMOGA are lessees under state oil and gas leases. Appellee HEYCO is a natural gas producer which holds a number of statutory leases on lands owned in trust by the SLO.

  1. The Royalty Dispute

    In the late 1970s and early 1980s, HEYCO entered into long-term gas supply contracts with various pipeline companies pursuant to which HEYCO agreed to supply the pipeline companies, at stipulated prices, with natural gas produced from certain state gas leases. In 1989, HEYCO had thirty-three such gas supply contracts with the El Paso Natural Gas Company and two with the Transwestern Pipeline Company. These contracts each contained "take-or-pay" clauses which obligated the pipeline purchasers either to take a certain minimum amount of gas each year or, failing to do so, to pay HEYCO the difference in value between the minimum contract amount and the amount actually taken.

    At the time these gas supply contracts were entered into, federal regulatory price ceilings on natural gas sold in the interstate market had resulted in decreased production and availability of natural gas. See generally Prenalta Corp. v. Colorado Interstate Gas Co., 944 F.2d 677, 679-80 (10th Cir.1991) (discussing effects of federal regulation on interstate gas market). Pipeline companies therefore were willing to enter into long-term contracts with substantial take-or-pay obligations in order to ensure a steady supply of natural gas for their customers. Id. HEYCO's gas supply contracts with Transwestern and El Paso were representative of this type of long-term take-or-pay contract.

    Following deregulation of natural gas pricing in the mid-1980s, the supply of natural gas increased and the market price dropped sharply. Pipeline companies, however, continued to be obligated under their existing take-or-pay contracts to purchase large quantities of natural gas at an above-market contract price. 1 In response to these economic forces, pipeline companies generally began reducing their gas "takes" without making any corresponding take-or-pay payments to producers. See Prenalta, 944 F.2d at 680. In HEYCO's case, for example, El Paso and Transwestern not only reduced their gas "takes," but also unilaterally lowered to market level the purchase price of any gas actually taken.

    Based on these price and take deficiencies, HEYCO made a claim against Transwestern for breach of its gas supply contracts. HEYCO subsequently entered into settlement negotiations with Transwestern, during which Transwestern sought amendments to the price and quantity terms of the gas supply contracts in exchange for a "buy down" payment. 2 Specifically, Transwestern hoped to lower its take obligations and to amend the contract to add a "market-sensitive" clause that would set the price of gas according to prevailing market rates. In January 1989, HEYCO agreed to accept a $275,000 nonrecoupable 3 buy down payment in exchange for certain price and take reduction amendments to the supply contracts. ("Letter Agreement," Appellant App. at 135-41.) For the remaining period of the contracts, Transwestern paid HEYCO the generally prevailing market price for its natural gas, which was substantially lower than the prior contract rate. The State of New Mexico has not received a royalty payment from HEYCO on the Transwestern settlement proceeds, although

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    HEYCO has paid the state all royalty on gas produced and sold at the lower spot market price since the Transwestern settlement.

    In February 1989, HEYCO also negotiated a settlement agreement with El Paso. ("Settlement Agreement and Release," Appellant App. at 143-46.) Pursuant to this agreement, HEYCO accepted a $312,181 nonrecoupable "buy out" payment 4 from El Paso. In exchange, HEYCO agreed to terminate the El Paso gas supply contracts and to discharge El Paso from any further obligations thereunder. HEYCO has not paid the State of New Mexico any royalty on the buy out proceeds received from El Paso.

    Before the district court, the Commissioner asserted a counterclaim against HEYCO arising out of HEYCO's failure to pay royalties on the El Paso and Transwestern settlement proceeds. The Commissioner's counterclaim sought royalty payments under five separate legal theories: (1) breach of the duty to market and breach of the duty of good faith and fair dealing; (2) constructive sale of gas; (3) breach of the duty to pay royalties; (4) unjust enrichment; and (5) third-party beneficiary. The district court held that no royalty was due under the express terms of the New Mexico statutory lease and granted summary judgment to HEYCO on the Commissioner's counterclaim.

  2. The Rule 1.059 Controversy

    On June 1, 1988, the Commissioner circulated a proposed amendment, entitled "Calculating and Remitting Oil and Gas Royalties," to Rule 1.059 of the SLO regulations. The amendment to Rule 1.059 was the Commissioner's attempt to standardize the practice of calculating royalties under state oil and gas leases (Rule 1.059(A), Appellant App. at 352), and to combat what the Commissioner perceived to be widespread underreporting of royalties by lessees. After the notice and comment period, the amendment to Rule 1.059 was adopted and became effective on January 1, 1990. For purposes of this appeal, the most important provision added by the amendment is a detailed definition of "proceeds" upon which lessees must now base their royalty payments to the state. See Rule 1.059(B)(13). The "proceeds" definition requires lessees to pay royalties to the state based on "the total consideration accruing to the lessee," and provides an extensive, yet nonexhaustive, list of examples. Id. 5

    In addition to the "proceeds" definition, amended Rule 1.059 imposes upon state lessees complicated accounting requirements with respect to oil and gas that is either sold, processed or transported under contracts which are not "arm's-length" agreements as defined by the Rule. According to the Commissioner, the purpose of the "arm's-length" provisions is to value oil and gas for royalty purposes at a true market value rather than an artificially low non-arm's-length price. Amended Rule 1.059 also requires lessees to obtain SLO approval of accounting procedures contained in non-arm's-length contracts for the sale of processed gas. Under subsection (F) of the Rule, the...

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