PUBLISH

UNITED STATES COURT OF APPEALS

Filed 10/16/96

TENTH CIRCUIT

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.

No. 95-2214

Appeal from the United States District Court

for the District of New Mexico

(D.C. No. CIV 90-715M)

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 PlaintiffsAppellees.

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

EBEL, Circuit Judge.
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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 for 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.
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I. BACKGROUND

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,

development and production in New Mexico. Many members of NMOGA

are lessees under state oil and gas leases. Appellee HEYCO is a natural gas
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producer which holds a number of statutory leases on lands owned in trust

by the SLO.

A. 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-
1

 For more detailed explanation of the take-or-pay crisis which

followed the federal government's deregulation of the interstate natural gas

market, see Richard J. Pierce, Jr., State Regulation of Natural Gas in a

Federally Deregulated Market: The Tragedy of the Commons Revisited, 73

Cornell L. Rev. 15, 18-20 (1987).

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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,
2

 A "buy down" is a settlement payment made to the producer which

accompanies renegotiation of other terms in the supply contract, such as "a

reduced price term, an extension of the delivery terms, a reduction in the

minimum or total quantity to be purchased, or some combination of these

elements." Howard R. Williams & Charles J. Meyers, 8 Manual of Oil and

Gas Terms 121 (1995) (quotation omitted).

3

 A nonrecoupable payment is "[t]hat portion of the amount paid under a

settlement agreement of a take-or-pay controversy which may not be recouped by

later taking gas in excess of the contractually required take-or-pay quantities." 

Howard R. Williams & Charles J. Meyers, 8 Manual of Oil and Gas Terms 704

(1995).

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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 HEYCO

has paid the state all royalty on gas produced and sold at the lower spot

market price since the Transwestern settlement.
4

 A "buy out" is a settlement payment made by a gas purchaser to the

producer in order to extinguish its liabilities under a take-or-pay clause and

to discharge the purchaser from further performance under the supply

contract. See 8 Howard R. Williams & Charles J. Meyers, Manual of Oil and

Gas Terms 122 (1995).

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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
5

 Rule 1.059(B)(13) provides in relevant part as follows:

(continued...)

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New Mexico statutory lease and granted summary judgment to HEYCO on

the Commissioner's counterclaim.

B. 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

 
5

(...continued)

"[P]roceeds" means the total consideration accruing to the lessee. It

includes but is not limited to: reimbursement for dehydration,

compression, measurement, or field gathering to the extent that the

lessee is obligated to perform them at no cost to the lessor;

reimbursements, payments, or credits for advanced prepaid reserve

payments subject to recoupment through reduced prices in later sales;

advanced exploration or development costs that are subject to

recoupment through reduced prices in later sales; any other

consideration given to the lessee, or any action taken or not taken in

exchange for reduced prices; take-or-pay payments; and tax

reimbursements. . . .

(emphasis added.) The parties seem to agree that the new "proceeds"

definition, if enforceable, would require the payment of royalties on all

take-or-pay settlements. However, because amended Rule 1.059 did not

become effective until January 1, 1990 (approximately one year after

HEYCO's settlement agreements with El Paso and Transwestern), the

Commissioner's counterclaim does not rely on the new "proceeds" definition

in seeking royalty payments from HEYCO.

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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 nonarm's-length contracts for the sale of processed gas. Under subsection (F)
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of the Rule, the Commissioner may disapprove of a lessee's proposed

methodology for calculating deductible processing costs and impose a

different methodology which more reasonably reflects the actual costs of

processing. See Rule 1.059(F)(2)(c).

Appellees argue that by promulgating Rule 1.059, the Commissioner

unilaterally has imposed substantial new obligations upon state oil and gas

lessees. Appellees contend that Rule 1.059 thus constitutes an

unconstitutional impairment of contracts and a denial of due process under

both the federal and state constitutions. Appellees also argue that the

Commissioner exceeded his authority under state law and usurped the

legislative power in promulgating the Rule. The district court, in granting

summary judgment to Appellees, agreed that the Commissioner acted

without authority in promulgating Rule 1.059. The court also agreed with

Appellees' argument that the Commissioner's action was a usurpation of

legislative power. The court did not address Appellees' other state or

federal constitutional claims.

II. DISCUSSION

We review the grant of a motion for summary judgment de novo,

under the same standard applied by the district court pursuant to Fed. R.
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Civ. P. 56(c). Universal Money Ctrs., Inc. v. AT&T, 22 F.3d 1527, 1529

(10th Cir.), cert. denied, 115 S. Ct. 655 (1994). Summary judgment is

appropriate “if the pleadings, depositions, answers to interrogatories, and

admissions on file, together with the affidavits, if any, show that there is no

genuine issue as to any material fact and that the moving party is entitled to

a judgment as a matter of law.” Fed. R. Civ. P. 56(c). If there is no

genuine issue of material fact in dispute, we must determine whether the

substantive law was correctly applied by the district court. Applied

Genetics Int'l v. First Affiliated Sec., Inc., 912 F.2d 1238, 1241 (10th Cir.

1990).

A. HEYCO's Obligation to Pay Royalties on the Settlement Proceeds

We first address whether HEYCO breached its duty to pay royalties

by failing to pay the state its royalty share of the settlement proceeds

received from El Paso and Transwestern. Our inquiry begins with the gas

royalty clause of the New Mexico statutory lease, which reads in part as

follows:

Subject to the free use without royalty, as hereinbefore provided, at

the option of the lessor at any time and from time to time, the lessee

shall pay the lessor as royalty one-eighth part of the gas produced and

saved from the leased premises, including casing-head gas. Unless

said option is exercised by lessor, the lessee shall pay the lessor as

royalty one-eighth of the cash value of the gas, including casing-head
6

 Because the question whether state lessees must pay royalties on lump

sum take-or-pay settlements is res nova in New Mexico and would control the

outcome of this case, the Commissioner asks us to certify the question to the

Supreme Court of New Mexico. While the importance and novelty of this

question both mitigate in favor of certification, we decline the Commissioner's

invitation to certify for two reasons. First, the Commissioner's request is not well

taken considering that the present suit was originally filed in state court by the

plaintiffs and removed to federal court by the Commissioner. Cf. Croteau v. Olin

Corp., 884 F.2d 45, 46 (1st Cir. 1989) ("[O]ne who chooses to litigate his state

action in the federal forum . . . must ordinarily accept the federal court's

reasonable interpretation of extant state law rather than seeking extensions via the

certification process."). Second, in the proceedings before the district court, the

Commissioner did not seek to certify the question, and only now (after receiving

an adverse ruling) has asked us to do so. See Massengale v. Oklahoma Bd. of

Examiners in Optometry, 30 F.3d 1325, 1331 (10th Cir. 1994) (citing Armijo v.

Ex Cam, Inc., 843 F.2d 406, 407 (10th Cir. 1988)) ("We generally will not certify

questions to a state supreme court when the requesting party seeks certification

only after having received an adverse decision from the district court."). We

therefore deny the Commissioner's Motion to Certify Questions to the Supreme

Court of New Mexico.

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gas, produced and saved from the leased premises and marketed or

utilized, such value to be equal to the net proceeds derived from the

sale of such gas in the field . . . .

N.M. Stat. Ann. § 19-10-4.1 (Michie 1994). 6 

Although the terms of the New Mexico oil and gas lease are

prescribed by statute, the lease itself is a contract between the State as

lessor on the one hand and HEYCO as lessee on the other. We therefore

apply general New Mexico contract principles in ascertaining the effect of

the particular provisions of the lease. See Leonard v. Barnes, 404 P.2d 292,

302 (N.M. 1965) (noting that an oil and gas lease “is merely a contract
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between the parties and is to be tested by the same rules as any contract"). 

Unless its provisions are ambiguous, "the lease must be given the legal

effect resulting from a construction of the language contained within the

four corners of the instrument." Owens v. Superior Oil Co., 730 P.2d 458,

459 (N.M. 1986) (citing cases). A contract is ambiguous when its language

"can be fairly and reasonably construed in different ways." Harper Oil Co.

v. Yates Petroleum Corp., 733 P.2d 1313, 1316 (N.M. 1987).

1. "Production is the key to royalty"

Here, we find the royalty clause to be clear and unambiguous: Under

its plain terms, the lessee need only "pay the lessor as royalty one-eighth of

the cash value of the gas . . . produced and saved from the leased premises

. . . ." N.M. Stat. Ann. § 19-10-4.1 (Michie 1994) (emphasis added). Thus,

the lessee is not obligated to pay a royalty on the "cash value of the gas" in

the abstract, but only on the cash value of gas which is actually "produced

and saved" from the leased property. See Diamond Shamrock Exploration

Co. v. Hodel, 853 F.2d 1159, 1165-68 (5th Cir. 1988) (holding that under

similar "production"-type royalty clause, “royalties are not due on `value’

or even `market value’ in the abstract, but only on the value of production

saved, removed or sold from the leased property.”). This construction of
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the lease agreement not only is compelled by the plain language of the

royalty clause, but also comports with the interpretation adopted by the

majority of courts which have addressed the "production"-type royalty

clause. See, e.g., Mandell v. Hamman Oil & Ref. Co., 822 S.W.2d 153, 165

(Tex. Ct. App. 1991) (citing Diamond Shamrock, 853 F.2d at 1167-68)

("Production is the key to royalty."); Killam Oil Co. v. Bruni, 806 S.W.2d

264, 267 (Tex. Ct. App. 1991) ("[T]he lease entitled the [lessor] to royalty

payments on gas actually produced."); State v. Pennzoil Co., 752 P.2d 975,

981 (Wyo. 1988) ("By its clear terms, [the lease] manifests the intention of

the parties that royalty payments were to be made only in the event of

production from the lease, that is, after physical extraction of the gas from

the land and its sale or use."); Diamond Shamrock, 853 F.2d at 1165

("[R]oyalties are not owed unless and until actual production. . . .").

In State v. Pennzoil Co., the Wyoming Supreme Court was called

upon to interpret a similar lease provision requiring the payment of

royalties "on gas . . . produced from said land saved and sold or used off the

premises . . . ." 752 P.2d at 976 (emphasis in original). At issue in that

case was whether the State of Wyoming was entitled, as lessor, to a royalty

on recoupable take-or-pay payments received by the lessees. Id. The State

argued that the royalty clause was ambiguous and thus should be interpreted
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broadly to require royalties "on all proceeds relating to th[e] gas whether or

not actual production and sale had occurred." Id. at 978-79. The court

rejected this argument, holding that the express terms of the lease required

actual "production" of gas to trigger the lessees' duty to pay royalty:

The word "production" has an established legal meaning when used in

a royalty or habendum clause of an oil and gas lease. "Production"

requires severance of the mineral from the ground. . . . [T]he lease

demonstrates that the parties intended the general meaning of

"production." . . . This language manifests the proposition that

royalties are due only upon physical extraction of the gas from the

ground and its removal.

Id. at 979 (citations omitted).

Similarly, in Diamond Shamrock Exploration Co. v. Hodel, 853 F.2d

1159, 1163 (5th Cir. 1988), the Fifth Circuit construed a federal off-shore

lease calling for royalties of a certain percentage, “in amount or value of

production saved, removed, or sold from the leased area." The court held

that this language expressly conditioned the payment of royalties upon

"production" of gas, id. at 1165, and that "[f]or purposes of royalty

calculation and payment, production does not occur until the minerals are

physically severed from the earth." Id. at 1168. Thus, the court concluded,

because take-or-pay payments are not payments for produced gas, but rather

are payments for the pipeline-purchaser's failure to take produced gas, such

payments are not subject to the lessor's royalty interest. Id. at 1167.
7

 In Mandell, as in this case, the pipeline company paid cash to settle

claims that it not only had breached the take-or-pay clause of the gas supply

contract, but also that it had underpaid for gas previously produced. While

the lessee in Mandell did not pay a royalty on the take-or-pay portion of the

settlement, it did tender a royalty on that portion of the settlement which

was attributable to the pipeline's underpayment for produced gas. 822

S.W.2d at 157. Here, however, HEYCO has not paid the state a royalty on

any portion of the settlements.

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Other courts have applied the reasoning of Pennzoil and Diamond

Shamrock to hold that, under a "production"-type royalty clause, no

royalties are due on cash payments received in settlement of the take-or-pay

provision of a gas supply contract. In Mandell v. Hamman Oil & Ref. Co.,

822 S.W.2d 153, 164 (Tex. Ct. App. 1991), for example, the Texas Court of

Appeals held that royalties were not due on the take-or-pay portion of a

settlement because "[t]ake or pay is not a payment for production; it is a

payment for nonproduction." 7

 Similarly, in Killam Oil Co. v. Bruni, 806

S.W.2d 264, 268 (Tex. Ct. App. 1991), the court held that a lessor was “not

entitled to royalties on the settlement proceeds arising from the take-or-pay

provision of the contract . . . because under a standard lease, take-or-pay

payments do not constitute any part of the price paid for produced gas. . . .” 

Accord Lenape Resources Corp. v. Tennessee Gas Pipeline Co., 925 S.W.2d

565, 569-70 (Tex. 1996); TransAmerican Natural Gas Corp. v. Finkelstein,

No. 04-95-00365-CV, 1996 WL 460010, at *6-*8 (Tex. Ct. App. Aug. 14,
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1996) (en banc); Roye Realty & Developing, Inc. v. Watson, No. 76,848,

1996 WL 515794, at *9 (Okla. Sept. 10, 1996); Independent Petroleum

Ass’n of Am. v. Babbitt, 92 F.3d 1248, 1259-60 (D.C. Cir. 1996).

From these cases, we believe that three guiding principles emerge

that are applicable to the issues here. First, royalty payments are not due

under a "production"-type lease unless and until gas is physically extracted

from the leased premises. Second, nonrecoupable proceeds received by a

lessee in settlement of the take-or-pay provision of a gas supply contract

are specifically for non-production and thus are not royalty bearing. Third,

any portion of a settlement payment that is a buy-down of the contract price

for gas that is actually produced and taken by the settling purchaser is

subject to the lessor’s royalty interest at the time of such production, but

only in an amount reflecting a fair apportionment of the price adjustment

payment over the purchases affected by such price adjustment.

In adopting this three-part framework, we reject the Commissioner's

suggestion that the "production" language in the royalty clause lease should

not be strictly construed. The Commissioner argues that the entire lease

agreement should be evaluated in light of the parties' intent in entering into

the contract, which the Commissioner characterizes as a "cooperative

venture" between lessor and lessee to develop the land and split all
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economic benefits arising therefrom. The Commissioner's "cooperative

venture" theory is an extension of the so-called "Harrell rule." See Thomas

A. Harrell, Developments in Nonregulatory Oil and Gas Law, 30 Inst. on

Oil & Gas L. & Tax'n 311 (1979). Under the Harrell rule, a gas lease is a

symbiotic endeavor in which "the lessor contribut[es] the land and the

lessee contribut[es] the capital and expertise necessary to develop the

minerals for the mutual benefit of both parties." Id. at 334. A corollary to

the “cooperative venture” theory is the argument that buy-down or buy-out

settlement payments enable the lessee to sell the released gas on the open

market at a cheaper price, and, accordingly, that subsequent production and

sale of such gas to a third party should be deemed to be at a price consisting

of two figures: the spot price received from the third party and an allocated

portion of the settlement payment. The Commissioner relies on two cases

which have applied the Harrell rule to require the payment of royalties on

take-or-pay settlement proceeds: Frey v. Amoco Prod. Co., 943 F.2d 578

(5th Cir. 1991) ["Frey I"], withdrawn in part on reh'g and question

certified, 951 F.2d 67 (5th Cir. 1992) (per curiam), certified question

answered, 603 So.2d 166 (La. 1992) ["Frey II"], reinstated in part on reh’g,

976 F.2d 242 (5th Cir. 1992) (per curiam); and Klein v. Jones, 980 F.2d 521
- 19 -

(8th Cir. 1992), aff’d after remand, 73 F.3d 779 (8th Cir. 1996), cert.

denied, 64 U.S.L.W. 3808 (U.S. Oct. 7, 1996) (applying Arkansas law).

In Frey, a private lessee-producer received a $66.5 million take-orpay buy down payment from a pipeline company. $20.9 million of this

amount represented a nonrecoupable settlement payment; the remaining

$45.6 million represented a payment for accrued take-or-pay deficiencies,

but which the pipeline could later recoup in the form of make-up gas. Frey

I, 943 F.2d at 580. The royalty clause in the relevant lease agreement

required the producer-lessee to pay a "royalty on gas sold by Lessee [at]

one-fifth ( 1/ 5) of the amount realized at the well from such sales." Id.

(brackets in original.) Although the lessee eventually paid royalties on the

recoupable portion of the settlement (as the corresponding make-up gas was

taken), no royalties were ever paid on the $20.9 million in nonrecoupable

settlement proceeds. The lessors filed suit in federal district court seeking

payment of royalties on the nonrecoupable settlement proceeds. Applying

Louisiana law, the district court ruled against the lessors. 708 F. Supp.

783, 787 (E.D. La. 1989), rev’d, 943 F.2d 578 (5th Cir. 1991). The Fifth

Circuit reversed, holding that a royalty was due the lessors under the

express terms of the lease agreement, which tied royalties to "sales" of gas

rather than the "production" of gas. See Frey I, 943 F.2d at 581. In so
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holding, the Fifth Circuit distinguished its earlier Diamond Shamrock

decision, where take-or-pay payments were held not subject to a royalty

under a lease agreement requiring royalties to be paid on the "amount or

value of production saved, removed, or sold." Id. (emphasis in original). 

The Diamond Shamrock case was distinguishable, the Fifth Circuit

concluded, because unlike the "sale" of gas, which in Louisiana is

accomplished at the time the gas purchase contract is executed, the

"production" of gas requires actual severance of the minerals from the

ground. Id.; see also id. at 588 (Jones, J., concurring) ("[W]e are not

attempting to overrule the Diamond Shamrock case, whose outcome

depended upon a standard production-type royalty clause.").

On rehearing, the Fifth Circuit withdrew that portion of its opinion

dealing with the royalty issue and certified the question to the Louisiana

Supreme Court. Frey v. Amoco Prod. Co., 951 F.2d 67 (5th Cir. 1992) (per

curiam). Responding to the certified question, the Louisiana Supreme

Court agreed with the Fifth Circuit's distinction between the "production"-

type royalty clause construed in Diamond Shamrock and a clause requiring

royalties to be paid on the "sale" of gas. See Frey II, 603 So.2d at 179. 

According to the court, the "sale" of gas--as opposed to the "production" of

gas--occurs under Louisiana law when the gas purchase contract is
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executed. Id. (citing La. Civ. Code. Ann. arts. 1767, 1775, 2450, 2471

(West 1987)). Thus, the settlement proceeds constituted a part of the

amount realized by the lessee from the "sale" of gas, and the lessors

therefore were entitled to a royalty share under the express terms of the

lease agreement. Id. at 178.

Although the Louisiana Supreme Court found that the settlement

payments were part of the amount realized from the "sale" of gas, the court

chose not to base its decision on this fact alone. Rather, the court also

invoked Professor Harrell's "cooperative venture" theory. Frey II, 603

So.2d at 173. In this regard, the court noted that under Louisiana law, an

oil and gas lease is a "cooperative venture in which the lessor contributes

the land and the lessee the capital and expertise necessary to develop the

minerals for the mutual benefit of both parties." Id. (citing Henry v.

Ballard & Cordell Corp., 418 So. 2d 1334, 1338 (La. 1982)). Based on

Professor Harrell's rule, the Frey II court gave the royalty clause an

"expansive reading," id., such that the receipt by the lessee of any economic

benefit traceable to the mineral lease triggers the lessee's duty to pay

royalties:

The lease represents a bargained-for exchange, with the benefits

flowing directly from the leased premises to the lessee and the lessor,

the latter via royalty. An economic benefit accruing from the leased

land, generated solely by virtue of the lease, and which is not
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expressly negated, is to be shared between the lessor and the lessee in

the fractional division contemplated by the lease.

Id. at 174 (citations omitted). Applying this reasoning, the court held that

the take-or-pay settlement payments were subject to the lessor's royalty

interest because the payments were traceable to the lessee's right to develop

and explore the property--a right expressly granted by the lease agreement. 

Id. at 180.

The Eighth Circuit's decision in Klein v. Jones, 980 F.2d 521 (8th Cir.

1992), aff’d after remand, 73 F.3d 779 (8th Cir.), cert. denied, 64 U.S.L.W.

3808 (U.S. Oct. 7, 1996) applied the Harrell rule to a standard

"production"-type lease arrangement. In Klein, the court reversed a district

court's order that certain payments made to the lessee-producer arising out

of a take-or-pay dispute were not subject to the lessor's royalty interest

under Arkansas law. 980 F.2d at 533. In remanding the case, the Eighth

Circuit opined that Arkansas, like Louisiana, would apply the "cooperative

venture" approach in interpreting oil and gas leases. Id. at 531 ("We also

recognize . . . that a lease arrangement is in the nature of a cooperative

venture . . . to develop the minerals for the mutual benefit of both

parties.").

We believe Frey II and Klein are distinguishable from the instant

case. First, the Frey II and Klein courts adopted the "cooperative venture"
- 23 -

approach largely because of unique state statutes which expanded the

definition of "royalty" in mineral leases. In Louisiana, for instance, the

Mineral Code states:

"Royalty," as used in connection with mineral leases, means any

interest in production, or its value, from or attributable to land

subject to a mineral lease, that is deliverable or payable to the lessor

or others entitled to share therein . . . . "Royalty" also includes sums

payable to the lessor that are classified by the lease as constructive

production.

La. Rev. Stat. Ann. § 31:213(5) (West 1989). Similarly, the Arkansas

statutes provide that "[i]t shall be the duty of both the lessee . . . [and the

purchaser] to protect the royalty of the lessor's interest by paying to the

lessor or his assignees the same price, including premiums, steaming

charges, and bonuses of whatsoever name for royalty oil or gas that is paid

the operator or lessee under the Lease for the working interest thereunder." 

Ark. Code. Ann. § 15-74-705 (Michie 1987). Both the Frey II and Klein

courts relied on these statutory provisions in concluding that royalties were

due on all economic benefits, including take-or-pay settlements,

attributable to the leased land. See Frey II, 603 So.2d at 171-72 (noting the

"expansive definition of royalty" provided in the Louisiana mineral code);

Klein, 980 F.2d at 529 (noting the Arkansas legislature's attempt to "expand

the scope of 'royalty' by special definitions and concepts"). In contrast, the
8

 It should be noted that the challenged SLO Rule 1.059, like the

Louisiana and Arkansas statutes, expands the types of lessee income subject

to royalty under the New Mexico statutory lease, thereby broadening the

state's royalty interest. See Rule 1.059(B)(13) (defining "proceeds" subject

to royalty as "the total consideration accruing to the lessee [which] includes

but is not limited to . . . payments subject to recoupment through reduced

prices in later sales; . . . any other consideration given to the lessee, or any

action taken or not taken in exchange for reduced prices; [and] take-or-pay

payments"). However, as noted, the Commissioner does not rely on the

amended Rule 1.059 because the Rule was promulgated subsequent to the El

Paso and Transwestern settlements.

- 24 -

New Mexico statutes do not contain an expanded definition of royalty. 8

Rather, New Mexico’s only pertinent statute specifically connects the

payment of royalties to the production of gas. N.M. Stat. Ann. § 19-10-4.1

(Michie 1994) (royalties are due on gas which is "produced and saved from

the leased premises"). Thus, because Frey and Klein were decided against a

different statutory backdrop, we do not find their reasoning persuasive

here. See John S. Lowe, Defining the Royalty Obligation, 49 SMU L. Rev.

223, 257 (1996) ("[B]oth Frey and Klein were based in part upon unusual

state statutes that may expand the royalty obligation. . . . Most states . . .

apparently have no such legislation. Thus, to the extent that Frey and Klein

were based upon statutory language, they may stand alone.").

Second, the fact that New Mexico has expressly conditioned the

payment of royalties upon "production" of gas distinguishes this case from

Frey, where the relevant royalty clause was triggered by "sales" of gas. 
- 25 -

Both the Fifth Circuit in Frey I and the Louisiana Supreme Court in Frey II

recognized this crucial distinction. See Frey I, 943 F.2d at 581 ("The Lease

affords royalty on the amount realized from sales, not on production.");

Frey II, 603 So.2d at 179 ("The Frey-Amoco Lease explicitly predicates

Amoco's obligation to pay royalty on the sale of gas. . . . Had the parties

desired to condition the payment of royalties on production of gas, the

Lease could easily have so provided.").

Third, the “cooperative venture” theory advocated by Professor

Harrell has not apparently received very much additional support, and

several recent cases have eschewed that approach in favor of a literal

reading of the lease terms. For example, in Independent Petroleum Ass’n

of Am. v. Babbitt, 92 F.3d 1248, 1259-60 (D.C. Cir. 1996) [“IPAA”], the

court declined to require royalties to be paid upon payments to settle or

adjust contract obligations unless such payments were recoupable against

production and were, in fact, recouped by the settling party through actual

production taken by the settling party. The mere fact that the lesseeproducer ultimately produced gas freed up by the settlement and sold it on

the spot market to other buyers did not provide a nexus between that

production and the settlement payment such that royalties were due on the

settlement payment. (Of course, the lessee-producer would owe royalties
- 26 -

on the spot price actually obtained for any such replacement sales.) The

IPAA court explained:

When gas is actually severed and sold to a substitute purchaser,

the settlement payment does not serve as payment for the gas. 

The link between the funds on which royalties are claimed and

the actual production of gas is missing. . . . The relevant

question in both cases [take-or-pay payments and contract

settlement payments], under Diamond Shamrock, is whether or

not the funds making up the payment actually pay for any gas

severed from the ground. When take-or-pay payments (or

settlement payments) are recouped, those funds do pay for

severed gas. But when payments (of either variety) are

nonrecoupable, the funds are never linked to any severed gas. 

Therefore, no royalties accrue on those payments.

IPAA, 92 F.3d at 1259-60 (footnote omitted). The Texas Court of Appeals

reached the same result in TransAmerican Natural Gas Corp. v. Finkelstein,

No. 04-95-00365-CV, 1996 WL 460010 (Tex. Ct. App. Aug. 14, 1996) (en

banc overturning of prior panel decision reported at 1996 WL 148175 (Tex.

Ct. App. Apr. 13, 1996)). There, the court rejected the argument that takeor-pay settlements should be allocated to subsequent production sold on the

spot market to third parties. The court stated, “we reaffirm . . . that a

royalty owner, absent specific lease language, is not entitled to take-or-pay

settlement proceeds, whether or not gas is sold to third parties on the spot

market.” Id. at *9; accord Roye Realty & Developing, Inc. v. Watson, No.

76,848, 1996 WL 515794, at *9 (Okla. Sept. 10, 1996); see also Lenape

Resources Corp. v. Tennessee Gas Pipeline Co., 925 S.W.2d 565, 569-70
9While New Mexico’s “Public Lands” law, N.M. Stat. Ann. tit. 19 (Michie

1994), does not expressly define “production,” its tax code does. For purposes of

New Mexico oil and gas tax law, “product” means “oil, natural gas or liquid

hydrocarbon, individually or any combination thereof, or carbon dioxide.” N.M.

Stat. Ann. §§ 7-29-2(E), 7-32-2(E) (Michie 1995). A “production unit” is “a unit

of property . . . from which products of common ownership are severed.” Id. §§ 7-

(continued...)

- 27 -

(Tex. 1996) (holding that “the pay option under a take-or-pay contract is

not a payment for the sale of gas”). But see Williamson v. Elf Aquitaine,

Inc., 925 F. Supp. 1163, 1168-69 (N.D. Miss. 1996) (following the panel

decision in TransAmerican Natural Gas Corp. v. Finkelstein which, as

noted above, was subsequently reversed by the Texas Court of Appeals

sitting en banc).

Because the present case involves a standard "production"-type lease

and arises under New Mexico statutory law (which is devoid of provision

similar to those in Arkansas and Louisiana expanding the lessee's royalty

obligation), we predict that New Mexico would not adopt the "cooperative

venture" approach. We therefore apply the plain terms of the statutory

lease and conclude that the state is not entitled to a royalty unless the

contested proceeds received by HEYCO were ultimately recouped by

HEYCO in exchange for actual "production" of gas from the leased tracts--

i.e., "physical extraction of the gas from the ground and its removal." 

Pennzoil, 752 P.2d at 979. 9
9

(...continued)

29-2(B), 7-32-2(B). Finally, “severance” means “the taking from the soil of any

product in any manner whatsoever.” Id. §§ 7-29-2(C), 7-32-2(C). Thus, under

New Mexico tax law, “production” means the taking of natural gas from the soil. 

See e.g. Fullerton v. Kaune, 382 P.2d 529, 532 (N.M. 1963) (tax case using the

words “production” and “extraction” interchangeably).

- 28 -

2. Are the El Paso and Transwestern settlement proceeds

attributable to the "production" of gas?

Our conclusion that royalty is tied to production does not, of course,

end our inquiry. We must now determine whether the El Paso and

Transwestern settlement proceeds, or any portions thereof, were paid to

HEYCO for produced gas as opposed to simply buying out contractual

obligations. We can attribute the settlement payments to production only

if, and to the extent, the settling purchaser recoups recoupable take-or-pay

payments by taking future make-up gas or takes actual production at a

reduced price because of the settlement provisions. 

The district court granted summary judgment to HEYCO on the

ground that the settlement proceeds received by HEYCO were not tied to

actual "production" of gas. Our independent review of the record, however,

leaves us less certain of this fact, at least as to certain portions of the

settlement proceeds. We believe there exists a genuine issue of material

fact whether the El Paso and Transwestern settlement proceeds are

attributable solely to take-or-pay deficiencies (i.e., non-production), or
10 HEYCO contends that the Commissioner has waived any argument

pertaining to past price deficiencies. In support of this contention, HEYCO

asserts that "[t]he Commissioner argued below that royalty was owed on the

entire settlement and did not raise any distinct argument that past prices

were settled and royalty bearing." Appellees’ Br. at 40-41. We disagree. 

The Commissioner's counterclaim alleged specifically that HEYCO owed

royalties on settlement payments because they were received in

"consideration for oil and gas that was produced or will be produced in the

future from state lands." Appellant’s App. at 34 (emphasis added). 

Moreover, in opposing HEYCO's motion for summary judgment, the

Commissioner argued that a material question of fact remained as to

"[w]hether any portion of the proceeds received by HEYCO for settlement

of its disputes with El Paso and Transwestern was for settlement of price

disputes." Appellant App. at 228. We therefore do not believe that the

Commissioner's argument is waived.

- 29 -

whether they are attributable, at least in part, to a price adjustment for the

actual production of gas from the SLO lands acquired or to be acquired by

El Paso or Transwestern. We therefore reverse the grant of summary

judgment in favor of HEYCO on the royalty issue and remand to the district

court for further proceedings on this question.

Although not entirely clear, the record in this case suggests that

HEYCO sought payment from the pipelines for: (1) the difference in price

between what the pipelines should have paid under their gas supply

contracts with HEYCO and the lower spot market price they actually paid

for gas produced prior to the settlement ("past price deficiencies") 10; (2)

the difference between what the pipelines would have been required to pay

under the gas supply contracts and the estimated future spot market price
11 Because the El Paso settlement was a buy out arrangement

terminating the gas supply contracts altogether, the future price deficiencies

are relevant only to the Transwestern buy down.

- 30 -

for the gas ("future price deficiencies") for future production subsequent to

the settlement taken under the modified gas supply contracts; 11 and (3) the

difference in value between the volumes of gas the pipelines were required

to take under the take-or-pay provisions of the contracts and the lesser

quantities of gas actually taken by the pipelines both prior to (accrued takeor-pay deficiencies) and subsequent to (future take-or-pay obligations) the

settlements.

As we have noted, the duty to pay royalty under a lease which

conditions royalty payments on "production" is not triggered unless and

until gas is physically extracted from the leased premises. Diamond

Shamrock, 853 F.2d at 1168; Pennzoil, 752 P.2d at 979. Thus, proceeds

received by the lessee in settlement of the take-or-pay provision of a gas

supply contract (for either accrued take-or-pay deficiencies or to abrogate

future take-or-pay obligations) are not royalty bearing because they are

payments for non-production. Mandell, 822 S.W.2d at 164; Killam Oil, 806

S.W.2d at 268. Although it does not appear here that any portion of the

settlement payment for reduced volume of gas taken was, or will be,

recoupable by future production, if there is such a recoupment tied to actual
- 31 -

production, at that point any payments so recouped would be royaltybearing. IPAA, 92 F.3d at 1259-60.

With regard to any portions of the settlement attributed to a reduction

in price, HEYCO does have a duty to pay the state a royalty on those

portions of the settlements which are attributable to past price deficiencies

because any such payment represents HEYCO's recovery of underpayments

for gas already produced and sold from the leased SLO lands. Cf. IPAA, 92

F.3d at 1262 & n.7 (Rogers, J., dissenting) (noting that the parties there

conceded that amounts paid to resolve disputes over the price of past

production are royalty bearing and considering that payments to obtain

future price reductions are also royalty bearing). However, any component

of the settlements that pertain to future price reductions present a more

difficult question. Because we hold that the New Mexico statutory lease

form does not require the payment of royalty unless and until gas is

physically severed from the ground, a lessee would not be required to remit

royalties up front on those amounts which are paid by a pipeline company to

buy down the price of future production under the supply contract. At the

same time, however, it would grant a windfall to the lessee if the lessee

were permitted to retain the entire lump sum cash "buy down" without ever

paying a royalty to the state on the buy-down settlement amount that is used
- 32 -

as a partial up-front payment for later gas that is produced and taken at

below-contract prices. As the Commissioner correctly points out, "if the

producer receives $1.00 m.c.f. today, before the gas is taken, and then

receives an additional $1.00 m.c.f. in three months when the gas is actually

produced and taken, royalty should be paid on $2.00 m.c.f. To hold

otherwise allows the producers to pocket $1.00 of the price without

justification." Br. of Comm'r at 19 n.3. Moreover, if royalties were not

ever payable on that portion of a settlement attributable to future price

reductions on actual production taken by the settling purchaser, a lessee

would be encouraged to avoid its royalty obligation by accepting large

nonrecoupable payments in exchange for reduced prices on future

production.

With these competing considerations in mind, we hold that the

lessee's duty to pay royalty on that portion of a settlement which is

attributable to future price reductions is not triggered until that future

production is actually taken by the settling purchaser. Thus, when a lessee

negotiates a buy down payment in exchange for a reduced future price term,

the state has no right to a royalty up front on that portion of the settlement

proceeds. However, as the Commissioner's hypothetical illustrates, when

the future production under the purchase contract is taken at the newly
- 33 -

"bought-down" price, the state should receive a royalty based on both: (1)

the proceeds obtained by the lessee from the sale of gas at the bought-down

price; and (2) a commensurate portion of the settlement proceeds that is

attributable to price reductions applicable to future production under the

renegotiated gas sales agreement as production occurs. We believe this

approach is faithful to the express terms of the New Mexico statutory lease,

which condition royalty payments on actual production. This approach also

eliminates a lessee's incentive to circumvent the royalty clause by

maximizing lump sum settlements while minimizing the future price of gas.

Because the record has not been fully developed on this question, we

must remand this case to the district court in order to determine which

portions of the settlement are attributable to nonrecoupable take-or-pay

payments (and thus are not royalty bearing), and which portions are

attributable to past and future price deficiencies (and thus are royalty

bearing to the extent that the payment is linked to actual production taken

by the settling purchaser at below- initial contract prices). The district

court also must determine what percentage of the sums attributable to

future price deficiencies currently are subject to the state's royalty interest. 

The record is not clear on this point, but because the HEYCO/Transwestern

settlement was reached in 1989, more than seven years ago, it is possible
12 We have concluded that the Commissioner's alternative arguments

of breach of the duty to market, constructive sale of gas, and unjust

enrichment are unavailing in this case because the state’s rights here are

governed by the terms of its leases with HEYCO. We have recognized that

the Commissioner may (depending on the facts) have a valid contractual

right to royalties on at least some portion of these settlement proceeds and

we see nothing in the Commissioner’s alternative claims that would enlarge

upon his contractual royalty rights. We also note that the Commissioner

does not raise the third party beneficiary claim on appeal, and thus that

argument is waived.

- 34 -

that Transwestern has already taken all of the then-anticipated production

upon which the future price reductions were based. If this is the case, the

state would be entitled immediately to its royalty share on the entire amount

of the settlement attributable to future price deficiencies. However, if

Transwestern has to date taken only a portion of the anticipated production

at the bought down price, then only a pro rata amount of the buy down

proceeds currently would be subject to the state's royalty interest. As

noted, the record before us does not adequately answer these difficult

questions, and thus summary judgment at this point is premature. We

acknowledge the complexity of the district court's task on remand, yet we

expect the parties will present additional evidence as to the allocation of

the settlement proceeds and will cooperate fully with the district court in

conducting this difficult accounting process. 12
- 35 -

B. Validity of Rule 1.059

The Commissioner next appeals the grant of summary judgment to

Appellees on their challenge to Rule 1.059. Appellees below asserted a

number of challenges to the rule under both the federal and state

constitutions. The district court agreed with Appellees' claims that the

Commissioner, in promulgating Rule 1.059, had exceeded the authority

given him under the New Mexico Constitution and had usurped a legislative

function. Because of its holding with respect to these two claims, the

district court found it unnecessary to address the balance of Appellees'

constitutional arguments. On appeal, the Commissioner contends the

district court erred in three respects: first, by failing to dismiss Appellees'

challenge as unripe; second, by ruling against the Commissioner on the

merits of Appellees' state constitutional claims, and third, by striking down

Rule 1.059 in its entirety without considering whether the invalid portions

of the Rule could be severed and the remaining portions upheld.

1. Ripeness

We first address a threshold jurisdictional issue. The Commissioner

asserts that Appellees' challenge to Rule 1.059 is not ripe because the

amended Rule has not yet been applied by the Commissioner in any
- 36 -

situation directly affecting the Appellees. Whether a claim is ripe for

judicial review is a question of law which we review de novo. New

Mexicans for Bill Richardson v. Gonzales, 64 F.3d 1495, 1499 (10th Cir.

1995). The familiar two-part ripeness inquiry requires us to "evaluate both

the fitness of the issue for judicial resolution and the hardship to the parties

of withholding judicial consideration." Id. (quoting Sierra Club v. Yeutter,

911 F.2d 1405, 1415 (10th Cir. 1990) (quoting Abbott Labs. v. Gardner,

387 U.S. 136, 149 (1967))) (internal quotation marks omitted). In applying

this test, we must "caution against a rigid or mechanical application of a

flexible and often context-specific doctrine." Yeutter, 911 F.2d at 1417.

The "fitness for judicial resolution" prong requires the court to

consider "both the legal nature of the question presented and the finality of

the administrative action. . . ." Id. We believe both of these factors favor

jurisdiction over Appellees' claims. Generally, where disputed facts exist

in the record and the issue presented for review is not purely a legal one, a

court must exercise caution before concluding that the claim is ripe. 

Powder River Basin Resource Council v. Babbitt, 54 F.3d 1477, 1484 (10th

Cir. 1995). However, Appellees' challenge to Rule 1.059 presents primarily

a legal question--i.e., whether the Commissioner's promulgation of Rule

1.059 was within the bounds of the authority granted to him under New
- 37 -

Mexico law. Resolution of this question would depend almost exclusively

upon the interpretation of the relevant New Mexico statutes and

constitutional provisions. Cf. id. ("[T]he question here was purely legal: 

Plaintiff asked the court . . . [whether a Wyoming statute] violated federal

law. . . . This judgment would be based almost exclusively on Wyoming's

legal duties under federal law."). Moreover, it is apparent from the record

that Rule 1.059 is a final action. Compare Lujan v. National Wildlife

Federation, 497 U.S. 871, 890-91 (1990) (challenge to Interior Department

program not ripe for review under the Administrative Procedure Act

because program did not constitute final agency action). Rule 1.059

became effective January 1, 1990, and, according to affidavits submitted to

the district court, the Commissioner is currently applying the regulation to

state oil and gas leases. We therefore conclude that Appellees' challenge to

Rule 1.059 is "fit for judicial resolution" under the first prong of the Abbott

Labs. ripeness test.

Applying the second prong of Abbott Labs., we believe that Appellees

would suffer hardship if judicial consideration of the Rule 1.059 issue were

withheld. "In evaluating potential hardship to the parties, a court should

consider (1) whether the challenged rule has had a direct impact on the

party challenging the rule, and (2) the possible harm to the parties of
13 The Commissioner argues that these affidavits were not properly

before the district court and thus may not be considered on appeal. 

Specifically, the Commissioner contends that because the challenged

affidavits were submitted only in connection with Appellees' motion to file

an amended complaint, the district court could not have considered them in

connection with the subsequent motions for summary judgment. The filing

of an affidavit for one particular purpose does not preclude its consideration

by the district court for other purposes in the litigation. See 10A Charles

Alan Wright, Arthur R. Miller & Mary Kay Kane, Federal Practice &

Procedure § 2722, at 55-56 (2d ed. 1983) ("An affidavit of a party that is on

file in the case will be considered by the court regardless of the purpose for

which it was prepared and filed. Thus, an affidavit submitted to support

another motion may be taken into account on a motion for summary

judgment.") (citing McCullough Tool Co. v. Well Surveys, Inc., 395 F.2d

230 (10th Cir.), cert. denied, 393 U.S. 925 (1968)). Thus, because the

affidavits at issue here were on file with the district court and were made

part of the record on appeal, the district court and this Court may consider

them in connection with the motions for summary judgment.

- 38 -

delaying judicial consideration." Powder River, 54 F.3d at 1484 (citing

Yeutter, 911 F.2d at 1415). The district court found that "the enforcement

of the revised rule results in considerable financial consequences to

plaintiffs in terms of new royalty payments." Appellant App. at 413. The

district court's finding is supported by the record, which contains a host of

uncontroverted affidavits from employees of various oil and gas producers

who are members of NMOGA. These affidavits show that industry

compliance with Rule 1.059 will be, and in some cases already is, very

time-consuming and expensive. 13 Any delay in attaining a judicial
- 39 -

resolution of this issue will likely cause additional harm to Appellees, and

thus we hold that the issue is ripe for review.

2. The Commissioner's Authority to Promulgate Rule 1.059.

The office of the Commissioner of Public Lands is established, and

its powers circumscribed, by state law. In this regard, N.M. Stat. Ann. §

19-1-1 (Michie 1994) provides that:

A state land office is hereby created, the executive officer of which

shall be the commissioner of public lands . . . who shall have

jurisdiction over all lands owned in this chapter by the state, except

as may be otherwise specifically provided by law, and shall have the

management, care, custody, control and disposition thereof in

accordance with the provisions of this chapter and the law or laws

under which such lands have been or may be acquired.

(emphasis added.) Similarly, the state constitution provides that:

All lands belonging to the territory of New Mexico, and all lands

granted, transferred or confirmed to the state by congress, and all

lands hereafter acquired, are declared to be public lands of the state

to be held or disposed of as may be provided by law. . . .

The commissioner of public lands shall select, locate, classify and

have the direction, control, care and disposition of all public lands,

under the provisions of the acts of congress relating thereto and such

regulations as may be provided by law.

N.M. Const. Art. XIII, §§ 1-2 (emphasis added). Interpreting these

constitutional and statutory provisions, the New Mexico Supreme Court has

declared that the Commissioner of Public Lands “is merely an agent of the
- 40 -

state with such powers, and only such, as have been conferred upon him by

the constitution and laws of the state, as limited by the [New Mexico]

Enabling Act." Hickman v. Mylander, 362 P.2d 500, 502 (N.M. 1961);

accord Zinn v. Hampson, 301 P.2d 518, 519 (N.M. 1956).

In contrast to the Commissioner's limited grant of authority, the state

constitution vests the New Mexico legislature with broad powers to

prescribe the terms and conditions of mineral leases on the state's public

lands. The New Mexico Constitution provides that:

Leases and other contracts, reserving a royalty to the state, for the

development and production of any and all minerals . . . may be made

under such provisions relating to the necessity or requirement for or

the mode and manner of appraisement, advertisement and competitive

bidding, and containing such terms and provisions, as may be

provided by act of the legislature. . . .

N.M. Const. Art. XXIV, § 1 (emphasis added). Thus, because the state

legislature is the body constitutionally empowered to enact laws governing

mineral leases on public lands, and because the Commissioner's delegated

authority is circumscribed by "such regulations as may be provided by law,"

N.M. Const. Art. XIII, § 2, the Commissioner has no authority to

promulgate rules or regulations inconsistent with legislative enactments in

this area. Accordingly, in order for Rule 1.059 to be within the

Commissioner's power to promulgate, the Commissioner must show that

Rule 1.059 is consistent with the terms of the statutory leases.
- 41 -

The district court's summary judgment order focused on only one

aspect of Rule 1.059--the Rule's definition of "proceeds." In essence, this

aspect of Rule 1.059 requires lessees to remit royalties based on the

"proceeds" obtained from the sale of gas removed from state lands, and

defines "proceeds" as

the total consideration accruing to the lessee. It includes but is not

limited to: reimbursement for dehydration, compression,

measurement, or field gathering to the extent that the lessee is

obligated to perform them at no cost to the lessor; reimbursements,

payments, or credits for advanced prepaid reserve payments subject to

recoupment through reduced prices in later sales; advanced

exploration or development costs that are subject to recoupment

through reduced prices in later sales; any other consideration given to

the lessee, or any action taken or not taken in exchange for reduced

prices; take-or-pay payments; and tax reimbursements.

Rule 1.059(B)(13). This expansiveness of Rule 1.059's "proceeds"

definition is its downfall. Whereas the statutory lease only requires the

payment of royalties on "production," Rule 1.059 would require state

lessees to pay royalties even when gas is not physically extracted from the

leased premises. Specifically, Rule 1.059's "proceeds" definition requires

royalty payments based on "take-or-pay payments"--which we have now

held do not bear royalties under the state leases. Moreover, as the district

court pointed out, the "proceeds" definition "creates new categories of

payments not already in State Leases . . . [such as] reimbursement for

dehydration, compression and measurement of field gathering." (Aplt.
14 Appellees contend that the Commissioner failed to raise the

severability argument in the district court and thus cannot raise it now for

the first time on appeal. We disagree. The Commissioner below argued that

"even if [a portion of the Rule is held invalid], the severability clause found

in the Rule would enable the Court to hold [that] portion of the Rule

objectionable while declaring the remainder of the Rule to be legally

enacted and enforceable." (Aplt. App. at 400.)

- 42 -

App. at 413.) Because the definition of "proceeds" in Rule 1.059 attaches

new and different obligations upon lessees under the New Mexico statutory

lease, we agree with the district court's conclusion that the Commissioner

exceeded his authority under state law and usurped a legislative function in

promulgating that aspect of the Rule.

3. Severability of the "Proceeds" Definition

Although the district court considered only the "proceeds" definition,

the court apparently invalidated Rule 1.059 in its entirety. The

Commissioner now argues that even if the "proceeds" definition is invalid--

which we hold it is--the district court erred in not considering whether the

remaining portions of the Rule could be preserved under the Rule's

severability clause. This clause provides that "[i]f any part or application

of this rule is held invalid, the remainder or its application to other

situations or persons shall not be affected." Rule 1.059(G). 14
- 43 -

Severability of a state regulation is a question of state law. National

Solid Wastes Management Ass’n v. Killian, 918 F.2d 671, 679 n.8 (7th Cir.

1990), aff’d, 505 U.S. 88 (1992); cf. Panhandle E. Pipeline Co. v.

Oklahoma ex rel. Comm'rs of Land Office, 83 F.3d 1219, 1229 (10th Cir.

1996) (addressing a statute, not a regulation). Under New Mexico law, the

valid portion of a partially invalid statute can continue in force if the

following three criteria are satisfied:

(1) the invalid part must be separable from the other portions without

impairing the force and effect of the remaining parts; (2) the

legislative purpose expressed in the valid portion can be given force

and effect without the invalid part; and (3) when considering the

entire act, it cannot be said that the legislature would not have passed

the remaining part if it had known that the objectionable part was

invalid.

Giant Indus. Ariz., Inc. v. Taxation & Revenue Dep't, 796 P.2d 1138, 1140

(N.M. Ct. App. 1990) (citing Bradbury & Stamm Constr. Co. v. Bureau of

Revenue, 372 P.2d 808 (N.M. 1962)). The existence of a severability

clause raises a presumption that the legislating body would have enacted

the remaining portions of a statute even without the invalidated sections. 

Chapman v. Luna, 678 P.2d 687, 693 (N.M. 1984), aff’d after remand, 701

P.2d 367 (N.M.), cert. denied, 474 U.S. 947 (1985). Although these rules

of construction are designed to test the severability of a statute, we see no

reason why a similar inquiry should not also govern the severability of a
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regulation. See Marez v. State Taxation & Revenue Dep't., 893 P.2d 494,

497 (N.M. Ct. App. 1995) (noting the "commonplace technique of

legislative drafting to provide for survival of non-affected provisions if

portions of a statute or regulation are found to be invalid") (emphasis

added).

In light of Rule 1.059's severability provision, we hold that the

district court's failure to consider the independent validity of the other

portions of Rule 1.059 was erroneous. Because severability is a legal

question, Panhandle E. Pipeline Co., 83 F.3d at 1229-31, a reviewing court

may conduct a severability analysis on appeal without resort to remand. 

However, the district court here never even considered the predicate

question whether the other provisions of the Rule were valid. Compare

Leavitt v. Jane L., 116 S. Ct. 2068, 2069 (1996) (per curiam) (considering

severability of statute where district court had invalidated one provision of

the statute but held the remainder valid). Thus, in the absence of a more

developed record on this question, it would be imprudent in this case to

conduct a severability analysis for the first time on appeal. Accordingly,

we vacate that portion of the district court's order invalidating Rule 1.059

in its entirety and we remand with instructions to consider: (1) whether the

remaining portions of Rule 1.059 are valid; and (2) if so, whether the
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invalid "proceeds" definition is severable from the lawful portions of the

Rule under New Mexico law.

III. CONCLUSION

The district court's grant of summary judgment in favor of Appellee

HEYCO on the Commissioner's counterclaim for royalty payments is hereby

REVERSED and REMANDED to the district court for further proceedings

consistent with this opinion. The declaratory judgment in favor of

Appellees NMOGA and HEYCO invalidating Rule 1.059 is AFFIRMED IN

PART as to the "proceeds" definition but otherwise is VACATED and

REMANDED to the district court in order to determine the validity of the

remaining features of Rule 1.059, and to determine whether any valid

portions of the Rule are sustainable under the Rule's severability clause.