Supreme Court Rules that District Courts Retain Jurisdiction Over “Waters of the United States” (WOTUS) Rule

On January 22, 2018, the United States Supreme Court issued a decision concerning rulemaking over the definition of “waters of the United States” (“WOTUS”) under the Clean Water Act (“CWA”) (the “WOTUS Rule”).  Nat’l Ass’n of Mfrs. v. Dep’t of Def., No. 16-299 (2018).  As explained in previous alerts circulated in March 2014, June 2015, May 2016March 2017July 2017 and November 2017, the WOTUS Rule, which re-defined jurisdictional “waters of the United States” under the CWA, has far-reaching implications for project development across energy, water, agricultural, construction, and transportation sectors.

Although the Supreme Court’s decision merely resolves a jurisdictional dispute between the federal courts of appeals and the federal district courts over which court has jurisdiction to hear challenges to the WOTUS Rule, the decision will result in the lifting of the existing stay of the WOTUS Rule, opening the door to disparate approaches to jurisdictional determinations under the CWA across the country.  The decision has significant implications for the fate of the WOTUS Rule and how federal agencies review permit applications that may affect jurisdictional waters under the WOTUS Rule.  In particular, the numerous legal challenges to the WOTUS rule that were previously raised in district courts are likely to resume,  but pending resolution of those challenges, implementation of the WOTUS Rule—which expands federal control over several types of water bodies—would be legally permissible.

Background

In 2015, after a lengthy and controversial rulemaking process, the U.S. Environmental Protection Agency (“EPA”) and the U.S. Army Corps of Engineers (“Corps”) issued the WOTUS Rule.  Immediately after the WOTUS Rule was issued, the rule was challenged in multiple judicial forums, including federal district courts and appellate courts.   On October 9, 2015, the Sixth Circuit granted a stay of the WOTUS Rule, effective nationwide, pending the court’s resolution of the question of whether it had jurisdiction over the case.  In re EPA, 803 F.3d 804, 807 (6th Cir. 2015).  In February 2016, a three-judge panel of the Sixth Circuit determined that the courts of appeals, rather than district courts, had jurisdiction over the WOTUS Rule.  In re U.S. Dep’t of Def., U.S. EPA Final Rule: Clean Water Rule: Definition of Waters of U.S., 817 F.3d 261 (6th Cir. 2016).  On January 13, 2017, the U.S. Supreme Court agreed to resolve the jurisdictional question over which federal court should hear challenges to the WOTUS Rule.  Nat’l Ass’n of Mfrs. v. Dep’t of Def., 137 S.Ct. 811 (2017).

In its January 22, 2018 decision, the Supreme Court held that challenges to the WOTUS Rule belong at the district rather than appellate court level, overturning the Sixth Circuit’s decision.   The Supreme Court remanded the case to the Sixth Circuit, with instructions to dismiss the case. Once that dismissal occurs, the nationwide stay of the WOTUS Rule will be lifted and challenges to the WOTUS Rule in the district courts will resume.

Future Challenges to the 2015 WOTUS Rule

More than two dozen cases were previously filed challenging the WOTUS Rule.  Some district courts dismissed the pending lawsuits, concluding that the courts of appeals had exclusive jurisdiction over challenges to the WOTUS Rule.  See Murray Energy Corp. v. EPA, 2015 WL 5062506, *6 (N.D.W. Va. Aug. 26, 2015); Georgia v. McCarthy, 2015 WL 5092568, *3 (S.D. Ga. Aug. 27, 2015); Arizona Mining Association v. EPA, No. 15-01752 (D. Ariz. May 3, 2016); State of Ohio v. EPA, No. 2:15-cv-2467 (S.D. Ohio April 25, 2016); Washington Cattlemen’s Association et al. v. EPA, No. 0:15-cv-03058 (D. Minn. Nov. 8, 2016); Chamber of Commerce v. EPA, No. 4:15-cv-386 (N.D. Okla.).  These challenges could potentially be refiled in light of the Supreme Court’s decision.

The North Dakota Federal District Court held that it had jurisdiction to review the WOTUS Rule, and it granted a preliminary injunction against the implementation of the WOTUS Rule within those states that had participating in filing the case, including North Dakota, Alaska, Arizona, Arkansas, Colorado, Idaho, Missouri, Montana, Nebraska, Nevada, New Mexico, South Dakota, and Wyoming.  The court, however, stayed the case pending a decision by the Supreme Court.  State of North Dakota et al. v. EPA, No. 3:15-cv-59 (D.N.D. May 24, 2016).  Therefore, the conflict in that case remains live.  In addition, other district court cases remain pending or were administratively closed following the Sixth Circuit’s order holding in abeyance petitions for review of the WOTUS Rule.  Parties could, however, file to reopen proceedings after the Sixth Circuit terminates its abeyance and dismisses its WOTUS Rule case in light of the Supreme Court’s decision.

In the interim, implementation of the WOTUS Rule would be legally permissible, except in the 13 states that obtained an injunction against the rule in North Dakota v. EPA, No. 3:15-cv-00059 (D.N.D. Aug. 27, 2015).  However, in light of the Trump Administration’s ongoing rulemaking efforts discussed below, it is unlikely that staff at the Corps or the EPA will seek to implement the WOTUS Rule.

Ongoing Rulemaking Efforts

Implementation of the WOTUS Rule will remain in question even after the Sixth Circuit’s nationwide stay of the rule is lifted.  On July 27, 2017, in response to an executive order by the Trump Administration, the EPA and the Corps unveiled a proposed rule that, if adopted, would rescind the definition of the WOTUS Rule.  The first step proposes a rule that would “re-codify” the WOTUS definition that was in place prior to the 2015 WOTUS Rule, and has been in force since the District of North Dakota and the Sixth Circuit enjoined the 2015 WOTUS Rule.  In the second step in the rulemaking process, the EPA and the Corps will work on a new rulemaking that will re-evaluate the WOTUS definition.  Neither a final rule recodifying the pre-2015 WOTUS definition, nor a final rule that reevaluates the WOTUS definition, has been issued at this time.  A final rule recodifying the pre-2015 WOTUS definition may, however, be issued at any time.

In addition, on November 16, 2017, the EPA and the Corps unveiled a proposed rule to amend the effective date of the 2015 WOTUS Rule, proposing that the 2015 rule would not be applicable until two years after the action is finalized and published in the Federal Register.  82 Fed. Reg. 55542 (Nov. 22, 2017).  The purpose of this proposed rule is to allow the EPA and the Corps time to reconsider the definition of “waters of the United States” before the 2015 WOTUS Rule goes into effect.  Although the comment period on this proposed rule has closed, a final rule has not been issued.  Until the EPA and the Corps finalize the proposed rule recodifying the pre-2015 WOTUS definition or finalize a rule amending the effective date of the 2015 WOTUS Rule, the 2015 WOTUS Rule could be lawfully implemented in most states, although such a result is unlikely while the agencies’ rulemaking efforts are pending.

© 2018 Van Ness Feldman LLP

Bye, Bye Birdie: Summary and Analysis of the Trump Administration’s Recent Policy Change of the Migratory Bird Treaty Act

I. Background

Just over a month ago, on December 27, 2017, the United States Solicitor’s office issued a Memorandum Opinion reversing the Obama-era policy of interpreting the Migratory Bird Treaty Act (“MBTA”) to include “unintentional” or “incidental” takings of migratory birds. Under the new interpretation, the federal agencies under the Department of the Interior (or the “Department”) will no longer be able to threaten or impose criminal liability with respect to the MBTA for any activity which unintentionally or incidentally impacts migratory birds.

For nearly 20 years, federal agencies1 have used the threat of criminal prosecution under the MBTA as leverage to impose costly mitigation on any activities requiring NEPA compliance or some sort of permit from a federal agency. At the same time, because MBTA does have a meaningful “take permit” regime, refusing to commit that even with such costly mitigation such projects were protected from criminal liability. As a practical matter, these mitigation requirements have increased the costs of infrastructure development, renewable energy development, and mining projects which traverse federal lands or have a federal nexus such that agency approval of some sort is required.

With this policy change, the Trump Administration has removed the threat of federal prosecution. However, it stops short of alleviating the costly mitigation obligations because of the outstanding requirements of a 2001 Executive Order and the protections required with respect to companion federal statutes, such as the Endangered Species Act and the Bald and Golden Eagle Protection Act. As outlined herein, the Memorandum Opinion relieves some pressure but leaves federal agencies with tools to continue to impose costly mitigation requirements aimed at preventing “incidental” or “unintentional” takes of migratory birds. In other words, absent revocation of the 2001 Executive Order, the Memorandum Opinion is merely lip service with respect to reducing cost impediments to infrastructure development, renewable energy development, and mining projects which traverse federal lands or have a federal nexus such that agency approval of some sort is required.

II. What is an “M-Opinion” and What Does the December 27, 2017, M-Opinion Actually Accomplish?

Many environmental organizations have expressed dismay at the December 27, 2017, M-Opinion, claiming that it will lead to a “parade of horribles” with respect to migratory birds.2  

Ostensibly, some of the hyperbole is aimed at drumming up “rage donations.3 However, to understand the impact of the M-Opinion, one must first take the time to understand exactly what an M-Opinion can and does do and what it cannot and does not accomplish. Notably, the M-Opinion in question did not, and cannot, repeal and replace the 2001 Executive Order directing agencies to impose mitigation to impacts associated with intentional and unintentional takings of migratory birds. This simple, indisputable, fact obviates the fear mongering.

The Department of the Interior can communicate using many different methods, each of which requires different formalities before issuance and results in a different amount of influence and authority (e.g., regulations, policies, guidance, memoranda, directives, and opinions). Some agency publications are advisory, some are specifically tailored to a particular case, and others are intended to reach everyone affected by a federal statute overseen by the Department or the agencies thereunder. The “M-Opinion” is one of the latter.

An M-Opinion (a “Memorandum Opinion”) is a written opinion issued by the Solicitor for the Department of the Interior on a particular topic that constitutes the Department’s official legal interpretation on a matter within its jurisdiction. M-Opinions are binding on all other offices and divisions within the Department of the Interior. Once issued, an M-Opinion can only be withdrawn, overruled, or modified by the Solicitor, the Secretary of the Interior, or the Deputy Secretary.

The MBTA was enacted in 1916 to respond to the overwhelming amounts of hunting that were devastating migratory bird populations. It is codified at 16 U.S.C. § 703. Section (a) of the MBTA makes it a crime to, “at any time, by any means or in any manner, to pursue, hunt, take, capture, kill,” or attempt to do so to “any migratory bird, any part, nest, or egg of any such bird….” The U.S. Fish and Wildlife Service has defined “take” to mean “to pursue, hunt, shoot, wound, kill, trap, capture, or collect” or attempt to do so.

Violations of the MBTA are criminal offenses:  some misdemeanors, some felonies. Misdemeanor violations of the MBTA are “strict liability” offenses, which means that it does not matter whether the offender intended to violate the statute. So, if a hunter shoots a bird believing it to be nonmigratory, but it turns out to actually be migratory, his intent or belief is irrelevant. By taking a migratory bird, he committed a federal crime.

On its face, the MBTA might seem easy enough to follow: don’t hunt or kill migratory birds out of season. But look at the language again—the MBTA forbids killing a migratory bird “by any means or in any manner.” Does that language extend to migratory birds that die after landing in retention ponds meant to contain toxic waste? Or to the birds that run into windmills (killing approx. 174,000 birds/year) or buildings (303.5 million)? What if you hit a bird with your car (causing an estimated 200 million bird deaths/year)? If your cat kills a pigeon (which is migratory and, thus, falls under the MBTA), have you committed a federal crime? (Cats kill an estimated 2.4 billion birds/year). These sorts of activities which aren’t meant to kill birds, but do anyway, are referred to commonly as “incidental take” or “unintentional take.”

Prosecutors began filing criminal charges under the MBTA based on incidental take more than 40 years ago. The MBTA has been amended a few times since then, but incidental take was not directly addressed by the statute4. Interpretations differ. On the one hand, it seems extreme to impose criminal charges against the owner of an energy project, but on the other, the MBTA seems written to protect migratory birds and power lines kill an estimated 30 million birds each year. The text of the statute seems like it is aimed at hunting and poaching, but it also expands the scope to killing birds “by any means. Courts across the country have split as to whether incidental take can trigger strict liability.

In an effort to resolve the discrepancy, the Solicitor issued M-Opinion 37041 in January 2017, which affirmed that incidental take wasprohibited under the MBTA. That M-Opinion was suspended by the new Acting Secretary of the Interior in February 2017. Then on December 22, 2017, the Deputy Solicitor issued a new M-Opinion, M-37050, which withdraws and replaces the old opinion and decrees that the MBTA does not extend to incidental take.

When boiled down, the analysis in the new M-Opinion (hereinafter referred to simply at the “M-Opinion”) interprets the statute differently in four significant ways:

  • First, the M-Opinion affirms that a violative action must have some intent behind it to take or kill a bird, i.e. “purposeful and voluntary affirmative acts directed at reducing an animal to human control.” [p. 22]. Driving a car, erecting a windmill, or owning a cat are not actions designed to kill birds, even if it is likely or foreseeable that some birds will die. But shooting a gun, setting a trap, knocking down a nest, those are all acts with some intent behind them to kill or capture. The latter actions will have strict liability applied against them, but the former actions will not. The old opinion applied strict liability to all actions.
  • Second, the M-Opinion gives a different interpretation of the statutory language.5  The old opinion interpreted the relevant language to prohibit any activity that kills a bird “by any means, in any manner.” But the new M-Opinion declares that such a broad reading cannot have been what Congress intended. Instead, the “any means, any manner” language should be more narrowly applied only to intentional acts aimed at the bird. In other words, any means or manner of an intentional act aimed at a bird (e.g. guns, bows, air rifles, nets, lasers, or any other creative ways to take the bird) will violate the statute.
  • Third, the M-Opinion looked at the legislative history of the MBTA and concluded that the MBTA was only ever intended to regulate overhunting, not to protect bird habitats or control any action that might have an incidental impact on migratory birds.
  • Finally, the M-Opinion disagreed as to the effect of subsequent legislation on the MBTA. For example, the old opinion relied on the 2003 legislation that authorized any incidental take by the military. Why, it reasoned, would that manner of incidental take need an explicit authorization unless every other form of incidental take was not authorized under the MBTA? But the new M-Opinion says that the 2003 legislation was at best a precautionary measure that did not change the scope or language of the MBTA itself. The M-Opinion reasons that if Congress wanted to incorporate incidental take into the MBTA, it would do so directly and not by such a vague reverse inference.
    • Similarly, the M-Opinion explains that a 2001 Executive Order from President Clinton, which expanded the definition of “take” to include incidental take, was only part of a direction as to how agencies should focus their energies, not an attempt to expand the scope of the MBTA itself (nor could an executive order change the text of a Congressional law). [p. 32]

Ultimately, the M-Opinion comes back to the Constitution and a common sense rationale. Due process under the Constitution requires that we be able to reasonably understand whether an action we take would constitute a crime. But the Opinion reasons that if incidental take constituted a criminal act, no one could know whether or not they would commit a crime from day to day.  The scope of liability “is virtually unlimited.” [p. 33]. Even if they drove a car while obeying all traffic laws or built a building or power line in compliance with all of the relevant regulations, if doing so killed a bird they would have committed a crime punishable by imprisonment. Only the prosecutor’s discretion would keep that person from jail. The M-Opinion warns that such a broad interpretation of the MBTA would not be constitutional.

The M-Opinion concludes that including incidental take within the scope of the MBTA makes the statute vague to the point of absurdity. It points out that even if a developer completely complies with the Fish and Wildlife Service’s MBTA Guidelines, compliance with those guidelines does “not provide enforceable legal protections” based on that compliance and the developer may still be prosecuted should bird death occur. [p. 38-39]. It “is literally impossible” to know what is required under the law if the MBTA includes incidental take, and that does not comply with the Constitution’s guarantee of due process. Id.

III. “Bird is [still] the Word” ”—the M-Opinion Falls Short of Relieving Developers Required to Traverse Federal Lands or Secure a Permit or Approval from a Federal Agency from Mitigating Impacts Associated with “Unintentional” or “Incidental” Impact to Migratory Birds

Just because incidental take is not a criminal violation of the MBTA doesn’t mean that federal agencies will suddenly allow an incidental “open season” to occur. Those agencies will still work to minimize unintentional impacts to migratory birds. And those agencies will also still be required to analyze and approve the environmental impact of projects before they can be approved. Put simply, if the agency doesn’t believe that enough is being done to prevent incidental take, it can and will require the developer to employ mitigation measures even without the threat of criminal prosecution. If developers don’t comply, the agencies won’t issue the relevant permits or decisions needed for a particular project to proceed.

This reality is somewhat acknowledged by the M-Opinion’s discussion of the 2001 Executive Order. The Opinion distinguished the 2001 Clinton Executive Order (“EO-13186” or the “2001 Executive Order” or “Executive Order 13186”)as only providing internal guidance to federal agencies, not interpreting the MBTA. But that Executive Order remains in effect, thereby reducing the overall efficacy of the M-Opinion.

The scope of Executive Order 13186 includes “unintentional take,” and defines it as “take that results from, but is not the purpose of, the activity in question.” Section 2(c). The 2001 Executive Order required each federal agency to enter into a Memorandum of Understanding to define the term “action” with respect to each agencies responsibilities under the 2001 Executive Order and that “that shall promote the conservation of migratory bird populations.” 2001 Executive Order at Section 3.

Pursuant to EO-13186, in April 2010, the Bureau of Land Management and Fish and Wildlife Service entered into the MEMORANDUM OF UNDERSTANDING between the U.S. Department of the Interior Bureau of Land Management and the U. S. Fish and Wildlife Service To Promote the Conservation of Migratory Birds (the “BLM-FWS MOU”). The BLM-FWS MOU provides that BLM will, “[i]n coordination with the FWS, develop conservation measures and ensure monitoring of the effectiveness of conservation measures to minimize, reduce or avoid unintentional take.” Paragraph G. Paragraph I provides that the BLM will “[i]ntegrate migratory bird conservation measures, as applicable, into . . . renewable (wind, solar, and geothermal) energy development NEPA mitigation. This will address habitat loss and minimize negative impacts.” Additionally, the BLM-FWS MOU defines “Action” as “any action, permit, authorization, collaborative effort, program, activity, project, official policy, rule, regulation or formal plan directly carried out by the agency.” Paragraph IX. Finally, the BLM-FWS MOU defines “take” as “to pursue, hunt, shoot, wound, kill, trap, capture or collect or attempt to pursue, hunt, wound, kill, trap, capture or collect (50 CFR Section 10.12).” Paragraph IX. It goes on to note that the “Executive Order further defines take to include intentional take, meaning take that is the purpose of the activity in question, and unintentional take, meaning take that results from, but is not the purpose of, the activity in question.” Id. Finally, it states that “[b]oth intentional and unintentional take constitute take as defined by the regulation.” Id. Consequently, the BLM-FWS MOU makes clear that anybody seeking a federal permit or right-of-way from the BLM will be required to continue to integrate mitigation measures to address impacts to migratory birds, both intentional and unintentional/incidental impacts.7

Summarily, the M-Opinion clarifies that criminal liability for “taking” a migratory bird under the MBTA will not extend to the unintentional or incidental impacts to migratory birds. However, the M-Opinion fails to address the seemingly inconsistent definitions of “take” contained in the agency MOUs with FWS executed pursuant to the 2001 Executive Order. Ultimately, because of the 2001 Executive Order and the MOUs executed as a result therefrom, all the M-Opinion did was remove the threat of criminal prosecution from the quiver of arrows used by federal agencies to impose mitigation requirements. Removal of the threat of criminal prosecution may allow project proponents to have more candid discussions regarding mitigation without the fear and threat of federal criminal prosecution. But federal agencies can (and likely will) still condition approvals and permits on the inclusion of the same panoply of mitigation requirements it always has, at the same cost.

The M-Opinion should be further amended to reconcile the inconsistency between its interpretation of the MBTA and the definition of “take” under the MBTA contained in the 2001 Executive Order and the agency MOU executed pursuant thereto. Absent such a clarification, there will continue to be confusion as to the scope of the MBTA with respect to whether a federal agency can require costly mitigation of incidental or unintentional impacts associated with infrastructure development, renewable energy development, and mining projects which traverse federal lands or have a federal nexus such that agency approval of some sort is required.

References:

1 As used herein, “federal agency” or “federal agencies” shall only include those federal agencies under the Department of the Interior.
See e.g. http://www.audubon.org/news/the-white-house-turns-its-back-americas-birds (last visited January 26, 2018).
3 https://www.npr.org/2017/03/26/520854771/the-resistance-faces-a-new-question-what-to-do-with-all-that-money (last visited January 26, 2018); https://www.gq.com/story/the-rise-of-the-rage-donation (last visited January 26, 2018)
4 Congress did, however, adopt a regulation in 2003 that authorizes the incidental take of migratory birds during military training exercises.  50 C.F.R. § 21.15.
5 Bear in mind that section (a) of the statute is a single sentence containing 230 words. The question of whether and how a single clause should apply to another clause within that sentence can make a significant difference in statutory interpretation.
6 Executive Order 13186 is available online at https://energy.gov/sites/prod/files/nepapub/nepa_documents/RedDont/Req-EO13186migratorybirds.pdf (last visited January 29, 2018)
7 The M-Opinion applies to all agencies under the Department of the Interior, which can be found online at: https://www.usa.gov/federal-agencies/u-s-department-of-the-interior (last visited January 29, 2018).  The other agencies have MOUs that likewise define “take” under the MBTA to include incidental or unintentional impacts to migratory birds.  See e.g. Bureau of Reclamation and FWS MOU, https://energy.gov/sites/prod/files/2013/10/f3/Final%20signed%20MOU%20-%20Migratory%20Birds_0.pdf (last visited January 29, 2018) (“Executive Order 13186 further defines take to include intentional take, meaning take that is the purpose of the activity in question, and unintentional (or incidental) take, meaning take that results from, but is not the purpose of the activity in question.  Both intentional and unintentional take constitute take as defined by the MBTA.”); National Park Service and FWS MOU, https://www.nature.nps.gov/biology/migratoryspecies/documents/MBMOUNPSSigned041210.pdf (last visited January 29, 2018) (“Executive Order 13186 further defines take to include intentional take, meaning take that is the purpose of the activity in question, and unintentional (or incidental) take, meaning take that results from, but is not the purpose of the activity in question. Both intentional and unintentional take constitute take as defined by the MBTA.”); Office of Surface Mining, Reclamation and Enforcement and FWS MOU, https://www.osmre.gov/lrg/docs/2016_MOU_Migratory_Bird_Conservation.pdf (last visited January 29, 2018) (“Executive Order 13186 further defines take to include intentional take, meaning take that is the purpose of the activity in question, and unintentional (or incidental) take, meaning take that results from, but is not the purpose of the activity in question. Both intentional and unintentional take constitute take as defined by the MBTA.”).

Copyright © 2018 Ryley Carlock & Applewhite. A Professional Association. All Rights Reserved.
This post was written by Jason Cassidy and Samuel Lee Lofland of Ryley Carlock & Applewhite.
More environmental news is available on the National Law Review’s Environmental Law page.

Trump Administration Releases Framework for Immigration Deal

The Trump Administration has released a new framework containing components of proposed immigration reform.

Not surprisingly, border security is at the top of the list and includes the following components:

  • New $25 billion trust fund for the (southern) border wall system
  • Funds for hiring more enforcement personnel
  • Immigration court reforms
  • Ending the “catch-and-release” policy and establishing an emphasis on the prompt removal of illegal border crossers
  • Ensuring the removal of criminal aliens, gang members, violent offenders and aggravated felons
  • Expedited removal for visa overstays

Legalization for DACA recipients and other DACA-eligible illegal immigrants is next:

  • Increase in the number of eligible individuals to 1.8 million (from 800,000)
  • Provision of a 10-12 year path to citizenship

Ending so-called “Chain Migration”:

  • Limit family sponsorship to spouses and minor children for U.S. citizens and Legal Permanent Resident sponsors
  • Exclude parents and other non-nuclear family members from sponsorship

Ending the Diversity Visa Lottery:

  • Reallocate the 50,000 diversity lottery visas to the family-based and employment-based backlogs. As of November 1, 2017, there were approximately 4 million applicants waiting for green cards, 112,000 are employment-based applicants.

This framework increases the number of “DACA-like” recipients but is otherwise similar to the principles that the Administration offered in October 2017 in exchange for DACA relief. The new proposal, however, does not include all of the earlier proposals such as requiring the use of E-Verify and eliminating federal aid to sanctuary cities.

It is reported that the Administration believes this framework could reach 60 votes in the Senate although its fate in the House is likely more uncertain. Due to the Administration’s DACA rescission in September 2017, Congress has only until March 2018 to find a solution for the future of the “Dreamers.”  More details about the framework are expected from the Administration soon.

Jackson Lewis P.C. © 2018
This post was written by Forrest G. Read IV of Jackson Lewis P.C.
Read more immigration news at the National Law Review’s Immigration page.

Reduction in U.S. Corporate Tax Rates Will Significantly Impact Outbound Tax Planning by U.S. Individuals

The Tax Cuts and Jobs Act (“TCJA”) represents the most significant tax reform package enacted since 1986. Included in this reform are a number of crucial changes to existing international tax provisions.  While many of these international changes relate directly to U.S. corporations doing business outside the United States, they nevertheless will have a substantial impact on U.S. individuals with the same overseas activities or assets.

One notable change under the new law was the reduction of the maximum U.S. corporate income tax rate from 35% to 21%. Not surprisingly, this change will have a corresponding impact on the ability of U.S. shareholders (both corporations and individuals) of controlled foreign corporations (“CFCs”) to qualify for the Section 954(b)(4) “high-tax exception” from Subpart F income.  This is because the effective foreign tax rate imposed on a CFC that is needed to qualify for this purpose must be greater than 90% of the U.S. corporate tax rate.  Therefore, this exception now will be available when the effective rate of foreign tax is greater than 18.9% (as opposed to 31.5% under prior law).

In addition to the reduction in corporate tax rates, the TCJA includes a partial shift from a worldwide system of taxing such U.S. corporate taxpayers to a semi-territorial system of taxation.  This “territorial” taxation is achieved through the creation of a dividends received deduction (“DRD”) for such domestic corporate taxpayers under Section 245A.[1]  This provision will allow a U.S. C corporation to deduct the “foreign-source portion” of any dividends it receives from a 10%-or-more-owned foreign corporation (other than a PFIC), as long as the recipient has owned the stock of the payor for more than one year during the prior two year period.  Assuming the foreign payor has no income that is effectively connected to a U.S. trade or business (“ECI”) and no dividend income from an 80%-owned U.S. subsidiary, the entire dividend generally will be exempt from U.S. federal income tax under this provision.[2]  In a corresponding change to Section 1248, when the relevant stock of a CFC is sold or exchanged, any amount of gain that is recharacterized as a dividend to a corporate U.S. shareholder under Section 1248 also is eligible for this DRD assuming the stock has been held for at least one year.

Despite these shifts toward partial territoriality, the new law retains the Subpart F rules that apply to tax currently certain income earned by CFCs (i.e., foreign corporations that are more than 50% owned by 10% U.S. shareholders (under the new law, both the 10% and 50% standards are measured by reference to either vote or value), as well as introducing a new category of income puzzlingly called “global intangible low-taxed income” (GILTI), though it has almost nothing to do with income from intangibles.[3]  GILTI will include nearly all income of a CFC other than ECI, Subpart F income (including Subpart F income that is excludible under the Section 954 (b)(4) high-tax exception), or income of taxpayers with very significant tangible depreciable property used in a trade or business.

The GILTI tax, imposed under Section 951A, applies to U.S. shareholders (both corporate and individual) of CFCs at ordinary income tax rates. Accordingly, U.S. individual shareholders of CFC typically will be subject to tax on GILTI inclusions at a 37% rate (the new maximum individual U.S. federal income tax rate).   U.S. C corporations that are shareholders of CFCs, on the other hand, are entitled under new Section 250 to deduct 50% of the GILTI inclusion, resulting in a 10.5% effective tax rate on such income.  Additionally, such corporate shareholders are permitted to claim foreign tax credits for 80% of the foreign taxes paid by the CFC that are attributable to the relevant GILTI inclusion.  Accounting for the 50% deduction and foreign tax credits, if any, a corporate U.S. shareholder’s GILTI inclusion that is subject to a rate of foreign income tax of at least 13.125% should result in no further U.S. federal income tax being due.[4]

In addition to the above GILTI provisions, Section 250 also permits U.S. corporations to deduct 37.5% of “foreign-derived intangible income” (FDII), resulting in an effective U.S. federal income tax rate of 13.125% on such income. FDII is the portion of the U.S. corporation’s net income (other than GILTI and certain other income) that exceeds a 10% rate of return on the U.S. corporation’s tangible depreciable business assets and is attributable to certain sales of property (including leases and licenses) to foreign persons or to the provision of certain services to any person located outside the United States.

Impact on Individual U.S. Taxpayers

While the TCJA substantially reduced the top U.S. corporate tax rate from 35% to 21%, individual U.S. income tax rates were not materially altered (i.e., the maximum individual U.S. federal income tax rate was reduced from 39.6% to 37%).  Nevertheless, the reductions in corporate tax rates and other relevant entity-level changes should be expected to have a dramatic impact on outbound U.S. tax planning for individual shareholders of CFCs.

Planning Using Section 962

Section 962, which has been a part of the Code since 1962, allows an individual (or trust or estate) U.S. shareholder of a CFC to elect to be subject to corporate income tax rates on amounts which are included in income under Section 951(a) (i.e., subpart F inclusions and amounts included under Section 956). The purpose behind this provision is

…to avoid what might otherwise be a hardship in taxing a U.S. individual at high bracket rates with respect to earnings in a foreign corporation which he does not receive. This provision gives such individuals assurance that their tax burdens, with respect to these undistributed foreign earnings, will be no heavier than they would have been had they invested in an American corporation doing business abroad.[5] (emphasis added).

The U.S. federal income tax consequences of a U.S. individual making a Section 962 election are as follows. First, the individual is taxed on amounts included in his gross income under Section 951(a) at corporate tax rates. Second, the individual is entitled to a deemed-paid foreign tax credit under Section 960 as if the individual were a domestic corporation. Third, when an actual distribution of earnings is made of amounts that have already been included in the gross income of a U.S. shareholder under Section 951(a), the earnings are included in gross income again to the extent they exceed the amount of U.S. income tax paid at the time of the Section 962 election.[6]

Historically, elections under Section 962 were made infrequently. Under the new law, however, this is likely to change as such elections will have much more significance to many more U.S. individual shareholders of CFCs.  As noted above, the new GILTI provisions will cause U.S. individual shareholders of CFCs to be subject to U.S. federal income tax at a 37% rate on a new category of income, which will be taxed in the same manner as Subpart F income (including with respect to eligibility to make a Section 962 election as to such income).[7]

The lower 21% corporate income tax rate under the new law coupled with the inability of individual shareholders to claim indirect foreign tax credits under Section 960 mean that, in some cases, U.S. individuals investing in CFCs through U.S. corporations will be better off from a tax perspective under the TCJA than U.S. individual shareholders making such investments in CFCs directly. For this reason, individual U.S. shareholders should consider whether it is beneficial to make Section 962 elections going forward, which would allow them to claim indirect foreign tax credits on any amounts included under subpart F, as well as under the GILTI provisions.[8]

Some of the unanswered questions facing taxpayers in this context are, first, whether individuals owning their CFC interests through S corporations or partnerships may make a Section 962 election at all. The IRS previously refused to issue a requested private letter ruling confirming the availability of the election in such cases,[9] though it appears based on informal discussions with Treasury and IRS officials as well as a footnote in the legislative history to Section 965 that the IRS may have since adopted a different view.[10]

Another issue that is not clear is whether an individual U.S. shareholder who makes a Section 962 election is eligible to claim the 50% GILTI deduction under Section 250 (which would have the effect of reducing the effective U.S. tax rate on such income to 10.5%). Based on the clear intent behind Section 962, which is to ensure that an individual U.S. shareholder who has an inclusion under Subpart F (including for this purpose, inclusions under Section 951(A) is subject to tax under Section 11 as if the shareholder invested abroad through a U.S. C corporation, such deduction should be allowed.  The IRS seems to have agreed with this logic in FSA 200247033, when it cited to the legislative history behind Section 962 and calculated the tax on a U.S. individual shareholder who made a Section 962 election as if the taxpayer actually invested through a separate U.S. C corporation doing business abroad.  The IRS noted that “…section 962 was enacted to relieve a U.S. individual shareholder of a CFC from a hardship that might otherwise result from a section 951(a) inclusion by ensuring that the tax burden for such individual would be ‘no heavier’ than it would be if the individual had instead invested in a U.S. corporation doing business abroad. If the amount included in income under Section 951(a) were derived by a taxpayer’s domestic corporation, such amount would have been subject to tax at the applicable corporate rates.” It also should be pointed out that while the regulations under Section 962 specifically state that the hypothetical corporate taxpayer may not reduce its taxable income by any deductions of the U.S. shareholder[11] the regulations make no mention of any prohibition against corporate level deductions, such as the 50% GILTI deduction allowable under Section 250 (emphasis added).

Finally, a third potential issue that may arise in this context is the tax characterization of an actual distribution of earnings and profits that were previously included in the U.S. shareholder’s gross income under Section 951(a). This issue arises whenever the CFC is located in a non-treaty jurisdiction, such that dividends paid by such a CFC could not qualify for the reduced “qualified dividend” rate under Section 1(h)(11).  When an actual distribution is made from such a company, the question is whether the distribution should be treated as coming from the CFC (and therefore be classified as ordinary income), or instead as coming from the deemed C corporation created by the Section 962 election (and thus be classified as qualified dividends). As explained above, the objective behind Section 962 is to tax the individual U.S. shareholder in the same amount that she would have been taxed had the investment in the CFC been made through a domestic C corporation. To achieve this objective and avoid exposing the shareholder to a significantly higher rate of tax in the United States, where962 election is in place, any distribution of earnings and profits by the CFC must be treated as coming from a domestic C corporation.  This issue is currently pending in the United States Tax Court.

Impact Under Section 1248(b)

Another outbound provision that should become more relevant to U.S. individual shareholders of CFCs is the limitation imposed under Section 1248(b) when a U.S. shareholder, directly or indirectly, sells the shares of a CFC. Under Section 1248(a), gain recognized on a U.S. shareholders’ disposition of stock in a CFC is treated as dividend income to the extent of the relevant earnings and profits accumulated while such person held the stock.  Significantly, where the U.S. seller is a C corporation, under the new quasi-territorial system, this conversion of gain into a dividend triggers an exemption from tax pursuant to the Section 245A dividends received deduction.

With respect to individual U.S. shareholders who sell stock in a CFC, recharacterization under Section 1248(a) also remains significant due to the rate differential between the taxation of qualified dividends and long-term capital gains (which are subject to a maximum federal income tax rate of 23.8% under Section 1(h)(11)), and non-qualified dividends (which are subject to a maximum federal income tax rate of 40.8%).

Section 1248(b), however, provides for a ceiling on the tax liability that may be imposed on the shareholder receiving a Section 1248(a) dividend if the taxpayer is an individual and the stock disposed of has been held for more than one year. The Section 1248(b) ceiling consists of the sum of two amounts.  The first amount is the U.S. income tax that the CFC would have paid if the CFC had been taxed as a domestic corporation, after permitting a credit for all foreign and U.S. tax actually paid by the CFC on the same income (the “hypothetical corporate tax”).  For example, assume a Cayman Islands CFC has $100 of income and pays $0 of foreign taxes.  Also assume the Cayman CFC would be in the 21% income tax bracket for U.S. federal income tax purposes under Section 11 based on its taxable income levels if it were a domestic corporation.  In this case, the hypothetical corporate tax would be $21 ($21 U.S. tax minus $0 of foreign tax credits).

The second amount is the addition to the taxpayer’s U.S. federal income tax for the year that results from including in gross income as long-term capital gain an amount equal to the excess of the Section 1248(a) amount over the hypothetical corporate tax (the “hypothetical shareholder tax”). Continuing with the same example and assuming the shareholder’s gain on the sale is $100, this hypothetical shareholder tax would be 23.8% of $79 ($100 Section 1248(a) amount less the hypothetical corporate tax of $21), or $18.80.

Adding together the hypothetical corporate tax and the hypothetical shareholder tax in this example thus yields $39.80 in U.S. tax on the $100 gain, for an effective tax rate of 39.8%. Given that the CFC in this example is not resident in a treaty country (i.e., the United States does not have an income tax treaty with the Cayman Islands), the amount of gain that is recharacterized as a dividend under Section 1248(a) (i.e., $100) would be taxable at a maximum federal rate of 40.80%, resulting in $40.80 of tax. Because this is greater than the Section 1248(b) ceiling of $39.80, the ceiling will apply, and the U.S. shareholder will pay U.S. tax of $39.80.  As a consequence of the significant reduction in U.S. corporate tax rates, it appears that the Section 1248(b) limitation will now always yield a lower effective tax than the tax that would be imposed under Section 1248(a).  While this may seem somewhat odd, it makes sense given that the U.S. corporate tax rate (which the hypothetical corporate tax rate is based on) was reduced from 35% to just 21%.

As illustrated in the above example, going forward, even where no foreign corporate income taxes are paid, the Section 1248(b) limitation will result in a lower tax liability than the tax that would be imposed under Section 1248(a). As the foreign tax burden increases, the Section 1248(b) limitation becomes more significant.  In fact, as long as the foreign corporate tax rate is at least 21%, the Section 1248(b) limitation will yield an effective tax rate of 23.8%, which is equal to the maximum individual U.S. federal income tax rate on qualified dividends.  Therefore, if a U.S. individual shareholder sells shares of stock in a CFC that is tax resident, for example, in Ecuador (a non-treaty country which currently has a corporate tax rate of 22%), the effective tax rate imposed on such shareholder based on the Section 1248(b) limitation will be the same as if the CFC were resident in a treaty country.

Even more interesting is the fact that it would appear to be possible to qualify for the reduced qualified dividend rates caused by the Section 1248(b) limitation even in situations where the foreign tax rate is less than 21%. This is due to the ability of such shareholders to take deductions for purposes of the hypothetical U.S. tax computations that may not be available under relevant foreign law. At least one federal court has confronted this issue. In Hoover v. the United States,[12] for purposes of determining the amount of corporate taxes that would have been paid if the CFC had been a domestic corporation, the U.S. District Court for the Central District of California allowed the hypothetical corporation to claim the former deduction available under Section 922 for Western Hemisphere Trade Corporations. This special deduction is available only to domestic corporations all of the business of which was conducted in North, Central, or South America, or in the West Indies, if, among other items, at least 95 percent of the company’s gross income was derived from foreign sources during a three-year testing period.  Clearly this deduction is not available for U.S. federal income tax purposes when computing the earnings and profits of a CFC, so it is noteworthy that the court allowed the taxpayer in Hoover to claim this special deduction in calculating the hypothetical corporate tax under Section 1248(b).

While the Section 922 deduction for Western Hemisphere Trade Corporations no longer exists, other relevant provisions are available that may provide a benefit to U.S. taxpayers in calculating the hypothetical corporate tax under Section 1248(b). For example, as noted above, Section 250 now provides a 37.5% deduction on FDII. This provision could provide a major income tax benefit to a U.S. taxpayer that owns a CFC that sells goods or provides services to non-U.S. persons when calculating the hypothetical corporate income tax under Section 1248(b).  This results from the fact that FDII is subject to an effective corporate tax rate of only 13.125% (which is much lower than the current 21% corporate tax rate).

Conclusion

As illustrated above, despite the negligible reduction of maximum U.S. individual tax rates from 39.6% to 37%, individual shareholders of CFCs nevertheless will benefit greatly from the more significant reduction in U.S. corporate tax rates. While there are a number of unanswered questions relating to the interaction between Section 962, GILTI, and qualified dividends, direct or indirect U.S. individual shareholders of CFCs now, more than ever, should seriously consider the impact of making a Section 962 election, especially where the CFC is tax resident in a treaty country and/or is subject to a relatively high rate of tax.


[1] All Section references are to the Internal Revenue Code of 1986, as amended (the “Code”), and the Treasury Regulations promulgated under the Code.

[2] No foreign tax credits are permitted as to such dividends for which a foreign-source DRD is allowed.

[3] Unlike subpart F inclusions, there is no high-tax exception to GILTI inclusions under Section 951A. Instead subpart F income that is excluded from a U.S. shareholder’s gross income under the Section 954(b)(4) high-tax exception also is excluded from the GILTI provisions.  Query whether it makes sense to cause certain non-subpart F income that is otherwise subject to an effective foreign tax rate greater than 18.9% to be recharacterized as subpart F income in order to avoid GILTI (e.g., by creating a related party transaction).

[4] For tax years after 2025, the deduction is scheduled to decrease from 50% to 37.5%, resulting in an effective tax rate of 13.125% rather than 10.5% assuming corporate rates remain capped at 21%.

[5] S. Rep. No. 1881, 87th Cong., 2d Sess. (1962), reprinted at 1962-3 C.B. at 798.

[6] Section 962(d); Treas. Reg. Section 1.962-3. The most obvious reason why a taxpayer would choose to make a Section 962 election is the ability to defer the U.S. federal income tax on the actual distribution from the CFC, as well as the possibility of obtaining “qualified” dividends under Section 1(h)(11) on the subsequent distribution.

[7] Section 951A(f)(1)(A).

[8] Section 951A(f)(1)(A). See also TCJA Conference report at p. 517

[9] See Rubinger and LePree, “IRS Takes Flawed Approach to Inclusion under Subpart F,” Tax Notes, v.123, no.7, 2009 May 18, p.903-910.

[10] Section 965(a) imposes a one-time deemed repatriation tax on any deferred earnings of certain “specified foreign corporations.” This tax applies to C corporations as well as U.S. individual shareholders of these corporations.  A Section 962 election also may be useful when calculating the tax due under Section 965 for an individual.

[11] Treas. Reg. Section 1.962-1(b)(1)(i).

[12] Hoover v. United States, 348 F. Supp. 502, 504 (CD Cal. 1972).

© 2018 Bilzin Sumberg Baena Price & Axelrod LLP

DOJ Limits Use of Agency Guidance Documents in Affirmative Civil Enforcement Cases

US Department of Justice litigators may no longer rely on guidance documents issued by federal agencies as binding on regulated entities for the purposes of affirmative civil enforcement litigation. The Department also specifies in a memorandum that such guidance documents cannot create any legal obligations for regulated entities.

The US Associate Attorney General, the third-ranking official within the Department of Justice (DOJ or Department), issued a memorandum on January 25 that prohibits DOJ litigators from treating any agency guidance document as “presumptively or conclusively establishing that a party violated [an] applicable statute or regulation.”[1] Given DOJ’s wide-ranging role in bringing civil enforcement matters, including but not limited to healthcare, environmental, tax, civil rights, and labor matters, this directive could have far-reaching implications.

Federal agencies routinely issue “guidance documents,” which the issuing agency then later suggests should be regarded as binding on the entities those agencies regulate. Agencies will often claim a regulated entity violated a regulation or statute because it violated a guidance document, even though the underlying regulation may be highly ambiguous or silent on the particular regulatory question at issue. In turn, many regulated parties have long felt that this practice of relying on guidance documents produces de facto expansion of regulatory burdens without the accountability of notice and comment rulemaking, an impact felt across a multitude of industries: energy, healthcare, finance, tax, and many others. Regulated entities have had to fear litigation for violating these documents, not simply for violating the actual regulatory and statutory texts.[2]

But the DOJ memorandum now clearly forbids Department litigators from relying on these guidance documents as binding rules for purposes of civil enforcement litigation. Noncompliance with a guidance document—short of independent proof of noncompliance with the underlying lawful regulation or statute itself—will no longer be relied upon as supporting an enforcement action. The memorandum is especially clear on this point: agency guidance documents cannot create any additional legal obligations.

IMPORTANT IMPLICATION OF DOJ MEMORANDUM

The memorandum provides needed relief for the regulated community. First and foremost, for affirmative civil enforcement cases brought in federal court—where DOJ and not the administrative agency itself brings the enforcement action—DOJ will assess, and will force the regulating agency to assess as part of enlisting DOJ to bring the case, whether the case can stand on its own without the benefit of guidance documents. In turn, that assessment will provide new arguments and leverage to those facing threatened actions or actually involved in litigation, and will remove a potential source of evidence and argument for DOJ regarding what a law or regulation requires.[3]

FURTHER CONSIDERATIONS

Strictly speaking the memorandum does not apply to administrative cases that an agency handles through its internal administrative law courts and where DOJ is not involved, or to cases involving independent agencies with federal court litigating authority independent of DOJ. When an agency brings a lawsuit in an administrative law court, or an independent agency (such as the Securities and Exchange Commission, Federal Energy Regulatory Commission, or Nuclear Regulatory Commission) brings enforcement litigation itself, DOJ litigators may not be involved. Thus, it is at least possible such other agencies may continue to accept that the violation of a guidance document necessarily indicates the underlying regulation or statute has also been violated.

On the other hand, while not formally restricting such agencies, the memorandum still may have effects on independent agency litigation by, for example, pressuring the agency litigators to treat guidance documents the same way the DOJ treats them. It would be odd indeed if administrative agency litigators in front of an administrative law judge treated a guidance document as binding, only to have DOJ litigators treat the same document as representing no binding or even presumptive legal obligation on appeal to a federal district court if the agency’s administrative judgment were later challenged. More broadly, DOJ’s leading role in formulating and announcing executive branch legal positions may pressure other agencies with independent litigating authority to take a similar step. Any and all such developments should prove useful in negotiations between regulated entities and independent agencies regarding potential enforcement actions.

Finally, the memorandum does not on its face prohibit a regulated entity from relying on guidance documents that may be favorable to the regulated entity and on which it has relied to shape its actions. Thus, regulated entities may be able to continue using guidance documents for legal defense, even where DOJ cannot use the documents offensively to establish a legal violation.

PART OF A PATTERN

DOJ’s January 25 memorandum fits within a broader Trump administration initiative to scale back what many argue is an economically oppressive and intolerably wasteful regulatory regime.

On January 30, 2017, less than a month into office, President Donald Trump issued Executive Order 13771, or what is now commonly known as the “One-in, Two-out” rule, which requires an agency to eliminate at least two existing regulations for every new regulation or significant regulatory action that must be submitted for review to the Office of Information and Regulatory Affairs within the Office of Management and Budget. In addition, the net incremental cost of the aggregate regulatory action must be neutral for 2017 and for some fixed amount annually thereafter. Executive Order 13777, issued February 24, 2017, went a step further, requiring agencies to establish “Regulatory Reform Task Forces” dedicated to evaluating existing regulations to make recommendations “regarding their repeal, replacement, or modification.” The Trump administration has called the first year of this initiative to deregulate a great success, noting a promulgation-to-elimination ratio of 22–1, or 67 deregulatory actions and only three regulatory actions. Those agencies claiming to have been most active include the Environmental Protection Agency and the Departments of Interior, Commerce, Health and Human Services, and Labor.

CONCLUSION

This development changes the playing field for regulated parties, giving them greater opportunity to push back against enforcement theories that largely rely on a “clear” guidance document regarding an underlying ambiguous or silent regulation or statute.


[1] Memorandum from the Associate Attorney General to the Heads of Civil Litigating Components, United States Attorneys, Regarding Limiting Use of Agency Guidance Documents in Affirmative Civil Enforcement Cases (Jan. 25, 2018).

[2] Id.

[3] DOJ attorneys may continue to use these documents, however, as evidence that a party read a document that merely explains legal mandates existing in statutes or regulations to prove the party had knowledge of the mandates. 

Copyright © 2018 by Morgan, Lewis & Bockius LLP. All Rights Reserved.
This article was written by Ronald J. Tenpas of Morgan, Lewis & Bockius LLP

Got the Message: PTAB Doesn’t Have to Construe Claim Term

The US Court of Appeals for the Federal Circuit affirmed a Patent Trial and Appeal Board (PTAB) decision, finding that the PTAB did not need to explicitly construe a claim term. HTC Corp. v. Cellular Communications Equipment, LLC, Case No. 16-1880 (Fed. Cir., Dec. 18, 2017) (Reyna, J).

Cellular Communications owns a patent directed to a communications system where the mobile device is assigned a plurality of codes for transmitting messages. When transmission conditions deteriorate, such as when there is a high amount of interference, the base station may command the mobile device to increase transmit power in order to send the message. To avoid operating at maximum transmission power, the patent’s claimed solution sets a “transmit power difference” for the plurality of codes in the mobile device at the start of a message transmission. Setting this transmit power difference allows the mobile device to increase transmit power to overcome interference and avoid aborting the message transmission.

HTC and ZTE filed inter partes review (IPR) petitions challenging several claims in Cellular Communications’ patent. The PTAB instituted IPR on three grounds:

  • Anticipation by Baker
  • Obviousness over Reed in view of Baker
  • Obviousness over Reed in view of Love

Ultimately, the PTAB issued a final written decision concluding that HTC failed to show that any of the challenged claims were unpatentable. HTC appealed.

On appeal, HTC argued that the PTAB failed to construe the term “message” according to its broadest reasonable construction. Specifically, HTC argued that the PTAB’s application of the term improperly excluded single frame EDCH messages, which were an embodiment disclosed in the specification of the challenged patent. The Federal Circuit rejected HTC’s argument and found that while neither the parties nor the PTAB explicitly construed the term “message,” the PTAB agreed in its analysis that a message transmission can occur over a single frame or over multiple frames, and thus properly understood “message” to encompass EDCH messages that last a single frame.

HTC also argued that the PTAB’s anticipation and obviousness findings were not supported by substantial evidence. However, the Federal Circuit rejected HTC’s argument, finding that the PTAB’s decision was supported by substantial evidence from the prior art references, expert declarations and admissions from HTC’s witnesses. The Court thus affirmed the PTAB’s finding of patentability.

© 2018 McDermott Will & Emery
This article was written by Amol Parikh of McDermott Will & Emery

New Ohio Court Ruling Tackles Issues Critical to Lessees

Another significant oil and gas law decision has recently been published out of the Ohio Seventh District Court of Appeals. In the case of Hogue v. Whitacre, 2017-Ohio-9377, released on December 22, 2017, the Seventh District addressed two important issues.  First the Court concluded that indirect costs such as costs of accounting, interest, postage, office supplies, telephone charges, and depreciation of office equipment are to be excluded in determining whether a well is producing in paying quantities while royalties, gas severance tax, maintenance, and operating costs directly relating to production of oil and gas are direct costs and will be considered.  On the second issue, dealing with temporary cessation of production, the Court considered mechanical issues of an off-lease third party’s facilities as the cause of the temporary cessation, and evaluated the reasonableness of the lessee’s actions in response to that event, rather than limiting a consideration of temporary cessation to mechanical issues only as to the well or lease as is the case in some jurisdictions.

In Hogue, the lessors asserted that the well on the lease entered into in 2006, had failed to produce in paying quantities during the period of 2014 to 2015. Production records showed that the well produced a profit in excess of $1,000 per year from 2006 to 2012, a small profit in 2013, a small loss in 2014 and 2015, and a profit of over $1,000 a year after that. During the time period of the loss, the well was shut in or had minimal production due to the shutdown of the third party transporter’s compressor station for repair and replacement. The trial court ruled for the well operator on consideration of cross motions for summary judgment.

On appeal, the lessors argued that cost exhibits provided by lessee should not have been considered and that certain indirect costs of operation were improperly excluded from the exhibits as prepared by the operator. The Seventh District, in reviewing the content of the exhibits, concluded that, in a determination of paying quantities in Ohio, only direct costs of operation of the well or wells in dispute should be considered and not indirect costs. The Court cited the recent decision of Paulus v. Beck Energy Corporation, 7th Dist. No. 16 MO 0008-2017-Ohio-5716 regarding the consideration of direct costs but acknowledged that there is no prior Ohio case law addressing what would be considered indirect costs,. In its decision, the Court included royalties, gas severance tax, maintenance, and operating costs directly relating to production of oil and gas as direct costs to be considered and refused to consider administrative overhead costs. Citing Mason v. Ladd Petroleum 1981 OK 73, 630 P. 2d 1283 (OK 1981),  the Court characterized charges such as costs of accounting, interest, postage, office supplies, telephone charges, and depreciation of office equipment as examples of general administrative charges which are indirect costs, not to be considered in a production in paying quantities analysis.

On the issue of whether a cessation of production from January 2014 to November 2015 resulted in termination of the lease as asserted by the lessors, the Court affirmed the ruling below, concluding that the cessation was the result of the compressor outage of the third party who transported the gas from the lease. The Court further held that the lessee acted reasonably in keeping the well shut in, even though other operators on the third party system produced small amounts of gas during the repair period. The Court noted that while there is no bright line rule in Ohio, no cases in Ohio have found a lease to be forfeited for lack of production for a cessation of less than two years. In addition, the Court noted that the lessee undertook to construct his own compressor on the lease during the shut in and that the third party repairs and the lessee-constructed compressor restored the lease to full production after November 2015. The Court’s conclusion regarding temporary cessation is noteworthy in considering the mechanical issues of an off-lease third party’s facilities as the cause of the temporary cessation, and in evaluating the reasonableness of the lessee’s actions in response to that event, rather than limiting a consideration of temporary cessation to mechanical issues of the well or lease as is the case in some jurisdictions.

© Steptoe & Johnson PLLC. All Rights Reserved.
This article was written by J Kevin West and R. Neal Pierce of Steptoe & Johnson PLLC