By Sabrina Canfield, Courthouse News Service

 WASHINGTON (CN) - The Department of Interior has authority to demand repayment of gas and oil revenues it overpaid to Alabama and Louisiana under an old and faulty revenue sharing scheme going back to 1986, a federal judge ruled.

However, the department violated the Debt Collection Act (pdf) in its letters to states demanding refund of overpayments by not offering the states an opportunity to "inspect and copy" its records, U.S. District Judge Reggie Walton held.

Louisiana and Alabama challenged federal rules for profit sharing of oil and gas revenue after the federal government changed its approach to profit allocation and demanded the return of overpayments identified while implementing the new allocation regime.

Judge Walton found the Interior Department can change its mind about how revenue sharing is allocated at anytime, and that when it does, it can demand overpayments that were made according to the old system.

Under the Outer Continental Shelf Lands Act (pdf), first passed in 1953, eligible coastal states receive 27 percent of the revenue generated from offshore leases within the first three-mile stretch of ocean seaward of state coastal waters. These are classified as "8(g) waters."

Allocated revenues between two coastal states under the department's allocation method between 1953 and 2007 were based on the "pro-rata percentage of acreage lying on each state's side of its extended lateral boarder," the ruling said.

The proportional allocation of revenues was determined by drawing a lateral boundary line between adjacent states all the way through the 8 (g) zone and sharing revenues for only those tracts intersected by this lateral boundary.

In 2007, the department changed its approach for distributing revenues to coastal states based on the then newly formed conclusions that a substantial amount of 8(g) acreage is located well within three miles of a state's seaward boundary, despite lying on the adjacent state's side of the lateral boundary; and thus, revenues from tracts with overlapping ownership between adjacent states were not being equally allocated.

Based on these conclusions, rather than drawing a lateral boundary between two states that stretched through the relevant 8(g) zone, the department began drawing a three mile arc at the point where the lateral boundary between adjacent states intersected the lease boundary.

This new approach was called the "arc approach."

In July 2011, the department sent letters to the states along the Gulf of Mexico advising them of the previously flawed approach to disbursing revenues to states that shared 8(g) tracts and seeking to recover overpayments from the states as a result of the its mistake.

Louisiana and Alabama sued, challenging the department's authority to change the profit sharing scheme, and calling its attempt to collect overpayments from as far back as 1986 "arbitrary and capricious" under the Administrative Procedures Act (pdf).

They also complained the department's decision to change their methodology for how profit sharing is allocated "was made in the absence of any reasonable explanation."

Judge Walton disagreed.

"On multiple occasions, the defendants notified the plaintiffs that they had disbursed 'excess revenue[s]' to the plaintiffs, explaining that the disbursements were the result[] ... [of] clerical and methodological errors used to disburse ... revenues" under OCSLA, Walton said.

The judge also found that under the federal Debt Collection Act the DOI can attempt to collect overpayments, even from as far back as 1986.

The letters defendants sent do not comport to the Debt Collection Act, however, because the letters do not offer plaintiffs an opportunity to inspect and copy defendants' records related to the claim of overpayment, as they are required to do.

Walton remanded the case back to the department for it bring its collection procedures into compliance with the Debt Collection Act.