Agency Action Is Arbitrary and Capricious When It Ignores a Potentially Controlling Royalty Settlement Agreement
1. Introduction
Case: Devon Energy Production Company v. DOI (10th Cir. Apr. 27, 2026) (published).
Parties: Devon Energy Production Company, L.P. and Devon Energy Corporation (collectively, “Devon”) vs. the United States Department of the Interior (acting through the Office of Natural Resources Revenue (“ONRR”)).
Context: The dispute concerns royalties owed to the federal government for natural gas produced under federal leases in New Mexico. State auditors, acting under federal authorization, audited Devon’s royalty reporting for 2004–2008 and disallowed certain deductions, particularly where midstream service providers bundled deductible and non-deductible charges.
Core issue on appeal: Whether ONRR acted “arbitrarily and capriciously” under 5 U.S.C. § 706(2)(A) by ordering Devon to pay additional royalties or provide more support for deductions without addressing a prior settlement agreement that Devon asserted it had relied upon to allocate bundled charges.
Devon’s position hinged on a prior settlement agreement resolving similar deductibility disputes for an earlier period. Devon argued that it used the settlement’s formula/rates to separate deductible from non-deductible components when vendors bundled charges. ONRR’s order, however, did not discuss the settlement agreement at all.
2. Summary of the Opinion
The Tenth Circuit reversed the district court’s affirmance of ONRR’s order. The court held that ONRR acted arbitrarily and capriciously by failing to consider the settlement agreement—an “important aspect of the problem”—because:
-
Legally, the settlement agreement could control over otherwise-applicable regulations under 30 C.F.R. § 206.150(b).
-
Factually, the settlement’s rate/formula could affect a substantial portion of the disputed royalties (the opinion notes that over 80% of the disputed royalties involved coalbed methane from the Fruitland Coal formation).
The court rejected the government’s attempt to salvage affirmance on harmless-error grounds because the record and agreement language did not make harmlessness “clear and indisputable.” The court remanded to the district court to determine the appropriate remedy—vacatur or remand without vacatur—under the Tenth Circuit’s established two-factor test.
Dissent: Judge Tymkovich would have affirmed, reasoning that the settlement agreement’s treatment rate did not apply during the audit period because (on the dissent’s view) either the agreement never set a perpetual treatment rate or any rate set expired before 2004–2008.
3. Analysis
A. Precedents Cited
1) Standard of review and “important aspect of the problem”
-
N.M. Cattle Growers Ass'n v. U.S. Fish & Wildlife Serv., 248 F.3d 1277, 1281 (10th Cir. 2001):
Used for the proposition that the court conducts de novo review of the district court’s APA review, applying the same arbitrary-and-capricious standard to the agency action.
-
Ctr. for Biological Diversity v. United States Env't Prot. Agency, 149 F.4th 1142, 1148 (10th Cir. 2025):
Supplies the key formulation: an agency acts arbitrarily and capriciously if it “fail[s] to consider an important aspect of the problem.” The majority uses this to frame the settlement agreement as a mandatory consideration, not an optional discussion point.
2) Alternative grounds to affirm and record sufficiency
-
Proctor & Gamble Co. v. Haugen, 222 F.3d 1262, 1273 (10th Cir. 2000):
Cited for the ability (in some circumstances) to affirm on an alternative basis not relied on by the district court—relevant to the government’s harmless-error argument.
-
Ashby v. McKenna, 331 F.3d 1148, 1151 (10th Cir. 2003):
Limits alternative affirmance where the record is insufficient. The majority uses Ashby v. McKenna to reject harmlessness arguments that depend on facts not developed in the administrative record (e.g., merger/name-change documents and assumption of settlement obligations).
-
Roberts v. Barreras, 484 F.3d 1236, 1244 (10th Cir. 2007) (quoting Colorado Property Acquisitions, Inc. v. United States, 894 F.2d 1173, 1175 n.5 (10th Cir. 1990)):
Establishes that alternative grounds must be “indisputable” and “appear clearly in the record.” The majority applies this to conclude that settlement expiration was debatable due to textual ambiguity.
3) Chenery and limits on post hoc rationalizations (flagged but not decided)
4) Remedy: vacatur vs remand without vacatur
B. Legal Reasoning
1) Royalty valuation and deductions set the stage for why the settlement mattered
The opinion frames the dispute within the federal royalty scheme: royalties are tied to the “value of the minerals extracted” (30 U.S.C. § 223), generally the arm’s-length sale value (30 C.F.R. § 206.152-53), with limited cost deductions (30 C.F.R. § 206.151), including certain transportation and treatment costs (30 C.F.R. §§ 206.156-58).
Critically, lessees cannot deduct costs of gathering or of putting gas into “marketable condition” (30 C.F.R. §§ 206.151, 206.152(i)).
Those rules created the core accounting problem: Devon paid vendors (Enterprise Field Services and Williams Field Services) who bundled deductible charges (e.g., some transportation) with non-deductible charges (e.g., CO2 removal needed to make coalbed methane marketable). Devon argued it applied a settlement-based rate to “separate” costs when the vendor invoices did not.
2) The “important aspect” omission: settlement agreement as a legal and factual cornerstone
The majority’s central move is to elevate the settlement agreement from “background” to “important aspect of the problem.”
-
Legal importance: The court cites 30 C.F.R. § 206.150(b) for the proposition that the settlement agreement “controlled over regulations that would otherwise conflict.” That is, if a valid and applicable settlement dictates a method/rate for allocating costs, ONRR must grapple with it rather than silently applying general regulatory expectations (like requiring invoice-level separation).
-
Factual importance: The agreement’s impact was potentially large (the opinion notes >80% of disputed royalties involved Fruitland Coal coalbed methane). If Devon’s reliance was proper, ONRR’s demanded additional royalties could be overstated for a substantial portion of production.
Because ONRR did not address Devon’s settlement-based allocation argument at all, the court found arbitrary-and-capricious decisionmaking under 5 U.S.C. § 706(2)(A) as articulated in Ctr. for Biological Diversity v. United States Env't Prot. Agency.
3) Harmless error rejected: uncertainty in both record and contract text
The government’s harmlessness theory had three parts—(i) different Devon entity; (ii) no assumption of settlement; (iii) settlement expired before audit period—and the court rejects each as a basis for affirmance:
-
Different entity / assumption issues: The majority refuses to speculate because the agency did not address corporate identity or assumption in the administrative process; merger/assumption documents were not in the record. Under Ashby v. McKenna, the record was inadequate to decide these alternative grounds.
-
Expiration issue: The majority holds that the settlement agreement was ambiguous on whether the treatment rate expired, making harmlessness not “clear and indisputable” under Roberts v. Barreras. The court parses the sentence tying “rates identified in Exhibit ‘B’ … for transporting coalbed gas” to an expiration trigger and finds plausible competing readings: one where only transportation rates expire and another where all rates (including treatment) do.
The dissent argued that any rate “for transporting coalbed gas” necessarily expired by the agreement’s triggers, and that Exhibit B did not independently establish a perpetual treatment rate. The majority, however, found that the parties’ own litigation positions undercut the dissent’s “no treatment rate set” framing, noting the government had described .0778 as “the agreed cost of CO2 removal under the … Settlement Agreement.”
4) Remedy left open: vacatur vs remand without vacatur
Even after finding the agency action arbitrary and capricious, the court does not itself decide whether ONRR’s order must be vacated. Applying W. Watersheds Project v. Haaland and Dine Citizens Against Ruining Our Env't v. Haaland, the panel remands to the district court to conduct the fact-intensive inquiry into seriousness of deficiencies and disruptive consequences.
C. Impact
-
Agencies must confront settlements as operative law in royalty disputes: The decision underscores that where a party raises a settlement agreement that may govern valuation/deductions—especially where regulations recognize settlement primacy (here, 30 C.F.R. § 206.150(b))—silence is not an option. ONRR must address applicability, scope, duration, and effect.
-
Administrative record discipline: The case illustrates a recurring APA dynamic: when an agency does not raise or analyze a theory (e.g., corporate identity/assumption), the record may lack the materials needed for a reviewing court to deem the agency’s omission harmless. This increases incentives for agencies to develop and articulate their reasoning at the administrative stage.
-
Bundled-cost allocation in oil & gas royalties: The dispute is a blueprint for how “bundled charges” can become the central friction point in marketable-condition cases. This decision will likely be cited by lessees arguing that historically negotiated allocation methodologies cannot be dismissed without reasoned analysis.
-
Remedy uncertainty remains case-specific: By remanding the vacatur question, the decision signals that even significant APA errors do not automatically yield vacatur; district courts must weigh disruption and seriousness under the Tenth Circuit framework.
4. Complex Concepts Simplified
- “Arbitrary and capricious” review (APA)
-
Under 5 U.S.C. § 706(2)(A), a court does not decide the “best” policy outcome; it checks whether the agency used reasoned decisionmaking. A key failure is ignoring an “important aspect of the problem”—here, a settlement that might control the calculation.
- “Marketable condition” vs. deductible costs
-
Some costs (e.g., certain transportation/treatment) may reduce royalty value. But costs required to make the product marketable—like removing excessive CO2 so gas can be sold—are often not deductible. This distinction drives disputes over what portion of a midstream bill is deductible.
- Bundled charges
-
Vendors may bill a single combined fee covering multiple services. If some services are deductible and others are not, the lessee must justify how it separated the bill into deductible and non-deductible parts. Devon claimed the settlement’s rate was that separation tool.
- Harmless error in APA cases
-
Even if an agency made a mistake, a court may still affirm if the mistake clearly did not matter to the outcome. The Tenth Circuit required the harmlessness theory to be “clear and indisputable” and supported by the record; ambiguity in the settlement agreement and gaps in the record defeated harmlessness here.
- Vacatur vs. remand without vacatur
-
If an agency action is unlawful, a court may set it aside (vacate) or send it back while leaving it temporarily in place. The Tenth Circuit applies a two-factor test focusing on the seriousness of the deficiency and the disruption of vacatur; the district court must apply that test on remand.
5. Conclusion
Devon Energy Production Company v. DOI reinforces a central APA requirement in the federal royalties context: when a regulated party points to a settlement agreement that may govern royalty deductions—and where regulations may give such settlements controlling force—an agency must meaningfully address the agreement’s applicability and effect. ONRR’s failure to do so was arbitrary and capricious because it ignored an important legal and factual aspect of the problem.
The decision also limits after-the-fact harmless-error justifications when the record is incomplete or the settlement text is ambiguous. Finally, it preserves remedial flexibility by remanding for the district court to decide whether to vacate the agency order or remand without vacatur under the Tenth Circuit’s two-factor framework.