EXXON CORP. v. EAGERTON

JUSTICE MARSHALL delivered the opinion of the Court.

These cases concern an Alabama statute which increased the severance tax on oil and gas extracted from Alabama wells, exempted royalty owners from the tax increase, and prohibited producers from passing on the increase to their purchasers. Appellants challenge the pass-through prohibition and the royalty-owner exemption under the Supremacy Clause, the Contract Clause, and the Equal Protection Clause.

I

Since 1945 Alabama has imposed a severance tax on oil and gas extracted from wells located in the State. Ala. Code § 40-20-1 et seq. (1975). The tax "is levied upon the producers of such oil or gas in the proportion of their ownership at the time of severance, but . . . shall be paid by the person in charge of the production operations." § 40-20-3(a).1 The person in charge of production operations is "authorized, empowered and required to deduct from any amount due to producers of such production at the time of severance the proportionate amount of the tax herein levied before making payments to such producers." § 40-20-3(a). The statute defines a "producer" as "[a]ny person engaging or continuing in the business of oil or gas production," including

In 1979 the Alabama Legislature enacted Act 79-434, which increased the severance tax from 4% to 6% of the gross value of the oil and gas at the point of production. Whereas the severance tax had previously fallen on royalty owners in proportion to their interests in the oil or gas produced, the amendment specifically exempted royalty owners from the tax increase:

The amendment also prohibited producers from passing the tax increase through to consumers:

The amendment became effective on September 1, 1979. The pass-through prohibition was repealed on May 28, 1980. 1980 Ala. Acts, No. 80-708, p. 1438.

Appellants in both No. 81-1020 and No. 81-1268 have working interests in producing oil and gas wells located in Alabama.2 They drill and operate the wells and are responsible for selling the oil and gas extracted. Appellants are obligated to pay the landowners a percentage of the sale proceeds as royalties, the percentage depending upon the provisions of the applicable lease. Within any given production unit, there may be tracts of land which the owners of the land have leased to nonworking interests, who are also entitled to a share of the sale proceeds. Appellants were parties to contracts providing for the allocation of severance taxes among themselves, the royalty owners, and any nonworking interests in proportion to each party's share of the sale proceeds. Appellants were also parties to sale contracts that required the purchasers to reimburse them for any and all severance taxes on the oil or gas sold.

After paying the 2% increase in the severance tax under protest, appellants and eight other oil and gas producers filed suit in the Circuit Court of Montgomery County, Ala., seeking a declaratory judgment that Act 79-434 was unconstitutional and a refund of the taxes paid under protest. The Circuit Court ruled in favor of appellants, concluding that both the royalty-owner exemption and the pass-through prohibition violate the Equal Protection Clause and the Contract Clause, and that the pass-through prohibition is also preempted by the Natural Gas Policy Act of 1978 (NGPA), 15 U. S. C. § 3301 et seq. (1976 ed., Supp. V). Although Act 79-434 contained a severability clause, the court held the entire Act invalid and ordered appellee Commissioner of Revenue of the State of Alabama to refund the taxes paid under protest. The Supreme Court of Alabama reversed, holding Act 79-434 valid in its entirety. 404 So.2d 1 (1981).

Appellants appealed to this Court under 28 U. S. C. § 1257(2). We noted probable jurisdiction. 456 U.S. 970 (1982). We now affirm in part, reverse in part, and remand for further proceedings not inconsistent with this opinion.

II

We deal first with appellants' contention that the application of the pass-through prohibition to gas was pre-empted by federal law.3 The applicable principles of pre-emption were recently summarized in Pacific Gas & Electric Co. v. State Energy Resources Conservation & Development Comm'n, 461 U.S. 190, 203-204 (1983):

Appellants contend that the pass-through prohibition was in conflict with § 110(a) of the NGPA, 92 Stat. 3368, 15 U. S. C. § 3320(a) (1976 ed., Supp. V), which provides in pertinent part as follows:

We agree with the Supreme Court of Alabama4 that the pass-through prohibition did not conflict with this provision. On its face § 110(a) of the NGPA does not give any seller the affirmative right to include in his price an amount necessary to recover state severance taxes. It simply provides that a seller who does include such an amount in his price shall not be deemed to have exceeded the federal price ceiling if he would not have exceeded it had that amount not been included. Nothing in the legislative history of the NGPA has been called to our attention to indicate that § 110(a) was intended to have a greater effect than its language would indicate.5

Although the pass-through prohibition thus was not in conflict with § 110(a) of the NGPA, we nevertheless conclude that it was pre-empted by federal law insofar as it applied to sales of gas in interstate commerce. To that extent, the pass-through prohibition represented an attempt to legislate in a field that Congress has chosen to occupy. The Natural Gas Act (Gas Act), 52 Stat. 821, as amended, 15 U. S. C. §§ 717-717w (1976 ed. and Supp. V), was enacted in 1938 "to provide the Federal Power Commission, now the FERC, with authority to regulate the wholesale pricing of natural gas in the flow of interstate commerce from wellhead to delivery to consumers." Maryland v. Louisiana, 451 U.S. 725, 748 (1981). As we have previously recognized, e. g., Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672, 682-683 (1954); id., at 685-687 (Frankfurter, J., concurring), the Gas Act was intended to occupy the field of wholesale sales of natural gas in interstate commerce, a field which had previously been left largely unregulated as a result of the absence of federal action and decisions of this Court striking down state regulation of sales of natural gas in interstate commerce. The Committee Reports on the bill that became the Gas Act clearly evidence this intent:

The Alabama pass-through prohibition trespassed upon FERC's authority over wholesale sales of gas in interstate commerce, for it barred gas producers from increasing their prices to pass on a particular expense — the increase in the severance tax — to their purchasers. Whether or not producers should be permitted to recover this expense from their purchasers is a matter within the sphere of FERC's regulatory authority. See FPC v. United Gas Pipe Line Co., 386 U.S. 237, 243 (1967) (emphasis added):

Here, as in Maryland v. Louisiana, the state statute "interfere[d] with the FERC's authority to regulate the determination of the proper allocation of costs associated with the sale of natural gas to consumers." 451 U. S., at 749. Just as the statute at issue in Maryland v. Louisiana was pre-empted because it effectively "shift[ed] the incidence of certain expenses . . . to the ultimate consumer of the processed gas without the prior approval of the FERC," id., at 750, Alabama's pass-through prohibition was pre-empted, insofar as it applied to sales of gas in interstate commerce, because it required that certain expenses be absorbed by producers.

We reach a different conclusion with respect to the application of the pass-through prohibition to sales of gas in intrastate commerce.6 Although § 105(a) of the NGPA extended federal authority to control prices to the intrastate market, 15 U. S. C. § 3315(a) (1976 ed., Supp. V), Congress also provided that this extension of federal authority did not deprive the States of the power to establish a price ceiling for intrastate producer sales of gas at a level lower than the federal ceiling. Section 602(a) of the NGPA, 92 Stat. 3411, as set forth in 15 U. S. C. § 3432(a) (1976 ed., Supp. V), states that

See Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400, 420-421 (1983) (in enacting the NGPA, "Congress explicitly envisioned that the States would regulate intrastate markets in accordance with the overall national policy").

Since a State may establish a lower price ceiling, we think it may also impose a severance tax and forbid sellers to pass it through to their purchasers. For sellers charging the maximum price allowed by federal law, a state tax increase coupled with a pass-through prohibition will not differ in practical effect from a state tax increase coupled with the imposition of a state price ceiling that maintains the price ceiling imposed by federal law prior to the tax increase. In both cases sellers are required to absorb expenses that they might be able to pass through to their customers absent the state restrictions. Given the absence of any express pre-emption provision in the NGPA and Congress' express approval of one form of state regulation, we do not think it can fairly be inferred that Congress contemplated that the general scheme created by the NGPA would preclude another form of state regulation that is no more intrusive.7

We conclude that the pass-through prohibition was pre-empted by federal law insofar as it applied to sales of gas in interstate commerce, but not insofar as it applied to producer sales of gas in intrastate commerce.

III

We turn next to appellants' contention that the royalty-owner exemption and the pass-through prohibition impaired the obligations of contracts in violation of the Contract Clause.8

A

Appellants' Contract Clause challenge to the royalty-owner exemption fails for the simple reason that there is nothing to suggest that that exemption nullified any contractual obligations of which appellants were the beneficiaries.9 The relevant provision of Act 79-434 states that "[a]ny person who is a royalty owner shall be exempt from the payment of any increase in taxes levied and shall not be liable therefor." On its face this portion of the Act provides only that the legal incidence of the tax increase does not fall on royalty owners, i. e., the State cannot look to them for payment of the additional taxes. In contrast to the pass-through prohibition, the royalty-owner exemption nowhere states that producers may not shift the burden of the tax increase in whole or in part to royalty owners. Nor is there anything in the opinion below to suggest that the Supreme Court of Alabama interpreted the exemption to have this effect. We will not strain to reach a constitutional question by speculating that the Alabama courts might in the future interpret the royalty-owner exemption to forbid enforcement of a contractual arrangement to shift the burden of the tax increase. See Ashwander v. TVA, 297 U.S. 288, 346-347 (1936) (Brandeis, J., concurring).

B

Unlike the royalty-owner exemption, the pass-through prohibition did restrict contractual obligations of which appellants were the beneficiaries. Appellants were parties to sale contracts that permitted them to include in their prices any increase in the severance taxes that they were required to pay on the oil or gas being sold.10 The contracts were entered into before the pass-through prohibition was enacted and their terms extended through the period during which the prohibition was in effect. By barring appellants from passing the tax increase through to their purchasers, the pass-through prohibition nullified pro tanto the purchasers' contractual obligations to reimburse appellants for any severance taxes.

While the pass-through prohibition thus affects contractual obligations of which appellants were the beneficiaries, it does not follow that the prohibition constituted a "Law impairing the Obligations of Contracts" within the meaning of the Contract Clause. See United States Trust Co. v. New Jersey, 431 U.S. 1, 21 (1977). "Although the language of the Contract Clause is facially absolute, its prohibition must be accommodated to the inherent police power of the State `to safeguard the vital interests of its people.' " Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U. S., at 410, quoting Home Bldg. & Loan Assn. v. Blaisdell, 290 U.S. 398, 434 (1934). This Court has long recognized that a statute does not violate the Contract Clause simply because it has the effect of restricting, or even barring altogether, the performance of duties created by contracts entered into prior to its enactment. See Allied Structural Steel Co. v. Spannaus, 438 U.S. 234, 241-242 (1978). If the law were otherwise, "one would be able to obtain immunity from state regulation by making private contractual arrangements." United States Trust Co. v. New Jersey, supra, at 22.

The Contract Clause does not deprive the States of their "broad power to adopt general regulatory measures without being concerned that private contracts will be impaired, or even destroyed, as a result." United States Trust Co. v. New Jersey, supra, at 22. As Justice Holmes put it: "One whose rights, such as they are, are subject to state restriction, cannot remove them from the power of the State by making a contract about them. The contract will carry with it the infirmity of the subject matter." Hudson Co. v. McCarter, 209 U.S. 349, 357 (1908).11 Thus, a state prohibition law may be applied to contracts for the sale of beer that were valid when entered into, Beer Co. v. Massachusetts, 97 U.S. 25 (1878), a law barring lotteries may be applied to lottery tickets that were valid when issued, Stone v. Mississippi, 101 U.S. 814 (1880), and a workmen's compensation law may be applied to employers and employees operating under pre-existing contracts of employment that made no provision for work-related injuries, New York Central R. Co. v. White, 243 U.S. 188 (1917).12

Like the laws upheld in these cases, the pass-through prohibition did not prescribe a rule limited in effect to contractual obligations or remedies, but instead imposed a generally applicable rule of conduct designed to advance "a broad societal interest," Allied Structural Steel Co., supra, at 249: protecting consumers from excessive prices. The prohibition applied to all oil and gas producers, regardless of whether they happened to be parties to sale contracts that contained a provision permitting them to pass tax increases through to their purchasers. The effect of the pass-through prohibition on existing contracts that did contain such a provision was incidental to its main effect of shielding consumers from the burden of the tax increase. Cf. Henderson Co. v. Thompson, 300 U.S. 258, 266 (1937); Beer Co. v. Massachusetts, supra, at 32.

Because the pass-through prohibition imposed a generally applicable rule of conduct, it is sharply distinguishable from the measures struck down in United States Trust Co. v. New Jersey, supra, and Allied Structural Steel Co. v. Spannaus, supra. United States Trust Co. involved New York and New Jersey statutes whose sole effect was to repeal a covenant that the two States had entered into with the holders of bonds issued by The Port Authority of New York and New Jersey.13 Similarly, the statute at issue in Allied Structural Steel Co. directly " `adjust[ed] the rights and responsibilities of contracting parties.' " 438 U. S., at 244, quoting United States Trust Co. v. New Jersey, supra, at 22. The statute required a private employer that had contracted with its employees to provide pension benefits to pay additional benefits, beyond those it had agreed to provide, if it terminated the pension plan or closed a Minnesota office. Since the statute applied only to employers that had entered into pension agreements, its sole effect was to alter contractual duties. Cf. Worthen Co. v. Kavanaugh, 295 U.S. 56 (1935) (statute which drastically limited the remedies available to mortgagees held invalid under the Contract Clause).

Alabama's power to prohibit oil and gas producers from passing the increase in the severance tax on to their purchasers is confirmed by several decisions of this Court rejecting Contract Clause challenges to state rate-setting schemes that displaced any rates previously established by contract. In Midland Realty Co. v. Kansas City Power & Light Co., 300 U.S. 109 (1937), it was held that a party to a long-term contract with a utility could not invoke the Contract Clause to obtain immunity from a state public service commission's imposition of a rate for steam heating that was higher than the rate established in the contract. The Court declared that "the State has power to annul and supersede rates previously established by contract between utilities and their customers." Id., at 113 (footnote omitted). In Union Dry Goods Co. v. Georgia Public Service Corp., 248 U.S. 372 (1919), the Court rejected a Contract Clause challenge to an order of a state commission setting the rates that could be charged for supplying electric light and power, notwithstanding the effect of the order on pre-existing contracts. Accord, Stephenson v. Binford, 287 U.S. 251 (1932) (upholding law which barred private contract carriers from using the highways unless they charged rates which might exceed those they had contracted to charge).

Producers Transportation Co. v. Railroad Comm'n of California, 251 U.S. 228 (1920), is particularly instructive for present purposes. In that case the Court upheld an order issued by a state commission under a newly enacted statute empowering the commission to set the rates that could be charged by individuals or corporations offering to transport oil by pipeline. The Court rejected the contention of a pipeline owner that the statute could not override pre-existing contracts:

There is no material difference between Producers Transportation Co. and the cases before us. If a party that has entered into a contract to transport oil is not immune from subsequently enacted state regulation of the rates that may be charged for such transportation, parties that have entered into contracts to sell oil and gas likewise are not immune from state regulation of the prices that may be charged for those commodities. And if the Contract Clause does not prevent a State from dictating the price that sellers may charge their customers, plainly it does not prevent a State from requiring that sellers absorb a tax increase themselves rather than pass it through to their customers. If one form of state regulation is permissible under the Contract Clause notwithstanding its incidental effect on pre-existing contracts, the other form of regulation must be permissible as well.14

IV

Finally, we reject appellants' equal protection challenge to the pass-through prohibition and the royalty-owner exemption. Because neither of the challenged provisions adversely affects a fundamental interest, see, e. g., Dunn v. Blumstein, 405 U.S. 330, 336-342 (1972); Shapiro v. Thompson, 394 U.S. 618, 629-631 (1969), or contains a classification based upon a suspect criterion, see, e. g., Graham v. Richardson, 403 U.S. 365, 372 (1971); McLaughlin v. Florida, 379 U.S. 184, 191-192 (1964), they need only be tested under the lenient standard of rationality that this Court has traditionally applied in considering equal protection challenges to regulation of economic and commercial matters. See, e. g., Western & Southern Life Ins. Co. v. State Board of Equalization, 451 U.S. 648, 668 (1981); Minnesota v. Clover Leaf Creamery Co., 449 U.S. 456, 461-463 (1981); Kotch v. Board of River Pilot Comm'rs, 330 U.S. 552, 564 (1947). Under that standard a statute will be sustained if the legislature could have reasonably concluded that the challenged classification would promote a legitimate state purpose. See, e. g., Western & Southern Life Ins. Co., supra, at 668; Clover Leaf Creamery Co., supra, at 461-462, 464.

We conclude that the measures at issue here pass muster under this standard. The pass-through prohibition plainly bore a rational relationship to the State's legitimate purpose of protecting consumers from excessive prices. Similarly, we think the Alabama Legislature could have reasonably determined that the royalty-owner exemption would encourage investment in oil or gas production. Our conclusion with respect to the royalty-owner exemption is reinforced by the fact that that provision is solely a tax measure. As we recently stated in Regan v. Taxation with Representation of Washington, 461 U.S. 540, 547 (1983), "[l]egislatures have especially broad latitude in creating classifications and distinctions in tax statutes." See Lehnhausen v. Lake Shore Auto Parts Co., 410 U.S. 356, 359 (1973); Allied Stores of Ohio v. Bowers, 358 U.S. 522, 526-527 (1959).

V

For the foregoing reasons, we conclude that the application of the pass-through prohibition to sales of gas in interstate commerce was pre-empted by federal law, but we uphold both the pass-through prohibition and the royalty-owner exemption against appellants' challenges under the Contract Clause and the Equal Protection Clause. Since the severability of the pass-through prohibition from the remainder of the 1979 amendments is a matter of state law, we remand to the Supreme Court of Alabama for that court to determine whether the partial invalidity of the pass-through prohibition entitles appellants to a refund of some or all of the taxes paid under protest. See n. 6, supra. Accordingly, the judgment of the Supreme Court of Alabama is affirmed in part and reversed in part, and the case is remanded for further proceedings not inconsistent with this opinion.

It is so ordered.