SPLIT ESTATES, SURFACE RIGHTS, MINERAL RIGHTS, AND LEASES AS THEY RELATE TO OIL & GAS PRODUCTION

PROPERTY DAMAGE CLAIMS, SPLIT ESTATES, SURFACE RIGHTS, MINERAL RIGHTS, LEASES, LOST LAND VALUE, AND TITLE INSURANCE AS THEY RELATE TO OIL & GAS PRODUCTION

As the oil and gas boom continues across the United States, many surface land owners are surprised at the rights that mineral lessees (usually oil or gas companies) have to use the surface of the land without any input, consent, or permission of the surface owner. It is critical for all landowners, but in particular for those surface owners who do not own the mineral rights underlying their property, to understand the implied rights of mineral lessees.

Groundwater is considered part of the surface estate, and not part of the mineral estate. Under most states’ laws, unless specified otherwise, the mineral estate consists only of oil, gas, uranium, sulfur and salt. Groundwater is part of the surface estate, even though it is located below the surface. Because of this, like the other portions of the surface estate, an oil & gas producer can use that amount of groundwater “reasonably necessary” to explore and produce minerals on the land. Generally, groundwater used for the exploration or drilling of oil does not require the oil company to obtain a permit from the local groundwater conservation district. Water used for production generally does fall within groundwater conservation district jurisdiction and requires a permit.

The Marcellus Shale natural gas discovery has triggered an associated boom in Pennsylvania land disputes, as formerly valueless mineral rights are now potentially worth millions. There are currently cases pending that address the so-called “title-washing”. The legal issue at stake, known as "title-washing," may affect many properties that were acquired in the last century through tax sales. It is rooted in the PA Supreme Court's interpretation of an 1804 law allowing counties that claimed undeveloped land for unpaid taxes to also retake title to the mineral rights, sometimes unbeknownst to the subsurface owner, who was not tax delinquent.

Standard home insurance policies generally contain strict exclusions regarding pollution damage

Over the past few years, many of the risks associated with hydraulic fracturing (“fracking” or “fracing”) have drawn increased attention from insurers and insurance underwriters.

Increasingly, insurers are taking steps to insulate themselves against liability when fracking pollutes land, air and water, damages people’s properties or leads to accidents. A standard homeowner’s insurance policy won’t cover harm from fracking pollution or property damage. In fact, home insurance policies generally contain strict exclusions regarding pollution damage and that includes pollution from spills, releases, emissions and so on. Some insurers have denied coverage altogether for homes where the mineral rights have been severed. Title insurance companies have been exempting anything to do with mineral rights from their policies, as well. Insurers have so far declined to offer special policies that would cover fracking risks. In 2012, Nationwide Insurance, for example, announced that its homeowners’ policies would not cover damage from fracking, saying the risks “are too great to ignore.”

Even if the oil & gas companies have insurance coverage, when insurance runs out, companies can still be sued for the harm they do. However, if they don’t have enough money to cover the claim, the people who were injured or their property was damaged may be out of luck. It is also known that some drillers use shell corporations or LLCs to shield their assets, so that a damaged property owner may not recover his/her entire damages. There is a very significant legislative and otherwise activity going on right now regarding as to who pays for uncovered damages. If the full net worth of the company (in addition to insurance coverage) is insufficient to cover the costs associated with an event, those costs will be borne by those who have suffered property damage or injuries.

According to the Insurance Information Institute, as risks associated with fracking become known to consumers, the development of insurance products for a new market may become attractive to insurers. From what we have seen several large insurers are leading the way, including Travelers, Liberty Mutual, AIG and others.

Considerable Risks

Fracking has considerable environmental and non-environmental exposures, some of which have been well-documented:

• Traffic accidents and traffic-related fatalities is one of the leading risks.

• Leaks or spills of process chemicals or brines from the production well, storage tanks and injection equipment.

• Spills of process chemicals and waste materials transported to and from the sites.

• Leaks or spills of diesel fuel, hydraulic oil used to operate the equipment on site.

• Well explosions or blowouts or otherwise losing control of the well due to mechanical failure, human error, lack of training, and so on.

• Lack of erosion control measures resulting in loss of habitat and other environmental damages.

• Methane or hydrogen sulfide or radon emissions from drilling activity.

• Allegations of groundwater contamination from subsurface leaks of fracking chemicals.

• Improper disposal of spent chemicals and wastewater generated by fracking.

• Corroded, leaking or otherwise damaged pipelines. As more pipelines are built, these losses will continue to increase. For example, in early July 2014, a pipeline operated by a subsidiary of Crestwood Midstream Partners LP, leaked 24,000 barrels, or more than 1 million gallons, of saltwater near Bear Den Bay on Lake Sakakawea, a reservoir of the Missouri River, about four miles northeast of Mandaree. Yesterday, August 26, 2014, a pipeline on the Fort Berthold Indian Reservation in western North Dakota leaked 3,000 barrels of brine.

• Train derailments (reaching record levels in damages in 2014), causing the release of frac sand and/or oil and gas or fracking wastewater.

• Release of chemicals to surface waters due to flooding or other natural peril.

• Earthquakes or other land movement due to fracking.

• Exposure of O&G workers to crystalline silica, diesel particulates, radioactivity (alpha, beta and gamma exposures) and other harmful chemicals.

We are now seeing that these exposures can be compounded by more traditional insurance perils. The recent flooding in Colorado and Pennsylvania has affected more than 2,000 drilling wells and could have potentially dispersed pollutants over a wide area. Pollution claims from numerous parties could follow, resulting in losses disproportionately high relative to standard flood losses. It is worth pointing out that many fracking sites are located in flood-prone areas, because the fracking companies want ready access to the water supply and to the railroad trucks to easily load and unload the process chemicals and production fluids. Another issue we are seeing is the “thinning out” of the drilling and other crews, as well trained and qualified personnel is not readily available. As we indicated in a recent blog, quite a few recent accidents have been attributed to “greenhats” or lack of proper or adequate training. Crews also come from the warm states of Texas, Louisiana, etc. that are not familiar with freezing weather issues that we typically face in Pennsylvania, New York, North Dakota, etc. Quite a few spills and other releases have been caused by lack of familiarity with cold weather.

Pollution insurance carriers have traditionally shied away from coverage for fracking risks, but during the last few years they (especially the larger insurers) have started to cautiously expand their coverage options. Examples of pollution programs available to companies involved in fracking include:

• Contractor’s pollution liability coverage for carriers that deliver process chemicals to fracking sites and remove waste materials from the sites.

• Site pollution liability coverage for fracking sites on a “sudden & accidental” basis.

• Combined general liability and pollution liability coverage for companies engaged in recycling wastewater generated at fracking sites and selling it back to the drilling companies for reuse at the sites. Carriers have been willing to include pollution coverage in this program.

• Control of Well insurance policies (well out of control, S&P, Cleanup and Containment (extended pollution), redrilling, Care, Custody & Control, third party equipment on site, including rig legal liability and many other coverages) are issued by a number of insurance companies, including Travelers/St. Paul Surplus Lines. In a typical well blowout scenario, the insured can incur actual costs, including premium and the retention of say $110,000, while the cost to the insurer, in case of a loss could be several million dollars. Thus, the losses can be significant. And we all know, “Anything that can go wrong, will go wrong”.

These insurance policies have a number of exclusion, including but not limited to: radioactive contamination, fines, penalties, exemplary or punitive damages, earthquake, excluded well(s) endorsement, etc.

Mineral rights, surface rights and split estates. The mineral estate is traditionally recognized as dominant over the surface estate

In a typical real estate transaction between a buyer and a seller, when title to real property is transferred, all corresponding rights (surface, subsurface and air) are transferred as well. In such a scenario, the property transferred is a ‘fee simple’ estate. The owner of a fee simple estate owns all corresponding rights to the land, including surface land, sky, water, and subsurface minerals.

However, many states’ real property laws (such as Pennsylvania, Colorado, Texas, Oklahoma, and many others) recognize separate ownership of the surface and mineral estates, and the distinct private property rights that are associated with each; these laws allow for the owner to stipulate severance of the surface from the subsurface rights, leading to a “split estate” system. The concept of the split estate dates back to English law, which reserved the mineral rights of all land to the King.

The split estate system allows one parcel to be owned by separate and distinct entities or a combination of entities. There is also a system called “fractional ownership” where the surface owner splits the ownership of the mineral rights with others, such as other family members, a corporation, or the government. Lastly, there is a “severed ownership” system, where the government owns all oil and gas resources below non-federally owned surface property. One party may own the right to farm the land, build a dwelling, or graze buffalo, but another party or parties owns the right to drill for the underlying oil and gas or other mineral resources.

This type of interest (i.e., the oil and gas mineral rights) is not insurable under a title insurance policy, since it could lead to potential title issues when the owner comes to sell his property. While he may desire to sell all rights to his land, the right to drill on the property has already been leased to a third party. Landowners should be aware, however, that granting mineral rights can adversely affect title to the property.

Much of the law related to split estates has evolved in response to disputes where a surface owner’s use of the surface estate for above-ground development has come into conflict with a mineral right owner’s use of the surface to explore for and develop the minerals lying beneath the surface. And as population growth has accelerated in the Western United States, together with a growing demand for oil & gas or sustainable and “clean” sources of energy, developers of the tighter shale formations or the renewable energy projects often find themselves negotiating with the various owners to secure sufficient rights to the surface to be able to perform any mineral development.

At common law, the mineral estate is traditionally recognized as dominant over the surface estate. In practice, this means that the surface estate is subject to an implied easement for the benefit of the mineral estate so that the mineral owner may utilize that portion of the surface estate as is reasonable and necessary to extract minerals. This preference in favor of mineral owners is supported on economic grounds, since the mineral estate could be rendered worthless if the mineral estate owner were unable to use the surface to access the minerals.

Courts have held that the mineral right has no value unless the oil or gas can be removed from the ground. That means that mineral owners have the right to reasonable use of the surface, regardless of whether or not the surface owner grants permission. State and federal regulations further define this relationship. Surface and mineral owners are encouraged to open a line of communication as soon as possible to discuss plans and needs. This can happen before drilling is planned. If the surface owner leases the land to another party, the surface owner is encouraged to include the lessee or any others who may have an interest in the surface use in discussions about the use of the property.

During the last few years, there have been many cases in the news where the homeowners were left in the dark regarding the ownership of the mineral rights under their properties. Due to the recent advances in the extraction of oil and gas from tight shale and other non-traditional formations, homebuilders and developers have been increasingly hanging on to the mineral rights underneath their projects, pushing aside homeowners' interests to set themselves up for financial gain when energy companies come calling. This is happening in regions far beyond the traditional American oil patch, which has a long history of selling subsurface rights. In most states, sellers aren't legally required to disclose to home buyers whether they are severing the mineral rights to a property. Builders sometimes flag the move in sales contracts or deeds and other documents they are required to file with local authorities. But buyers don't necessarily review their paperwork very closely, especially if, as real-estate agents say happens often, they don't hire a lawyer to help them with the transaction. This is a huge case of buyer beware.

The disposition of mineral rights is rarely explained to buyers before or during closings, and title searches don't always pick up the information, either. Many states also don't require home buyers to have their own lawyer present at closings. And even though builders and developers sometimes file mineral deeds with county registrars, homeowners may not know to search through county property records to find that information. Title insurance policies may or may not disclose the reservations, but they are exempt from mineral title reporting.

Unfortunately, home buyers often do not understand the concept of the split estate and may later be shocked to learn that oil and gas developers who have leased or otherwise obtained the mineral rights to the property are entitled to enter upon or beneath the land to drill for or otherwise develop the resources. There are three ways in which a drilling company can obtain rights to drill underneath privately-owned real estate. It can purchase outright the deed to the subsurface rights below the fee estate. Alternatively, it can sign a lease agreement with the fee owner. Lastly, it can obtain drilling rights through compulsory integration, in which the government compels a property owner to lease his rights to the drilling company. Compulsory integration is used in situations where the drilling company already has control of a statutorily-prescribed percentage of the surrounding land.

The best option for a surface owner to protect himself is to be involved in the negotiations of the mineral lease. When the surface owner and mineral owner is the same person, it is easier to ensure that these terms are raised with the oil company. When the surface and minerals are owned by separate parties, however, these provisions may be overlooked by a mineral owner. It is important for a surface owner to seek to be involved in lease negotiations and to negotiate protections into a lease. This involvement is usually sought by reaching an agreement with the mineral owner that will allow for surface owner involvement in negotiations or an agreement that the mineral owner will require certain terms be include in all mineral leases. For example, a mineral lease could require that a surface owner and the mineral lessee mutually agree on the location of any wells or other drilling activities. A mineral lease could also require that at the conclusion of drilling, the surface estate must be placed back into the same condition that it was prior to drilling being commenced. A third option would be to include a liquidated damage clause in the lease that would require the oil company to pay a set amount at the beginning of the lease to cover surface damages.

Where are the mineral ownership records?

The deed to the property is a good place to start. For surface owners, if the deed says ownership of the property is fee simple or fee simple absolute, that means the surface and mineral rights might be intact unless otherwise indicated in the chain of title. A chain of title search is the only definitive way to determine if minerals are owned, and title insurance does not normally cover mineral ownership. If a personal copy of the deed isn't available, the information is most likely on file with the Clerk and Recorder for the county in which the land is located. A legal description of the land would be helpful in finding mineral deeds, grants, or reservations. If initial searches are unsuccessful, some title companies or landmen may provide assistance. Make sure that surface and mineral rights ownership are included in the title search. In some states, such as New York, public records may be inadequate in verifying mineral rights ownership.

Due Diligence for Oil & Gas Properties

Through their due diligence, mortgagees, typically banks, ascertain the owner of the real property, assess the value of the property, and determine whether there are any encumbrances that may affect the property. Leasing mineral rights to a third party encumbers the property and may devalue it. Additionally, these leases may allow for certain related onsite activities, such as storing wastewater on the mortgaged property. This could trigger a breach of the terms of the mortgage, which may accelerate the mortgage and force the landowner to pay the remainder of the mortgage immediately. Furthermore, the mere execution of an oil and gas lease without the consent of the mortgagee may lead to a default if the mortgage contains a restriction on encumbering the real property, as most mortgages do. Lastly, leases that allow oil companies to conduct certain drilling activities on the property may not comply with secondary mortgage market regulations, which would also trigger a default on the mortgage itself.

If the landowner ever wants to refinance his property, the lender would require title insurance, which would reveal the lease. Title insurance policies insure the mortgage lien against loss or damage if any interests exist in the land other than that of the landowner. Due to the rights granted to a lessee under an oil and gas lease to use the property, their potential long term nature and the inability to terminate such leases, they are likely to be shown as an exception on the title insurance policy. The presence of these leases could prevent lenders from lending money to the property owner because of the inherent dangers of drilling. The banks fear that if the drilling damages the property and they have to foreclose, their lien would be worthless. They would be left foreclosing on a property not worth the remainder on the loan, and they would suffer a loss.

A similar situation arises when the fee owner seeks to sell. The lenders are finding that the lease has a negative impact on the loan to value ratio, making it difficult for landowners to find buyers who can bring a deal to close.

Mortgagees require title insurance when granting a loan. This protects them from potential title defects and is a prerequisite to selling the mortgages on the secondary market to Fannie Mae and Freddie Mac. Title policies insure the lien-holder against a possible claim of title from a third-party who claims an ownership interest in the land. Leasing out oil or gas rights may cause a problem with title insurance. Mortgagees require coverage to protect them and ensure that the property value will not decrease due to the existence of the oil lease. This may be difficult to obtain as title companies have no way of knowing if the value will decrease, at least until regulations are in place to protect landowners. New York State has placed a moratorium on fracking until proper regulation is put into place.

To remove the lease as an exception to the title, title insurance companies normally require the lease term to be expired and an affidavit from the fee owner that no activity is occurring and that they have not been receiving any payments under the terms of the lease. If the lease has not expired, or the mineral rights were a fee conveyance, it may pose a problem for subsequent purchasers and financing. If this occurs, an affirmative language is included that the surface rights and any improvements will not be affected. This language usually is satisfactory to the purchaser(s) and the secondary market.

What about partial mineral ownership and pooling?

In some cases, more than one party may own minerals under a parcel of land. Even if some of the mineral owners do not want to drill, state law allows that the mineral interests may still be developed. In response to citizen concerns, some states legislatures enacted statutes mandating a written disclosure to home buyers that the natural resources located underneath the properties that they are about to purchase may be owned and accessed by someone else.

Mineral rights may or may not be held by the same owner as the surface rights. A previous owner may have “severed” all or part of the minerals from the surface. If a surface owner does not know whether he or she owns any or all of the mineral rights the first places they should look are their deed and title insurance policy. These are not definitive but will be a good starting place. To be absolutely sure it will be necessary to have an attorney do a Title Opinion.

What are surface damage/disruption payments?

Most states’ laws state that while developing oil and gas reserves is necessary, surface owners must be justly compensated for damages to the property caused by drilling and other activities. When determining damages, consideration must be given to how long the oil and gas activity will be present.

Damages must be paid for:

· Loss of agricultural production and income;

· Lost land value;

· Lost value of improvements

The neighbors also are entitled for damages to their land, lost land value, nuisance, trespass, noise pollution, and so on. As we have recently reported, juries across the United States have awarded nuisance damages to surface owners affected by the oil & gas drilling activities.

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