PROPERTY DAMAGE CLAIMS, SPLIT
ESTATES, SURFACE RIGHTS, MINERAL RIGHTS, LEASES, LOST LAND VALUE, AND TITLE
INSURANCE AS THEY RELATE TO OIL & GAS PRODUCTION
https://sites.google.com/site/metropolitanforensics/split-estates-surface-rights-mineral-rights-and-leases-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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