The Institute for Energy Law TEXAS MINERAL TITLE COURSE May 2-3, 2013 Houston, Texas

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1 The Institute for Energy Law TEXAS MINERAL TITLE COURSE May 2-3, 2013 Houston, Texas IRREGULAR OWNERS UNLEASED, NONPARTICIPATING, UNPOOLED, OR UNCERTAIN OWNERS AND HOW TO MANAGE THE ISSUES Richard F. Brown 2013 Brown & Fortunato, P.C.

2 2 I. INTRODUCTION 1. Management expects to own the production when the well is completed. 2. The Landman and the Title Examiner work together to meet that expectation. 3. Objective lease everyone, leave no holes in the Prospect. 4. Leasing the known owners who want to lease is the easy part. 5. What to do about everyone else? a. Some can be leased. b. Some can be marginalized. c. Some are risks that can be managed. d. Some will make the Prospect undrillable. 6. What are the principal legal issues? 7. What are the principal legal remedies? 8. The focus is on title not regulatory, not issues with other working interest owners.

3 II. The Prospect 3

4 4 III. GENERAL LEASING CONCEPTS A. Practical Solutions for Unleased Owners and Other Causes of Holes in the Prospect 1. Find and confirm the hole in the Prospect. 2. Recalcitrant owners - be sure the hole cannot be leased. 3. Inability to find the owner exhaust the possibilities. 4. Uncertainty as to the correct owner lease everyone. a. Figure it out later if the Prospect can afford it. b. Lease everyone means whoever owns executive rights. c. Executive rights frequently will not include the power to pool ratifications. d. Too many unknowns, too little time, gaps, etc. no answer. 5. Simple curative is sometimes a simple answer. Example Exhibit B Stipulation of Interest and Exhibit C Cross-Conveyance and Boundary Agreement. 6. If you cannot lease, then evaluate the risk, manage the risk, possibly seek a judicial remedy.

5 5 B. Limitations Title and Adverse Possession 1. Management may choose to rely on limitations title. a. Practical assumption too old to matter. b. Practical solution not a legal solution (actually assumption of the risk). c. Implicit if challenged, title is defensible based on adverse possession. 2. Adverse possession can only be established in trespass to try title complex, challenging, and expensive. 3. Reasonable business decision based on an understanding of adverse possession to weigh the risk. 4. General concepts of adverse possession. a. Actual and visible possession of land. b. Adverse (to true owner) claim. c. For a long time (statutory periods).

6 6 5. All the issues matter but the focus is on time. a. No time to litigate. b. Old time problems not likely to be contested. c. Statutory time periods to perfect title by adverse possession. 6. Statutory time periods (continuous adverse). a. 3 years peaceable, adverse, under color of title (consecutive chain of transfers). b. 5 years peaceable, adverse, cultivate and use under recorded deed. c. 10 years peaceable, adverse, cultivate and use (no deed). d. 25 years peaceable, adverse, cultivate and use (regardless of disability). 7. Adverse possession of mineral interests. a. Unsevered minerals adverse possession of surface extends to mineral estate. b. Severed minerals after adverse possession has begun adverse possession of surface extends to mineral estate. c. Severed minerals before adverse possession has begun the minerals must be produced to perfect adverse possession title. 8. If the hole in the Prospect cannot be filled by practical solutions or limitations title legal and practical issues arise that are difficult to forecast and to plan around.

7 7 IV. Oil and Gas Property Concepts A. Surface Use and Access Rights 1. Mineral estate is dominant estate common law use and access. 2. Right to use so much of the surface as is reasonably necessary, having due regard for rights of surface owner. 3. Lease easements contract use and access. a. Express lease easements. b. Implied lease easements. 4. Lease easements cannot be used to benefit off-lease premises.

8 Dominant Estate and Easements 8 Red Tract No rights. Any entry a trespass. Cannot cross Red Tract. Cannot drill. Yellow Tract Generally not a problem. Rights from 2/3 Owner. Owe 1/3 Owner compensation? White Tracts No problem tractby-tract. Crossing other tracts? Consider pooling.

9 9 B. Ownership in Place and the Rule of Capture 1. Basic principles of ownership of oil and gas. 2. Ownership-in-place theory mineral owner owns the minerals in place as part of the realty. 3. Therefore to lease Blackacre, you must lease from the mineral owner. 4. Five essential attributes of a mineral estate: a. right to develop (right of ingress and egress) b. right to lease (executive right) b. right to bonus d. right to delay rentals e. right to royalty 5. Owners can split them up anyway they want, but rights to develop and to lease presumptively follow the mineral estate. To lease Blackacre, you must lease from the owner of the right to develop and the right to lease. 6. Ownership-in-place subject to Rule of Capture; owner of the wellsite acquires title to all production from the well, even if it migrated from adjoining land. 7. An unleased owner in the wellsite tract is a big problem.

10 10 Ownership in Place and the Rule of Capture Locations #1 Cannot be drilled. All production belongs to unleased Red Tract Owner. #2 Can be drilled. #3 Can be drilled; unleased 1/3 cotenant. #4 Can be drilled. #5 Many problems. Must be pooled. Can pool Yellow Tract but 1/3 ineffective; 1/3 of 1/16 NPMI ineffective; ineffective as to Red Tract and a trespass.

11 11 C. Non-Apportionment Rule, Entirety Clause, and Community Lease 1. Non-Apportionment Rule Blackacre is leased, lessor conveys a divided tract, e.g., SW/4. a. Operations anywhere may hold the lease. b. Only the owner of the producing tract shares in the proceeds. 2. Entirety Clause if now owned or hereafter owned as separate tracts, the leased premises shall nevertheless be treated as an entirety.... a. Operations anywhere will hold the lease. b. Reverses the Non-Apportionment Rule. c. Lessors share royalty proportionately. d. Non-participating owner has the option to ratify or not. 3. Community lease owners of separate tracts jointly execute a single lease. a. Operations anywhere will hold the lease. b. Reverses the Non-Apportionment Rule. c. Lessors share royalty proportionately. d. Non-participating owner has the option to ratify or not.

12 Non-Apportionment Rule, Entirety Clause, and Community Lease Yellow Tract If W/2 and NE/4 under a community lease or entirety clause, Lessors share proportionately in #3 and #4. Unleased 1/3 could ratify and share proportionately, or take undiluted from #3 and nothing from #4. 1/16 NPMI could ratify and share proportionately or take undiluted from #3 and nothing from #4. W/2 Leased, and then the SW/4 is conveyed to X. X gets nothing from #4. If lease has entirety clause, X shares proportionately in #4. 12

13 13 D. Cotenants 1. Cotenants owners of undivided portions under a single tract. 2. Each cotenant can develop, but cannot exclude the other cotenants. 3. Producing cotenant must account to non-producing cotenant for his pro rata share of the net profits. 4. Net profits means market value minus reasonable and necessary expense of developing, extracting, and marketing the minerals. 5. Deductions only for expenses which benefit the common estate. a. No right to recover costs. b. Only a right of reimbursement out of production, if any. c. No deductions for dry hole, failed workover, etc. (does not benefit common estate). d. Non-consenting cotenant may ride the well(s) down and cherry pick which ones to ratify. e. Accounting nightmare. 6. Lessee of a cotenant becomes a cotenant of the unleased cotenant owners in the leased tract.

14 Cotenants 14 Yellow Tract Lessee is a cotenant with 1/3 Unleased Owner and 1/3 of 1/16 NPMI Owner. From #3, pay royalty to Lessors. After cost recovery, also pay 1/3 of production to 1/3 Unleased Owner less 1/3 continuing costs (and less the share payable to the NPMI Owner).

15 15 E. Good Faith and Bad Faith Trespass 1. Trespass entering or developing the minerals without the right to do so. 2. Damages good faith or bad faith trespass. 3. Good faith trespasser has an honest and reasonable belief in the superiority of his title. 4. Good faith trespass true owner may recover value at the surface minus reasonable costs of drilling, operating, and producing. 5. That is, good faith trespasser gets to offset his costs against production. a. No right to recover costs, only a right to reimbursement out of production, if any. b. Not one dollar of profit. 6. Bad faith trespasser must account for the value at the time of severance without deduction. 7. That is, bad faith trespasser pays back all value and walks away, donating all costs.

16 16 Good Faith/Bad Faith Trespass Locations #1 Cannot be drilled. #2 Can be drilled. #3 Can be drilled and not a trespass because 2/3 leased. #4 Can be drilled. #5 Many problems: Each tract traversed is a drill site tract. Each production point on the wellbore is a drillsite. Extends under both leased, unleased, and partially leased tracts.

17 V. NON-EXECUTIVE INTERESTS 17 A. Types of Interests 1. Executive right or right to lease is one of the sticks in the bundle of sticks that make up the property rights in the mineral estate. 2. NPMI owner owns the minerals, does not own the right to lease the minerals, but shares in bonus [usually]. 3. NPRI an interest carved out of the mineral fee estate as a free royalty which does not carry with it the right to lease, to receive bonus, or to receive delay rentals [usually]. 4. Real property interest.

18 18 B. Bonus Payments 1. Royalty payments are made directly to the owner of the NPMI or NPRI. 2. Parties may allocate the right to bonus however they choose. 3. In the absence of contrary intent, the NPMI has the right to bonus and the NPRI does not. 4. Bonus payment should probably be made directly to the owner of the NPMI, but there is some case law putting the duty to account on the holder of the executive right. 5. Some leases provide that any nonparticipating payments shall be made out of the amount payable to the Lessor (holder of the executive right). 6. Duties of the holder of the executive right unclear.

19 19 C. Ratification and Pooling 1. Producing cotenants must account to non-producing cotenants on the basis of value less cost. 2. Non-producing cotenants can elect to consent by ratifications and then share on the basis of lease royalty. 3. Ratification is: a. Formal ratification of lease covering non-producing cotenant s tract (Example D). b. Division order (maybe). c. Accepting payments (maybe). d. Filing suit. 4. Be clear which lease(s) is ratified 5. Ratification should be recorded. 6. In Texas, the executive cannot pool NPRI and the same rules probably apply to NPMI.

20 20 7. Ratifying leases: a. Pooling clause. b. Entirety clause. c. Community lease. 8. Non-executive can only ratify his executive s lease(s). 9. Concept is that by signing such a lease, the executive is making an offer to the non-executive to join in the (possible) pooling, which the non-executive can accept or decline. 10.Timing of ratifications: a. How long to accept not certain. b. Non-executive may ride the well down and make the election based on the location and the results. c. The non-executive may selectively ratify pooled units (lease plus pooling), rather than a global lease ratification. 11. Designation of Unit (Example Exhibit F): a. Some risk that the non-executive can ratify (as to a lease(s)). b. Other working interest owners probably cannot ratify.

21 21 D. Joint Operating Agreements 1. Joint Operating Agreement ( JOA ) is a contractual agreement among working interest owners governing the allocation of risks, costs, and production. 2. It will reflect whatever the parties agree upon. 3. Typically: a. Contract Area big box and a sharing arrangement inside the box. b. Individual loss. c. Joint loss. 4. Because risk of unleased interests can be spread out, it may make Prospect drillable.

E. Examples 22 SECTION 1 DIAGRAM (PROSPECT WITH OWNERSHIP) 1. Add to our example Prospect lease royalty provisions. 2. Example calculations in the paper.

22 E. Examples 22 SECTION 1 DIAGRAM (PROSPECT WITH OWNERSHIP) 1. Add to our example Prospect lease royalty provisions. 2. Example calculations in the paper. 3. Additional detail in a separate presentation. 4. Big question who gets the unleased owner s share?

23 VI. LITIGATION 23 A. MIPA 1. Mineral Interest Pooling Act. 2. Forced Pooling, but only 2 or 3 per year granted. 3. Purpose is to encourage large tract owners to voluntarily pool and let small tract owners in. 4. Why isn t it used more often? a. Does not apply to State lands. b. Does not apply to old fields (prior to 3/3/61). c. Does not apply to wildcats. d. Limitation on the risk penalty (100% on non-participating owner). e. Limitation on size of pooled unit (proration unit, > 160 acres for oil and > 640 acres for gas). f. Standing issues, procedural issues, timing issues, proof issues, cost issues.

24 24 1. May provide a solution for: a. Missing owners. b. Contingent owners. 2. Missing owners: a. Diligent search. b. Paid no taxes for five years. c. File suit, serve by publication. d. Attorney ad litem. e. Receiver can lease. B. Receivership 3. Contingent Owners similar solution for interests arising by way of remainder, reversion, possibility of reverter, executory devise, or occurrence of condition subsequent.

25 25 C. Partition 1. Joint owners of real property, including mineral owners, may compel a partition: a. By sale. b. In kind. 2. If minerals are unknown, courts assume all parts of the tract are equally endowed with minerals partition in kind. 3. If minerals are known partition by sale. 4. Right to partition is limited to possessory interests (e.g., Red Tract not subject to partition because the 1/32 NPRI is non-possessory). 5. Prior to leasing, 2/3 Owner of Yellow Tract could have partitioned (e.g., the west 2/3 of the NE/4) and then leased all of the partitioned tract. 6. However the leased 2/3 Owner cannot partition because the Lessor has no possessory interest.

26 26 D. Trespass to Try Title 1. Trespass to Try Title ( TTT ) is the procedure for a legal remedy to determine title and possession. 2. Plaintiff has burden of establishing a prima facie case: a. Regular chain of title from the sovereign. b. Superior title out of a common source. c. Title by limitations (adverse possession). d. By prior possession, not abandoned (no proof of title in Defendant). 3. If Plaintiff fails to carry the burden, Plaintiff loses Plaintiff s title or claim to title. 4. If Plaintiff meets burden, Defendant will lose Defendant s title or claim to title, unless Defendant can prove a better title or right. 5. Attorney s fees are not recoverable.

27 27 E. Declaratory Judgments 1. Uniform Declaratory Judgments Act. 2. Construing the meaning and effect of instruments included in the chain of title. 3. Elements: a. Parties must have an interest under a deed, will, or contract; b. Controversy; c. Court must be able to fully resolve the controversy. 4. Remedy is a declaration defining the respective rights, duties, and legal status of the parties in the suit. 5. Judgment affects only the parties. 6. Attorney s fees are recoverable. 7. Boundary disputes can now be brought either in TTT or as a DEC Action.

28 28 F. Quiet Title 1. An equitable action. 2. Remedy is a decree that an adverse claim is not valid, which will remove the cloud on title. 3. A cloud on title has been defined as any deed, contract, judgment, or other instrument not void on its face which purports to convey any interest in or makes any charge upon the land of a true owner, the invalidity of which would require proof. 4. Elements. a. Plaintiff has an interest in property; b. Plaintiff s title is affected by Defendant s claim; and c. Defendant s claim, although facially valid, is actually invalid or unenforceable.

29 VII. CONCLUSION Get your title work early to find the holes in your Prospect while there is still time to fix them. 2. Get a lease, exhaust all possible practical remedies. 3. Be careful about relying on limitations title. 4. Confirm your access rights and surface use rights. 5. Figure out the wellsite tract and avoid any unleased interest. 6. Figure out who has to ratify leases (NPRI, NPMI, unleased, etc.). 7. Figure out the pooling strategy, and who has to ratify. 8. Possible judicial, administrative, and contractual remedies: JOA, TRC, MIPA, Receivership, Partition, TTT, DEC Action, and Quiet Title. These are, in summary form, guideposts and suggestions for clearing title during the lease acquisition phase of Prospect development.

30 The Institute for Energy Law TEXAS MINERAL TITLE COURSE May 2-3, 2013 Houston, Texas IRREGULAR OWNERS UNLEASED, NONPARTICIPATING, UNPOOLED, OR UNCERTAIN OWNERS AND HOW TO MANAGE THE ISSUES Richard F. Brown 2013 Brown & Fortunato, P.C.

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