MINERAL vs. ROYALTY DISTINCTION

1 MINERAL vs. ROYALTY DISTINCTION AAPL 58 th Annual Meeting San Francisco By: Stan T. Ingram Travis Conner BIGGS, INGRAM & SOLOP, PLLC 111 E. Capitol Street Suite 101 Post Office Box 14028 Jackson, Mississippi 39236-4028 1

Stanley T. Ingram, J.D. Stan T. Ingram, a member of the law firm of Biggs, Ingram & Solop, PLLC, in Jackson, Mississippi, has thirty-two (32) years experience in title examinations and certification; preparation of oil and gas title opinions (preliminary, supplemental and division order title opinions); property rights disputes; exploration issues, including geophysical trespass issues; real estate closings, title issues; acquisition of easements and rights-of-way; real estate/mineral sales and purchases; and the preparation of real property acquisition and use related documents. Mr. Ingram received his Bachelors of Public Administration from the University of Mississippi and his Juris Doctorate cum laude from Mississippi College School of Law. He has published numerous articles on real property and natural resources issues. Mr. Ingram also actively practices administrative law before a number of state boards and commissions, including the State Oil and Gas Board, Mississippi Real Estate Commission, Mississippi State Board of Dental Examiners and Mississippi State Board of Medical Licensure. He is a member of the Mississippi Oil & Gas Lawyers Association (President, 1998), Mississippi Association of Petroleum Landman (MAPL) and the U.S. Oil & Gas Association. Published or Written Articles: Notorious Provisions of Selected Non-Standard Lease Forms MAPL Saturday CPL Program Ethical Considerations and the Obligation to Disclose MS Oil & Gas Institute, April 24, 1992 Geophysical Trespass - The Dominant Estate, Cotenancy, Advanced Geophysical Exploration Techniques, 2002 AAPL Gulf Coast Institute, November 7, 2002 How to Obtain Oil, Gas and Mineral Leases covering Church and Religious Property MAPL Seminar, June, 2002 The Oil & Gas Lease Landman 101 Seminar, April 22, 2006 Curing Title Problems presented to the MAPL/MO&GLA 2008 Triennial Oil & Gas Seminar, May 9, 2008

Mississippi Oil & Gas Law Update presented to the Ark-La-Tex Association of Professional Landmen Seminar, February 26, 2009 Oil, Gas and Mineral Land Law Understanding Rights Under Oil and Gas Leases Halfmoon, LLC Seminar, August 13, 2009 Mississippi Land Descriptions (revisited) Triennial Oil & Gas Seminar, April 29, 2011 SPECIAL THANKS: Special thanks to Travis Conner, attorney with Biggs, Ingram, Solop & Carlson, PLLC, who assisted in the research and preparation of this paper. Travis has been with our firm for three (3) years and is a graduate of Purdue University and Mississippi College School of Law. Prior to practicing oil and gas law, he worked as a Petroleum Landman in Mississippi.

TABLE OF CONTENTS A. INTRODUCTION...1 B. RULES OF CONSTUCTION...1 C. GENERAL CHARACTERISTICS OF A MINERAL INTEREST...2 D. GENERAL CHARACTERISTICS OF A ROYALTY INTEREST...2 E. SPECIFIC TERMS OF CONSTRUCTION...3 F. STATE BY STATE ANALYSIS...6 ALABAMA...6 ARKANSAS...6 CALIFORNIA...8 COLORADO...9 ILLINOIS...10 KANSAS...11 KENTUCKY...12 LOUISIANA...13 MICHIGAN...14 MISSISSIPPI...15 MONTANA...16 NEW MEXICO...18 NORTH DAKOTA...19 OHIO...20 OKLAHOMA...21 PENNSYLVANIA...22 TEXAS...23 UTAH...25 WEST VIRGINIA...26 WYOMING...28

THE MINERAL vs. ROYALTY DISTINCTION A. INTRODUCTION Every landman and title attorney has been called upon to review what purports to be a simple mineral deed or reservation which, at first blush appears to pass mineral ownership with all of the inherent rights to execute oil, gas and mineral leases. A decision is then made as to the person/entity from whom the mineral lease should be secured. All this appears simple until you consider additional language in the deed which appears to limit the interest conveyed/reserved. It is at this point you begin questioning whether or not the potential lessor owns a mineral or royalty interest. It has been stated, one of the most vexing oil and gas title questions for landmen, lawyers and the courts is determining whether a deed creates a mineral or a royalty interest. i As will be hereinafter discussed in more detail, the attributes incidental to either a mineral or royalty interest are generally consistent across all states, but the resulting decisions based such attributes is nothing close to consistent. Before we launch into a detailed discussion of such attributes and how the courts have applied each, one must have a clear understanding of the general rules of construction applicable to all deeds. B. RULES OF CONSTRUCTION The main objective in construing a deed is to ascertain the intent of the parties based on the verbiage contained in the deeds subject to the following general rules: 1. Four Corners Doctrine. Construction of the deed should be based upon the entire instrument and each word and clause, if at all possible, should be reconciled and given a meaning that can be reasonably done. This is what is referred to as the Four Corners Doctrine recognized in most but not all jurisdictions. If the deed can be interpreted using all four corners, the courts will not permit parole or extrinsic evidence of the intent of the parties; 2. Earlier Clauses Prevail. Earlier clauses in the deed prevail over repugnant and inconsistent subsequent clauses. However, this rule does not apply where, from the whole instrument, the intention of the parties is plain; 3. Doctrine of Merger. All negotiations between the grantor and grantee or lessor and lessee with respect to the scope of a deed are merged in the deed and it is an error to admit oral testimony where there is no ambiguity therein; 4. Written Words Prevail over that Printed. Where written provisions cannot be reconciled with printed provisions in the deed, written provisions will control;

5. Typed-in Words Prevail over that Printed. If printed and typed written provisions are inconsistent, typed written provisions will prevail; 6. Construed Against Grantor. A deed must be construed most strongly against the grantor and most favorably to the grantee; 7. Construed Against Preparer. In similar fashion, a deed shall be construed most strongly against the party who prepared it; and 8. That which is not specifically reserved is conveyed. While not a rule of construction, most courts stand by the general principle that where words in a deed are ambiguous and the parties by their acts have given a practical instruction thereto, such a construction may be resorted too. C. GENERAL CHARACTERISTICS OF A MINERAL INTEREST While there are some variations from state to state, as will be hereinafter noted, the general characteristics of ownership of minerals in place are as follows: 1. The mineral owner has the right of entering, occupying and making such use of the surface as is reasonably necessary in the exploring, drilling, mining, removing and marketing of the minerals; 2. Such a mineral interest is not free of the costs associated with exploring, drilling, mining, removing and marketing of the minerals; 3. The mineral owner has the right to execute oil, gas and mineral leases, thus conveying the right of exploring, mining, removing and marketing to third parties. 4. The mineral owner has the right to receive all bonus and delay rentals associated with executing oil, gas and mineral leases; and 5. The owner of minerals also owns the possibility of reverter of the minerals in fee upon expiration of the lease; D. GENERAL CHARACTERISTICS OF A ROYALTY INTEREST Conversely, the distinguishing characteristics of a royalty interest that is a nonparticipating interest in production, subject to the variations as will be hereafter noted, are as follows: 1. The royalty owner has no right to explore, mine, remove or market the minerals, thus no right of ingress and egress; 2

2. Such an interest in production is not charged with any of the costs of exploring, mining, removing and marketing of the minerals; 3. The royalty owner has no right to grant oil, gas and mineral leases to third parties; and 4. The royalty owner has no right to receive bonus and/or delay rentals. If all deeds and/or reservations were to describe the interest conveyed/reserved consistently utilizing the above distinguishing characteristics, there would be no issue or reason to write this paper. The problem, as we will point in each of the referenced states, is that the above characteristics of ownership, can be separately conveyed or reserved thereby altering, in many instances the interests conveyed/reserved from that of a mineral to royalty and vice versa. E. SPECIFIC TERMS OF CONSTRUCTION Of further interest, as we review the case law on this subject from state to state, we also point out that the courts have wrestled with particular terms and phrases when added to interpreted deeds as being either a mineral interest or royalty interest. This would include the following: 1. Effect of words Minerals, Mineral Interest or Mineral Acres. While of the word minerals or mineral interest or mineral acres has influenced many courts to construe the interest as a mineral interest, it is well established that such a designation in and of itself is not conclusive. If the instrument references other characteristics which point to a royalty interest, such characteristics may outweigh the mineral reference resulting in a royalty construction. 2. Effect of words in, on and under. Generally, the grant or reservation of minerals in and under will create a mineral interest if such a grant or reservation does not otherwise contain contradictory provisions. 3. Effect of words in, on and under and that which may be produced. According to William and Meyers, Oil and Gas Law, Section 304, perhaps the most common method of creating a mineral interest is by a grant or reservation of oil, gas and other minerals in and under and that may be produced from the land. This phrase, standing alone will create a mineral interest. It seems that reference to that which may be produced will result in a royalty conveyance in the states of Arkansas, Kansas and Oklahoma. 3

4. Effect of words produced and saved. The combination of these words has consistently resulted in interpretation of a royalty interest. Where the instrument grants and reserves oil, gas and other minerals produced and saved without other provisions relating to the characteristics of a mineral interest, the courts have construed such verbiage as being a royalty. 5. Effect of words Royalty, Royalty Interest or Royalty Acres. In majority of the oil producing states, the use of such terms without other conflicting characteristics, will create a royalty interest, that is, an interest in oil and gas production as if and when such production is achieved. This includes Mississippi, Colorado, Kansas, Arkansas, New Mexico and Texas. As will be noted below, use of the word, royalty is not conclusive and where followed by contradictory elements consistent with a mineral interest, have swayed many of the courts to conclude the grant/reservation to be that of a mineral interest. 6. Effect of words share of profits. If a grant/reservation includes the right to share in profits, i.e. a portion of all royalties, incomes, rentals, etc., the conclusion (and reasonably so) is that of a mineral interest. The only exception appears to be West Virginia, Oklahoma and Colorado, wherein there still appears to be some confusion in this regard. 7. Effect of words non-participating in bonus, rental and Executive Right Because a mineral interest by character participates in the right to execute leases and therefore receive the bonus, rental and royalty under said lease, the pure royalty interest would share in production only and has no interest in bonus, rental or the executive right. Thus, in most jurisdictions, where such rights create a mineral interest, problems are encountered when the deed conveys what appears to be a mineral interest followed by a reservation of the right to receive bonus, rental and the executive right (to execute leases). For example, a deed grants 1/16 of all oil, gas and other minerals in, on and under lands, but the grantor then reserves all right to bonus, rentals and right to execute leases. A granting clause clearly suggests a conveyance of a 1/16 mineral interest, but when we consider the reservation of the usual elements of mineral ownership, some courts find the same to be of a royalty conveyance (but not in all jurisdictions). 8. Effect of words No Executive Right. As this paper will hereinafter show, there are a number of jurisdictions which recognize that the executive right, is a separate interest in real property, subject to being conveyed and/or separately reserved. Thus, a party can receive an undivided interest in all oil, gas and other minerals but denied the right to execute 4

leases and receive the bonus and rentals therein. A number of cases have held this to be a non-executive mineral interest. In some cases, a reservation of the executive right implies a reservation of a right to receive bonus and rental. 9. Effect of words non-participating in bonus and rental. A number of decisions were found, wherein the grantor conveyed and/or reserved all rights to bonus and rental but with no reference to the executive right. In such a situation, the courts have held that the reservation of bonus and rentals creates an implied reservation of the executive right. The only remaining question is to whether or not the interest conveyed/reserved is that of a royalty or mineral. The most logical conclusion is that in such a situation the reservation of a mineral interest, less the incidence of bonus and rental, is nothing more than a reservation of a mineral interest without those rights. Thus, it is conceivable that a party can convey/reserve a mineral interest with executive rights but not participate in bonus and rental. 10. Effect of conveying/reserving abnormally large royalty. A number of cases were found wherein a grantor conveyed or reserved an undivided 1/2 interest with rights generally attributable to that of a royalty interest. Obviously, if one were to convey/reserve 1/2 of all minerals produced, the properties would be overburdened and thus unleaseable. A number of situations were found wherein the courts ruled that the abnormally large fraction would be indicative of a conveyance/reservation of a mineral interest. In recent times, the industry has seen an increase in the retained royalty from the usual 1/8 to 1/4 or greater. Accordingly, a grant or a reservation of an undivided 1/4 interest in all oil, gas and other minerals that may be produced, could conceivably be a reservation or a royalty, depending on the other terms and provisions. One Texas decision was found in this regard. As succinctly stated in Williams and Meyers, Oil and Gas, Section 304, as a matter of judicial policy, where the instruments do not specify the rights of the parties, two options are available to courts desiring to make a consistent, coherent body of law on this subject. Courts could take the position that the instruments are ambiguous and admit extrinsic evidence to aid in their construction. Many authors and jurists however, believe that a second course should be adopted, i.e. the instruments should be regarded as unambiguous and a construction give to them that seems best to comport with the parties intentions. When interpreting a grant or reservation, the characteristics of the two (2) kinds of estates must be kept in mind. Each deed must be considered as a whole keeping in mind that the owner of mineral rights may convey or reserve any one or more the separate elements or attributes. 5

F. STATE BY STATE ANALYSIS ALABAMA Early jurisprudence in Alabama establishes and interesting distinction between the ownership of a mineral interest and a royalty interest. In McCall v. Nettles, two (2) deeds contained the following language, to wit: [f]ifty per centum of all rentals that may be derived form coal, oil, gas or other minerals leases in and to said lands and fifty per centum of all royalties whether in kind or money. ii While the reservations did not explicitly reserve executive rights, and presumably none passed, the court held that a mineral interest was retained because the reservation spoke to an interest in the minerals themselves as they are imbedded in the ground before there is an effort to extract them. iii Also, when a grant in a conveyance is limited specifically to all the oil royalty, and gas royalty, combined with the right of ingress and egress for mining, drilling and exploration (via printed form), a royalty interest is conveyed. iv In Pilcher v. Turner, the grantors reserved all interest in oil and gas under the conveyed lands, together with full and exclusive right and power to sell, lease, assign or otherwise dispose of said mineral rights, but with the condition that upon production of minerals, 1/2 of all proceeds would be paid to the grantee. v When leasing of the mineral rights became an issue, due to an alleged ambiguity with the reservation, it was determined that the reservation clearly spoke to the mineral estate, and passed only a royalty interest, or proceeds that could be recovered by production. vi In doing so, the court relied on the full and exclusive right to lease that was retained. vii In a final interesting case, the Alabama Supreme Court was charged with determining the classification of a non-participating royalty interest: fee estate or personal property. viii While there was no direct contention that a royalty interest was sold, it was offered that a royalty interest not subject to production could not vest until a later date, and therefore would violate the rule against perpetuities. ix Relying on case law from Arkansas, and specifically declining to follow Kansas jurisprudence, it was held that a royalty interest was an interest in real property because the value and alienability of this right was the same as a severed mineral interest. x As such, a royalty interest in Alabama cannot be considered personal property. ARKANSAS As it has been stated in the introduction to this paper, nationwide jurisprudence is at least somewhat consistent in following a general rule that the mineral estate contains five noteworthy elements. Arkansas, like some other states that will be discussed below, does not appear to have concise law on the elements of the mineral estate, but given geographical proximity to Texas, and occasional reliance on its oil and gas law, it is believed that Arkansas would recognize the five (5) elements of the mineral estate, as articulated in Altman v. Blake. xi They are as follows: 1. The right to explore, develop, and ingress and egress; 2. The right to execute oil and gas leases, i.e. executory rights; 3. The right to receive bonus payments on execution; 4. The right to receive delay rentals; and 6

5. The right to receive royalty payment under an existing lease. For some specific examples of Arkansas interpretation of instruments in the mineral/royalty realm, we begin with Smiley v. Thomas, xii where a deed entitled Warranty Deed, Oil, Gas and Mineral Royalty was subject to scrutiny. The grant in Smiley conveyed an undivided one-half interest in and to all of the oil, gas and other minerals, in, under and upon the conveyed lands, with the right to receive an undivided 1/2 of all oil and gas rentals due. xiii The Arkansas Supreme Court, relying on a prior decision with identical language, xiv held that there was no dispute that a mineral interest was passed to the grantee. xv The Smiley decision can be attributed to the use of the language in, under and upon to signify a mineral interest. Likewise, when a conveyance contains a clear reservation of all the oil, gas and mineral rights, a reservation of a mineral interest will be achieved. However, when ambiguous language accompanies this same reservation language, like the instrument being labeled as a Royalty Deed, Arkansas courts will ascertain the intent of the parties through the four (4) corners of the instrument. xvi In such a case, the granting or reservation clause will be superior to the instrument title, for the sake of harmony. xvii On the other hand, when a conveyance uses the language produced and saved in a reservation or grant, a royalty rather than mineral interest is created. xviii This is because the language oil and gas produced and saved from the land, [] is not synonymous with those minerals in their natural state. xix Also, in cases where an ambiguity exists in the instrument, the intent of the parties will control, especially if there is specific language in the instrument relating to the parties understanding of what is being conveyed. xx CALIFORNIA Following similar case law in other states, an owner of a fee mineral interest in California is considered the owner an expense-bearing interest, i.e. bearing the cost to explore, drill and produce oil, gas and other minerals, and may convey that right to others via a mineral lease. Accordingly, a conveyance of oil, gas and other minerals in and under land, is a conveyance of a mineral fee. Adding the verbiage and that may be produced does not convert the interest to an expense-free royalty. In Little v. Mountain View Dairies, Inc., the Supreme Court of California early on addressed the nature as well as elements of a mineral fee interest. xxi In Little, the Supreme Court of California, considered a 1935 mineral deed conveying as follows: Eight and one-third percent (8 1/3%) of all oil, gas and other hydrocarbons substances, and minerals, in, under and/or which may be hereafter produced and saved from. xxii Ten years later, the successors to the grantors leased the property providing for a 1/6 royalty. The successors of the grantee argued that the addition of the words and which may hereafter be produced and saved changed the deed from a mineral fee to a royalty, thus entitling them to receive 1/2 of the royalty provided in the lease. xxiii In ruling that the interest conveyed 7

was a mineral fee, the court cited earlier decisions of Callahan v. Martin and Dabney-Johnson Oil Company v. Walden, xxiv the latter of which made a number of interesting observations regarding the nature and characteristics of mineral v. royalty in California, to-wit: 1. The owner of land has the exclusive right to drill and produce oil. This right is a valuable right which may be transferred. The right when granted is a profit a prendre, a right to remove a part of the substance of the land. A profit a prendre is an interest in real property in the nature of an incorporeal hereditament. 2. The profit a prendre, whether it is unlimited as to duration or limited in terms of years is an estate in real property. If it is for a term of years, it is a chattel real, which is never the less an estate in real property, although not real property (please note that this differs from the majority states which considers a lease a determinable fee interest ). 3. One who grants a thing is presumed to grant also whatever is essential to its use. The right of entry is incident to the grant of a mineral fee, and exists without express mention. 4. The right to receive future rents and royalties is an incorporeal hereditament, which is an interest in land and may be subject of a grant. xxv In Dabney-Johnson, the Supreme Court of California considered the following grant: a two percent in said land owner s royalty of all gas, oil and other hydrocarbon substances to be produced and saved and sold from said described land, together with all of the rights and privileges granted in that certain lease above set out. xxvi The interest is described as a royalty, and in holding that the interest was exactly that (an expense-free royalty), the court reasoned that since the 2% had been carved from the land owner s larger percentage royalty under an existing lease, it would necessarily be implied that after termination of the lease, the 2% interest remained a royalty. xxvii The court concluded that in absence of extrinsic evidence or other controlling language in the deed, a grant of a fraction of all oil, gas and other minerals that my be produced and saved from the land creates a mineral fee. xxviii COLORADO Colorado has placed reliance in other jurisdictions to define the elements of a mineral estate, and did so succinctly in Simpson v. Langholf, as follows: Where the conveyance or reservation, as the case may be, consists of an interest in perpetuity to all the oil and gas mineral that may be extracted, the conveyance or reservation is a grant or reservation of the minerals in fee simple with the attributes and rights that go with such ownership, including the right to enter upon 8

the land for exploration of oil, participation in delay rentals, bonuses and leasing. xxix In addition to providing a definition for a mineral interest, Simson is interesting in a number of other respects. In looking at a fractional interest of all oil and/or gas produced and saved and marketed from the conveyed lands, the Colorado Supreme Court approved the introduction of extrinsic evidence to conclude a fee mineral estate was intended to be vested in the grantee. xxx This is notable in two (2) respects: first, that the language produced and saved could be considered a mineral interest, and second, that the traditional four (4) corners approach was expanded to allow extrinsic evidence to determine the intent of the parties on an unambiguous instrument. Ultimately, the Simson Court relied on the language assigned and set over, along with the fact that no oil, gas and mineral lease existed, to conclude a mineral interest was conveyed. xxxi Similar to Simson, in the case of Corlett v. Cox, a mineral interest was deemed reserved through language that excepted a percentage of oil and gas under the reservation language all gas, oil and minerals that may be produced on any of all the [] lands, or in other words reserves 1/2 of the usual 1/8 royalty. xxxii While the court applied the four (4) corners approach to determine the parties intent, heavy reliance was given to the fact that no oil, gas and mineral lease was in force and effect at the time of the conveyance, and the agreement between the parties indicated the fee reservation was in partial payment for the lands. xxxiii In contrast, a non-executive mineral interest is created where a reservation does not retain the executive rights to the fee estate. In Mull Drilling Company, Inc. v. Medallion Petroleum, Inc., a 1/4 interest in and to all oil, gas and other minerals was reserved by the grantors, but further clarified as non-participating in any leases, participation being limited to royalty only payable under said leases, and it shall not be necessary for said grantors, heirs or assigns, to join in the execution of any leases. xxxiv This language being unambiguous that the reservation did not include executive rights, it was clear that the grantees would benefit from delay rentals or bonuses for execution of future leases. xxxv In making this ruling, the court also acknowledged that a royalty interest flows from production of oil and gas on the subject lands, with no rights to participle in bonus, rentals or execution of lease, while a non-executive mineral interest participates in production on leased lands subject to the provisions of the oil, gas and mineral lease, and a non-executive mineral owner has no executive rights. xxxvi ILLINOIS In Illinois, the language in and under and that may be produced from creates a mineral interest absent other provisions relating to the minerals. xxxvii In Triger, the court determined a mineral interest in fee for infinite duration was transferred from the language of the deed that included the right of ingress and egress for the purpose of exploration and development. xxxviii Interestingly, the court, through dicta, stated that in Illinois no title to minerals vests in a grantee until it s actually removed from the land. xxxix However, in a subsequent decision, the Illinois Supreme Court interpreted another document which was a reservation of 1/16 of all oils and minerals produced from the premises hereby conveyed. xl At the time of the deed, lands were subject to an oil, gas and mineral lease providing for a 1/8 royalty so the issue was whether or 9

not the interest reserved is a royalty (1/2 of 1/8) or a mineral interest which would result in a royalty of 1/16 of 1/8. Determining the parties intent by the well established Four Corners Rule of Construction, i.e. deed must be construed as a whole to determine the party s intent, the court ruled that reference to produced construing the creation of a royalty interest. xli At first glance, one may find the decisions to be contradictory, but the facts in Triger are clearly distinguishable because all attributes of mineral ownership were specifically reserved. We note that in Hardy, the reservation of the royalty was for 15 years. This fact may have been taken into consideration in Logue v. Marsh, xlii wherein a 1972 deed contained a reservation of all royalties from existing wells under and by virtue of any lease, pooling or unitization agreement. Citing that production from existing wells would not be perpetual and thus a finite interest, the court ruled that the interest reserved was a royalty alone and not a mineral interest. xliii Distinguishing term vs. perpetual interest as a basis of determining whether an interest is mineral or royalty is rather interesting, especially when we consider the ruling of the federal court in Vanderbark v. Busiek, xliv wherein the Seventh Circuit, construing Illinois law, interpreted a reservation of a 3/4ths of the oil, gas and other petroleum royalties which may arise out of any present or future lease and 3/4ths of all bonuses, rents and royalty and other benefits which may accrue under present and future leases. In this case, the grantor excepted a mineral interest in view of the fact that the reservation was of a perpetual right in the grantor, and the reservation of a perpetual interest in royalty has the effect of reserving the thing for which the royalty is paid [i.e., the mineral estate for oil, gas and petroleum products]. xlv KANSAS Following most states, the owner of a mineral estate in Kansas enjoys the right to use so much of the surface as is reasonably necessary to drill, explore and produce oil, gas and other minerals. Where issues have been raised concerning whether an interest conveyed or reserved is that of a mineral versus royalty, there are a number of decisions providing guidance. The executive rights, rights to bonus, delay rentals and royalty are generally referred to in Kansas as the owner s right to participate. These rights may be separated from the mineral estate by creating a non-participating mineral interest. These interests may be owned, conveyed and reserved or inherently separated from other interests. xlvi As in most states, a mineral estate is classified as real property in Kansas. Conversely, royalty is deemed to be a non-mineral interest and considered personal property with a mere right to share in oil and gas when it is actually produced. xlvii According to an excellent summary of Kansas law is found in the AAPL Nationwide Comparison of Laws on Leasing Exploration and Production, xlviii royalty in Kansas refers to a cost free share of production. However, a royalty interest may be created by a mineral interest owner without the necessity of a lease. xlix When distinguishing between minerals versus royalty, a number of Kansas decisions hold that the verbiage in, on and under and/or that may be produced creates a mineral interest when no other provision concerning the minerals are present. l Shepherd v. John Hancock describes the plain meaning of the language in, on and under as contrary to the definition of royalty; li and 10

Rutland Savings Bank and Steele considered the use of the language in and under and that may be produced from as unambiguous and creating a mineral interest only. lii Terms that indicate an interest in oil and gas production, but not bonus, delay rental, or developing executive rights, such as royalty, royalty interest and royalty acres, create a royalty interest. liii Although a perpetual royalty interest is valid in most states, in Kansas it has been held to violate the rule against perpetuities. liv To avoid problems with the rule against perpetuities, royalty interests are generally conveyed for a definite term of years subject to extensions during such time as there is production in paying quantities. KENTUCKY Kentucky, like many other states, has relied on reputable oil and gas treatises for a basic framework for mineral and royalty interests. This is best evidenced in Gallin v. Combs, lv where the Court of Appeals of Kentucky offered the following definitions: A royalty interest created by grant or reservation prior to lease is commonly referred to as a perpetual nonparticipating royalty. The owner of such an interest is not privileged to enter on the land and produce oil and gas and thus has no authority in the execution of leases covering the mineral estate. The mineral fee owner has the sole privilege of drilling for and producing the oil and gas and, therefore, the sole legal power to execute a lease to a third person. The nonparticipating royalty owner is entitled to his stipulated portion of the producing expense free. Where instruments of conveyance have used the words royalty or profits in describing the interest intended to be granted or reserved, the courts generally have held a royalty interest was created, but where the grant or reservation is expressed merely in terms of an interest in the oil, gas, or other minerals it is held that a mineral fee interest is created. lvi Direct application of these general rules is often tricky, but Kentucky does have jurisprudence to further develop its treatment of the mineral royalty distinction. Staying with Gallin v. Combs, a reservation of a fractional one-sixteenth of all minerals on or under said land was an unambiguous exception of fee minerals in place. lvii For an example of a less certain grant of an oil and gas interest, the phrase 1/64 oil and gas royalty was determined to convey fee simple title to a mineral interest. lviii In this instance, the interpretation of the interest passed was supported by the granting clause conveying oil and gas royalties and interest in oil and gas. lix Essentially, the court acknowledged that the term mineral, although not used in the conveyance, is an indefinite term that must be analyzed through looking at the surrounding circumstances, and the instant case turned on the original intent of the grantor to convey all interest owned, royalty and mineral. lx Turning to Kentucky law on royalty interests, in Texas Co. v. Bowen, lxi a 1/32 part of Royalty was conveyed, with the specific intent that the grantee would receive 1/32 part of all oil and gas lying in and under said land, and the grantor reserving full executive rights to release the property (the property being under an existing oil, gas and mineral lease). The dispute existing between the parties was whether a 1/32 of 1/8 or 1/32 of the whole royalty interest was 11

conveyed, since the conveyance was subject to an existing lease. lxii Finding the granting language ambiguous, but holding that patent ambiguity does not allow parol evidence, lxiii it was concluded that a 1/32 of the whole was conveyed. lxiv This interpretation relied heavily on the reservation of the grantor of the executive rights to re-lease the lands. lxv In a similar case with an identical result, a reservation of a 1/16 royalty interest in all the oil and gas now being produced or which may hereafter be produced was considered to except 1/16 of the whole, not 1/16 of 1/8 royalty interest. lxvi In addition to determining that the interest reserved would not be reduced by any royalty on a current or future oil, gas and mineral lease, the court held that the use of the phrase now being produced or which may hereafter be produced negated any claim for an interest in minerals in place, but instead reserved only a royalty interest. lxvii LOUISIANA Unlike the other states analyzed in this article, where the basis for interpretation of mineral royalty issues is developed through case law, Louisiana relies on statutory authority to define the mineral estate, royalty interests, and executive rights. lxviii At the heart of Louisiana mineral law is prescription of the mineral and royalty estate for non-use, essentially a reversion to the surface owner after a term of ten (10) years without production, subject to certain statutory rules and regulations. While this statutory scheme is different than other states that hold the severance of fee minerals lasts in perpetuity, we find case law that speaks to the same issues in defining the mineral and royalty estates. Beginning with the mineral estate (servitude), a reservation of an interest in minerals in and under the conveyed property is indicative of a reservation of the mineral estate, giving the party possessing the mineral estate the right of ingress and egress for exploration and production. lxix However, the reservation of a fractional royalty in all oil, gas and mineral rights under conveyed lands would only preserve a royalty interest, even when the reserving party executed an oil, gas and mineral lease after the reservation. lxx Therefore, if a party intends to reserve anything other than royalty, it is always wise to use specific terms that indicate a greater interest like mineral interest or mineral rights. lxxi With a mineral interest/servitude being an interest in land, Louisiana holds that a mineral royalty is not a servitude, but a passive, non-cost bearing interest and an inferior and conditional real right which entitle the owner only to participate and share in the gross production of minerals from another s land or from land subject to a mineral servitude owned by and burdened with such interest when and if production is obtained. lxxii Therefore, any benefit that is received by a royalty owner is contingent solely on the mineral owner s efforts in exploration and production, lxxiii and the royalty interest holder would have no operational or executive rights. lxxiv Louisiana also has several cases that speak to a reservation s impact on the bonus or rentals that are paid on or after the execution of an oil, gas and mineral lease. This was the case in Ledoux v. Voorhies, lxxv where a fractional conveyance of a mineral interest was coupled with the specific grant of full executive rights, but subject to a division of royalties between the respective mineral owners. When the parties reserving royalty claimed they were entitled to receive bonus and delay rentals, the court rejected this claim because nowhere in the reservation was there specific language excepting all income, bonuses or rentals the lease might bring, save 12

as therein specified. lxxvi On the other hand, in Mt. Forest Fur Farms of America, Inc. v. Cockrell, lxxvii although the reservation specifically stated a perpetual royalty interest was excepted, when combined with the exclusive right to executed all future oil, gas and mineral leases, it was held that the owner of the executive rights intended to reserve all right to future bonus or delay rentals. lxxviii While both Ledoux and Cockrell have been overruled on the basis that the cases should have been remanded for a trial on the merits, lxxix thereby allowing extrinsic evidence to determine the intent of the parties, each provides a good framework for what language should be included in a reservation if bonuses and delay rentals are to be excepted. MICHIGAN While no specific mineral versus royalty case law was discovered, it appears that Michigan applies the traditional tenants the define a mineral interest, namely (i) the right to explore and develop, with rights of ingress and egress for production, (ii) executive rights for the mineral interest, (iii) including the right to receive royalty, bonus or delay rentals. In addition, both an oil and gas lease, and the realty by which they are secured (the mineral rights), are real property. lxxx MISSISSIPPI A number of notable decisions have been rendered by the Mississippi Supreme Court addressing the mineral versus royalty distinction. It was first addressed in Palmer v. Cruze, lxxxi and later Westbrook v. Ball. lxxxii As it was said in Westbrook, it is all a matter of contract, and a mineral owner can transfer or reserve any or all part of his rights, whether it be leasing rights, royalty interest, or minerals. lxxxiii It was not until 1959, when the Mississippi Supreme Court rendered the decision in Mounger v. Pittman, lxxxiv that the Court specifically addressed the mineral versus royalty distinction. In this case, a grantor executed a deed at a time when the property was not subject to any mineral lease, but contained the following reservation: We do hereby reserve for ourselves, our heirs and assigns, 1/8th of all the oil and gas which may be produced from said lands to be delivered in tanks and pipelines in the customary manner, and this shall be a covenant running with the land and all sales and other conveyances of said lands shall be subject to this reservation and easement. lxxxv The question was whether the reservation reserved unto the grantors a non-participating royalty or an interest in the minerals in place. The lower court held that it was a reservation of minerals in place. The court set forth the distinguishing characteristics of a non-participating royalty interest, (1) such share of production is not chargeable with any of the costs of discovery and production; (2) the owner has no right to do any act or thing to discover or produce the oil and gas; (3) the owner has no right to grant leases; and (4) the owner has no right to receive bonus and delay rentals. lxxxvi Conversely, the court cited the distinguishing characteristics of minerals in place as (1) such interest is not free of the costs of discovering production; (2) owner has the right to do any and all acts necessary to discover and produce; (3) the owner has the right to grant leases and (4) the owner has the right to receive bonus and delay rentals. lxxxvii Of note, the court held that particular words are not always determinative and even 13

though reservations specifically refers to royalty interest if other language therein reserves the remaining incidences of the mineral estate, the reservation may be construed as reserving a mineral right. lxxxviii In Mounger, the court was specifically construing the words which may be produced from said lands, adding that such a reference in and of itself is not sufficient to establish a reservation of royalty only. lxxxix If parties use a standard printed form customarily used in the industry as a mineral deed, but make a number of changes to the printed form, such changes may effectuate a change from mineral to royalty deed. See Harris v. Griffith xc (deleting from printed form any right under an existing lease). Also, one or more incidents of ownership are oftentimes implied as opposed to expressly stated. See Lackey v. Corley xci (three of the four characteristics of a non-participating royalty expressly stated but the fourth was implied). This is consistent with the rule of construction that the instrument should be read as a whole. Mississippi also follows the well established principle that a mineral deed or reservation may convey or reserve certain attributes of a mineral ownership. Thus, in a mineral deed, the grantor may convey an undivided mineral interest but reserve unto himself all bonus and delay rentals, or both, without specifically altering the interest conveyed to that of a non-participating royalty. See Thornhill v. Systems Fuels, Inc. xcii (conveyance of a mineral interest followed by a reservation of all bonus and delay rentals under any oil and gas leases did not so change the character of the mineral deed so as to transfer it into a non-participating royalty, i.e. referred to as a non-participating executive right ). MONTANA In Montana, the term royalty was first addressed by the courts in Hinerman v. Balkwin, xciii wherein a landowner when executing a lease attempted to set the lease aside based on a mistaken understanding of the word royalty. The Montana Supreme Court ruled that the term has a very well understood definite meaning in mining and oil operations. xciv As thus used, it means a share of the profit paid to the owner of the property. xcv The distinguishing characteristics of royalty versus minerals were later litigated in two important decisions. xcvi Interpreting a purchase and sale agreement providing for a reservation of all except two percent (2%) of the landowner s royalty rights in and under all oil, gas and other minerals in, under and upon said premises, the court in Stokes launched unto an excellent summary of Montana law. xcvii First, it recited that Montana is an ownership in place state with regard to oil, gas and other minerals. The general rule was stated that both petroleum and gas as long as they remain in the ground are part of the realty. Second, Montana recognizes the rule that title to the mineral estate and land, including oil and gas interest, may be segregated in whole or in part from the rest of the fee simple title. Third, under a mineral deed conveyance, that is, a conveyance of the mineral fee, the grantee is the recipient of the following incidence of ownership: 1. The right to go upon the land, to conduct exploratory operations and produce the oil and gas. If there is a subsisting oil and gas lease, this right is subject thereto but may be exercised when and if the lease terminates; 2. The right to execute and oil and gas lease; 14

3. The right to share in the bonus under future leases; 4. The right to share in rentals under existing and future leases; and 5. The right to share in royalties under existing and future leases. xcviii The court went on to recite that whether a royalty or mineral interest has been granted, also necessitates an analysis of the term royalty. In doing so, the court made the following observations: 1. Royalty standing alone has a very well understood and defined meaning in mining and oil and gas operations, i.e. a share of the produce or profit paid to the owner of the property, namely in the personal property which the owner is to receive from the granted privilege of producing minerals. 2. In its broadest sense, however, the term royalty refers to an interest that the landowner may create by outright grant or reservation either before or after execution of an oil and gas lease. 3. If unlimited as to time, the interest is referred to as a perpetual non-participating royalty. 4. Royalty does not carry with it the right to participate in execution of, the bonus payable before, the delay rentals to accrue under oil, gas and mineral leases executed by the owner of the mineral fee. xcix Drawing distinctions and comparisons to a previous decision in Marias River Syndicate v. Big West Oil Co., c the court placed great emphasis on the words in and under and upon as creating a mineral interest. Unfortunately, the court did not render a final interpretation, concluding that the contractual provision was ambiguous and remanded the case back for further trial as to the intent of the parties. What this does show however, is that Montana follows the general rule of law permitting consideration of outside evidence where a deed s language is ambiguous. In fact, this rule of construction has been codified as Montana Code Ann. 28-2-905 and 70-1-513. In 1970, the Montana Supreme Court, in Smith v. County of Musselshell, ci added further clarification to the issue. In that case, the court was asked to interpret a previous court decree finding that the county had retained the following interests in a 1941 land deed: 6% of all oil, gas and other minerals lying in and under and that may be produced from said premises. cii Relying on the distinctions set forth in Stokes and Marias River Syndicate, supra, the court concluded this was a reservation of a mineral deed. The court held that even if a reservation contains the word royalty use of the words lying in and that may be produced 15

from said premises connotes a mineral interest inasmuch as there is no expressed provision in the deed for a royalty payment free and clear of the cost of its discovery and production. ciii NEW MEXICO Two decisions in New Mexico are particularly illustrative of the mineral versus royalty distinction. In Atlantic Refining Co., civ the New Mexico Supreme Court interpreted a deed conveying an undivided 1/16 interest in all the oil, gas and other minerals, in and under or that may be produced from 40 acres of land together with the right of ingress and egress at all times for the purpose of developing the same. At first blush, this would clearly be a conveyance of a 1/16 mineral interest. However, the granting clause was then followed by the following intention provision: This conveyance is intended only as a Mineral Deed and to convey only an undivided one half of the Royalty on the above described Forty Acres of land to wit: An undivided one sixteenth of said Minerals thereunder or which may be produced therefrom, but not so as to affect in any way the title in fee simple to said lands nor to convey any interest whatever in or to any rentals or future rentals of Oil, or Gas minerals in under or that may be produced from said lands, but same is reserved unto grantor, specifically, and in [sic] the intention of this mineral deed is to convey, and it is so understood, and [sic] undivided one half of the Royalty, or an Undivided one sixteenth (1/16) of the Minerals thereunder. cv Based upon the above intention clause, the court ruled that the conveyance was of an undivided 1/16 of 8/8ths royalty interest. In so doing, the court made a number of interesting observations: 1. That the title Mineral Deed is of little aid in constructing the affect of the instrument. Citing Kansas law 2. That creation of the right of ingress and egress as generally connoting a mineral interest, and is not controlling. Citing Williams and Myers in West Virginia decision 3. Ordinarily a conveyance of an interest in minerals in and under or thereunder without further provision is construed as a mineral interest. Citing Arkansas authority 4. Reservation of the right to receive any part of bonus or rentals indicates an intent to convey royalty only. Citing Texas law After defining a royalty interest as being that share of the product or profits (ordinarily 1/8) reserved by the owner for permitting another to develop his property, the court found that the above intention clause clearly indicated an intent to reserve a royalty as opposed to mineral interest. cvi In an earlier decision, the New Mexico Supreme Court interpreted a 1942 deed to 160 16