Legal Issues in the Conveyance of Subsurface Rights - Module 2 of 5

Legal Issues in the Conveyance of Subsurface Rights

Rights and Conflicts in a Divided Estate

Oil, gas and mineral rights fit into the larger system of property laws in a unique way. This module provides a more in-depth explanation of the characteristics of oil, gas, and mineral interests in the United Sates. We will discuss how and why mineral rights are conveyed between private parties as well as what limits these transactions.

The United States takes a unique approach to mineral and subsurface rights. American property rights can be divided into surface and subsurface estates, each of which may be bought and sold independently, including interests that can be conveyed separately from the land itself.[1]

Mineral owners and lessees have the right to remove minerals from underneath land owned by other people. Mining and drilling operations would be impossible if mineral rights did not include some ability to disturb the surface estate, as underground extraction naturally interferes with other uses of land. Consequently, mineral rights also come with an implied easement over the surface property, giving the mineral owner the right to make reasonable use of the surface lands as necessary and proper for the completion of extraction operations.

Over time, the law has developed several methods to deal with the issues arising from conflicting uses of the surface and subsurface estates. For example, the mineral estate’s implied easement over the surface property cannot be used to justify an unreasonable interference to the surface property, nor may it interfere with the use of neighboring property.[2]  

The Bundle of Mineral Rights

Mineral rights are best conceptualized as a bundle of legal rights, duties, and obligations, including the rights to:  make decisions affecting subsurface exploration, receive bonus payments, receive delay rentals, and receive royalty payments.[3]

The right to make decisions with regards to exploration is commonly known as the “executive right” and is the most important property right with respect to mineral development because it allows the creation of an economically valuable mineral estate. The executive right is what gives a developer the opportunity to know what valuable petroleum and mineral commodities are stored underground.[4] ,

Mineral rights can be owned individually, so the entity that owns the executive right may not necessarily own the associated mineral or royalty interest.[5] In fact, this arrangement is so common that it’s referred to as a “naked right,” an industry term describing an extraction company that owns an executive right but none of the associated mineral or royalty interests.[6] This can be a valuable option when it’s unclear whether valuable subsurface commodities can be found in the area at all.

The right to receive bonus payments, delay rentals and production payments from a mineral interest are also mineral rights that reflect the economic reality of oil, gas, and mineral extraction. Bonus payments – which means  payments made on mineral leases – are common benefits that landowners receive in exchange for conveying their subsurface rights to oil, gas, and mineral developers.

Mineral holders often must make delay payments to maintain the right to the minerals without developing the underground resources. Even if a developer doesn’t actually extract anything from the subsurface estate, landowners are entitled to payments for delay. If a well or mine is productive, however, mineral interest holders must pay a share of production to the lessor as a production payment.[7]

Despite their similarity, production payments should not be confused with royalty interests, which do not entitle the property owner the right to participate in the execution of oil, gas and mineral activities. Royalty interests do not give the property owner rights to any share of ordinary cash, delay rentals or bonuses to which the mineral holder may be entitled.[8] A royalty interest is created by deed and continues to be enforceable regardless of whether the owner of the mineral interest makes money by extracting commodities from the land.

 Landowners can convey mineral rights through deeds, lease agreements or both. Both deeds and leases create possessory interests in the mineral estate, meaning the holder is entitled to access and use of the oil, gas, or minerals underneath the land. However, the long-term impact on legal rights can differ when conveying these interests through a deed or a lease. Let’s look at each of those interests now.

Interests Through Deed

The possession of a good title is necessary for legal ownership of property.  A deed is a written instrument that conveys ownership right from one owner to another.  Just like surface property, mineral rights can also be conveyed by deed.

Property law imposes some basic requirements on deeds. First, a deed must identify the owner as grantor and she must be competent to carry out the transfer.  It also must identify the purchaser, or "grantee," include a legal description of the property. It may say the amount paid for the property but need not. Once the deed is signed by the grantor before a legal witness and recorded in the public land records, the property right contemplated by the deed is legally transferred.[9]   

The language used in the deed is critical to the scope of the property right because it identifies the rights or interests being exchanged through the deed. The simplest property conveyance by deed is a fee ownership. Under this arrangement, a single owner is entitled to the entire estate including the surface lands, the subsurface minerals, and all the of legal and economic interests involved.[10] However, when an estate is broken up and sold as individual rights and interests, the terminology of conveyance is central to determining the rights and duties it creates.

Minor differences in the language of conveyance in a deed can have a substantial impact on legal rights and responsibilities. For example, a grant or reservation of mineral interests in a deed could be described as the “oil, gas, and other minerals in, on, and under” the land in question. Many deeds only mention the conveyance of a fractional interest in minerals “produced” from lands with a “reservation of bonus, rental, and executive rights.” This language would create a royalty interest.[11] Royalty interests do not include the right to use the surface estate or create any right or obligation to share in profits or costs. Rather, a royalty interest is an amount paid based on extracted material but does not come with any rights to do the extracting.[12] Because the language of conveyance has such a meaningful impact on the mineral owners’ rights and responsibilities, it’s critical for any mineral deed to articulate the scope of the conveyed property rights.

Oil, gas, and mineral rights were designed to be flexible to encourage the best possible economic use. Mineral rights can be deeded in “horizontal divisions,” meaning that different entities may hold independent interests in minerals located at different depths. Transferring mineral rights at different depth intervals is carried out through “severance deeds,”  which include all interests for the subject property from the surface of the property to a specified depth, or from one depth to another.[13] For example, a severance deed may convey one mineral interest “from the surface of the land to a depth of 12,000 feet,” to a party and a separate mineral interest “from a depth of 12,001 feet to a depth of 15,000 feet” to another entity.[14]

Deeds are used to convey everlasting mineral or royalty interests. The traditional manner to transfer rights forever was for the transfer to be made to “the assignee, his heirs, successors or assigns” or equivalent language. Today, though, a grant that merely states “to recipient” or the like also establishes an ownership interest that does not lapse or expire.

Non-permanent mineral estates are typically established by leases, which are the preferred method of mineral rights for many professionals in the modern oil, gas, and mining industries.

Mineral Leases

Mineral leases are the keys to most modern oil, gas, and mineral extraction operations. A mineral lease creates a leasehold interest in subsurface minerals, meaning the lessee has the right to use and possess the commodities below the surface property for a designated period.

Mineral rights leases are preferred over deeds that convey ownership outright because they are efficient and flexible.[15] Landowners may lack the resources or expertise necessary to develop subsurface commodities. Likewise, extraction companies may prefer to test a well or mine with a limited scope of rights under a mineral lease rather than to buy the subsurface estate outright.

A lease conveying mineral interests contains information about the parties involved, the term of the lease, a legal description of the land and any specific provisions that may be appropriate. However, lease agreements are fully customizable and can be tailored to suit the needs of both the landowner and the oil, gas, or mineral company involved. As a result, mineral lease agreements are typically drafted to be highly specific, ensuring that each party’s rights are protected.[16]  

Mineral Estate Through Dormant Mineral Acts

Over the past few decades, many petroleum and mineral-rich states have been enacting dormant mineral statutes, designed to ensure that mineral interests belong to owners that can make good use of the commodities found under the property. These laws often provide that a mineral estate reverts to the owner of the surface property if it is not utilized for its minerals for a specified period of time. For example, if someone sold or leased a mineral interest to a developer and the developer did nothing to extract petroleum or minerals for several years, a dormant mineral statute could return these unused mineral rights to the original property owner.[17]

After multiple dormant mineral acts were overturned on constitutional grounds in the 1970’s, the United States Supreme Court weighed in on the matter in 1982 in Texaco v. Short, wherein it established the groundwork for dormant mineral acts still in effect today.[18]

That case involved an oil and gas company’s challenge to an Indiana statute that provided that a mineral estate would revert back to the original landowner if the subsurface property went unused for twenty years. However, mineral owners who had not utilized their interests in the period of twenty years could avoid severance and protect their interests by filing a statement of claim in the recorder’s office. The statute was self-executing and did not require any notice to a mineral owner when a lapse had occurred.[19]

Texaco, a major international oil and gas development company, brought a challenge to the Indiana statute, claiming that it violated the Due Process Clause of the Fifth Amendment by depriving the mineral rights (a property interest) without “due process” of law or that it owed “just compensation” to Texaco under the Fifth Amendment, which requires compensation when the government takes property.

However, the Court rejected Texaco’s challenge and upheld the Act. The Court, after noting that the severed mineral estates were deemed abandoned, concluded that the State of Indiana had not taken anything from the plaintiff and therefore owed no compensation under the constitution. After a lengthier analysis, the Court also determined that the two-year grace period was sufficient to meet due process requirements, and that Indiana was not required to provide any notice to the owner of the mineral estate when the ownership right is severed due to nonuse.[20]

The details of dormant mineral laws determine the exact rights and responsibilities created by the statutes. The National Conference of Commissioners on Uniform State Laws developed a Uniform Dormant Minerals Act after the Short case was decided that reflects an approach to these policies similar to Indiana law. However, several jurisdictions have their own variants on dormant mineral laws, so practitioners should be aware of how these statutes may be applied.

Conclusion

American property law allows land owners to strip away and sell property interests one by one, or to convey them all at once. This structure gives many people the opportunity to make higher economic use of a tract of land. While this system affords flexibility to developers and mineral rights owners, it also requires a unique legal structure for it to function. As the course continues, you’ll get a more in-depth look at the lease terms, contracts, and other transactions that have become common across oil, gas and mineral arrangements.