Subsurface Interests in Blackacre

Introduction:

Land consists of the surface and subsurface. The surface of land is typically the most functional layer. The surface is where the home or business rests. The surface is easily visible to the human eye. The surface is how we ambulate from point A to point B.

For all of these reasons, it is not surprising that many people never consider the fact that there is land lying beneath the surface layer - abundant land. In many instances, this subsurface land has no practical meaning. It simply functions as a part of the whole that supports the surface layer and structures constituting the real property.

But sometimes just the opposite is true. The subsurface of blackacre may be loaded with valuable oil, gas or minerals. In such an instance, the subsurface becomes extremely valuable to its owner and anyone else who can put their grubby paws on it.

In this writing, I will explore the different ways in which oil, gas and minerals can be transferred. They may be transferred by conveyance, giving the grantee an ownership interest similar to that of the fee simple. They may also be transferred by lease, such as the ever popular oil and gas lease. Either method acts to realize on the value that the subsurface has to offer. As you will learn with the oil and gas lease, the homeowner typically earns profit from its oil producing land via a lease agreement with an oil company. The oil company does all the physical work and, if oil is found, the owner receives its payment in the form of royalties. It’s really a win-win. Unless you are as strong as the Baby Hercules, I doubt many of us could drill our own oil well. Furthermore, most people never know they are sitting on oil rich land until a landman approaches them requesting a lease.

Section 1 – Severing the Interests.

A subsurface interest can be severed from a surface interest:

In the lion’s share of cases, the surface owner and subsurface owner are one in the same person. Conversely, it is possible for one person to own the surface of blackacre, while another owns all or only a portion of the subsurface.

Severance is accomplished in one of two ways: 1) by grant, or 2) by reservation. Reservation, by far, is the common way in which a severance is accomplished.

Example of severance by grant:

Dave Phillips, a single man, as owner of all of blackacre, conveys to Lael Bryant, all the oil, gas and mineral rights lying beneath blackacre.

This conveyance results in a severance of the surface and subsurface interests. Lael Bryant would now own the rights to all the oil, gas and mineral deposits, while Dave Phillips continues as owner of the surface. Oftentimes a “Mineral Deed” would be used to accomplish this task. However, any deed would suffice, as long as there exists a clear recital in the body of the deed evidencing the intention of the grantor.

Example of severance by reservation:

Melissa Woloch, as the owner of all of blackacre, conveys to Lisa Giraud, reserving unto the grantor, Melissa Woloch, and her heirs, all oil, gas and mineral rights.

This conveyance reaches the same conclusion as our first conveyance (a severance of the surface from a portion of the subsurface). The only difference is that our second example was by way of reservation, not an outright conveyance.

*Although a conveyance or reservation of oil, gas or mineral rights acts to convey ownership to its grantee, such ownership interest is not as strong as that of the fee simple absolute. As you will learn in Section 2, there are statutory provisions in Michigan that act to terminate subsurface interests if those interests are not preserved within a specified period of time. It’s sort of like “inverse adverse possession.”

Section 2 – Termination of Oil, Gas and Mineral Interests.

Once oil, gas or mineral interests are severed from the surface owner, the clock begins to tick. The owner of the subsurface interest must be attentive to its rights or suffer the consequences. Statutory provisions are typically invoked by a surface owner who is attempting to reestablish its ownership in the subsurface. It is not actually the surface owner who prevails under the statutes; rather it is the subsurface owner that loses under the statutes.

Obviously, the easiest way for a termination of a severed interest is for the subsurface owner to convey its interest back to the surface owner. Short of this, a surface owner must rely on statutory law in its attempt to regain ownership of the severed subsurface rights.

In this section I will be discussing two statutes: 1) the so-called Twenty Year Dormancy Act, and 2) the Marketable Record Title Act.

The Dormancy Act deals exclusively with severed oil and gas interests. Severed mineral interests are not subject to the Dormancy Act. Please keep this in mind, as many practitioners continue to screw this up.

The Marketable Record Title Act deals exclusively with severed mineral interests. Severed oil and gas interests are not subject to the Marketable Title Act. Please keep this in mind, as many practitioners continue to screw this up.

A proper analysis involves distinguishing these two acts. Property searchers and title examiners are never required, nor should they ever invoke a statute for the purpose of disregarding a severed interest. These statutes are used by underwriters and attorneys involved in the heat of battle. Searchers and examiners report the interest, underwriters and attorneys invoke the statutes.

The Twenty Year Dormancy Act: (Act 42 of 1963)

This act deals exclusively with termination of oil or gas interests in land.

This statute addresses the presumed abandonment of oil and gas interests owned by someone other than the surface owner. It allows for a (20) year period of dormancy, at which time the oil and/or gas interest will re-vest in the surface owner, as disclosed by (MCL 554.291) and (Land Title Standard 15.4).

Section 291 specifically states that the Dormancy Act will not apply if the owner of the oil or gas interest does any of the following within twenty (20) years after creation of the interest:

1) Sells the interest, or
2) Leases the interest, or
3) Mortgages the interest, or
4) Transfers the interest.

Additionally, a drilling permit issued within the last 20 years, or actual production or withdrawal of oil or gas from the lands will act to preserve the interest.

This list is not exhaustive, but it gives you the idea: move it or lose it.

NOTE: Numbers 1 through 4 must be filed for record at the register of deeds.

In lieu of the above, the owner of the oil or gas interest may file a simple claim of interest at the ROD to preserve their interest for an additional 20 year period (MCL 554.292).

Of course, someone attempting to invoke the Dormancy Act will have to do some additional legwork. After all, only certain things are required to be filed of public record. The issuance of a drilling permit, or the actual production or withdrawal of oil or gas would take further investigation and documentation.

Remember, the Dormancy Act only encompasses oil and gas interests that have been severed. It’s like a railroad switch: if you are dealing with severed oil and gas interests, you are dealing with the potential clash with the Dormancy Act.

The following segment concerns mineral interests. Mineral interests are not one and the same as oil and gas interests. As such, mineral interests are handled under a different statute: The Marketable Title Act.

The Marketable Record Title Act:

As used in this act, “mineral interest” means an interest in minerals in any land if the interest in minerals is owned by a person other than the owner of the surface of the land. Mineral interest does not include an interest in oil or gas or an interest in sand, gravel, limestone, clay, or marl.

(MCL 565.101) reads, in part: “Any person, having the legal capacity to own land in this state, who has an unbroken chain of title of record to any interest in land for 20 years for mineral interests and 40 years for other interests, shall at the end of the applicable period be considered to have a marketable record title to that interest . . . .”

Most in the industry are familiar with the concept of “40 year marketable title.” This frequently comes into play when we are dealing with a fee simple interest of the surface owner. So this statute makes it easy to apply to mineral interests. We simply put 20 years in the place of 40 and perform the proper analysis.

The Marketable Title Act differs dramatically from the Dormancy Act in one way. The Marketable Title Act looks to create an interest after the expiration of 20 years, while the Dormancy Act looks to terminate an interest after the expiration of 20 years.

Section 2: Summary

Subsurface interests can be severed from the surface. This is accomplished by grant or reservation. Once severed, simply identify what interest has been severed. If it is oil and or gas, it will be subject to the Dormancy Act. If it is a mineral interest, as defined by statute, it will be subject to the Marketable Title Act.

In transition, parties are not always interested in owning a subsurface interest. In the case of oil and gas production, an oil company wants access to property for the purpose of drilling and exploration. If oil is found, the oil company takes its share and remits a portion of the earnings to the homeowner in the form of a royalty payment.

Section 3 - The Oil and Gas Lease.

An oil company will aggressively approach a property owner when it believes that valuable oil or gas may be sitting beneath the owner’s surface. An “Oil and Gas Lease” is often procured by the oil company in an attempt to accomplish its goal.

Oftentimes, an oil company will procure numerous leases from numerous landowners in a common area. In this instance they may choose to pool the leases in a so-called “pooling agreement.” This allows the oil company much more freedom in its exploration.

Example: Lot 1 and Lot 8 are part of the same pooling agreement. The oil company begins drilling on Lot 1, which drilling extends underground to Lot 8. It is under Lot 8 that the oil is found. The cool thing about a pooling agreement is that regardless of the land on which the drilling is commenced, the underground exploration can extend tremendous distances under the surface. It’s like a giant arm probing beneath the surface.

If production of oil is accomplished, the various members (property owners) of the pooling agreement will be subject to a “Division Order.” This order is a mathematical equation designed to pay royalties to an owner whose land is producing.

Termination of the Oil and Gas Lease:

The lease itself will expire in one of three (3) ways:
1) By expiration of its primary term;
2) By voluntary release by the lessee; or
3) If under production, by cessation of production.

Now, if a lease is not properly released of record, it may be necessary for the owner to take advantage of Michigan’s statutory procedures to accomplish this task.

Statutory Termination of Oil and Gas Lease, as set forth in Act 81 of 1929, as follows:

The owner must serve upon the lessee, in person or by registered mail, or by publication, for three (3) consecutive weeks in the county where the land is situated. This notice must state that the surface owner considers the lease terminated (MCL 554.281)

The owner MUST wait 30 days after first giving notice before filing with the register of deeds an affidavit setting forth (see page 2 of 554.281), along with a copy of the notice served on the lessee.

If, within 30 days of filing of the affidavit, the register of deeds does not here from the lessee, the clerk shall record the affidavit and the oil and gas lease will be legally terminated.

A reading of the statute shows that there is a 60 day period between first giving notice to the lessee and the effectual termination of the oil and gas lease.

Summary:

You may find it interesting that Michigan ranks 17th in the United States in oil and gas production, nearly 2 billion dollars a year. It is serious business and very competitive business. That’s what we should all desire, the chance to compete.

This writing concerned the severance of oil, gas and mineral rights from the surface. Remember that a proper analysis requires first determining what interest has been severed and how was it severed. In other words, are you looking at a transfer of ownership or are you looking at a lease?

When analyzing interests, it is beneficial to use the following checklist:

First, establish what interest was actually transferred.

1) Is it a transfer in ownership of oil and gas? If the answer is affirmative, this transfer will be subject to the Dormancy Act.

2) Is it a transfer of mineral interests? If the answer is affirmative, this transfer will be subject to the Marketable Title Act.

3) Is it a transfer via an oil and gas lease? If the answer is affirmative, statutory provisions exist that give the owner or original lessor power to terminate the lease, of record, short of a voluntary termination from the original lessee.

And remember to distinguish the Dormancy Act, which acts to terminate an interest, from the Marketable Title Act, which acts to create an interest. Very important stuff regarding proper analysis.

Some of the information incorporated in this writing was obtained from a recent meeting of the Michigan Land Title Association (MLTA).

That completes my brief overview of subsurface interests.

dave