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Landowners face mortgage, title issues when gas leases are sold

The gas men were coming. That’s what Susan Condlin needed to tell Ted Feitshans when she called his office in January 2010.

Condlin, the Lee County director for the N.C. Cooperative Extension, had seen advertisements in the newspaper from companies looking to sign up gas leases, and suspected residents needed help.  Feitshans, an extension associate professor in the Agricultural and Resource Economics Department, was the man for the job.

By June 2010, when Feitshans gave his first information session to a packed house in Lee County, Denver-based Whitmar Exploration Co. had already signed up 40 leases and Charlotte-based Tar Heel Natural Gas was mailing out ready-to-sign checks and contracts, according to the News & Observer.

That session came too late for those who’d already signed leases. But others in Lee County and elsewhere who own land with potential gas reserves would be wise to heed his message: Drilling for natural gas in North Carolina may be a few years away, but the time for lawyers and landowners to act is now – to prepare, not to sign.

“There’s lots of legal work to be done right now,” Feitshans said. This is not Texas, he added, where landowners and attorneys are familiar with the laws and the negotiations associated with gas drilling.

North Carolina’s piedmont has long been an area rich with minerals. The first gold rush in the U.S. happened here, in 1799, and Lee County served as the source of coal for the Confederacy.  But it was not until 2009 that geologists identified deposits of natural gas along a 150-mile stretch from Anson and Union Counties near the South Carolina border through Durham and up to the Virginia border.

Gas company landmen quickly followed, trying to lock up leases with unknowing Lee County landowners in early 2010, even though the hydraulic fracturing process (fracking) used to extract the gas was, and remains, illegal here.

That may change after the legislature reviews a report from the Department of Environment and Natural Resources (DENR) on the viability of natural gas exploration through fracking, due in May 2012.  Even then, if the legislature sanctions natural gas drilling, there’s a regulatory framework to be built and a myriad of legal issues to be sorted before any wells are active.  “I’d be very surprised to see a producing well within the next three years,” Feitshans said.

“It’s way too early for landowners to sign anything,” said Glenn Dunn of Raleigh’s Poyner Spruill.  Dunn has practiced environmental law for more than 30 years and was general counsel to the state Department of Natural Resources in 1984.  “Landowners certainly need to be careful at this early stage when fracking is not even legal in this state. There’s lots to be done on the public policy and regulatory side before the private side gets going.”

But it’s not too soon for landowners and lawyers to arm themselves with the knowledge needed to deal with the gas companies.

“They should be educating themselves about their property, about the leasing process, and about the natural gas market,” said Brandon King, an extension associate who works with Feitshans.

Who owns the rights?

Mineral rights have been bought and sold for years in Lee County and elsewhere in North Carolina, Feitshans said.  The coal mining companies that owned parcels typically retained those rights when they sold off the land.  “If you look at a lot of deeds in Lee County, you’ll see that they excluded the mineral rights,” he added.

Map showing the distribution of Mesozoic basins in North Carolina. Jeffrey C. Reid and Kenneth B. Taylor, North Carolina Geological Survey

Lee County Tax Administrator T. Dwane Brinson identified at least 36 parcels where the mineral rights had been severed, according to a News & Observer report in November.  Brinson’s office has since determined that each of those parcels may have been divided several times over.  “For example, we have one parcel that has been divided into 39 parcels, so now we’re looking at trying to figure out ownership rights for each of those,” Brinson said.

In other instances, mineral rights may have gone unmentioned, been extinguished, or the deeds not filed.

And mineral rights aren’t necessarily gas rights, Feitshans said. “Because this is shale gas, shale is very clearly a mineral under North Carolina law. But if I’m fracking it, now it’s a gas and not a mineral.  It seems self-evident that the method of extraction shouldn’t determine who owns it, but that’s an open question.”

That’s just one of many matters of law to be sorted out.  “If the General Assembly makes this legal, there’s going to be a lot of legal work to be done about who owns this stuff, assuming that gas in large quantities is discovered,” Feitshans said.

Some of that work exists already. Andrew Branan, a partner with the Wright Law Co. in Hillsborough, has a client with an extended family who’s been trying to sort out interests in a number of tracts in different counties.  Those tracts were passed down over time and are now owned in fraction by different people.

“The land involved that’s not over the shale play is easier to deal with, because it’s likely to have a more recent valuation,” Branan said. “But when it comes to land over the basin in Lee County, it’s a bit trickier. There’s this questions out there, because whoever in the family ends up with that land could end up with a producing gas well on it.”

It’s important for landowners to learn as much as they can about their property, especially if they have large acreage and a potentially large reserve below — certainly to enhance their negotiating position going forward, but also to sort out in advance ownership rights that may have been passed down through families and now exist in fractional shares.

With the leasing process, though, ownership may become academic, as companies will often assume the risk they may not own the rights. “Most landowners are probably better off letting the leasing companies bear the risk that the landowner doesn’t own the rights,” Feitshans said. “That’s an important lesson. Don’t warrant anything.”

Do no harm

Gas drilling, particularly residential or farming property, sets off all sorts of alarms in the real estate lending world, as landowners in New York and elsewhere are learning the hard way.

“Many of us who signed leases are now against drilling,” New York resident Ellen Harrison said at a recent fracking hearing in Binghamton, N.Y., as reported in the Wall Street Journal. “We had no idea we could no longer get mortgages on our property.  We had no idea we could no longer get homeowners insurance.”

Any third party with an interest in a landowner’s property – lender, mortgage company, homeowner insurer, title insurer – has one primary concern: preserving the value of that property.  Bringing heavy equipment on the land, storing hazardous waste there, or other activities associated with drilling has the potential to harm resale value and is very likely a breach of agreements with those entities.

This is certainly an issue for farmers with USDA Farm Service Agency loans, Feitshans noted, and not only because of the potential for default.  “If there’s property that’s surplus to the farming operation that’s more than $5,000 in value, FSA gets the cash proceeds to pay down the note,” Feitshans said. “So if you sell your gas rights, the check goes to the FSA but the farmer has to pay taxes on it. And there’s all these other USDA programs that farmers have. They may find, for example, that they’ve got to pay back conservation payments they get.”

Getting a mortgage otherwise is fraught with difficulties.  A growing number of lenders, including Wells Fargo, are now unwilling to give mortgages on land with gas leases, according to a report in the New York Times. Loan underwriters are unable to get reliable appraisals, as comparable sales of properties with gas leases are difficult to find or quantify.

Title insurers will likely not insure the risk of a gas lease, according to attorney Elisabeth N. Radow, who recently authored at article on the issue in the New York State Bar Association Journal.  “Gas leases signed after the policy date are not covered by the policy,” Radow wrote. “Gas leases in effect when the policy is issued will be listed as exceptions.”

In New York, title insurance gas endorsements specifically void title insurance coverage if the land is used for a commercial venture, according to Greg May, a vice-president, residential mortgage lending with Tompkins Trust Company.  (Investors Title Co. and the NC Land Title Association did not return calls for comment on whether that is likewise true in North Carolina).

And homeowner’s insurance, even in its broadest form, does not cover risks associated with drilling, according to Radow.

The inherent tension between lenders and others wanting to preserve the value of property and gas men wanting to exploit that value has prompted legislators and regulators throughout the country to call for investigations into the scope of the problem and find solutions that will protect landowners, according to a recent New York Times report. “It is clear to me that we cannot wait any longer,” Arizona congressman Raul M. Grijalva said. “A strictly hands-off ‘buyer beware’ attitude is no longer appropriate.”

Making the deal

Ted Feitshans agrees with Glenn Dunn; it’s too soon to sign a lease.

“The leases that have been signed are all on speculation,” Feitshans said. “The prices we’ve seen for bonus payments are $1 to $20 an acre, and royalty rates of about 12.5 percent.  If you were in Louisiana or Texas, even in this down market, you’d be getting $3,000 to $5,000 an acre as your bonus payment, and up to 20 percent for your royalty rate.”

Right now landowners need to become as educated as possible about what’s involved in signing a lease and should be prepared to negotiate everything, Brandon King said. That obviously includes price, and owners should be up to speed on what market conditions might come into play that will influence price, he added.  The Cooperative Extension Service has a lot of resources available, and so do online forums like gohaynesvilleshale.com, where royalty owners discuss what companies they’re dealing with and share other market information.

Attorneys should do the same. “For any attorney dealing with multiple companies looking to sign a lease with a landowner, a few hours difference in responding to offers can mean the difference in thousands of dollars to the landowner if the attorney doesn’t know how to respond appropriately and know which deal to take at the right time,” King said.

That involves knowing the terms of gas leasing agreements generally and evaluating them as they apply to clients, and watching the market once drilling gets underway. “Right now we don’t have the competition for landowners to get the best deal,” King said. “The drillings not there, and we don’t yet have data to assess well activity, like you can do in Texas. Timing is part of it, and having the data. You can’t make decisions like that on the fly if you don’t know what you’re negotiating position is.”


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