• Proceeds from Production: You Have to Know When to Hold 'Em
  • February 24, 2015 | Author: William E. Ward
  • Law Firm: Holland & Hart LLP - Salt Lake City Office
  • Once an oil or gas well has been drilled and begins producing, one of the critical title decisions that a landman or division order analyst must make is when to hold proceeds in suspense. Most oil and gas producing states have a statute requiring that proceeds be paid to owners within a set amount of time after the date of first production or a penalty is imposed on the operator.1 If it is determined by a court or administrative agency that proceeds were not timely paid and were instead held in suspense improperly, the penalty on the operator can be imposed retroactively and can be substantial.2

    As an initial matter, it is important to distinguish between proceeds that are not paid because they are suspended and proceeds that are not paid because the owner cannot be located to receive the payment. In the event an owner entitled to proceeds cannot be located, the proceeds are technically deemed unclaimed, not suspended. If the last address of record for the payee is no longer current, the operator is required to conduct an inquiry reasonably calculated to locate the owner. This should include a review of both traditional and online databases. Evidence of this search should be maintained in case there is a future challenge. If the owner remains unlocatable after completing a diligent search, the proceeds should be treated as unclaimed and the ultimate disposition of the funds will be governed by the unclaimed property statutes within the state of the last known address. Suspended funds, on the other hand, are not subject to the unclaimed property statute and it is not uncommon for suspense accounts to continue to accrue proceeds for many years. It is also possible to have proceeds attributable to an owner who are both in suspense and are unclaimed. This is often the case for unlocatable heirs or devisees of a decedent when there is no completed probate proceeding. In this case, because the proceeds are subject to potential multiple claims, they are suspended until the probate action is concluded and then, if the interest is vested but the owner is unlocatable, the proceeds become unclaimed property. We note that it is also possible for an owner to change from unlocatable to suspended. For example, if further research discloses that a payee is deceased, the proceeds should then be held in suspense until the necessary curative is recorded to properly vest title in the decedent’s heirs or devisees.

    An operator may choose to obtain a division order title opinion to assist it in confirming the title of the owners, locating the last address of record for the owners, and making the decision for which owners, if any, to hold proceeds in suspense. Several oil and gas producing states provide a measure of legal protection to an operator if it acts in accordance with a title opinion when deciding to suspend proceeds.3

    One recent decision from North Dakota highlights the potential danger in making the decision to suspend proceeds. In the unreported decision of Tank v. Burlington Res. Oil and Gas Co., LP,4 the U.S. District Court ruled that an operator unjustifiably held in suspense the proceeds payable to a royalty owner whose mineral interest was subject to an existing mortgage that predated the oil and gas lease. First, the title attorney indicated that that there was a risk in having the lease invalidated upon a foreclosure and required a subordination of the mortgage to the lease. Second, because the mortgage contained what appeared to be an absolute assignment of production proceeds, the title attorney indicated that confirmation should be made as to who should receive the proceeds. Both of the requirements appear to be reasonably necessary to protect the operator from potential liability. The court, however, determined that neither issue qualified as an “existing” dispute that justified holding the proceeds in suspense. As to the presence of the existing mortgage, the court said that until there was an actual foreclosure there was no title dispute. As to the uncertainty of which party was entitled to receive proceeds, the court said that a determination should have been made based on the records and a check cut to someone.

    The standard set forth in this case reaffirms the need to have a division order title opinion that clearly articulates the owners whose proceeds should be suspended and sets forth the nature of the dispute which authorizes the suspension. The dispute should be one that is not easily resolved and contains the potential for the operator to be exposed to multiple liability. Operators should insist that their title examiners provide clear instructions as to the nature and scope of the title defect, the exact portion of the owner’s interest that should be held in suspense, and include detailed guidance as to the curative required to be completed before the proceeds should be paid. By law in some states (or, as a matter of good practice, in those states without a statutory requirement), a copy of the title opinion requirement (but only that requirement) outlining the issue causing the suspension should be provided to the owner. This information should be provided to the owner prior to the statutory deadline to make the first payment.

    Finally, whether to suspend proceeds for any owner is ultimately the decision of the operator, and not the title attorney. The business risk of a potential challenge can always be assumed and payments made even though a title examiner instructed that proceeds should be suspended. As a practical matter, there may be situations where there is a legal defect in title that authorizes suspension, but the real risk of a challenge is remote and the operator may elect to assume the risk and not hold the interest in suspense, particularly where the operator’s interest is derived from the potentially disputed interest. If the division order title opinion does not provide sufficient facts to enable an operator to make this decision, the operator should inquire of the title examiner to fully understand and analyze the risk that would be assumed if the payments were made with the title defect outstanding.

    1See Colo. Rev. Stat. Ann. §§ 34-60-118 and -118.5; Mont. Code. Ann. § 82-10-110; Nev. Rev. Stat. Ann. § 522.024; N.M. Stat. Ann. § 48-9-6; N.D. Cent. Code Ann. § 47-16-39.3; Tex. Bus. & Com. Code Ann. § 9.319; Tex. Nat. Res. Code Ann. §§ 91.401, 91.402, and 91.403; Utah Code Ann. §§ 40-6-8 and -9; Wyo. Stat. Ann. § 30-5-305.
    2The possibility of a retroactive penalty adds to the risk for a new operator that assumes responsibility for distributing proceeds already held in suspense when it acquires a prior operator’s property.
    3In New Mexico and Utah the protection is limited to the opinion of an attorney licensed in the state. See N.M. Stat. Ann. § 70-10-5; Utah Code Ann. § 40-6-9(8).
    4No. 4:10-CV-088, 2013 WL 3766526 (D.N.D. July 16, 2013).