Texas House Bill 2207, effective January 1, 2016, statutorily subordinates certain real estate mortgages to oil and gas leases, introducing an interesting tweak to the long-standing and well-established “first in time, first in right” rule. However, this statute is not without its limitations.  For example, it only applies to mortgages executed on or after January 1, 2016.  Additionally, the statute goes on to clarify that, although the lease is to survive the foreclosure, the right to use the surface estate may be terminated and extinguished by the foreclosure to the extent the security interest had priority over the lessee.

To better explain, let’s take a step back. One of the most common title issues that can impact an oil and gas lease, and a frequent cause of headaches to Texas landmen, are encumbrances dated prior to the oil and gas lease such as mortgages, deeds of trust, and liens. In Texas, purchasers generally will take title to real property subject to prior claims to the same property by third parties, so long as purchaser has actual notice of the prior instrument or constructive notice where the prior instrument is properly filed in the appropriate public records.[1]

As a result, the law used to be that, where a creditor foreclosed on a prior recorded mortgage or deed of trust, the foreclosure could extinguish the oil and gas lease.[2] As a result, oil and gas lessees would often request that creditors subordinate their liens to the encumbered oil and gas lease. While some lenders were uncomfortable with the idea of subordinating their mortgage, many were happy to do so, taking comfort in the fact the debtor could have bonus checks and royalty checks from which to pay their loans.

Fast forward to the US shale revolution, which ushered in an onslaught of lessees purchasing thousands and thousands of oil and gas leases. In areas such as the Barnett Shale, many leases covered property in heavily urbanized areas largely subject to prior recorded mortgages. By 2015, lenders were constantly being solicited for subordinations and many lessees were faced with battling overburdened and sluggish mortgage service companies with little knowledge of the oil and gas industry.

In comes Texas House Bill 2207, which may provide some relief to financial institutions and lessees alike. Codified as Tex. Prop Code § 66, this new law introduces a statutory subordination by providing, in part, that “any oil or gas lease covering real property subject to a security instrument that has been foreclosed remains in effect after the foreclosure sale if the oil or gas lease has not terminated or expired on its own terms and was executed and recorded in the real property records of the county before the foreclosure sale.”

As described above, however, this new statute contains important limitations.  For example, it only impacts mortgages executed on or after January 1, 2016, and will not save an oil and gas lease from termination and extinguishment as to the right, under the oil and gas lease, to use the surface.  Oil and gas companies will want to be careful in handling mortgages executed prior to January 1, 2016, and should carefully consider the potential effect of a foreclosure on the surface rights under the oil and gas lease.

It will be interesting to see how the courts handle these statutory provisions relating to the surface estate. In Texas, the owner of the mineral estate, or its lessee, is considered the “dominant” estate and therefore possesses certain rights to use the surface. But this statute contemplate a scenario where the lessee will own an oil and gas lease without the right to use the surface.  Consider this: in a situation where a lessee is producing oil or gas from a wellhead located on the tract of land foreclosed on, what impact will termination and extinguishment of the right to use the surface have on continued operation of the well?  What about plugging and abandonment? What about the right to equipment on the surface?