By now, you have probably heard about some of the changes in title policies and title searches caused by the recent oil and gas activity in Ohio.  Title insurers also recently added to their policies a standard exception for any “lease, grant, exception or reservation of minerals or mineral rights.”

Essentially, this language means that any separate mineral interest created at any point in time by any party is now an exception to the title insurance policy, regardless of whether it is expressly disclosed.  In other words, there will be no coverage offered whatsoever if one of those interests negatively impacts the property in the future, even if it was not specifically disclosed in the policy.  And because title insurers will not insure against oil and gas interests, there isn't much incentive for them to include such interests as exceptions in their title searches, especially when the cost of obtaining such information can be staggering.

Even if a title insurer could be persuaded to remove the aforementioned exceptions, many mineral interests were granted in the first half of the 20th century, which is farther back than the average title search extends. These topics are discussed in-depth in a two-part post published previously on the Oil & Gas Law Report blog.  Read part one and part two

Today's topic focuses on what the above changes mean for lenders. The existence of a severed mineral interest or an oil and gas lease is of consequence to lenders because those interests have the potential to significantly decrease the value of the mortgaged property. A severed subsurface mineral interest is the dominant estate when compared to the surface, and impliedly includes the right to use as much of the surface area as is reasonably necessary to enjoy the subsurface rights. Subsurface leases (most often oil and gas leases) will often expressly convey similar rights to the lessee, and could contain terms and conditions rather unfriendly to the surface owner. In practice, this means that the owner of valid subsurface rights on a particular parcel could theoretically build roads, install pipelines or construct a drilling pad on the mortgaged property. Although often the potential for royalties might offset some of this devaluation or risk, the ultimate surface rights claimed by the owner of the mineral estate do have the potential to significantly decrease the value of the mortgaged property. 

How this type of operation could devalue a property should be fairly obvious.  And some leases prohibit the landowner from building on, digging in and even landscaping over a certain portion of the land.  The discovery that such a prohibition exists over a critical portion of the property could severely limit the uses that can be made of the property as well as the number of potential buyers and, in turn, the value of the collateral.

Given the state of affairs in the realm of title insurance, what can lenders do to protect themselves short of refusing to extend credit in resource-rich regions?  Most obviously, lenders can no longer rely on standard title insurance to protect against devaluations in mortgaged land caused by unknown mineral interests, or even to reveal the existence of those interests. Ideally a lender would find a way to persuade a title company to remove the standard mineral exceptions mentioned above; but, unfortunately, that result is exceedingly unlikely and may well be impossible under today's underwriting standards.

Assuming there is no title insurance to be had, lenders should obtain as much information as possible about the mineral interests applicable to the collateral property.  This information can help lenders assess their risk levels with respect to any given property.  For example, lenders should search for a title insurer who will include mineral interests in the title search, even if it refuses to insure against those interests.  And the lender should request that the title search extend back at least 100 years rather than the standard 40 or 60 years.  But both of these additional services will be accompanied by additional fees.

Another option is to retain a company specializing in searches designed to turn up severed interests and oil and gas leases.  However, this option is typically recommended for large-scale projects so it may not be a viable option for lenders who do not issue a large volume of mortgages.  Finally, lenders can search oil well records with the Ohio Department of Natural Resources and/or conduct physical due diligence (i.e., a site walk) to determine whether there are any active wells on the property.

All these options are less than satisfying, and lenders will need to get creative to protect themselves from the hidden perils of undisclosed mineral interests.