Keith Brock, Anderson & Byrd, LLP
2023 2nd Quarter Newsletter
Title Opinions Will Save You Money.
I am perplexed that operators insist upon purchasing title insurance before closing a $100,000 real estate transaction but will invest twice as much into an oil and gas lease through lease acquisition and drilling without having the title examined. In Eastern Kansas, many operators never obtain title opinions before purchasing a lease or drilling new wells and even scoff at outsiders who require title reviews before acquiring leases. While I do not know when or why this Eastern Kansas tradition began, I do know that it is unique to Eastern Kansas. In my practice, I have the opportunity to work for operators all over the state of Kansas and also in most other oil and gas producing states, and with the single exception of Eastern Kansas, I have not encountered any other geographic area in which title opinions are not a prerequisite to buying a lease, drilling wells, selling production and borrowing money against a lease. While I do not positively know why Eastern Kansas has not embraced the title opinion, I do know that title opinions are a sound business practice because they reduce risk and save money. Although title opinions represent an upfront cost, this article will explain the cost savings the title opinion provides.
Operators typically recognize the most apparent reason for obtaining a title opinion: to reduce risk and protect their investment. Most believe that the only thing they are risking when obtaining a new lease or drilling upon a property is the capital that they have invested. However, while the invested capital is at risk, additional and potentially more substantial liabilities exist if production is obtained from a lease with a failed title. If an operator produces from a lease without a title examination, and a necessary party did not join in executing the lease, or other title defects are discovered, the operator may be required to pay the unleased mineral interest owner for all oil and gas produced. In addition, if a court finds that by failing to examine the title, an operator has become a "bad faith" trespasser, the operator will not be able to recover any costs of production. Therefore, an operator who produces a lease without obtaining a title opinion may be risking the money spent to acquire the lease, the capital spent developing the lease, the money spent to produce the lease, and the value of all oil or gas produced from the lease.
The cost savings provided by title opinions are extremely common and substantial. If a title opinion is obtained before a lease is acquired, the cost of any curative work is typically borne by the seller before closing occurs. However, if a buyer purchases a lease without obtaining a title opinion, they must generally absorb the cost of such curative work when it is later discovered. Generally, the longer you wait to discover and correct a title defect, the more expensive it is to fix; something as simple as a missing signature becomes a very expensive quiet title or probate proceeding once the missing signatory dies or goes out of business. In addition, if an operator acquires a lease without obtaining a title opinion, they may not be able to sell production from the lease without a title opinion. They will not be able to borrow money against the lease nor sell it to anyone who intends to borrow money against it without first obtaining a title opinion. The lack of title work will command a significant reduction in the purchase price from any sophisticated buyer. Just like your mechanic, attorneys provide routine maintenance for clients who request it and overhauls for clients who neglect routine maintenance. A title opinion is simply routine maintenance in your business; foregoing them is akin to not changing your vehicle's oil. It may not cost you today, but eventually, it will, and when it does, you may pay severely.
Operators are generally apprehensive about obtaining title opinions because of the initial cost and the time in which it takes to obtain one. From my perspective, the time delay is a misconception as I can typically accommodate virtually any time frame that is needed. However, if ample time is allowed to complete the work, it certainly reduces the cost. The cost of a title opinion is usually less than the cost of correcting a title defect when it is discovered later. In addition, once you obtain a title opinion, it is incredibly simple to update it later to serve as a drilling title opinion, a division order title opinion, or a lending title opinion. The fact is that title work will be required on virtually all productive oil and gas leases at some time during their existence. For this reason, the prudent operator obtains a title opinion before they invest substantial capital into the lease and before the need for the opinion becomes an emergency, thus avoiding potential increased expense.
This article is intentionally limited to why title opinions are important, and it will be followed with later articles addressing different types of title opinions and the necessary characteristics of a quality title opinion.
DISCLAIMER: This article does not constitute legal advice, and no attorney-client relationship is intended or implied.