Texas Legislature Imposes Statutory Subordination of Real Estate Mortgages to Oil and Gas Leases

Jackson Walker
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The explosive growth of oil and gas leasing and drilling in the Barnett Shale play turned an issue that had always been a nuisance for the oil and gas industry into a significant problem. When an oil and gas producer takes a mineral lease from a mineral owner (who may or may not own surface rights), that lease is subject to the rights of all prior grantees of the mineral owner, including any holders of mortgages. Of course, if the oil and gas lease precedes the mortgage, the mortgage is subject to the lease, and the issues discussed below do not arise. (Note, this discussion assumes timely recordation of all instruments in the real property records.) When the mortgage precedes the lease, the oil and gas producer would seek a subordination of the mortgage to the oil and gas lease from the holder of the mortgage. With a subordination, if the mortgage is foreclosed, the lease will remain in effect. Without a subordination, a foreclosure of the mortgage will negate the oil and gas lease.

Historically, many lenders were happy that their borrowers would have the possibility of royalty income as an additional source of funds with which to repay their loans and, as a result, would readily grant such subordinations.  However, with the urban drilling boom in the Barnett Shale, many leases cover only residential subdivision lots ("roof top leases"), a large percentage of which were subject to mortgages when the leases were taken.  The situation was further complicated by the sale of these mortgages by the mortgagee as securities managed by service companies, many of which knew nothing about the oil and gas industry.  Securing subordination agreements became difficult, and in some cases practically impossible.  As a result, instead of being an occasional inconvenience, resolving this issue became a major title curative problem which, if not overcome, created a significant title risk.

To address this issue on behalf of the industry, the 84th Regular Session of the Texas Legislature passed and Governor Abbott signed House Bill 2207 adding Chapter 66 to the Texas Property Code.  The statute becomes effective on January 1, 2016.  The author of the bill was James L. Keffer, a Republican from Eastland.

The statute deals with the following situation:  An oil and gas lease is taken on the mineral estate in land that is already subject to a mortgage.  Subsequently, the mortgage is foreclosed.  In that situation, the statute provides that the oil and gas lease does not terminate, even if the lease had not been subordinated to the mortgage.  The buyer at the foreclosure sale takes its interest in the land subject to the oil and gas lease.  As such, the statute creates a legislatively imposed subordination of the prior mortgage to a subsequent oil and gas lease.

The statute goes on to provide that although the oil and gas lease survives the foreclosure, any right on the part of the oil and gas producer to use the surface of the land based upon the terms of the oil and gas lease terminates with that foreclosure.  This loss of surface use may not be a problem under a "roof top lease," but would be a serious problem under leases covering larger tracts and, indeed, any tract on which oil and gas wells have been or are being drilled. 

The statute not only applies to mortgages executed in the future, but also undertakes to limit retroactively the rights of mortgage holders under existing mortgages.

Oil and gas producers holding these leases will benefit from the legislatively imposed subordination.  If nothing else, they will save the substantial time, effort, and cost that was being invested in securing subordinations.  However, producers will have to be aware of the potential effect on surface rights.  Lenders to landowners who own part or all of the mineral estate and whose land is mortgaged to support the loans are burdened by this statute.  The rights of those lenders are limited.  Landowners may find that the statute is an impediment to borrowing in some circumstances.  On the other hand, lenders to oil and gas producers whose loans are secured by mortgages on the producer's oil and gas leases are benefited.  Those lenders' mortgages are less vulnerable to loss from foreclosure of prior mortgages granted by the lessors of the producer/borrower's oil and gas leases.  Again, however, the effect of the surface use provisions of the statute on oil and gas producers can adversely affect the value of those lenders' collateral.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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