McCracken, J. R.

English

Texas A&amp;M Repository

L-1662REALESTATEMENT: THE LANDOWNER'S GUIDETO LIGNITE LEASING IN TEXASJ. R. McCracken, J.D.*Texas landowners who have coal and lignite face acomplex situation when considering leasing arrange-ments, as the following case illustrates. After 25 yearsofbarely making a living, an East Texas farmer thoughthe had discovered his fortune at last. A land broker or"land man" from a national energy development com-pany had asked to lease the rights to mine the coal andlignite on and under his property. However, therewas just one small catch. Ten years ago, the farmerhad sold the rights to the "oil, gas, and other miner-als" on his property to a speculator who now claimedthat he owned the coal and lignite on the farmer'sland. The farmer went to his attorney to find out whoown~d these rights."Probably you do" was the best answer that hislawyer could give him in light of the present state ofthe law in Texas.Determining Lignite OwnershipCourt RulingsWhether the owner of the surface estate (land-owner) or the owner of the mineral estate (speculator)has legal rights to the coal and lignite under a piece ofland has not been decided finally by the SupremeCourt of Texas. The first major case on this issue,Acker v. Guinn in 1971, involved iron ore rights on a*Research assistant, Texas Real Estate Research Center,Texas A&M University; member, State Bar of Texas.10.30particular piece of land. The Texas Supreme Courtdecided that the owner of the surface estate ownedthe iron ore and established the test that if a substanceis located so near the ·surface that it must be mined bymethods that would destroy or substantially impairthe surface, a grant or lease of "oil, gas and otherminerals" would not be deemed to include the surfacematerials. The court reasoned that the owner of thesurface estate would not have given away his rights touse the surface or allow it to be destroyed withoutspecifically stating this in the lease.The next and latest case involving lignite rightswas Reed v. Wylie, decided in 1977. The Texas Su-preme Court applied the rule of Acker v. Guinn andheld that a substance ~s not a mineral (in terms of an"oil, gas and other minerals" grant) if substantialquantities of it lie at or near the surface or are soclosely related to the surface that production will stripaway and substantially destroy the surface. Tne courtheld that the lignite under these circumstances wouldbelong to the surface owner. Yet to be answered bythe court, how~ver, are the questions of what. "at ornear the surface" means and whether or not the courtsare legally bound to examine the most reasonablemethod of mining that existed when the lease wassigned to determine if that method would have ~e­stroyed the surface. The best interpretation at thistime is that lignite will be deemed to belong to theowner of the surface estate in most instances.Assurance oflegal rights, however, is only the firststep; the landowner still should consult an attorneyabout the terms and conditions of a typical coal andlignite lease.Te as Agricultural Extension Service. The Texas A&M University System. Daniel C. Pfannstiel, Director. College Station, TexasExamining the LeaseThere is no standard form of lease in the coal andlignite industry such as the Producers 88 in the oil andgas industry. Each coal company (lessee) has a pre-ferred form which the landowner (lessor) will be askedto sign; however, the landowner should rememberthat many, if not most, of the provisions of theseleases are negotiable to some degree.Mining ProvisionsUnless otherwise agreed to in writing, a typicalcoal and lignite lease will allow the coal company tomine the lignite by any means available, not just bysurface mining methods. At this time, however, sur-face mining is the only economically profitablemethod. If surface mining is used, the coal companymust comply with the Texas Surface Mining and Rec-lamation Act of 1977 and obtain a surface mining op-erations permit from the Railroad Commission ofTexas.First, when negotiating the terms of the lease, thelandowner will want to consider how long the leasewill be in effect. Coal and lignite mining requires avery long period of time for the operation to be set upand to start production. Most coal companies willwant a 40- or 50-year lease, while most landownerswill want as short a term as possible. A common com-promise is to grant an initial primary term of 10 to 15years with the option to renew the lease for another15 to 25 years. All leases will provide also that thelease terms and conditions will continue in full forceand effect even after the scheduled termination of thelease "for so long thereafter as mining operations arebeing conducted."Financial ArrangementsAnother primary consideration, of course, is theamount of economic benefits to the landowner. Be-fore he signs a lease, the landowner should be familiarwith the financial terms of the lease.Bonus or Advanced Royalties. Basically, abonus is a payment made by the coal company toinduce the landowner to sign a lease. It is not recov-ered later out of production royalties. If there is onelong primary term, a typical bonus might be $25 to$35 an acre. If there is a short primary term with anoption, the initial bonus might be $15 to $25 an acrewith a second bonus of $25 to $35 an acre paid whenthe option is exercised.Rather than pay a bonus, however, some coalcompanies will pay an advanced royalty to get thelandowner to sign the lease. This payment is similar toa bonus, except that it is recovered or paid back to thecompany from future royalties as production begins.If paid as advance royalties, these payments may beslightly higher than if paid as a bonus. The landownershould be careful to insert a clause in the leasestipulating that these advance royalties may be takenfrom only 40 or 50 percent of the landowner's shareonce production begins. This will assure him of someincome on a continuing basis even when the advanceroyalties are being recovered by the coal company.Annual Rentals. Annual rentals are payments bythe coal company to keep the lease in effect for theentire term of the lease. These payments are usually$1 or $2 per acre paid annually.Royalties. Royalties are payments to the land-owner for his share of production. In coal and ligniteleases one of three common types of royalty paymentclauses will be included. The royalty may be based ona per ton figure. That is, the landowner may be paid aspecific amount, for example $.20 per ton of minedcoal. This method of royalty payment is the easiest tounderstand and check.A second method of payment is more difficult tounderstand and verify. The landowner may be paid bythe acre-foot, for example, $500 per acre-foot. Anacre-foot is a thickness of one foot of coal underlyingone acre of land.A third method of royalty payment is to base theroyalty on a percentage of the market or proceedsprice at the minehead, commonly five percent. If theprice is to be determined at a place other than theminehead, the transportation costs should be de-ducted and the percentage should be taken of the netproceeds. The landowner must be careful, however,to determine where the coal is being shipped and whothe buyer is. If the coal buyer and the coal companyare financially related companies (parent, subsidiary),it may be unfair to the landowner to deduct transpor-tation costs.Because the lease may be for a number of years,the landowner may want to protect himself and insiston a clause providing for an increase in the royaltypayments if the inflationary trend of the economy con-tinues. An index considered by most to be fair to bothlandowners and coal companies is the Monthly Indexof Wholesale Prices: Basic Commodities and ThirteenRaw Materials, as computed by the Bureau of Eco-nomic Analysis, United States Department of Com-merce.Surface Damages. In addition, the landownershould receive payment for surface damages. This in-cludes payment for the loss of the use of the surfaceduring mining operations; the amount of the paymentdepends on the productivity of the land prior to min-ing, but several hundred dollars per acre is not un-common. The landowner also will be paid for thedamages to the surface estate prior to production.This includes payment for the loss of structures,roads, tanks, crops, fences or similar effects. Beforesigning the l€;ase, a fair market value should be placedon any of these items that will be totally or partiallydestroyed. A landowner may insist also that the coalcompany build a new fence, tank, water well or simi-lar structure as part of the consideration for the lease.Pooling Clause. A unitization or pooling clausemayor may not be included in a coal and lignite lease.Some coal companies insist on it, while others do not.Most landowners oppose it. Basically, it provides thatthe owner's land may be pooled by the coal companywith the other land leased in the area to form a miningunit, possibly of 5,000 to 10,000 acres. The advantageto the landowner is that he will receive some incomelong before his land is mined if the coal companystarts mining at the far end of the unit. The disadvan-tage is that the quantity and quality of the coal on hisland may be superior to the other land in the unit, andhis payments might be less than if his land weremined separately.As mentioned previously, the Texas Surface Min-ing and Reclamation Act requires the coal company todo certain things, one of which is to reclaim anysurface-mined lands, that is, to restore them to theiroriginal or substantially beneficial condition. Thereare heavy penalties, both civil and criminal, if the coalcompany violates any order of the Railroad Commis-sion with regard to reclamation. Furthermore, thecoal company is required to post a bond large enoughto pay for the costs of reclamation should it be neces-sary for a third party to complete it. As additionalprotection, however, the landowner should insist on aclause in the lease which states that the coal companywill comply with all federal and state laws and regu-lations in the mining operation. This assures that thelandowner would have the right to sue the coal com-pany for a breach of its promise to restore the landafter mining.Another important consideration for the land-owner is the reservation of the right to mine or pro-duce other minerals, especially oil and gas, if they arediscovered on his property after the lignite lease issigned. The production of oil and gas is more lucrativethan coal production, and since the coal lease will bein effect for such a long period of time, the landownerwill want to reserve the right to develop other miner-als ifhe gets the chance. The coal company will objectstrenuously to this idea because such activities mightinterfere with its operations. It is a difficult problemwhich may require legislation to resolve.All leases also will include a "force majeure"clause which provides that if the production is stop-ped because of an act of God (tornado, flood, earth-quake or similar natural disaster) or because of anact of the government (labor strike, materials short-age) or other act outside of the control of the coalcompany, the lease will not terminate and the pri-mary term of the lease will be extended by the sameperiod of time that production was halted.Warranty Clause. One clause to examine veryclosely is a warranty clause whereby the landownerwarrants or promises the coal company that he has agood and marketable title to his property. The land-owner should have no reservations about warrantingthe title to the surface of his land. However, if thesurface estate and mineral estate previously havebeen divided (see "Real Ownership of Heaven andEarth," Tierra Grande, First Quarter 1978), heshould avoid warranting title to the coal or lignitewhich is or will be mined because of the uncertainstate of the issue of lignite ownership in Texas. If theowner of the mineral estate were to successfully estab-lish in a lawsuit that he, not the landowner, ownedthe lignite, then the coal company certainly would suethe landowner to recover all of the prior paymentsmade to him.The landowner should insist also on a clausewhereby the coal company will pay the taxes on anyimprovements or equipment it places on the owner'sland.Surrender Clause. Every lease will include a re-lease or surrender clause which allows the coal com-pany to terminate the lease with regard to all or anyportion of the leased lands. The coal company wouldhave to pay any financial obligations then due andowing at that time, but it would be relieved of anyfuture obligations. To protect himself, the landownermight want to insist on a clause that provides aminimum annual rental payment regardless of howmany acres may be released.Taking Final PrecautionsWhen a landowner leases his land for lignite min-ing operations, he will be losing his rights to use theland for long periods of time and will have substantialamounts of it totally destroyed. Reclamation proce-dures, if properly followed, ultimately should restorethe land to its original or substantially beneficial con-dition. To give up his rights, the owner must receiveadequate financial incentives. The coal and lignitelease is the legal instrument by which he must protecthimself and provide for compensation. Before hesigns a lease, he should clearly understand what thelease will mean to him over its entire duration. Con-sulting with a tax specialist is recommended. Heshould remember that any advance royalties will betaken out of his share of production at a later date.Finally, he should realize that many, if not most,terms of the lease are negotiable. A landowner shouldnot be afraid to ask for or insist on certain clauses orrequirements. Because of the technical and legal as-pects of a coal and lignite lease, he should consult anattorney prior to negotiating and signing a lease.Educational programs conducted by the Texas Agricultural Extension Service serve people ofall ages regardless ofsocio-economic level, race,color, sex, religion or national origin.Cooperative Extension Work in Agriculture and Home Economics, The Texas A&M University System and the United States Department ofAgriculture cooperating. Distributed in furtherance of the Acts of Congress of May 8, 1914, as amended, and June 30, 1914.5M-8-78, New AECO-6

Realestatement:  The Landowner's Guide to Lignite Leasing in Texas.

Texas A&M University

L-1662
REALESTATEMENT: THE LANDOWNER'S GUIDE
TO LIGNITE LEASING IN TEXAS
J. R. McCracken, J.D.*
Texas landowners who have coal and lignite face a
complex situation when considering leasing arrange-
ments, as the following case illustrates. After 25 years
ofbarely making a living, an East Texas farmer thought
he had discovered his fortune at last. A land broker or
"land man" from a national energy development com-
pany had asked to lease the rights to mine the coal and
lignite on and under his property. However, there
was just one small catch. Ten years ago, the farmer
had sold the rights to the "oil, gas, and other miner-
als" on his property to a speculator who now claimed
that he owned the coal and lignite on the farmer's
land. The farmer went to his attorney to find out who
own~d these rights.
"Probably you do" was the best answer that his
lawyer could give him in light of the present state of
the law in Texas.
Determining Lignite Ownership
Court Rulings
Whether the owner of the surface estate (land-
owner) or the owner of the mineral estate (speculator)
has legal rights to the coal and lignite under a piece of
land has not been decided finally by the Supreme
Court of Texas. The first major case on this issue,
Acker v. Guinn in 1971, involved iron ore rights on a
*Research assistant, Texas Real Estate Research Center,
Texas A&M University; member, State Bar of Texas.
10.30
particular piece of land. The Texas Supreme Court
decided that the owner of the surface estate owned
the iron ore and established the test that if a substance
is located so near the ·surface that it must be mined by
methods that would destroy or substantially impair
the surface, a grant or lease of "oil, gas and other
minerals" would not be deemed to include the surface
materials. The court reasoned that the owner of the
surface estate would not have given away his rights to
use the surface or allow it to be destroyed without
specifically stating this in the lease.
The next and latest case involving lignite rights
was Reed v. Wylie, decided in 1977. The Texas Su-
preme Court applied the rule of Acker v. Guinn and
held that a substance ~s not a mineral (in terms of an
"oil, gas and other minerals" grant) if substantial
quantities of it lie at or near the surface or are so
closely related to the surface that production will strip
away and substantially destroy the surface. Tne court
held that the lignite under these circumstances would
belong to the surface owner. Yet to be answered by
the court, how~ver, are the questions of what. "at or
near the surface" means and whether or not the courts
are legally bound to examine the most reasonable
method of mining that existed when the lease was
signed to determine if that method would have ~e­
stroyed the surface. The best interpretation at this
time is that lignite will be deemed to belong to the
owner of the surface estate in most instances.
Assurance oflegal rights, however, is only the first
step; the landowner still should consult an attorney
about the terms and conditions of a typical coal and
lignite lease.
Te as Agricultural Extension Service. The Texas A&M University System. Daniel C. Pfannstiel, Director. College Station, Texas
Examining the Lease
There is no standard form of lease in the coal and
lignite industry such as the Producers 88 in the oil and
gas industry. Each coal company (lessee) has a pre-
ferred form which the landowner (lessor) will be asked
to sign; however, the landowner should remember
that many, if not most, of the provisions of these
leases are negotiable to some degree.
Mining Provisions
Unless otherwise agreed to in writing, a typical
coal and lignite lease will allow the coal company to
mine the lignite by any means available, not just by
surface mining methods. At this time, however, sur-
face mining is the only economically profitable
method. If surface mining is used, the coal company
must comply with the Texas Surface Mining and Rec-
lamation Act of 1977 and obtain a surface mining op-
erations permit from the Railroad Commission of
Texas.
First, when negotiating the terms of the lease, the
landowner will want to consider how long the lease
will be in effect. Coal and lignite mining requires a
very long period of time for the operation to be set up
and to start production. Most coal companies will
want a 40- or 50-year lease, while most landowners
will want as short a term as possible. A common com-
promise is to grant an initial primary term of 10 to 15
years with the option to renew the lease for another
15 to 25 years. All leases will provide also that the
lease terms and conditions will continue in full force
and effect even after the scheduled termination of the
lease "for so long thereafter as mining operations are
being conducted."
Financial Arrangements
Another primary consideration, of course, is the
amount of economic benefits to the landowner. Be-
fore he signs a lease, the landowner should be familiar
with the financial terms of the lease.
Bonus or Advanced Royalties. Basically, a
bonus is a payment made by the coal company to
induce the landowner to sign a lease. It is not recov-
ered later out of production royalties. If there is one
long primary term, a typical bonus might be $25 to
$35 an acre. If there is a short primary term with an
option, the initial bonus might be $15 to $25 an acre
with a second bonus of $25 to $35 an acre paid when
the option is exercised.
Rather than pay a bonus, however, some coal
companies will pay an advanced royalty to get the
landowner to sign the lease. This payment is similar to
a bonus, except that it is recovered or paid back to the
company from future royalties as production begins.
If paid as advance royalties, these payments may be
slightly higher than if paid as a bonus. The landowner
should be careful to insert a clause in the lease
stipulating that these advance royalties may be taken
from only 40 or 50 percent of the landowner's share
once production begins. This will assure him of some
income on a continuing basis even when the advance
royalties are being recovered by the coal company.
Annual Rentals. Annual rentals are payments by
the coal company to keep the lease in effect for the
entire term of the lease. These payments are usually
$1 or $2 per acre paid annually.
Royalties. Royalties are payments to the land-
owner for his share of production. In coal and lignite
leases one of three common types of royalty payment
clauses will be included. The royalty may be based on
a per ton figure. That is, the landowner may be paid a
specific amount, for example $.20 per ton of mined
coal. This method of royalty payment is the easiest to
understand and check.
A second method of payment is more difficult to
understand and verify. The landowner may be paid by
the acre-foot, for example, $500 per acre-foot. An
acre-foot is a thickness of one foot of coal underlying
one acre of land.
A third method of royalty payment is to base the
royalty on a percentage of the market or proceeds
price at the minehead, commonly five percent. If the
price is to be determined at a place other than the
minehead, the transportation costs should be de-
ducted and the percentage should be taken of the net
proceeds. The landowner must be careful, however,
to determine where the coal is being shipped and who
the buyer is. If the coal buyer and the coal company
are financially related companies (parent, subsidiary),
it may be unfair to the landowner to deduct transpor-
tation costs.
Because the lease may be for a number of years,
the landowner may want to protect himself and insist
on a clause providing for an increase in the royalty
payments if the inflationary trend of the economy con-
tinues. An index considered by most to be fair to both
landowners and coal companies is the Monthly Index
of Wholesale Prices: Basic Commodities and Thirteen
Raw Materials, as computed by the Bureau of Eco-
nomic Analysis, United States Department of Com-
merce.
Surface Damages. In addition, the landowner
should receive payment for surface damages. This in-
cludes payment for the loss of the use of the surface
during mining operations; the amount of the payment
depends on the productivity of the land prior to min-
ing, but several hundred dollars per acre is not un-
common. The landowner also will be paid for the
damages to the surface estate prior to production.
This includes payment for the loss of structures,
roads, tanks, crops, fences or similar effects. Before
signing the l€;ase, a fair market value should be placed
on any of these items that will be totally or partially
destroyed. A landowner may insist also that the coal
company build a new fence, tank, water well or simi-
lar structure as part of the consideration for the lease.
Pooling Clause. A unitization or pooling clause
mayor may not be included in a coal and lignite lease.
Some coal companies insist on it, while others do not.
Most landowners oppose it. Basically, it provides that
the owner's land may be pooled by the coal company
with the other land leased in the area to form a mining
unit, possibly of 5,000 to 10,000 acres. The advantage
to the landowner is that he will receive some income
long before his land is mined if the coal company
starts mining at the far end of the unit. The disadvan-
tage is that the quantity and quality of the coal on his
land may be superior to the other land in the unit, and
his payments might be less than if his land were
mined separately.
As mentioned previously, the Texas Surface Min-
ing and Reclamation Act requires the coal company to
do certain things, one of which is to reclaim any
surface-mined lands, that is, to restore them to their
original or substantially beneficial condition. There
are heavy penalties, both civil and criminal, if the coal
company violates any order of the Railroad Commis-
sion with regard to reclamation. Furthermore, the
coal company is required to post a bond large enough
to pay for the costs of reclamation should it be neces-
sary for a third party to complete it. As additional
protection, however, the landowner should insist on a
clause in the lease which states that the coal company
will comply with all federal and state laws and regu-
lations in the mining operation. This assures that the
landowner would have the right to sue the coal com-
pany for a breach of its promise to restore the land
after mining.
Another important consideration for the land-
owner is the reservation of the right to mine or pro-
duce other minerals, especially oil and gas, if they are
discovered on his property after the lignite lease is
signed. The production of oil and gas is more lucrative
than coal production, and since the coal lease will be
in effect for such a long period of time, the landowner
will want to reserve the right to develop other miner-
als ifhe gets the chance. The coal company will object
strenuously to this idea because such activities might
interfere with its operations. It is a difficult problem
which may require legislation to resolve.
All leases also will include a "force majeure"
clause which provides that if the production is stop-
ped because of an act of God (tornado, flood, earth-
quake or similar natural disaster) or because of an
act of the government (labor strike, materials short-
age) or other act outside of the control of the coal
company, the lease will not terminate and the pri-
mary term of the lease will be extended by the same
period of time that production was halted.
Warranty Clause. One clause to examine very
closely is a warranty clause whereby the landowner
warrants or promises the coal company that he has a
good and marketable title to his property. The land-
owner should have no reservations about warranting
the title to the surface of his land. However, if the
surface estate and mineral estate previously have
been divided (see "Real Ownership of Heaven and
Earth," Tierra Grande, First Quarter 1978), he
should avoid warranting title to the coal or lignite
which is or will be mined because of the uncertain
state of the issue of lignite ownership in Texas. If the
owner of the mineral estate were to successfully estab-
lish in a lawsuit that he, not the landowner, owned
the lignite, then the coal company certainly would sue
the landowner to recover all of the prior payments
made to him.
The landowner should insist also on a clause
whereby the coal company will pay the taxes on any
improvements or equipment it places on the owner's
land.
Surrender Clause. Every lease will include a re-
lease or surrender clause which allows the coal com-
pany to terminate the lease with regard to all or any
portion of the leased lands. The coal company would
have to pay any financial obligations then due and
owing at that time, but it would be relieved of any
future obligations. To protect himself, the landowner
might want to insist on a clause that provides a
minimum annual rental payment regardless of how
many acres may be released.
Taking Final Precautions
When a landowner leases his land for lignite min-
ing operations, he will be losing his rights to use the
land for long periods of time and will have substantial
amounts of it totally destroyed. Reclamation proce-
dures, if properly followed, ultimately should restore
the land to its original or substantially beneficial con-
dition. To give up his rights, the owner must receive
adequate financial incentives. The coal and lignite
lease is the legal instrument by which he must protect
himself and provide for compensation. Before he
signs a lease, he should clearly understand what the
lease will mean to him over its entire duration. Con-
sulting with a tax specialist is recommended. He
should remember that any advance royalties will be
taken out of his share of production at a later date.
Finally, he should realize that many, if not most,
terms of the lease are negotiable. A landowner should
not be afraid to ask for or insist on certain clauses or
requirements. Because of the technical and legal as-
pects of a coal and lignite lease, he should consult an
attorney prior to negotiating and signing a lease.
Educational programs conducted by the Texas Agricultural Extension Service serve people ofall ages regardless ofsocio-economic level, race,
color, sex, religion or national origin.
Cooperative Extension Work in Agriculture and Home Economics, The Texas A&M University System and the United States Department of
Agriculture cooperating. Distributed in furtherance of the Acts of Congress of May 8, 1914, as amended, and June 30, 1914.
5M-8-78, New AECO-6


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Realestatement: The Landowner's Guide to Lignite Leasing in Texas.

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Realestatement: The Landowner's Guide to Lignite Leasing in Texas.

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