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Life Estates: Oil and Gas Law Implications

Posted in Contracts and Leases, Mineral Interest, Ohio, Real Estate, Tax issues

Life estates have been recognized as an interest in land at common law since the Middle Ages. Even so, how they relate to the ownership of and payment for oil and gas can result in outcomes that may not be intuitive.

According to common law and statute, there can be no gap in the perpetual ownership of land. For instance, if the owner of a piece of property dies intestate, state statute (in Ohio, R.C. 2105.06) often states to whom the land will be distributed. For this reason and others, land ownership often is divided between a “present” interest and a “future” interest. Frequently, that division takes the form of a life estate and a remainder.

Life Estates Generally
A life estate is an estate that its holder, the “life tenant,” holds only for the duration of a specified person’s (usually the life tenant’s) life. At the death of the life tenant (or, if the life estate is one “for the duration of another person’s life, upon that person’s death), the property passes automatically to one or more individuals or organizations called “remaindermen.” A life estate can be created by deed, by devise in a will, or, if a will is unclear or ambiguous, by judicial implication.

Both the life tenant and the remaindermen have real interests in the property, but they do not have rights to the property at the same time. Instead, their interests in the property are “stacked in time;” the life tenant has a current, exclusive right to possess the land, while the remaindermen’s interest become activated only upon her death.

Prohibition against Waste
During her possession, the life tenant is entitled to the full use and enjoyment of the land, but she may not use the land in such a way as to injure or devalue the remaindermen’s future interests. Doing so constitutes “waste,” for which the life estate is forfeitable. In Ohio, for example, Revised Code Section 2105.20 provides that a life tenant who commits waste or allows another to commit waste “shall forfeit” that part of the property to which the waste was committed and is liable to the remaindermen for damages caused by the waste.

Division of Proceeds
A life tenant generally is entitled to the rents, profits, and other income of the land during her possession. And, because she enjoys the income of the land, the life tenant has a duty to pay the property taxes on the real estate during her possession. The corpus of the property, however, belongs to the remaindermen. Consider the following example:

Tim dies and in his will leaves the family farm to his wife, Laura, “for her life.” The will also leaves their children, Rachael and Ryan, the remainder of the estate upon Laura’s death. Applying the general rules above, if Laura decides to rent the farm, she is entitled to 100% of the income she receives. But she may not sell the land without her children’s consent because she holds no interest in the corpus of the property. Rachael and Ryan, on the other hand, are not entitled to the use, enjoyment, or income from the farm during their mother’s life and, because they do not have possession of the property during that period, also may not sell the farm without her consent.

Valuation of Life Estate and Remainders
In the example above, were Laura, Rachael and Ryan to agree to sell the farm, Laura would be entitled to compensation for the sale of her interest. Her interest would be valued using her age and the present fair market value of the property. Several agencies, including the Internal Revenue Service, publish actuarial charts that are used for this purpose. Rachael and Ryan would then share the remaining sale proceeds equally.

Application to Mineral Interests
The relatively straightforward rules above become more complicated when underground minerals are involved. Expanding upon our earlier example, suppose that the land Tim devised to Laura, Rachael and Ryan contains underground deposits of oil and natural gas. Now who is entitled to what, and who has the right to enter into a lease for production of oil and gas?

Neither the Life Tenant nor Remaindermen Can Unilaterally Enter into an Oil and Gas Lease.

Neither a life tenant nor remaindermen, acting alone, can develop the property for oil and gas purposes or execute a lease which, standing alone, authorizes such development.

Ohio appellate courts have stated that a life tenant commits enjoinable waste if she unilaterally commences extraction activities or enters into an oil and gas lease. Fourth & Central Trust Co. v. Woolley, 31 Ohio App. 259, 262, 165 N.E. 742 (1st Dist. 1928), citing Kenton Gas & Elec. Co. v. Dorney, 9 Ohio C.D. 604, 1898 WL 1401 (Ohio Cir. 1898). This rule is based on the view that oil and gas are part of the corpus of the land, in which the life tenant has no interest. The extraction of the minerals from the corpus devalues it, harming the remaindermen.

Conversely, remaindermen may not extract minerals (or lease the land to someone else to do it) during the life tenant’s possession because the remaindermen have no current right of possession of the property. The remaindermen’s (or their agent’s) entry on the land to conduct drilling operations is trespass.

Development can, however, be undertaken if:

  • Both the life tenant and the remaindermen join a single lease;
  • The life tenant and remaindermen execute separate leases to the same lessee developer or oil company;
  • Either the life tenant or the remaindermen execute a lease and the other later ratifies the lease; or
  • The life tenant and remaindermen execute separate leases to different lessees, but through assignment, sale, or other transfer, ownership of both leases comes to rest in a single party, or the lessees execute a joint operating agreement to cooperatively develop the property.

Division of Proceeds
If a lease is undertaken, the general rule that the life tenant is entitled to income from the property and the remaindermen the corpus often still applies. Delay rentals are generally considered income and are paid directly to the life tenant. Royalties and leasing bonuses, which are paid in exchange for the extraction of minerals from the land, are considered a part of the corpus of the estate. Many jurisdictions, including Ohio, require that they be invested during the period of the life tenancy, with the interest earned from their investment paid to the life tenant. See Fourth & Central Trust Co., 31 Ohio App. at 265-266. After the life estate ends, the remaindermen are entitled to the amounts invested.

The Open Mine Doctrine
The rules on proceeds change dramatically, however, if land was under an oil and gas lease or oil and gas was being produced on it at the time a life estate was created. Under a set of principles known as the “open mine doctrine,” a life tenant is entitled to the royalties from any wells working at the time the life estate was created and any wells opened after the life estate begins that are opened under the authority of a lease or conveyance that the former owner made prior to the creation of the life estate. Siley v. Remmele, 4th Dist. No. 86 CA 6, 1987 WL 7585, * 1. Thus, while a life tenant is not entitled to royalties from leases executed after her estate is created, she is entitled to the royalties from oil or gas produced subject to prior leases.

Those contemplating creating a life estate should remember that the instrument granting the estate can vary or modify the rules discussed above in any way the grantor or parties see fit. In the absence of such changes, the discussion above can serve as a guide as to how Ohio courts considering these issues might rule.