A PRIMER ON MINERAL INTERESTS IN ILLINOIS REAL ESTATE
by Joe Kusmierczak, ATG Law Clerk

Minerals Defined

The legal definition of "mineral" is broader than its scientific definition. The Illinois Supreme Court has long held that "[o]il and gas are classed as minerals, that term not being confined to metallic substances." Poe v Ulrey, 233 Ill 56, 84 NE 46 (Ill 1908).

Despite this well-settled legal definition, the meaning of the term can vary widely in common usage. In resolving minerals disputes, courts often find themselves facing the difficult task of determining which substances the term was intended to include in a particular conveyance. In response, the Illinois Supreme Court has ruled that courts should look beyond the definition of "minerals" and examine the context in which the term is used, including the language of the conveyance, the surrounding circumstances, and the intention of the grantor when ascertainable. Kinder v LaSalle County Carbon Coal Co, 310 Ill 126, 141 NE 537 (Ill 1923). In Kinder, the Court concluded that a conveyance of "all bituminous or stone coal and other minerals" did not convey any interest in limestone, gravel, sand, and similar substances. In narrowly construing the meaning of "other minerals," the Court reasoned that coal was the only known substance with appreciable commercial value, and that both parties knew that these "other minerals" could not be removed without making the surface unsuitable for agricultural purposes.

But later courts, faced with the daunting task of determining whether language like that in Kinder conveyed any interest in oil and gas development, declined to follow Kinder. In a series of cases known as the "coal and other minerals" cases, these courts opted for a stricter adherence to the legal definition. Barely twenty years after its decision in Kinder, the Illinois Supreme Court decreed that "[o]il and gas, by the overwhelming weight of authority, are minerals." Jilek v Chicago, Wilmington & Franklin Coal Co, 382 Ill 241, 245, 47 NE2d 96, 98 (Ill 1943). Similarly, a conveyance of "oil, gas, and other minerals" would likely be construed to include coal. See Novak v Smith, 197 Ill App 3d 390, 554 NE2d 652 (5th D 1990).

While Kinder has been largely ignored, it has never been expressly overruled. That it retains some vitality is evinced by a recent decision from the Third District. In Save Our Little Vermillion Environment, Inc v Illinois Cement Co, 311 Ill App 3d 747, 752, 725 NE2d 386, 390 (3rd D 2000), the court observed that the real significance of Kinder lay in the recognition that limestone, gravel, and sand "[are] of an entirely different nature from coal and oil." (Quoting Kinder, 310 Ill at 134, 141 NE at 540). Courts rarely need to glean intent in cases involving coal, oil, and gas because those are commercially valuable fossil fuels that can usually be extracted with minimal impact on the use and enjoyment of the overlying surface estate. But courts must examine extrinsic evidence in cases involving limestone, gravel, sand, and the like because these substances are less commercially valuable and usually can only be extracted with great impact on the overlying surface estate (e.g., quarrying).

Property Interests in Minerals

Mineral interests in property assume two basic forms: that of an estate in fee, and a mineral lease. This article will provide a basic explanation of how these respective interests are created, the rights and obligations attendant to each, and how they can be terminated.

The Minerals Estate

A mineral estate can be created by severing the surface rights from the underlying mineral rights. This can be accomplished either by a conveyance of the mineral rights alone, or by a conveyance of the surface estate, whereby the grantor reserves the interest in the underlying minerals. The legal result is two separate and distinct estates in land, subject to independent ownership and separate taxation, either of which may be conveyed or devised. Shell Oil Co v Moore, 382 Ill 556, 561, 48 NE2d 400, 402 (Ill 1943).

Mineral interests can also be acquired through adverse possession. If the mineral interest has not been severed from the surface interest, then adverse possession of the surface constitutes adverse possession of the underlying minerals as well. But, as explained in some detail below, the requirements to take mineral interests by adverse possession are more difficult to meet once those interests have been severed from the surface interests.

When the mineral estate is severed from the surface estate, the means to attain and enjoy the minerals pass by implication. Jilek, 382 Ill 241 at 250, 47 NE2d 96 at 100. Thus, the owner of the surface estate is servient to that of the mineral estate insofar as he must tolerate such use and occupation of the surface as may be reasonably necessary to mine the minerals. Schmidt v Schmidt, 284 Ill App 623, 1 NE2d 419 (2nd D 1936). This implied right to attainment and enjoyment of the underlying minerals is not so broad as to permit the owner of the minerals estate to cover the surface "with railway tracks, reservoirs, structures and manufacturing equipment.... These rights necessarily must be covered by an express contract... or they will not exist." Jilek at 251, 101. Similarly, in absence of an express release or waiver, the rights of ownership of the surface estate includes a right to subjacent support, and such right does not depend upon whether mining is done with great care or in accordance with industry custom. Mason v Peabody Coal Co, 320 Ill App 350, 51 NE2d 285 (3rd D 1943).

While title to metallic ores and coal vests at the time of the conveyance, title to oil and gas does not. This is because solid minerals are liable to ownership in place, while oil and gas-like underground water-are of a wandering nature and may escape. Poe v Ulrey, 233 Ill 56, 84 NE 46 (Ill 1908). Accordingly, title to coal vests at the time of the conveyance, but title to oil and gas does not vest until they are actually found and reduced to possession. Updike v Smith, 378 Ill 600, 39 NE2d 325 (Ill 1942). So a grant of oil and gas rights is really a grant of exploration and production rights. Such a grant is nonetheless one in fee simple. The interest granted vests in the grantee at the time of the conveyance, and neither the surface owner nor his subsequent grantees can interfere with or repudiate them. Chicago, Wilmington & Franklin Coal Co v Herr, 40 F Supp 311 (ED Ill 1941).

At common law, once a mineral estate has been severed from the surface estate, it cannot be terminated by mere non-use or abandonment. Uphoff v Trustees of Tufts College, 351 Ill 146, 155, 184 NE 213, 216 (Ill 1932). Thus, mineral interests can lie dormant, even through several transfers of title. The result, over time, can be missing or unknown owners. The difficulty in ascertaining and locating such owners had a substantial deterrent effect on would-be gas and oil developers. The Illinois legislature responded by enacting the Dormant Mineral Interests Act in 1969. The Act was intended to facilitate development of dormant oil and gas interests by permitting consolidation of ownership into one person where it had formerly been diffused amongst many unknown or missing persons. It provided that unless an individual duly recorded his interest, his failure to actually produce oil or gas in any 25-year period created a presumption of abandonment. There was great uncertainty amongst oil and gas title examiners as to the Act's validity because, at common law, abandonment required both intent to abandon and an affirmative act of relinquishment. Furthermore, the Act required neither notice nor opportunity to be heard be given to missing or unknown owners. A decade after its enactment, the Act was ruled unconstitutional by the Illinois Supreme Court in Wilson v Bishop, 82 Ill 2d 364, 412 NE2d 522 (Ill 1980).

While mineral interests cannot be terminated through abandonment, they may be acquired by adverse possession. But because severance creates two separate estates in land, "each estate is incapable of possession by the mere occupancy of the other... even if the [deed or conveying instrument] purports to convey the whole property." Uphoff, 351 Ill at 154, 184 NE at 216. Thus an adverse claimant must show more than mere title to, or possession of, the overlying surface estate. He must engage in open and regular removal of solid minerals, or production of oil or gas, or perform other acts for a period of 20 years, so as to apprise the community that the mineral interest is in the exclusive use and enjoyment of the adverse claimant. Pickens v Adams, 7 Ill 2d 283, 292, 131 NE2d 38, 43 (Ill 1955).

As to missing or unknown owners, the Severed Mineral Interest Act provides for presumptive adverse possession. Any surface owner may lay adverse claim to the underlying severed mineral interests of missing or unknown owners. The adverse claimant must file a petition with the clerk of the court which includes a legal description of the lands; a statement of the claimant's interest in the lands, as well as that of the defendant owner(s); the name(s) and last known address(es) of the missing or unknown owner(s); a statement that said owner(s) cannot be located or ascertained after diligent search; evidence of the diligent search; and a statement that the undeveloped mineral interest impairs the enjoyment of that interest presently held by the adverse claimant. The clerk will serve notice to the known owner(s) by certified mail, and to the unknown or missing owner(s) by publication. The court will then render judgment as to presumptive adverse possession. The presumptive adverse possessor will take title to the interests of any and all unknown or missing persons who fail to contest the claim within seven years after the initial judgment, so long as he pays all taxes legally assessed to the property. 765 ILCS 515/11, et seq.

The Mineral Lease

Mineral leases are subject to the same rules as are ordinary leases. They must be agreed to by competent and authorized persons. Because leases are a species of contract, they are subject to the Statute of Frauds. No authority will be cited here for the general propositions that minerals leases must be in writing; must be properly signed or executed; and may be voided for want of mutuality or consideration.

Illinois courts have long held that a mining right is a right to excavate to obtain minerals. People ex rel Carrell v Bell, 237 Ill 332, 337, 86 NE 593, 594 (Ill 1908). As noted above, oil and gas have long been classified as minerals in Illinois. Accordingly, mining rights have long been construed to include oil and gas leases. Carrell, 237 Ill at 337-338, 86 NE at 595. But the term "lease" can be misleading in the context of minerals leases generally, and oil and gas leases in particular. While such leases can be for a primary term, e.g. five years, they typically contain a clause which provides that the lease shall continue "so long thereafter" as certain conditions are met. While these conditions will be discussed in some detail below, the crucial point is that those leases that are of an indefinite duration by virtue of their "thereafter" or habendum clauses have been held to convey a freehold interest in property. Updike v Smith, 378 Ill 600, 604, 39 NE2d 325, 327 (Ill 1942). Such leases do not, however, work a severance of the oil and gas from the overlying surface estate. Updike, 378 Ill at 605, 39 NE2d at 328. Instead, "under a mining lease, the minerals belong to the lessor as long as they remain in the land, but the lessee has the right to explore and reduce them to possession, upon which he pays the reserved royalty or rent." People ex rel Hargrave v Phillips, 394 Ill 119, 123, 67 NE2d 281, 282 (Ill 1946).

The term "oil and gas royalty" usually refers to the compensation due the lessor under an oil and gas lease. But the term is also used to describe a fractional minerals interest that has been granted or reserved by the landowner prior to the execution of a given lease. The former must be carefully distinguished from the latter. A fractional minerals interest entitles its owner to a fractional share, payable in money or in kind, of all petroleum products free and clear of any exploration, development, or production costs. But the owner of a fractional minerals interest "may not drill for nor take oil from the leased premises without the consent of the lessee, and has no control over such operations, and cannot prevent the lessee from entering upon the surface of the premises to produce oil." Ohio Oil Co v Wright, 386 Ill 206, 217, 53 NE2d 966, 971 (Ill 1944). His interest is not an interest in the land itself, but a right to accrued royalties, i.e. royalties on actual production. Hardy v Greathouse, 406 Ill 365, 372-373, 94 NE2d 134, 137 (Ill 1950). Illinois courts have characterized accrued royalties as personal property. See Walsh v Union Oil Co of California, 131 Ill App 2d 1015, 1019, 268 NE2d 706, 709 (5th D 1970).

A lease can be terminated in one of three ways: by expiration of its primary term; by breach of its express or implied provisions; or by abandonment. Because expiration of the primary term and breach of express provisions present fairly simple legal issues, the following discussion will focus upon breach of implied provisions and abandonment.

Illinois courts acknowledge that oil and gas leases contain an implied covenant of reasonable development. As stated in Baker v Collins, 29 Ill 2d 410, 412, 194 NE2d 353, 355, (Ill 1963) "[a]fter the discovery of oil and gas in paying quantities, the law... implies a duty on the part of the lessee to reasonably develop the premises, particularly where the principal consideration for the lease is a royalty to be paid to the lessor." The lessee has a duty to act like "an ordinarily prudent person engaged in like business." Daughtee v Ohio Oil Co, 263 Ill 518, 524, 105 NE 308, 311 (Ill 1914). While courts may consider a number of factors when determining whether the lessee has met this duty, the "probable profitability" of further development is of "prime importance." Baker, 29 Ill 2d at 413, 194 NE2d at 355.

Breach of the duty of reasonable development is readily distinguishable from abandonment. Breach implies a clear failure to comply with the provisions of the lease. Abandonment, however, implies initial compliance, followed by a cessation of operations. Because a lease confers certain rights upon the lessee for the length of the primary term, courts require proof of intent to abandon where the lessee allegedly abandons the lease during the primary term. As the Fifth District observed in Belden v Tri-Star Production Co, Inc, 106 Ill App 3d 192, 203, 435 NE2d 927, 934 (5th D 1982), "[a]bandonment... has been described as an intentional relinquishment of a known right. As such, a party who seeks to declare an abandonment of an oil and gas lease must prove that the abandoning party intended to do so...."

The first Illinois case to address the issue of abandonment was Gillespie v Ohio Oil Co, 260 Ill 169, 102 NE2d 1043 (Ill 1913). The lease provided for a primary term of five years, "and so long thereafter as oil or gas is produced thereon." Because the lease contained no reference to "paying quantities," the Court found that "[t]here was clearly no abandonment of the lease" where the lessee "was in possession... and was pumping the well daily" even though "the quantity [of oil] produced was so small as to make the venture unprofitable...." Gillespie, 260 Ill at 171, 102 NE at 1044.

Intent to abandon can often be inferred from the lessee's actions. As the Illinois Supreme Court observed in Spies v DeMayo, 396 Ill 255, 275, 72 NE2d 316, 325 (Ill 1947), "cessation of operations for a considerable period of time, if unexplained, may be sufficient to warrant a declaration as a matter of law that an oil lease has been abandoned." The court held that the lessee's decision to remove the engine from the pumping unit and cease production for some two years constituted "abandonment in fact as well as in law...." Spies, 396 Ill at 275, 72 NE2d at 325. The court also ruled that "the lessee, in abandoning its lease and failing to remove its property within a reasonable time thereafter, thereby abandoned such property." Id at 275, 326.

But this "element of proof [of intent] is unnecessary if it is claimed that the lease has expired under its own habendum clause." Belden, 106 Ill App 3d at 203, 435 NE2d at 934. This is because the lessee's rights are not fixed under the habendum clause, but are conditional upon satisfaction of its provisions. When seeking termination, the lessor need only show that oil and gas are not being produced in paying quantities, or that the lessee is not exercising reasonable diligence in producing oil or gas.

In Metz v Doss, 114 Ill App 2d 195, 197, 252 NE2d 410, 412 (4th D 1969), the lease provided for a primary term of one year, "and as long thereafter as oil or gas, or either of them, is produced from said land by lessee." While the lease made no reference to "paying quantities," the court noted that "[t]he purpose of an oil and gas lease is to obtain production... in the ordinary sense of the term and hence results in royalties to the lessor." Metz, 114 Ill App 2d at 198, 252 NE2d at 412. There had been no commercial production of gas for nine years. The court ruled that the furnishing of free gas for domestic use by the lessor merely satisfied the "free gas" clause in the lease. While the lessee had expended large sums of money to develop the property into a gas storage reservoir, this simply did not constitute production necessary to continue the lease under the habendum clause.

In Doty v Key Oil, Inc, 83 Ill App 3d 287, 404 NE2d 346 (5th D 1980), the lease contained a "shut-in" clause providing that the lessee could continue the lease for one year, in the absence of production, by shutting-in a well and tendering a payment within 90 days thereafter. As Professor Summers explained, the shut-in clause is a creature of practical necessity that "permits the lessee who has discovered gas in paying quantities during the primary term for which there is no market to keep the lease alive by the payment of a fixed money royalty." 2 Summers, Oil & Gas § 299 at 266 (Rev. Ed. 1959). In Doty, gas was discovered in significant quantities during the primary term. The lessee flared the gas for an entire year, but no oil was produced. Not until the primary term had expired did the lessee shut-in the well and tender payment. This delay was crucial. The court distinguished Gillespie, ruling that "the mere flaring of the instant well was not production in the same sense that the pumping of even a small quantity of oil could constitute production." Accordingly, the lease had not been abandoned per se, but had instead expired according to the terms of the habendum clause.

While cessation of production for an unreasonable amount of time may constitute abandonment during the primary term, or may allow the lease to expire pursuant to the habendum clause, temporary cessation of production may not. As the Illinois Supreme Court stated in Gillespie v Wagoner, 28 Ill 2d 217, 220, 190 NE2d 765, 766 (Ill 1963), "[w]e believe the proper rule to be that temporary cessation of production after the expiration of the primary term is not a cessation of production within the contemplation and meaning of the 'thereafter' clause if, in light of all surrounding circumstances, reasonable diligence is being exercised by the lessee to continue production...." In Wagoner, the lessee had ceased production for over two years, and had removed the motor from the pump jack. The court deemed the lessee's excuses, including financial difficulties and inclement weather, insufficient to meet the reasonable diligence requirement.

Other courts have applied the Wagoner rule and reached different results. In Smith v Duncan, 230 Ill App 3d 164, 595 NE2d 645 (5th D 1992), the lessee claimed that numerous stoppages in production were due to a chained gate, inclement weather, soft roads, and continual problems with the pump motor despite regular mechanical maintenance. In light of evidence that the lessor had blocked access to the subject property during the winter months, forbade improvement of the dirt access road with rock, and was likely responsible for "bothering" the motor, the court found that the lessee had shown reasonable diligence.

Once a lease has been terminated it may be necessary to give notice to the lessee. Leases often contain a notice and demand clause, requiring written notice of breach and a reasonable period to cure the breach. Even in the absence of such a clause, notice is typically required where the circumstances involve breach of express or implied terms of the lease. But according to Wagoner, 28 Ill 2d 217, 220-221, 190 NE2d 765, 766, no notice is required where the lessee has abandoned the lease, or the lease has expired pursuant to the habendum clause: "[t]he lessor was under no duty to give notice to the lessees of his intention to cancel the lease for failure to continue production. The lease terminated under the terms of the 'thereafter' clause."

Finally, the Mineral Lease Release of Record Act provides that it is the duty of the lessee, his heirs, representatives, successors or assigns to have the lease released of record within sixty days of the termination of the lease, at no cost to the lessor, regardless of whether termination was a result of expiration, breach, or abandonment. 765 ILCS 510/1.

Conclusion

Mineral interests in property exist in two basic forms, the estate in fee and the lease. The minerals estate is separate and distinct from the overlying surface estate. Once these estates have been severed by a conveyance or reservation, a well-developed body of law confers certain rights and obligations upon their respective owners. Owners and practitioners should therefore take great care when drafting instruments purporting to convey or reserve an interest in minerals. The law pertaining to mineral leases, especially oil-and-gas leases, is equally well developed and full of pitfalls for the unwitting party. Prospective lessees in particular should take careful note of their legal duties, lest they forfeit their legal rights through breach or abandonment. If you plan to insure title to minerals that have been severed or leased, please first call the Underwriting Department to discuss your chain of title and ATG's requirements.

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