FRACTIONALIZATIONby Will Brackett
Bequeathing Mineral Rights
Mineral rights are commonly inherited and passed down from one generation to another within families. People who own minerals commonly obtain their mineral rights via inheritance from an older relative and plan to hand down their mineral ownership interest to their heirs.
The act of handing down one’s property such as minerals to someone else via a last will and testament is known as bequeathing.
Minerals can be bequeathed many times as the ownership interest is passed down over the generations from one heir to the next. The problem that can arise from this is it is not unusual for the ownership interest to be divided several times – into smaller and smaller pieces – as the minerals are passed down within families over time.
When the ownership interest is divided into smaller and smaller pieces as it is passed down over time, this is known as fractionalization.
Fractionalization can be a problem if the mineral ownership interest is divided so many times over the years that the pieces become so small that they have little or no value at all.
Many mineral owners do not consider the impact of dividing their interest and assume that doing so is the equitable way to pass down the minerals to their heirs.
Instead, mineral interests that have become very small due to extensive fractionalization are likely to draw less leasing interest from oil and gas companies. Oftentimes oil and gas producers will avoid areas with a large number of small, fractionalized mineral interests, even if those areas appear to be promising for oil and gas production, and instead opt for areas with fewer and larger mineral interests.
Furthermore, if an oil and gas company does seek leases in an area with many fractionalized mineral interests, the mineral owners will have substantially less leverage in negotiating favorable terms in their leases.
Another issue with fractionalization is it makes it more likely that mineral interest owners’ contact information will get lost or not be registered with the oil and gas company holding the lease, making it impossible for these owners to receive their royalty payments.
So, what can a mineral owner do to avoid dividing – fractionalizing – a mineral interest which he or she plans to bequeath to succeeding generations?
Alternatives to Fractionalization
There are alternatives to fractionalizing a mineral interest when it is to be passed on from one generation to another.
First of all, can a fractionalized mineral interest can be re-consolidated? The answer is yes, and doing so can strengthen a mineral ownership position.
Re-consolidating fractionalized small mineral interests back into a larger interest is usually accomplished by deeds. Oftentimes, the smaller interests are re-consolidated and placed into a trust or family partnership that will be the single owner of the re-consolidated mineral interest.
In fact, the establishment of a trust or family partnership can be among the best alternatives to fractionalization, especially if the family’s mineral ownership is sizable.
As noted above, a trust or family partnership can be the sole legal owner of an undivided mineral interest or collection of undivided mineral interests. The family can then apportion the ownership interests in the trust or partnership. This allows for the mineral interest to remain undivided while the family members divide the ownership (and thus the income) of the trust or partnership among themselves as they see fit.
Putting mineral interests into a trust or family partnership can also have tax benefits and may reduce administrative and probate expenses.
Another common alternative to fractionalization is the transfer of whole mineral interests among heirs. This option certainly works best when there is more than one whole mineral interest and more than one heir. For example, a parent who owns two separate mineral interests and has two children could bequeath a mineral interest to each child.
Other, less common alternatives to fractionalization exist, such as donating small interests to charities.
Lastly, some families may decide small mineral interests (for which re-consolidation is not an option) are not worth continuing to own and opt to sell those interests to a buyer of mineral properties.
For more information on re-consolidating fractionalized mineral interests, alternatives to fractionalization, or bequeathing mineral rights to your heirs, please consult an attorney experienced in such matters.