Mortgage Subordinations

Written by about Leases + Ownership and Transfers on August 14, 2013

Drillers typically ask the landowner’s bank to subordinate their interest in the land (the mortgage) to the driller’s interest (the oil and gas lease).  The driller, of course, was concerned that they would lose their interest in the land if the bank foreclosed on the property.  If the bank’s interest was subordinated to the driller’s, however, the driller would retain their interest even in the event of foreclosure.  In the past, banks granted subordinations without hesitation.  Lately, however, banks are approaching mortgage subordinations much more carefully.  The general concern involves the enormous amounts of money involved in recent Utica shale drilling.  Larger banks sometimes have a policy against granting subordinations.  Smaller, regional banks, on the other hand often approach subordinations on a case by case basis.  Other banks sometimes will charge a fee for giving consideration to a subordination.  All banks, regardless of size, need to assure themselves of how an oil and gas lease for Utica shale affects the value of the landowner’s property.  A lot of times the answer to this question can’t be so easily ascertained.  However, our firm is well-positioned to provide valuations for Utica shale rights, and can help.

From our standpoint, much of the refusal to grant mortgage subordinations is confusing because Ohio has a law that expressly protects oil and gas leases in the event of foreclosure.  ORC 1509.31(d) states that:

“If a mortgaged property that is being foreclosed is subject to an oil or gas lease, pipeline agreement, or other instrument related to the production or sale of oil or natural gas and the lease, agreement, or other instrument was recorded subsequent to the mortgage, and if the lease, agreement, or other instrument is not in default, the oil or gas lease, pipeline agreement, or other instrument, as applicable, has priority over all other liens, claims, or encumbrances on the property so that the oil or gas lease, pipeline agreement, or other instrument is not terminated or extinguished upon the foreclosure sale of the mortgaged property. If the owner of the mortgaged property was entitled to oil and gas royalties before the foreclosure sale, the oil or gas royalties shall be paid to the purchaser of the foreclosed property.”

Even in light of this protection, drillers continue to insist on mortgage subordinations before commencing drilling operations.  Similarly, even though the oil and gas lease is -by statute- superior to a mortgage, banks continue to systematically refuse to grant subordinations.  Lately we have been advising our clients to meet with their bank and approach them as partners in a venture.  Both parties have an awful lot to gain if a good Utica well is drilled on the property.

About Eric Johnson

ERIC C. JOHNSON attended Ohio State University, earning a degree in economics and then graduated from the University of Cincinnati Law School in 1983. His areas of practice are personal injury law, real estate, oil and gas, contracts, litigation and appeals.