The Oklahoma Surface Damage Act: Basics for the 'Non-Oil-and-Gas' Practitioner
By Shannon L. Ferrell
Oklahoma has been producing oil and gas since its territorial days1 and has a rich body of oil and gas law in its statutes, regulations and case law. However, record-high oil prices in recent years and recent discoveries of new formations have unleashed a flurry of new oil and gas activity across the state, even into areas that had seen little such activity in the past (and even though these prices are well below those record levels as this article goes to press, there is also wide speculation that increases in global demand will place upward pressure on prices in the future). As a result, many practitioners may be facing issues of oil and gas law for the first time. Thus, this article will present a very basic overview of one of the fundamental pieces of Oklahoma's oil and gas law: the Oklahoma Surface Damage Act.
WHAT IS THE SURFACE DAMAGE ACT?
Since recognition of the ability to sever real property into surface and mineral estates, a natural tension has existed between the two. As holder of the servient estate, the surface owner was obliged to allow the use of his or her property for the development of the mineral estate, generally without any compensation. Oklahoma's rule had long been that a severed surface owner was not entitled to any payment for damages caused by the use of the surface for the production of oil and gas unless such use was negligent in scope or amount.2 The basis given for this rule was two-fold: that the surface owner (or his or her predecessor) must have paid a price for their interest that was "discounted" and that the mineral estate must necessarily carry with it the rights to access and develop that right.3
However, as Oklahoma's oil and gas industry grew, this rule became fraught with practical challenges. The "reasonableness" standard frequently led to time-intensive judicial proceedings that could prove costly for both well operators and surface owners. Recognizing that a change was needed to protect both Oklahoma's energy and agricultural industries,4 the Oklahoma Legislature passed the Surface Damage Act5 that went into effect on July 1, 1982.
Under the act, oil and gas well operators must enter good-faith negotiations with the surface owner to determine the amount of damage that will be done to the surface, measured in terms of the difference in the fair market value of the property immediately before the drilling operations and its value immediately after those operations. If an agreement cannot be achieved, appraisers are appointed by the court to provide a third-party determination of these damages. If the parties still do not agree on this amount, they may demand a jury trial. These procedures represent the compromise at the core of the act: the mineral estate was afforded an expedited means of entering the property even over the objection of the surface owner - in exchange for the requirement to negotiate and pay damages for the use of the surface estate (even if such damages would have been "reasonable" under the old rule).
WHO AND WHAT ARE (AND AREN'T) COVERED BY THE ACT?
The parties under the act are the "operator" and the "surface owner" of the property where oil and gas operations will occur. "Operator" is defined as "a mineral owner or lessee who is engaged in drilling or preparing to drill for oil or gas," and "surface owner" as "the owner or owners of record of the surface of the property on which the drilling operation is to occur."6 One implication of these definitions where the surface of the property is under lease, is that it is the surface landlord, and not the tenant, who is party to the act's procedure. Landlords and tenants in areas where oil and gas development is likely should therefore be sure to address the possibility of mineral development and how any surface damages occurring during the lease will be handled.
The definition of "operator" has also been used to limit the scope of activities covered by the act. In Anschutz Corp. v. Sanders, the Oklahoma Supreme Court noted that the definition of operator as "one engaged in drilling or in preparations to drill" evinced an intent by the Oklahoma Legislature to limit the act to drilling and production operations, and held that the act did not apply to damages caused by seismic operations or other geophysical exploration activities.7 Thus, entry to the property for geophysical exploration is not subject to the requirements of the act. Seismic exploration is governed by the Oklahoma Seismic Exploration Regulation Act8 and the rules promulgated under it by the Oklahoma Corporation Commission.9 While the Seismic Exploration Regulation Act requires only notice, and not compensation, for seismic operations, negotiation for such entry often occurs to expedite the operations. Further, compensation for geophysical operations may still be recovered if such operations cause an "unreasonable" amount of damage.10
Finally, while the act may prescribe the procedure for the award of damages caused to the surface estate by the drilling of the well, damages for pollution, nuisance, or other causes may still be recoverable via other means. However, the practitioner must use care in determining whether such actions are properly brought with a claim under the act or if they must be made in a separate action.11
WHAT EXACTLY IS THE MEASURE OF 'SURFACE DAMAGES?'
Curiously, the act contains no definition of "surface damages." To set the parameters for what such damages must include, the Oklahoma Supreme Court noted that the procedures under the act essentially mimic a condemnation procedure, enabling the operator to "take" a limited amount of the surface for their operations.12 Given this analogy, the court has determined that the proper amount of damages under the act is basically the same as that in a condemnation proceeding. The difference in the fair market value of the property before and after the triggering event, which, in the case of the act, is the drilling and operation of the well.13
While estimating a "before" and "after" value of property may sound like a simple exercise, one must bear in mind that this estimate must be made prior to the actual commencement of well operations. Thus, both parties must carefully examine the plans for well operations and the property affected thereby in determining damage amount. The Oklahoma Supreme Court has noted that the following items, while not necessarily individual items of compensable damages, are all factors that may play into the determination of the damages amount under the act:14
1) The location or site of the drilling operations.
2) The quality and value of the land used or disturbed by said drilling operations.
3) Incidental features resulting from said drilling operations which may affect convenient use and further enjoyment.
4) Inconvenience suffered in actual use of the land by the operator.
5) Whether the damages, if any, are temporary or permanent in nature.
6) Changes in physical condition of the tract.
7) Irregularity of shape and reduction, or denial, of access.
8) The destruction, if any, of native grasses, and/or growing crops, if any, caused by drilling operations.
As discussed later in this article, landowners may have some "homework" in preparing this valuation.
WHAT IS THE ACT'S PROCEDURE?
Prior to entering the property, the operator must provide via certified mail a notice letter to the surface owner stating the operator's intent to drill and specifying 1) the proposed location of the well, and 2) the approximate date that drilling operations are scheduled to commence.15 Once this notice has been delivered, the operator has five days to commence "good-faith negotiations" with the surface owner. Assuming that the parties can negotiate an agreed amount of damages, the operator can enter the site once a written damages contract is executed.16 If this amount is properly paid, the act has been satisfied.17
If these negotiations do not yield an agreed amount of damages, the operator can still enter the property to commence operations if, and only if, it satisfies the next two requirements under the act's procedure. First, the operator must file surety with the Oklahoma Secretary of State to ensure the payment of whatever damages awarded may eventually be determined.18 Second, the operator must petition the district court for the county in which the proposed well site is to be located for the appointment of appraisers who will be tasked with estimating the damages awarded under the act. Once the bond and petition requirements have been met, the operator is then entitled to enter the property and commence its operations.19 While it may seem counter intuitive to the surface owner that the operator can enter the property without an agreement as to the damages amount, this is the compromise of the act, as discussed above.
If the operator petitions the district court for the appointment of appraisers, the surface owner must be given 10 days notice of such petition. Once service of this notice is achieved, the parties have 20 days to nominate their appraisers. One appraiser is nominated by the operator, and another is nominated by the surface owner. These appraisers then confer and nominate the third appraiser who must be a state-certified appraiser in good standing with the Oklahoma Real Estate Appraisal Board. Should the parties fail to submit their nominations (or should the first two appraisers fail to select a third), the district court will make its own appointment.20 The compensation for the appraisers is set by the district court and is borne equally by the surface owner and the operator. Once appointed and sworn in, the appraisers have 30 days to inspect the property, estimate the amount of damages due the surface owner under the act, and submit a written report to the district court which is then forwarded by the court to the parties.21
The filing of the appraisers' report marks the next watershed moment in a proceeding under the act at which the parties have basically three options from which to choose. First, if the parties agree to the appraised amount, the amount can be tendered by the operator, and the matter is essentially closed. Second, either party may, within 30 days of the filing of the report, file an exception to the report which triggers a review by the court followed by either confirmation, rejection, or modification of the report by the court, or an order for a new appraisal.22 Third, either party may, within 60 days of the filing of the report, file a demand for jury trial.23 It should be noted here that the oil and gas operations at the site in question may continue even if an exception or demand for jury trial is made, so long as the operator posts an amount equal to the appraised damages with the court clerk.24 The decision of the court on any exceptions to the appraisal report and the verdict of a jury trial are both appealable decisions.
The decision to demand jury trial should not be undertaken lightly, as it will trigger the act's provisions regarding costs and attorneys fees, as discussed in greater detail in the paragraph to follow.
WHAT ABOUT ATTORNEYS FEES AND PENALTIES?
The act expressly provides for the award of costs and attorneys fees, with a number of caveats. Such costs and fees are only awarded by the court if a demand for jury trial has been made.25 Further, costs and fees are only recoverable by a party if that party receives a verdict more favorable than the appraisal report.26 The Oklahoma Supreme Court has noted that one purpose of this requirement is to promote the act's aim of providing compensation to the landowner as soon as possible after a taking has occurred "by ensuring that a demand for jury trial will not be filed as a delaying tactic but will only be used when a good-faith belief in success exists on the part of the party seeking a jury trial."27
Aside from its provisions for attorneys fees, the act also carries a potent penalty for operators who fail to follow its dictates. If an operator knowingly enters a parcel without providing notice to the surface owner, or fails to carry through with the act's requirements (i.e. fails to either secure an agreement with the landowner or follow the appraisal and bonding requirements), the operator may be liable to the surface owner for triple the amount of surface damages eventually determined.28
HOW CAN SURFACE OWNERS BE PROACTIVE IN HANDLING SURFACE DAMAGE ISSUES?
Given all this, what can a surface owner do to be prepared to make his or her best case if a notice letter comes? One important step is to gain a thorough understanding of the land that may be impacted. Thorough records regarding the property including soil data, agricultural production records, photographs, and financial performance reports can all aid the surface owner in proving the value of the property prior to its taking. The landowner can contact the local Natural Resource Conservation Service, Farm Service Agency, and OSU Cooperative Extension of-fices for resources to help in farm recordkeeping and information regarding the productivity of similar lands in the area.
Another step the landowner can take is to work with an attorney to prepare a "surface use agreement" or similar document in which the terms for the use of the property are spelled out in advance. Such agreements may include liquidated damages terms based on the acreage of property taken out of use by the wellsite and for any damage to crops or livestock, requirements for the maintenance and repair of fences and gates, requirements for preservation of drainage structures (such as terraces) and vegetative cover on exposed soils, specifications for the restoration of soils after operations, and so on. Sound, objectively-determinable bases for the terms of the agreement (publicly available market prices, published materials on best agricultural practices,etc.) will help the surface owner pursue approval of the agreement by the operator.
Even though the Oklahoma Surface Damage Act has been around for some time, the movement of the oil and gas industry into new areas makes it important for practitioners to be familiar with some of its basics, so that they can help their clients - both well operators and surface owners alike - navigate its provisions and work together for the prosperity of the state.
1. See Muriel H. Wright, First Oklahoma Oil was Produced in 1859, 4 Chronicles of Oklahoma, No. 4 December, 1926.
2. See Davis Oil Co. v. Cloud, 766 P.2d 1347, 1349-1350 (Okla. 1986).
3. See id.
4. See Davis Oil Co. 766 P.2d at 1349-1351: It cannot be said that the surface of the land constitutes a less vital resource to the State of Oklahoma than does the mineral wealth which underlies it. The surface supports development for business, industrial and residential purposes. It also supports our vital agricultural industry. The passage of the surface damages act guarantees that the development of one industry is not undertaken at the expense of another when the vitality of both is of great consequence to the well-being of our economy. In times when both the agricultural and oil and gas segments of our economy are suffering it is especially important that such legislation is enforced.
5. 52 Okla. Stat. §§ 318.2 - 318.9.
6. 52 Okla. Stat. § 318.2 (1), (2).
7. Anschutz Corp. v. Sanders, 734 P. 2d 1290, 1291 (Okla. 1987).
8. 52 OKLA. STAT §§ 318.21 - 318.23
9. See generally OKLA. ADMIN. CODE. § 165:10-7-31.
10. For example, Oklahoma law provides strict liability on the use of explosives; see Superior Oil Co. v. King, 324 P.2d 847 (Okla. 1958), Seismograph Service Corporation v. Buchanan, 316 P.2d 185, 186-187 (Okla. 1957). Additionally, 52 Okla. Stat. § 318.23 states that seismic test hole blasting within 200 feet of any habitable dwelling, building, or water well cannot be conducted without written permission from the owner of the property.
11. See Ward Petroleum Corp. v. Stewart, 64 P.3d 1113 (Okla. 2003), in which the Oklahoma Supreme Court held that claims for tort claim of pollution damage could bring claim in same case with claim under Act, but two causes must be kept on separate procedural tracks), see also Dyco Petroleum Corp. v. Smith, 771 P.2d 1006 (Okla. 1989), wherein the court held that act did not provide a remedy for nuisance but special concurrence observed that a separate action for such nuisance could be maintained.
12. See Davis Oil Co. 766 P.2d at 1353.
13. See Davis Oil Co. v. Cloud, 766 P.2d. at 1352-1353, Andress v. Bowlby, 773 P.2d 1265, 1267 (Okla. 1989), Dyco Petroleum Corp., 771 P.2d at 1008 (Okla. 1989), Houck v. Hold Oil Corp., 867 P.2d 451 (Okla. 1993).
14. Davis Oil Co., 766 P.2d at 1352.
15. 52 Okla. Stat. § 318.3. If the surface owner cannot be located with reasonable diligence, notification of the intended commencement of operations can be accomplished by filing an affidavit of the search efforts with the district court and publishing notice of the operations in the county newspaper . See 52Okla. Stat. § 318.3, 318.5(B)
16. 52 Okla. Stat. § 318.5(A).
17. However, as noted elsewhere, separate claims for pollution or nuisance might still be available to the surface owner.
18. 52 Okla. Stat. § 318.4(A). It should be noted, however, that each operator is only required to file one bond for all of its operations in the state, i.e. the bonding requirement applies per operator, not per well. See Ranken Energy Corp. v. DKMT Co., 2008 OK CIV APP 61, ¶ 9.
19. 52 Okla. Stat. § 318.4(C), 318.5(A).
20. 52 Okla. Stat. § 318.5(C).
22. The decision of the court regarding the exceptions is appealable per 52 Okla. Stat. § 318.6.
23. 52 Okla. Stat. § 318.5(F).
24. 52 Okla. Stat. § 318.6.
25. 52 Okla. Stat. § 318.5(F). Note, however, that Tower Oil & Gas Co. Inc. v. Paulk, 776 P.2d 1279, 1281 (Okla. 1989), the court allowed attorneys fees in a case where a demand for jury trial was made and then later withdrawn by the operator. The court noted "the filing of the demand for jury trial is the activating event rather than the entry of a jury verdict."
26. 52 OKLA. STAT. § 318.5(F).
27. Tower Oil & Gas Co. Inc., 776 P.2d at 1281.
28. 52 OKLA. STAT. § 318.9.
About the Author
Shannon Ferrell is an assistant professor of agricultural law in the OSU department of agricultural economics. He spent a number of years in private practice, focusing on environmental, energy and corporate law, and served as the Oklahoma Renewable Energy Council president for 2006. His research at OSU focuses on energy law issues for Oklahoma landowners, renewable energy and legal issues in production agriculture.
Originally published in the Oklahoma Bar Journal – May 9, 2009 -- Vol.80, No. 13