Whenever a party that is responsible for the disbursement of oil and gas production proceeds is unable to disburse such proceeds to the legal owner, the proceeds are typically “suspended” and placed in a “suspense account.” While this action (or inaction) may be taken by the operator, the responsibility for the disbursement of proceeds from the sale of oil has typically fallen on the first purchaser of that oil, usually a third-party gatherer, because, historically, royalty owners have been entitled, under the terms of their respective leases, to take their royalty share of oil in kind. This often proves challenging, with the purchaser relying on one or more division orders signed by the persons or entities entitled to payment. This works best when the purchaser has previously been provided with a division order title opinion that allows it to prepare the division orders (which must necessarily add up to 100%), based on a competent attorney’s examination of the relevant title records. Receiving a division order title opinion, however, may be more aspirational than customary, and it can even prove difficult to obtain signed division orders, particularly in states, such as Ohio, that do not require that an interest owner provide one.
Operators and oil gatherers that hold funds in suspense (“holders”) typically consider such funds to be held in escrow. In theory, a suspense account is a distinct escrow account into which the holder deposits proceeds attributable to production relating to a specific property interest with respect to which there is some question as to ownership or with respect to which the owner cannot be located. In practice, this rarely occurs. Some holders maintain instead a single suspense account into which all suspended proceeds are deposited, commingling the suspended funds with respect to unrelated interests. More commonly, however, a suspense account is simply an internal account that exists solely for bookkeeping purposes and includes not only all suspended proceeds, obviously commingled, but also other funds of the holder. Notwithstanding the effective treatment of all monies in such accounts as operating funds of the holder, it is almost certainly rare, at best, for the holder to have reported the suspense proceeds as income for federal or state income tax purposes.
While there are many legitimate reasons to suspend payment—including the existence of a cloud on a claimant’s title, pending litigation affecting the claimant’s interest, or the fact that the holder is missing other important information, such as the claimant’s Social Security or taxpayer identification number, or a valid current address—it is not always evident how best to address this problem, which often lingers for many years. Few holders recognize that this situation may violate applicable law that requires that funds not claimed for more than a statutorily prescribed dormancy period be turn over to the applicable state in accordance with applicable state law.
Every U.S. state, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, and the Canadian provinces of Quebec, British Columbia, and Alberta have unclaimed property programs that require that abandoned or unclaimed property be turned over to the applicable government and that seek to locate the respective owners of such property. Unclaimed property laws have been around since at the 1930s, but have become much broader and more enforced in the last 25 years. Unclaimed property laws are derived from escheat, a common-law doctrine that transfers the property of a person who dies without heirs to the crown or state.
Despite the fact that unclaimed property laws are basically derived from the doctrine of escheat, jurisdiction is not determined by the laws of the state in which the oil and gas property to which the suspended interest relates is located. Under unclaimed property laws, intangible personal property that is unclaimed (the term that succeeds escheat term “abandoned”) does not escheat to the state nor is it available for anyone who can assert possession and control over it, but it is instead transferred to the state as a permanent custodian for its owners. The state keeps the property or the proceeds from its sale for its rightful owners.
The obvious question is this: Which state? The existence of jurisdictional conflicts is one of the most troublesome aspects of dealing with unclaimed funds. The U.S. Supreme Court has addressed this issue in a number of cases, including Texas v. New Jersey, 379 U.S. 674 (1965), and Delaware v. New York, 507 U.S. 490 (1993). Those decisions effectively divide the universe of unclaimed intangible property into two categories: (1) property for which the holder has a last known address of the rightful owner on its books and records (“Address Property”); and (2) property for which the holder does not have a last known address on its books and records (“Non-Address Property”). According to the Supreme Court, Address Property must escheat to the state where the address is located, whereas Non-Address Property escheats to the state of the holder’s corporate domicile. Needless to say, this rule substantially benefits to the State of Delaware, where an inordinately high percentage of the nation’s corporations, limited liability companies, and limited partnerships are domiciled.
Due in large part to the nature of the oil and gas business, suspense accounts can, over time, grow to substantial amounts. Significant penalties can be asserted if the proper escheat procedures timely and properly followed. It is important to evaluate compliance with these arcane but still very applicable state specific requirements.