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Celia Flowers

ELECTRONIC SIGNATURES, REMOTE ONLINE NOTARIES AND E-RECORDING

June 29, 2020 by Janna Fain

Author: Celia Flowers

TABLE OF CONTENTS
I. PAPER DOCUMENTS ARE GRADUALLY BEING REPLACED BY ELECTRONIC DOCUMENTS. 4
II. ELECTRONIC SIGNATURES IN GLOBAL AND NATIONAL COMMERCE ACT (E-SIGN)-, UNIFORM ELECTRONIC TRANSACTIONS ACT (UETA), AND UNIFORM REAL PROPERTY ELECTRONIC RECORDING ACT (URPERA). 4
A. The E-SIGN Authorized Electronic Contracts Almost Twenty Years Ago. 4
1. Parties to the Electronic Contract Must Consent. 4
2. The E-SIGN Exempts Some Types of Transactions. 4
B. The UETA also Authorized Electronic Signatures in Business Contracts Over Twenty Years Ago. 5
1. Parties Using Electronic Signatures in Electronic Contracts Must Consent. 5
2. The UETA Expressly Exempts Some Types of Transactions. 6
3. Definitions Under the UETA Demonstrate the Act’s Broad Nature. 6
4. The UETA has been Broadly Adopted by Individual States’ Legislatures. 7
C. The URPERA Enabled Recordation of Electronic Contracts Many Years Ago. 7
1. The Recording of Paper Documents Electronically Led the Way to Electronic Document Recordation. 7
2. The URPERA has been Adopted in Fewer States. 7
III. THE RECENT ADOPTION OF REMOTE ONLINE NOTARIZATION ACT (RON). 7
A. An Acknowledgment by a Notary Allows a Document to be Recorded in the Public Records. 8
B. Requirements for Notarization are Recognized by the Acts Enabling Electronic Contracts. 8
C. RON Enables Notarization by a Notary When the Party is in a Different Location. 8
1. RON Changed the Definition of Personal Appearance. 8
2. A Discussion of RON Applying the Texas Act Emulated by the ALTA Model Act. 9
D. RON also Requires Consent. 10
E. RON Provides for Methods of Confirming the Identity of the Signer. 10
1. Knowledge Based Authentication (KBA). 10
2. Credential Analysis. 10
3. Visual Confirmation. 10
F. RON Adds an Additional Notary Commission. 11
G. Document Retention is Required by RON. 11
H. The Principal and the Notary May be in Different Locations. 11
1. Regulations were Added by the Secretary of State to Implement RON. 11
IV. RON PRESENTS ISSUES COMMON AMONG THE STATES. 12
A. Mandatory Disclosure. 12
B. Multifactor Authentication (discussed in detail above). 12
C. Audio-Video Recording. 13
D. Location of the Notary. 13
E. Location of Signer. 13
F. Secure Technology. 13
G. Retention of Data. 14
H. Fees. 14
I. Defective Acknowledgments. 14
V. Recording Laws. 14
A. State Laws Should Confirm a Document Utilizing RON can be Recorded. 14
B. Why is “Papering Out” Important? 14
1. “Papering Out” – How to Solve the Issue of Recording. 16
VI. OTHER ISSUES. 17
A. Statute of Limitations for Defective Acknowledgments using RON. 17
B. Jurisdictional Requirements. 17
C. Amendments to the Model Act. 17
D. Title Insurance Coverage. 18
E. Where is the Original? 18
F. Title Opinions Reviewing Documents that are Totally Electronic. 18
VII. ADVANTAGES OF RON. 19
A. No Mail Outs. 19
B. Landmen and Attorneys May Want to Consider a Third-Party Vendor. 19
VIII. RISKS OF RON. 20
A. Unauthorized Access. 20
B. Fraud. 20
C. Mistakes and Errors. 20
IX. UTILIZATION OF RON IN THE OIL AND GAS INDUSTRY. 20
X. ELECTRONIC DOCUMENTS, SIGNATURES, NOTARIZATIONS AND RECORDING WILL CONTINUE TO AFFECT CURRENT PRACTICES. 21

 
 
ELECTRONIC SIGNATURES, REMOTE ONLINE NOTARIES AND E-RECORDING

I. PAPER DOCUMENTS ARE GRADUALLY BEING REPLACED BY ELECTRONIC DOCUMENTS.
In the traditionally paper-intensive industries of oil and gas and real estate, old school paper trails are being replaced with electronic documents, signatures, acknowledgements, and recordings. The federal Electronic Signatures in Global and National Commerce Act (E-SIGN) act has been around for almost twenty years and legitimizes the use of electronic signatures and documents. Additionally, many states have adopted specific electronic signature and other technology-driven acts affecting acknowledgments of signatures and recording of legal documents that change the definition of “presence before a notary” without case law catching up to provide interpretation of those laws. This paper addresses the legal side of these technology-driven model acts, including the Uniform Electronic Transactions Act (UETA), the Uniform Real Property Electronic Recording Act (URPERA) and the Remote Online Notarization Acts (RON). While the number of states adopting these types of acts is increasing, the details in recording documents in various jurisdictions and acceptance between states impact the use for conveyancing documents. The transition from paper-recorded documents and in-person acknowledgments to fully electronic enforceable instruments in all jurisdictions has its challenges.

II. ELECTRONIC SIGNATURES IN GLOBAL AND NATIONAL COMMERCE ACT (E-SIGN)-, UNIFORM ELECTRONIC TRANSACTIONS ACT (UETA), AND UNIFORM REAL PROPERTY ELECTRONIC RECORDING ACT (URPERA).
A. The E-SIGN Authorized Electronic Contracts Almost Twenty Years Ago.
President Clinton signed the E-SIGN in 2000. See 15 U.S.C. §§7001-7031. The federal statute recognizes that electronic contracts, electronic signatures and other electronic records are the legal equivalent to paper documents with original signatures. See 15 U.S.C. §7001(a)(1)-(2). Being a federal act, E-SIGN affects people who wish to do business electronically in all 50 states.
1. Parties to the Electronic Contract Must Consent.
E-SIGN requires consumers to affirmatively consent to allow the use of electronic records, including electronic signatures, in consumer transactions. See 15 U.S.C.§7001(c)(1)(A). Before the consumer consents, he must be provided with a “clear and conspicuous statement” informing him of the option to have the record provided electronically or made available in paper form as well as the right to withdraw the consent (among other disclosures.) See 15 U.S.C. §7001(c)(1)(B). Consumers must be given a statement of the software and hardware requirements necessary to access and retain the electronic records. See 15 U.S.C. §7001(c)(1)(C). Additionally, consumers must electronically confirm their consent in a manner that “reasonably demonstrates” they can access information in the particular electronic form that will be used to provide the information to the consumer. See id. The legal effectiveness, validity, or enforceability of any contract executed by a consumer shall not be denied solely because of the failure to obtain electronic consent or confirmation of consent by that consumer. See 15 U.S.C. §7001(c)(3).
2. The E-SIGN Exempts Some Types of Transactions.
The act applies to all transactions, including interstate or foreign, unless an exception applies. The E-SIGN provisions do not apply to a contract or other record to the extent it is governed by a statute, regulation, or other law governing the creation and execution of wills, codicils, or testamentary trusts. See 15 U.S.C. §7003(a)(1). Additionally, E-SIGN does not apply to a state statute, regulation, or other law governing adoption, divorce, or other matters of family law. See 15 U.S.C. §7003(a)(2). Further, the act does not apply to many provisions of the Uniform Commercial Code in effect in any state. See 15 U.S.C. §7003(a)(3). Among the other excluded transactions, the provisions of the E-SIGN do not apply to court orders or notices, or official court documents (including briefs, pleadings, and other writings) required to be executed in connection with court proceedings. See 15 U.S.C. §7003(b).
B. The UETA also Authorized Electronic Signatures in Business Contracts Over Twenty Years Ago.
In July of 1999, the National Conference of Commissioners on Uniform State Laws, also known as the Uniform Law Commission, (ULC) approved a uniform act to enable the use of electronic signatures in business contracts and recommended it for enactment in all the states. If a state adopts the ULC’s official version of the UETA, the E-SIGN Act provides that state law will supersede where a conflict exists between the E-SIGN Act and the UETA.
See 15 U.S.C. §7002(a)(1). See also Allen v. WELLS FARGO BANK, NA, Dist. Court, ND Texas 2016. Allen asserted Wells Fargo violated 15 U.S.C. §7003 because the substitute trustee’s deed was electronically recorded. Wells Fargo argued 15 U.S.C. §7003 was “inapplicable” in the present case as Texas state law modifies, limits and supersedes that statute. The court agreed and only exercised diversity jurisdiction over this case.
The UETA applies to electronic records or electronic signatures relating to a transaction. See Tex. Bus. & Com Code Ann. §322.003. The UETA does not require a record or signature to be created, generated, sent, communicated, received, stored or otherwise processed or used by electronic means or in an electronic form. See Tex. Bus. & Com Code Ann. §322.005(a). In other words, the act allows the use of electronic records or signatures in a transaction but does not require parties to use an electronic method.
1. Parties Using Electronic Signatures in Electronic Contracts Must Consent.
The UETA only applies to transactions where each party has agreed to conduct transactions by electronic means. See id. at (b). The E-SIGN, on the other hand, simply states that a party may not be required to use or accept electronic signatures or electronic records. See U.S.C. §7001(b)(2). Whether the parties have agreed to conduct a transaction by electronic means is to be determined from the context and surrounding circumstances, including the parties’ conduct. See Tex. Bus. & Com Code Ann. §322.005(b). If the issue is raised, the party seeking to enforce the contract must prove the parties intended to be bound by electronic communication. As an example, in one case the parties agreed to explicitly communicate only in writing at the inception of the relationship. However, while conducting business together, the parties communicated primarily through email because of its speed. One party stated that she could only be reached by email. The court reasoned that these actions demonstrated a preference for email communication; therefore, the Court held this was consent to conduct business through email. See Crestwood Shops, LLC v. Hilkene, 197 S.W. 3d 641 – Mo Court of Appeals, Western Dist. 2006.
In another case, the Court held legally sufficient evidence of an agreement to conduct business electronically where the parties exchanged communications regarding offers and counteroffers about the subject property via e-mail messages and ultimately agreed via email. See Dittman v. Cerone, No. 13-11-00196-CV, 2013 WL 865423, at *7-8 (Tex. App.-Corpus Christi Mar. 7, 2013, no pet.). Email communications are frequently used during negotiations to buy oil and gas leases or mineral/royalty interests as well as during mergers and acquisitions. Email has virtually replaced typed letters sent by mail as the traditional form of correspondence. Offers and counteroffers are often communicated by email until the ultimate agreement is reached and final documents are emailed for signature. Of course, the absence of a final agreement within the electronic communications could imply the parties had not consented to use the electronic means.
See Central Illinois Light v. Consolidation Coal, 235 F. Supp. 2d 916. See also McClare v. Rocha, 86 A. 3d 22 – Me: Supreme Judicial Court 2014 – “Jim says he would be happy to speak with McClare directly if it would facilitate an agreement” appears to provide evidence that the reference to the sale price contained in the same email was not intended to comprise all of the details of a not-yet-completed agreement.
Additionally, there must be evidence of a clear agreement for consent. References to other necessary documents or telephone communications may indicate the parties did not clearly consent to the use of the electronic means for the entire contract terms. See id.
The determination of whether an electronic signature exists, or a record is “signed,” is also a question of fact. That determination should be made considering all surrounding circumstances. See Tex. Bus. & Com Code Ann. §322.002, Official Comment No. 7. Where a party has expressly stated another method of signing, an electronic signature is not acceptable. For instance, if one party tells the other party to sign and return the paper document, an electronic signature will not suffice. See Powell v. City of Newton (2010) 364 N.C. 562 [703 S.E.2d 723, 727-728]. Similarly, where the parties specifically discuss how they will sign an agreement which differs from an electronic method, then an electronic signature will not work. See J.B.B. Investment Partners, Ltd. v. Fair, 232 Cal. App. 4th 974, 990-91 (Ct. App. 2014).
A party who agrees to conduct one transaction by electronic means may refuse to conduct other transactions electronically. See Tex. Bus. & Com Code Ann. §322.005(c). Therefore, a party can decline to conduct a future transaction electronically after initially agreeing to conduct a transaction electronically. Moreover, the parties to an electronic transaction may vary the provisions of the UETA by agreement. See id. at (d). However, not all the UETA provisions may be varied by the parties. For example, a party’s right to refuse to conduct subsequent transactions electronically may not be waived. See id. at (c). Additionally, a party’s right to be provided documents created in the transaction in a form that can be retained by the party cannot be waived. See Tex. Bus. & Com Code Ann. §322.008(d).
2. The UETA Expressly Exempts Some Types of Transactions.
The UETA does not apply to a transaction to the extent it is governed by a law governing the creation and execution of wills, codicils, or testamentary trusts. Further, the UETA does not apply to most provisions of the Uniform Commercial Code. See Tex. Bus. & Com Code Ann. §322.003(b).
3. Definitions Under the UETA Demonstrate the Act’s Broad Nature.
The UETA defines a “record” as “information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form”. See Tex. Bus. & Com Code Ann. §322.002(12). An “electronic record” is a record that is “created, generated, sent, communicated, received, or stored by electronic means”. See id. at (7). Electronic records include emails, voice mail, facsimile and any information stored on a computer, including scanned or digital images of documents. See id. at Official Comment No. 6.
The idea of an electronic signature is clearly intended to be broad and not specially defined in order to cover a variety of different electronic medium. For example, an “electronic signature” does not have to be an electronic duplication of the signer’s actual signature. The “electronic signature” can also be an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted by a person with intent to sign the record. See id. at (8). Electronic signatures include a named affixed to an email, a personal applying of a symbol, standard webpage click-through process, or clicking an “I Agree” button on web site. See id. at Official Comment No. 7.
The key concept of the UETA is that a record or signature will not be denied legal effect or enforceability solely because it is in electronic form. See Tex. Bus. & Com Code Ann. §322.007(a). Likewise, a contract will not be denied legal effect or enforceability solely because an electronic record was used in its formation. See id. at (b). If a law requires a record to be in writing, an electronic record satisfies the law. See id. at (c). Similarly, if a law requires a signature, an electronic signature satisfies the law. See id. at (d). If a law requires a signature or record to be notarized, acknowledged, verified, or made under oath, the requirement is satisfied if the electronic signature of the person authorized to perform the notary act, together with all other information required by law, is attached to or logically associated with the signature or record. See Tex. Bus. & Com Code Ann. §322.011.
4. The UETA has been Broadly Adopted by Individual States’ Legislatures.
The UETA has been adopted on a state-by-state basis and has been enacted in 47 states along with the District of Columbia, Puerto Rico and the U. S. Virgin Islands. Washington, Illinois, and New York have not adopted the UETA; however, similar legislation governing electronic transactions have been enacted in those states. See Uniform Law Commission (ULC). (1999). Electronic Transactions Act. Retrieved April 25, 2019, from https://www.uniformlaws.org/committees/community.
C. The URPERA Enabled Recordation of Electronic Contracts Many Years Ago.
In 2002, the ULC began work on the Uniform Real Property Electronic Recordation Act (URPERA) to harmonize local recording laws used in the different states. The URPERA removed any doubts that existed under prior law regarding the record ability of electronic documents containing electronic signatures. The URPERA permits, but does not require, local filing offices to create electronic recording systems. See URPERA §3(a). Like the UETA, the URPERA recognizes electronic signatures, electronic verification/acknowledgment of documents, and the general validity of electronic documents. See id.
1. The Recording of Paper Documents Electronically Led the Way to Electronic Document Recordation.
The technology to support electronic signatures and notarization has been available since early 2000’s. With that technology, the signer of the document was intended to be physically present before the notary. The computer technology affixed the signatures and acknowledgments. The URPERA allowed county clerks and recorders to electronically record information in the real property and land records. Paper documents executed the traditional way could still be used, but a recording office could convert them to electronic form. See id. at §4. The URPERA paved the way for electronic recording by the record clerks. However, in counties where electronic recording was not available, some of the documents required in a transaction were signed electronically, but those documents requiring recordation were still executed by original signatures in the presence of the notary. In these “hybrid” transactions, the documents that needed to be recorded in the public record were printed out, “wet signed”, and acknowledged by the notary while the other documents, not requiring recording, were simply electronically signed and acknowledged.
2. The URPERA has been Adopted in Fewer States.
As of March 2019, only 35 states have adopted the URPERA, as well as the U.S. Virgin Islands, and it continues to be introduced by state legislatures for adoption. In 2019, West Virginia and Alaska introduced legislation to adopt the URPERA. So far, Oregon, California, Montana, North Dakota, Colorado, Nebraska, Iowa, Missouri, Louisiana, Ohio, New Jersey, Maine, Vermont, New Hampshire, and Massachusetts have not adopted the URPERA. In many of the states that have not adopted the uniform act, a state statute addresses the recordation of electronically signed documents. See Uniform Law Commission (ULC) (Ed.). (2004). Real Property Electronic Recording Act. Retrieved April 16, 2019, from https://www.uniformlaws.org/committees/ community.

III. THE RECENT ADOPTION OF REMOTE ONLINE NOTARIZATION ACT (RON).
With the adoption of the E-SIGN, the UETA, and the URPERA, recording offices utilizing electronic recording cover areas where approximately 80% of the US population live. See id. Despite the widespread availability, few real estate conveyances are originated in total electronic form. The lack availability of electronic recording leaves many rural areas without access. This was partially due to the fact the official recorder’s requirements for filing are left to the individual states to make the decision whether to adopt and implement electronic filing systems. See Tex. Bus. & Com Code Ann. §322.003, Official Comment No. 3. With the change in how the notarization process can take place with RON, there is a renewed possibility of using fully electronic documents even in areas where the recorder has not implemented electronic recording.
A. An Acknowledgment by a Notary Allows a Document to be Recorded in the Public Records.
Although the subject matter and form of contracts differ, any contract can be created, executed, acknowledged, and maintained in a wholly electronic format. Real estate transactions, which include an oil and gas transactions, differ from other commercial transactions in that some of the documents necessary to the transaction require recording in the public record to protect the parties’ rights as to third parties. Of course, the contract signed by the parties is enforceable between the parties without any further action. Therefore, the decision whether to use an electronic medium for the agreements between the parties should be a matter for the parties to determine. See id.
However, for the agreements or documents to be effective as to third parties, state laws generally require recording with a governmental office designated by the state as the official custodian of those records. Most recording statutes require an acknowledgement of the signer’s signature by a notary for recording. If an electronic filing system has not been adopted by the governmental office, recording requires a piece of paper with an original notarized signature to perfect rights against third parties. Certainly, this requirement that a document be recorded to protect the parties’ rights is a consideration for the parties in deciding whether to enter into an electronic contract or agreement. See id.
Therefore, even with the UETA and the URPERA justifying the use of fully electronic documents, the move to wholly electronic documents has been hindered partially because the governmental entity in charge of recording was not set up to electronically record fully electronic documents. Therefore, a paper document remained essential for recording purposes.
As time passed, more county recorders across the nation began to implement electronic recording. The recorders in many large cities across the country accept electronic filing of documents. However, in many rural areas where no electronic recording systems are in place, the parties still must submit paper documents with “wet signed” and properly acknowledged signatures for the recorders to allow the document to be filed of record.
B. Requirements for Notarization are Recognized by the Acts Enabling Electronic Contracts.
The UETA allows the notary public and the filing entity to act electronically; however, the act does not eliminate any of the other requirements of the notarial laws. See §1.00(2) for an analysis of the UETA. The Act simply allows the signing and the notarization to be done electronically. The person executing the document must still appear in the room with the notary. The notary must satisfy himself as to the identity of the signer and swear to that identification. See Tex. Bus. & Com Code Ann. §322.011.
C. RON Enables Notarization by a Notary When the Party is in a Different Location.
1. RON Changed the Definition of Personal Appearance.
RON enables notarization of signatures to occur using audio-video technology via the internet where the notary and the signer are in different locations. See §1.00(2) for an analysis of the UETA; see also “Love, R. & Flowers, C.” (December 2018). What’s the Legal Basis for Ron? Texas Land Title Institute. Essentially, it changed the definition of “personal appearance” required for a notarization to include an on-line audio-visual internet appearance that satisfies certain conditions. See Tex. Civ. Prac. & Rem. Code §121.006(c). Therefore, the execution of documents requiring notarization can be completed without the signers having to be in the notary’s physical presence. With the implementation of RON, a landman would no longer have to travel to the location of the lessor to notarize the oil and gas lease. Similarly, complicated assignments requiring the signatures of multiple parties can be handled without the parties each signing while physically present in the room with a notary.
a. States’ Adoption of RON is Increasing.
The first RON bill passed in Virginia in 2011. In 2015, Montana approved the use of RON for transactions involving real estate located in the state. In 2017, RON bills were passed in Texas and Nevada. Remote notarization laws have now passed in twenty-two states: Virginia, Texas, Vermont, Michigan, Indiana, Minnesota, Montana, Nevada, Ohio, Utah, Tennessee, Arizona, Idaho, Kentucky, Maryland, North Dakota, South Dakota, Oklahoma, Washington, Iowa, Nebraska (pending governor’s signature) and Florida (pending governor’s signature). Some of the state’s statutes required the writing of regulations. Texas & Nevada released RON regulations in 2018. In 2020, the following states have passed RON Legislation: Arizona, Florida, Idaho, Indiana, Iowa, Kentucky, Maryland, Michigan, Minnesota, Montana, Nebraska, Nevada, New Jersey, North Dakota, Ohio, Oklahoma, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, and Washington. See American Land Title Association (ALTA).
b. The Model Bill for RON was Drafted by the Real Estate Industry.
The American Land Title Association (ALTA), using the Texas legislation as a starting point, worked with the Mortgage Bankers Association (MBA) to release a model bill for RON in 2017. The ULC added RON to the Uniform Law on Notarial Acts (RULONA), which was originally promogulated in 2010. New Section 14A dealing with remote notarization was added in 2018. ULONA has been enacted in 12 states: Colorado, Idaho, Iowa, Minnesota, Montana, North Dakota, Oregon, Pennsylvania, Rhode Island. Vermont, Washington, and West Virginia. See Uniform Law Commission (ULC), Law on Notarial Acts, Revised Law on Notarial Acts, Revised – Uniform Law Commission (2018), https://www.uniformlaws.org/committees/community (last visited May 20, 2019).
The authors of the model did not include any participants from the oil and gas industry. The act centered around the real estate and mortgage industries. Because RON applies to documents requiring notarization, it affects the oil and gas industry when it comes to the recordation of documents. Although, the needs of the oil and gas industry were not specifically considered, the security provisions implemented by the act, as discussed later, provide for a secure manner of notarization that applies in all instances of use of RON.
2. A Discussion of RON Applying the Texas Act Emulated by the ALTA Model Act.
In Texas, RON was the result of Texas House Bill 1217 (HB 1217), which became effective July 1, 2018. HB 1217 made the following statutory changes to various codes in Texas allowing for RON implementation:
a. RON Changed the Texas Civil Practice and Remedies Code Chapter 121.
The Texas Civil Practice and Remedies Code Chapter 121, Acknowledgments & Proofs of Written Instruments, was amended to expand the definition of personal appearance to include, “an interactive two-way audio and video communication.” See Tex. Civ. Prac. & Rem. Code, Chapter 121.006(5)(c)(2) and (5)(d). Thus, a continuous feed transmitted over a internet connection is now a vehicle for a notary to remotely take an acknowledgment or sworn statement. See “Love, R. & Flowers, C.” (December 2018). What’s the Legal Basis for Ron? Texas Land Title Institute, at Page 1. This new vehicle for a notarization was made expressly subject to the new Subchapter C, Online Notary Public, of Chapter 406 of the Texas Government Code, discussed below.
The Secretary of State was authorized and directed to adopt rules and standards by July 1, 2018. The final rules and standards were adopted August 19, 2018.
b. Texas Government Code Chapter 406 was Amended to Support RON.
Chapter 406 of the Government Code now includes Subchapter C, entitled Online Notary Public. Subchapter C includes the following:
The new subchapter included new terminology with the following definitions:
a. “Credential analysis” by a third party;
b. “Electronic” and “Electronic document” to encompass non-paper documents;
c. “Electronic notarial certificate,” “Electronic seal,” and “Electronic signature” to capture the act of online notarization by a notary;
d. “Identity proofing” by a third party; and
e. “Notarial act”, “Online notarization”, “Online notary public”, “principal”, and “Remote presentation” to structure and standardize RON. See Tex. Gov’t Code Ann. §406.101.
The new terminology outlines new ways of authentication of documents- verifying the correct person is signing the document – using identity proofing and credential analysis as discussed further below. These methods are in addition to the notary seeing the person visually through the video feed and comparing with signer’s state issued photo ID. The notary visually looking at the signer and the signer’s ID was the only method used where notarization takes place with the notary and the signer in the same room. Additionally, the required technology provides for a linking of the signature, identity, and document to the time it was signed thus creating an audit trail.
D. RON also Requires Consent.
As with the UETA, RON also requires the consent of the parties to conduct the notarization using the online technology. The technology captures the parties’ verification of their consent at the beginning of the transaction process so the consent can be recorded before the signer proceeds to signing and acknowledgment. Proof of that consent is captured by the technology and the consent is verifiable in the future, if needed.
E. RON Provides for Methods of Confirming the Identity of the Signer.
1. Knowledge Based Authentication (KBA).
The signer must correctly answer dynamic knowledge-based authentication questions provided by a reputable third-party vendor. This consists of a series of timed, personal questions, which only the true signer should be able to answer. See The Mortgage Industry Standard Maintenance Organization, Inc. (MISMO) Standards for Remote Online Notarization.
2. Credential Analysis.
The signer presents an ID that will be subjected to a technological credential analysis to confirm the ID is not fraudulent or modified. RON service providers must use automated software processes to aid the notary with their role in verifying each signer’s identity. See id. The ID must pass an authenticity test using technology to confirm that the credential is not fraudulent or inappropriately modified. This requires the technology to use information held or published by the issuing source of the ID or authoritative sources, as available, to confirm the validity of credential details. Confirmation of all this information must be accomplished during the notary session, and the output of the authenticity test is provided to the notary. The output may simply indicate a “pass” or “fail”. See id.
3. Visual Confirmation.
The ID is compared to the person being viewed in real time through the audio-video transmission. See id. The notary will view the picture on the ID and compare with the visual of the signer through the audio video transmission. Before RON, the only method to confirm identification was an in person visual confirmation.
F. RON Adds an Additional Notary Commission.
In Texas, Sections 406.105 – .107 of Subchapter C of the Government Code, also went to great lengths to create a new position and commission for an “online notary public.” Only a licensed “online notary public” may perform an “online notarization.” The online notary must first qualify and be commissioned as a traditional notary. That notary may then go the extra step to obtain the online notary license simply by filing an application. Of course, the application and process are “on-line”. See “Love, R. & Flowers, C.,” (December 2018). What’s the Legal Basis for Ron? Texas Land and Institute, at Page 1. Once the application is filed, the commission will be approved without any educational requirements or additional training.
G. Document Retention is Required by RON.
Perhaps the greatest burden an online notary public will face is the record retention requirement included in the model act and in Texas. Specifically, Section 406.108 of the Texas Government Code requires the notary to keep a “secure electronic record of electronic documents notarized by the online notary public.” Section 406.108 includes the actual video and audio conference as a part of the specific storage requirements. The record must be backed-up, tamper proof, secure, and maintained for 5 years. See id.
The real estate and mortgage industries both have current record retention requirements imposed by their various state and national regulator. The oil and gas industry, however, has not been subject to such requirements. Nevertheless, if the landman or attorney wants to obtain a license as a remote online notary to conduct the online notarization themselves, the landman or attorney will have to meet the document retention requirement.
H. The Principal and the Notary May be in Different Locations.
The Texas version of the rule, Section 406.110 of the Texas Government Code, specifically states that RON can be used regardless of where the principal is physically located at the time of the online notarization. The code does not say the notary can be located elsewhere in another state. See id., at Page 3. Traditional legal theory has been that a notary loses his/her authority once outside the jurisdiction of licensure. See National Notary Association website, nationalnotary.org and American Association of Notaries, texasnotary.com. And, of course, a Texas notary must be a Texas resident, or a resident of a contiguous state but acting in Texas. Nothing is said about an online notary licensed under another state’s laws taking an acknowledgment of a Texas resident’s signature, wherever the Texas resident may be. See “Love, R. & Flowers, C.,” (December 2018). What’s the Legal Basis for Ron? Texas Land Title Institute, at Page 3.
1. Regulations were Added by the Secretary of State to Implement RON.
Some of the other states’ legislation included both the actual creation of RON and the rules governing the process. However, in Texas, the legislation did not include the rule making. The Secretary of State proceeded, as directed by the legislature, and promulgated rules that were adopted August 19, 2018, after a period for public comment. These rules were codified in the Texas Administrative Code, Chapter 87, Notary Public. The Secretary of State chose to repeal the existing rules for notary publics, reorganize, and adopt new rules. See id.
The new rules implemented modern consistent administrative provisions to track the Government Code as amended. These rules outline the procedure for the submission of the Online Notary application. Again, it is important to note, an applicant must already be a notary public, and then, the notary can apply for an online notary commission. The application is required to be completed and submitted online. See “Love, R. & Flowers, C.,” (December 2018). What’s the Legal Basis for Ron? Texas Land Title Institute, at Page 2. The online notary is a distinct and separate commission on top of the standard notary commission. See id. The online notarization and notary seal will indicate that the notarization is remote and by a commissioned remote online notary. See Tex. Admin. Code §§87.0, et seq. In addition, the electronic technology will utilize “Public Key Infrastructure (PKI) technology from a PKI service provider that is X.509 compliant.” See id. PKI is a set of hardware, software, processes, policies and procedures that enable the secure use of digital signatures and encryption.
See Wikipedia contributors. (2019, June 13). Public key infrastructure. In Wikipedia, The Free Encyclopedia. Retrieved 18:32, June 17, 2019, from https://en.wikipedia.org/w/index.php?title=Public_key_infrastructure &oldid=901665342.
The provisions of Chapter 87 detail the records required to be retained. The recording shall include, at minimum: (1) confirmation by the notary public that the principal has successfully completed identity proofing and credential analysis; (2) visual confirmation of the identity of the principal through visual inspection of the credential used during credential analysis; and (3) the actual notarial act performed. If the principal is personally known to the online notary public, the audio-visual conference shall include a statement to that effect and a recording of the actual notarial act performed. See Tex. Admin. Code §87.41.
On the issue of whether the online notary must be physically located in Texas at the time of the notarization, Section 87.41(a) states, “An online notarization may only be performed by a notary who is commissioned as an online notary public.” See id. This could be read to require a Texas commissioned online notary for Texas property. However, there is not current recorded cases clarifying this issue. Nevertheless, it would be logical that if the parties are in Texas and dealing with Texas property, the notary must be commissioned in Texas.
In this connection, however, one must remember that the Texas rules only apply to Texas notaries. This does not address the outstanding question of using out of state remote on-line notaries with a notary commission issued by another state to notarize when the signing parties are located in Texas. Another question arises as well as if the signing party is physically located outside of Texas and the notary is commissioned in another state. See “Love, R. & Flowers, C.,” (December 2018). What’s the Legal Basis for Ron? Texas Land Title Institute, at Page 3.

IV. RON PRESENTS ISSUES COMMON AMONG THE STATES.
As previously discussed, RON has been adopted in a variety of states. Although there is a model act created by industry, the ULC has not promulgated a uniform act. The ULC did revise the RULONA to include RON; however, the committee has not indicated it would be addressing any other uniform act covering the other issues raised by RON. As a result, the states that continue to adopt RON may do so by using the framework adopted by another state or the model legislation created by ALTA and TMBA. However, nothing keeps the states from adopting their own unique version. Because the subject matter of RON is unique and the industry cooperative efforts have identified issues associated with RON that should be addressed in any proposed legislation, there are common issues identified that should be addressed in the states’ legislation. Without a uniform act proposed by ULC, the states are left to piece the legislation together themselves.
A. Mandatory Disclosure.
Any legislation introduced should require the disclosure of the use of remote online notarization in the notarial certificate. See Mortgage Bankers Association—American Land Title Association: Model Legislation for Remote Online Notarization, §8(4). Prior to the use of RON, the party’s consent is necessary. The idea of this disclosure is to make it transparent the transaction involved a RON.
B. Multifactor Authentication (discussed in detail above).
Any Legislation should require identity to be verified through the following processes using public and private/proprietary data sources: (1) remote presentation of a government-issued credential; (2) credential analysis; and (3) identity proofing. See ALTA.org, & Mortgage Bankers Association. (n.d.). Model Legislation for Remote Online Notarization §8(2)(b). Retrieved May 20, 2019, from https://www.alta.org/advocacy/ online-notarization.cfm. Virginia’s and Montana’s statutes provide for no regulation regarding these three means of multifactor authentication. Montana is updating their statute in 2019 to bring it more in line with the model act. Vermont’s statute allows the use of RON but has no prescriptive measures. Vermont’s law will not become effective until the Secretary of State promulgates rules and that process has been slow. Utah and Idaho just passed their legislation following this provision of the model act. States that do not provide for this security make other states nervous regarding accepting their notaries’ acknowledgments. If a state that has no requirements for authentication, licenses a RON notary and does not prohibit that notary from working outside the state, it could compromise the stability of the land records in states that went to great lengths to require security and authentication requirements.
C. Audio-Video Recording.
Any legislation should require the creation and retention of an audio-video recording of the notarial act and define what should specifically retained similar to required by the Secretary of State in Texas. See ALTA.org, & Mortgage Bankers Association. (n.d.). Model Legislation for Remote Online Notarization §§6(2)—(4). Retrieved May 20, 2019, from https://www.alta.org/advocacy/online-notarization.cfm. Most of the states who adopted legislation have this requirement.
D. Location of the Notary.
As previously discussed, the location of the notary was left open ended in Texas. The proponents of any legislation may want to consider requiring the notary to be physically located within the state where the parties and property are located while performing RON.
See ALTA.org, & Mortgage Bankers Association. (n.d.). Checklist for Conforming Laws Related to Remote Online Notarization (“RON”). Retrieved May 20, 2019, from https://www.alta.org/advocacy/online-notarization.cfm. See also ALTA.org, & Mortgage Bankers Association. (n.d.). Model Legislation for Remote Online Notarization §1(2) & §5. Retrieved May 20, 2019, from https://www.alta.org/advocacy/online-notarization.cfm.
Virginia, Texas, and Michigan failed to delineate this requirement. California has debated this point in considering its legislation. Most of the other states adopted a form of the model act and addressed this issue.
E. Location of Signer.
The laws should specifically allow the signer, whose signature is being notarized, to be located outside the state at the time of RON.
See ALTA.org, & Mortgage Bankers Association. (n.d.). Checklist for Conforming Laws Related to Remote Online Notarization (“RON”). Retrieved May 20, 2019, from https://www.alta.org/advocacy/online-notarization.cfm. See also ALTA.org, & Mortgage Bankers Association. (n.d.). Model Legislation for Remote Online Notarization §2 & §3. Retrieved May 20, 2019, from https://www.alta.org/advocacy/online-notarization.cfm.
F. Secure Technology.
The law should require secure technology that restricts access to electronic notarial records, requires venders and notaries to take precautions in preparation and transmission of electronic records, and determine if access to the records should be granted to some third parties like a title agent, escrow agent or title insurer engaging the notary.
See ALTA.org, & Mortgage Bankers Association. (n.d.). Checklist for Conforming Laws Related to Remote Online Notarization (“RON”). Retrieved May 20, 2019, from https://www.alta.org/advocacy/online-notarization.cfm. See also ALTA.org, & Mortgage Bankers Association. (n.d.). Model Legislation for Remote Online Notarization §6(3) & §§7(1)—(3). Retrieved May 20, 2019, from https://www.alta.org/advocacy/online-notarization.cfm.
This is a subject the oil and gas industry should weigh in on to provide guidance as to what third parties can later have access to the records. In the case of the oil and gas industry parties, the definition of third parties should at least be expanded to address access by the company that currently owns the oil and gas lease or interest. The model act provides the “parties” shall be provided access. Of course, that would include the parties who had their signatures notarized. This concept limits any company wherein its officers, who executed the documents, might not be the parties the company needs to access the documents later. Companies in states where this legislation has already passed without consideration of the variation in parties that may need later access may want to seek reforms to that legislation.
G. Retention of Data.
The laws adopted should allow the notary to designate a third-party repository to hold the recording and electronic journal on their behalf.
See ALTA.org, & Mortgage Bankers Association. (n.d.). Model Legislation for Remote Online Notarization §6(4). Retrieved May 20, 2019, from https://www.alta.org/advocacy/online-notarization.cfm.
The states adopting RON have retention requirements ranging from five to ten years.
H. Fees.
The MBA-ALTA Model act and the RULONA amendment do not address fees for RON. Fees will most likely be regulated by the individual states’ statutes. The language in each state varies. Currently, the Virginia legislation does not provide for a set fee. A Montana and Michigan notary public may charge a fee not to exceed $10 for each notarial act. Indiana’s notary fee is $15 for each notarial act. Tennessee, Minnesota, Ohio, Texas, Utah and Nevada notaries can charge $25 for each notarial act.
I. Defective Acknowledgments.
The drafters of the law should consider whether they want documents filed with defective acknowledgments to be constructive notice to third parties and decide what the effect a defective acknowledgement should have upon recording. One alternative would be to implement a short statute of limitations for challenging the document based solely upon a defective remote online acknowledgment. Texas’s legislation did not address this issue. The subsequent legislative attempt to address this issue by imposing a statute of limitations in Texas did not make it out of the legislature. Therefore, in Texas the existing laws regarding the effect of defective acknowledgments for paper documents would appear to apply to RON documents.

V. Recording Laws.
A. State Laws Should Confirm a Document Utilizing RON can be Recorded.
Any law addressing RON should confirm that an electronic document notarized by RON is recordable in the official land records and, once recorded, will serve as constructive notice to third parties. The law should include a provision to allow the electronic documents to be printed out to a paper document in a form that will be accepted for recording by the recorders (“papering out”) who do not have electronic recording capabilities.
See ALTA.org, & Mortgage Bankers Association. (n.d.). Model Legislation for Remote Online Notarization, Pages 7-9. Retrieved May 20, 2019, from https://www.alta.org/advocacy/online-notarization.cfm.
Virginia, Montana, Texas, Nevada, Utah, and Indiana did not include any “papering out” provisions. The legislation in Vermont, Michigan and Ohio is not clear. Texas revisited this issue in the 2019 Legislature and passed a revision to allow “papering out” effective September 1, 2019.
B. Why is “Papering Out” Important?
The Texas Property Code, Chapter 12, Recording of Instruments, governs the recording of real property conveyances in Texas. As discussed above, as in many other states, in Texas, recording is necessary to impart constructive notice of the document to third parties. See Tex. Prop. Code, Ch. 13, Effects of Recording. Section 12.001 of the Texas Property Code addresses an acknowledgment by a notary, but it does not contemplate a remote online notarization, which necessarily involves an electronic signature and an electronic document. See “Love, R. & Flowers,
C.,” (December 2018). What’s the Legal Basis for Ron? Texas Land Title Institute, at Page 3.
Section 12.0011, Instruments Concerning Property, Original Signature Required for Certain Instruments, defines a “Paper document” as a document received by a county clerk in a form that is not electronic. See id. A remote online-notarized document is obviously an electronic document, not a paper document. This section becomes important when addressing the question of recording a remote online notarized document that needs to be “papered out,” or printed/copied, to be recorded in a county that does not electronically record. When the document is printed out, it becomes a paper document, but it is questionable whether it meets the requirements for recording a paper document. See id.
The existing law in Texas states a paper document may not be recorded unless it contains an original signature that is acknowledged, or the paper document is attached as an exhibit to an affidavit that has an original acknowledged signature. The provision allowing an affidavit to be attached was not comprehensive enough to apply to an electronic document. The legislation passed in Texas effective September 1, 2019 does provide a method for the electronic document to be printed out and the affidavit of a notary attached to authenticate the document as a true copy of the electronic document. This presented two immediate problems – one of the main features of remote online notarization is the avoidance of paper documents, and if an affidavit is used, how will the recorder index the affidavit so that it will appear in the chain of title? A second notary will also be required to acknowledge the signature of the affiant on the affidavit proving up the “papered out” document with an original signature of the second notary. Therefore, there would still have to be an original signature on the affidavit. See “Love, R. & Flowers, C.,” (December 2018). What’s the Legal Basis for Ron? Texas Land Title Institute, at Page 3. The original signature on the affidavit must be obtained from someone that is in the county where the property is located enabling the document to be recorded if the document is going to be recorded in person at the recorder’s office. Otherwise, the document must be sent by mail for recording, which brings in the possibility for the original affidavit verifying the electronic document to be lost.
Section 12.0011(c) also provides that an original signature “may not be required” for an electronic instrument that complies with the requirements of Chapter 15, Texas Property Code; Chapter 195, Local Government Code; Chapter 322, Business & Commerce Code; or “other applicable law.” Chapter 15 is the Uniform Real Property Electronic Recording Act adopted in 2005 in Texas. The Act allows the recording of electronic documents if the county clerk chooses to implement electronic recording. Also, 15.005(b)(3) allows the conversion of paper documents into an electronic form by the county clerk. See id. It is the practice in counties where electronic recording is available for the title company or attorney to make a copy of the original document and send to the county clerk through their electronic recording system.
Chapter 195 of the Local Government Code establishes the rules by which electronic documents may be recorded. Section 195.003 limits the persons who may file electronically. Persons who may file electronically with the county clerk must be: (1) an attorney licensed in the state; (2) a bank savings and loan association, savings bank or credit union doing business under law of the United States or this state; (3) a federally chartered lending institution, a federal government-sponsored entity, and instrumentality of the federal govern, or a person approved as a mortgagee by the United States to make federally insured loans; (4) a person licensed to make regulated loans in the state; (5) a title insurance company or title insurance agent licensed to do business in this state; (6) an agency of this state; or (7) a municipal clerk. If the County has a population of 500,000 or more, the Section also provides for the county to authorize a person to file electronic documents with a county clerk if the county enters into a memorandum of understanding with the person for that purpose. See Local Government Code, Chapter 195.003. The provision does not apply in a county smaller than 500,000. Clearly, a landman is not listed on the list to be able to electronically record at the county clerk’s office. However, an attorney is on the list authorized to electronically record. Therefore, this part of the statute appears to be a barrier for the landman attempting to electronically file an oil and gas lease unless a memorandum of understanding is reached with each county clerk in the large counties. This issue should be addressed at the state legislature level to include members of the oil and gas industry who typically file documents for similar purposes as the real estate industry. The states implementing RON with “papering out” provisions, thus allowing the second notary to attest that the document is a true and correct copy of the electronic original, would enable landmen to file documents in person at the recorder’s office or by mail.
Of course, on the real estate side, the already existing practice is a conversion of a “wet” signature original document to a pdf or other electronic document by the title company or attorney for filing electronically through the county clerk’s system. Clearly, an electronically signed document may be recorded in a county with electronic recording. See “Love, R. & Flowers, C.,” (December 2018). What’s the Legal Basis for Ron? Texas Land Title Institute, at Page 4. The problem facing landmen is to be sure the legislation includes the landman as one of the persons authorized to electronically record using the clerk’s electronic recording system. Primarily, in Texas the area of the state with oil and gas activity does not include the counties with the large populations so the landman taking leases in those areas utilizing RON and electronic documents would not be able to electronically regard.
1. “Papering Out” – How to Solve the Issue of Recording.
The fix for this situation in Texas, and other states, would be to alter the existing law to permit the recording of a paper document that is a copy of an electronic document remotely online notarized. The current version of the model act envisions simply recording a copy of the remotely notarized document, apparently assuming chain of custody and the remote notary seal will satisfy concerns regarding alteration or possibly fraud and forgery. As mentioned above, the Texas proposed solution was to attach an affidavit from a notary verifying the document is the original that has not been tampered with. Such a law would also need to direct the clerk as to indexing the document to provide notice via a grantor/grantee search. See id. If the law is not specific as to how the document should be indexed, many clerks would index the affidavit verifying the document by the affiant instead of the true grantor/grantee in the document. Thus, the instrument could be lost and not show up in the chain of title of either the grantor or grantee.
The new legislation in Texas expanded the permissible types of “paper documents” defined in Property Code Section 12.0011 allowed to be recorded to include a copy of an electronic record declared to be a true and correct copy of the electronic record by affidavit (as set out in the proposed Section 12.0013) by a notary public or other officer who may take an acknowledgment or proof of a written instrument under Section 121.001, Civil Practice and Remedies Code. See Tex. Prop. Code §12.0011(b); see also Senate Bill 2128, 86th Legislature, 2019-2020.
Rather than have the original remote online notary provide an affidavit verifying the electronic document, the affiant of a prove-up affidavit could be another notary who is able to confirm the authenticity of the document by confirming the document has not been tampered with. The declaration confirming the document has a signature and a seal of the notary attesting to the declaration. The idea of having two notaries in the transaction in a county where there is no electronic recording seems very cumbersome. The original notary may not be in the county where the document needs to be recorded. Yet, ideally the document should be able to be recorded in person at the clerk’s office without transmitting the document through the mail.
The idea of any notary being able to confirm the authenticity of the document is a departure from the persons allowed to electronically file in Local Gov’t Code 195.003. This would have typically been a title company employee but could be a lender or attorney. The proposed legislation in Texas provides a form for the Declaration of Authenticity to be used. As discussed above, this change opens the door in the oil and gas arena for the landman to be the notary that can attest to the electronic document and then file that document as if it was a paper document at the county clerk’s office.
In addition, the Local Government Code Chapter 193 in Texas will be amended effective September 1, 2019, to provide for indexing by the grantor/grantee of the exhibit document (being the copy of the electronic document) instead of indexing using the affiant of the affidavit. Additionally, Chapter 12 of the Property Code will be amended effective September 1, 2019, to add Section 12.0013, which would direct a county clerk to record a paper or tangible copy of an electronic record if the paper or tangible copy of the electronic record: (1) contains an image of an electronic signature or signatures that are acknowledged, sworn to with a jurat, or proved according to law; and (2) has been declared by a notary public or other officer who may take an acknowledgment or proof under Section 121.001, Civil Practice and Remedies Code, to be a true and correct copy of the electronic record.
A notary public or other officer who may take an acknowledgment or proof under Section 121.001, Civil Practice and Remedies Code, may declare that a paper or tangible copy of an electronic record is a true and correct copy of an electronic record by: (1) executing and attaching an official seal to a tangible paper declaration under penalty of perjury; and (2) affixing or attaching the declaration to the printed paper or tangible copy of an electronic record.
As a result of the legislation, the County Clerk must accept an electronically notarized document for recording if printed out and certified by a notary to be a true and complete copy of an electronic original. Such a provision would allow recordation of electronic documents in jurisdictions that do not currently accept electronic recordings.

VI. OTHER ISSUES.
A. Statute of Limitations for Defective Acknowledgments using RON.
In Texas, there is no separate statute of limitations to cut off challenges to remote notarization, the acknowledgment, and the recording. Not unlike the two-year statute currently in place for acknowledgments, a straightforward two-year statute makes sense, possibly dropping the current limiting language for a “ministerial defect.” See Tex. Civ. Prac. & Rem. Code §16.033 and Title Examination Standard 4.20. However, the move toward creating a separate statute of limitations in Texas for the RON stalled. As mentioned before, the only statute of limitation applicable would apply the same for RON as any traditional acknowledgment.
B. Jurisdictional Requirements.
As discussed, whether a notary has the right to acknowledge documents for parties outside the state where they are commissioned, and whether each state requires a notary to be commissioned in the state where the property or people are located, presents an issue as to the acceptance of the notarization of documents between states. Hopefully, time will take care of this issue as more states adopt legislation addressing jurisdictional requirements for a physical presence of a notary licensed under any state laws and more states adopt legislation addressing reciprocity issues from state to state. Additionally, the issue may be solved if the ULC drafted a uniform RON act or revised the RULONA and the URPREA to promote reciprocity.
C. Amendments to the Model Act.
The MBA and ALTA are collectively addressing technical standards but also modifications to the uniform model bill. Texas has been somewhat of a lead in this area, but all states will want to be observant as to any national trends or requirements. There might be positive changes made to include the landman and oil and gas attorneys if the American Association of Professional Landmen could weigh in with the other associations on changes that would include the needs of the land professional.
D. Title Insurance Coverage.
ALTA may also take affirmative steps to provide title insurance coverage for documents remotely notarized. Arguably, the Texas policy insuring language for Covered Risk 2. (a) (iii), (iv), (vi) already addresses this:
(iii)a document affecting title not properly created, executed, witnessed, sealed, acknowledged, notarized or delivered;
(iv) failure to perform those acts necessary to create a document by electronic means authorized by law:
(vi) a document not properly filed, recorded or indexed in the Public Records including failure to perform those acts by electronic means authorized by law.
E. Where is the Original?
The idea of a wholly electronic contract that is not a type of document that needs to be filed of record raises questions. If the document has been memorialized by recording in the public records, the document is always locatable. When RON is utilized, the notary or third-party vendor will have control of the executed documents for at least some period, and the document can be accessed by the parties. But what if the document is not the type of contract that would require recording? What is the original? Where is the original located? How would a party prove the document is authentic?
There is no case law interpreting RON. There is older case law interpreting UETA that can be analogous. If the document is wholly electronic, courts apply the usual rules of evidence. In a proceeding, evidence of a record or signature may not be excluded solely because it is in electronic form.
See §1.00 Ruiz v. Moss Bros. Auto Group, Inc., 232 Cal. App. 4th 836 – Cal: Court of Appeal, 4th Appellate Dist., 2nd Div. 2014- Discussed authenticating a signature. Any writing must be authenticated before the writing, or secondary evidence of its content, may be received in evidence. (Evid. Code, § 1401; People v. Valdez (2011) 201 Cal.App.4th 1429, 1435 [135 Cal.Rptr.3d 628]; People v. Goldsmith (2014) 59 Cal.4th 258, 271 [172 Cal.Rptr.3d 637, 326 P.3d 239].) “Authentication of a writing means (a) the introduction of evidence sufficient to sustain a finding that it is the writing that the proponent of the evidence claims it is or (b) the establishment of such facts by any other means provided by law.” (Evid. Code, § 1400, italics added; People v. Valdez, supra, at p. 1435 [proponent met its burden of producing evidence to show authenticity of writing “`when sufficient evidence has been produced to sustain a finding that the document is what it purports to be.'”]; People v. Skiles (2011) 51 Cal.4th 1178, 1187 [126 Cal.Rptr.3d 456, 253 P.3d 546] [“[W]riting can be authenticated by circumstantial evidence and by its contents.”].).
Certainly, if a document is fully electronic and is not recorded in the public records or held by a third-party vendor by agreement, the loss of the fully electronic document could be a total loss. Parties who desire to conduct business with totally electronic documents must pay attention to the back up of their electronic data. How could you prove to the court the document ever existed? The storage of electronic documents requires a layered backup system, so the electronic document is not lost. If a party undertakes handling their own document storage, much attention should be paid to redundancy.
F. Title Opinions Reviewing Documents that are Totally Electronic.
As time goes on, more and more documents will be electronically recorded, including documents that are totally electronic in nature. Title opinions covering oil and gas interests, just like commitments for title insurance coverage, have not made a distinction between paper documents sent for recording versus paper documents that have been electronically recorded. Additionally, title examiners have not commented on electronic documents electronically recorded. Because the legality of electronic documents and signatures has been around for almost twenty years, title attorneys general accept either method of recording. However, there is not any notation on those documents as to whether the documents were paper documents with original signatures recorded in the record or paper documents with original signatures that were converted to a pdf and filed electronically.
Most RON legislations require the acknowledgment of the document and notary stamp to disclose that the document was notarized with the use of RON. The landmen and attorneys doing title examinations and title opinions need to understand the RON legislation and rules in the states where they practice. Following the same reasoning as to the use of UETA and URPERA, where title opinion requirements were not made, if those laws and rules condone the use of RON, the use of electronic documents/signatures and acknowledgments need not be addressed in title opinions.

VII. ADVANTAGES OF RON.
A. No Mail Outs.
With the use of RON, documents will no longer have to be mailed out to the signers. Every time documents are mailed or transmitted by a private carrier such as “fed ex,” those documents are at risk to be lost. When the documents are returned, there is always a possibility the signer did not sign in all the required places. The RON process and technology tags all the locations in the documents where a signature or initial is needed so none are left off.
Sometimes documents are mailed out to accommodate the parties’ schedules. When a party cannot be present at a specific time, the party may utilize a power of attorney. The possibility of fraud increases with the use of powers of attorney in these instances of accommodating the parties. The utilization of RON should avoid the overuse of powers of attorney executed just for the convenience of the parties.
Signers using RON are not limited to any particular hours to sign the document. Notaries or vendors providing the notarization service can do so at any hour of the day or night. Additionally, once executed, the documents are immediately available to the parties. Once again, obtaining the “original” does not depend on the documents being returned by the mail or fed ex several days later.
B. Landmen and Attorneys May Want to Consider a Third-Party Vendor.
As noted in numerous places throughout this paper, the requirements surrounding RON are complicated and onerous. It is difficult, if not virtually impossible, for an individual landman or attorney to meet the security and retention requirements. As happens many times with regulatory changes, an entire industry has appeared to provide the services of RON for parties to utilize. Many of these vendors are flexible. Their service is reasonably priced and often less than utilizing a “mobile notary” (notary in a car) to drive to the parties’ location and notarize a document.
In choosing a vendor, depending on the client’s priorities, the landman or attorney might consider whether they can have an option to virtually attend the signing with the signer and the notary. In real estate, some vendors are accommodating the title agent conducting the entire closing using the virtual audio-video medium with the commissioned online notary doing the notarial act. Another option for the landmen, attorneys or their legal assistants is to become a commissioned RON notary themselves but use the vendor to provide the technology and document retention.
An additional consideration in choosing a vendor would be their retention of documents policy. Depending on the client’s requirements, the length of time the vendors keep the documents on the company’s behalf can be negotiated with the vendor. The vendors will provide information regarding methods to access the documents and train personnel on its use.

VIII. RISKS OF RON.
A. Unauthorized Access.
Access to electronic notarial records, electronic signatures and seals should be kept secure from unauthorized access or use. It may be impossible to make any electronic document tamper-proof; but, through the application of technology, the electronic document can be made tamper-evident, so that any changes made after execution can be easily detected. Most available technologies have this function.
B. Fraud.
Fraudulent manipulation of documents and complete forgeries have always been a threat to the oil and gas and real estate industries. Some of the fraud encompasses the forgery of signing someone else’s name and/or filing a false document. Although the new technology does not alleviate these issues, it goes a lot further than the current day practices to deter forgeries. Remember, under the current practice of notarization the only method the notary has of verifying a person’s identity is looking at the person’s ID and looking at the person sitting in front of them. The notary must decide in that moment if the picture in the ID is in fact that person. The notary has no way to verify that the ID is even official or real. As discussed above, RON technology requires additional authentication avenues that lead to more secure process.
C. Mistakes and Errors.
As with all transactions, electronic transactions are susceptible to mistakes and errors. UETA provides rules for determining the effect of such errors. “If the parties agree to use a security procedure to detect unintended changes or errors, and one party does not comply with the security procedure, the complying party may avoid the effect of the error or change to the electronic record. See Tex. Bus. & Com. Code Ann. §322.010(b)(c). If an automated transaction involves an individual on one side and an electronic agent on the other, the individual may avoid the effect of an erroneous electronic record if two requirements are met. First, the electronic agent must not have provided an opportunity to prevent or correct the error. Second, when the individual learned of the error, the individual: 1) promptly notified the other party; 2) took reasonable steps to return or destroy any consideration received; and 3) did not use or receive any benefit or value from the received consideration.” See id. at (c)(d).
If neither of the above rules apply, the legal effect of any changes or errors will be determined by the parties’ contract or by other applicable laws, including the law of mistake. See id. at (d). While the UETA procedures for avoiding the effect of certain erroneous transactions do not apply to all possible mistakes and errors involving electronic transactions, they do provide some guidance. Unfortunately, UETA does not address important security issues such as forgery, hacking, cyber-attacks and other forms of fraud. Parties must attempt to protect themselves from these potential abuses using security procedures such as passwords and encryption along with appropriate insurance coverage.
Interestingly, with the addition of RON, its requirements may reduce the number of mistakes and errors. The technology enables the parties to view the documents to be executed in advance. The idea is that if the parties review the documents beforehand, this extra time may allow mistakes to be discovered before execution of the documents.

IX. UTILIZATION OF RON IN THE OIL AND GAS INDUSTRY.
Obviously, an industry person who is dealing with documents required to be notarized can utilize RON to accommodate their clients. For example, a landman can be present from a distance with the lessor while the lessor executes an oil and gas lease enabling the landman to answer questions that arise without traveling miles to the lessor’s location anywhere in the country. Similarly, company representatives required to execute documents that require acknowledgments can execute at their convenience. Additionally, multiple companies’ representatives can appear around a virtual closing table for discussions and execution of documents requiring notarizations without travel. Likewise, those parties buying mineral interest or royalty interest can “close” that transaction around a virtual closing table and have the deeds or assignments executed immediately avoiding the time delay for mailing out documents thus preventing interference from outside forces. The documents are instantly available to all parties.

X. ELECTRONIC DOCUMENTS, SIGNATURES, NOTARIZATIONS AND RECORDING WILL CONTINUE TO AFFECT CURRENT PRACTICES.
In summary, the authorities for electronic signatures, notarization, and recording have existed for almost twenty years. The online notarization statutory implementation introduces only a few new concepts with no real change to the underlying act of notarization. The methods of identity proofing and credential analysis required are far more robust than the security of the current practice of in-person notarizations. The secure storage requirements implemented as a requirement for the notary also accommodates needed access of the documents by the signers. And, perhaps the most far reaching change is in the definition of “presence,” which was expanded so that the person signing the document requiring notarization does not have to be in the same room with the notary.
The concept of a “solely electronic” document, signed electronically and notarized electronically in the presence of the notary or by using RON and finally recorded electronically is logical. With the recognition that “personal appearance” can be achieved via the internet, the next step, of course, must be to implement the RON process as uniformly as possible in all states with adequate safeguards and requirements. The process must accommodate parties that may buy, sell, lease, or borrow against real property located in areas where electronic recording is not feasible or otherwise adopted. The national model act overlooked this, as did Texas. Yet, even those transactions may be electronic with the implementation of a “papering out” provision with the use of RON. Other issues remain, including the use of notaries in other states, without the safeguards provided in the Texas legislation and the model act, remotely notarizing transactions affecting real property of another state. The technology developed around RON can detect any access or changes made to the document proving the authenticity of the electronic document. For real estate, the title insurance underwriters can make choices and requirements about the use of RON in transactions where title insurance will be issued. But what about the oil and gas industry? Attention to current legislation already adopted to add provisions recognizing the specific needs of the oil and gas industry might be called for. Further attention by the industry is certainly called for in states still contemplating the form of their legislation. The technology is now available, and the benefits are obvious. Thus, hopefully, the oil and gas industry will begin to take advantage of these benefits and embrace the move to the fully electronic document.

Filed Under: Publication Tagged With: Celia Flowers

Celia Flowers Speaks at TLTA Seminar

December 4, 2019 by Janna Fain

TYLER, TX (December 4, 2019) – On Wednesday, December 4, Flowers Davis Senior Partner and East Texas Title Companies owner Celia C. Flowers joins other attorneys and title professionals in presenting to the Texas Land Title Association (TLTA) in San Antonio. Celia’s topic is “Boundary Line Agreements and Easements”. This day-long standalone seminar precedes the TLTA Institute, and the information is relevant to any real estate or title professional.

Founded in 1908, TLTA is a statewide trade association representing the Texas title insurance industry and currently serving over 13,000 professionals involved in the safe and efficient transfer of real estate. Celia C. Flowers is owner of East Texas Title Companies and Senior Partner at Flowers Davis PLLC, both based in Tyler.

Filed Under: News Tagged With: Boundary Lines, Celia Flowers, Easements, TLTA

Flowers Davis Sr. Partner Celia Flowers Presents at Rocky Mountain Mineral Law Foundation Event

July 31, 2019 by Janna Fain

MONTERREY, CA (July 20, 2019) Flowers Davis Sr Partner Celia Flowers presented at the 65th Annual Rocky Mountain Mineral Law Institute in Monterrey, CA.

Celia’s topic, presented in the Landman’s section of the program, was “Where Is the Original? How Do Electronic Signatures, Online Notaries, and E-Recording Change Our Record Driven Industry?” She elaborated on how electronic signatures, recordings, and acknowledgments are replacing old-school paper trails in the traditionally paper-intensive industries of oil and gas and real estate. Through her company East Texas Title Companies, Celia pioneered this service in East Texas. ETTC was also one of the first title companies nationwide to adopt the technology.

Read more about the conference here: https://www.rmmlf.org/conferences/ai65/overview#tab

Filed Under: News Tagged With: Celia Flowers

East Texas Business Owner Demonstrates Latest Closing Technology at National Meeting

January 29, 2019 by Will Mokry

TYLER, TX (January 21, 2019) ¬¬– East Texas business owner and attorney Celia C. Flowers was one of three early adopters to present to the Large Agents Group of the American Land Title Association (ALTA) in Boca Raton this past week. Celia provided a video of a mock closing, demonstrating how her company, East Texas Title Companies, provides secure digital closings and remote online notary (RON) to her Texas clients. RON allows parties to close real estate transactions virtually any time from virtually anywhere in an encrypted and secure environment. Texas was one of the first seven states to approve RON, with 20 more states joining in 2018. Acceptance and implementation by title companies has been following legislation at a slower pace. Celia and her colleagues also discussed processes and lessons learned since implementing RON.

ALTA is the national trade association and voice of more than 6,000 title insurance agents, abstracters and underwriters. The Large Agents group of ALTA consists of the 35-40 largest title agents in the country, with representation across the nation. Celia C. Flowers is owner of East Texas Title Companies and Partner at Flowers Davis PLLC, both based in Tyler.

Filed Under: News Tagged With: Celia Flowers

Horizontal Wells Crossing Unit Lines – From Permitting To The Division of Royalties

November 21, 2017 by Will Mokry

Authors: Celia Flowers & Melanie Reyes

The proliferation in horizontal drilling over the last decade has given rise to new, complex legal issues.  One area where the law has increasingly lagged behind the technology is in the calculation of royalties for horizontal allocation wells – in particular, the question of the division of royalties from horizontal wells crossing adjacent units has dogged the petroleum industry in recent years.  While the issues of permitting and royalty apportionment have not been wholly resolved by Texas courts with regard to wells crossing adjacent unit lines, a review of existing Texas Railroad Commission orders and case law authority pertaining to wells crossing adjacent leases provides credible guidance.

  1. Permitting horizontal wells as allocation wells with the Texas Railroad Commission (“RRC”) 

When sixty-five percent of the royalty interest owners within a pooled unit or units have approved a drilling plan and execute Production Sharing Agreement (PSA), the Texas Railroad Commission (RRC) will issue a PSA well permit.  Production Sharing Agreements and PSA permitting has become an accepted means of conducting business around horizontal drilling.  A bigger issue arises, however, when less than sixty-five percent of royalty owners fail or refuse to enter such an agreement.

While little case authority exists, the precursor to this issue originally arose with the RRC in the framework of whether pooling authority was required before a lessee could drill a horizontal well that crossed lease lines, where that lessee held leases on all tracts crossed by the horizontal well. The issue was presented to the RRC by EOG Resources Inc. for its Klotzman Lease (Allocation) Well NO. 1H (Status NO. 744730), Eagleville (Eagle Ford-2) Field, Dewitt County, as an Allocation Well Drilled On Acreage Assigned from Two Leases, Docket No. 02-0278952 (Sept. 24, 2013) (final order).  EOG filed an application for a drilling permit for a horizontal well purporting to form an approximately eighty-acre drilling unit by utilizing 40 acres from two separate leases.  EOG held a working interest in both leases.  However, the lessors had not given EOG pooling authority under the leases, and the Klotzmans and Reillys (lessors) protested EOG’s application for a drilling permit.

The lessors alleged the act of drilling across lease lines and producing from multiple tracts and leases constituted unauthorized pooling, despite the label attached to the permit application, and therefore, EOG Resources, Inc. had no good-faith claim to the right to drill the well. The lessors further argued that such a well would necessarily require the removal of captured minerals from the lease prior to measurement. In their view, the inescapable prospect of downhole commingling breaks down an analogy between an allocation well and a collection of wells isolating each lease. In the latter, production could be measured at the surface of each well, and no disputes would arise over what production is attributable to a particular lease. Lessors argued that the plain language of Rule 26 required measurement prior to removal of production from a lease.[1]

In response, EOG insisted that no pooling resulted from the drilling of an allocation well. Additionally, it asserted that Rule 26 had no applicability or relevance to downhole commingling. On the narrow question of whether it held a good-faith claim to the right to drill, EOG pointed to the leases, which indisputably granted the right to drill on and through the lands described in the leases.  It argued that because the rights and duties under a lease are a matter of contract between a lessor and lessee, it maintained that interpretation of contractual rights is the province of courts rather than the Commission.[2]

The RRC ultimately determined that EOG was not required to demonstrate any pooling authority in order for the RRC to issue a permit to drill a horizontal well that crosses lease lines, where all the leases involved are held by the lessee. Id.  The lessors filed suit in district court in Travis County, but the case settled before trial.[3]  Moreover, in the wake of the “Klotzman” challenge, the RRC has continued to issue permits to drill horizontal allocation wells where the applicants show a good-faith claim of a right to drill, which is satisfied with a showing of leasehold or mineral rights. Texas case law has long held that the RRC has authority to determine whether an applicant has such a good-faith claim.[4]

A horizontal allocation well refers to: 1) a horizontal well that traverses more than one tract in which 2) less than sixty-five percent of the royalty interest owners have approved the drilling plan (thus failing the RRC’s guidelines for issuing a Production Sharing Agreement or PSA well permit).   Instead of conditioning the grant of a permit for a horizontal allocation well upon an affirmative representation by the applicant that it has pooling authority or has otherwise obtained the consent from its lessors to drill the multi-tract horizontal well, the RRC only requires the applicant to represent that it has the entire working interest for those traversed tracts without any further representation by the applicant that it has pooling authority or has obtained the consent of royalty owners for a multi-tract well.

It is important to note, however, that Texas courts have routinely held that the RRC’s authority does not extend beyond the permitting process.[5]  Once the permit has been issued, the parties continue to be bound by their existing contractual relationships and longstanding common law (i.e. tort law).[6] Moreover, Texas courts have yet to specifically address the applicability of the above analysis, the permitting of horizontal wells as allocation wells, to scenarios involving adjacent units.

Upon filing and paying the required fee, it has become the practice of the RRC to routinely allow a permit, originally issued as a horizontal allocation permit, to be amended to become a PSA permit should the required number of royalty owners execute PSAs.

  1. Payment of Royalties under an Allocation Well

The RRC refers to a “horizontal drainhole well” as any well that consists of one or more horizontal drainholes.[7] A horizontal drainhole is defined as that part of the wellbore that deviates at more or less of a right angle from the vertical wellbore; it begins at the penetration point, where it penetrates the field at an interval capable of production, and ends at the terminus point, the point farthest from the penetration point but within the producing interval. See id. § 3.86(a)(2), (5), (6) (2000). For purposes of designating a proration unit and allocating production allowables, units are determined by the length of the horizontal displacement between the penetration point and the terminus point, i.e., the horizontal displacement of the drainhole.[8]

The first case addressing the consequences of drilling horizontal wells across unpooled interests was Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex.App.—Austin 2000, pet. denied). Humble Exploration Company, Inc. Oil Company obtained three leases from the Lueckes in 1979.[9]  Those leases were eventually assigned to Browning Oil Company, and in 1994, Marathon Oil Company and Browning Oil Company, Inc. entered into an operating agreement to develop the area which included the Lueckes’ acreage under the leases. Although those leases contained pooling provisions, they also contained anti-dilution provisions restricting the quantity of lease acreage that could be pooled with the lease.[10]

In late 1994, Marathon approached the Lueckes seeking to amend the leases to allow pooling for horizontal wells.  The effect of the proposed amendment would have nullified the anti-dilution provisions, and the Lueckes refused.[11] Nevertheless, in February 1995, Browning and Marathon drilled two successful horizontal wells across tracts, which included Luecke tracts. They filed a Certificate of Pooling Authority with the RRC, showing the location of the first well on a purported pooled unit consisting of 839.18 acres, 268.68 of which were owned by the Lueckes; and that the second well was located on a purported pooled unit consisting of 346.625 acres, 114.86 of which were owned by the Lueckes.

The Lueckes filed suit against Browning and Marathon, claiming that the purported “units” for the two horizontal wells violated the pooling provisions and the anti-dilution provisions in their leases. Following a jury verdict for the Lueckes, Lessees appealed.  The Court of Appeals determined with ease that the pooling and anti-dilution provisions of the leases applied to the horizontal wells.[12]

The appellate court concluded that Lessees were required to comply with the lease provisions and that they breached those provisions. However, with regard to the Lueckes’ claim that they were entitled to royalties for total production from the wells undiluted by distribution among other pooled landowners, the court disagreed. It concluded that because the breach rendered the pooled units invalid, the Lueckes were not entitled to receive royalties on oil and gas produced from tracts they did not own.[13]  As the court plainly stated, each tract traversed by the horizontal wellbore is a drillsite tract, and each production point on the wellbore is a drillsite.[14] However, “[a]lthough the Lueckes’ tracts are drillsite tracts, they cannot claim royalties for total production when they have no legal claim to oil and gas recovered from other lessors’ drillsite tracts.” [15]   The better remedy is to allow them to recover royalties as specified in the lease, compelling a determination of what production can be attributed to their tracts with reasonable probability.[16]

The appellate court, though not explicitly addressing commingling, applied a “reasonable probability” standard to the allocation of production from un-pooled tracts.  However, it expressly recognized the harm it could do to the burgeoning horizontal drilling industry and stated: “[d]raconian punitive damages for a lessee’s failure to comply with applicable pooling provisions could result in the curtailment of horizontal drilling. We decline to apply legal principles appropriate to vertical wells that are so blatantly inappropriate to horizontal wells and would discourage the use of this promising technology.” [17]  Thus, the court awarded the un-pooled owners “royalties for which they contracted, no more and no less.” [18]

More recently, the San Antonio Court of Appeals decided Springer Ranch Ltd. v. O.F. Jones III. et. al.[19]  Springer Ranch brought suit against Rosalie Matthews Sullivan (its neighbor) and other owners of adjoining mineral estates.  Springer Ranch sought a declaratory judgment with regard to a 1993 contractual agreement, originally executed to govern allocation of royalties with respect to vertical wells drilled on the parties’ properties.[20]  The lawsuit, however, arose years later following a dispute between the parties over allocation of royalties from a horizontal well.  The horizontal well bore was located on Spring Ranch’s land, crossed the boundary of Sullivan’s land, and ultimately, ended on Sullivan’s land.  The trial court held that the 1993 contract required that royalties from the horizontal well in dispute, and any future horizontal wells crossing the parties’ property lines, must be allocated based upon the productive portions of the well underlying the parties’ properties.[21]  An appeal followed.

On appeal, the appellate court acknowledged the distinction between the manner in which production is obtained from horizontal wells, as opposed to vertical wells, and explained that a horizontal well only produces hydrocarbons from the part of the well that lies within the hydrocarbon-bearing reservoir, or “correlative interval.”[22]  It further explained that “[a]long the horizontal displacement are take points through which hydrocarbons flow into the well.  A royalty, as a fraction of production, is only obtainable from the part of the SR2 well actually within the correlative interval. Despite Springer Ranch’s argument that the calculation should be based on the whole length of the well, it is not the whole length of the well from which the production is obtained…. the royalties must be allocated on the basis that the productive portions of the SR2 well are situated on both Springer Ranch’s and Sullivan’s properties.”[23]

These cases have generated a variety of methods employed by lessees/operators who must account to unpooled interest owners burdened by a portion of a horizontal well. Typically, these consist of calculating either: (1) the length of a horizontal drainhole within a tract relative to total length within the correlative interval; or (2) the number of take points within a tract relative to the total number along the entire horizontal drainhole.  It appears that absent unusual operational circumstances, production from a horizontal well should be allocated to each drill site tract proportionately based upon each tract’s share of the open wellbore in the pay zone.  Nevertheless, the Supreme Court of Texas has not addressed what standard governs damages for production from unpooled interests along a horizontal well.  Until it does, it appears that a lessee may allocate production on an unpooled basis, without liability under the commingling theory, provided it can establish with reasonable probability what production originates from the segment or segments of the drainhole within the unpooled lease.

  • Hypothetical

Gas Unit #1 and Gas Unit #2 are adjacent units in Reeves County, Texas.  Both units and the leases within the units are currently held by production.  Happy Oil Co. owns 100% of the leasehold interest in both units.  Happy Oil Co. is in the process of drilling Big Gas Well — a horizontal well with a lateral drainhole crossing both Gas Unit #1 and Gas Unit #2.

Ideally, Happy Oil Co. should obtain PSAs from the royalty owners in both of the existing units with attention paid to getting the PSAs from owners along the drill path on the horizontal well.  Obtaining PSAs from these royalty owners adds contractual protection for Happy Oil Co., giving it specific contractual approval from those royalty owners of the method of allocation of production between the two existing units and among the royalty owners within each unit.   Should Happy Oil Co. obtain the required 65% of royalty owners in both units, Happy Oil Co. could obtain a PSA permit from the RRC.

If it is unclear at the beginning of the process whether the requisite percentage of royalty owners in both units will execute Production Sharing Agreements (PSAs), approving the allocation of production between the royalty owners within each unit for Big Gas Well, Happy Oil Co. will then be faced with obtaining an allocation well permit. Given the facts surrounding the drilling of Big Gas Well, where the lessee, Happy Oil Co., owns 100% of the leasehold interest in both units crossed by the horizontal well, the RRC would allow permitting of the well as an “allocation” well since the good faith claim of right to drill is satisfied.  Therefore, it would be efficient and prudent for Happy Oil Co. to proceed with drilling this well under an allocation permit.  And, if 65% of the royalty owners eventually execute a PSA, Happy Oil Co. could always amend its RRC permit from an allocation permit to a PSA permit (although, such additional efforts are probably unnecessary).

As to royalty allocation, Happy Oil Co. should allocate royalties among the owners in each unit in the amount each owner proportionately owns in the existing unit multiplied by the percentage that such unit’s acreage occupies in the area covered by the measured horizontal wellbore.  This method incorporates the methods that meet the specifications set forth thus far in Browning and Springer Ranch:  (1) the length of a horizontal drainhole within a tract relative to total length within the correlative interval; or (2) the number of take points within a tract relative to the total number along the entire horizontal drainhole.  Said method could also be committed to writing in the form of a PSA, which, as noted would provide additional contractual protection.

  1. Conclusion

Technology moves at a rapid rate.  Unfortunately, cases move through the court system at a snail’s pace.  Thus, practitioners do not always have proper guidance when the case law lags behind.  Nevertheless, although the permitting processes and royalty calculations for horizontal wells is still developing, there is enough authority from both the RRC and Texas courts that practitioners can now proceed with reasonable assurance that acceptable methods used in lease line cases will eventually be adopted for unit purposes as well.


[1] Rules 26(a)(2) and 27(a) provide that oil and gas are generally to be measured before leaving the lease from which they are produced.  See 16 Tex. Admin. Code §§ 26(a)(2), 27(a) (2012); see also Clifton A. Squibb, “The Age of Allocation: The End of Pooling As We Know it?”, 45 Tex. Tech L. Rev. 929, Texas Tech Law Review, Summer, 2013, fn. 21, 81-89 (citing closing briefs made before RRC).

[1] Id.

[1] Reily. v. R.R. Comm’n of Texas, No. D-1-GN-13-004306(98th Dist. Ct., Travis Cty., Tex. Dec. 23, 2013).  EOG was also involved in another suit with similar issues. However, that suit has likewise been settled insofar the claims asserted against EOG’s relating to the above issues are concerned.  Spartan Texas Six Capital Partners, Ltd. v. Perryman, 494 S.W.3d 735 (Tex.App.—Houston [14th Dist.] 2016, aff’d as modified).

[1] See Magnolia Petroleum Co. v. R.R. Comm’n, 170 S.W.2d 189, 191 (Tex. 1943).

[1] See FPL Farming Ltd. v. Environmental Processing Systems L.C., 351 S.W.3d 206 (Tex. 2011).

[1] Id.

[1] See 16 Tex. Admin. Code §3.86(a)(4) (2000).

[1] Browning Oil Co. v. Luecke, 38 S.W.3d 625, 635 (Tex.App.—Austin 2000, pet. denied).

[1] Id. at 636.

[1] Id. at 637.

[1] Id. at 638.

[1] Id. at 640. 

[1] Id. at 645. 

[1] Id. at 635. 

[1] Id. at 646. 

[1] Id. at 647. 

[1] Id. 

[1] Id. 

[1] 421 S.W.3d 273 (Tex. App.—San Antonio 2013, no pet.).

[1] Id. at 277.

[1] Id. at 277-78.

[1] Id. at 285.

[1] Id. at 286.

Filed Under: Publication Tagged With: Celia Flowers, Melanie Reyes

Cost-Free Royalties – Where Valuation Begins and Post-Production Cost Deductions End

November 20, 2017 by Will Mokry

Authors: Celia Flowers & Melanie Reyes

Texas jurisprudence has long held that the royalty “stick” of the mineral estate is free of production costs. Although the royalty interest is not subject to production costs, royalty is usually subject to post-production costs. Heritage Resources, Inc. v. NationsBank, 939 S.W.2d 118, 122 (Tex. 1996). Nevertheless, parties are free to contract around this general rule and may allocate post-production costs however they see fit. See id. The ability to contract around default laws seems relatively simple. Whatever the law holds, the parties simply sign a contract to achieve a different result. Unfortunately, the courts have made this process much more difficult in the context of drafting around the post-production cost deduction default rules. And, the problem primarily lies in the manner in which a particular royalty is valued and the time/place where the value determination is made. Without an in-depth understanding of royalty valuation methods, many drafters find themselves attempting to draft around default laws that simply cannot be altered. This is further complicated by the fact that there are numerous means of valuing a royalty.

I. Royalty Valuation Methods
The two primary methods of royalty valuation are “market value” and “proceeds value”. The two primary times/places royalties are valued are “at the well” and “down-stream sales” to third parties. Understanding how, when, and where the royalty valuation takes place is the key to understanding how to allocate post-production cost deductions between the parties and how to draft around the default rules.

“Market value” is what a willing buyer would pay a willing seller in an arms-length transaction, generally determined by comparable sales. If comparable sales are unavailable, understanding the time/place of royalty valuation becomes of paramount importance. “Market value at the well,” means value at the well, net of any value added to the product after it leaves the wellhead. Judice v. Mewbourne Oil Company, 939 S.W.2d 133, 135 (Tex. 1996). This method deducts postproduction costs. Thus, all increase in the ultimate royalty value attributable to the expenses incurred after production is built in to the market value at the well equation.

“Proceeds” or “amount realized” royalty valuation methods require measurement of the royalty based on the amount the lessee in fact receives under its sales contract for the product. The caveat here, however, much like with the “market value” method, is the time/place of the valuation. If the lease language itself indicates that the point of sale takes place “at the well,” then, the equation contemplates post-production deductions. Thus, the coupling of “proceeds” or “amount realized” with “at the mouth of the well,” results in the same valuation as “market value at the well.”

II. No Post Production Deduction Clauses
The Texas Supreme Court’s first major holding related to attempts to draft around post-production cost deductions came in the 1996 Heritage Resources, Inc. v. NationsBank case. 939 S.W.2d 118 (Tex. 1996). In Heritage Resources, the royalty valuation method was “market value at the well.” However, the leases also included the following prohibition: “provided, however, there shall be no deductions from the value of Lessor’s royalty by reason of any required . . . transportation, or other matter to market such gas.” Id. at 120-121. The court noted that the “no deductions” clause only prohibited deductions from the “value of the Lessor’s Royalty.” See id. (emphasis added). Accordingly, the court reviewed the “no deductions” clause in light of the “market value at the well” royalty valuation method, holding that because post-production cost deductions are inherent in this valuation method, the “no deductions” clause necessarily became “surplusage” and therefore had no effect. Id.

Since Heritage Resources, drafters have taken is two-fold approach. First, the drafter attempts to remove any language marrying the “no deductions” clause with the “royalty valuation” method. Second, drafters attempts to expressly disclaim the Heritage Resources holding in the lease addendum. The effectiveness of this solution, however, has been called into question due to a series of cases. See Warren v. Chesapeake Exploration, L.L.C., 759 F. 3d 413 (5th Cir. 2014)(“no deductions” clause in addendum ineffective where royalty valuation method “at the well”); Potts v. Chesapeake Exploration, L.L.C., 760 F.3d 470 (5th Cir. 2014) (“no deductions” clause ineffective where royalty valuation method is “market value at the point of sale” but “point of sale” is at the well.)

After nearly 20 years, the Texas Supreme Court finally revisited Heritage Resources in the 2015 Chesapeake Exploration, LLC v. Hyder case. Hyder involved multiple royalty clauses. One valued royalty as market value at the well, one valued royalty as price actually received, and one value royalty as “gross production obtained.” The first two clauses were limited by the following: “The royalty reserved herein by [lessors] shall be free and clear of all production and post-production costs . . .” Id. The third clause, although containing no express post-production deduction limitation, was expressly called a “cost-free” royalty. Id. at 478. Finally, the lease included an express disclaimer of the Heritage Resources holding. Id. at 477.

The only issue that was explicitly decided by the Texas Supreme Court was whether the third royalty valuation method allowed for post-production cost deductions. Hyder, 2016 WL 352231 at 1. The court held that the “cost-free” designation prohibited the lessee from deducting post production costs. See id. at 2. Nevertheless, while the lessors in Hyder may have won the day, the war still seems to favor the lessees due to the court’s analysis therein.

The first problem with Hyder is that it gives effect to the “cost free” language in the third royalty valuation method, but it ignores the “free and clear” language limitation on the other to two royalty clauses in the same lease. Is “cost free” now a defined term of art that, regardless of timing of royalty valuation, frees the royalty (any royalty) of bearing post-production costs? Had the Heritage Resources case included the “cost free” language, would that result have been different, irrespective of the implication of timing? And, why is the term “cost free” effective but the phrase “free and clear of all post-production costs” surplusage?

The second Hyder problem is that, in dicta, the court opines that by making a lease a “proceeds lease,” this, in and of itself, is sufficient to avoid post-production cost deductions from the lessor’s royalty. See id. at 2. But, this conclusion is inconsistent with prior law relating to “proceeds leases.” The high court has previously held that a “proceeds lease” that uses a “net proceeds” methodology, per se, contemplates post-production cost deductions. This is so because a “net proceeds” calculation is synonymous with the amount realized, calculated at the mouth of the well. Conversely, a “gross proceeds” lease would theoretically not allow such deductions. See Judice, 939 S.W.2d at 136.

It’s important to note that in the 5th Circuit Potts case, the lease at issue was a proceeds lease, but the court held that the lessor’s royalty still bore the cost of post-production activities. In that case, the author (who wrote the concurrent opinion in Heritage Resources) was very careful to stress that the underlying reasoning behind Heritage Resources was not a matter of “market value” versus “proceeds” methodologies. The Heritage Resources reasoning stems from the “when and where” valuation — specifically, at what point is the royalty valued: at the well or downstream after processing? In Potts, the point of sale was at the well; thus, the lessor’s royalty included post-production cost deductions. This “timing” analysis, although perhaps overly complicated, at least makes logical sense and provides a more solid understanding of the rule set out in Heritage Resources.

But, the Texas Supreme Court does not address Potts at all in Hyder. Unfortunately, in connection with the first two royalty clauses at issue in Hyder, the court does not address the “timing” analysis, either. In failing to do so, the question of whether a “no deductions” clause will have any effect on a “proceeds” lease that calculates royalty at the mouth of the well is left unclear. The Hyder case expressly states: “the price-received basis for payment in the lease is sufficient in itself to excuse the lessors from bearing postproduction costs.” Hyder, 2016 WL 352231 at 2. Standing alone, that statement seems to imply that timing does not matter – call it a proceeds lease and no deductions. But, as noted, such an implication flies in the face of long-standing Texas law with respect to how a price paid at the well calculation is derived, and it undermines the only logical reasoning behind the Heritage Resources holding – that timing is the key. If this Hyder statement relates solely to “gross proceeds” leases, it could be harmonized with existing law. But, a “net proceeds” lease, as examined in both Judice and Potts, is a different animal altogether.

Another aspect of the Hyder case that is interesting is the court’s rejection of the Heritage Resources disclaimer. In the context of “timing,” again, this holding makes sense. If a royalty is valued at the well – be it market value or actual price received – those calculations include post-production cost deductions, and thus, a disclaimer of the Heritage Resources holding is as ineffective as a “no deductions” clause. But, again, the court veers away from the timing analysis in its analysis of the royalty clauses. Still, the bottom line seems to be that a disclaimer of Heritage Resources is of no effect under any circumstances.

As to the specific holding in the case as it relates to the royalty clause, the court states:

Heritage Resources does not suggest, much less hold, that a royalty cannot be made free of postproduction costs. Heritage Resources holds only that the effect of a lease is governed by a fair reading of its text. A disclaimer of that holding, like the one in this case, cannot free a royalty of postproduction costs when the text of the lease itself does not do so. Here, the lease text clearly frees the gas royalty of postproduction costs, and reasonably interpreted, we conclude, does the same for the overriding royalty. The disclaimer of Heritage Resources’ holding does not influence our conclusion. Id. at 5.

Finally, the Hyder dissent is worth note. The majority held that the “cost-free” language of the overriding royalty clause controlled, but the dissent focused on the “gross production” language. Hyder, dissent, 2016 WL 352231. The dissent notes that “gross production” is not as familiar a term as “market value at the well” or “amount realized, calculated at the mouth of the well.” Id. But, based on the standard definition of “gross” and “production,” the dissent concludes this phrase is synonymous with an “at the well” calculation. See id.

Under such a reading, the dissent would have held that the “cost free” language was surplusage because, as Heritage Resources holds, a “no deductions” prohibition clause cannot free a royalty from a valuation method that is inherently based on a post-production cost deduction calculation. In other words, gross production is what is obtained at the well, and thus, no post-production costs have been incurred at the time of production. The dissent would have resolved this tension “to give full meaning to ‘gross production,’ which defines the interest where “cost-free” is only an adjective describing it.” Id.

Despite the inherent problems with the new Hyder decision, the Texas Supreme Court now has the opportunity to clarify the opinion in light of the problems raised by the dissent as the case of Commissioner of General Land Office of State of Texas v. Sandridge Energy, Inc. is now at the high court and briefs on the merits have been submitted. 454 S.W.3d 603 (Tex. App.—El Paso 2014, pet filed). Sandridge Energy involves the interpretation of the following clause: “gross production or the market value thereof such value to be based on the highest market price paid or offered for gas of comparable quality in the general area where produced and when run, or the gross price paid or offered to the producer whichever is greater.” Id. at 608. The El Paso court of appeals determined this clause equivalent to be a market-value at the well valuation. See id. at 616. It will be interesting to see if the high court grants petition for review, and if so, how the opinion attempts to harmonize the case with Hyder.

II. WHERE DO WE GO FROM HERE?
After 20 years of drafting around Heritage Resources, the majority of practitioners are looking back and realizing that their efforts to work around the holding were most likely in vain. Due to the Hyder opinion, Lessors who may have seen their royalty free of post-production costs could now be receiving royalty checks for lower amounts. The question now is: How do we draft a royalty valuation clause and/or no-deductions clause to meet the understanding of the parties?

At first glance, for lessees, the answer seems relatively clear. If the royalty is calculated as the market value “at the mouth of the well,” the royalty is subject to post-production costs irrespective of the addition of a no-deductions clause or a Heritage Resources disclaimer. But, due to the Hyder language that the price-received basis for payment is “sufficient in itself to excuse the lessors from bearing postproduction costs,” the implication is that any “proceeds” could free the lessor’s royalty from postproduction costs whether it is a gross proceeds or a net proceeds lease. This may be an unintended consequence of the Hyder language, but the argument is not ripe for adjudication, and drafters will have to hope the high court eventually clarifies this language. In the meantime, if the lessee wants the lessor to bear post-production costs, the safest bet is to calculate the lessor’s royalty as market value at the well.

For lessors, the picture is even less clear. Drafters now know that a market value at the well royalty valuation will render a no deductions clause surplusage no matter what language they use in the no deductions clause. But, what about “market value at the point of sale”?

This will depend on “where” the actual point of sale occurs. If evidence demonstrates the point of sale is “at the well,” the lessor is back to square one and a no deductions clause will be ineffective. Thus, it becomes imperative that the lessor determine “where” the actual point of sale will occur before relying on this language. Moreover, a lessee may change its point of sale over the course of a lease. Accordingly, lessors may need to firm up the point of sale language to something more specific such as: “cost free royalty, calculated by the market value at the final point of sale, downstream, after all processing, transporting, gathering, marketing, and other post production operations have occurred.

As to a proceeds lease, lessors, like the lessees, would be at risk relying on the Hyder language. To be fool-proof, a proceeds lease should be just as specific as a market value lease. Therefore, the royalty valuation clause should specifically state that the royalty is “cost free, calculated by the gross proceeds or total amount realized at the final, downstream point of sale, after all processing, transporting, gathering, marketing, and other post production operations have occurred.

CONCLUSION
Whether the drafter is preparing a lease favorable to a lessor or lessee, the traps inherent in formulating a cost-free or burdened royalty are now abundant due to the confusing nature of the case law. As noted, the courts’ analyses logically turn on timing. However, because Hyder arguably steers away from this logic, the effects of proceeds leases are now unclear. Thus, drafters, in order to be safe, should use succinct, specific language in the royalty valuation clause and stop relying on no-deduction addendums until Texas courts hopefully, one day, shore up this issue with a clear, bright-line edict.


[1]           Chesapeake Exploration, L. L. C. v. Hyder, 2016 WL 352231 1. ; 59 Tex. Sup. Ct. J. 290 (Tex. Jan. 29, 2016) opinion substituted for Chesapeake Exploration, L. L. C. v. Hyder, 58 Tex. Sup. Ct. J. 1182 (Tex. 2015).  *Please note, the original opinion was withdrawn and a new opinion substituted in its place on January 29, 2016.  A detailed review of the substituted opinion, however, demonstrates no significant, substantive changes between the original and the new opinion.  Citations in this paper will be made to the Texas Supreme Court’s most recent Hyder opinion.

Filed Under: Publication Tagged With: Celia Flowers, Melanie Reyes

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