New Estate Tax Laws Will Benefit Family Farm Succession Planning

Someone recently asked me if I believe in miracles. I do now! On December 17, 2010, after more than 6 years of inaction, bickering, hemming and hawing, Congress, suddenly and unexpectedly, miraculously acted to create what I believe is likely to become permanent change to the Federal Estate and Gift Tax Laws.

Acting to "extend" the so-called "Bush Tax cuts," for two years, the Congress actually enacted some wholly new provisions in the Tax Code relating to Estate and Gift taxes. While most of the "extension" will be, in my view, a "wait and see" proposition during and after the next 2 years, the Estate and Gift provisions seem to me to have set a "new bar" for certain provisions, from which it will be difficult, if not impossible, for Congress to turn back. In this season of "joy," I say Hallelujah!

I have been saying to clients for a number of years that aside from philosophical views on taxes and tax policy, what we really need Congress to do is just give us some law that is consistent. Planning requires consistency and some semblance of permanency so we can rely on our planning to work. So the new provisions come as a welcome surprise and relief. Many of us have been calling for some "common sense" provisions like a reasonable figure for the size of a taxable estate, and indexing for inflation. They did that. Wow! I write another blog (linked in the header above), the Michigan Estate Planning Blog, and back in February, I wrote a rather scathing (for me, anyway) scolding to Congress for its inaction and gridlock in the name of partisan politics. I recently posted a new Blog, jokingly suggesting that Congress read my Blog. They seriously seem to have addressed all of the items on my "wish list." The highlights of the new law are:

• The taxable estate figure (formerly known as "unified credit," now known as "exemption equivalent) has been set at $5 million
  
• The exemption equivalent was "decoupled" under the "Bush Tax cuts," so while the estate tax amount was increased and eventually (temporarily) eliminated, the Gift Tax amount was inexplicably frozen at $1 million. The new law reunifies this so that both figures are now set at $5 million.
  
• There is a new concept (referred to a "portability") which now allows a married couple to "share" their unused unified credit, I think effectively eliminating the need to create and maintain complex dual trust plans in many, if not most circumstances.
  

  
  

These developments are bound to help us in planning for farm families with multiple generations involved in the business. One of the big issues with agribusinesses is that they are generally capital intensive and cash poor. This means that while Uncle Sam is looking for payment of Federal Estate taxes on a multi-million dollar estate, the heir's ability to pay is hampered by the fact that the assets are capital which must be used in the operation. Giving us a $10 million threshold to work with will make family succession planning for family farms much more tenable.

At the same time, the portability feature will make lifetime planning simpler and therefore more effective, and will give added flexibility to make after-death adjustments to plans which may have been difficult or impossible under the old rules.

The nature of successful family farm businesses is that assets tend to continue to grow in value. Raising the Federal Gift tax threshold to the same $5 million mark as the Estate tax threshold makes lifetime gift planning much more effective, allowing substantial gift transfers of farm assets to the next generation before they appreciate significantly in value.

These new provisions were made retroactively effective as of January 1, 2010. In an uncharacteristic move, Congress not only made these fundamental decisions, but they anticipated some of the problems that might be caused by their inaction during the first 11 months of 2010. They appear to appreciate the potential unfairness of imposing a retroactive law people who had the misfortune to die before its effective date. For estates of individuals dying between January 1, 2010 and December 17, 2010, the administrators are given the right to elect between the prior 2010 law and the new law. And, in order to give these persons the time to analyze the effect of their election, the deadlines for filing Estate and Gift Tax returns and for making "qualified disclaimers" has been extended until 9 months after the December 17 date.

The details of the new provisions will undoubtedly come to light during the next several months and it will make for interesting times. Farm clients who have not done the Estate Planning they should do will now have an opportunity under the new laws to do so in a more palatable and simple manner. For those who have done their planning, this will be a great opportunity to review, upgrade and perhaps simplify their existing programs, while taking advantage of some of the new opportunities under the new rules.

We will likely be reporting on developments in the new law frequently over the next months. Stay tuned.

Read more...

Should You Sign that “Standard” Oil & Gas Lease?

Over the past 25 years, I have reviewed many Oil and Gas Leases brought to me by landowner clients. Usually they have been "printed" form documents and have mostly been similar if not identical, almost as if every developer was using the "same" form. The all reference, royalties, delay payments, bonus payments, and often "paid up" provisions. This phenomenon might lead one to conclude that there is a "standard" Oil Industry or Michigan Oil and Gas Lease Form.

The reality is that there is not, and has never been, a "standard" form. Oil and Gas activities are regulated by the State of Michigan, Department of Environmental Quality (DEQ) under Michigan's Natural Resources and Environmental Protection Act (MCL 324.61001 – 62103). While there are regulations and while the State leases lands for Oil and Gas (and has their own approve lease language), other than requiring certain provisions, the state has not mandated or approved any standard lease for.

Perhaps unfortunately, developers are left to their own creativity with written lease documents. You cannot rely on the fact that their form is printed and looks "standard." Many developers still use the anachronistic printed form lease language mentioned above. However, a number of them have become more creative, and some of the leases I have recently reviewed have made a broad leap from being an Oil and Gas lease to a much more general Resources Lease (even though generally still titled "Oil and Gas" Lease). It is also important to understand the most of the time, the person you negotiate the lease with is an independent agent (known in the industry as a "Landman"), either working for the developer, or independently and then selling or assigning the lease to an oil producer later. Consequently, you might ultimately be dealing with a completely different party than the party you originally negotiated the lease with. To avoid problems with oral communication and later misunderstanding, it is crucial that the written document be clear.

How Oil and Gas Leases Work

Traditionally, Oil and Gas Leases have two phases (referred to as "terms"), a "primary term," and a "secondary term." The primary term is usually a term of years (e.g., 5 years), and most often, involves the developer doing "exploration and testing" to determine if there is oil or gas in appropriate quantity on the premises. The "rent" for the primary term usually consists of a flat dollar-per-acre amount, and can be paid over the term, or can be paid all at once at the beginning of the lease term (the latter is referred to as "paid up" and is what I most commonly see in Michigan). This payment during the primary term of the lease is usually referred to in the lease documents as "delay rental payments," but is often colloquially referred to in the industry as the "bonus" or bonus amount.

The secondary term normally begins when actual production activity commences and payment is generally in the form of a percentage royalty on product that is removed. The Secondary term generally lasts as long as there is active production (and could continue for many years).

In the past, bonus amounts have been as low as a $10 flat fee for the entire parcel to $50 per acre. The customary royalty has been 1/8 of production, less the costs of the developer to remove and refine the oil or gas into usable form. And, in the past, there was usually little room to negotiate in most instances and these amounts were generally accepted.

The "New" Oil and Gas Lease

There has been remarkable change in the industry in recent years. The hugely increased worldwide demand for oil and gas, coupled with new measuring, explorations and drilling technologies, has created an upsurge in interest in farmland and other open land for oil exploration and production. In the past year, I have seen "bonus" amounts as high as $5,000 per acre (and have heard about even higher amounts), and well-informed land owners are negotiating the royalty. I have seen royalties of 1/6, or expressed as a straight percentage (e.g., 15%), without any reduction for the post-production costs mentioned in the previous paragraph! There is significant competition for lands which might either have oil or gas, or might become part of a "unitized" contiguous parcel which is or may be producing actively. Indeed, the motivation for many of the developers is to "tie up" the land so it cannot be leased by competitors or competing interests.

The key thought here, is that the landowner is today more than ever in a position to negotiate the lease and even to dictate terms. Landowners – particularly farmers – want to be able to protect their primary use of the land whether for cultivation, grazing, rental, or recreation. At the same time, if the oil and gas producer is going to make a tidy profit, the landowner certainly should share in that profit!

What You Should Look For in a Landowner-Friendly Oil and Gas Lease

When negotiating an Oil and Gas Lease, the landowner needs to keep in mind his or her interests. Of course, the primary consideration is continued, uninterrupted cultivation or other use of the land. In most cases, this means surface uses. Most developer-prepared leases do not thoroughly address these important landowner concerns. Nor do they, in my view, usually clearly define—and limit, where appropriate—the specific commodities being leased (and sold off the land). A Landowner-friendly Oil and Gas Lease should include, at a minimum, provisions that:

Clearly and precisely define what the minerals (oil, gas, and hydrocarbon related substances) that are being extracted. I recently reviewed a Lease that went well beyond this limited definition to include "other minerals" found and extracted. The problem was the "other minerals were not well defined. We took the position with the developer that if they found other minerals and wanted to extract them, we would negotiate at that time for additional lease payments or royalties, based on the quantity and value of minerals found (if we even wanted them extracted at all). Another issue that arises in nearly all Oil and Gas Leases is whether water can be extracted and used and what kind of water (e.g., fresh, brine, etc.) and in what quantities. It is also possible that the developer will inject brine into the subsurface, and the Landowner needs to consider their views about this activity. All these points should be specifically addressed in the written document.

Clearly and precisely define the activities permitted on the premises. Will the lease include the right to disturb the surface in any way? Will pipelines, power transmission lines, roads, pumping stations, tanks, or buildings be permitted? If so, it is important that the lease agreement reserve significant control over these things to the Landowner. These facilities must be constructed in a manner which is least likely to interfere with current or even intended future use of the land. Structures should be placed, to the extent feasible, at corners of parcels, near existing roads, and out of the way of the other potential uses. It is important that any underground facility be buried at "plow depth" (we prefer a specified depth – e.g., "not less than 48 inches" or similar language), and that above-ground facilities be thoughtfully placed (for example, it is imperative that above-ground structures be placed where they will not interfere with pivot-based irrigation systems). It is equally important that when any facility, road, or structure is place on the surface, that the landowner be additionally compensated (over and above the bonus and royalty) for the loss of that acreage from production. We recommend a Lease Provision that requires the developer to provide a site-plan for the Landowner's prior approval before any construction begins.

Clearly define those uses that the Landowner is reserving (which should be everything except the mineral rights being conveyed in the lease agreement). Lessees commonly want exclusive rights to certain physical attributes of the property so that they can exclude other uses which they think might interfere with their own use. However, the Landowner needs to be cognizant of the other opportunities available including wind leasing rights and telecommunication towers (and possibly solar rights in the future), as well as other mineral, gravel, sand, timber, etc., resources which might be sold from the property. The lease agreement should specifically reserve the right to the Landowner to lease and/or sell those items, so there is no misunderstanding in the future. Site plans and placement should also have in mind the possibility of wind and communications towers in the future.

For livestock farmers, it is important that the Oil and Gas Lease expressly provide for fencing and gating around surface facilities and structures, and that it provide clearly who is responsible for the fencing and gating.

Surface interference and Damage is clearly one of the primary issues to be negotiated and resolved. This includes siting issues as mentioned above, as well as the actual disturbance of the surface. If continued agricultural use is intended, a provision for separating and setting aside the topsoil should be part of the agreement. When laying underground pipeline or power conduits, the "double-ditching" method should be specified (requiring the producer to place topsoil on one side and subsoil on the other when trenching, and replacing subsoil first and then topsoil). Of course, modern trenching and equipment may obviate this need. The lease should also clearly provide for the producer to restore the surface to its original condition and at the end of the lease, to remove all surface equipment. The State of Michigan also has specific well closing and capping requirements and the lease should clearly provide for the Lessee's responsibility to comply with all state requirements.

Industry" Provisions

There are certain provisions that are generally found (or should be addressed) in virtually every Oil and Gas Lease. They should be reviewed and understood. Negotiation of these provisions will be circumstances driven. The following list is illustrative, but by no means complete :

• Pooling or consolidation refers to the producer combining your leased lands with (normally contiguous) land owned by other landowners that they have under lease. Michigan (as do most other states) has minimum acreage requirements for a single operation and for drill/pump spacing and has the statutory authority to require or order pooling in some circumstances. Most agreements also address voluntary pooling in the sense the producer may choose to pool lands over and above any state regulatory requirements. It is advisable for the Landowner to require in the lease that such "voluntary" pooling is subject to Landowner approval, rather than wholly at the producer's discretion, except to the extent that it must be done to comply with state requirements. Pooling can be a positive thing, as it may allow production and royalty payments to commence if there is production on some of the other pooled lands, and can also mean that your land could be under lease and never have any surface activity. However, the Landowner should retain some control over the pooling to insure limits on the numbers of acreage pooled, and the ability to sever land which has not been made part of the pool into a separate lease.
  
• Warranty clauses, requiring the landowner to warrant and defend title to the land and/or minerals are consistently found in the printed lease forms. They should be deleted. As a practical matter, the landmen or developer will do their own title searching and due diligence prior to executing leases.
  
• A Shut-in provision, allows a producing well to be stopped or shut down temporarily, usually for "reasons beyond the control of the producer." These provisions should be carefully reviewed and understood. They should provide for some kind of payment during the shut-in period, possibly accelerating over time, and for a limit on how long a well may be shut-in.
  
• "Mother Hubbard" Clauses provide that the lease covers any contiguous land owned by the landowner. This provision should be eliminated or tightly modified. They are commonly found in the "fine print."
• 
  

Can I Get More Money Than Is Being Offered?

Clearly, the bottom line here is whether the lease payments justify tying the property up. So, how much can you expect to be paid? The obvious (and lawyerly) answer is: it depends. There are certain formations that have been determined to have significant production or capability. If your land is in one of those formations, you can expect not only command higher payments, but to have greater negotiating leverage. If your land is in more "marginal" areas, you can expect lower payments and less willingness on the part of the lessee to negotiate the terms of its form lease. In other words, the proverbial statement, "your mileage may vary" applies here. There are, however, some points to keep in mind when considering entering an Oil and Gas Lease.

As a general rule, the longer the primary term of the lease, the higher the "delay payment" should be. The landowner should try to keep the primary term as short as possible. Any options to renew should come with new delay payment obligations, possibly accelerating for each new renewal option. The primary term will be extended to the (possibly unlimited) secondary term if active production is established. Obviously the definition of "active production" is very important.

Both delay payments and royalty payment provisions, particularly in a "hot" area, should be carefully considered. What is the "going rate" being paid for similar tracts? In addition to word-of-mouth and information from the potential lessee, there are resources, such as the Michigan Oil And Gas Association (remember that they represent the producer), the Michigan Department of Environmental Quality (DEQ), The National Association Of Royalty Owners (NARO), which represents landowners, which can provide information and links to other sources of information.

Calculation of royalty payments is an important consideration. Stating the royalty in terms of a fraction or percentage is only part of the equation. How that payment is calculated is equally important. The percentage can be set in terms of the "market price" at the well head, or in terms of the actual price received for the product. It is also possible for the Landowner to receive payment "in-kind." Normally, the Landowner is not equipped to market crude oil, so this is generally more common for natural gas and usually limited to quantities the Landowner would use personally.

Perhaps more important to the calculation is at what stage of production the royalty payment is applied. Traditionally, the producer would offer a 1/8 royalty, minus certain post production costs. Those costs can be substantial and as noted earlier, include items which are really not true "costs." More importantly, if the producer is getting the majority of the payment for the end product, it would seem more appropriate for them to bear the post-production costs. These provisions should be carefully reviewed and the Landowner should firmly negotiate for a "gross" payment. In the process, there may be some costs which will be agreed upon; usually they are taxes which it does seem appropriate for the Landowner to share.

In the context of a (albeit rather long) Blog post, it is impossible to cover all the concerns and probabilities. It should not come as any surprise to the reader that I strongly recommend that any offered Oil and Gas Lease agreement be reviewed by counsel who is qualified to review and counsel on these issues.

Read more...

Should You Sign That Wind Lease?

If you own land, especially farmland, in the “Thumb” region or in Southeastern Michigan, you have likely been approached (or likely will be approached) by developers for a Wind Energy Lease. For most landowners, this is a very new idea, and it may seem very lucrative to lease a portion of your land for wind exploration and the possible erection of wind turbines on a relatively small part of your land.

Like any “deal” being offered by a complete stranger, beware!

Before signing one of these lease agreements, you should do some exploration of your own, about the developer and the terms of the agreement being proposed.

Wind Energy Background

The current national political “regime” has suggested that “renewable energy” is a priority. In light of these priorities, in 2008, The legislature in Michigan created the “Clean, Renewable, And Efficient Energy Act.” Among other things, the Act requires large electric providers to maintain a substantial portion of their total energy portfolio from so-called renewable energy generating sources. For the most part, the companies have identified Wind Energy as the major method of fulfilling this requirement.

The act also provides, that they may only own up to 50% of these producing resources, creating a market opportunity for developers of “Wind Energy Farms” who will sell them the remaining 50% of the energy requirement. This has created a demand for land from the energy companies themselves, private developers of Wind Energy Farms, and owners of “transmission lines.”

The cost of installing and maintaining a wind turbine is substantial (in the hundreds of thousands of dollars for each turbine) and in order to create enough megawatts for viable sale to a company, the Wind Farms must have many turbines. There are “spacing” requirements for the turbines, dictated by both wind statistics and governmental zoning regulations. Because of these considerations, the land mass necessary to ensure a viable operation is significant. There is also an incentive for developers to “tie up” land partly because they do not have enough statistics to know the exact mapping of the turbine placement, and partly simply to keep competitors from acquiring the lands.

Zoning Issues

At this time a number of local townships do not have comprehensive zoning regulations for wind turbines and wind farms and many are scrambling to try to get them in place. As you are perhaps aware, these turbines and farms have also generated some controversy, which of course, affects the process of creating a zoning ordinance, both politically and procedurally. In April of 2008, the Michigan Department of Labor and Economic Growth released some sample language for wind zoning. However, as they emphasize, the jurisdiction for zoning remains with the local villages, townships, cities, etc. Thus, zoning is likely to vary from municipality to municipality. When negotiating a Wind Lease, it would be a good idea to become familiar with your municipality’s zoning ordinance, if one exists.

Wind Farm Developers

Developers are consistently persistent about getting landowners “signed up.”

Land owners often feel pressured to sign, thinking it may be their only opportunity. However, there are numerous developers seeking land, and Lease Agreements vary greatly, in content and quality. A Wind Energy Lease is a very long term proposition (20-40 years), and you will be dealing with the developer for a long time.

You should learn something about the company you will be doing business with. Most reputable developers will have public information available (in all probability on the internet). It is also likely that they will be members of one or more associations devoted to promoting renewable energy and creating quality standards for the creation, operation and maintenance of renewable energy facilities. The American Wind Energy Association is one of the major associations, and I usually check to see if the developer is a member. Being a member or not does not make them “good” or “bad.” But it is an indicator of their sophistication and knowledge. Another membership organization is the American Council On Renewable Energy (ACORE).

Wind Energy Lease

It is also important that you take enough time in your review of the "deal" they are offering you to make sure you are comfortable with the terms of the Agreement and its long term consequence to your own use and enjoyment of the land. You need to consider what rights you are giving up when you sign a lease.

Wind Farm Projects normally have 3 phases: Exploration, Construction, and Operation. The proposed Lease Agreement does indeed describe 3 phases. These leases are essentially "option" agreements and do not guaranty that wind energy turbine(s) will actually be placed on your land. In light of that, the payment for exploration is lower. But the payment should compensate you for the interruption or loss of use.

Payment

There are no "set" prices, but recent Michigan State University study suggests the payment per acre for exploration is generally in the $5 - 10 per acre range. You should consider just how long you want to "tie up" the land for exploration purposes, particularly in light of the relatively low payments being received. Consider a short time period for exploration (1 - 3 years) with options to renew, but leaving the payments negotiable on renewal. This gives you the ability to rotate the land back into some other more productive use, or to seek other developers of wind energy.

Payments for the construction and operations phases vary greatly. Construction often is compensated by a flat amount for each tower/footing placed on your land. Again, it should represent some measure of the loss of the land (which will now be more permanent). Payment for operation can be paid by a flat fee or by a percentage of the actual production of energy. You must take care to be certain that, whichever method, you are being compensation in relationship the production and payment being received by the developer.

It is important to understand how the developer will be paid

As a general rule, these wind farms do not stand on their own, economically. The reason they are being sought is that there is a rather complex series of tax credits and other “green tag” credits which are paid to developers. Often, they are able to enter into a Power Purchase Agreement with Electric Providers which grants them a guaranteed payment rate. Knowledge of how the developer will be paid will assist in negotiating fair terms for the land owner. The Lease should contain "audit" rights for you. You should be provided with access to the power agreement between the power company and the developer, and proof of the payments the developer receives so that you can "audit" the payments made to you based on the lease formula. You should also have access to the power production information on a regular basis (the metering records, etc., showing the actual power produced by each turbine subject to the lease).

Rights Given and Retained

Developers seek exclusive control over large tracts of land. In most cases, the landowner doesn’t really want to give up the degree of control sought by the developer. Careful negotiation means including exactly what uses you want to retain as part of the written lease agreement. This may include the ability to farm the land, hunt or conduct other recreational activity, build or develop structures, whether commercial or residential, and ability to enter into other leases, such as oil, gas and other minerals, telecommunication towers, etc.

Even during the exploration phase, the developer will seek the right to construct roads, erect towers, etc., and even sometimes erect buildings and structures. The scope of that activity and how it interferes with your use and cultivation of the land must be considered during all phases of the Lease. An important consideration for farmers is ensuring that all underground cabling is set below minimum, plow depth.

An Exit Strategy

A Wind Farm will likely be a project in the millions of dollars for the developer. They will probably have to obtain financing and may pledge their interest as security for the financing. It is important to understand your rights in this process. What happens if they default on their obligations to creditors, or on their obligation to complete the process and to pay you? The lease should contain a statement that the developer covenants to keep the land free from mechanics or other liens of any kind and will promptly take all proper steps to remove any such lien that arises from their activities.

A well written lease should also contain provisions which cover what will happen at the end of the lease. There should be provisions for “decommissioning” or removal of all towers and equipment and leaving the land as they found it, in a condition which allows other uses contemplated by you. There should be a fund or a bond posted for ensuring that this gets done.

Summary

As you can see, this is not a simple process involving standard documents and activities. It is not possible to enumerate all the considerations which must be addressed in this process. It is important to remember that we are talking about a 20-40 year “relationship” with the developer. It is well worth the landowner’s while to engage some assistance in negotiating this kind of arrangement.

Read more...

LEGAL REPRESENTATION FOR THE FARM INDUSTRY

This Blog is sort of an ongoing “page” linked from my MICHIGAN ESTATE PLANNING and MICHIGAN BUSINESS LAW Blogs. You most likely arrived here by clicking on a link in one of these pages. If you got here on your own, welcome, and please check the links on the linkbar at the top of this blog to my other Blogs on ESTATE PLANNING, BUSINESS LAW, and ASSET PROTECTION. If you are a professional advisor (accountants, financial planners, bankers, insurance professionals and consultants) you may want to check my ISSUES FOR ADVISORS Blog which can be found from the ESTATE PLANNING or BUSINESS LAW BLOG. It is an archive of my “Issues For Advisors” quarterly Newsletter. I you wish to be put on my electronic mailing list for the newsletter, please shoot me an e-mail and I’ll add you.

I have had the very good fortune of working with many agricultural producers over my 25 plus years of practice, including farmers, large and small, family and corporate, including cash crop, dairy, poultry, beef, hog, timber and fruit farmers. I have also represented co-ops, farm implement dealerships, elevators, and crop insurance, seed and feed sales persons.

A substantial part of my practice as been agriculture related Estate Planning, Business Setup and representation, and Succession Planning for these clients. This has given me the opportunity to learn about and apply many of the state an federal laws related to agriculture.

These laws include, among others, Land Use laws such as Michigan’s Farmland Development and Open Space Preservation law (P.A. 116); Michigan’s “Land Division Act,” Michigan Law capping valuation increases under the Agricultural Use Exemption, The Michigan Right to Farm Act, Michigan’s Generally Accepted Agricultural Management Practices (“GAAMPS”), and others. I have also worked with federal and state law as it relates to farm businesses in the area of Federal set aside and entitlement programs, under USDA programs.

My general business focus has allowed me to understand the interaction between general business entities and how they are peculiarly related to farming operations including land ownership, and other issues, using corporations, partnerships, limited liabilities companies, cooperatives and occasionally other entities.

My focus on Estate Planning has helped me work with farm families who have special problems and concerns with “Passing Down The Farm” to children, including an understanding of the Federal Estate and Gift Tax, capital gains issues, and personal issues on how to “fairly” transfer assets to the next generation.

This page will be supplemented, from time to time with articles and commentary germane to farms and farming.

Read more...