Bonanzas That End Badly: Cautionary tales from Marcellus Shale windfalls

Sudden wealth can bring unexpected legal consequences

Pittsburgh Post-Gazette
30 May 2011
By Tim Grant,

Stuart "Buzz" Hutchison III, an estate and trusts lawyer at K&L Gates, has advised families who have sold or are considering selling Marcellus Shale drilling rights.

Farmers who used to barely get by are now collecting sizable royalties from natural gas producers that have purchased drilling rights on their land. But in some cases, the sudden wealth has created a whole new set of challenges and unintended legal consequences.

"None of my clients had even heard of Marcellus Shale until a few years ago. It simply wasn't on the radar screen," said Stuart "Buzz" Hutchison III, an estates and trusts lawyer at K&L Gates who advises several families who either have sold, or are considering selling, drilling rights.

With millions of dollars potentially at stake, family disputes over Marcellus Shale drilling rights can get downright ugly. While working with many of these Western Pennsylvania landowners to create estate plans, Mr. Hutchison said, he has seen enough strained family relations to know the windfall riches can be a blessing and a curse.

"We don't know the ramifications of this kind of income being paid to people who may not have the financial sophistication to know how to handle the money, because it's so new," he said.

"Like a lottery winner suddenly showered with wealth, history has shown it often ends badly."

Complicating matters is that many of the farms in this area are inherited over decades or even centuries, with several heirs owning fractional shares of the land. Lease agreements often involve getting several family members to sign off.

In one case he is familiar with, Mr. Hutchison said a family member who lives outside the state owns a 1/32nd (about 3 percent) share of a 300-acre farm south of Pittsburgh and is objecting to Marcellus Shale drilling on the property for environmental reasons, although everyone else in the family wants to move forward.

"What is this family going to do?" Mr. Hutchison asked. "While she has objections to the Marcellus Shale drilling, she has suggested she might be willing to sell her interest in the farm to the other owners. But the figure she has suggested for the sale price is considerably more than the other members feel her interest is worth.

"I find it somewhat amusing that while she is opposed to the drilling, she is not opposed to the money," Mr. Hutchison said.

"As long as she gets cashed out, she doesn't care what happens to the farm."

The lease agreements gas producers are signing with landowners have two components. The lump-sum payment is a one-time payment, now ranging from $1,800 to $2,500 an acre. Then landowners receive royalty payments on the natural gas that is drilled at the site; royalties range from 12.5 percent to 15 percent or more of the profits.

A classic example of a family estate plan being thrown into havoc because of Marcellus Shale involves a family business that owns thousands of acres that have been divided into shares of stock owned by family members, who range in age from the 90s to the mid-20s.

In 1995, Mr. Hutchison said, he recommended to the owners that, for estate tax planning purposes, they should create a family partnership with their children. They did that, putting some of their company shares into the family partnership, and over a period of six to eight years gifted those shares to their children.

The income from those shares over the last five years has been about $80,000 a year, split five ways.

"Most of our clients who are considering gifts to their children or grandchildren do not want those gifts to be a disincentive for the younger generation to work and become productive citizens," Mr. Hutchison said.

The $80,000 a year income was not enough to concern the parents. However, Mr. Hutchison said a major driller has recently made an offer to the family that will amount to an after-tax windfall of $12 million to the children.

"This is the law of unintended consequences," Mr. Hutchison said. "The parents are worried.

"It was absolutely outstanding estate planning. But because of the unknown factor of the Marcellus money, do the children now have too much money readily available, and will this windfall affect their lives in a negative manner?

"The jury is still out on whether this family and others who are receiving these large payouts are going to be able to address these concerns."

Tim Grant: tgrant@post-gazette.com or 412-263-1591.