Rist v. Toole County , 117 Mont. 426 ( 1945 )

Royalty interests in oil and gas are taxable only on the net proceeds from the production of said oil and gas and are not taxable with and as a part of the land on an advalorem basis.

"Royalty" where used in connection with oil and gas interests has a well defined meaning in Montana. It means a share of the product or profit paid to the owner of the property. Homestake Exploration Corp. v. Schoregge, 81 Mont. 604, 262 P. 388; Hinerman v. Baldwin, 67 Mont. 417, 215 P. 1103; Marias River Syndicate v. Big West Oil Co., 98 Mont. 254, 38 P.2d 399.

It will be observed that, in the form of conveyance used by the original owner in the present instance, the land owner expressly conveyed "all of his right, title, and interest in and to a percentage royalty of all of the oil and of all of the gas produced and saved from" the land owned by him, and royalty interest conveyed is made perpetual by expressly providing that the "royalty" is assigned "under the lease now covering said lands as well as any lease or leases that may be hereafter made covering said premises." The conveyance also contains a covenant warranting title to the royalty interest conveyed (R. 10-13).

The interest transferred was and is a present interest in the oil and gas saved, that is a share of the product from the land and consequently the interest conveyed is a "royalty" within the definition adopted by the Supreme Court of Montana in the cases above cited.

This "royalty" interest in the minerals in the land is real property and the owner has the right to transfer such interest, and the grantee of the "royalty" acquires and is vested with ownership in perpetuity of an interest in fee in land and in real property. Broderick v. Stevenson Consol. Oil Co., 88 Mont. 34,290 P. 244; Krutzfeld v. Stevenson et al., 86 Mont. 463,284 P. 553; Aronow v. Bishop, 107 Mont. 317, 86 P.2d 644; Homestake Exploration Corp. v. Schoregge, 81 Mont. 604, 264 P. 388; Marias River Syndicate v. Big West Oil Co., 98 Mont. 254,38 P.2d 399.

The foregoing authorities demonstrate that this Supreme Court definitely adheres to the principles of divisibility and separate ownership of mineral interests in oil and gas in land and that such interests are real property.

The combined assessment of the mineral interest with and as a part of the assessment of the land without segregating the respective taxable interests of the owners thereof, is wholly void.

In Montana taxes are levied upon persons and not the property owned by the person. The value of the property owned is merely the measure by which the amount of the taxes to be levied is determined. This appellate court in reaffirming this legal theory of taxation in the case of Wheir v. Dye et al., 105 Mont. 347,73 P.2d 209, said:

"This Court has long been committed to the theory that all taxes are levied upon persons and not upon property; that it is the person who is taxed, and that while strictly speaking the property which the person owns is used to determine the amount of tax he shall pay, it is the person who after all pays the tax. The person is liable. In addition to the property being a means of determining what the person shall pay, it is also security for the payment." (Citing Ford Motor Co. v. Linnene, 102 Mont. 325,57 P.2d 803.)

As heretofore discussed (ante pp. 2-5) the law recognizes the separate property ownership of the respective mineral and surface interests owned by different persons. It also insists that each person be taxed upon the basis of the property owned by him, and not by property owned by another.

Where the ownership of the minerals is divided or where there is a division of the mineral and surface interests, each owner is taxable upon the value of his interest only. Homestake Exploration Corp. v. Schoregge, 81 Mont. 604, 264 P. 388; Fulton Oil Co. v. Toole County, 86 Mont. 367, 283 P. 769; Queen City Oil Co. v. Toole County, 86 Mont. 401, 283 P. 771; Northern P. Ry. Co. v. Musselshell County, 54 Mont. 96,169 P. 53. Defendants Toole county and the treasurer thereof appeal from a judgment permanently enjoining them from issuing or taking tax deed to certain lands. The cause was submitted upon an agreed statement of facts reciting that on April 16, 1926, one DeGroat was the owner in fee simple of certain lands in Toole county; that on that date he executed, acknowledged and delivered to one Reisinger a written instrument assigning to the latter "an undivided five and one-half per cent (5 1/2%) royalty of and in all of the oil and gas and other minerals produced and saved" from those lands; that on May 12, 1926, said Reisinger by like instrument assigned to the plaintiff an undivided 1/10 of 1% royalty therein; that the said instruments were recorded in the office of the clerk and recorder of that county on May 7 and May 15, 1926, respectively; that the lands are in the Kevin-Sunburst oil field, in which oil and gas in paying quantities had theretofore been discovered and produced; that the land had a separate surface value for agricultural and grazing purposes; that the county assessor assessed the land to DeGroat for taxation for the years 1927 to 1940, inclusive, "on the value of the whole thereof including the value of the probable oil and gas production therefrom and without in any manner segregating the independent surface value of said lands from the value of the probable oil and gas production therefrom and without segregating the value of the interest of said Walter DeGroat from the value of the interest of plaintiff in said lands"; that the taxes were levied on the basis of such assessments and were not paid for 1927; that on February 2, 1928, the county treasurer sold the lands to Toole County for the said taxes and issued a certificate of sale to the county; "that Toole County, Montana, has heretofore on the 20th day of November, 1940, given plaintiff and other persons interested in said lands, written notice in conformity with the statutes of Montana" of its intention to apply for a tax deed embracing said lands; "that there are approximately forty-five owners of oil and gas royalties in and to aforesaid lands which royalties are of the same character as the royalty interest of plaintiff whose rights will be prejudicially affected by the issuance of the aforesaid tax deed * * *." The transfers of royalty were by written documents entitled "Assignment of Royalty" and transferred fractional "royalty of all of the oil and all of the gas produced and saved" from the land. They recited "and I do hereby assign said royalty under the lease now covering said lands as well as any lease, or leases, that may be hereafter made covering said premises."

The judgment decreed that all assessments and tax levies for the years 1927 to 1940, inclusive, were wholly void, and permanently enjoined the defendants from executing or issuing, and defendant county from demanding or receiving, any purported tax deed based upon sale for collection of tax levies for those years, or any thereof.

Plaintiff's and respondent's contention is that his oil and gas royalty interest constitutes a separate fractional mineral title in fee simple segregated from the rest of the fee title to the land, and that the combined assessment of the mineral interest with that of the remaining interests in the land, without segregating the respective interests of the various owners, was wholly void and will not support tax deed proceedings.

Defendants' contention is that the oil royalty is not a fee-simple interest in the land since it relates only to personal property, namely, to oil and gas after production and severance from the real estate; that it, therefore, like the oil lease, constitutes only a profit a prendre which, although an interest in land, is not a separate fractional title in fee, but is incident to and dependent upon that title and falls with it upon issuance of tax deed; that it can be protected only by due payment of or redemption from the tax levied against the fee-simple title.

The question therefore is whether the royalty assigned to plaintiff constitutes an undivided fractional fee-simple interest in the oil, gas and other minerals in place, segregated from the balance of the fee-simple title and therefore to be taxed separately and not included with DeGroat's fee-simple interest for taxation purposes.

It is well settled that the title to mineral interests in[1] land, including oil and gas interests, may be segregated in whole or in part from the rest of the fee-simple title (Krutzfeld v. Stevenson et al., 86 Mont. 463, 284 P. 553; Broderick v. Stevenson Consolidated Oil Co., 88 Mont. 34,290 P. 244; Hodgkiss v. Northland Petroleum Consolidated, 104 Mont. 328,67 P.2d 811), and that the separate fractional titles should be taxed separately to their several owners. Northern Pacific Ry. Co. v. Mjelde, 48 Mont. 287, 137 P. 386; Anaconda Copper Mining Co. v. Ravalli County, 52 Mont. 422, 158 P. 682; Musselshell County v. Morris Development Co., 92 Mont. 201,11 P.2d 774. The method of taxation of separate mineral interests has been considered by this court on numerous occasions but need not be examined here. The issue presented by this appeal is whether the royalty interest in question constitutes such fee-simple interest in the land as is taxable as real estate separately from the balance of the title.

This court long ago adopted the standard and universal[2] definition of royalty. In Hinerman v. Baldwin, 67 Mont. 417,215 P. 1103, 1108, it said: "The word has a very well understood and definite meaning in mining and oil operations. As thus used, it means a share of the produce or profit paid to the owner of the property. Webster's Dictionary." The expression "a share of the produce or profit paid to the owner of the property" is quite different from a share or interest in the property itself. It recognizes that the originator of the royalty is still the owner of the real property to which it relates, and that the assignee's interest is only in the "produce or profit" therefrom, — namely, in the personal property which the owner is to receive for the granted privilege of producing minerals from his land.

This court repeated the same definition in Homestake Exploration Corporation v. Schoregge, 81 Mont. 604, 264 P. 388,391, and proceeded to say:

"The general rule is that: ``Both petroleum and gas, as long as they remain in the ground, are a part of the realty. They belong to the owner of the land, and are a part of it as long as they are on it or in it, or subject to his control.' Gas Products Co. v. Rankin, 63 Mont. 372, 207 P. 993, 24 A.L.R. 294; 18 R.C.L. p. 1205; Mills-Willingham on Oil and Gas, pp. 20, 21.

"``The owner of the fee has the same title to the oil and gas in place which characterizes the ownership of solid minerals in like circumstances, but by his lease, regardless of the form of the granting clause, he does not intend to convey the oil and gas in place or any interest therein. * * * By a lease of this description the lessee is vested with a present property right in the leased premises, namely, to search for oil and gas under the conditions of the lease and to appropriate them as personal property if found, yielding the stipulated royalty. This is a right to take a profit from the lands of another, and within the common law classification may be regarded as a profit a prendre.' Veasey on Oil and Gas, 18 Mich. Law Review, 773. * * *

"By the provisions of these leases and the assignments the operator or lessee is given merely a right to enter upon the land for the purpose of exploring for oil, and developing and producing the same, if found. The lessee acquires no corporeal interest in the land itself, but rather a privilege a prendre. Until the actual discovery of oil, the interest of the lessee in the land is inchoate. Oil remaining in the ground before recovery is a part of the land, and belongs to the owner of the land; but, when recovered, it becomes personal property. Such personalty is thereupon subject to division in accordance with the terms of the contract of lease."

In that case this court pointed out that the royalty, whether of the kind known as landowner's royalty or that known as overriding royalty, constituted an interest in the privilege of producing minerals, and in the personal property when and as severed and produced from the land, but not an interest in the minerals in place; in other words, it is a privilege a prendre, and not a portion of the fee-simple title. To the same effect is Broderick v. Stevenson Consolidated Oil Co., supra.

Again in Northern Pacific Ry. Co. v. Gas Development Co.,103 Mont. 214, 62 P.2d 204, 206, this court spoke of "the royalty, which only accrues as a result of the production of oil or gas."

Thus the concept of royalty is very different from that of the fee-simple title to minerals in place in the ground, as involved in Krutzfeld v. Stevenson et al.; Broderick v. Stevenson Consolidated Oil Co.; and Hodgkiss v. Northland Petroleum Consolidated, supra. The difference is well summarized as follows in Hickey v. Dirks, 156 Kan. 326, 233 P.2d 107, 109, "As we have had frequent occasion to observe, terms relating to conveyance of oil and gas interests have often been loosely and inaccurately used. (Citing cases.) This is particularly true with reference to the term ``royalty.' A mineral deed is one which involves a severance, from the fee, of a present title to minerals in place. It either effects such severance of title in the first instance or conveys a part of such mineral ownership previously carved from the fee. It is a realty conveyance. (Citing cases.) ``Royalty' is that part of oil and gas payable to the lessor by the lessee out of oil and gas produced. It is sometimes referred to as part of the compensation to the title owner for the privilege of exploring, developing, and producing oil and gas from the tract."

Glassmire's "Oil and Gas Leases and Royalties," 2d Ed., clearly explains the difference as follows:

"A mineral deed is an instrument in the form of a general warranty deed which grants or transfers the minerals in place, or the right to obtain them. It conveys the minerals themselves, which produce the royalty, subject to the lease. To avoid confusion of terms, the distinction must be kept clearly in mind between the thing itself and the proceeds of the thing.

"It was recognized that simple assignments of royalty proper, accruing under a lease, conveyed nothing except proceeds when and as obtained, or purely personal property interests. Something more definite and perpetual was demanded, and the mineral deed, as covering oil and gas, then came into its own and accomplished its primary purpose of separating the fee estate in the minerals from the fee estate in the land, not as an operating contract, but as an instrument by which royalties might be obtained in the same way as the owner of the land might obtain them. A royalty proper is a participation in the proceeds derived under the terms of the lease. A mineral deed is not a ``royalty' but is an evidence of mineral ownership, or the rights thereto, which interest may or may not produce a royalty under an existing or subsequent lease. * * * (Section 23.)

"Mineral deeds are often erroneously called ``royalty deeds,' but that designation is a misnomer for it confuses the royalty proper with that which produces the royalty, or rather it mistakes the proceeds of the thing for the thing itself. * * *

"A conveyance or assignment of royalty for a definite or indefinite term of years does not anywhere constitute a grant of minerals, and no severance from the land is consummated under them. Even in Texas, an ownership state, it has been held that an assignment of rents and royalties accruing under an existing lease amounts merely to a transfer of personal property and is not such a conveyance of land as to bring it within the statute of frauds." (Section 21.)

The subject is similarly discussed in 3 Summers Oil and Gas, Perm. Ed., Chapter 20, in which that authority says, at page 500: "Purchasers of oil and gas rents and royalties have apparently realized partially, if not fully, the precarious nature of the interest procured by a deed granting only rents and royalties under existing and future leases. Consequently many of the royalty deeds now in use purport to grant, not only the rents and royalties under an existing lease, but in addition a proportionate interest in the present or reversionary mineral fee, so that upon expiration of the existing lease the grantor and grantee, or their successors in interest, become owners of the oil and gas and other minerals under the land as tenants in common with legal powers to execute, jointly, a new lease. It would seem to be a simple matter to make this type of conveyance so that there would be no doubt as to the extent and character of the interest or interests conveyed." In a note the author refers to a number of cases in which such deeds of mineral interests are found, including Hochsprung v. Stevenson, 82 Mont. 222,266 P. 406; Krutzfeld v. Stevenson, supra; Broderick v. Stevenson Consolidated Oil Co., supra, and decisions from Arkansas, Kansas, Kentucky, Texas and West Virginia.

It will be noted that Professor Summers refers to the fact,[3, 4] mentioned above in connection with our discussion of the definition of "royalty," that if the conveyance is of a portion of the fee-simple title to minerals in the ground, the grantee becomes a tenant in common with the grantor as to that title and must join in subsequent leases; otherwise his interest will not be included. Therefore the grant of royalty under future leases is inconsistent with an intention to convey part of the mineral title itself.

The authorities emphasize that it is only by virtue of his ownership of the minerals in place that the lessor is entitled to exact a royalty of part of the oil and gas produced, but that it is neither necessary nor usual for him to convey any part of the mineral title in order to transfer the corresponding royalty interest. Thus where only a royalty interest is purported to be transferred there is no justification for an attempt to read into the grant another and greater interest. This is true whether the express recital is of a royalty interest in general, or of a royalty interest under an existing lease, or of a royalty interest under any and all leases thereafter given. In fact, where the instrument, as here, expressly purports to include royalties under future leases, it is logically impossible to infer the conveyance of mineral interests. For, as noted above, it is impossible for the grantor to make leases covering mineral interests theretofore conveyed to others, and futile for him to attempt the assignment of the corresponding royalties. It follows that the express assignment of royalty in future leases utterly negatives an intent to convey title to the assignee so as to make him a tenant in common, with full authority over his own share of the ownership. It is only where no title, but only a royalty interest is transferred, that a reference to royalty under future leases can have any meaning.

The most recent case we have found concerning a transfer of royalty interest under both existing and future leases is Riffel v. Dieter, 159 Kan. 628, 157 P.2d 831, 836, just reported in the advance sheets for May 11, 1945. The court said: "Clearly the primary purpose of the instrument was to convey to Dieter one-half of the royalty rights of the Riffels in any production on the 280 acres. * * * Nowhere in the instrument are there any provisions which could be construed as conveying to Dieter any interest in the minerals in place." Exactly the same is true as to the purpose and effect of the royalty assignment here involved.

Decisions can be found expressing, or seeming to express, various shades of opinion as to the effect of the reservation or assignment of royalties upon the fee-simple title to minerals in and under the land; but the differences or apparent differences have usually resulted from a failure to distinguish between royalties and mineral interests.

A clear instance of this confusion is plaintiff's reliance upon Broderick v. Stevenson Consolidated Oil Co., supra; Krutzfeld v. Stevenson et al., supra; and Marias River Syndicate v. Big West Oil Co., 98 Mont. 254, 38 P.2d 599, 600, as authority for the proposition that the grantee of a royalty interest thereby "acquires and is vested with ownership in perpetuity of an interest in fee of land." But the first two of those cases involved, not royalties, but mineral deeds expressly conveying fractional interest "in and to all the oil, gas and other minerals in and under" the land, and "in all oil, gas and other minerals in and upon said land." In the Marias River Syndicate case the owner conveyed the lands with reservation of a fractional "interest and royalty in and to all oil and gas and other minerals of whatsoever nature, found in or located upon orunder said land or premises above described, or that may be produced therefrom." The final phrase, "or that may be produced therefrom," is the only part of the reservation referring to production or severance of minerals. This court therefore correctly decided that the effect of the reservation could not be narrowed by that phrase, or by the use of the word "royalty." It said in conclusion upon this point: "This reservation or exception in effect legally and successfully severed the 12 1/2 per cent interest in the oil and gas and other mineral in and under the land from the residue of the oil, gas, and mineral and surface rights conveyed to the grantee in the deed in question. Separate interests in the oil and gas were thereby created, and the owners of these respective interests became the owners of the oil and gas as tenants in common."

The court was not there speaking of a royalty interest. It expressly distinguished between a mere royalty interest and a conveyance of an interest in the mineral title, and indicated that a mere royalty assignment, like an oil lease, does not constitute a conveyance of part of the estate in fee, but only an assignment of a right dependent upon the assignor's fee.

We have found no Montana decision to the contrary. Fulton Oil Co. v. Toole County, 86 Mont. 367, 283 P. 769, has no reference to real property; it relates only to personal property, i.e., to oil produced, and to net proceeds taxes thereon.

There are some decisions to the contrary, notably in California, whose courts reject the principle, well settled in Montana, that fee-simple interests can be created in oil and gas in place underground; they therefore recognize no difference between royalty assignments and mineral deeds.

As noted above, plaintiff's sole contention is that the royalty interest is separately taxable because it constitutes "an interest in fee of land." The dissent, however, suggests the further question whether under our statutes real property taxes are limited to fee-simple titles. It is true that section 1996, Revised Codes, provides that, for taxation purposes "The term ``real estate' includes:

"1. The possession of, claim to, ownership of, or right to the possession of land.

"2. All mines, minerals, and quarries in and under the land, subject to the provisions of section 2088 of this code, all timber belonging to individuals or corporations growing or being on the lands of the United States, and all rights and privileges appertaining thereto.

"3. Improvements."

Reference is made to the second part of the definition. However, that is expressly made "subject to the provisions of section 2088 of this code," which provides, in accordance with section 3 of Article XII of the Constitution of Montana, that "all mines and mining claims, both placer and rock in place, containing * * * valuable mineral deposits, after purchase thereof from the United States, shall be taxed at the price paid the United States therefor." The only other provisions are that any separate and independent surface value of such mine or claim shall be taxed at its full value for such other purposes; that machinery and surface improvements having a value separate and independent of mines and mining claims shall be taxed as other personal property, and that the annual net proceeds of all mines and mining claims shall be taxed as other personal property.

Assuming what the record does not show, that this land was[5] purchased from the United States as mines or mining claims, either placer or rock in place, certainly a royalty interest does not constitute a surface value, or machinery, or improvements with a value independent of such mines or mining claims. Therefore if included in the first three items of section 2088 at all, it is merely as an incident to the mine or mining claim, which is to be taxed "at the price paid the United States therefor." It is not included in the fourth item, "annual net proceeds," which are to be taxed "as other personal property"; for it is not such proceeds, but represents only the right to a portion of proceeds which may possibly follow in the future. Thus that subdivision of the definition does not support the dissent.

Apart from the express reference to section 2088, the[6, 7] provision is only one of three subdivisions of the definition. If it contemplates a separate assessment and taxation of the various items mentioned, so do the other two subdivisions. The first subdivision refers to the "right to the possession of land." However, it does not follow that the assessor must attempt the separate assessment of every separate possessory interest or right in land, whatever its character. Tenants, like lien-holders and the owners of other interests less than the fee, understand that their interests are not independent of, but are dependent upon the landowner's title, and usually therefore are not separately assessed and taxed. A month to month lease gives a right to the possession of land, but such tenancy has never been considered as an estate taxable separately from the fee. The same is true as to all ordinary tenancies constituting less than an estate of inheritance, including even an estate for life. With respect to the latter the law is not that it shall be taxed separately from the fee, but that "the owner of a life estate * * * must pay the taxes" (Sec. 6776, Rev. Codes), which means the entire tax upon the land itself. Anderson v. McClenathan,62 Mont. 387, 205 P. 230.

The general rule is stated by textwriters as follows:[8] "Ordinarily, a leasehold interest, although technically a chattel, is not assessable as such against the owner thereof, but is regarded as one of the lesser interests to be included in the single assessment against the owner of the freehold estate in the land. However, * * * under some statutes a leasehold must be valued separately." 61 C.J. 632, sec. 779. "Land or any estate or interest therein is undoubtedly property; but inasmuch as a parcel of land is generally taxed as a unit, the different estates or interests therein are not separately assessed." 51 Am. Jur. 437, sec. 415. The latter rule has been changed in Montana, but only as to separate interests in fee. Northern Pacific Ry. Co. v. Mjelde; Anaconda Copper Mining Co. v. Ravalli County; and Musselshell County v. Morris Development Co., supra.

The only references we have found to the separate taxation of any of the various items included in the three subdivisions of the above definition of "real estate" in section 1996 are the provisions that the improvements (subdiv. 3 of the definition) shall be assessed separately from land (Sec. 2001); and the provision of the classification statute (Sec. 1999) as follows, with regard to Class One (taxable at one hundred per cent of its full value under section 2000): "* * * where the right to enter upon land to explore or prospect or dig for oil, gas, coal, or mineral is reserved in land by any person or corporation, the surface title to which has passed to another, the assessor and the state and county boards of equalization shall determine the value of the right to enter upon said tract of land for the purpose of digging, exploring, or prospecting for gas, coal, oil, or minerals, and the same shall be placed in this classification for the purpose of taxation."

Obviously the royalty right in question here does not come within that provision. There may be other express statutory provisions altering the general rule stated above, but if so they have not been cited. On the contrary, section 1999 classifies "all land, * * * with improvements" in Class Four for taxation upon a basis of thirty per cent of its true value, and, as noted above, section 2001 provides that "land and the improvements thereon must be separately assessed." With the possible exception noted (section 1999, Class One) we find no statute which suggests the separate assessment or taxation of less than the land itself (the fee-simple estate therein). Certainly the use of the word "land" without qualification seems to negative any intention that any of the minor possessory or other rights mentioned in section 1996 shall be assessed and taxed separately from the land itself, except as expressly provided by law. But whatever the rule, it must apply to subdivision one of the definition no less than to subdivision two.

It may be, as suggested, that it is the assessor's duty, under general statutory provisions, separately to assess and tax as real estate all the various types of tenancies and rights therein amounting to less than estates in fee, including royalty interests as distinguished on the one hand from operating rights or interests in fee simple and on the other hand from cash royalties actually paid (taxable under section 2088 ff., as personal property). But as noted above, the general rule is otherwise and has not been shown in this case to have been changed by statute.

A tax deed is not derivative but "creates a new title in the[9, 10] nature of an independent grant from the sovereignty, extinguishing all former titles and liens not expressly exempted from its operation." Sec. 2215, Rev. Codes; State ex rel. City of Great Falls v. Jeffries, 83 Mont. 111, 270 P. 638, 640; Richardson v. Lloyd, 90 Mont. 127, 300 P. 254. It therefore strikes down, not only the former owner's fee title, but all encumbrances and incidents thereof, including oil leases and assignments of royalty interests. Like mortgages and other interests dependent upon the fee, leases and royalty interests must be accepted subject to that legal limitation and to the circumstance that it may become necessary to see that the taxes upon the fee are paid in order to preserve rights dependent thereon.

It follows that the remedy of plaintiffs and others similarly situated is not to enjoin the taking of a tax deed, but to prevent it by a redemption of the land from the tax lien. The decree is therefore reversed and the cause remanded with directions to dismiss the complaint.

Associate Justices Morris, Adair, and Cheadle, concur.