1. Frank Z. Ruttenberg Bracewell & Giuliani LLP Frank.ruttenberg@bgllp.com 210 299-3467 Thank you for your participation in the Texas Real Estate Land Institute Outlook Conference, and for attending my presentation on Groundwater Marketing. I hope you found my presentation informative and useful. For your convenience, I have attached a copy of my power point presentation. If you should have any questions about my presentation or about water law issues, please do not hesitate to contact me. Drafting Groundwater Transfer Agreements

2. Frank Z. Ruttenberg Bracewell & Giuliani LLP 106 S. St. Mary’s Suite 800 San Antonio, Texas 78205 Texas Realtors Land Institute April 2008

3. Drafting Groundwater Transfer Agreements Overview  History of Texas Water Law – Groundwater vs. Surface Water  Surface Water – Owned by State adjudicated and use by permit  Groundwater – Owned by Landowner  Early Legal/Regulatory Scheme – Groundwater Law developed when there was generally sufficient supply of groundwater Rule of Capture – law of biggest pump - A rule that addressed lack of liability for over pumping

4. Drafting Groundwater Transfer Agreements

5. Drafting Groundwater Transfer Agreements

6. Recent Trends – Regulation of Groundwater  Increasing demand = Increased pressure on legal system to sort out rights to this resource = Increased Legal involvement  Under authority granted by the Texas Constitution, the State retained the authority to regulate the conservation of our groundwater resources.

7. Drafting Groundwater Transfer Agreements Groundwater Regulation  Major Water Bills over the last four legislative sessions SB-1, SB-2 and SB-3  As a part of this regulatory scheme there are approximately 90 groundwater districts and 16 groundwater Management Areas now in existence in the State of Texas.

9. Drafting Groundwater Transfer Agreements Result : Cities, industry and property owners are scrambling to firm up water rights – including groundwater Water Rights – which use to be a passing thought to property owners are now – in certain circumstances - a very valuable property right People are searching for the right way to obtain value from these groundwater rights

10. FirstWhat are we trying to transfer? Next - What issues typically arise between a buyer and seller or lessors and lessees of these rights? Last - How might we address these issues in transfer documents? Drafting Groundwater Transfer Agreements Purpose of Outline – To Address

11. Drafting Groundwater Transfer Agreements Transfers of Groundwater Beginning Questions -What is the nature and character of these Groundwater Rights we are attempting to transfer ? Real Property? Personal Property? Does it matter?

12. Drafting Groundwater Transfer Agreements Transfers of Groundwater Case Law : G roundwater is a part of the surface estate of the land (not the mineral estate); The owner of land has the exclusive property rights to the groundwater to be used at their will; and The rights to this groundwater include all rights that they might have for any other species of property.

13. Drafting Groundwater Transfer Agreements BUT Regulation Relating to Groundwater Transfers SB-1, SB-2 AND SB-3 – authorized groundwater districts to:  Regulate the production of groundwater  Regulate transfers of groundwater within a district; an  Regulate transfers of groundwater out of the groundwater district.

14. ISSUES RELATING TO THE PURCHASE SALE OR LEASGIN OF GROUNDWATER Drafting Groundwater Transfer Agreements

15. Purchase and Sale of Groundwater How do we purchase and sell groundwater? Most Common Forms: Buy the land and get the groundwater as a part of the bundle of sticks (not covered in this outline) Purchase of groundwater in fee simple Transfer of groundwater for a period of time  Fee simple determinable  Lease  License  Water supply agreements

16. Drafting Groundwater Transfer Agreements Purchase and Sale of Groundwater Legal Description:  What groundwater is being conveyed? – geological description.  Exclusive or non-exclusive right to develop and use groundwater.  If less than all is conveyed - determine the priority for use (withdrawal limitations) and access (spacing limitations). Physical Limitations Regulatory Limitations

17. Drafting Groundwater Transfer Agreements Access to Groundwater from Surface Estate Now that you have the Groundwater ? What else do you need and why???

18. Drafting Groundwater Transfer Agreements Purchase and Sale of Groundwater Legal Description:  What does a water right give you –  What does a water right NOT give you  O&G Distinction  Naked Water Right  DON’T BUY A NAKED WATER RIGHT!!

19. Drafting Groundwater Transfer Agreements Access to Groundwater from Surface Estate What else does the Purchaser of Groundwater need? The right to use the surface estate for the exploration and development of the groundwater estate on an exclusive or non- exclusive basis; The right to place infrastructure on the surface estate (through a fee interest, lease or easement); and The right of ingress and egress to construct, operate and repair a water collection system.  Implied easement of necessity?

20. Drafting Groundwater Transfer Agreements Purchase and Sale of Groundwater Legal Description:  DON’T BUY A NAKED WATER RIGHT!!  In City of Del Rio vs. Clayton Sam Colt Hamilton Trust– Del Rio argued that a severance without access was void due to the fact that it violated the Texas Constitution Art 1 Sec 26 – rule against perpetuities  Implied easement of necessity?

21. Drafting Groundwater Transfer Agreements Access to Groundwater from Surface Estate Development Responsibility – determine who will develop and deliver the groundwater? Withdrawal Collection Storage Treatment Delivery Capital investment Operating responsibility Impact on Pricing

22. Drafting Groundwater Transfer Agreements Access to Groundwater from Surface Estate Development Responsibility – Capital investment Exploration Cost Infrastructure cost Right of Way Cost Marketing Cost Political Cost

23. Drafting Groundwater Transfer Agreements Access to Groundwater from Surface Estate Operating responsibility Maintenance Repair Liability

24. Drafting Groundwater Transfer Agreements Access to Groundwater from Surface Estate Development Responsibility – Impact on Pricing What are you selling? Water in place or water delivered? Alteration of price after a return on infrastructure?

25. Drafting Groundwater Transfer Agreements Access to Groundwater from Surface Estate Operating covenants or behavioral covenants relating to the Landowner’s use of the surface estate; Groundwater Owner wants :  Flexibility as to placement of facilities at beginning and in future;  Access for construction maintenance and operations;  Restricted use by landowner that will not interfere with withdrawal of groundwater;  Limitations on surface penetrations (Oil and Gas);  Limits on environmentally harmful use - sanitary control easements;

26. Drafting Groundwater Transfer Agreements Access to Groundwater from Surface Estate Operating covenants or behavioral covenants relating to the Groundwater owner’s use of the surface estate; Landowner wants –  Restricted use by groundwater owner  Construction standards  Limits on location of facilities - low intrusion factor  High maintenance responsibility  Preservation of development rights for other uses, and  Duty of mitigation.

27. Drafting Groundwater Transfer Agreements Purchase and Sale of Groundwater Mitigation: Rework wells Deliver groundwater to site Provide access to delivery system $$$$ cost to mitigate

28. Drafting Groundwater Transfer Agreements Purchase and Sale or Lease of Groundwater Consideration: Lump sum Payment based upon the quantity of water withdrawn.  Address any “growth rate escalator” on deferred payments (PPI/CPI or others).  Determine if there will be minimum or guaranteed payments – partial or total take or pay arrangements.  Where minimum water payments are to be made, address credits for excess water payments.

29. Drafting Groundwater Transfer Agreements Purchase and Sale of Groundwater How much will I be Paid? Attend - Water Marketing Panel – Later in the Afternoon When Does Payment Begin?  Prior to production -  At the time of production Measurement and Audit Rights

30. Drafting Groundwater Transfer Agreements Access to Groundwater from Surface Estate Termination of Rights to Use Groundwater Ownership of facilities after termination; Condition of facilities after termination; and Plugging of wells upon termination.

31. Drafting Groundwater Transfer Agreements General Contract Provisions Default and Termination Special Provisions for termination Indemnity Governmental limitations

32. Drafting Groundwater Transfer Agreements General Contract Provisions Insurance Provisions Lender Non Disturbance and Subordination Agreements Release Provisions

33. Drafting Groundwater Transfer Agreements General Contract Provisions Force Majeure Physical Limitations Regulatory Limitations Temporary Interruptions Permanent Interruptions

34. Issues relating to due diligence in connection with the purchase and sale of groundwater Drafting Groundwater Transfer Agreements

35. Review or investigative period; Investigate groundwater hydrology and geology; Investigate water quality; Determine infrastructure needs and costs (wells, pipelines, etc.); and Determine the limitations on withdrawal and transfer of groundwater set by the groundwater district or other regulatory body, if any. Due Diligence Issues - Water

36. Drafting Groundwater Transfer Agreements Determine that no prior severance has occurred; Review title for effect of prior liens and encumbrances. Remember, security instruments may encumber the groundwater estate; and Review mineral interests which may have a claim on the water rights. Mineral estate owners may own implied surface easements and rights to use groundwater in exploration. Title Insurance Due Diligence Issues Real Property

37. Drafting Groundwater Transfer Agreements General Contract Provisions WATER SUPPLY AGREEMENTS Need reliability Quality Control Priority Commitment

38. Drafting Groundwater Transfer Agreements Frank Z. Ruttenberg Bracewell & Giuliani LLP 106 S. St. Mary’s Suite 800 San Antonio, Texas 78205 Texas Realtors Land Institute April 2008