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Texas Supreme Court Weighs In On Application of Rule Against Perpetuities to Overriding Royalty Reservations

Last week the Texas Supreme Court issued its opinion in Yowell v. Granite Operating Company, No. 18-0841, again grappling with the ancient Rule Against Perpetuities in the context of modern oil and gas transactions–the second time in two years in which the court tackled the inscrutable “Rule.”Top-Ten

The facts (simplified): The Yowells own an overriding royalty on production from a 1986 oil and gas lease. Upland Resources owned the lease. In May 2007, Amarillo Production Company took a top lease on the same land as the 1986 lease, and three months later it sued Upland, contending that the 1986 lease had expired. The parties settled: Upland’s 1986 lease wass terminated, Amarillo Production’s 2007 lease became effective.

The overriding royalty owned by the Yowells was created in an assignment of the 1986 lease that contains the following language, known as an “anti-washout clause”:

Should the Subject Leases … terminate and in the event Assignee obtains an extension, renewal or new lease or leases covering or affecting all or part of the mineral interest covered and affected by said lease or leases, then the overriding royalty interest reserved herein shall attach to said extension, renewal or new lease or leases; and an appropriate recordable instrument shall be executed to evidence Assignor’s overriding royalty interest therein. Further, any subsequent extension or renewal or new lease or leases shall contain a provision whereby such overriding royalty shall apply and attach to any subsequent extensions or renewal of Subject Leases.

The successors to Upland, Granite Oil and Apache, refused to recognize the Yowells’ continued overriding royalty in the 2007 lease, contending that the grant of an override in “future leases” violates the Rule Against Perpetuities.

The “Rule,” as lawyers call it, was inherited from English Common Law.  The Texas Constitution prohibits “perpetuities” as “contrary to the genius of a free government.” Tex. Const. art. I Sec. 26. The common law provides that “no property interest is valid unless it must vest, if at all, within twenty-one years after the death of some life or lives in being at the time of the conveyance.” The Rule is intended to prevent property owners, by will or conveyance, from imposing contingencies on ownership for long periods of time. For example, a will may not provide that property shall pass in perpetuity to the oldest heir of the decedent and his heirs in perpetuity. The Rule is famous as one of the most difficult topics in law school, and it is notoriously difficult to apply. The Supreme Court of California held in 1961 that it was not legal malpractice for an attorney to draft a will that violated the Rule.

Because of the complexity and harshness of the Rule, the Texas Legislature passed a statute, codified as Texas Property Code Section 5.043, providing that, if an instrument is found to violate the Rule, “a court shall reform or construe” the instrument “to effect the ascertainable general intent of the creator of the interest.  A court shall liberally construe and apply this provision to validate an interest to the fullest extent consistent with the creator’s intent.” The Yowells argued that, if the overriding royalty reservation violated the Rule, the court should reform it so that it complies with the Rule. Granite and Apache argued that the statute did not apply to reservations of overriding royalty.

Granite and Apache argued that the Yowells could have no interest in the new 2007 lease because that interest might “vest” more than 21 years after the death of all persons living on the date the interest was created, the date of the assignment that reserved the overriding royalty.

The Supreme Court held that the attempt to reserve an overriding royalty in a “future lease” violated the Rule, but that Section 5.043 does apply. It remanded to the court of appeals “to consider whether the Yowells’ interest can be reformed to comply with the Rule.”

The assignment provided that the override would apply to any extensions, renewals or “new leases.” The Yowells cited a federal case from the 10th Circuit, Independent Gas & Oil Producers v. Union Oil of California, 669 F.2d 624 (1982), which held that the Rule did not prevent an override from attaching to a second lease executed after the termination of the original lease. The court distinguished the federal case: “We agree with the Tenth Circuit’s conclusion that Union’s ORRI in renewals or extensions of Lease I did not violate the rule. … Whether an ORRI reservation in new leases violates the rule was not addressed in Union Oil.” In a footnote, the opinion says the Yowells conceded that, under prior precedent, the 2007 lease was a “new lease.” There is no discussion in the opinion on the difference between an extension or renewal and a new lease, or why a reserved overriding royalty in  an extension or renewal of a lease would not violate the Rule but a “new lease” would. Apparently the former is “vested” at the time of the reservation, but the latter is not.

Another interesting aspect of the case relates to the language in the reservation of override that “an appropriate recordable instrument shall be executed to evidence Assignor’s overriding royalty interest” in the new lease. Granite and Apache argued that the Yowells “have only a contract right to sue Granite for failure to comply with its obligation to execute an appropriate recordable instrument evidencing the Yowells’ ORRI following Granite’s acquisition of the 2007 Lease.” In a footnote, the court said “we recognize that the Yowells also have a contract right. The Yowells declined to pursue a claim for breach of contract in this Court. These characterizations are not, however, mutually exclusive, and the Yowells are not precluded from seeking a declaration of property ownership merely because they could have also pursued a claim for breach of contract.” Could the Yowells have obtained the same result, without running into the complexities of the rule, just by suing for breach of contract with the measure of damages the amount of overriding royalty they would have received had the lessee complied with it obligation to execute an instrument “evidencing the Yowells’ ORRI” in the 2007 lease?

The Court also distinguished its prior opinion in ConocoPhillips v. Koopmann, 547 S.W.3d 858 (2018). In Koopmann, Streiber conveyed land to the Koopmanns, reserving a term royalty for 15 years and as long thereafter as there was production in paying quantities.  The issue addressed by the Court was whether the reserved term royalty interest violated the Rule. The Court held that, because the interest that would revert to the Koopmanns if and when production ceased was an “executory interest” that might not vest within the time required by the Rule, it technically did violate the Rule; but the Court nevertheless held that the interest was valid and enforceable because “the Rule’s purpose would not be served by invalidating it.” In Koopmann, the Court said the Rule’s purpose is to prevent “landowners from using remote contingencies to preclude alienability of land for generations.” The Court then concluded that, unlike the reservation in Koopmann, the reservation of overriding royalty in future leases did violate the Rule’s purpose: “In order for the Yowells to attach their interest to the 2007 Lease, … additional remote contingencies beyond the natural termination of the 1986 Lease must occur. Not only must the mineral owner execute another oil and gas lease but one of [the lessee’s] successors must also obtain that lease. These are the sort of remote and uncertain contingencies the Rule seeks to prevent.” (It seems that an extension or renewal of the prior lease would also be the same sort of remote and uncertain contingencies, and yet apparently an override applying to an extension or renewal of lease would not violate the Rule. This seems to put form over substance; parties could avoid a wash-out clause by how they characterize the “new” lease.)

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