The Texas Supreme Court recently issued an opinion that may have caused some attorneys to relive a law school nightmare. In Yowell v. Granite Operating Company, the Court determined that an anti-washout provision in a reservation of an overriding royalty interest violated the infamous rule against perpetuities (the “Rule) by attempting to attach the overriding royalty interest to a new oil and gas lease.[i]
The Rule 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.”[ii] Originally the rationale of the Rule was to prevent real property owners from controlling interests in the real property for long periods of time. For an example of a scenario violating the Rule, suppose a ranch owner grants the ranch to Ben for as long as the property is used for a school, then to the owner’s grandchildren. Because the ranch could ceased to be used as a ranch more than 21 years after the death of Ben, the second transfer fails. However, the simplicity of the Rule in application can quickly become complex.
The recent decision in Yowell was the first time that the Court analyzed the application of the Rule to an anti-washout provision in new leases. Previous cases determined that the anti-washout provision did not violate the Rule for leases that were renewed or extended.[iii]
In Yowell, the original lease was acquired in 1986. The original lessee later assigned its interest while reserving a 2.25% ORRI. The reservation (now owned by the Yowells) was made subject to an anti-washout provision that was to cover any extension, renewal or new lease executed by the lessee. In 2007, a top lease was taken and shortly thereafter, the top lessee sued alleging that the 1986 lease had terminated. The parties ultimately settled their dispute and agreed that the 1986 Lease had terminated and the new 2007 lease was in effect. The lessee decided that the new 2007 lease negated the obligation to pay the Yowells the ORRI. The Yowells sued and sought a judicial declaration of ownership and recovery of the payments. The trial court granted the motion for summary judgment filed by the defendants, holding that the ORRI violated the Rule. The Court of Appeals of Amarillo affirmed the ruling.
In the Court’s analysis, the Court first determined whether the Yowells’ ORRI was a property interest that could be subject to the Rule. The Court affirmed that the ORRI was a real property interest and that any contingency regarding whether or not the ORRI would be extended to a future lease did not affect the real property characterization of the interest.
The Court then analyzed whether the ORRI as extended to new leases violated the Rule. The ORRI did not vest in new leases at the time of its creation due to the existence of contingencies, including that the original lease had to terminate. Because the ORRI had not vested, the Court turned to whether or not it would vest within the 21 years after the death of some life in being at the time of reservation. Applying the anti-washout clause to new leases violated the Rule because the enjoyment of the ORRI under future leases relied on additional events that may not occur within the prescribed timeframe such as the original lease terminating and a new lease being granted.
Because the clause at issue in its application violated the Rule, the Court held that the interest should be reformed under Texas Property Code § 5.043, which provides that if an instrument is found to violate the Rule, the instrument shall be reformed or construed “to effect the ascertainable general intent of the creator of the interest.” The Court left the trial court to grapple with the practicalities of how an unconstitutional deed can be reformed, particularly when there is no measuring life.
Additional questions left unanswered in the opinion may become the subject of future litigation. For instance, the court did not address defendants’ arguments regarding the distinction between the four year statute for reformation and actions for the recovery of real property, which have no time limitations other than the adverse possession statutes. The Court also declined to guide operators faced with attributing payment to such an interest. Numerous overriding royalty interests that exist of record that may now be deemed invalid due to their violation of the Rule; however, the Court provided no indication as to whether an operator has a continuing duty to pay the owner of that interest because the instrument may be reformed.
Until those questions are fully addressed, any attempt to include an anti-washout provision that would apply to new leases should be drafted to ensure the interest vests within the Rule’s timeframe. And until there is further guidance from the courts on how these interests will be reformed, operators face vexing questions of how to handle potentially invalid but reformable interests.
[i] 2020 WL 2502141 (Tex. May 15, 2020).
[ii] Id. at *3.
[iii] See, e.g., Sunac Petroleum Corp. v. Parkes, 416 S.W.2d 798, 802-03 (Tex. 1967).
Thompson & Knight LLP
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