05 Dec Overriding Royalty Interests and the Rule Against Perpetuities – Yowell v. Granite Operating Co.

by Adam Burke and Harrison Long

Of the many legal principles passed down from English Common Law, few are more vexing than future interests^[1], particularly when applied to the already esoteric field of oil and gas law. Determining what turn of phrase gives rise to reversions, reverters, remainders, or executory interests is tricky enough— but then come contingent remainders, vested remainders, shifting and spring executory interest, etc.

Why all the fuss?

Even if a future interest is not something one has the right to enjoy presently, it may be so certain to occur that the interest is deemed “vested”^[2] in the owner. This phenomenon matters for an important reason: the Rule Against Perpetuities (“RAP”).

RAP states that an interest in property must vest in someone, if at all, within 21 years after the death of lives in being at the time the instrument was executed.^[3] If the conveyance cannot vest in someone within that timeframe with certainty then the conveyance is void. The reason for the rule goes back to some of the earliest foundational concepts in English property law— namely, that property should be used rather than being forever bound in labyrinthine arrangements. However, future interests that are “vested” do not violate RAP as the future interest “vests” in the future interest owner at the time of its creation, rather than at some point in the future. ^[4] Due to the nature of oil and gas transactions, issues of vesting and RAP violations are fertile ground for confusion and litigation.

Long settled in Texas oil and gas law is the nature of the oil and gas lease, being a fee simple determinable in the lessee, with the lessor retaining a possibility of reverter. The lessee’s fee simple ownership is “determinable” because most leases are for a term of years, and so long as there is production in paying quantities, with production being the determinable part of such. The oil and gas lease may or may not terminate long after the RAP period, but the lessor’s possibility of the fee mineral interest reverting back to the lessor is considered “vested” in the lessor at the time the lease is executed.^[5] However, what of an Overriding Royalty Interest (“ORI”)^[6] and attempts to prevent ORI’s from being “washed out” by subsequent leases? The Texas Supreme Court dealt with just such an issue in Yowell v. Granite Operating Co., 2020 Tex. LEXIS 425 (Tex. 2020).

In Yowell, the petitioners (“Yowell”) reserved an ORI in a prior lease. The predecessor in interest to respondent (“Granite”) took a top lease from the mineral interest owner covering the same land as the prior lease. A lawsuit ensued followed by a settlement agreement where, in sum, the prior lease was terminated and Granite owned the leasehold interest in the new lease. However, Granite ceased paying Yowell’s ORI.

Yowell believed it was entitled to receive ORI payments under the new lease, as the instrument creating the ORI (the “Instrument”) contained anti-washout provisions, namely that the reserved ORI applied to new leases executed by the original lessee or their successors, which occurred here (the possibility of the ORI applying to a new lease being the “Future Interest”). Granite argued that the Future Interest was not a property interest. Yowell appealed the trial and  appellate courts’ holdings that the Future Interest violated RAP. This left the Texas Supreme Court with two questions: 1) was the Future Interest a property interest? 2) If the Future Interest was a property interest, did it violate RAP?

The court noted that an ORI is non-possessory property interest and stated that “whether the [ORI] is extended and in what form… will be contingent of a leasing decision by the lessor, a non-party to the [ORI]. But that contingency does not deprive an [ORI] that continues under a new or renewed lease of its character as a property interest.” However, that contingency of whether to renew the prior lease, or to take a new lease, raises the question of whether or not the ORI in new leases (i.e., the Future Interest) vests when the ORI is first created. If so, then the Future Interest would not violate RAP. If not, RAP would void the Future Interest.

The court held that the Future Interest violated RAP, declaring the Future Interest to be an “executory interest” vesting “only upon the happening of a condition or event” with such conditions being “not certain to occur, if ever.” The court elaborated that three (3) conditions must occur for the Future Interest to vest: 1) the prior lease must terminate, 2) the mineral interest owner must execute a new lease covering all or part of the same mineral interest, and 3) the new lease must be obtained by the original lessee or their successor. The court noted that none of those conditions were certain to occur, thereby preventing the Future Interest from vesting in Yowell at the ORI’s inception and voiding the ORI due to RAP.

Yowell did have one small victory, though: Tex. Prop. Code § 5.043 mandates reformation of instruments found to violate RAP so as to avoid the consequences of RAP, if possible. However, as the court remanded that issue for further proceedings, the court did not touch upon the issue of how the Future Interest might be reformed.

Yowell v. Granite Operating Co. demonstrates the importance of drafters’ mindfulness of RAP when dealing with future interests. In attempting to preserve ORI’s with anti-washout provisions, drafters must remember that the ORI is carved from the leasehold estate, rather than the land; as the court states: “The holder of an [ORI] under potential future leases does not have a guaranteed, present right to a share of future production, in this way, an [ORI] differs from other royalty interests and cannot be presently vested at the time it is created.” Therefore, language should be used in such agreements to protect the ORI owner from potential violations of RAP.

^[1]              “A future interest is an ownership interest in property that does not currently entitle the owner to possession or enjoyment of the property. The owner’s right to possession or enjoyment is postponed until some time in the future and may be contingent or vested.” Restatement (Third) of Property: Wills and Other Donative Transfer § 25.1.

^[2]              “A future interest is either contingent or vested. A future interest is contingent if it might not take effect in possession or enjoyment. A future interest is vested if it is certain to take effect in possession or enjoyment.” Restatement (Third) of Property: Wills and Other Donative Transfer § 25.3.

^[3]              See, ConocoPhillips Co. v. Koopman, 547 SW3d 858, 866-67 (Tex. 2018).

^[4]              See, Kelly v. Womack, 153 Tex. 371, 268 SW.24 903, 905-06 (Tex. 1954).

^[5]              See, Koopman, 547 SW3d at 867 (citing Rosson v. Bennett, 294 SW 660, 662 (Tex. 1927)).

^[6]              “An [ORI] is a non-possessory ‘share of either production or revenue from production (free of the costs of production) carved out of a lessee’s interest under an oil-and-gas lease.’ Id., fn.1 (quoting Overriding Royalty, Black’s Law Dictionary (11th ed. 2019)).