Lease provisions intended to prevent overriding royalty interests from lapsing when a lease changes hands do not protect those interests from violating the Texas Constitution’s rule against perpetuities, the Texas Supreme Court has ruled.
The court, however, added a big caveat by saying the royalty interests may be judicially reformed under a state law allowing courts to ascertain the general intent of the creator of the interest.
So-called “anti-washout” clauses are a common feature in hundreds, and possibly thousands, of oil and gas leases. Texas courts have long said the clauses are valid when applied to lease extensions and renewals, but this was the first time the Supreme Court had addressed whether existing overriding royalty interests would extend to a completely new lease.
Tommy Yowell, et al. v. Granite Operating Co. and Apache Corp., et al. is being followed by royalty owners and energy. Development interests, including the Texas Oil and Gas Association, worried that lower court rulings would permit unknown executor interests to reduce the value of their leasehold estates at any moment in the future.
The dispute involves a section of land in Wheeler County leased in 1986. The Yowell group became the successor-in-interest in 2007. In 2013, the Yowell Group sued Granite and Apache, which had acquired the leases, for unpaid royalties.
Granite and Apache argued that the anti-washout clause in the original document should not apply because it violates the anti-perpetuities rule, designed to prevent perpetuities and monopolies as “contrary to the genius of a free government.”
The trial court granted summary judgment for the energy companies and the 7th Court of Appeals agreed. In a 2-1 decision, the court of appeals said the overriding royalty interest was dependent on the leasehold from which it was carved and did not survive when the underlying lease was terminated.
A unanimous Supreme Court said May 8 that an overriding royalty interest is a real-property interest that violates the Texas Constitution’s rule against perpetuities. It reversed lower courts’ summary judgment against the royalty owner and remanded the case to the Amarillo Court of Appeals to consider whether the lease language can be reformed to allow the continuing validity of the royalty interest. A provision in the Texas Property Code allows reformation when the perpetuities rule is violated.
Justice Brett Busby said the Yowells’ overriding interest in new leases did not vest when created and is an executory interest to which the rule against perpetuities applies.
“At the time this ORRI was reserved, it provided no immediate, fixed right of present or future enjoyment as to new leases because those leases were not yet in existence,” said Busby.
He said it only would apply to a new lease if the 1986 lease terminated, the lessor granted a new lease covering all or part of the same mineral interest, and the new lease was obtained by a successor of the lessee at the time of the reservation.
“The Yowells’ ORRI in new leases was not vested at the time of its creation and is contingent on at least three events that may not happen at all, let alone within the lives in being plus twenty-one years stipulated by the Rule. This interest therefore violates the Rule,” said Busby.
Because the court of appeals had declined to apply the Property Code reformation, the Supreme Court remanded the case for further proceedings.
Amarillo attorney and longtime state representative John Smithee represented Yowell. Austin attorney Ryan Clinton represented Granite.