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The Texas Supreme Court Decides Important Case Involving Reformation of Royalty Interests that Violate the Rule Against Perpetuities

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On  May 15, 2020, the Texas Supreme Court decided Yowell v. Granite Operating Co., a case involving the application of the Rule Against Perpetuities to an anti-washout clause in an overriding royalty interest provision purporting to attach to any future “new leases” of the same mineral rights. The opinion continues a trend of avoiding judicial invalidation of interests for violating the Rule, but leaves open the question as to whether and when the statute of limitations would bar an action seeking to recover an interest in real property.

In a 1986 assignment of an oil and gas lease, the assignor reserved to itself an ORRI that the Yowells eventually came to own, which contained an anti-washout clause providing that if the leases terminated

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 lease, 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.

In 2007, Amarillo Production Company obtained top leases on the property, and sued Upland Resources, the current lessee, to terminate the bottom leases due to lack of production.  In connection with a settlement of that litigation, after releasing its interest in the underlying leases, Upland changed its name to Granite Operating Company, and Amarillo assigned the leases to Granite, reserving a 5% ORRI, which it then assigned to Peyton Oil & Gas and PAC Production, in the proportions of 2% and 3% respectively. Granite later assigned the leases to Apache.

In 2013, the Yowells filed suit to recover their ORRI, which they claimed automatically attached to the new leases.  Apache and PAC contended that the language purporting to attach the ORRI to new leases violated the Rule.  The Amarillo Court of Appeals held that the provision violated the Rule Against Perpetuities and was not subject to reformation under section 5.043 of the Texas Property Code and, even if it were, it would decline to reform it under section 5.043 due to the Yowells’ nearly six-year delay in filing suit.  The Supreme Court reversed, holding that the ORRI is a real property interest that violates the Rule, but must be reformed, if possible, pursuant to section 5.043, and remanded for consideration of whether the ORRI in new leases can be reformed so as to not run afoul of the Rule.  The Supreme Court also held that the four-year residual statute of limitations did not bar the Yowells’ request for reformation.

The Court began its analysis by noting that article I, section 26 of the Texas Constitution prohibits perpetuities.  Characterizing the ORRI as both a property right and a contract right (which it noted are not mutually exclusive), the Court concluded that the Yowells had a property interest in the 2007 lease subject to the Rule.  According to the Court, “the ORRI holder and the lessee cannot agree among themselves that a renewal or new lease will be granted; that executive right is retained by the lessor as the reversionary owner of the mineral interest.  But they can agree that if the lessee or its successor obtains a renewal or new lease covering the same property, the ORRI holder or its successor will continue to own a share of production from that property payable out of the lessee’s interest.”  Id. at 8. The contingency of a leasing decision by the lessor, however, “means that the part of the ORRI extending to future leases was not vested at the time of its creation, which gives rise to the perpetuities problem.”  Thus, the Yowells’ ORRI “in new leases did not vest at the time of its creation and is an executory interest to which the Rule applies,” and the inclusion of automatic attachment language did not avoid the Rule violation.  The ORRI “simply could not vest in new leases that did not exist and that the parties to the reservation lacked the ability to create.” 

Two years earlier, in ConocoPhillips Co. v. Koopmann, 547 S.W.3d 858 (Tex. 2018), the Court declined to invalidate a nonparticipating royalty interest that violated the Rule “because the Rule’s purpose would not be served by invalidating it,” and it did not constitute an unreasonable restraint on alienation.  The Yowell Court held that if the natural termination of the 1986 lease were the only contingency for the Yowells’ interest to attach, the Koopmann exception would apply to validate their interest.  For the Yowells’ interest to attach, however, two additional contingencies needed to occur—the mineral owner had to execute another lease, and one of the original assignees’ successors had to obtain that lease—and thus, the Koopmann exception did not apply. 

The Court then held that section 5.043 of the Texas Property Code “is a judicial mandate” requiring reformation of commercial instruments creating property interests that violate the Rule.  The Court rejected Granite’s and PAC’s argument that the 4-year residual statute of limitations barred the Yowells’ request for reformation, observing that “[r]eformation under section 5.043 is not an ‘action’ to which the residual statute of limitations would apply.  Rather, the Legislature enacted a remedial mandate for courts to reform interests, like the one in this case, that violate the Rule.”  The Court remanded the case for further proceedings to determine whether⸺and, if so, how⸺the Yowells’ ORRI (insofar as it extended to new leases) can be reformed so as to not violate the Rule, and for “any other grounds for summary judgment the court of appeals did not reach.”

Interestingly, the Court left unanswered what appears to be an issue of first impression and is one of the “other grounds for summary judgment” that the court of appeals did not reach.  Although the Court held that there is no limitations period applicable to a request for reformation under section 5.043, it must nevertheless be requested in the context of a timely-filed lawsuit.  The Court repeatedly indicated throughout the opinion that the Yowells had a contract right, but noted that they chose not to pursue it.  What is not evident from the opinion is that the Yowells did not file suit until nearly six years after they learned that their ORRI had not attached to the 2007 lease, and thus, a claim for breach of contract, with a 4-year limitations period, would have been time-barred.  Instead, the Yowells characterized their suit as one to recover an interest in real property, which they asserted is not subject to any statute of limitations.  PAC argued that the exception in the 4-year residual statute of limitations to actions “for the recovery of real property,” which is addressed in the adverse possession statutes, does not apply to actions for the recovery of an interest in real property, and that the Yowells’ claim to recover their ORRI in the 2007 lease was time-barred, just as a claim for breach of contract would have been.  Thus, limitations is likely to remain an issue on remand.

The Yowell decision also highlights several practical considerations for ORRI clauses.  The anti-washout clause is an important protection for the holder of an ORRI.  Because an ORRI is created out of a lessee’s interest in a lease, the ORRI will live or die with the lease.  Thus, a lessee could intentionally deprive the holder of an ORRI of the benefit of the ORRI by simply terminating the burdened lease and putting in place a new lease that is not subject to the ORRI.  This type of gamesmanship is exactly what a “new lease” portion of an anti-washout clause purports to protect against. 

While the present case affirms that the “extension or renewal” portion of the anti-washout provisions fall outside of the Rule, it calls into question the efficacy of anti-washout clauses that purport to attach to “new leases.”  Nevertheless, there remains several ways for the ORRI holder to protect the “new lease” aspect of their anti-washout clauses, such as: (1) including “savings” language regarding the Rule indicating that it is the intent of the parties that the vesting of the subject interest occur within the time limits of the Rule; (2) including specific time limits for the anti-washout provision’s application to new leases; (3) remaining vigilant and being mindful of statute of limitations; and (4) timely enforcing any “new lease” portion of the anti-washout provision within any applicable limitations period.   

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