The Validity of Top Leases

I recently had occasion to review the Texas Supreme Court’s decision on a long-running dispute between BP America and Laddex, Ltd. The case is centered around a disagreement of the terms in a decades old lease and its result has been significant for the energy industry. The case, known as BP America Production Co. v. Laddex, Ltd., began in 2007. British Petroleum America (BP) had been producing out of a single well on property in Roberts County, Texas since 1971, however Laddex believed BP’s lease expired and signed a top lease with the mineral owners. BP believed they still had rights to the land and so Laddex filed suit.

Arguments

This case reached the Texas Supreme Court after both the initial jury and the Court of Appeals in Amarillo, Texas ruled in favor of Laddex. However, BP argued that the jury’s findings were incorrect as there was not sufficient evidence to support the jury’s verdict. BP also contended that Laddex’s lease is void under the Texas rule against perpetuities. Laddex argued that BP’s well had not been producing “payable quantities of oil” for 15 months and therefore any “prudent operator” would have halted all operations. Thus, according to Laddex, the terms of the BP lease stated that should BP’s production stop, the lease would be terminated and the rights given back to the lessor, allowing Laddex the right to sign a new lease and assume operations on the property.

BP submitted evidence that their well “inexplicably” began producing in payable quantities of oil again after the 15-month lapse in production. However, the jury in the case concluded that a prudent operator would have halted all operations at the well. BP responded by saying the jury unfairly limited the time frame over which they looked at production.

The rule against perpetuities states that no interest in real property 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 purpose of the rule is to promote the free transfer of land for later generations by not encumbering the property with contingencies that will allow someone to dictate land ownership for years beyond the grave. It is a rule descended from English common law and its application has been debated many times by Texas lawyers and courts.

The court of appeals held that the rule did not invalidate the top lease at issue and that the trial court erroneously charged the jury on the production-in-paying-quantities question, necessitating a new trial.

Supreme Court Ruling

The Supreme Court agreed with the appellate court and affirmed its decision. The Court stated that the rule does not apply to present interests or to future interests that vest at their creation. In addition, the Court noted that the Laddex top lease commences “on the date that either (1) releases of the BP lease executed by all owners of record are filed in the real property records, or (2) a judgment terminating the BP lease becomes final and nonappealable”. As a result, the Court held that the Laddex lease was a present conveyance of a vested interest and therefore does not violate the rule against perpetuities.

As to the “production in paying” quantities issue, the Court reminds us of the two-pronged test that applies: whether a well is producing paying quantities depends on (1) whether the well “pays a profit, even small, over operating expenses;” and (2) if not, whether, “under all the relevant circumstances a reasonably prudent operator would, for the purpose of making a profit and not merely for speculation,” continue to operate the well as it had been operated”. The Court held that the jury was not allowed to consider the production from the well after the 15 month period, and they should have been. Therefore, this portion of the case was remanded to the trial court to be tried again.

As a practical matter, these days oil and gas attorneys who are preparing a top lease always put a time limit on the top lease. This eliminates any claim that the top lease violates the rule against perpetuities.