Published on:

Overriding Royalty Interests Can Violate Rule Against Perpetuities

The Texas rule against perpetuities (the “Rule”) was something all lawyers learned about in law school, but it seemed at the time like a concept we would not run into very often in real life law practice. Unfortunately, it comes up regularly in connection with Texas oil and gas leases and related interests.

In Texas, the Rule states that a property interest must vest within 21 years after the death of some life or lives in being at the time of the conveyance of that property interest. If it does not, then the interest is a perpetuity. Perpetuities are prohibited by Texas Constitution Article 1, section 26 as restraints on free alienation of property. A conveyance that violates the Rule is void.

In Tommy Yowell v. Granite Operating Company et al, the Texas Supreme Court had occasion to review a claim that an overriding royalty interest (ORRI) violated the Rule. As many of you know, an ORRI is a share of either oil and gas production or revenue from that production that is carved out of a lessee’s interest under an oil and gas lease. In most cases, when the oil and gas lease to which the ORRI is attached terminates, the ORRI terminates as well. In this case, the ORRI contained a provision that purported to cover any extension or renewal of the existing lease as well as any new leases. When the operator of a new lease stopped paying royalties to Yowells, they sued.

The Court then set out the two questions that are critical to a determination about the Rule: first, did the property interest vest at the time it was created? If the answer is yes, then the Rule does not apply. If the answer to that question is no, then the second question is: will the interest vest within the Rule’s timeframe? If the answer is yes, then there’s no violation. If the answer is no, then the Rule is violated.

On the first question, the Court decided that the Yowell’s interest was a property interest, and not just a contract right. A contract right is not subject to the rule against perpetuities, but a property interest is. On the second question, the Court held that at the time the ORRI was created, it provided no right in new oil and gas leases because those leases were not yet in existence and there was no assurance they would exist within the Rule’s timeframe. The Court also noted that the original conveyance of the ORRI was by a lessee. A lessee has no right to create a vested future interest in production, only the mineral owner can do that.

The Court next determined that Texas Property Code Section 5.04, which allows reformation of certain documents, may apply to this ORRI. As a result, the case was sent back to the trial court to determine how the ORRI might be reformed.

This case illustrates, once again, how important careful drafting of oil and gas documents is.