Anti-Washout Clause Defeated by the Rule Against Perpetuities

Originally published by Charles Sartain.

Co-author Chance Decker

Is an overriding royalty interest lasting beyond the term of a lease-now-in-effect impossible to create?  You saw the recent Texas Supreme Court opinion invalidating an anti-washout clause in TRO-X v. Anadarko Petroleum Corp. Now, you see Tommy Yowell et al v. Granite Operating Company et al.  In light of these opinions one could wonder if an override is as valuable a tool in an oil and gas trade as it used to be.

An assault on overrides?

In TRO-X, a reserved override didn’t extend to a new lease despite anti-washout language because the clause only applied to “extensions,” “renewals” and “top leases”. If only TRO-X had included “new leases” in its anti-washout clause, it could have saved its override, one would assume. A harsh lesson about drafting robust anti-washout clauses, but a fix nonetheless.

In Yowell, the grantor did include “new leases” in its anti-washout clause. Still, in a case of first impression the Amarillo Court of Appeals held the grantor’s override was washed out because that clause violated the Rule Against Perpetuities.

The Rule spoils the party

According to the court, because an overriding royalty interest is derived from a particular oil and gas lease which constitutes the assignor’s mineral estate, its validity is subject to the terms, conditions and existence of such a lease. The interest doesn’t have a life of its own. Its duration can’t be greater than the leasehold estate, but it can be shorter.

The lease to which the Yowell override originally attached was for three years and as long thereafter as there was production or operations. Thus, the lease had the potential to continue well beyond the perpetuities period (a life in being plus 21 years). Because the anti-washout clause purported to reserve an overriding royalty interest in any “new leases” executed after termination of the existing lease (which might not be executed until after perpetuities period had run) it was invalid under the Rule Against Perpetuities. Additionally, even if the existing lease terminated within the perpetuities period, the new lease might not be executed until after the period had run. For this additional reason, the anti-washout clause violated the Rule and was void. With no anti-washout clause to save it, the grantor’s override terminated when the original lease was terminated. Poof!

The court rejected the argument that the override vested when it was reserved and thus complied with the Rule. While the royalty interest in the existing lease may have vested as soon as it was reserved, “[t]here could be no concurrent vesting of title in a new lease which was not then in existence and which might never come into existence.”

There’s a way …

Can one protect an overriding royalty interest if all the lessee has to do to destroy it is execute a new lease, anti-washout clause notwithstanding? Have you considered a perpetuities savings clause?

Think about it. Now, go sign up leases; reserve overrides; live well; and remember who your friends are.

Aretha, RIP

Curated by Texas Bar Today. Follow us on Twitter @texasbartoday.

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