In Yowell v. Granite Operating Co . 557 S.W.3d 794 (Tex. App.—Amarillo 2018, pet. granted), the Texas Court of Appeals for the Seventh District in Amarillo affirmed the trial court’s determination that an “anti-washout” provision in a mineral assignment did not extend an overriding royalty interest to new leases.

Last week, the Texas Supreme Court granted the Yowell Group’s petition for review, and set oral argument for January 9, 2020 to weigh-in on the issue.

In Yowell, certain successors-in-interest (the “Yowell Group”) to an overriding royalty that was reserved by Aikman Oil Corporation (“Aikman”) when Aikman assigned the underlying oil and gas leases. Upland Resources, Inc. (“Upland”) ultimately acquired the underlying oil and gas leases. Subsequently, Amarillo Production Company (“Amarillo”) obtained top leases covering the same acreage. Amarillo sued Upland and claimed that the underlying leases terminated due to cessation of production.

Amarillo and Upland settled the lawsuit. As part of the settlement, Upland agreed to release its interest in the underlying leases. Amarillo agreed to assign its top leases to Upland’s designee and retained a five percent overriding royalty interest. Upland subsequently changed its name to Granite Operating Company (“Granite”), and Amarillo assigned its top leases to Granite. Granite ultimately assigned the top leases to Apache Corporation (“Apache”).

The Yowell Group filed a lawsuit to establish that their overriding royalty interest in the underlying leases had attached to Amarillo’s top leases. The Court granted summary judgment in favor of Apache and Granite on the issue of attachment.

On appeal the Court observed that an overriding royalty interest is an interest carved out of the working interest created by an oil and gas lease, and is derivative of a particular oil and gas lease. Generally, an overriding royalty interest does not survive termination of the assigned lease unless the instrument creating the interest provides an express provision to the contrary.

The Aikman lease contained an “anti-washout” or “evergreen” clause aimed at imposing the overriding royalty interest on any extension or renewal of the Aikman lease, or any future lease of the minerals that required three things for the overriding royalty interest to attach to the top leases: (1) termination of one or more of the underlying leases; (2) acquisition of an extension, renewal, or new lease or leases by the assignee of the underlying leases; and (3) the extension, renewal or new lease must cover or affect all or part of the mineral interest covered and affected by the underlying leases.

The underlying leases indisputably terminated leaving the Court to assess whether the remaining two conditions were met.

The Court concluded that the top leases were not renewals or extensions of the underlying leases when they contained numerous different terms than the underlying leases and were executed by different parties. Amarillo’s acquisition of the top leases did not inure to Granite’s benefit, but was adverse to the leasehold title subsequently assigned to Apache. Accordingly, the top leases constituted “new” leases as opposed to any renewal or extension of the underlying leases.

The Court next considered whether the anti-washout provision could cause the overriding royalty interest to attach to the “new” leases. In comes the Rule Against Perpetuities (the “Rule”)—“No interest 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.”

Under the Rule, a conveyance must be viewed as of the date the instrument is executed, and the interest is void if by any possible contingency the grant violates the Rule. The Court applied the Rule to the anti-washout provision and determined that the interest created by the provision was contingent on the expiration of the underlying leases which were of indefinite duration. Where an interest in an oil and gas lease is “contingent on expiration” of an existing oil and gas lease, it generally violates the Rule, and is therefore, void.

The interest created by the anti-washout provision depended on the creation of a new lease—an uncertain contingency. The time between the expiration of the underlying lease and the creation of a new lease to which the overriding royalty interest could purportedly attach is an indeterminate period which could exceed twenty-one years plus a life in being at the time of the assignment. Accordingly, the Court concluded that the anti-washout provision violated the Rule.

The Court rejected the Yowell Group’s argument that the overriding royalty interest vested when Aikman originally carved the interest out of the underlying lease. Instead, the Court found there could be no vested interest in any future lease that did not exist at the time of assignment.

When the underlying leases terminated, so did the overriding royalty interest of the Yowell Group according to the Court of Appeals.

Practice Tips :

• Review any “anti-washout” or “evergreen” provisions to assess whether they contain “new lease” language.

• Depending on the underlying factual circumstances, the interest created by the conveyance or assignment may violate the Rule Against Perpetuities if contingent on a “new lease” that was not in existence at the time the interest was created.

• Stay tuned for the Texas Supreme Court’s opinion on this issue of first impression.