Wednesday, August 28, 2019
How Does the Rule Against Perpetuities Apply in the Oil and Gas Context?
One of the most difficult concepts for law students, and practicing lawyers for that matter, is the Rule Against Perpetuities (RAP). The rule bars a person from using a deed or a will (or other legal instrument) to control the ownership of property well beyond their death – known as “control by the dead hand.” It’s an ancient rule of property law that is intended to enhance the marketability of property by limiting the ability to tie-up the ownership of property for too long of a time period. Wedel v. American Elec. Power Service Corp., 681 N.E.2d 1122 (Ind. Ct. App. 1997). The RAP is, essentially, grounded in public policy. See, e.g., Symphony Space, Inc. v. Pergola Properties, Inc., 88 N.Y.2d 466, 669 N.E.2d 799 (N.Y. 1996).
The RAP often comes into play in estate planning situations with respect to wills and trusts, particularly in large estates where the desire is to keep land in the family for many generations into the future. But, it can also be involved when real estate is transferred and oil production is present or might be in the future. But the Rule has been applied to oil, gas, and mineral leases, too. If some future interest in a mineral deed is granted, the RAP requires the interest to vest (the point in time when a person becomes legally entitled to what has been promised) within 21 years of the lifetimes of those living at the time of the grant. If it is possible for the vesting to happen beyond that 21 years, then the Rule voids the contingent future interest.
Indeed, in 2018, the Texas Supreme Court modified the application of the rule in the context of oil and gas, and recently the Kansas Supreme Court refused to apply the RAP to a defeasible term mineral interest (an interest that is capable of being terminated/voided) – a very common form of mineral ownership.
The implications of not applying the RAP to oil and gas interests - that’s the topic of today’s post.
The RAP originated In the late 17th century in England. In the Duke of Norfolk’s Case, 3 Ch. Cas. 1, 22 Eng. Rep. 931 (Ch. 1682), Henry, the 22nd Earl of Arundel, created an estate plan that sought to pass a portion of his property to his oldest son (who was mentally disabled) and then to his second son. Other property would pass to his second son, and then to his fourth son. Henry’s estate plan also contained provisions for shifting property many generations later if certain conditions should occur. When Henry’s second son succeeded to his older brother’s property, he didn’t want the property to pass to his younger brother. The younger brother sued to enforce his interest as created by Henry’s estate plan. The House of Lords held that the shifting condition that the estate plan created could not have an indefinite existence. The Court was of the view that tying up the ability to transfer property for too long of a time period beyond the lives of the persons that were alive at the time of the initial transfer was impermissible. Just how long was too long was not determined until 1833 in Cadell v. Palmer, 1 Cl. & Fin. 372, 6 Eng. Rep. 936 (H.L. 1832, 1833) where the court set the time limit at lives in being plus 21 years.
A similar property law concept to the RAP is the rule barring unreasonably restraints on alienation. Both concepts are based on the common law’s general distaste of restrictions on the ability to transfer property. See, e,g, Cole v. Peters, 3 S.W.3d 846 (Mo. Ct. App. 1999). But, the concepts are not identical – it is possible for an unreasonable restraint on alienation to occur without triggering the RAP.
2018 Texas Case
In Conoco Phillips Co. v. Koopmann, 547 S.W.3d 858 (Tex. Sup. Ct. 2018), the Texas Supreme Court held that the RAP did not void a 15-year non-participating royalty interest that was reserved in a deed. Accordingly, the Court changed the application of the RAP such that, at least in Texas, it will not void an oil, gas and mineral deed if, regardless of the grant or reservation (it no longer makes a difference whether the interest is created by grant or reservation), the holder of the future remainder interest is at all times ascertainable and the preceding estate was/is certain to terminate. Thus, according to the Texas Supreme Court the RAP will not apply if the future contingent interest is transferable and/or inheritable; the holder of the future interest is known or knowable at all time; and the previous estate is certain to end at some point.
Recent Kansas Case
As noted above, a recent Kansas Supreme Court decision, Jason Oil Company v. Littler, No. 118,387, 2019 Kan. LEXIS 204 (Kan. Sup. Ct. Aug. 16, 2019), involved the application of the RAP to a defeasible term mineral interest. The Court refused to apply the rule.
A defeasible term mineral interest is a durational estate that involves a mineral, royalty or nonexecutive mineral interest for a fixed term of years and for an indefinite period of time thereafter, usually so long as oil or gas is produced. That’s what was it issue in Jason Oil.
In late 1967, a grantor executed two deeds conveying tracts of real estate in the same section of the county. The east half of the section was conveyed to one grantee and the a quarter of the section was conveyed to another grantee. Both deeds stated, “"EXCEPT AND SUBJECT TO: Grantor saves and excepts all oil, gas and other minerals in and under or that may be produced from said land for a period of 20 years or as long thereafter as oil and/or gas and/or other minerals may be produced therefrom and thereunder." The grantor died a few years later and the local probate court distributed set percentages of the residue of the grantor’s estate, including the reserved mineral interest, to the grantor’s descendants.
The 20-year term expired on December 30, 1987. From that time until May 31, 2017, there was no drilling activity on either tract and no gas or mineral production. In 2016, the plaintiff sued to quiet title to both tracts. The plaintiff claimed that it held valid and subsisting oil and gas leases. One set of the grantor’s heirs claimed that they owned an interest in the minerals via the grantor’s will – the grantor owned a fee simple determinable in the mineral rights and that, as a result, they were devised an interest in the minerals. However, another set of the grantor’s heirs claimed that those mineral interests were subject to an invalidated by the RAP because they were “springing executory interests.”
Note: A springing executory interest is an interest in an estate in land created by the conditions of a grant wherein the grantor cuts short the grantor's own interest in the property in favor of the grantee, contingent upon the occurrence of a specific condition. It’s an executory (future) interest that follows an interest that the grantor held upon the happening of a stated event.
If the RAP applied to invalidate their interests, those heirs claimed that their interests should be reformed under the Uniform Statutory RAP contained in Kan. Stat. Ann. §59-3405(b) to conform to the parties’ intent and avoid violating the RAP. The other set of heirs continued to maintain that the RAP invalidated the other heirs’ interest and that the Uniform Statutory RAP was void for violating the Kansas Constitution. As a result, they claimed that they owned the minerals by virtue of the residuary clause of the grantor’s will.
The trial court held that a defeasible term mineral interest is a future estate reserved to the grantor and a reversion. As a reversion remaining to the grantor, the court concluded, it wasn’t subject to the RAP. In addition, the trial court determined that the grantor’s reserved right had not alienated the surface and mineral estates of the tracts.
The Supreme Court agreed with the trial court that the decedent reserved a defeasible term interest. However, the Supreme Court opined that the trial court “…veered off course” by finding (1) the future estate kept by the decedent in the mineral estate was a reversion and (2) the reservation of the defeasible mineral interest was a reversion and not subject to the RAP. However, the Supreme Court declined to apply the RAP concluding that the application of the RAP would be counterproductive to the purpose behind the RAP and create “chaos.” The Supreme Court held that when a grantor (the decedent in this case) creates a defeasible term (plus production) mineral interest by exception that leaves a future interest in an ascertainable person, the future interest in the minerals is not subject to the RAP. In sum, the Supreme Court held that the RAP did not apply because the interest vested during a lifetime, however it reverted back to the surface estate because of the lack of production.
Defeasible term mineral interests are prevalent with oil and gas properties. If the RAP were to apply to these interests, the RAP would invalidate the grantee’s interest. That would often be contrary to the parties’ intent. In fact, had the Kansas court applied the RAP, the future right to the on-half mineral interest upon termination would be void and the landowner (and heirs) would own it forever. Clearly, the parties in Jason Oil did not intend that result. Thus, the Court’s refusal to apply the RAP advanced the underlying public policy of protecting the transferability of interests in land.
The Kansas Supreme Court’s opinion is significant. When application of the RAP would fail to promote transferability of interests in land, it should not be applied. In addition, when a a particular form of property interest (such as a defeasible term mineral interest) has a long history of usage within a particular industry, it is not a good idea to have the RAP apply. In that situation, it would have the serious potential of disrupting titles and impairing commerce in property rights. These points are true even though the Kansas Supreme Court said it was creating a “narrow exception” to the RAP for defeasible term mineral interests. That means the public policy implications of the Court’s decision could apply in future cases.