Top Leases Can Survive the Rule Against Perpetuities

In BP Am. Prod. Co. v. Laddex, Ltd., 07-13-00392-CV, 458 S.W.3d 683, Tex. App. LEXIS 1521 (February 17, 2015), the Amarillo Court of Appeals upheld the validity of a top lease and remanded the case to determine whether there was a cessation of production in paying quantities which potentially terminated the underlying lease.

In Laddex, the lessors executed a lease on January 13, 1971 (“Arrington Lease”), which was eventually assigned to BP. Id. at 684. The Arrington Lease provided for a primary term of five years and so long thereafter as oil or gas is produced from the land. Id. The Mahler D-2 Well was the only well drilled on the property and produced steadily until August 2005, when production slowed significantly. Id at 685. Then, in November 2006 the well inexplicably resumed producing in quantities comparable to what it had produced prior to its 2005 slowdown. Id.

In 2007, the landowners entered into a “top lease” with Laddex (“Laddex Lease”), which conveyed the landowners’ reversionary interest in the mineral estate of the same property covered by the Arrington Lease. Id. Subsequently, Laddex filed suit, seeking termination of the Arrington Lease asserting that the Arrington Lease terminated when production slowed between August 2005 and November 2006. At trial, the jury found that the well failed to produce in paying quantities under the Arrington Lease and that a reasonably prudent operator would not have continued to operate the well for profit. Id. BP appealed the trial court judgment that the Arrington Lease terminated and the mineral interests reverted back to the landowners and to Laddex, the owner of the top lease. Id. On appeal, BP argued that the Laddex Lease violated the Rule against Perpetuities and that the charge to the jury improperly restricted the timeframe of when production ceased under the Arrington Lease. Id.

First, the Amarillo Court of Appeals rejected BP’s argument that the Laddex Lease violated the Rule against Perpetuities (“the Rule”). The Court explained that if a top lease conveys a presently vested interest, then it would not be subject to the Rule; however, if a top lease conveys an interest that cannot vest until a condition precedent occurs, then it would be subject to the Rule. Id. at 686 (citing Hamman v. Bright & Co., 924 S.W.2d 168, 171 (Tex. App. – Amarillo 1996, writ granted w.r.m.)). The Laddex Lease provided that it “is intended to and does include and vest in [Laddex] any and all remainder and reversionary interest … in the Leased Premises upon expiration of any prior oil, gas or mineral lease ….” Id.[1] Further, the Laddex Lease did not include the “effective only upon” language frequently included in top leases that have violated the Rule. Id. at 687. Thus, the Court concluded that the Laddex Lease conveyed a vested interest in the landowners’ reversionary right, because the landowners’ reversionary interest in the mineral estate does not come into existence upon the expiration of the Arrington Lease (a condition precedent), rather, it came into existence and was presently vested in the landowners upon execution of the Arrington Lease. Id. at 686. Therefore, the Laddex Lease conveyed to Laddex a presently vested interest in the reversionary interest mineral estate, and did not violate the Rule. Id. at 687.

Second, the Court concluded that the trial court erred when it limited the timeframe in its charge to the jury regarding cessation of production, which charge read: “From August 1, 2005 to October 31, 2006, did the Mahler D-2 Well fail to produce in paying quantities?” Id. at 688. The Court explained that the trial court was required to submit to the jury a charge to determine whether the Arrington Lease failed to produce in paying quantities over a “reasonable period of time.” Id. The Court concluded that the trial court’s charge to the jury was improper because it limited the jury’s consideration to a period of time that was not reasonable to assess whether the Arrington Lease had ceased producing in paying quantities. Id. By isolating the timeframe to a fifteen-month period of slowed production, the charge failed to reflect the true profitability of the Arrington Lease, as well as the resumption of production in November 2006. Id. Additionally, the Court noted that the limited timeframe in the jury charge was unreasonable because the Laddex Lease was executed in November of 2007, one year after production had resumed under the Arrington Lease. Id.

Laddex is significant because it provides that top leases will be valid if the lease conveys a presently vested interest that is not conditioned on future a event, i.e. the expiration of an existing lease. Laddex also illustrates the importance of maintaining detailed and accurate production records to demonstrate that a lease has been held production and has not expired during a low period of production.

[1] The Court distinguished Hamman v. Bright & Co. from the present case because the lessors inHammon retained all vested interests in the “bottom lease” until it terminated.Id. at 687. In that situation the “top lease” violated the Rule because the “top lease” conveyed an interest “that would vest in the grantee only upon termination of the bottom leases…” Id. As such, the interests that were conveyed “had the potential for vesting outside the period provided by the Rule, and are void as a matter of law.” Id. By contrast, the Laddex Lease conveyed a presently vested interest in the mineral estate and did not condition the vesting of the reversionary interest on any occurrence. Id.