Oil and Gas and the Rule Against Perpetuities (RaP)

Back to considering the doing away with the Rule Against Perpetuities...

If the Rule Against Perpetuities were abolished you wouldn't have to be concerned about it invalidating a top lease. (A top lease is an oil and gas lease that becomes effective when an existing oil and gas lease terminates.) The problem comes up when if the top lease violates the rule against perpetuities -- and is therefore void. This happens because of the two term structure of the oil and gas lease. The primary term of the lease is the time given for the lessee to decided to and find a place to drill a well on the leased property, and is usually for a number of years. Once the primary term is expired the lease will expire unless there is production (something coming out of the ground). Secondary terms will continue forever if there is production forever -- and there is part one of the problem.

Say you have a piece of land somewhere with tons of oil under it. You aren't an oil company so you lease (sell the mineral rights to) your property to one for some money and a percent royalty in the oil they pump out of the ground. This oil company hems and haws and doesn't seem like they are going to do anything about getting the oil up and paying you royalties. Being the anxious land owner you are you are ready to find a replacement oil company, and you do. They offer you some money for the rights to the minerals once the first lease terminates (and the mineral rights revert back to you) and execute the top lease. Enter the problem: they have the rights once the current lease terminates, but if the first lessee drills a well and starts taking oil the lease may never terminate.

Because of this possibility, even if the first lease terminated, the top lease is void -- thanks RaP!

There are solutions to prevent this from happening though. One of which is to put a term of years on the top lease. For example, if the current lease does not terminate in 20 years this top lease terminates. The other involves conveying the interest you hold in the minerals: the reverter. When the mineral interest is conveyed with the limitation "for as long as there is production," a reverter is created. The holder of the reverter is the person who gets the property when the lease terminates, and most importantly it is a presently vested interest.

It's all about the drafting. Since people are so much easier to locate maybe abolishing the RaP makes sense -- it would eliminate this problem.