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Kansas Reverses Course; Royalty Interests Reserved in the Grantor Vest Immediately

Posted in Mineral Interest, Real Estate

The Supreme Court of Kansas recently decided an interesting oil and gas case. The opinion in Rucker v. DeLay, 289 P.3d 1166, (Kansas, Oct. 19, 2012) contains an intriguing analysis of future royalty interests vs. mineral interests. Though the decision has interesting legal implications, it should be a practical lesson for those trying to convey or reserve oil and gas rights.

Summary of Facts

In 1924, Earl and Leah DeLay sold their farm and reserved the following interest:

“The grantor herein reserves 60% of the land owner’s one-eighth interest to the oil, gas or other minerals that may hereafter be developed under any oil and gas lease made by the grantee or by his subsequent grantees.”

Over the following nine decades Mr. and Mrs. Delay or their successors ratified two different oil and gas leases on the property but no oil or gas was ever produced.

In 2008, Mr. and Mrs. Rucker, the current owners of the property, filed a quiet title action against the DeLay heirs alleging that the 1924 deed reservation was a royalty interest that had not vested in the DeLay heirs (because there was no production) and therefore violated the rule against perpetuities (RAP). The DeLay heirs alleged that the reservation created a mineral interest and that the RAP did not apply.

The district court sided with the Ruckers and held that the deed reservation created a perpetual, nonparticipating, royalty interest that was subject to termination under Kansas law because it violated the RAP. Feeling bound by early Supreme Court cases, the Court of Appeals agreed.

On further appeal, the Supreme Court first concluded that it need not decide whether the DeLay interest is a royalty interest or a mineral interest because the parties did not properly raise that issue. The only issue presented to the Supreme Court was whether the royalty interest reserved by Mr. and Mrs. DeLay was void because it violated the RAP.

The Supreme Court began its analysis by defining the terms in dispute. The Court observed:

“A royalty interest refers to the right to share in the production of oil and gas at severance. In Kansas, a royalty interest is considered personal property. Royalty interests are often contrasted with mineral interests, which refer to oil and gas in place. In Kansas, mineral interests are real property.”

Then the Court confirmed that property interests are subject to the RAP and summarized the rationale for the RAP as follows:

“The rule against perpetuities springs from considerations of public policy. The underlying reason for and purpose of the rule is to avoid fettering real property with future interests dependent upon contingencies unduly remote which isolate the property and exclude it from commerce and development for long periods of time, thus working an indirect restraint upon alienation, which is regarding at common law as a public evil.”

As for future interests, the Court instructed:

“The common-law rule against perpetuities ‘precludes the creation of any future interest in property which does not necessarily vest within twenty-one [21] years after a life or lives presently in being ….’ A future interest is an ownership interest that does not currently entitle the owner to possession or enjoyment of the property because the right to possess is delayed until some future time.*** There are two kinds of future interests — reversions and remainders.

A future interest is a reversion if it was retained by the transferor and a remainder if it was created in the transferee.”

The Court concluded that the royalty interest in this case is a reversion because Mr. and Mrs. DeLay retained a portion of the royalty in the deed.

The Supreme Court then discussed earlier cases where it had voided royalty interests while favoring mineral interests. The Supreme Court had previously held that in order to vest, a royalty interest must be created by an oil and gas lease that is actually put into production. No production, no vesting. In prior decisions the Court had observed, “[i]t is, therefore, wholly problematic when, if ever, such an interest under future leases would vest. Such a grant violates the rule against perpetuities, a rule against too remote vesting.”

The DeLay heirs urged the Supreme Court to overrule and reverse its flawed and already heavily criticized analysis of royalty interests and the RAP. In support of their position the DeLay heirs recited the dissenting opinion of one of the Kansas Supreme Court judges in a prior case who opined, “A royalty interest creates a present interest in real property and the only uncertainty is whether that interest will ever result in a share in the production.” Likewise, the DeLay heirs cited Alabama precedent critical of prior Kansas Supreme Court analysis on the subject, as well as the leading oil and gas treatise, which noted, “[i]t is an odd fact that in Kansas the perpetuities attack has succeeded only with respect to royalty and nonexecutive mineral interests.”

The Kansas Supreme Court relented, holding:

“The criticism about this court’s prior vesting analysis has some merit. Thus, we decline to extend it to royalty interests reserved in the grantor. It is better to right the ship and apply the well-recognized property law principles excepting reservations from the rule against perpetuities despite any ‘conceptual’ difficulties this may cause. *** We hold that the DeLays’ royalty interest is not void under the rule against perpetuities. We reverse the district court’s order quieting the DeLays’ title.”

Conclusion

As we have discussed before in posts about life estates, fractional mineral interests and The Duhig Rule, oil and gas interests are unique, and attempts to convey them without the help of qualified legal counsel can lead to unintended results. Though the decision in the DeLay litigation may have achieved what the parties intended in the 1924 deed reservation, the fact is that it took years of litigation to achieve that result. If Mr. and Mrs. Delay had received better advice in 1924, they may have been able to avoid this whole mess and may have been advised to reserve 60% of the minerals (not the royalty), which could have been much more valuable and is probably what DeLay really wanted anyway.