What is a “Washout Provision”?
The term “washout provision” can be misleading because there is actually no such provision. Instead, it refers to the situation where an overriding royalty interest is created in an assignment of an oil and gas lease to a new owner. When the assigned lease expires, the overriding royalty interest also ends or is “washed out” of existence. In some cases, a lessee may allow a lease to expire to avoid having to pay the overriding royalty interest and to increase its net revenue interest. Once the lease ends, the lessee can obtain a new lease from the mineral owner without any overriding royalty obligation.
The Anti-Washout Provision
To prevent this scenario, the “anti-washout provision” was created. This provision is designed to ensure that the overriding royalty interest remains intact if the lease is extended. In Yowell v. Granite, a recent (2022) Texas Supreme Court case, the transfer contained language stating that the overriding royalty interest would continue to apply to not only lease extensions but also to new leases.
Rule Against Perpetuities
However, the court ultimately ruled that the anti-washout provision in Yowell which included new leases, was invalid because it violated the Rule Against Perpetuities (RAP). The RAP stipulates that a transfer of ownership of real property more than twenty-one years after the death of the primary recipient is void. This rule originated from 17th century English probate law to prevent “ruling from the grave” where the deceased would devise his property to Party A and include language in the will that upon the death of Party A the property would pass to Party B and upon the death of Party B, the property would pass to party C, etc. The result was that the property would not vest for many years after the death of the original owner.
Result
The same argument can be made for the anti-washout provision in an assignment for “new leases.” The transfer of the assignment must ultimately vest within 21 years of lives in being. If each new lease re-establishes the overriding royalty interest, it may not ultimately vest for many years to come. Thus, Texas courts deem the anti-washout provision for new leases invalid as it violates the RAP.
Sources: Texas Ruling Challenges Oil And Gas Anti-Washout Provisions by Michael K. Reer, an associate at Harris Finley & Bogle PC, www.hfblaw.com
HAPL Newsletter, The Interplay of Anti-Washout Clauses and the Rule Against Perpetuities By: M. Ryan Kirby, J. Brian Davis, and Gina Hong of Kirby, Mathews & Walrath, PLLC http://www.kmwenergylaw.com/assets/Articles/Approved/Interplay%20of%20Anti-Washout%20Clauses%20and%20the%20Rule%20Against%20Perpetuities.pdf
Gibson, Dunn Newsletter: Texas Supreme Court to Address Anti-Washout Clauses for Overriding Royalty Interests https://www.gibsondunn.com/wp-content/uploads/2019/10/texas-supreme-court-to-address-anti-washout-clauses-for-overriding-royalty-interests.pdf
