Rule Against What?

October 28, 2020

By Jason R.S. Cassady

Red Question MarkThe “Rule Against Perpetuities” is a phrase that sends shivers down the spine of many law school students. Designed to prevent ownership of land from being controlled forever (or in perpetuity), the common law provided that a contingent interest must vest within 21 years of a life in being. This definition includes many words that need to be defined for full context.

First, something is “contingent” if it might happen but has not yet happened, thus it has not “vested”. For example, if Bill Black conveyed Blackacre to Sam Smith for his lifetime, with a remainder to Sam’s surviving children, the identity of Sam’s surviving children is unknown prior to his death. It is possible that Sam could have more children, it is possible Sam could adopt children, and it is possible one of Sam’s children could predecease him. This uncertainty makes the remainder contingent. When Sam dies, the remainder will “vest,” and the exact identity of Sam’s surviving children will then be known. By contrast, a conveyance to Jim Jones for his lifetime, with remainder to Jane Jones would establish a vested remainder in Jane because it is certain Jane will own the property after the death of Jim.

Second, a “life in being” appears to be a relatively simple concept – a life in being is someone who is alive. However, there are often questions of who is considered a life in being and when that person is considered a life in being. A person is a life in being when the contingency is created. As to Sam Smith and his children, Sam Smith was the life in being at the time of the conveyance from Bill Black. However, if Bill Black had instead bequeathed (rather than conveying) Blackacre in his last will and testament to Donna Doe for her lifetime, with a remainder to Donna’s surviving children, Donna would be the life in being at the date of Bill’s death because the contingency did not exist until Bill died.

As to Sam Smith and his children, the Rule Against Perpetuities was not violated because Sam’s children obtained a vested interest at the moment of Sam’s death. Sam was the life in being and the remainder interest vested within 21 years of his life.

Like the examples above, the Rule Against Perpetuities is mostly involved in the context of gifts, trusts and estate planning. However, the Rule Against Perpetuities received recent attention when the Texas Supreme Court applied it to an interest created in a commercial arms-length transaction. In Yowell v. Granite Operating Company, 63 Tex. Sup. Ct. J. 1070 (2020), the court held that an extension and renewal clause for a reserved overriding royalty interest violated Texas’ Rule Against Perpetuities. In the oil and gas industry, an exploration oil company will sometimes reserve a small amount of future revenue (an overriding royalty interest) when it conveys leasehold interests to another company. To prevent the assignee from terminating the assigned leases and obtaining new leases free of the reserved revenue, the agreements often include provisions attaching the reserved revenue to these potential future leases by defining them as extensions and renewals of the assigned leases.

In Yowell, the court held that because it is unclear if the assigned leases will ever be extended or replaced, the extension and renewal clause violated the Rule Against Perpetuities. The holding that this clause violated the Rule Against Perpetuities was not a total disaster in this case as the Texas Supreme Court remanded the case with instruction to reform the offending provision to comply with the Rule Against Perpetuities, if possible, pursuant to a provision in the Texas code.

While the Texas Rule Against Perpetuities has been held to apply to at least some arms-length transactions, 29 states, including Minnesota and North Dakota, have adopted the Uniform Statutory Rule Against Perpetuities. See Minn. Stat. ch. 501A and N.D. Cent. Code §§ 47-02-27.1 through -27.5. This uniform act includes an exception to the Rule Against Perpetuities for most arms-length transactions. This uniform act also includes a provision which instructs a court to reform a provision which violates the Rule Against Perpetuities. This instruction to reform applies both as to provisions created in violation of the current statute and as to provisions which violated the law as it existed when the provision was created if before adoption of the current statute.

By way of contrast, Iowa has its own statutory Rule Against Perpetuities, but it has not adopted a form of the Uniform Statutory Rule Against Perpetuities. See Iowa Code § 558.68. While the common law and Uniform Statutory Rule Against Perpetuities are based upon possible events, Iowa law gives preference to actual events over possible events – and includes statutory instruction for judicial reformation of provisions which violate the Rule Against Perpetuities.

Regardless of the state, care should be taken when agreeing to a provision in an arms-length transaction which may violate the Rule Against Perpetuities. That care should include understanding the Rule Against Perpetuities under the relevant law and, if appropriate, inclusion of a savings clause to avoid future litigation for reformation.