Colorado Supreme Court Revisits Rule Against Perpetuities

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[author: Ginny Olmstead]

In March of this year, the Colorado Supreme Court revisited a fundamental doctrine of property law, which it described as “long cherished by law school professors and dreaded by most law students: the infamous rule against perpetuities.”  The rule applies an unusual formula to prevent property from remaining “tied up” by grants of contingent future interests vesting too remotely in time.  Although the rule was originally crafted to prevent excessively long family settlements, courts have since applied it to commercial transactions as well.  This has created some odd results in case law governing commercial transactions, because the rule’s formula is structured around “lives in being” and potential heirs.  Addressing these abnormalities and clarifying some of the inconsistency in its own prior decisions, the Colorado Supreme Court, in Atl. Richfield Co. v. Whiting Oil & Gas Corp., recently held that a fully revocable option within a commercial agreement did not violate the common law rule against perpetuities, either in its traditional form or as it existed in Colorado case law prior to the adoption of the Rule Against Perpetuities Act.  320 P.3d 1179 (Colo. 2014).  As such, the Court concluded that the option at issue should not have been subject to reformation by the trial court pursuant to the Act.

The option at issue in Atlanta Richfield Co. was granted as part of a 1983 amendment to an agreement formed in 1968 between Equity and ARCO to develop oil shale on a piece of property in western Colorado known as the Boies Block.  The amendment granted Equity a non-exclusive, revocable option to repurchase the interest in the Boies Block property and ARCO retained the “sole and exclusive right to cancel [the option] at any time during its term,” which was set to expire in 2008.  After discovering natural gas on the property in the early 2000s, Equity attempted to exercise its option to repurchase the property, but because the valuation formula contained in the agreement was significantly below the market price at the time, ARCO refused.  The lawsuit ensued.

The trial court concluded that the revocable option violated the common law rule against perpetuities; however, the court inserted a savings clause pursuant to C.R.S. § 15-11-1106(2) into the contract to prevent the option from being voided by the common law rule.  The trial court then granted specific performance of the reformed option to the option holder.  Affirming the decision of the trial court, the court of appeals held that the trial court properly applied Section 15-11-1106(2), and did not revisit the question of whether the option was actually in violation of the rule.  The Colorado Supreme Court granted certiorari to review whether the statute authorized the trial court to reform the revocable option.

The Court sought to determine whether Section 15-11-1106(2) of the Rule Against Perpetuities Act required the Court to modify a revocable option within a commercial agreement alleged to be in violation of the rule.  The Act, which applies to non-vested property interests created after May 31, 1991, replaces the common law rule with a “wait and see” approach that declares donative transfers as valid if the property interest either vests or terminates within ninety years of its creation. Specifically, Section 15-11-1106(2) requires a court, upon request, to reform interests created prior to May 31, 1991 that have been determined, in a judicial proceeding, to violate the State’s rule against perpetuities as it existed before May 31, 1991.  Thus, as a threshold matter, the court reviewed whether the revocable option in question was in violation of the common law rule, as it existed prior to the Act’s enactment.

The Court discussed the rule’s history, noting that the rule stemmed from a policy that encouraged keeping property marketable and discouraged “dead-hand control” on property perpetuated by intergenerational transfers.  By imposing its limit on restraints on alienation, the rule was designed 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[.]”  First Nat’l Bank & Trust Co. v. Sidwell Corp., 678 P.2d 118, 127 (Kan. 1984).  In contrast to rules discouraging general restraints on alienation, the rule against perpetuities more specifically limited family gift transactions by voiding contingent future interests vesting beyond the perpetuities period: “twenty-one years after some life in being at the creation of the interest.”

When the rule was expanded to apply beyond family gift transactions to all contingent interests in property, issues arose.  Courts applied the rule to commercial options, reasoning that the option holder has an equitable interest in the land, contingent upon its exercise of the option.  Thus, a contingent option to purchase not exercised within the period of perpetuities would be void under the rule because the interest would not vest in time.  After courts began to criticize the rule’s use in a commercial context, the Restatement (Third) of Property took the approach that the rule does not apply to options and rights of first refusal with respect to the purchase of land because the rule in a commercial context “operated arbitrarily, applying a time period totally unsuited to commercial transactions.  Lives in being plus 21 years is too long for some servitude arrangements and irrational in others.”  Rest. (Third) of Prop.: Servitudes § 3.3 cmt. b (2000).

The Court in Atlanta Richfield Co. recognized that its own struggle with applying the rule against perpetuities to commercial cases had resulted in a confused body of case law in Colorado that blurred the line between the common law rule against perpetuities and the rule against unreasonable restraints on alienation.  In addition, the Court focused on public policy justifications for the rule and applied it “only where the purposes of the rule are served, such as preventing a practical restraint on alienation or encouraging improvement of the property.” In order to determine whether the option violated Colorado’s version of the rule, the Court engaged in a lengthy analysis of its own prior holdings that applied the rule against perpetuities in the commercial transaction context, comparing that analysis to more textbook applications of the rule.

When addressing options and preemptive rights, the Court had effectively been applying a general rule against unreasonable restraints on alienation, which focuses on the reasonableness of the restraint, instead of the traditional form of the rule against perpetuities, which focuses on remoteness of vesting.  The Court concluded that, under either version of the rule, the revocable option in question did not raise common public policy concerns, because it did not discourage either party from investing in or improving the land.  ARCO faced no risk of loss because it could cancel the option at any time.  Similarly, Equity and ARCO were joint owners of the Boies Block, so Equity was not discouraged from improving the land.  Further, the option did not restrain ARCO’s ability to alienate the property because it did not grant Equity an absolute right to purchase the property.  Instead, ARCO retained the right to extinguish the option at any time, giving it full power to develop or dispose of the property.

Based on its analysis of the rule, the Court determined that the revocable option within the parties’ commercial agreement did not violate either the traditional version of the rule against perpetuities or the rule as it had evolved in case law because the option was fully revocable at ARCO’s sole and exclusive discretion, so there was no unreasonable restraint on alienation.  Despite the opinion’s strong language regarding the impracticability of applying the rule against perpetuities in a commercial context, the court did not draw a bright line rule regarding the rule’s applicability to commercial transactions.  Instead, it declined to reach that question after holding the fully-revocable option in question was not subject to reformation under Section 15-11-1106(2) because it would not violate either version of the rule.

 

Topics:  Commercial Leases, Commercial Real Estate Market, Rule Against Perpetuities

Published In: Civil Procedure Updates, General Business Updates, Commercial Real Estate Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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