In Fallon Family, L.P. v. Goodrich Petroleum Corp. et al. (In re Goodrich Petroleum Corp.), 894 F.3d 192 (5th Cir. 2018), the Fifth Circuit applied the “strong arm” power of a trustee in order to defeat a claim by a landlord that a lease was “dissolved” under Louisiana state law after the tenant (the debtor in the bankruptcy case) breached a separate settlement agreement that resolved an earlier landlord/tenant dispute.
The tenant and the predecessor to the landlord had entered into a long-term mineral lease years before the tenant filed for bankruptcy in 2016. In 2012, the landlord claimed that the tenant had breached the lease, and litigation thereafter ensued. In 2015, the parties settled the litigation which was documented by a settlement agreement requiring the tenant to pay $1.6 million, with $650,000 to be paid immediately and the balance over time. In addition, the parties signed an Amendment and Ratification of the lease and recorded it in the land records. The recorded document recited that in exchange for good and valuable consideration, “the receipt and sufficiency of which is hereby acknowledged,” the lease is “ratified in its entirety, and remains in full force and effect,” but made no reference to the terms of the settlement. Thereafter, the tenant made the initial cash payment under the settlement agreement and one of the note installment payments before it filed a Chapter 11 case and ceased further payments.
The landlord argued in the bankruptcy case that the settlement agreement was an executory contract that the debtor was required to assume or reject. To be an “executory contract” both parties must have material duties to be performed. Because only the tenant had obligations under the settlement agreement, it was not executory, so the court rejected the landlord’s argument. The landlord also argued that the lease should be deemed dissolved under Louisiana law because payments were not made under the settlement agreement. The bankruptcy court rejected that argument on the basis that under Bankruptcy Code §544(a)(3) a trustee has the rights and powers of a hypothetical bona fide purchaser for value (a “BFP”). Because the recorded ratification agreement stated that the lease had been ratified and was in full force and effect, the rights of the trustee based on the recorded document defeated the right of the landlord under state law to terminate the lease due to a breach of the off-record settlement agreement. The district court and then the Fifth Circuit affirmed on the same grounds. The Fifth Circuit found it significant that third parties were not put on notice of the remaining payments under the settlement agreement.
The decision is a novel application of the strong arm power of a trustee, which is usually applied to avoid pre-petition transfers of property. Instead of applying §544(a)(3) to avoid a transfer, the court held that by granting a trustee the rights and powers of a BFP for value, the Bankruptcy Code could be used to defeat a remedy that would otherwise apply under state law.
While the Fifth Circuit’s application of § 544(a)(3) is noteworthy, the decision may not have a broad application. The case is only applicable if the relevant state law requires that documents must be recorded to be effective against third parties and if that law is interpreted to require that the business terms of the documents be recorded. The landlord in Fallon Family could have avoided the result in this case by amending the lease to incorporate the terms of the settlement into the recorded lease amendment. Had it done so, the lease would have had to have been assumed or rejected in the bankruptcy case and, if assumed, the breach would have to have been cured.
Note that in Maryland, the general rule under Real Property Article (“RP”) §3-101(a) is that deeds and leases for seven years or longer must be recorded. However, RP §3-101(e) permits parties to record memoranda of leases without the rental provisions.
For questions, contact Larry Coppel (410) 576-4238.