Substantial Performance Operates to Preserve Lease

The Southern District of Ohio in Baile-Bairead, LLC v. Magnum Land Servs., LLC, No. 2:12-CV-00957, 2014 U.S. Dist. LEXIS 65787 (S.D. Ohio May 13, 2014) addressed and clarified several issues relating to substantial performance of oil and gas leases and tender of payments to extend the primary term of an oil and gas lease.

In September 2006, Baile-Bairead, LLC, by its two members, David C. Barrett, Sr. and his wife, Friedel L. Barrett (the “Barretts”), entered into two oil and gas leases with Magnum Land Services, LLC (“Magnum”).   The leases were acknowledged by the Barretts, individually, as Lessors, and then the Barretts, individually, signed two orders of payment.  Magnum tendered the initial payment to “David C. Barrett and Friedel L. Barrett.” Subsequently, Magnum assigned the leases to Belmont Resources, LLC (“Belmont”).  Each lease was for a primary term of five years with an option to renew the leases for an additional term of five years.  Paragraph 4 of the leases required payment of the option to renew to be tendered to Lessor at “Lessor’s address above.”  The leases also contained provisions providing for a cure period to address a potential breach or failure to make the requisite payment under the leases.  Subsequently, Magnum assigned the leases to Belmont Resources, LLC (“Belmont”). Id. at *2.

The leases were set to expire on September 22, 2011, and no oil or gas was produced in paying quantities during the primary term.  Magnum sent a letter to the Barretts, dated September 14, 2011, to renew the leases for an additional five-year period.  Included with Magnum’s letter was a check for the lease renewal, made payable to David C. Barrett and Friedel L. Barrett – the same individuals that executed the leases and received the initial payments under the leases. Magnum’s renewal letter was sent to the wrong address, 884 S. Barrett Rd., rather than the correct address of 844 S. Barrett Rd.  It was undisputed, however, that Friedel L. Barrett received Magnum’s renewal letter.  Also, since the execution of the leases, David C. Barrett, Sr., had died. Id. at *6.

David C. Barrett, Jr., now serving as managing member of Baile-Bairead, LLC, responded to Magnum and Belmont on September 26, 2011 and attempted to unilaterally terminate the leases.  David C. Barrett, Jr. informed Magnum and Belmont that the leases “have expired and been forfeited” in accordance with Ohio Rev. Code § 5301.332 because “no drilling has occurred on the premises and there was no extension payment made to the named Lessor, Baile-Bairead LLC, on or before the September 22, 2011 deadline.”  Id. Belmont responded that “the payment has properly been tendered and it is Belmont’s position that the leases remain in effect . . . if you desire that the checks be reissued to the LLC we will accommodate that request upon confirmation of the lessor’s agreement that the leases remain in place.”  Id. at *7. Baile-Bairead reasserted its position that the leases expired and were forfeited and offered to negotiate new oil and gas leases covering the Baile-Bairead’s property.

Not only did Baile-Bairead reject Belmont’s tender of the option to renew, but also Baile-Bairead, on January 31, 2012, sent a letter and an Affidavit of Forfeiture to the Washington County Recorder, which requested that the Washington County Recorder make a note in the margins that the leases had been cancelled.  The Washington County Recorder marked the leases as cancelled.  On May 17, 2012, Magnum filed with the Washington County Recorder two separate Affidavits of Notice of Extension of Oil and Gas Lease, one for each lease.  Subsequently, Baile-Bairead filed suit to have the leases declared forfeited as a result of Belmont’s alleged failure to tender the renewal payment properly. Id. at *9.

Under the terms of the renewal option clause, the Lessee may exercise its option to extend the terms of the lease for five more years by making a payment to the Lessor at Lessor’s address in the lease.  The address in the lease was 844 Barrett South Rd., but the payment was sent to 884 S. Barrett Rd.  The Court found that Belmont improperly tendered payment to the lessor, Baile-Bairead LLC, under the plain language of the lease.  2014 U.S. Dist. LEXIS 65787, at *14. 

Despite the fact that Belmont did not comply with the terms of the renewal option, Belmont’s actions constituted substantial performance and Belmont’s tender of the renewal payment was sufficient to renew the leases for an additional five year term.  Under Ohio law, “[a] party does not breach a contract if it ‘substantially performs’ the terms of the contract, even if performance does not conform exactly to the plain language of the contract.”  Id. (citing Burlington Res. Oil & Gas Co. v. Cox, 133 Ohio App. 3d 543, 548-49, 729 N.E.2d 398, 402 (Ohio Ct. App. 1999) (explaining that “merely nominal, trifling, or technical departures from the terms of a contract are not sufficient to breach it.”)).   The Court explained that Belmont substantially performed its obligations under the leases:

“Belmont operated in good faith, simply executing the bonus payment in exactly the same manner as the initial bonus payments had been executed.  Eight days before the September 22, 2011 deadline, Belmont – by way of Magnum – sent a check addressed to the same people who were paid for the initial lease:  David C. Barrett and Friedel L. Barrett.”

Baile-Bairead, 2014 U.S. Dist. LEXIS 65787, at *16-17.

Next, Baile-Bairead LLC put forth three alternative reasons for why the leases were invalid, regardless of whether Belmont properly tendered the bonus payments and extended the leases.  First, Baile-Bairead contended that Belmont did not meet its duty to cure the defective payment in a timely manner.  However, Baile-Bairead attempted to cancel the leases unilaterally and did not provide Belmont an opportunity to cure.  The Court rejected Baile-Bairead’s claim because “Baile-Bairead was contractually obligated to provide Belmont some length of time – at least thirty days – to cure its deficiency.  It violated this obligation by refusing to do so.  Id., at *25.

Second, Baile-Bairead argued that the leases were never valid because they were not properly executed or acknowledged in 2006, because the Barretts signed them in their individual capacities rather than as the limited liability company.  Id. at *28.  The Court rejected that argument:

“The real issue, again, concerns whether or not the Barretts were authorized to sign on behalf of Baile-Bairead.  Because they were here, and because Ohio law did not require specification that they signed the leases in their representative capacity, the Barretts’ signatures do nothing to take away from the validity of the leases.”

2014 U.S. Dist. LEXIS 65787, at *29.

Finally, Baile-Bairead argued that the leases were invalid because Magnum and Belmont violated implied covenants attached to the leases.  Id. at *30.  “Under Ohio law, certain covenants are implied in oil and gas leases, including the obligation to drill, explore, and reasonably develop the leased land.”  Id. (citing Am. Energy Servs. v. Lekan, 75 Ohio App. 3d 205, 215, 598 N.E.2d 1315, 1321 (Ohio Ct. App. 1992)).  The Court concluded that Belmont had not breached an implied covenant of the lease because the leases specifically provided for an option to renew the primary term of the lease without a requirement of development during that period.  Id., at *32-33.

Belmont brought a counterclaim against Baile-Bairead for slander of title arising out of Baile-Bairead’s actions to have the recorder mark the leases as forfeited.  Id. at *34.  “Under Ohio law, ‘[s]lander of title is a tort action’ that requires a claimant to prove:  ‘(1) there was a publication of a slanderous statement disparaging claimant’s title; (2) the statement was false; (3) the statement was made with malice or made with reckless disregard of its falsity; and (4) the statement caused actual or special damages.’”  Id. at *34 (citing Columbia Gas Transmission Corp. v. Ziegler, 83 F. App’x 26, 31 (6th Cir. 2003) (citing Green v. Lemarr,  139 Ohio App. 3d 414, 430-31, 744 N.E.2d 212, 224 (Ohio Ct. App. 2000)).  The Court concluded that Baile-Bairead published false and disparaging statements regarding Belmont’s title, which satisfied the first two elements.  Id. at *35.  The Court also concluded that a “reasonable jury could find that Baile-Bairead acted with reckless disregard of Belmont’s rights in cancelling the leases.”  Id.

In conclusion, of course it is important to comply with the terms of the lease, but under Ohio law, substantial compliance with the terms of the lease may be not be treated as a breach of the lease.  Thus, when negotiating or tendering payment to difficult lessors that may be attempting to terminate a lease prior to the expiration of the primary term or prevent a lessee from renewing a lessee, a good faith effort by the lessee to comply with the terms of the lease may be sufficient under Baile-Bairead.  However, it is important to recognize the interpretation of whether a lessee’s conduct will be deemed substantial performance is a factual question that can only be resolved by the courts.