The Fifth Circuit’s recent ruling in Fallon Family, L.P. v. Goodrich Petroleum Corp. reinforces that parties to mineral leases should be very careful when drafting documents to be recorded in public records.  The case stems from a 1954 mineral lease between the Fallon Family L.P.’s predecessor in interest, as lessor, and Goodrich Petroleum, as lessee.  The lease covered 487 acres in Caddo and DeSoto Parishes in Louisiana.  In 2012 the Fallon Family sought to terminate the lease on the grounds that Goodrich had ceased continuous operations on three units within the leased area.  In October of 2014, the Fallon Family filed two notices of lis pendens in both parishes to put third parties on notice that there was a pending suit that could affect the leased premises.  Four days later, the parties agreed to settle the dispute and memorialized the settlement in a Settlement Agreement.

Under the Settlement Agreement, Goodrich made a one-time payment of $650,000 and gave the Fallon Family a $1,000,000 promissory note to be paid in $100,000 bi-annual installments.  Having resolved the dispute over the lease, the parties filed in both parishes a Lease Ratification which stated:

NOW, THEREFORE, for the promises and covenants exchanged below, and other good and valuable consideration exchanged by the Parties on or near this date, the receipt and sufficiency of which is hereby acknowledged, the Parties agree to [the listed promises and covenants].

The Lease Ratification went on to provide that the lease was affirmed, ratified, and in full force and effect.  There was no mention of the Settlement Agreement or the promissory note.

Goodrich made one payment on the promissory note, but failed to make the second payment and filed for protection under Chapter 11 of the Bankruptcy Code.

In the bankruptcy proceedings, the Fallon Family sought, among other things, to dissolve the Settlement Agreement because of Goodrich’s breach (i.e., its failure to make payments on the promissory note).  Dissolution of the Settlement Agreement would allow the Fallon Family to pursue a claim for termination of the lease and, presumably, to lease it to another interested party.  Goodrich, in opposition, took the position that section 544 of the Bankruptcy Code, nicknamed the “strong arm” provision of the Code, allowed it to step into the shoes of a bona fide purchaser of the lease and “avoid” the settlement agreement, in a sense “strong-arming” the Fallon Family into continuing the lease despite the breach.  The bankruptcy court, the district court, and the Fifth Circuit all agreed with Goodrich.

For purposes of § 544, the debtor-in-possession (or trustee) is treated as a different entity than the prepetition debtor.  It grants a debtor-in-possession (or trustee) all of the rights and powers of a bona fide purchaser of real property who perfected such purchase at the time of the commencement of the case, whether or not such a purchaser exists.  As the court put it, “the Bankruptcy Code creates a legal fiction affording a debtor-in-possession the abilities it would have as a bona fide purchaser of the debtor’s interests in immovable property at the time the bankruptcy is filed.”

Under Louisiana’s law of registry, a third party (which the court found a bona fide purchaser of real property to be) may rely on the absence of documents in the public record to determine interests in immovables.  The court ruled that because the lease ratification stated that the lease was in full force and effect and that consideration for the lease ratification had been fully paid, Goodrich, wearing the hat of a third party, may rely on that statement (or, more precisely, on the absence of any indication in the public record that the lease’s continuing viability was dependent on payment under the promissory note) and thus prevent the Fallon Family from dissolving the settlement agreement regardless of the fact that Goodrich, as the prepetition debtor, had in fact breached the agreement.  The court concluded that “because the Lease Ratification shows the purchase price has been paid, the Fallon Family cannot dissolve the Settlement Agreement.”  The Fallon Family was, thus, left with a $900,000 unsecured claim against Goodrich without the ability to terminate the lease.  Showing little sympathy, the court concluded with these words: “Unfortunately, creditors often do not receive the full amount of their claims; however, this is a feature, not a flaw, of the design of the bankruptcy system.”

This ruling serves as an important and costly lesson that any documents recorded in the public record should be carefully worded to accurately represent the true nature of all interests in immovable property.  If the rights and interests in immovable property are made subject to a conditional or ongoing obligation (like a promissory note), the recorded document should explicitly reference that obligation.