Opinion ID: 775024
Heading Depth: 2
Heading Rank: 1

Heading: Lease Termination

Text: 18 Plaintiffs contend that the district court erred when failing to find a genuine issue of material fact regarding Plaintiffs' power to terminate the Lease on grounds that Equitable unreasonably suspended royalty payments or, alternatively, on grounds that Equitable violated implied covenants in operation under the Lease.
19 The district court found that Equitable did not breach the Lease when suspending royalty payments because Equitable instead paid the royalties into an escrow account. Plaintiffs argue that Equitable has provided no evidence that it actually escrowed the royalties while attempting to determine the rightful owners of such royalties, and thus there is a genuine issue of material fact as to whether Equitable breached the Lease. 20 Equitable, rather than insisting that it had in fact escrowed the royalties, offers the alternative response that under Kentucky law, a lessor that has not received royalty payments cannot forfeit the lease, but can instead bring an action for payment. Thus, Equitable argues, the issue of whether the royalties were escrowed is unresponsive to the question of whether a genuine issue of material fact exists as to a material breach of the Lease. In addition, Equitable notes that Plaintiffs do not seek payment of the unpaid royalties, presumably because those royalties have already been deposited with the Court Registry System pursuant to the December 3, 1999 district court order. Plaintiffs instead merely reference the unpaid royalties as grounds for terminating the Lease. 21 Under Kentucky law, in the event of nonpayment of royalties, a lease at most permits an unpaid lessor to seek to recover a deficiency, rather than forfeit the lease, absent clear language to the contrary. Kelley v. Ivyton Oil & Gas Co., 265 S.W. 309, 311 (Ky. Ct. App. 1924) ([A] forfeiture of the lease will not be decreed because of arrears of rent or royalty except upon clear language in the lease providing therefor.) Further, Equitable notes, even if the lease permitted a forfeiture, [t]he least-favored of all forfeitures are those founded upon mere delay in the payment of money. Denniston v. Kenova Oil Co., 220 S.W. 1078, 1080 (Ky. Ct. App. 1920). Plaintiffs offer no authority in support of their claim that, under Kentucky law, mere nonpayment of royalties empowers a lessor to terminate a lease with or without clear language providing for such termination in the lease itself. Accordingly, our analysis will focus on the claim for which Plaintiffs do offer precedential support; namely, that a lessor may terminate a lease upon the lessee's breach of implied covenants to develop property.
22 Plaintiffs contend that the Lease included implied covenants of reasonable development, further exploration, market production, and protection from drainage. In doing so, Plaintiffs rely upon McMahan v. Boggess, 302 S.W.2d 592 (Ky. Ct. App. 1957); Gregory v. Sohio Petroleum Co., 261 S.W.2d 623 (Ky. Ct. App. 1953); Midland Gas Corp. v. Reffitt, 149 S.W.2d 537 (Ky. Ct. App. 1941); Swamp Branch Oil and Gas Co. v. Rice, 70 S.W.2d 3 (Ky. Ct. App. 1934); and Warfield Natural Gas Co. v. Allen, 59 S.W.2d 534 (Ky. Ct. App. 1933). Specifically, Plaintiffs argue that under the prudent operator standard, the lessee owes a duty of diligence which would be reasonably expected of an operator of ordinary prudence, having due regard for both the interest of the lessee and the interest of the lessor. McMahan, 302 S.W.2d at 594.Plaintiffs maintain that a question of material fact exists as to whether Equitable and its predecessors, by merely making one $200 annual payment on one producing well on the property, failed to operate the Lease with due regard for the interest of Plaintiffs. 23 In McMahan, the Kentucky Court of Appeals noted that it is recognized in Kentucky that in leases of this nature there is an implied obligation to develop the leasehold in good faith and with reasonable diligence. See 302 S.W.2d at 593 (citations omitted; emphasis added). The lease in McMahan was an oil and gas lease that required the lessees to begin drilling within one year or pay a delay rental of $1 per acre. The term of the lease was five years and for so long thereafter as gas or oil was produced. The leases in Gregory, Midland Gas, and Swamp Branch were also of the nature of theMcMahan lease, in that each provided a specified lease term, followed by an indefinite extension of the lease term in the event that gas or oil was being produced. 24 Equitable distinguishes the leases in the McMahan line of cases as production, rather than flat-rate, leases, a distinction at issue in Bruen v. Columbia Gas Trans. Corp., 426 S.E.2d 522 (W.Va. 1992). In Bruen, the West Virginia Supreme Court of Appeals found that for flat-rate leases, a lessor's duty is merely to pay the flat rate, rather than develop the lease as required under production leases. Specifically, the court opined that if an oil and gas lease contains a clause to continue the lease for a term 'so long thereafter as oil and gas is produced,' but also provides for 'flat-rate' rental payments, then quantity of production is not relevant to the expiration of the term of the lease if such 'flat-rate' rental payments have been made by the lessee. Id. at 527. As an example of a flat-rate rental payment, Bruen described a lease in which the rental payment had no relation to the quantity of gas contemplated or actually produced. It was compensation fixed in advance of production and without any definite knowledge as to what the production would be. Hence, the rental reserved was the same for wells of light production and wells of heavy production. Id. at 525 (citation and emphasis omitted). 25 In the matter at hand, the district court, although not citing Bruen, mirrored its reasoning: Plaintiffs' implied covenant claim could not warrant relief because the lease at issue provides for the payment of a royalty of $200 per year, rather than on production. Thus, the abundance of oil and gas, or lack thereof, produced on the real property at issue has no bearing on this action. (J.A. at 600-01.) 26 Plaintiffs respond that the fixed royalty payment does not exclude operation of implied covenants under the Lease. However, Plaintiffs' case law support for this claim consists of the McMahan line of cases discussed above, which all involved leases whose rental payments were tied to production levels. See Gregory, 261 S.W.2d at 624 (royalty interest in seven-eighths of oil produced from entire leasehold); Midland Gas, 149 S.W.2d at 537 (gas royalty of one-eighth of sale price for all gas sold and marketed from the premises); and Swamp Branch, 70 S.W.2d at 4 (royalty of one eighth of all gas from every well drilled on premises, the product from which is marketed and used off the premises). Moreover, the lease inMcMahan expressly required lessees to begin drilling within one year or otherwise pay a delay rental of $1 per acre.McMahan, 302 S.W.2d at 593; see also Union Gas & Oil Co. v. Gillem, 279 S.W. 626, 627 (Ky. Ct. App. 1925) (requiring lessee to begin drilling within one year or pay a delay rental of ten cents per acre). 27 Nevertheless, the Lease in this case also included production clauses similar to those in the McMahan line of cases. Specifically, the Lease provided for a royalty of one-eight [sic] part of all oil produced . . . from the leased premises, as well as a requirement to locate and commence a well on said premises within three months . . . or pay . . . [$1] per acre annually. (J.A. at 697.) These production components of the Lease cast doubt on the district court's finding that the abundance of oil and gas, or lack thereof, produced on the real property at issue has no bearing on this action. (J.A. at 600-01.) Moreover, the sharp flat-rate/production distinction highlighted by Equitable was made under West Virginia, not Kentucky, law. 28 Accordingly, because Equitable has not produced any Kentucky authority for the position that implied covenants do not operate under a lease that includes a fixed rental payment, even when that lease also includes royalties tied to production, we question the district court's finding, as a matter of law, that no implied covenants were in operation under the Lease. However, we may affirm on any grounds supported by the record, even if different from the grounds relied on by the district court. United States v. Allen, 106 F.3d 695, 700 n. 4 (6th Cir. 1997). Because, as discussed below, we find Plaintiffs' implied covenant claim unavailing on grounds of failure to provide notice to, or make demand of, Equitable regarding any implied covenant, we affirm the district court's ultimate award of summary judgment. 29 Plaintiffs have failed to show a genuine issue of fact as to their satisfaction of the clear requirement under Kentucky law that notice be provided to, or demand be made of, Equitable regarding the need to comply with an implied covenant: 30 It is well settled law of this jurisdiction that where the right to have a lease forfeited for breach of the implied covenant to develop the property diligently and prudently is asserted, the lessor must have put the lessee in default by making definite and unequivocal demand of him that he do so within a reasonable time, or by giving that character of notice that compliance with the implied covenant is required. That is a condition precedent to the maintenance of a suit to forfeit, and the burden is upon the lessor to prove it. 31 Sapp v. Massey, 358 S.W.2d 490, 492 (Ky. Ct. App.1962). 32 Plaintiffs contend that two letters contained in the record, one dated August 24, 1995, from the widow of George Hoover, and one dated January 15, 1996, from Margaret Hayes, daughter of George Hoover, provided Equitable with requisite notice. However, these letters only alleged nonpayment of royalties, without any mention of implied covenants. Plaintiffs have offered no evidence of any notice to, or demand of, Equitable regarding any implied covenant. [Where] the lessor did not, at any time, demand that the lessee begin operations and give [lessee] a reasonable opportunity to do so . . . there is no basis for the contention that the lease in question was forfeited because of the lessee's failure to begin operations. Ohio Valley Oil & Gas Co. v. Irvin Dev. Co., 212 S.W. 110, 111 (Ky. Ct. App. 1919). 33 Accordingly, under Sapp and Ohio Valley, we find that no genuine issue of material fact exists as to whether Plaintiffs gave notice to, or made demand of, Equitable regarding the need to comply with any implied covenant. Plaintiffs thus cannot forfeit the Lease on grounds of Equitable's purported breach of implied covenants because Plaintiffs have produced no evidence that they satisfied the condition precedentfor forfeiting a lease on those grounds. Sapp, 358 S.W.2d at 492. The district court therefore did not err in finding that no genuine issue of fact existed as to whether Plaintiffs may terminate the Lease under Kentucky law. 34 Nevertheless, Plaintiffs offer an alternative argument in favor of their power to terminate the Lease. UnderMid-Southern Toyota, Ltd. v. Bug's Imports, Inc., 453 S.W.2d 544 (Ky. Ct. App. 1970), the Lease, being of indefinite duration, may be terminable after a reasonable period of time. Mid-Southern Toyota noted the general rule that courts avoid finding a right in perpetuity unless contract language is unequivocal. Id. at 549. The court in Mid-Southern Toyota then applied the rule, especially applicable to distributorship contracts . . . that the contract is terminable after a reasonable time. Id. (citation omitted). Kentucky courts have also applied this rule in the more general context of business contracts.Elec. & Water Plant Bd. v. S. Cent. Bell Tel. Co., 805 S.W.2d 141, 143 (Ky. Ct. App. 1990). 35 First, Plaintiffs fail to address why this Court should apply a Kentucky business contract rule to a lease of real property. Second, the duration provision at issue is distinguishable from the provisions found to be indefinite in Mid-Southern Toyota and South Central Bell, because the Lease in this case terminates upon a particular event. Specifically, the Lease provides that it shall remain in force for the term of ten years from this date and as long thereafter as oil or gas, or either of them, is produced from said land by the Lessee. (J.A. at 697.) In contrast, the distributorship contract in Mid-Southern Toyota provided a term of one year, renewable after that one year term so long as a certain sales level was met, at which point the contract became of indefinite duration. Mid-Southern Toyota, 453 S.W.2d at 549. The business contract in South Central Bell provided that notwithstanding termination of a joint use agreement, this agreement shall remain in full force and effect with respect to all [utility] poles jointly used by the parties at the time of such termination. S. Cen. Bell, 805 S.W.2d at 143. The court in South Central Bell then noted that the provision provide[d] no time period for the agreement pertaining to the original [utility] poles to end. Id. Similarly, the court in Brownsboro Road Restaurant, Inc. v. Jerrico, Inc., 674 S.W.2d 40, 41 (Ky. Ct. App. 1984), which applied Mid-Southern Toyota to a franchise agreement, noted that there was nothing in the agreement indicating that the parties intended it to terminate upon any particular time or event. 36 Even if we were to apply a Kentucky business contract rule to a lease of real property in this case, Plaintiffs have also failed to argue in support of applying Mid-Southern Toyota to a lease that terminates upon a particular event, specifically, the lessee's failure to produce oil or gas on the property. Because Plaintiffs have not addressed why this Court should apply the Mid-Southern Toyota rule to a lease of real property, or to any contract that terminates upon a particular event, we find unavailing Plaintiffs' claim that the Lease was terminable after a reasonable time. 37 Accordingly, because Plaintiffs offer no evidence of notice to, or demand of, Equitable regarding implied covenants to develop the property, and because Plaintiffs offer no argument as to why Mid-Southern Toyota should apply to a lease of real property that terminates upon a particular event, the district court did not err when finding no genuine issue of material fact regarding Plaintiffs' power to terminate the Lease under Kentucky law.