Do I Have to be Reasonable?: The Right to Arbitrarily Restrict Transfer of Occupancy and Mineral Leases

DO I HAVE TO BE REASONABLE?: THE RIGHT TO ARBITRARILY RESTRICT TRANSFER OF OCCUPANCY AND MINERAL LEASES BLAKE A. WATSON * You desire to enter into a long-term commercial lease and are equally interested in four available sites. The terms of the proposed leases are identical except as to the right to transfer: Lease 1: This lease may not be assigned, subleased, or otherwise transferred. Lease 2: This lease may not be assigned, subleased, or otherwise transferred without the consent of the lessor, which the lessor may withhold in its sole discretion. Lease 3: This lease may not be assigned, subleased, or otherwise transferred without the consent of the lessor. Lease 4: This lease may be assigned, subleased, or otherwise transferred with the consent of the lessor. You are also a landowner with two offers to lease your land for oil and gas development. Both proposed leases initially contain the following provision: “This lease may be assigned, subleased, or otherwise transferred.” In response, you countered with language that says, “This lease may not be assigned, subleased, or otherwise transferred without the consent of the lessor, which the lessor may withhold in its sole discretion .” Neither prospective lessee, however, is willing to accept this italicized language and after further negotiations, you are presented with the following two choices: Lease A: This lease may not be assigned, subleased, or otherwise transferred without the consent of the lessor. Lease B: This lease may not be assigned, subleased, or otherwise transferred without the consent of the lessor, which consent shall not be unreasonably withheld. What to do? As a tenant, you should select the commercial lease that least restricts your ability to transfer. 1 But do any of these leases actually Copyright © 2019, Blake A. Watson. * Professor of Law at the University of Dayton School of Law. All writings and mistakes are the author’s own. 28 CAPITAL UNIVERSITY LAW REVIEW [47:27 restrict the right to withhold consent? Lease 1 expressly prohibits transfers, but the lessor could choose to waive the provision. 2 The other three leases suggest that transfers are permitted, but Lease 2 makes it clear that the decision to approve a transfer request is left in the lessor’s “sole discretion.” 3 As discussed below, 4 some states have held that the lessor’s veto power in Lease 3 and Lease 4 is constrained by an implied “reasonableness” standard. 5 Other states, however, continue to adhere to the traditional view that the lessor, in both Lease 3 and Lease 4, “may arbitrarily withhold his assent without giving any reasons, and in granting his assent may impose such conditions as he sees fit.” 6 In the “traditional” states, consequently, all four leases are the same; the lessor has total control over whether to permit a transfer. The choice between the two oil and gas leases appears more straightforward. As a landowner, you want to maximize your control over the transfer of the oil and gas lease and therefore would select Lease A, 1 You would likely prefer a lease that expressly states the “lease may be assigned, subleased, or otherwise transferred.” Prospective lessors, however, will not agree to an unrestricted transfer right. 2 See Susan E. Myster, Protecting Landlord Control of Transfers: The Status of “Sole Discretion” Clauses in California Commercial Leases , 35 SANTA CLARA L. REV. 845, 877 (1994–95) (noting that, if the lease contains a provision prohibiting a transfer, “the landlord would be free to unilaterally waive this provision.”). 3 See Nev. Atl. Corp. v. WREC Lido Venture, LLC, No. G039825, 2008 WL 5065977, at *1 (Cal. Ct. App. Dec. 2, 2008) (the lease gave the landlord the right to withhold consent to a proposed assignment “for any reason whatsoever or for no reason.”). 4 See infra Section IV. 5 See, e.g. , Dick Broad. Co. v. Oak Ridge FM, Inc., 395 S.W.3d 653, 656–57 (Tenn. 2013) (“[W]here . . . the agreement is silent regarding the anticipated standard of conduct in withholding consent, an implied covenant of good faith and fair dealing applies and requires the non-assigning party to act with good faith and in a commercially reasonable manner . . . .”). 6 Abrahamson v. Brett, 21 P.2d 229, 232 (Or. 1933). See also infra Section III (The lessor with absolute discretion to grant or withhold consent can choose to condition consent on the payment of a “transfer” fee or an upward adjustment of the rent; this would not be permitted if the right to withhold consent is subject to a reasonableness standard); Julian v. Christopher, 575 A.2d 735, 739 (Md. App. 1990) (“Where, as alleged in this case, the refusal to consent was solely for the purpose of securing a rent increase, such refusal would be unreasonable unless the new subtenant would necessitate additional expenditures by, or increased economic risk to, the landlord.”). Under the traditional view, the lessor in Lease 3 is telling the lessee “you cannot transfer unless I say you can,” whereas the lessor in Lease 4 is telling the lessee “you can transfer unless I say you cannot.” The end result is the same. See, e.g. , Friedman v. Thomas J. Fisher & Co., 88 A.2d 321, 322–23 (D.C. Mun. Ct. 1952) (the effect of a typewritten provision that the lessee may sublet with consent was the same as the printed provision that the lessee shall not sublet without consent). 2019] ARBITRARILY RESTRICTING MINERAL LEASE TRANSFERS 29 which does not include a reasonableness standard. There are, however, two potential problems. First, it is possible that any constraint on the transferability of a mineral lease will be held invalid as an impermissible restraint on alienation. 7 If so, the negotiations regarding the right to transfer are pointless! Second, even if the clause is a permissible restraint on alienation, in states that imply a reasonableness standard, an argument can be made that the only difference between Lease A and Lease B is that the reasonableness standard in the latter lease is expressly stated rather than implied. It is thus possible that Lease A—despite the absence of a reasonableness standard—grants precisely the same transfer rights as Lease B! This article addresses the right to arbitrarily restrict the transfer of occupancy and mineral leases. 8 With respect to occupancy leases, the emphasis will be on commercial leases, although the arbitrary restriction of 7 See generally, e.g. , Shields v. Moffitt, 683 P.2d 530 (Okla. 1984). In Shields , the issue was “whether . . . [a] clause in the oil and gas lease which provides that the lease may be assigned only with the written consent of the lessors constitutes an unlawful restraint on alienation which renders the restrictive clause void.” Id. at 532. The Court held that the clause in question is “void and of no force or effect.” Id. at 533. See also infra Section II. 8 The right to act arbitrarily is equated with the right to act unreasonably. See Slavin v. Rent Control Bd., 548 N.E.2d 1226, 1228 (Mass. 1990) (“A majority of jurisdictions subscribe to the rule that a lease provision requiring the landlord’s consent to an assignment or sublease permits the landlord to refuse arbitrarily or unreasonably.”). See also Gamble v. New Orleans Hous. Mart, Inc., 154 So.2d 625, 626 (La. App. 1963), writ refused , 156 So.2d 229 (La. 1963) (describing a silent consent clause as giving the lessor “the arbitrary and absolute right, without any reason and even in bad faith, to refuse to give the permission required by the provision.”); Henry Conklin & Sons, Inc. v. Conklin, No. 14-80-19, 1982 WL 6741, at *4 (Ohio Ct. App. Mar. 1, 1982) (stating that, under a silent consent clause, “[T]he lessor has the full and arbitrary right to refuse to give his consent irrespective of the character of the proposed assignee and although actuated by mere caprice or whim.”); Paul v. Bd. of Zoning Appeals, 110 A.2d 619, 621 (Conn. 1955) (“‘Arbitrary’ means ‘[d]epending on will or discretion,’ that is, not governed by any fixed rules or standards.”). The lease may expressly state that the consent may be withheld “for any reason,” “unreasonably,” “arbitrarily,” or in a party’s “sole discretion.” The lessor is the sole arbiter of the transfer request. Additionally, the right to arbitrarily withhold consent does not confer total freedom of choice . See William G. Coskran, Assignment and Sublease Restrictions: The Tribulations of Leasehold Transfers , 22 LOY. OF L.A. L. REV 405, 423 (1988–89) (noting that even a sole discretion standard “does not allow the lessor total freedom. For example, he or she cannot engage in prohibited discrimination.”). See also Nev. Atl. Corp. , 2008 WL 5065977, at *6 (“A landlord exercising sole discretion in considering an assignment cannot make the decision based on illegal grounds.”); Forest Lake Facilities, LLC v. Wells Fargo Bank, N.A., No. 17-1766, 2017 WL 4736716, at *2 (D. Minn. Oct. 19, 2017) (even though the mortgage gave the lender “sole discretion” to withhold consent to lease modifications, in light of allegations of bad faith, the Court concluded that the breach of contract claim could not be resolved on a motion to dismiss). 30 CAPITAL UNIVERSITY LAW REVIEW [47:27 residential lease transfers will also be discussed. With regard to mineral leases, the focus will be on oil and gas leases and related agreements. 9 There are two overarching issues. First of all, is there a right to arbitrarily restrict lease transfers? Part I of this article examines why a party to an occupancy lease would want the absolute right to veto transfers, and discusses whether parties should be permitted to bargain for such a right. Residential and commercial leases that contain “sole discretion” clauses have been upheld in the past, and are endorsed by the Restatement (Second) of Property, which states that a landlord can unreasonably withhold consent to lease transfers if “a freely negotiated provision in the lease gives the landlord an absolute right to withhold...