6Aug

Supreme Court Splits Over Use of Expert Testimony and Other Extrinsic Evidence When Construing Obligations in Oil and Gas Agreements

Barrow-Shaver Res. Co. v. Carrizo Oil & Gas, No. 17-0332, 2019 Tex. LEXIS 688 (June 28, 2019)

On June 28, 2019, a divided Texas Supreme Court issued its opinion in Barrow-Shaver Resources Company v. Carrizo Oil & Gas, LLC, a decision that will impact what evidence a court can consider in oil and gas contract disputes and possibly how oil and gas agreements are negotiated and drafted. The Court discussed the line between admissible evidence of “surrounding circumstances” and inadmissible parol evidence, when prior drafts and the use of expert testimony regarding industry custom and usage is offered to construe an unambiguous agreement. The Court also discussed the use and function of “consent-to-assign” provisions and the inability to rely on oral representations that conflict with the terms of a written agreement.

The Texas Supreme Court held that Carrizo Oil & Gas, LLC (“Carrizo”) did not breach a farmout agreement by withholding consent to an assignment sought by Barrow-Shaver Resources Company (“BSR”), even if Carrizo’s refusal to provide that consent was unreasonable, because the parties’ agreement did not restrict Carrizo’s ability to withhold consent. The Supreme Court also concluded that Carrizo did not fraudulently induce BSR into signing the agreement, even if Carrizo had orally promised that it wouldn’t unreasonably withhold consent, because BSR cannot justifiably rely on Carrizo’s alleged promise when that promise is not included in the written agreement.

General Overview

The dispute focused on a “consent-to- assign provision” in a farmout agreement. A prior draft of the agreement provided BSR must obtain Carrizo “written consent” prior to an assignment, but that “consent shall not be unreasonably withheld.” However, the final agreement did not contain any restriction on Carrizo’s ability to withhold consent. When BSR attempted to assign its interest in the agreement, Carrizo demanded $5 million. BSR claimed that Carrizo breached the agreement by unreasonably withholding its consent or, in the alternative, fraudulently induced BSR to enter into an agreement that did not expressly provide that consent could not be unreasonably withheld by promising that consent would be provided. BSR argued that a prohibition on unreasonably withholding consent should be implied into the agreement based on, at least in part, expert testimony that the custom and usage in the oil and gas industry is to imply into the agreement that consent cannot be unreasonably withheld. Carrizo argued, among other things, the removal of “consent shall not be unreasonably withheld” from the draft agreement evidences the parties’ intent to contract around any sort of implied obligation.

A divided Supreme Court issued three separate opinions – a majority opinion authored by Justice Green, a concurring and dissenting opinion authored by Justice Guzman, and a dissent authored by Justice Boyd. The three opinions primarily disagree on what evidence is appropriate for the trial court to consider when determining whether Carrizo breached the agreement by withholding consent. All three opinions agreed the agreement is unambiguous. The majority concluded that the parol evidence rule bars admission of both the prior drafts and expert testimony of industry custom and usage. The concurring and dissenting opinion would have permitted evidence of the industry custom and usage, but agreed the prior drafts must be excluded under the parol evidence rule. The dissent would have allowed both the prior drafts and expert testimony for the purpose of determining whether industry custom and usage would prohibit a party from arbitrarily withholding consent and for purposes of determining whether BSR and Carrizo intended to contract around such a usage.

Background

Under the disputed farmout agreement, BSR could earn an interest in a 22,000-acre “Parkey Lease” owned by Carrizo in exchange for its services in drilling a producing oil and gas well. The parties negotiated the terms of the agreement, with particular attention being paid to a “consent-to-assign provision.” The original draft of the agreement provided by BSR included a provision providing that BSR could only assign with Carrizo’s written consent, but that “consent shall not be unreasonably withheld.” BSR objected to removing a restriction on Carrizo’s ability to withhold consent, but Carrizo allegedly orally represented that it would consent to a requested assignment, even if the language was not expressly in the agreement. Ultimately, the parties executed a farmout agreement that provided:

The rights provided to [Barrow-Shaver] under this Letter Agreement may not be assigned, subleased or otherwise transferred in whole or in part, without the express written consent of Carrizo.

BSR spent $22 million drilling a well, but had unsuccessful results. Raptor Petroleum II, LLC (“Raptor”) approached BSR and offered approximately $27 million for an assignment of BSR’s rights in the farmout. When BSR approached Carrizo to request written consent to the assignment, Carrizo responded by proposing to sell its interest in the Parkey Lease to BSR. BSR did not respond to this offer and Carrizo ultimately refused to consent to BSR’s proposed assignment to Raptor, causing Raptor’s offer to fall through.

BSR sued Carrizo for breach of contract, fraud, and other claims. Both parties agreed their agreement was unambiguous. BSR argued that the agreement was silent on whether Carrizo could withhold consent and sought to introduce expert testimony of the industry custom and usage to prove Carrizo breached the agreement by unreasonably withholding consent. Carrizo argued that it could withhold consent for any reason because the agreement excluded any express agreement that consent would not be unreasonably withheld.

The trial court excluded all evidence of the parties’ negotiations, but permitted both parties to offer expert testimony on the industry custom and usage of consent-to-assign provisions and whether such provisions would permit Carrizo to withhold consent. The jury returned a verdict for over $27,000,000. The court of appeals reversed the judgment and rendered a take nothing judgment against BSR, holding that the purposeful deletion of “shall not be unreasonably withheld” in the prior drafts “conclusively established” that the parties that Carrizo could withhold consent for any reason or no reason at all.

Consent-to-Assign Provisions

The Supreme Court agreed that the consent-to-assign provision was clear and unambiguous and concluded that the agreement can and should be construed based on its plain language. Two types of consent-to-assign provisions exist — those that restrict a party’s right to withhold consent and those that don’t. If a contract does not expressly restrict a party’s right to withhold consent, the Court will not imply any obligation to act reasonably or in good faith.

The farmout agreement required BSR to obtain Carrizo’s written consent before BSR could assign its interests to Raptor. There was no restriction on Carrizo’s ability to withhold consent. Therefore, the Court concluded that Carrizo could withhold consent for any reason or no reason. The Court rejected BSR’s argument that a duty to act reasonably or in good faith should be implied into the contract. Accordingly, Carrizo did not breach the contract by refusing to consent to the proposed assignment. The Supreme Court reasoned that to imply an obligation that Carrizo may not unreasonably withhold consent would be tantamount to rewriting the parties agreement.

The Line Between Surrounding Circumstances and Parol Evidence

The Supreme Court has previously held that Texas courts may properly consider “surrounding circumstances” evidence. However, the Supreme Court has cautioned, “there are limits.” See David J. Sacks, P.C. v. Haden, 266 S.W.3d 447, 450-451 (Tex. 2008). “Extrinsic evidence cannot be used to show that the parties probably meant, or could have meant, something other than what their agreement stated.” Anglo-Dutch Petroleum Int’l, Inc. v. Greenberg Peden, P.C., 352 S.W.3d 445, 451 (Tex. 2011). Under the banner of “surrounding circumstances” evidence, some Texas trial and appellate courts have admitted evidence of parties’ prior negotiations and evidence of industry custom and usage in the oil and gas industry for the purpose of construing unambiguous contracts. See e.g. PNP Petroleum I, LP v. Taylor, 438 S.W.3d 723 (Tex. App.—San Antonio 2014, pet. denied) (considering evidence of prior red-lined drafts of an unambiguous agreement and witness testimony).

The Court explained that it is proper to consider, as “surrounding circumstances,” that the parties were “sophisticated oil and gas entities” that were “represented by counsel” and their “experienced representatives considered and edited drafts of the agreement before coming to a final agreement.” The Court said that the surrounding circumstances provide that the consent-to-assign provision was a bargained-for exchange. This was all the Court held was proper to consider. Similarly, in Murphy Expl. & Prod. Co.-USA v. Adams, the Supreme Court held that it was proper to consider that a 2009 oil and gas lease was “drafted with horizontal shale drilling in mind,” therefore it was proper for the Court to keep “the realities of this type of drilling in mind” when interpreting the contract.” 560 S.W.3d 105, 110 (Tex. 2018).

The Court held that the court of appeals should not have considered substantive evidence of the parties’ negotiations, such as the red-lined drafts. The “parol evidence rule applies to writings that evidence the creation … of a right of obligation under the contract.” The Court held that the “evidence of the parties substantive negotiations directly relates to the creation of the parties’ unambiguous agreement,” therefore introduction of the evidence is barred by the parol evidence rule. The parties’ testimony of industry custom and usage was also held inadmissible. While trade usage can be a useful form of evidence in certain circumstances such as when language is “vocation or trade specific,” the Court held that if the language is plainly understandable then the parties should not be permitted to offer expert testimony that would contradict or add terms to an unambiguous agreement. The Court explained that expert testimony would “likely be appropriate” if construing the “unreasonably withheld,” but that it was inappropriate here because a requirement to obtain “written consent” is not industry specific and is clearly understood. The Court concluded that to accept the expert testimony offered by BSR “would make almost every term, word, or phrase in every agreement, and any obligation not in an agreement, susceptible to litigation and ultimately a jury determination based on competing expert testimony, regardless of clarity.”

Justifiable Reliance

The Court rejected BSR’s fraudulent inducement claim, holding that BSR could not have justifiably relied on Carrizo’s alleged oral representations that it would provide consent to an assignment, even if an express restriction was not in the contract. Relying on the 2018 opinion in JPMorgan Chase Bank, N.A. v. Orca Assets G.P., L.L.C., the Supreme Court held that a contradiction between an oral promise and a written agreement exists when the written agreement “conflicts with the earlier representation such that a reasonable person could not read the agreement and still plausibly claim to believe the earlier representation.”

The farmout’s omission of any limitation on Carrizo’s ability to withhold consent led the Court to conclude that BSR could not justifiably rely on Carrizo’s alleged oral representations that it would provide consent if requested when the agreement did not include any express restriction on Carrizo’s ability to withhold consent.

Chris Halgren
Chris represents clients in a wide variety of litigation matters. Chris strives to identify an aggressive, yet practical approach to accomplish his clients' needs, taking into account the particular legal and business issues presented. With horizontal drilling transforming the energy landscape across Texas, Chris developed an emphasis on oil and gas related matters. He has represented operators, non-operators, and landowners in a variety of disputes ranging from seismic misappropriation, leasing issues, royalty disputes, title litigation, lease termination, midstream accounting, and other related contractual disputes. Chris has been selected to the Texas Super Lawyers Rising Stars list, a Thomson Reuters service, (2014-2019).
Chris Halgren

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