AUSTIN – Continuing its deference to the plain language in a contract, a narrow majority of the Texas Supreme Court rejected a $27.7 million contract-breach and fraud verdict in a closely watched dispute over assignment of drilling rights under an oil and gas “farmout” agreement.
The court split 5-4 on the issue of whether industry custom and use should be considered in interpreting the contract, with the majority rejecting evidence of industry custom to import an obligation that does not exist in the contract.
Justice Eva Guzman, in a strongly worded dissent, accused the majority of ignoring “a centuries-old practice firmly rooted in our jurisprudence, recognized by learned treatises, and applicable to commercial contracts nationwide, including in Texas.”
Barrow-Shaver Resources Co. won the verdict from a Smith County jury against Carrizo Oil & Gas, which had demanded $5 million to sign off on a $27.7 million deal with Raptor Petroleum.
Carrizo was the only one of 32 affected parties that refused to sign off on the deal assigning development rights over 22,000 acres in North Texas’s Caddo Arch Bend. After drilling $22 million worth of dry holes in 2011, Barrow-Shaver had jumped at Raptor’s offer. When the deal fell through, Barrow-Shaver sued Carrizo for contract breach and fraud.
At trial, Barrow-Shaver and Carrizo agreed that the consent-to-assign clause was unambiguous, but differed on whether industry custom and usage implied that consent could only be withheld on a reasonable basis. The jury heard conflicting expert testimony on that issue.
The Supreme Court ruling upheld a 2017 decision from the Seventh Court of Appeals in Amarillo, which found that the contract was not ambiguous and that a clause requiring Carrizo to act reasonably was deleted during contract negotiations.
The case attracted numerous amicus letters from royalty owners and energy developers offering far different views of industry use and traditional regarding consent to assign clauses in farmout agreements. A farmout agreement is a contract between a working-interest owner and a drilling operator with no interest in the minerals until it completes its services under the agreement.
During oral arguments last December, Scott Brister said a ruling against his client Barrow-Shaver would result in less drilling, as a party with a small interest could blow up a deal by trying to “turn a pittance into a payday.” Brister is a former Supreme Court justice and current partner at Hunton Andrews Kurth.
Marcy Hogan Greer presented Carrizo’s case, arguing that the words in a contract matter. “Contract interpretation starts and ends where the parties had a meeting of the minds,” said Greer, an attorney with Alexander Dubos Jefferson & Townsend.
The majority agreed with Greer. Justice Paul Green delivered the court’s opinion, in which Justices Debra Lehrmann, John Devine, Jimmy Blacklock and Jeff Brown joined.
Green disputed Guzman’s assertion that the court’s holding allows Carrizo or a similarly situated party to extort a last-minute payment in exchange for consent.
“Our holding simply recognizes the obligations the contract imposes – Barrow-Shaver must obtain Carrizo’s consent if it wants to assign its contractual rights – and the obligations it does not impose – Carrizo need not provide a reason if it chooses not to consent, nor is Carrizo under any obligation when asked to give consent,” said Green. “Our holding does not run afoul of our long-established oil and gas principles.
Guzman was joined by Chief Justice Nathan Hecht and Justice Brett Busby in her concurring and dissenting opinion. She would have reversed and rendered judgment in Barrow-Shaver’s favor based on the jury’s finding that Carrizo breached the farmout agreement by failing to act in accordance with the consent provision as understood in the industry. She concurred with the majority’s rejection of Barrow-Shaver’s fraud claim.
“The Court’s insistence on characterizing the record contrary to the jury’s findings is equally alarming but ultimately proves the industry expects industry players to act reasonably in multi-million dollar energy transactions,” she said.
Justice Jeffrey Boyd wrote a separate dissent, saying he would remand the case for a new trial on both the breach-of-contract and fraud claims. He said the jury should hear all of the evidence regarding the parties’ negotiations and draft agreements to determine whether Carrizo and Barrow-Shaver mutually intended to incorporate a certain industry usage.
“I think it unlikely, if not implausible, that the Texas oil-and-gas industry honors a ‘usage or custom’ that prohibits a party from unreasonably withholding its contractually required consent,” said Boyd. “But Barrow-Shaver created a fact issue by alleging and submitting evidence that it does… And the jury agreed with Barrow-Shaver.”
The SCOTX case is No. 17-0332 Barrow-Shaver Resources Co. v. Carrizo Oil & Gas Inc.