Early in December the Texas Supreme Court heard oral argument in three cases in which the Court likely will render provide important guidance as to key issues for contract interpretation and the interplay between contract and fraud claims.
The field of conflict is a familiar one. Two sophisticated parties, represented by able counsel, sign a multi-page single-spaced contract containing all the usual provisions, including a merger clause, disclaimers of reliance, and other prose designed to ensure that any post-execution disputes are determined according to the words of the contract and involve only contractual remedies.
When a dispute arises, one party asserts that the written contract doesn’t (or at least doesn’t fully) evidence the parties’ real agreement; that promises were given, and/or representations made, that weren’t in the written agreement, and may even contravene the text. Tort claims are asserted; punitive damages are sought.
The defendant points to contractual disclaimers of liability and limitations of remedies and damages.
It’s not as if the field hasn’t been plowed. The Texas Supreme Court has addressed such issues many times in the past three decades. In Southwestern Bell Telephone Co. v. DeLanney and Jim Walter Homes, Inc. v. Reed, the Court ruled that extra-contractual tort remedies will not apply and tort damages are not recoverable where the obligation arose out of the contract and any loss is to the subject matter of the contract (a doctrine commonly but mistakenly truncated as the “economic loss rule”).
In Formosa Plastics Corp. USA v. Presidio Engineers & Contractors, Inc., the Court held that tort remedies and damages nevertheless remain available where the contract was induced by fraud. In Schlumberger Technology Corp. v. Swanson and Forest Oil Corp. v. McAllen, the Court held that contractual disclaimers can preclude fraudulent inducement claims if the parties, with sufficient specificity, evidence an intent to waive such claims or disclaim reliance on representations about the specific issue in dispute; in Italian Cowboy Partners v. Prudential, the Court erected a boundary on such disclaimers by holding that exculpatory language that amounted to nothing more than a merger clause will not suffice.
In National Property Holdings v. Westergren, Grant Thornton v. Prospect High Income Fund, and most recently in JPMorgan Chase Bank v. Orca Assets, the Supreme Court held that even in the absence of sufficiently-comprehensive disclaimers, a party may not successfully claim reliance on extra-contractual statements if the alleged representation or promise directly conflicts with the expressed contract language or if “red flags” render such reliance unreasonable.
The trilogy of cases argued in early December — Mercedes-Benz v. Carduco, Barrow-Shaver Resources Co. v. Carrizo Oil & Gas, Inc., and IBM v. Lufkin Industries, Inc. — collectively involve all of those issues and more.
Barrow-Shaver included several of the issues in a single case. Carrizo, the lessee under a mineral lease, signed a farmout agreement with Barrow-Shaver (“BSR”). During negotiations, Carrizo’s representative sent a draft of the agreement that included a provision requiring Carrizo’s consent for any assignment of the agreement; the draft language further provided that Carrizo’s consent “shall not be unreasonably withheld.”
But as the parties continued to exchange drafts, Carrizo’s representative struck the latter clause; thus the signed farmout agreement contained the consent-to-assign restriction but was silent as to any restrictions on withholding consent.
When BSR received an offer of more than $27 million for the transfer of the farmout, Carrizo refused to give consent, offering instead to sell the lease to BSR for $5 million. At trial, the jury found against Carrizo on all of BSR’s claims–breach of contract, fraud, and tortious interference—and the court entered judgment for BSR for the $27 million amount.
The Tyler Court of Appeals reversed and rendered a take-nothing judgment. The deletion and resulting omission of the reasonable-consent requirement set the stage for three issues argued before the Supreme Court.
First was the admissibility of evidence of deleted text. The District Court refused to allow evidence of the parties’ negotiations, including the four drafts of the agreement; the Court of Appeals disagreed, finding that the excluded information constituted evidence of circumstances surrounding the execution of the farmout, traditionally admissible for consideration by the court in determining whether a contract is ambiguous.
At oral argument, BSR contended among other things that deletion of text doesn’t necessarily mean that the parties intended its converse—especially in this situation, where Carrizo both proposed and thereafter struck the reasonable-consent provision, and theoretically could have done so precisely to set up a subsequent argument that its consent could properly be arbitrarily withheld.
The Texas Supreme Court has never definitively ruled on admissibility of “text in the trash” as an aid to contract construction or interpretation.
Next was the issue of evidence of custom and usage, proffered at trial by both parties. After hearing expert and fact witness evidence on the subject, the jury found that Carrizo breached the farmout agreement because “there was a custom and usage in the oil and gas industry that a consent to assignment not be unreasonably withheld.” The Court of Appeals did not reach the question because of its determination that the farmout agreement unambiguously allowed for arbitrary refusal of consent.
At the Supreme Court, BSR argued that “consent” was a term to be interpreted according to industry usage, and that the jury should decide what it meant before the trial court decided whether the contract was ambiguous; Carrizo countered that “consent” has a plain meaning and that BSR’s evidence of industry usage would contradict that meaning.
Finally, concerning its fraud claim, a BSR witness testified that Carrizo’s representative assured him three times during the contract negotiations that Carrizo would give its consent to an assignment of the farmout agreement.
The Court of Appeals held that the oral promise was directly contradicted by the consent requirement, with the result that there was no evidence of justifiable reliance, a requisite for a fraud claim based on the oral promise. At oral argument before the Supreme Court, Carrizo also argued that the deletion of the reasonable-consent requirement and the surrounding discussions amounted to “red flags” likewise negating any justification for reliance on the alleged oral representation.
Carduco, argued on the same day as Barrow-Shaver, also involves the issue of an extra-contractual promise allegedly contradicted by the written contract.
Plaintiff Carduco purchased a Mercedes dealership in Harlingen, allegedly counting on Mercedes’ promised approval of its intention to move the dealership to McAllen—when Mercedes was already working to put another dealer in a new franchise in McAllen.
The jury found Mercedes liable for fraud in the inducement and awarded Carduco more than $21 million in damages. The Court of Appeals rejected Mercedes’ contention that Carduco’s dealership agreement, which included an acknowledgment that Mercedes could add new dealers in the dealer’s area of interest, negated justifiable reliance on an oral representation that Mercedes’ representatives were not aware of any plans to assign another franchise to the area because did not directly contradict such representations.
Carduco and the third case in the trilogy, IBM v. Lufkin, both turned in part on the sufficiency of disclaimers of reliance. The Texas Supreme Court in Schlumberger held that “… a disclaimer, where the parties’ intent is clear and specific, should be effective to negate a fraudulent inducement claim. As an example, a disclaimer of reliance may conclusively negate the element of reliance, which is essential to a fraudulent inducement claim.”
In its dealer agreement Carduco acknowledged that no extra-contractual representations were made by Mercedes and “… no such representations or statement were relied upon by Carduco in executing the contract.”
The Court of Appeals concluded that such language did not clearly and unequivocally disclaim reliance—for reasons including that the language was “boilerplate,” and there was no evidence that it was negotiated by the parties; and (in the court’s view) the disclaimer did not address the specific matter in question — Carduco’s intended move to McAllen — because there was no evidence that the move had been in dispute when the dealer agreement was executed.
In IBM v. Lufkin, the dispute involved IBM’s installation of an Enterprise Resource Planning system; IBM was accused of having induced Lufkin to execute a Statement of Work (“SOW”) for the project by representing that its software was already eighty percent configured, when in actuality the functionality desired by Lufkin proved to require substantial customization; and similarly induced Lufkin to execute subsequent change orders by representing that the system would function as promised.
The SOW included Lufkin’s statement that it was “not relying on any representation made by … IBM that is not specified in … this SOW ….” But because the SOW also contained IBM’s acknowledgment that Lufkin’s staff had shared with IBM information that was “the basis for our understanding of this proposal …,” the Court of Appeals held that such exchange of information was “‘specified’ and incorporated in the SOW” — and, thus, that Lufkin had not effectively disclaimed reliance on pre-contract oral representations.
A final issue that frequently arises in cases such as the early-December trilogy is whether tort remedies are available and tort damages recoverable in light of the parties’ contractual relationship.
In IBM v. Lufkin, the Court of Appeals held that Lufkin’s fraudulent inducement claim was not barred by the so-called economic loss rule because of IBM’s common-law duty not to fraudulently induce Lufkin to execute the SOW. That conclusion would seem to flow logically from Formosa Plastics and its progeny—except that, again, Lufkin avoided disclaimers by contending that pre-contract representations had been expressly incorporated into the SOW; under that circumstance, it could be argued that Lufkin’s loss was indeed to the subject matter of the contract.
In sum, the Texas Supreme Court’s rulings in the early-December trilogy will likely include significant pronouncements on several issues material to contract and fraud claims:
- • The admissibility of evidence of industry custom or industry usage in construing a contract—in particular, when such appears to vary or contradict the express language of the contract—and whether it makes a difference if such evidence is deemed to involve an industry custom being applied to a practice or industry usage applied to a term.
• The admissibility and utility of evidence of “text in the trash”—language deleted from earlier drafts, or proposed for inclusion but rejected—when determining the contracting parties’ intent.
• What constitutes a direct contradiction of alleged extra-contractual promises or representations by the express contract language, sufficient to preclude tort claims based on those promises or representations.
• The degree of specificity required for a contractual disclaimer of reliance that successfully negates the reliance element of a fraud claim.
• The circumstances under which the breach of a promise or falsity of a representation contained within the contract will support “contort” liability.
T. Ray Guy is a Litigation partner and head of Litigation practice in the Dallas office of Weil, Gotshal & Manges. Guy concentrates his practice on the trial and supervision of civil litigation in federal and state courts and in arbitrations.