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SCOTX Issues Another Key Decision for Interpreting Oil-and-Gas Contracts

The Texas Supreme Court, beginning in 2017, began issuing a number of decisions altering the analysis for the interpretation of oil-and-gas agreements, principally mineral leases and conveyances. I wrote about many of these opinions as they were released:

In December of last year, the Texas Supreme Court heard oral arguments in Barrow-Shaver Resources Co. v. Carrizo Oil & Gas Inc., another case involving the construction of an oil-and-gas contract. I previously wrote about the Barrow-Shaver litigation, when it was the subject of a decision handed down by the Tyler Court of Appeals. As I explained in my earlier post:

The parties had entered into a farmout agreement that gave BSR [Barrow-Shaver Resources] the opportunity to earn mineral acreage from Carrizo upon drilling wells that produce in paying quantities. BSR, in turn, sought to assign its rights under the agreement to a third party, Raptor Petroleum. Carrizo withheld consent for the assignment, however, and—according to BSR—had no reasonable basis for doing so. Indeed, BSR went so far as to accuse Carrizo of extortion, inasmuch as Carrizo allegedly demanded a $5 million payment in exchange for its consent.

In draft form, the parties’ agreement included the following provision: "The rights provided to BSR under this Letter Agreement may not be assigned, subleased or otherwise transferred in whole or in part, without the express written consent of Carrizo, which consent shall not be unreasonably withheld." (Emphasis added.) In its final form, however, the agreement was revised to delete the emphasized language. According to Carrizo, by striking this clause, the parties understood that Carrizo could withhold consent for any reason or, for that matter, for no reason at all.

Additionally, BSR had presented compelling expert testimony that Carrizo's attempt to charge $5 million, in exchange for its consent, was inconsistent with long-standing industry custom and practice. The Court of Appeals in Tyler sided with Carrizo—and, last month, the Texas Supreme Court affirmed by a thin, 5-4 majority.

There are at least two core takeaways from the decision:

  1. Prior drafts and the parties' negotiations are off limits. The majority held that courts cannot consider the parties' prior negotiations when construing an unambiguous contract. On this score, the final agreement between BSR and Carrizo provided only that there could be no assignment without Carrizo's consent. This alone (without considering the deletion of the draft language emphasized above) is enough to show that Carrizo was under no obligation to refrain from unreasonably withholding its consent. This represents a departure from Wenske and Murphy, where the Court was gravitating toward surrounding circumstances and away from strict plain-language constructions.
  2. Industry custom and practice are likewise out of play. When a contract is unambiguous, according to the majority in Barrow-Shaver, parties cannot introduce evidence of industry custom and practice "to alter or contradict the terms" of the contract (as BSR had done in the trial court). At the same time, however, the Court explained that custom-and-practice evidence might be admissible to "inform the meaning of words that carry their plain meaning in some contexts, but may also carry a special meaning in the context of a particular industry." This is in tension with the Court's prior pronouncements in Wenske and Murphy, where the significance of terms of art had been downplayed.

In short, the law in Texas surrounding the interpretation of oil-and-gas contracts has been a shifting landscape over the last several years. Rulings out of the Texas Supreme Court have not necessarily been models of clarity, and there are some obvious disconnects between Barrow-Shaver, on the one hand, and Wenske and Murphy, on the other.