The Supreme Court of Texas Affirms the Freedom of Contract

In January and February, the Supreme Court of Texas published two decisions
that focus squarely on the freedom of contract in the energy industry.

While the novel coronavirus continues (rightfully so) to garner all the headlines, it is worth highlighting some of the other legal news swirling around the state. In January and February, the Supreme Court of Texas published two decisions that focus squarely on the freedom of contract in the energy industry. “Perhaps no principle of law is as deeply ingrained in Texas jurisprudence,” one of the recent cases noted, “as freedom of contract.”

On Jan. 31, the first of these decisions was published: Energy Transfer Partners v. Enterprise Products Partners, No. 17-0862. The Energy Transfer decision addressed whether parties have freedom to contract for conditions precedent to partnership formation. In this case, two separate companies—Energy Transfer and Enterprise—agreed to work together to explore the viability of a pipeline project. However, “in three written agreements, they reiterated their intent that neither party be bound to proceed until each company’s board of directors had approved the execution of a formal contract.” Thereafter, the parties formed an integrated team to pursue the potential pipeline project and marketed the deal to potential customers as a “50/50 JV.” But after months of trying the deal never came together, and Enterprise ended its relationship with Energy Transfer. Thereafter, Enterprise entered into a different pipeline deal with different partners.

Energy Transfer sued, arguing “that despite the disclaimers in the parties’ written agreements, they had formed a partnership to ‘market and pursue’ a pipeline through their conduct.” Energy Transfer relied heavily upon Section 152.051(b) of the Texas Business Organizations Code (TBOC), which states that “an association of two or more persons to carry on a business for profit as owners creates a partnership, regardless of whether: (1) the persons intended to create a partnership; or (2) the association is called a ‘partnership,’ ‘joint venture,’ or other name.”

Enterprise countered that principles of freedom of contract governed the issue and suggested “that if parties cannot by contract protect themselves from the creation of an unwanted partnership, detrimental economic consequences to the state and constant litigation will ensue.”

The Supreme Court of Texas sided with Enterprise, holding “that parties can conclusively negate the formation of a partnership under Chapter 152 of the TBOC through contractual conditions precedent.” The Supreme Court noted there was no evidence that Enterprise disavowed the agreements that required board-of-directors-approved contracts.

On Feb. 28, the second of these decisions was published: Chalker Energy Partners III LLC v. Le Norman Operating LLC, No. 18-0352. The Chalker decision addressed whether an email exchange constituted the meeting of minds required for contract, in light of the nature of the transaction and the parties’ expressed contemplations. Specifically, Chalker (through its agent) was using a virtual data room to sell certain oil and gas assets. Potential bidders were given access to the data room only after signing a confidentiality agreement, which contained a “no obligation” clause that generally provided that no contract shall be deemed to exist between Chalker and a buyer unless and until a definitive agreement has been executed and delivered. After signing the confidentiality agreement, Le Norman Operating made a bid for the assets, subject to the execution of a mutually acceptable purchase and sale agreement. The other high bidder was Jones Energy. Both bids were ultimately rejected.

Chalker then offered to sell 67% of the assets. In response, Le Norman Operating emailed a bid for the assets to Chalker’s agent, which bid included the requirement that a PSA similar to the one contemplated in the previous bid be executed. Chalker decided to accept the deal and its agent emailed Le Norman Operating that the seller was “on board to deliver 67% subject to a mutually agreeable PSA.”

Undeterred, Jones Energy presented Chalker with a new offer, which was accepted by Chalker and a PSA was executed. Upon learning of the deal with Jones Energy, Le Norman Operating demanded that Chalker “honor the alleged contract entered into through email exchange.” Le Norman Operating then sued for breach of contract, arguing that the parties reached an agreement through email. Le Norman Operating also argued that if the “no obligation” clause created a condition precedent to contract, than Chalker waived it through its conduct.

The Supreme Court held that Chalker and Le Norman Operating did not execute and deliver definitive agreements as required by the confidentiality agreement. In deciding the issue, the Supreme Court noted that Texas’ public policy favors freedom of contract, stating: “By including the no obligation clause in the confidentiality agreement, Chalker and LNO agreed that a definitive agreement was a condition precedent to contract formation.” The Supreme Court also found that the emails were “more akin to a preliminary agreement than a definitive agreement.” While many headlines about this case simply suggest email exchanges are not contracts, don’t be so sure. The decision hinged on the inclusion of the no obligation clause in the confidentiality agreement. Without it, the decision may have been different.

The big takeaway from these two cases? Contracts matter, at least in Texas. Double check what you’re signing and be prepared to live with the deal you make.

John Polzer, partner (litigation), and Machir Stull, partner (business law), are with Cantey Hanger. Visit www.staging.poised-team.flywheelsites.com.