Texas Supreme Court Refuses to Inject “Reasonableness” Standard when Interpreting Unqualified Consent-to-Assign Clause

In deciding Barrow-Shaver Resources Company v. Carrizo Oil & Gas, Inc., the Texas Supreme Court affirmed that under Texas law, courts should not ”read in” a reasonableness standard when interpreting an unqualified, or silent, consent-to-assignment clause in a farmout agreement.

Barrow-Shaver Resources Company (Barrow-Shaver) and Carrizo Oil & Gas, Inc. (Carrizo) were parties to a farmout agreement; Carrizo granted Barrow-Shaver a conditional, partial assignment of Carrizo’s interest in a 22,000-acre lease in exchange for Barrow-Shaver’s drilling a producing well.  During the negotiations, Carrizo’s draft included a consent-to-assign clause that prohibited Barrow-Shaver from assigning its rights under the farmout agreement without Carrizo’s express written consent, “which consent shall not be unreasonably withheld”; however, Carrizo deleted that key phrase in a later draft.  Barrow-Shaver objected to the deletion but ultimately kowtowed based on Carrizo’s oral assurances that it would consent to an assignment if Barrow-Shaver chose to make an assignment.  The consent to assign provision in final farmout agreement stated: “The rights provided to [Barrow-Shaver] under this [Farmout] Agreement may not be assigned, subleased or otherwise transferred in whole or in part, without the express written consent of Carrizo.”

Barrow-Shaver then spent approximately $22 million drilling a well with unsuccessful results.  Later, a third party offered Barrow-Shaver $27 million to assign its rights under the farmout agreement.  When Barrow-Shaver sought Carrizo’s consent, Carrizo initially declined but later conditioned its consent on Barrow-Shaver’s paying Carrizo $5 million.  Barrow-Shaver rejected this offer, Carrizo refused to consent to the assignment, the third party offer fell through, and Barrow-Shaver sued Carrizo for breach of contract and fraud.

At trial, Barrow-Shaver asserted that because the consent-to-assign provision was silent as to the basis on which Carrizo could withhold its consent, the jury must be allowed to hear evidence of industry custom and usage (specifically, that Carrizo’s demand to be paid for its consent is inconsistent with the industry custom).  The trial court allowed the jury to consider the industry custom and usage to determine whether Carrizo breached the agreement.

The jury found that Carrizo breached the agreement and awarded Barrow-Shaver over $27 million.  The court of appeals reversed, finding that that the trial court abused its discretion by not allowing into evidence prior drafts of the farmout agreement to establish that Carrizo had bargained for the right to withhold its consent for any reason or no reason.

In a 5-4 decision, the Supreme Court affirmed the court of appeals ruling and held that Carrizo’s right to refuse consent to the assignment is unqualified.  Thus Carrizo was entitled to withhold its consent for any reason or no reason and therefore as a matter of law did not breach the farmout agreement.  The Court stated that “[b]y not addressing the circumstances under which [a party] could withhold consent, the agreement speaks to the parties’ agreement – an unqualified right to withhold consent.”

In so holding, the Court also noted that the parole evidence rule prevented the introduction of evidence regarding the parties’ negotiations or prior drafts.  And because the provision was unambiguous, industry custom and usage should not have been considered to alter or contradict the express terms of the farmout agreement.

The Court went further and rejected Barrow-Shaver’s implicit assertion that an implied duty of good faith and fair dealing either existed or required that the Court imply, or “read in,” a reasonableness standard.  Citing to established Texas lease law as precedent, the Court reiterated that Texas law does not support implying a reasonableness standard in consent-to-assign provisions and could find no reason why that principle should not apply to farmout agreements.  In critiquing one dissenting opinion, the majority said that use of industry custom to inject a reasonableness obligation into the consent to assign provision is a veiled attempt to create a covenant of reasonableness and good faith.

In short, unlike Louisiana courts (see, courts in Texas remain reticent to adopt the view of implying a standard of “reasonableness” when interpreting silent consent-to-assignment clauses.  But don’t over-read the Louisiana cases: the hurdle to overcome a refusal to grant consent is still a very high one under Louisiana law.

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