Bell v. Chesapeake Energy and Parol Evidence in the San Antonio Court of Appeals

Decisions out of the Fourth Court of Appeals in San Antonio are particularly important for oil and gas producers in the Eagle Ford Shale. The court covers trial courts in the western and southern part of the play, including two of Texas’s top-ten oil-producing counties (Karnes and La Salle) and three of Texas’s top-ten gas-producing counties (Webb, Karnes, and La Salle).

The court’s recent decision in Bell v. Chesapeake Energy Corp., 04-18-00129-CV, 2019 WL 1139584 (Tex. App.—San Antonio Mar. 13, 2019, no pet. h.) is a reminder that the Fourth Court of Appeals’ view of parol evidence—particularly when it comes to earlier draft versions of oil and gas leases—may not be in sync with other Texas courts. Considering the court’s important role in the Eagle Ford Shale, this should be of importance to oil and gas companies operating in the area.

For an unambiguous agreement, Texas courts generally do not consider changes to and deletions from earlier drafts of the agreement. There is a limited exception made for changes to pre-printed form agreements. See Houston Expl. Co. v. Wellington Underwriting Agencies, Ltd., 352 S.W.3d 462, 470–72 (Tex. 2011); Port of Houston Auth. of Harris County v. Zachry Const. Corp., 377 S.W.3d 841, 856 n.10 (Tex. App.—Houston [14th Dist.] 2012), rev’d on other grounds, 449 S.W.3d 98 (Tex. 2014).

But in the Fourth Court of Appeals, this rule appears to have been relaxed in recent cases. Starting with BP American Production Co. v. Zaffirini, 419 S.W.3d 485, 499 (Tex. App.—San Antonio 2013, pet. denied), the court found that the oil and gas lease at issue was unambiguous. Nonetheless, the court still closely examined the parties’ negotiations and the drafts of the lease they exchanged before signing the agreement. Id. at 500–01. The court held that the negotiations “inform and confirm the lease terms,” and the Court saw no conflict in using these negotiations as evidence in the decision.

The next year, in PNP Petroleum I, LP v. Taylor, 438 S.W.3d 723 (Tex. App.—San Antonio 2014, pet. denied), the court examined a trial court’s exclusion of lease-negotiation evidence. The lease at issue contained a shut-in royalty clause, which usually requires the lease at issue to be capable of producing gas in paying quantities at the time it is shut-in.” Id. at 736 (quoting Hydrocarbon Mgmt., Inc. v. Tracker Exp., Inc., 861 S.W.2d 427, 432–33 (Tex. App.—Amarillo 1993, no writ). “This is true even though the shut-in royalty clause makes no mention of capacity for paying production.” Id. (quoting Hydrocarbon Mgmt., 861 S.W.2d at 433). But an earlier draft of the lease had struck the phrase “capable of producing oil/gas” and replaced it with “not producing oil/gas.” The court held that this evidence was admissible and showed that “the parties did not intend to apply the oil and gas industry’s generally accepted meaning of the term ‘shut-in royalty’ in the Savings Clause.” Id. at 737.

Finally, just this month, the court again used the parties’ earlier lease negotiations to interpret an unambiguous oil and gas lease. In Bell v. Chesapeake Energy Corp., 04-18-00129-CV, 2019 WL 1139584 (Tex. App.—San Antonio Mar. 13, 2019, no pet. h.), the producer argued that its obligations under a lease’s offset-well provision should incorporate the “reasonably prudent operator” standard. Id. at *10. The court, however, noted that the parties had explicitly eliminated that standard after it appeared in an earlier draft of the lease. Again, the court found that “the intentional deletion of the reasonably prudent operator language must be given effect,” and that the parol evidence rule did not bar admission of the evidence. Id. at *11.

This use of prior drafts as parol evidence has not been universally well-received. Magistrate Judge Austin in Lind v. International Paper Co., A-13-CV-249-DAE, 2014 WL 4187128 (W.D. Tex. Aug. 21, 2014), criticized the Fourth Court of Appeals’ decisions in Zaffirini and PNP Petroleum. Judge Austin said the appellate court’s reading of relevant Texas Supreme Court precedent was “flawed” and constituted “plainly significant extensions” of relevant caselaw. Id. at *7.

But regardless of this criticism, many trial courts in the Eagle Ford Shale will continue to be bound by these decisions. And when examining leases, those same trial courts are likely to pay close attention to the parties’ earlier drafts, red lines, and deletions, even when the leases at issue are found to be unambiguous. When drafting and negotiating leases, producers in the Eagle Ford Shale shouldn’t only worry about the language in the final document, but also about what the parties’ edits and changes show about that final draft. Add in the Texas Supreme Court’s new focus on the “context” and “circumstances” in which the parties executed an agreement (see Murphy Exploration & Production Co.-USA v. Adams, 560 S.W.3d 105 (Tex. 2018)), and suddenly interpreting an unambiguous oil and gas lease may require parties to go far beyond the four corners of the agreement in dispute.

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Chris Hogan focuses his litigation practice on resolving complicated disputes for corporate and individual clients, including those in the energy industry.  Chris has substantial experience in federal court, state court, and arbitration proceedings.  He has been honored to represent as lead counsel major energy companies such as Marathon Oil, BPX, BHP Billiton, and Carrizo Oil & Gas.