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Business Litigation Alert: "Texas Supreme Court Ruling Highlights the Importance of Heeding 'Red Flags' During Pre-Contract Negotiations"

Last month, the Texas Supreme Court upheld a lower court’s decision to toss a lawsuit by Orca Assets GP LLP against JP Morgan Chase over property in the Eagle Ford Shale.  Orca accused JP Morgan of fraud and double-leasing the oil and gas property.  However, the Texas Supreme Court concluded that the lawsuit should be tossed because Orca ignored “red flags” during the negotiations.  Because of these “red flags,” the Court reasoned, it was not reasonably justifiable for Orca to rely upon representations that JP Morgan made to Orca even though those representations were false.

Central to the Court’s decision was the fact that Orca, although a newly founded company, was made up of “sophisticated oil and gas business people … richly experienced in negotiating and acquiring oil and gas leases.”   And, because of the sophistication and experience, Orca was required to fully investigate on its own the truth of the bank’s representations, rather than “blindly relying” on them.

The Court’s ruling makes it clear that when companies do not conduct complete due diligence prior to closing a deal, they may forgo legal protections.  It might seem like common sense, but ignoring warning signs because the other side assures you that there is no problem is actually quite prevalent, so it is important to remember to dig deeper.

  • Do your homework.  If this case teaches us anything, it teaches us that you cannot rely on the word of the party sitting across the negotiating table.  You must conduct your own investigation to ensure that the claims of the other party are in fact true.
  • If it doesn’t seem right, look closer.  We tend to overlook red flags in numerous situations, but when entering into any transaction, ignoring anything that seems “off” could lead to serious legal issues down the road.  Always take a closer look.
  • Know who you are negotiating with.  It is also always important to do your research into any individual or company you are doing business with.  The more you know about the other party up front, the less surprises you will have down the road.

This is another cautionary tale of what can happen when you rely too much on the word of another party in a transaction or negotiation. In order to protect your company and yourself, due diligence is key and red flags must never be overlooked.

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