Alert: "Texas Supreme Court Confirms No Obligation Clauses Can Prevent Contract Formation"
On the heels of its opinion in Energy Transfer Partners, L.P. v. Enter. Products Partners, L.P.,1 in which the court held that parties can agree to conditions precedent before the partnership formation factors in Tex. Bus. Org. Code. § 152.052 will apply, the Texas Supreme Court has now held in Chalker Energy Partners III, LLC v. Le Norman Operating LLC2 that the same concept applies to contract formation in a purchase and sale transaction. Parties to a transaction can agree that conditions precedent must occur before a binding agreement will be formed, even where email communications indicate an agreement was reached on material terms of the transaction.
In Chalker, owners of oil and gas interests, including Chalker, (“Sellers”) sought to sell their interests through a bid process. The Confidentiality Agreement governing the transaction contained a “No Obligation” clause providing as follows:
No Obligation. The Parties hereto understand that unless and until a definitive agreement has been executed and delivered, no contract or agreement providing for a transaction between the Parties shall be deemed to exist and neither Party will be under any legal obligation of any kind whatsoever with respect to such…. For purposes of this Agreement, the term “definitive agreement” does not include an executed letter of intent or any other preliminary written agreement or offer, unless specifically so designated in writing and executed by both Parties.
Bidder Le Norman signed the Confidentiality Agreement and submitted a bid for 100% of the interests, subject to the execution of a mutually acceptable purchase and sale agreement (“PSA”). That deal fell through. Le Norman then emailed the Sellers a counterproposal for 67% of the interests, including the execution of a PSA as a term. The Sellers emailed back their agreement and indicated they were onboard to deliver a mutually agreeable PSA. Before a PSA was signed, however, Jones Energy submitted a bid. The Sellers decided to “change horses” and executed a PSA with Jones.
Le Norman sued for breach of the email agreement. The Sellers counterclaimed for a declaration that they did not breach any contract with Le Norman. Both parties moved for summary judgment. The trial court found for the Sellers, holding that the parties did not intend to be bound and a PSA was a condition precedent to contract formation. The court of appeals reversed holding that the email communications raised a fact issue that the PSA condition had been waived, precluding summary judgment.The
Texas Supreme Court reversed and rendered. The Court noted a long history in Texas of freedom of contract allowing parties to protect themselves from binding agreements by stipulating the conditions upon which they will be bound. The Court found the emails were akin to a preliminary agreement and the parties communications consistently indicated a PSA was necessary to finalize a deal. The Court also found the emails insufficient to demonstrate waiver of the “definitive agreement” condition precedent by conduct. The emails were simply part of the continuing negotiations under the bidding procedures and Confidentiality Agreement.
Bottom line, “[b]y including the No Obligation Clause in the Confidentiality Agreement, the Sellers and [Le Norman] provided themselves with the freedom to negotiate without fear of being bound to a contract.”
Takeaways for Businesses
Chalker gives contract drafters comfort that they can control the terms for when an agreement will become binding by taking the following actions:
- Including “No Obligation” clauses with clear and specific conditions precedent that must occur before a contract will be formed. In fact, including the Chalker clause itself could be a good choice as it has been court tested;
- Insuring that a future definitive agreement is not just contemplated to memorialize an agreement already made—the definitive agreement must be made a condition precedent to a binding agreement;
- As the transaction progresses, being careful not to waive the conditions by conduct or other action indicating waiver; and
- Lastly, if your transaction ends up at the courthouse, remember that the party alleging waiver bears the burden to plead it as an affirmative defense and obtain factual findings on the issue.
1 No. 17-0862, 2020 WL 622763 (Tex. Jan. 31, 2020).
2 No. 18-0352 (Tex. Feb. 28, 2020).