READY! FIRE! AIM! TWO DRAFTING TRAPS TO AVOID IN PAPERING A “RUSH” DEAL
| Jurisdiction | United States |
Dykema Gossett PLLC
San Antonio, Texas
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Synopsis
I. "Subject to the PSA" Clause vs. Merger by Deed
II. Perils of the "Notwithstanding" Clause
Abstract
Agreements for the acquisition of oil and gas properties--indeed, acquisition agreements in any context--often require highly complex legal drafting within a short time frame. Parties are typically eager to get under contract and close as quickly as possible to avoid the other party losing interest or backing out. Sellers, in particular, want to limit the amount of time their assets are off the market and the amount of time their buyers may inspect the assets for defects. These time constraints make acquisition agreements particularly prone to errors and drafting oversights.
This paper will discuss the proper use and risky misuses of two clauses common to oil and gas acquisition agreements that are often perceived as drafting shortcuts in "rush" deals. The first topic is the effect of a "subject to the Purchase and Sale Agreement" clause in an assignment of leases, and the degree to which it controls over the actual assignment terms and prevents merger of the Purchase and Sale Agreement into the assignment. The second topic is when, how, and to what extent the phrase "notwithstanding anything herein to the contrary" will cause the language it precedes to override other contract terms.
I. "Subject to the PSA" Clause vs. Merger by Deed
The urgency involved in a sale of oil and gas leases does not end when the parties sign a formal purchase and sale agreement (PSA). In the author's experience, the parties' eagerness to close usually intensifies. Typically, the weeks between contracting and closing are a whirlwind of time-intensive due diligence, including data room analysis, review of financial records and corporate filings, examination of title documents and material contracts, regulatory and environmental inspections, purchase price adjustments and knockdowns, and minor renegotiations.
With all that activity, both before and after getting under contract, the parties look for time-saving efficiencies wherever they can find them. As a result, the formal assignment of leases often gets less drafting attention
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than it deserves. Rather than carefully drafting the assignment to closely track the relevant PSA terms, it is tempting to simply pull an unrelated assignment form from your files, fill in the blanks and exhibits, and add a clause making the conveyance "subject to" the terms of the PSA. The thinking behind this approach is that the PSA terms will control in the event they conflict with the assignment terms, so an error or omission in the assignment is not critical.
This thinking is wrong and hazardous due to the legal doctrine of "merger by deed," or the merger doctrine. It holds that when the seller executes, and the buyer accepts, a conveyance pursuant to a contract for sale of real property, the contract "merges" into the conveyance.1 As a result, the contract terms regarding the property conveyed do not survive closing, even if they contradict the conveyance terms. Put another way:
[I]n the absence of fraud, accident or mistake in the execution, the deed, an absolute conveyance on its face, must be considered the final expression and the sole repository of the terms upon which [the parties] have agreed with respect to the property conveyed, the consideration and the method of payment. 2
But can the merger doctrine be expressly overridden? Not easily, it seems. The merger doctrine is so durable that, under current Texas case law, it likely cannot be defeated by making the conveyance "subject to the terms" of the contract for sale, as the following cases demonstrate in the oil and gas context.
A good illustration of how merger by deed and a "subject to" clause interact is Devon Energy Production Co. v. KCS Resources, LLC, decided in 2014 by the Houston 14th District Court of Appeals.3 Devon Energy Production Co. (Devon) had entered into a PSA to sell KCS Resources, LLC (KCS) a large package of mineral tracts, which was duly closed by delivery of deeds. Years later, a third-party operator proposed new wells on some of the mineral tracts and a question arose as to whether Devon had conveyed all of its right, title, and interest in the entire tracts, per the deed language, or merely in certain existing wells thereon listed in the PSA. Devon filed a declaratory judgment action to determine the parties' respective rights.
KCS argued that because the rights of the parties rest solely in the deeds, per the merger doctrine, a construction of the PSA by the court would not resolve any justiciable claim and therefore the court lacked jurisdiction to construe it.4 Devon countered that because the deeds were
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"expressly made subject to" the PSA, no merger occurred and the PSA terms still control what interests were conveyed.5 The court disagreed:
The Supreme Court of Texas has long recognized that the conveyance provisions in a contract for the sale of real property merge into the deed executed in accordance with the contract.
The merger doctrine requires courts to look to the deed alone in evaluating the parties' respective rights even if the terms of the deed vary from the contract. 6
The court further stated, "we reject Devon's argument that the [deed's] language that it is made `subject to' the PSA indicates the parties' intent that the PSA would not be merged into, superseded by, or mooted by the [deed]."7 As supporting evidence, the court cited revisions made to legal descriptions in the deed exhibits due to title errors found during KCS's due diligence investigations, though the PSA exhibits were not correspondingly revised. "[I]f the conveyance terms of the [deed] were `subject to' the PSA," the court stated, "then the revisions the parties made to deeds during the due-diligence period would be irrelevant" and would "undermine the purpose of the merger doctrine."8
The court also rejected Devon's argument that the merger doctrine does not apply because the PSA contains surviving collateral terms, meaning contract obligations not fully performed by execution and delivery of the deeds, such as indemnification provisions and covenants to cooperate in effectuating the intent of the PSA.9 The court agreed that such terms are not released or impaired by the merger doctrine, observing that in another case the PSA merged into the deed only as to "the property conveyed, the consideration and the method of payment."10 But Devon's claim failed because the parties disputed the scope of the conveyance, not the surviving collateral terms of the PSA.11
In March 2017, the Corpus Christi Court of Appeals directly addressed a similar merger question involving overriding royalty assignments in Burlington Resources Oil & Gas Co. v. Texas Crude Energy, LLC.12 This holding was recently reversed by the Supreme Court of Texas on the substantive question of whether the overriding royalty assignments allow deduction of post-production costs, thereby mooting the merger issue. The
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supreme court therefore did not rule on the merger question, leaving the court of appeals opinion with some precedential value on that narrow issue.13
In Texas Crude, Burlington Resources Oil & Gas Co. (Burlington) and Texas Crude Energy, LLC (Texas Crude) had entered into a prospect development agreement (PDA) and joint operating agreement (JOA). The PDA and JOA contained "area of mutual interest" clauses providing, among other things, that Texas Crude will retain an overriding royalty interest in any lease it acquires and assign the working interest to Burlington, and likewise Burlington will assign an overriding royalty interest to Texas Crude in any oil and gas lease it acquires.14 The assignments state that they are "made pursuant to the terms and conditions of" the JOA or the PDA.15
The override assignments state that the override will be paid based on the "amount realized" from the sale of production.16 As operator and owner of the working interests that the overrides were carved out of, Burlington had been proportionately deducting post-production costs from Texas Crude's overriding royalty payments. Prompted by the landmark holding in 2016 by the Supreme Court of Texas in Chesapeake Exploration, L.L.C. v. Hyder,17 Texas Crude sued Burlington to recover those post-production costs, arguing that the "amount realized" language in the assignments prohibited such deductions.
Burlington countered that, even if the assignments themselves prohibit post-production cost deductions, the court should still construe the assignments as creating "typical" overrides that bear such costs because the assignments were expressly made subject to18 the terms and conditions of the PDA and JOA, and the PDA and JOA do not authorize or contemplate
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creation of overrides that are free of such costs.19 Burlington further argued that the assignments "must be read in conjunction with the PDA and JOA" because multiple instruments executed as part of a single transaction should be construed as a whole.20 The JOA expressly required accounting on an after-post-production costs basis ("actual net proceeds") and Burlington argued that the assignments should be construed as consistent with the JOA.21
Citing Devon, the court of...
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