The Texarkana Court of Appeals recently upheld a $12.4 million breach of contract judgment against Petrohawk, which arose out of Petrohawk’s agreement with the plaintiff landowners to schedule multiple closings to sign oil and gas leases, and its subsequent refusal to lease additional properties after the first closing. Petrohawk Props., L.P. v. Jones, No. 06-14-00003-CV, 2015 WL 170225 (Tex. App.—Texarkana Jan. 14, 2015, no pet. h.).
The case provides important guidance on how contractual changes should be analyzed in light of the statute of frauds and changed conditions after an initial agreement is reached. Whether a change in an agreement is material or requires reduction to writing often depends on the agreement’s wording and the facts of the particular case. Parties are best served by carefully documenting any modification to their agreements to avoid expensive and protracted litigation over enforcement.
This dispute has its roots in a legendary natural gas boom that took place in the Haynesville Shale formation in 2008. Exploration companies competed aggressively for available leases, offering bonuses as high as $30,000 per acre. But requisite title investigation constrained the leasing activity. In East Texas’s Harrison County, where this case arose, landmen overwhelmed the clerk’s office and had to take turns using the office’s computer terminals.
It was during this leasing frenzy that Petrohawk Properties, L.P. (“Petrohawk”) entered into an Agreement to Lease Oil and Gas Mineral Interests (the “Agreement”) with a family group of mineral interest owners (“Plaintiffs”). The Agreement specified conditions under which Petrohawk would lease mineral interests from Plaintiffs covering the Haynesville and Bossier Shale formations, if Plaintiffs could deliver their interests “free and clear of Title Defects.” The Agreement called for an August 15, 2008 closing of “not more than 8,500 net mineral acres,” at a lease bonus of $23,500 per acre. The total lease bonus that Petrohawk would have to pay Plaintiffs at closing was potentially almost $200 million. Petrohawk expected to close on at least 4,800 acres.
The Agreement required Petrohawk to place $10 million in escrow for the closing. The Agreement would terminate and Petrohawk would recover the escrowed funds if, at closing, Plaintiffs were unable to deliver free and clear title to mineral acreage that exceeded $10 million in lease value (i.e., 426 acres). Petrohawk would forfeit the $10 million as liquidated damages if Plaintiffs delivered at least 426 acres and other conditions were satisfied, but Petrohawk nevertheless refused to close the transaction. The escrow deposit thus protected Plaintiffs’ interests while their properties were promised exclusively to Petrohawk and title was investigated.
Petrohawk was to notify Plaintiffs of any title defects not later than five days before closing. If Plaintiffs were unable to cure the defects by closing, they would enjoy a 30-day grace period during which Petrohawk would still honor the $23,500 per acre bonus.
The title work progressed more slowly than hoped and the parties agreed to delay the closing to August 27. The parties also agreed to a second “clean-up” closing on September 17. On August 27, the parties closed on 2,200 mineral acres and Petrohawk paid Plaintiffs more than $51 million, including the $10 million escrow deposit.
Additional title difficulties caused the parties to postpone the September closing to October 9, and to agree to a third and final closing on November 6, 2008. However, in the fall of 2008, the United States was in the midst of a financial crisis. On October 7, Petrohawk notified Plaintiffs that, in light of “uncertainty in the capital markets,” it would not lease additional acreage. Petrohawk eventually took the position that Plaintiffs had 30 days to clear title on additional acreage after the August 29 closing and, having not done so, Petrohawk had no further obligations under the Agreement. Plaintiffs sued for breach of contract and a jury awarded them $12.4 million in damages, plus $4.2 million in attorneys’ fees and post-judgment interest.
On appeal, Petrohawk argued, among other issues, that the statute of frauds barred recovery under the changed Agreement. As the court noted, “[t]he statute of frauds applies to oil and gas leases and contracts to acquire the same.” Generally, modifications to an agreement subject to the statute of frauds must be in writing, but an oral modification may be enforceable. In particular, the court held that an oral modification to extend time of performance is enforceable if it is made before the written contract expires and if it is not material, i.e., it does not change other contractual rights and duties.
Petrohawk argued that the parties’ agreement to hold the second closing materially changed the Agreement and was, therefore, unenforceable under the statute of frauds. Under Petrohawk’s reasoning, the Agreement contemplated only one closing where Petrohawk could accept the leases or forfeit its $10 million escrow deposit. Having released the escrow deposit in the first closing, Petrohawk argued that it lost its “walk away” option. Multiple closings, Petrohawk argued, deprived Petrohawk of its ability to weigh its “walk away” option against “all” Plaintiffs’ leases. This situation allegedly would have required Petrohawk to “accept whatever leases Plaintiffs presented and subjected Petrohawk to ‘unlimited and indeterminate liability.’”
As a threshold matter, the Texarkana court held that Petrohawk’s lease obligations were “neither unlimited, nor indeterminate, nor unseen” because Petrohawk performed all the title work for Plaintiffs’ mineral interests and was in a position to choose what it would lease based on the state of the title. Moreover, the court pointed out that Petrohawk’s obligation to lease did not exceed 8,500 acres.
As to the $10 million escrow deposit, the court held that Petrohawk did not lose its walk away option because of the Agreement’s modification, but instead because Petrohawk partially performed its contractual obligations. The court reasoned that Plaintiffs fulfilled their obligation to present mineral acres worth at least $10 million in lease value at the first closing, and Petrohawk chose to proceed with the transaction and apply the $10 million escrow deposit to the purchase price. Under these conditions, the court held that the parties’ decision to proceed with multiple closings did not change their rights and obligations and did not substantially alter the Agreement itself. In conclusion, the court held that the modification was not material, did not need to be in writing, and its enforcement was not barred by the statute of frauds.