Case Analysis: Force Majeure Based on the Collapse in Oil Prices?
While commodity prices have been on a wild ride for years now, oil and gas companies have generally been able to raise money to bankroll future drilling operations. But this may have changed. Operators are now finding it more difficult to get financing for future drilling projects. As access to money dries up, operators may find that they can no longer press forward with their original drilling plans. But what happens when those operators contractually promised to drill those wells under a farmout or other agreement? Can they rely on force majeure to get out of their promise?
Unfortunately for practitioners in Texas, the Texas Supreme Court passed up on the opportunity to clarify the law on this issue. It recently denied review of a divided court of appeals decision in TEC Olmos, LLC v. ConocoPhillips Co., 555 S.W.3d 176 (Tex. App.—Houston [1st Dist.] 2018, pet. denied). Nonetheless, that case still holds some important lessons for companies in light of the current financial issues for the oil and gas industry.
In TEC Olmos, the court looked at a dispute between two parties to a farmout agreement. Under the contract, Olmos was required to drill a well by a specified deadline or it would have to pay ConocoPhillips $500,000. After the parties signed the agreement, oil prices crashed, Olmos’ expected financing fell through, and Olmos could not find any other financing. Based on these events, Olmos declared force majeure under the farmout agreement. The force-majeure provision read as follows:
Should either Party be prevented or hindered from complying with any obligation created under this Agreement, other than the obligation to pay money, by reason of fire, flood, storm, act of God, governmental authority, labor disputes, war or any other cause not enumerated herein but which is beyond the reasonable control of the Party whose performance is affected, then the performance of any such obligation is suspended during the period of, and only to the extent of, such prevention or hindrance, provided the affected Party exercises all reasonable diligence to remove the cause of force majeure.
In the trial court, ConocoPhillips prevailed based on two arguments: (1) force majeure protection cannot be triggered by “foreseeable” events; and (2) mere economic hardship cannot be the basis for declaring force majeure.
A divided First Court of Appeals upheld the trial court’s ruling that force majeure did not apply. The majority first tackled whether a force majeure event had to be unforeseeable. It noted that a federal circuit split exists on this issue. The Third Circuit in Gulf Oil Corp. v. F.E.R.C., 706 F.2d 444 (3d Cir. 1983) required a party declaring force majeure to show the event was not foreseeable, even if the event was listed in the force majeure clause. The Fifth Circuit in Eastern Air Lines, Inc. v. McDonnell Douglas Corp., 532 F.2d 957, 963 (5th Cir. 1976), on the other hand, did not limit force majeure to only unforeseeable events.
The majority, however, did not tackle this circuit split. Instead, it noted that in each federal case the force-majeure event in question was expressly listed in the parties’ force-majeure clause. The farmout before the court, however, did not list a downturn in the oil market as a potential force-majeure event. The only language that could have applied was the force-majeure provision’s catch-all language, covering “any other cause not enumerated herein but which is beyond the reasonable control of the Party whose performance is affected.” Relying on force-majeure common law, the court held that Olmos needed to make “a showing of unforeseeability” to trigger a catch-all provision. Because a fall in commodity prices was not an unforeseeable event, Olmos could not rely on this language to claim force majeure.
Justice Harvey Brown filed a vigorous dissent. He noted that the majority’s requirement of foreseeability was not located anywhere within the parties’ agreement, and the court should have enforced the force-majeure provision as-written. Because the fall in commodity prices and subsequent financing failure “hindered [Olmos] from complying with [its] obligation” under the farmout, Justice Brown disagreed with the majority’s position.
Considering the dissent and the Texas Supreme Court’s emphasis on enforcing the plain language of parties’ contracts, I thought there was a good chance the Texas Supreme Court would grant review of this case. But the Court declined the chance to look at the divided court of appeals’ decision.
TEC Olmos is an important decision for operators in several respects. First, it shows another way that Texas courts will go beyond the four corners in interpreting contracts. In Murphy Exploration & Production Co.-USA v. Adams, 560 S.W.3d 105 (Tex. 2018), we saw the Texas Supreme Court emphasize consideration of the context and surrounding circumstances when reading oil and gas agreements. TEC Olmos suggests that courts are willing to import more common-law concepts when interpreting contract language going forward.
Second, it shows that Texas courts are not necessarily going to be sympathetic to the plight of oil and gas companies based on the recent crashes in oil and gas prices. When I was in law school, it seemed to be gospel that bad market conditions never qualified for force majeure. My guess is a lot of Texas judges heard the same thing in law school, and they are not going to change their thinking now.
Third and finally, TEC Olmos provides operators with a road map for writing future force-majeure provisions. If any potential force majeure event could be considered “foreseeable”—like a downhole failure or regulatory stall on new drilling—operators should be sure to expressly list it in their force-majeure clauses. Otherwise, an operator could find force majeure unavailable to it, even for events that should fall easily fall under the catch-all provision. Being explicit ahead of time can save a big headache down the road.