How do Texas Courts measure contractual time periods? The answer can have a big impact on compliance and potential damages.
In this case, the Texas Supreme Court was faced with a complex, multi-layered dispute revolving around the interpretation of a large ranch lease and several materially identical purchase and sale agreements with drilling commitments and re-assignment obligations. Primary issues involved were (1) how to calculate when a lease terminated, (2) whether a re-assignment obligation expanded to all of Apache’s interest or only each seller’s respective interest in the lease, and (3) how to calculate the “back-in trigger” or “project payout,” and (4) whether the trial court properly excluded the appellants’ expert witness.
Lease Termination Date
The bulk of the opinion focuses on when the subject lease partially terminated. The parties agreed that the lease partially terminated at the end of 2015, but they disagreed as to whether that partial termination occurred on December 31, 2015 or the next day on January 1, 2016. This one-day difference was material, because the re-assignment obligations under the purchase and sale agreements were measured by the calendar year. Apache was required to submit an annual drilling commitment by November of each year, covering the next calendar year. If that commitment would result in lease termination, then that triggered Apache’s re-assignment obligation at that time.
Thus, a one-day difference as to when the lease terminated had a full calendar year impact on the potential re-assignment obligation. If it expired December 31, 2015 then Apache’s alleged re-assignment obligation arose as part of its 2015 drilling commitment due in November of 2014. However, if it expired January 1, 2016 then the alleged re-assignment obligation arose as part of its 2015 drilling commitment due one full year later.
Given that oil prices plummeted over that one-year span, Apache claimed that upwards of $180 Million in potential damages rode on the answer to whether the lease expired on New Year’s Eve of 2015 or New Year’s Day of 2016.
The Lease provided for an effective date of January 1, 2007, “from which date the anniversary dates of this Lease shall be computed.” The Lease also indicated that the lease had a primary term of “three years from the effective date.” The lease also contained a unique continuous development clause, under which the lease was divided into three equal “blocks” and each block could be maintained by conducting sufficient continuous operations “on each block each year after the expiration of the Primary Term.”
The Court held that, because the lease measured time periods “from” an effective date, the termination date was governed by a default, common law rule for contracts that measure time “from” or “after” a specified measuring date. In addition, in the Court’s view, the lease’s reference to “anniversary dates” further indicated the parties intended to follow that default common law rule. Under that rule, “the measuring date—the date ‘from’ or ‘after’ a period is to be measured—is excluded in calculating time periods. For periods of years, therefore, the period ends on the anniversary of the measuring date, not the day before the anniversary.” As an example, the Court indicated that “a period measured in years ‘from’ or ‘after’ June 30 (the measuring date) will end on a future June 30, not a future June 29.” In this case, that mean the lease expired on January 1, 2016.
The Court indicated that this rule does not apply where a contract does not measure periods “from” or “after” a given date. Moreover, this rule also will not apply where parties have departed from the rule.
How can parties depart from this default, common law rule? According to the Court, “parties may freely depart from [the default rule] by demonstrating a clear contrary intent within their agreement.” The Court gave a few suggestions as to how parties may deviate from this rule:
- Specifying a date certain that the period would end;
- Specifying that the effective date is to be included in calculating the time period;
- Specifying that the term is to last for a period of years “and no longer;”
- “includ[ing] something…that, at a minimum, is clearly incompatible with the default rule, amounting to displacement by necessary implication.”
- Expressly describing how the date will be calculated, either through “a myriad of other ways to clearly measure time,” or other “bespoke methods.”
Ultimately, the Court indicated the question is to be determined from the intent as expressed within the instrument as a whole, and that there are no particular formations or magic phrases.
The Court stated that “courts will enforce any lawful agreement regarding the calculation of time without requiring any particular formulation or magic language.” However, the Court stated that “clarity” is required in order to “preclude post hoc efforts to rewrite contracts … under the guise of ambiguity.”
Turning back to the lease at issue in this case, the Appellants had three primary arguments as to why they believed the lease should not be governed by the general rule. The Court rejected each of those arguments.
First, appellants argued that a January 1 effective date would suggest that the lease was intended to expire on December 31st, otherwise the primary term would actually run for three years and one day. The Court acknowledged that was technically accurate, but said they “fail to see why that matters.” The Court suggested parties are not confined to using round numbers and, in the Court’s view, parties add “and a day” in “all sorts of circumstances.” The Court suggested the parties could have departed from the default rule by including the January 1st effective date in the calculation, by saying “the primary term was to last for three years and no longer,” or they could have expressly set forth a December 31 end date.
Second, the appellants pointed to lease amendments that controlled continuous development during the 2011-2014 timeframe (before the 2015 year in dispute). Those amendments used the word “during” instead of “after,” and they referred to a “calendar year” or specifically set a December 31 end date. The appellants presumably argued that the amendments reflected that the parties intended the terms to end on December 31. However, in the Court’s view, the amendments used “markedly different durational language” which shows an intent to use dates that differ from the lease, and also shows the parties were capable of departing from the default rule when they wished to do so. The appellants also pointed out that one amendment stated that the lease was “currently” in effect as of “January 1, 2010,” which they argued indicated an understanding that the primary term had already expired on December 31, 2009, and not on January 1, 2010. The Court rejected that argument, as it was a mere statement and not an amendment of the lease term, and because it did not “otherwise provide the clarity necessary to displace the default rule.”
Third, the appellants pointed to the recorded lease memorandum, which stated that the lease’s primary term would end on December 31 of 2009. The Court indicated that this did not control and was not even to be harmonized with the lease, because the lease memorandum itself stated that it was “subject to the conditions in the Lease,” which the Court construed as “proclaiming that the lease controls whenever the two are in conflict.”
Scope of Re-assignment Obligation
Next, the Court turned to the appellants’ argument that their individual purchase and sale agreements required Apache to offer back to each seller/appellant all of Apache’s interest, not merely the respective interest that Apache purchased from each individual seller.
Specifically, the appellants/sellers argued that this should extend to and include a large percentage interest that Apache later acquired in an additional transaction with one of the other sellers that were not appellants.
The applicable provision of each PSA provided that the re-assignment obligation extended to “all of [Apache’s] interest in the affected Leases (or parts thereof)[…].”
The appellants/sellers argued that “all” means “all” and therefore the obligation encompassed all of Apache’s interest. The appellants also pointed out that other provisions distinguished between the interest purchased from an individual seller, from the collective interests purchased from all sellers. The appellants also argued that the purpose of the re-assignment obligation was to allow the sellers to take over and save a lease, which they argued would be difficult without a more expansive reading.
The Court rejected these arguments, pointing out that the re-assignment obligation was individually owed to each “Seller” and not collectively to the “Sellers.” Therefore, in the Court’s view, the obligation could not be read as extending to the entirety of Apache’s interest, otherwise “multiple parties would each simultaneously have the right to the exact same interests.” The Court pointed out how the underlying Joint Operating Agreement had several provisions providing guidance as to how to distribute interests in different situations, such as the non-consenting operations provisions, provisions for abandoning producing wells, renewal and replacement provisions, and an area of mutual interest provision. In the Court’s view, the lack of such a provision in the PSA’s re-assignment obligation reflected that the parties did not intend for the re-assignment obligation to require Apache to simultaneously offer to re-assign its entire interest to each seller. In that context, the Court construed the word “all” to refer to “all the interest that [each Seller] sold to Apache.”
Calculating the “Back-In Trigger” and “Project Payout”
Each PSA provided each seller “the right, but not the obligation,” to “back-in for up to one-third (1/3rd) of the interests conveyed to [Apache…],” such right being “exercisable at Two Hundred Percent (200%) of Project Payout” which it defined as the “Back-In Trigger.” In turn, the PSAs defined “Project Payout” as “the first day of the next calendar month following that point in time when the sum of [certain revenues] equals the sum of [certain costs].”
Apache argued that “200% of Project Payout” refers to the point when the specified revenues double the specified expenses. The Court construed the Sellers’ argument as defining it as the point in time when specified revenues equal the specified expenses. The Court rejected that argument and sided with Apache.
The Court acknowledged that its interpretation, along with these definitions, resulted in “a rather awkward linguistic construction,” because when the definition is ported into the text , “Back-In Trigger” would be literally read as “200% of the first day of the next calendar month” when certain revenues equal certain expenses. Presumably the focus of argument here was on the clumsy drafting that resulted in text referring to “200% of a day,” rather than “the day when revenues are 200% of costs.”
Expert Witness Issue
Finally, the Court turned to the issue of the seller’s expert witness. The trial court had excluded the expert’s testimony as to fair market value of the leases at issue, on grounds that his testimony assumed a December 31 lease expiration date whereas the trial court had held that the lease expired January 1. Again, while this was only a day in terms of lease termination, that meant a full year of difference in terms of Apache’s alleged re-assignment obligation. Without significant explanation, the Supreme Court held that it agreed with the trial court regarding the lease expiration date, and concluded that the trial court properly excluded the expert testimony that was based on a different date.
Conclusion and Takeaways
Oil and gas lawsuits often depend upon the proper calculation of time periods, as oil and gas operations are frequently governed by overlapping layers leases and agreements, several of which often have independent or connected time periods. For instance, commencement or production dates can be critical in farmout agreements. As another example, joint operating agreements often set forth important time periods for commencing operations, providing notifications, proposals, and consent notices. Purchase and sale agreements often have important deadlines for due diligence, closing, notices, and post-closing risk allocation concepts. This case is notable in its guidance for calculating time periods, and as a case-study in how important these issues can be in a lawsuit.
To learn more, watch oil and gas attorney Austin Brister break down the case details in the video below: