After an energy transaction closes, unsatisfied parties increasingly are claiming that the other side misrepresented some material issue during the course of the deal. Not surprisingly, this phenomenon often occurs during rapid or unanticipated movements in commodity prices, cost of capital, development costs, regulation and the like.
Such fraud claims often focus on representations concerning the prospects of oil and gas production, including reserve estimates and general remarks concerning future production from certain leases or wells. Given the risk of such claims, in-house counsel need to ensure that company representatives know what they can and cannot say about the prospects for production when buying or selling energy assets.
Since the Texas Supreme Court’s 1983 decision in Trenholm v. Ratcliff, pure expressions of opinion generally cannot form the basis of a fraud claim; even if those opinions are later determined to be incorrect, they are not considered factual misrepresentations.
This distinction between factual statements and opinions, however, depends on not only what someone said but also the circumstances in which he made the statement. As noted in Trenholm and subsequent cases, an opinion may give rise to fraud in three situations.
First, the speaker knows the statement is false.
Second, the speaker purports to have special knowledge of facts underlying the opinion and has reason to know that the other party would rely on that knowledge. An example would be when those facts are not equally available to both parties.
Third, the opinion is based on or intertwined with false statements of fact. In this respect, a court may consider "the speaker’s knowledge, the comparative levels of the speaker’s and the hearer’s knowledge, and whether the statement relates to the present or the future" in determining whether a statement is one of fact or opinion, noted the Texas Supreme Court in Transport Insurance Co. v. Faircloth (1995).
Courts generally consider statements about future events, such as the prospects for production, to be opinions that alone are insufficient to support a fraud claim. But this may change when such an opinion is contrary to factual information known by the speaker or bolstered by special knowledge of facts that will occur in the future.
For example, it can be risky to make general statements concerning the prospects of production when others may view such statements as conflicting with undisclosed production data. In the 13th Court of Appeals’ decision in Exxon Corp. v. Miesch (2012), the court addressed lessors’ allegation that the lessee’s representatives stated during lease renegotiations that the reserves under lease were depleted, "there is nothing there" or they would last only a couple more years, and the lessee "could not continue to produce" the fields under lease.
The lessors claimed that the lessee refused to turn over well logs and interpretive data supporting its assertions. Further, the lessors claimed that such information indicated materially more reserves than represented and revealed undeveloped fields ignored in the lessee’s analysis.
As a result, the Corpus Christi/Edinburg court reversed the trial court’s directed verdict. It found that the lessee’s representations could form the basis of a fraud claim because they were based on past and present facts and the lessee had special knowledge of facts that would occur in the future.
Other cases demonstrate the flip side of this scenario, finding that representations concerning the prospects of production are mere opinions or predictions when the underlying data is disclosed or publicly available.
In Paull v. Capital Resource Management (1999), Austin’s 3rd Court of Appeals applied this reasoning to a field summary containing predictions of future production, payout and rates of return. The 3rd Court found that those could not form the basis of a fraud claim when the wells at issue failed to produce as predicted, because the parties had equal access to the underlying information such as projected future costs, past production and production of analogous fields.
El Paso’s 8th Court of Appeals also took this approach in Holland v. Thompson (2010), when it found that a fraud claim could not be based on a buyer’s general statements to a mineral interest owner indicating that the wells at issue were "old" and "playing out," there was "no reason" to begin new production and he did not "foresee" any, and the field was "drained" or "used up."
Although the buyer had filed an application with the Texas Railroad Commission the year before, indicating that the buyer planned to drill additional wells in the field, the 8th Court found that the buyer did not have special knowledge concerning future drilling plans because the Railroad Commission records were equally available to both the buyer and seller.
Words to the Wise
Given these principles, here are some considerations for in-house counsel for buyers and sellers of energy assets. These may be helpful to keep in mind when company employees or contractors make representations concerning the prospects of production.
• Make available relevant data to support opinions or projections concerning future production. This, of course, is easier said than done, depending on the circumstances the buyer creates, including timing, level of sophistication and other variables.
The seller in Paull avoided a fraud claim on the ground that it based its estimate of future production on information either provided to the buyer or accessible through public records. But a seller of properties might be able to pre-empt misrepresentation claims or more easily defeat them by providing all key data underlying the production estimate.
• Conflicts between general value statements and data about past or present production can bolster fraud claims. Generalizations are subject to interpretation and misinterpretation. Thus, specificity and supporting data may derail later claims.
Data may conflict with subjective value statements about the prospects of production. That’s why it’s best to avoid generalized value statements, such as the field is "played out" or "used up." These could give rise to a fraud claim if an opposing expert uses past production data to show a possibility of future production.
• Update any factual information provided in support of an opinion concerning future production or that a court may view as intertwined with such an opinion.
In Allen v. Devon Energy Holdings (2012) Houston’s 1st Court of Appeals addressed a negative opinion of future production, which was based on two facts: the lack of success drilling in the area so far and the absence of certain drilling technology essential for profitable production in the area.
The 1st Court reversed summary judgment in favor of the defendant where the former minority owner brought fraud claims against his former company when, two years after redeeming his interest, the company sold for 20 times the value calculated in the redemption agreement. Because both of these facts changed before the transaction at issue closed, the court found that the production opinion was supported by false statements of fact.
On Jan. 11, the Texas Supreme Court granted the petition for review and remanded the case pursuant to a settlement agreement. But the 1st Court did not withdraw its opinion, and the case is still instructive: Disclosing changed circumstances prior to a transaction may help a company avoid subsequent litigation.
• Including traditional disclaimers in transaction documents may help avoid or defeat fraud claims. To be effective, however, disclaimers of reliance and other such clauses must meet various tests prescribed by the Texas Supreme Court.
Although opinions and predictions generally will not lead to viable fraud claims, Texas case law teaches in-house counsel to advise company representatives to stick closely to objectively verifiable facts that are supported by materials disclosed during the course of the transaction. Otherwise, an opinion concerning future production may become the focus of post-closing litigation (valid or not) when a party becomes dissatisfied with the outcome of the deal.