Preferential Rights to Purchase and Consents to Assign

Transcription

1 Presented: Association of Corporate Counsel Houston Chapter October 2, 2013 Houston Preferential Rights to Purchase and Consents to Assign Louis J. Davis Author contact information: Louis J. Davis Baker & McKenzie LLP Houston, Texas

2 PREFERENTIAL RIGHTS TO PURCHASE AND CONSENTS TO ASSIGN By Louis J. Davis 1 Baker & McKenzie LLP I. INTRODUCTION AND SCOPE This paper is divided into two parts, the first addressing preferential rights to purchase, and the second concerning consents to assign. The first part of this paper is intended to provide a comprehensive analysis of the wide array of issues affecting the operation of preferential rights, including a discussion concerning the types of transactions that trigger preferential rights, the notice requirements that must be provided by the grantor to the rightholder following a triggering event, the process by which the rightholder exercises the preferential right, the situations in which a preferential right provision terminates, the possibility that parties other than the initial grantor and holder of the preferential right may become subject to the preferential right, the remedies available to the rightholder when the grantor breaches the preferential right, and the defenses available to the grantor in case of litigation alleging a breach of the preferential right. It is important to acknowledge, with sincere thanks, that this paper draws heavily upon several previous works. Robert K. Wise, Andrew J. Szygenda, and Thomas F. Lillard provide an excellent and thorough discussion of preferential rights. 2 Rick Strange and Thomas Fahring similarly produced an exhaustive article with a special emphasis on preferential rights in package transactions, when the burdened property is sold by the grantor as part of a package of various assets. 3 The first part of this paper uses a similar structure to that of Wise, Szygenda, and Lillard to group the legal issues that affect preferential rights and builds upon their work by emphasizing the effect of cases decided since their article was published in The second part of this paper addresses consents to assign and issues related to enforceability and breach thereof. First, it provides a background for consent-to-assign analysis by examining landlord-tenant law. Then, it discusses four forms of consent-to-assign provisions and issues that arise when they are encountered. Finally, it highlights some special concerns when dealing with consent provisions in state leases. The previous papers of Terry Cross 4 and Corby Considine 5 each contain detailed summations of judicial interpretations of consent-toassign provisions and discussion of important drafting considerations, and were very helpful in the preparation of the second part of this paper. 1 This paper is the result of the collective and significant efforts of several contributing authors and editors, including Baker & McKenzie Houston Office Oil and Gas Associates Rahul Vashi and Jonathan Lancton, and Baker & McKenzie Houston Office Summer Associates Katherine Jordan, Ross Staine and Benjamin Fedorko. Grateful thanks are extended to each for making the time to get this paper prepared. 2 Robert K. Wise, Andrew J. Szygenda & Thomas F. Lillard, First-Refusal Rights Under Texas Law, 62 BAYLOR L. REV. 433 (2010). 3 Rick Strange & Thomas Fahring, Rights of First Refusal and Package Oil and Gas Transactions, 53 S. TEX. L. REV. 29 (2011). 4 Terry I. Cross, The Ties that Bind: Preemptive Rights and Restraints on Alienation that Commonly Burden Oil and Gas Properties, 5 TEX. WESLAYAN L. REV. 193 (1999). 5 Corby Considine, Restrictions on Assignability (1996). 2

3 II. PREFERENTIAL RIGHTS TO PURCHASE Preferential rights to purchase are found in a diverse range of contracts. Often variously referred to as pref rights, preemptive rights, or rights of first refusal, a preferential right gives the rightholder an opportunity to purchase the burdened property upon the grantor s decision to sell. The language of a preferential right will specify the terms and conditions the rightholder must accept in order to exercise the preferential right. There is no limit to the number of scenarios in which a preferential right may be granted. A preferential right can even be granted as the sole term of a contract. For instance, a preferential right is created when Bill and John enter into a contract under which Bill gives John valuable consideration and John grants to Bill a right of first refusal to purchase Blackacre if and when John decides to sell Blackacre. More often, preferential rights to purchase property are created in conjunction with an initial transfer of an interest in the property. For instance, Bill may agree to lease a unit in an office building from John, and as part of the lease agreement, John may grant Bill a preferential right to purchase the leased unit, or other units within that building, in the event John sells the unit(s). In the oil and gas context, preferential rights are of particular significance in joint operating agreements. Under a joint operating agreement, multiple parties share an interest in an oil and gas property. In this scenario, in order to maintain certainty regarding operations amongst owners, it is generally advantageous to give each party to the joint operating agreement a preferential right to purchase the interest of the other parties to the joint operating agreement in the event a party wishes to sell its interest in the oil and gas property. Otherwise, the parties would have to constantly be wary that an undesirable, litigious, uncooperative, or financially unstable party could accede to an interest under the joint operating agreement. Importantly, preferential rights are not options, despite exhibiting many option-like characteristics, and are thus treated differently from options by courts. Until a triggering event occurs (typically the grantor s desire to sell), the rightholder has no authority to compel the grantor to sell the property. 6 Only after the preferential right has been triggered and sufficient notice of the triggering event has been given to the holder is an irrevocable option created in favor of the holder. 7 In this manner, preferential rights have been referred to as dormant options. 8 A. TRIGGERING EVENTS Preferential rights are creatures of contract, and as such, will trigger according to the language used in drafting the right. Most preferential rights are drafted to trigger upon some event related to the sale of the property. For instance, the preferential right may be drafted to trigger upon the grantor s desire to sell. Alternatively, the preferential right may be drafted to trigger upon the grantor s decision to accept a bona fide offer. The most commonly litigated issue regarding the triggering event is whether a sale has occurred. 6 Hicks v. Castille, 313 S.W.3d 874, 881 (Tex. App. Amarillo 2010, pet. denied). 7 Riley v. Campeau Homes, Inc., 808 S.W.2d 184, 188 (Tex. App. Houston [14th Dist.] 2002, no pet.). 8 A.G.E., Inc. v. Buford, 105 S.W.3d 667, 673 (Tex. App. Austin 2003, pet. denied). 3

4 1. Triggering Preferential Rights Generally The typical preferential right is triggered whether the grantor transfers all or merely some of his rights to the burdened property. The Texas Supreme Court stated that [t]he term sale, when used in a property context, is commonly understood to mean any conveyance of an estate for money or money s worth.... [A]nd a purchase of a fee simple, determinable fee, fee subject to a condition subsequent, or life estate would each be considered a sale of those interests. 9 Consequently, because an oil and gas leases is a fee simple determinable interest, the Texas Supreme Court held that a preferential right is triggered when the grantor leases oil and gas rights to a third party. 10 Texas courts have determined in certain instances a wide variety of transactions do not constitute sales that will trigger a preferential right. For instance, courts have held typical preferential rights to not be triggered upon the gift of burdened property 11 or by the transfer of burdened property pursuant to a foreclosure sale. 12 Additionally, transfers of burdened property under a divorce decree, 13 execution of a mortgage on the burdened property, 14 and transfers between co-owners, such as tenants in common, will not normally trigger a preferential right. 15 In some instances, a preferential right provision may refer to the triggering event as a disposition of property rather than a sale. Under such a provision, some of the aforementioned transactions could trigger the right. For instance, in Dixie Pipe Sales, Inc. v. Perry, a preferential right was triggered by a transfer upon the grantor s death because language in the preferential right provision referred to a disposition as the triggering event. 16 The particular language and circumstances surrounding creation of a preferential right can determine when it triggers. For example, in Hinds v. Madison, a group of individuals (the Madisons ) owned approximately 15,000 acres of land. 17 The Madisons entered an agreement with another group (the Hinds ) to lease approximately 2,850 acres for five years for purposes of grazing. 18 The lease contained a termination provision coupled with a preferential right in favor of the Hinds, stating in the event of a sale, lessors shall have the right to terminate this lease.... In this connection, however, in the event of sale, lessee shall have a preference right to purchase. 19 The Madisons arranged a sale of the land in a transaction expressly made subject to the lease (e.g., the Madisons did not exercise their right to terminate the grazing lease upon their sale of the leased premises). 20 Although the Hinds argued that the lease granted them an opportunity to purchase the leased premises on the same terms as the proposed sale, the court interpreted the lease to not trigger the preferential right under the facts of the case. 21 Instead, the 9 Cherokee Water Co. v. Forderhause, 641 S.W.2d 522, 525 (Tex. 1982). 10 Id. at A.P. Simons Co. v. Julian, 531 S.W.2d 451, (Tex. Civ. App. Eastland 1975, no writ). 12 Draper v. Gochman, 400 S.W.2d 545, 548 (Tex. 1966). 13 Earthman s, Inc. v. Earthman, 526 S.W.2d 192, 202 (Tex. Civ. App. Houston [1st Dist.] 1975, no writ). 14 Draper, 400 S.W.2d at Tex. Co. v. Graf, 221 S.W.2d 865, 866 (Tex. Civ. App. Fort Worth 1949, writ ref d n.r.e.). 16 Dixie Pipe Sales, Inc. v. Perry, 834 S.W.2d 491, 494 (Tex. App. Houston [14th Dist.] 1992, writ denied). 17 Hinds v. Madison, 424 S.W.2d 61, (Tex. Civ. App. San Antonio 1967, writ ref d n.r.e.). 18 Id. at Id. 20 Id. 21 Id. 4

5 court interpreted the preferential right as triggering only upon sales of the leased premises that occurred after the Madisons had exercised their early termination right under the lease. 22 Consequently, the preferential right in favor of the Hinds was not triggered Corporate Transactions and Triggering Preferential Rights When the grantor of a preferential right is a corporation or other business entity, absent change of control type language as a triggering event, restructurings or other forms of reorganization generally will not trigger the preferential right. For instance, a sale of stock in a corporation that owns property burdened by a preferential right will not trigger the preferential right. 24 Furthermore, a preferential right will not be triggered when the grantor-corporation merges with another corporation. 25 Moreover, the preferential right will probably not trigger when the burdened property is transferred from a subsidiary corporation to a parent corporation. 26 In Tenneco, Inc. v. Enter. Prods. Co., the Texas Supreme Court held that (1) a stock sale does not trigger a preferential right provision absent express language to that effect; and (2) multiple transactions will not be viewed together to determine whether a preferential right has been triggered. 27 In Tenneco, a corporation ( Tenneco Oil ) entered into a joint operating agreement with four other corporations (the Enterprise Parties ), under which each party s interest was burdened with a preferential right to purchase a natural gas fractionation plant. 28 The language creating the preferential right expressly stated that each party s interest in the plant could be transferred to a wholly owned subsidiary without triggering the preferential right. 29 Tenneco Oil transferred its interest in the plant to a wholly owned subsidiary ( Tenneco Natural Gas ) and sold all the stock of Tenneco Natural Gas to a third party. 30 The Texas Supreme Court first acknowledged that the initial asset transfer from Tenneco Oil to Tenneco Natural Gas could not have triggered the preferential right because of the express exemption of transfers to subsidiaries in the contract language. 31 Moreover, the court held that a sale of stock and a sale of assets are fundamentally different transactions that cannot be equated for purposes of determining the triggering of a preferential right. 32 Finally, the court rejected an argument that the asset transfer from Tenneco Oil to Tenneco Natural Gas and subsequent stock sale should be treated as a single transaction based on the intent of Tenneco Oil to circumvent the preferential right. 33 Rather, [v]iewing several separate transactions as a single transaction to invoke the 22 Id. at Id. 24 Tenneco, Inc. v. Enter. Prods. Co., 925 S.W.2d 640, 646 (Tex. 1996). 25 Engel v. Teleprompter Corp., 703 F.2d 127, (5th Cir. 1983) (applying Texas law). 26 Questa Energy Corp. v. Vantage Point Energy, Inc., 887 S.W.2d 217, 222 (Tex. App. Amarillo 1994, writ denied). 27 Tenneco, 925 S.W.2d at Id. at Id. at Id. at Id. at Id. at Id. 5

6 right of first refusal compromises the law s unfavorable estimation of such restrictive provisions. 34 The Tenneco opinion presents an opportunity for grantors of preferential rights to avoid application of the preferential right. Correspondingly, grantees of preferential rights should consider Tenneco when negotiating the terms of a preferential right provision. If a preferential right cannot be triggered by a transfer to a grantor s affiliate, then ordinary preferential right language that states the triggering event as the grantor s desire to sell can be circumvented merely by incorporating the burdened property into a subsidiary corporation and selling stock of that subsidiary corporation to a third party. It is possible that even when a grantor that is an individual transfers the burdened property to a wholly owned corporation, the preferential right will not be triggered upon a subsequent sale of that corporation s stock. 3. Package Sales and Sales of a Portion of the Burdened Property A preferential right on a single burdened property will generally trigger when the grantor sells that property as part of a package of assets. 35 Moreover, a preferential right burdening a tract of land will trigger when the burdened tract is sold as part of a larger plot of land. 36 Similarly, a sale of only a smaller portion of the burdened property will trigger the preferential right, but only as to that smaller portion of the property. 37 In other words, the preferential right will trigger, but the grantee will only have the right to purchase the portion of the property that the grantor attempted to sell, and not the entire property. 38 B. NOTICE OF TERMS REQUIREMENT A preferential right will not ripen into an option in favor of the grantee until the grantee receives sufficient notice. Courts use a two-step approach to determine whether the notice requirement is satisfied. First, the grantor has an initial duty to make a reasonable disclosure of the terms to the grantee. 39 Second, upon receiving a reasonable disclosure of the terms, the grantee has a duty to conduct a reasonable investigation of any terms unclear to him. 40 If no reasonable disclosure is made, the preferential right will not ripen into an option without the grantee s receipt of actual knowledge of the sale (which, in some instances, may not happen until well after the sale has occurred). 34 Id. 35 Navasota Res., L.P. v. First Source Tex., Inc., 249 S.W.3d 526, (Tex. App. Waco 2008, pet. denied) (holding a preferential right to purchase a working interest in oil and gas property was triggered when the working interest was sold, along with stock of the grantor, and the grantor entered into an area of mutual interest with the third-party purchaser); McMillan v. Dooley, 144 S.W.3d 159, (Tex. App. Eastland 2004, pet. denied) (holding a preferential right on an oil and gas lease was triggered upon the sale of that lease with two others); Riley, 808 S.W.2d at 189 (holding a preferential right on a condominium unit was triggered upon the sale of that unit in a package with twenty-four other units). 36 Comeaux v. Suderman, 93 S.W.3d 215, 221 n.3 (Tex. App. Houston [14th Dist.] 2002, no pet.); Foster v. Bullard, 496 S.W.2d 724, (Tex. Civ. App. Austin 1973, writ ref d n.r.e.). 37 Hicks, 313 S.W.3d at Id. 39 Koch Indus., Inc. v. Sun Co., 918 F.2d 1203, 1212 (5th Cir. 1990) (applying Texas law). 40 Id. 6

7 Often, the contract creating the preferential right will explicitly state the grantor s obligations regarding notice. Nevertheless, the reasonable disclosure requirement can be satisfied even if the grantor fails to fully comply with all the notice requirements actually specified in the contract. In Comeaux v. Suderman, a lessee ( Comeaux ) held a preferential right to purchase a one acre tract of land. 41 The preferential right stated that the lessor ( Suderman ) must notify [Comeaux] in writing of the true and complete terms and conditions of any proposed sale. 42 After agreeing to sell thirty-five acres of land, including the burdened one acre, for $350,000, Suderman notified Comeaux of the sale. 43 However, Suderman did not specify the total acreage that was being sold and did not provide any other terms of the agreement in his notice to Comeaux. 44 The court held that the notice, while not a model of clarity, reasonably disclosed Suderman s intention to sell the leased premises and additional property to a third party for a total price of $350, Once Suderman satisfied the reasonable disclosure requirement, the burden of conducting a reasonable investigation as to unclear terms fell upon Comeaux. 46 Because the reasonable disclosure requirement was satisfied and Comeaux did not conduct a reasonable investigation to determine the additional details of the transaction, the court noted that the technical sufficiency of the notice was irrelevant. 47 When the preferential right provision expressly prescribes notice requirements, the grantor typically will not have to do more than what is expressly stated in order to satisfy the reasonable disclosure requirement. In Fasken Land & Minerals, Ltd. v. Occidental Permian Ltd., an operating agreement for oil and gas properties gave each party to the agreement a preferential right to purchase any other party s interest. 48 The agreement required that any party who desires to sell a burdened interest must give notice that includes (1) the name and address of the prospective purchaser;... (2) the purchase price or in the event of the transfer of a business entity or group of properties, an allocation of that portion of the purchase price attributable to [the burdened interest]; (3) a legal description sufficient to identify the property and interest; and (4) all other terms of the proposed sale. 49 One of the parties to the agreement ( Altura ) decided to sell its burdened interest along with various other properties to a third party. 50 Altura and the third party allocated $63 million of the purchase price to the burdened interest. 51 Other parties to the agreement (the Fasken Entities ) demanded that Altura provide documentation to verify the allocation of purchase price between the burdened interest and other properties. 52 The court found that by specifying requirements for notice, the parties prescribed what would constitute full information concerning the proposed transaction and by doing so, clearly limited the purpose of giving written notice to information considered material to the 41 Comeaux, 93 S.W.3d at Id. 43 Id. 44 Id. 45 Id. at Id. 47 Id. 48 Fasken Land & Minerals, Ltd. v. Occidental Permian, Ltd., 225 S.W.3d 577, 581 (Tex. App. El Paso 2005, pet. denied). 49 Id. at Id. at Id. at Id. at

8 right holders ability to exercise the preferential right. 53 Thus, Altura was not required to provide any additional information to the Fasken Entities in order to trigger the preferential right. 54 It should be noted that the court found the notice requirements stated in the Fasken operating agreement to be precise and comprehensive. 55 If the notice provision was ambiguous or more restrictive, it is possible that the grantor would have had to provide more information than expressly required in order to satisfy the reasonable disclosure requirement. 56 C. EXERCISING THE RIGHT 1. Generally Upon receiving notice, the grantee must manifest acceptance by agreeing to all the terms and conditions of the third party s offer. In order to effectively exercise the preferential right, the holder s expression of acceptance must be positive, unconditional, and unequivocal. 57 The acceptance must also be conveyed in the manner designated by the contract or the notice given by the grantor. 58 For instance, in Abraham Investment Co. v. Payne Ranch, an attempted oral acceptance was ineffective when the grantor s notice demanded that acceptance be conveyed by signing and returning the notice letter. 59 The court deemed it irrelevant that the manner of acceptance was designated unilaterally by the grantor in the notice, even though the contractual provision was silent on the matter The Exact Match Requirement & West Texas Transmission Generally, the rightholder s acceptance must precisely match the triggering offer. Any attempt to add, remove, or alter terms typically amounts to a rejection and accompanying counteroffer, and will be ineffectual for purposes of exercising the preferential right. However, a line of cases beginning with West Texas Transmission, L.P. v. Enron Corp. holds that the rightholder must only accept terms that are commercially reasonable, imposed in good faith, and not specifically designed to defeat the preemptive rights. 61 In West Texas Transmission, Valero Transmission Company ( Valero ) had a preferential right to purchase an interest in a natural gas transmission pipeline from Enron Corporation ( Enron ). 62 Enron entered into an agreement to sell the pipeline interest to a third party, subject to approval of the transaction by the Federal Trade Commission (the FTC ). 63 The FTC notified the parties that the sale to the third party would not violate antitrust laws but that a sale to Valero would be prohibited. 64 Valero argued that it should be allowed to exercise its preferential right without having to agree to the FTC approval requirement. 65 The Fifth Circuit rejected Valero s 53 Id. at Id. 55 See id. at See id. at Hicks, 313 S.W.3d at Abraham Inv. Co. v. Payne Ranch, 968 S.W.2d 518, 525 (Tex. App. Amarillo 1998, pet. denied). 59 Id. 60 Id. 61 W. Tex. Transmission, L.P. v. Enron Corp., 907 F.2d 1554, 1563 (5th Cir. 1990) (applying Texas law). 62 Id. at Id. at Id. at Id. at

9 argument, holding that Valero could only exercise their preferential right by accepting all the sale terms in the agreement between Enron and the third party, including the FTC approval clause. 66 The FTC approval clause was made in good faith, absent evidence of subterfuge or collusion, and without an ulterior motive to override Valero s right of first refusal. 67 The FTC approval clause was commercially reasonable because Enron and the third party agreed to it only after extensive arms-length negotiations which resulted in a comprehensive pipeline purchase agreement. 68 The Fifth Circuit emphasized that [w]here two sophisticated businesses reach a hard-fought agreement through lengthy negotiations, it is difficult to conclude that any negotiated term placed in their contract is commercially unreasonable. 69 Furthermore, the FTC approval clause was designed to serve the function of reducing Enron s risk of liability for fines rather than to defeat the preferential right. 70 In Shell v. Austin Rehearsal Complex, Inc., the Austin Court of Appeals held that sufficient evidence supported a jury s finding that terms were imposed in bad faith, commercially unreasonable, or intended to defeat the preferential right. 71 In that case, Austin Rehearsal Complex ( ARC ), as the lessee, leased space within a commercial building in order to operate a music rehearsal business, and held a preferential right to purchase additional space within that building, from two individuals (the Shells ). 72 The preferential right expressly triggered when the Shells either sold or leased space within the building to third parties. 73 ARC received notice of various transactions entered into by the Shells during 1993 and 1994, but declined to exercise its preferential right during this period. 74 However, ARC notified the Shells of a desire to expand its business to additional space in Subsequently, the Shells entered into a lease transaction with a third party that included a lengthy list of terms and conditions (including restrictions on the use of loud speakers or amplifiers, limits on objectionable noises or vibrations, and a prohibition on signs viewable from the exterior) that ARC contended were commercially unreasonable and were specifically designed to frustrate ARC s right of first refusal. 76 Because the Shells included especially restrictive terms in their agreement shortly after receiving notice that ARC intended to expand and would likely exercise the preferential right, the court found that the jury s response... could be supported by evidence of bad faith, commercial unreasonableness, or intent to defeat ARC s option. 77 In Stewart v. Langdon, the Fort Worth Court of Appeals clarified that the West Texas Transmission framework applies to terms that are included by either the grantor of the preferential right or the third party purchasing the burdened property. 78 The Stewart court also 66 Id. at Id. 68 Id. 69 Id. 70 Id. at Shell v. Austin Rehearsal Complex, No CV, 1998 Tex. App. LEXIS 5035, at *30 (Tex. App. Austin Aug. 13, 1998, no pet.) (not designated for publication). 72 Id. at * Id. at *3. 74 Id. 75 Id. 76 Id. 77 Id. at * Stewart v. Langdon, No CV, 2010 Tex. App. LEXIS 7036, at *12 13 (Tex. App. Fort Worth Aug. 26, 2010, pet. denied) (mem. op.). 9

10 held that an auction provision in the sale agreement between the grantor and third party was imposed in bad faith and intended solely to defeat the preferential right. 79 Several individuals (the Appellees ) held a preferential right to purchase real estate from another individual ( McGilvery ). 80 McGilvery entered into a sales contract with a third party that included an auction provision. 81 The auction provision stated that should the Appellees choose to exercise the preferential right according to the terms of the agreement between McGilvery and the third party, the third party would then have an option to amend his offer to the grantor. 82 The court indicated that it was irrelevant whether the auction provision was imposed by the third party or McGilvery. 83 Moreover, the auction provision was intended to defeat the preferential right because it create[d] a situation in which, if Appellees wanted to exercise their preemptive right, they would be forced to participate in an auction.... Under [the] auction terms, there would never be a definite, final price term for Appellees to accept or reject because [the third party] would always have an opportunity to make a higher bid. 84 Some Texas courts have entirely rejected the West Texas Transmission framework. The Amarillo Court of Appeals has argued that West Texas Transmission is not valid Texas law, noting that the exception to the exact match rule derives from the law of other jurisdictions rather than Texas law. 85 However, in a more recent case, the Amarillo Court of Appeals applied West Texas Transmission without considering its possible invalidity. 86 While this issue is yet to be taken up by the Texas Supreme Court, the majority of Texas appellate and district courts follow West Texas Transmission. 87 The holder of a preferential right faces a dilemma when it is unclear whether the terms of the grantor s sale must be accepted to exercise the right. Consequently, Texas courts acknowledge that the holder can notify the grantor of an intent to accept, subject to a court s determination that a particular term is objectionable, and then file a declaratory judgment action prior to the deadline for accepting West Texas Transmission Applied to Package Sale and Partial Sale Transactions Despite general acceptance of West Texas Transmission, Texas courts have typically refused to apply the framework with respect to package sale transactions. Thus, the grantor cannot require the holder of a preferential right to purchase multiple assets in addition to the burdened property, even if a term requiring the purchase of additional assets is imposed in good faith, commercially reasonable, and not designed to defeat the preferential right. 89 The Waco and Eastland Courts of Appeals have expressly distinguished West Texas Transmission as only 79 Id. at * Id. at * Id. at * Id. 83 Id. at * Id. at * Abraham Inv. Co., 968 S.W.2d at 527; see also McMillan, 144 S.W.3d at (noting that West Texas Transmission has not uniformly been accepted by Texas courts). 86 Hicks, 313 S.W.3d at See e.g., FWT, Inc. v. Haskin Wallace Mason Prop. Mgmt., L.L.P., 301 S.W.3d 787 (Tex. App. Fort Worth 2009, pet. denied). 88 See Tex. State Optical v. Wiggins, 882 S.W.2d 8, 10 (Tex. App. Houston [1st Dist.] 1994, no writ). 89 Navasota, 249 S.W.3d at 543; Comeaux, 93 S.W.3d at

11 applying to the conveyance of a single asset. 90 Moreover, several courts have concluded that the grantor cannot require the holder to purchase assets in addition to the burdened property without considering the application of West Texas Transmission. 91 However, in FWT, Inc. v. Haskin Wallace Mason Property Management, L.L.P., the Fort Worth Court of Appeals applied West Texas Transmission to a package sale and held that the holder of a preferential right had to purchase the entire package of assets in order to exercise the preferential right. 92 A partnership ( Haskin Wallace ) purchased undeveloped real property from a corporation ( FWT ) for the purpose of constructing a galvanizing facility. 93 FWT retained a preferential right to purchase the real property from Haskin Wallace. 94 Haskin Wallace initially owned one entity ( Texas Galvanizing ) and formed another entity ( U.S. Galvanizing ) to operate the galvanizing business. 95 Subsequently, Haskin Wallace reached an agreement to sell the assets of Texas Galvanizing and U.S. Galvanizing to a third party ( Valmont ). 96 In conjunction with the sale, Haskin Wallace would lease the burdened property to Valmont, giving Valmont an option to purchase it subject to FWT s preferential right. 97 FWT attempted to exercise the preferential right, but only as to the burdened property. 98 The court held that West Texas Transmission applied to package sales whenever the preferential right is expressly made subject to the same terms and conditions offered by a prospective, bona fide, third-party purchaser. 99 In this manner, the court distinguished prior cases such as Navasota Resources as not having language within the preferential right unambiguously requiring the holder to accept the same terms and conditions as the third party s offer. 100 For purposes of package sales, the court indicated that a sale of assets that are closely related to the burdened asset is likely to be commercially reasonable. 101 Because U.S. Galvanizing and Texas Galvanizing were galvanizing businesses and since the burdened property was used to conduct a galvanizing business, the transaction as a whole was commercially reasonable. 102 No arguments were presented suggesting that the transaction was imposed in bad faith or designed to defeat FWT s preferential right. 103 Therefore, FWT was required to purchase the entire package of assets in order to exercise its preferential right as to the burdened real property. 104 In the sole Texas case dealing with the sale of a portion of the burdened property, the Amarillo Court of Appeals applied West Texas Transmission. 105 In Hicks v. Castille, an individual ( Castille ) held a preferential right to purchase a four-acre tract of land from another 90 Navasota, 249 S.W.3d at 536; McMillan, 144 S.W.3d at Comeaux, 93 S.W.3d at 221 n.2; Hinds, 424 S.W.2d at FWT, 301 S.W.3d at Id. at Id. 95 Id. 96 Id. at Id. 98 Id. at Id. at Id. at Id. at 802 n Id. 103 Id. at Id. 105 Hicks, 313 S.W.3d at

12 individual ( Hicks ). 106 Hicks entered into an agreement to sell a.28-acre portion of the burdened land for $50, The court found no evidence that the sale failed to satisfy any of the West Texas Transmission criteria. 108 Notably, the court emphasized that even if the sale actually defeated the preferential right, it was not specifically designed to defeat the right. 109 Only when the grantor imposes terms that are intended to defeat the preferential right is that particular element of West Texas Transmission not met. 110 Consequently, the court held that Hicks was required to purchase the.28-acre tract in order to exercise his preferential right. 111 Moreover, the Hicks court distinguished package sale transactions involving the sale of the burdened asset from sales of a portion of the burdened asset. 112 Unlike in the package sale scenario, an attempted sale of only a portion of the property burdened by a preferential right is not beyond the scope of the agreement that created the preferential right because it only involves property that is subject to the original preferential right agreement Assigning a Value to the Burdened Property in Package Sales As discussed in the previous subpart, most Texas courts hold that a rightholder is only required to purchase the burdened property when the grantor attempts to sell the burdened property in a package along with other assets. 114 In such a case, the purchase price must be apportioned between the assets in order to determine what price the holder must pay to exercise the preferential right. Texas courts will generally uphold an allocation made by the grantor-seller absent affirmative evidence of bad faith or of some other improper basis for the allocated price. 115 For instance, in Navasota Resources, L.P. v. First Source Texas, Inc., the Waco Court of Appeals upheld an allocation of $700 per acre of a property burdened by a preferential right even though evidence indicated that fair market value for that property would be higher. 116 An entity ( Navasota ) held a preferential right to purchase a working interest in an oil and gas property from a corporation ( First Source ). 117 A third party ( Chesapeake ) entered into a transaction to purchase the working interest from First Source along with several other assets that were owned by First Source s parent corporation. 118 First Source notified Navasota of the sale and specified that, of the total purchase price, $700 would be allocated to each acre of the working interest. 119 First Source also indicated that Navasota would be required to purchase the entire package of assets in order to exercise the preferential right, a notion that was firmly rejected by 106 Id. at Id. 108 Id. at Id. at 881 n See id. 111 Id. at Id. at 882 n Id. 114 See Navasota, 249 S.W.3d at Id. at 542 (citing various courts outside of Texas for this proposition and noting that Texas decisions appear to follow this approach). 116 Id. at Id. at Id. at Id. 12

13 the court. 120 Nevertheless, First Source argued that if Navasota were not required to purchase the entire package of assets, they should at least be required to pay more than $700 per acre for the working interest. 121 In support, First Source contended that the fair market value for the working interest is higher than $700 and was being sold at a discount only because Chesapeake was willing to purchase additional assets. 122 The court held that Navasota was only obligated to pay $700 per acre, the amount allocated in the purchase agreement. 123 Similarly, where the package of assets including the burdened property consists of uniform, indistinguishable assets, Texas courts are likely to allocate the purchase price pro rata between the transferred assets. In Foster v. Bullard, an individual ( Foster ) held a preferential right on an approximately 48-acre tract from another individual ( Bullard ). 124 The preferential right provision required that Foster pay an amount consistent with [a third party s] offer, but not less than $ per acre. 125 Bullard sold nearly 2,500 acres that included the burdened 48- acre tract at a price of $650 per acre. 126 Bullard notified Foster that he would have to pay $3,000 per acre in order to exercise the preferential right. 127 In support, Bullard introduced evidence that he had previously negotiated a deal with another potential buyer under which the 48-acre tract would be sold as part of a 164-acre tract for upwards of $3,000 an acre. 128 The court held that Foster was only required to pay $750 per acre in order to exercise the preferential right. 129 The prior negotiations involving a potential sale at $3,000 per acre were superseded by the actual sale for $650 per acre, and no evidence suggested that the actual purchaser valued the specific 48-acre tract at a higher relative value than the other acreage. 130 D. TERMINATION Once the preferential right has been triggered due to a triggering event and the holder s receipt of notice, the right matures into an irrevocable option for a limited period of time. 131 The terms of the preferential right provision will generally determine how long the holder will have to exercise the right. Failure to exercise the right within this limited time period results in termination of the preferential right. 132 If no amount of time is specified, the holder s power of acceptance terminates after a reasonable time. 133 For instance, in Comeaux v. Suderman, a rightholder failed to give timely notice of acceptance within thirty days, as required by the contract, and consequently, the grantor was able to sell to a third party without restriction. 134 The grantor ( Suderman ) notified the rightholder ( Comeaux ) of a property sale including a 120 Id. at Id. at Id. 123 Id. at Foster, 496 S.W.2d at Id. 126 Id. at Id. 128 Id. 129 Id. at Id. 131 Riley, 802 S.W.2d at See e.g., Comeaux, 93 S.W.3d at 220 ( [A] failure to exercise an option according to its terms, including untimely or defective acceptance, is simply ineffectual, and legally amounts to nothing more than a rejection. ). 133 Buford, 105 S.W.3d at Comeaux 93 S.W.3d at ,

14 one-acre property burdened by a preferential right, specifying the total price but not indicating the amount of land that was actually being sold. 135 Even so, the court found that the notice given by Suderman was sufficient, thereby creating an irrevocable option in favor of Comeaux. 136 Because Comeaux failed to exercise the option within the requisite thirty days, it expired, leaving Suderman unburdened by the preferential right when selling to the third party. 137 The preferential right will terminate even sooner if the holder responds to the grantor with a rejection. Significantly, a failure to unconditionally accept all the terms of the agreement between the grantor and third party will constitute a rejection and counteroffer, thereby terminating the preferential right. 138 Once the preferential right has matured into an option, it will not terminate prior to the expiration of the allowable time period because of the termination or revocation of the third party s offer to the grantor. 139 This is a particularly important consideration in package sales where the burdened property constitutes the 'crown jewel' of the properties being sold. In such a scenario, if the third party terminates or revokes its offer, the grantor could be forced to sell the high-value property and be left with low-value property, which may not be capable of being sold on its own. However, termination or revocation of the third party s offer prior to receipt of notice will prevent maturation of the preferential right into an option. 140 E. BINDING PARTIES OTHER THAN THE INITIAL GRANTOR AND HOLDER When the grantor sells property burdened by a preferential right, the third-party purchaser will take the property subject to the preferential right, regardless of whether it is real property or personal property. 141 Thus, so long as the period for exercise has not expired, the rightholder can exercise the right when the property is in the hands of a third-party purchaser. 142 Technically, this should never occur unless the grantor has violated the preferential right because preferential rights, by definition, require the grantor to sell the property to the rightholder should the right be exercised. Transferring to a third party prior to the expiration of the period during which the rightholder can exercise necessarily places the grantor in peril of violating the preferential right. Transferees who agree to take the burdened property subject to the preferential right will also be bound. 143 For preferential rights burdening real property, an important distinction exists between real covenants and personal covenants. A real covenant runs with the land, while a personal covenant only binds the parties to the initial contract. A preferential right is a real covenant that runs with the land if (1) privity of estate exists between the contracting parties; (2) the covenant 135 Id. at Id. at Id. at See e.g., Tex. State Optical, 882 S.W.2d at See e.g., Riley, 808 S.W.2d at ; Henderson v. Nitschke, 470 S.W.2d 410, 414 (Tex. Civ. App. Eastland 1971, writ ref d n.r.e.). 140 Holland v. Fleming, 728 S.W.2d 820, 823 (Tex. App. Houston [1st Dist.] 1987, writ ref d n.r.e.). 141 Jarvis v. Peltier, No CV, 2013 Tex. App. LEXIS 5017, at *14 (Tex. App. Tyler Apr. 24, 2013, no pet.) ( A purchaser from a seller who has given a right of first refusal to buy takes the property subject to that right. ). 142 See id. 143 Strange, supra note 3 at

15 touches and concerns the land; (3) the parties intended the covenant to run with the land; and (4) the covenant specifically binds the parties or relates to a thing in existence. 144 When a preferential right constitutes a real covenant, subsequent transferees of the grantor s interest in the property will be bound by the preferential right. 145 Moreover, subsequent transferees of the rightholder s property interest will obtain the benefit of the preferential right, even if the rightholder does not purport to assign any contractual rights. Texas courts consistently hold that a preferential right can satisfy all the requirements to be a real covenant. 146 In MPH Production Co. v. Smith, the Texarkana Court of Appeals discussed the privity of estate and intent to run with the land requirements, holding that a preferential right did constitute a real covenant. 147 The sequence of transfers occurred as follows: (1) The owner of land (the Initial Grantor ) conveyed the surface rights along with a preferential right to purchase the mineral rights to several individuals (the Initial Rightholders ); (2) the Initial Rightholders conveyed the surface rights to another group of individuals (the Second Rightholders ); (3) the Initial Grantor transferred the mineral rights to a corporation (the Second Owner ) without giving notice of the sale to either the Second or Initial Rightholders; and (4) the Second Owner transferred the mineral rights to another corporation (the Third Owner ) without giving notice of the sale to either the Second or Initial Rightholders. 148 The Third Owner argued that the preferential right did not run with the land because no privity of estate existed between the Initial Grantor and Initial Rightholder when the right was created and because the Initial Grantor and Initial Rightholder did not intend the right to run with the land. 149 Notably, it was not disputed that the Third Owner had an obligation to honor the preferential right as to the Initial Rightholder, who did not receive notice of the sales; rather, the dispute concerned whether the Second Rightholders had the benefit of the preferential right. 150 The court first held that privity of estate existed between the Grantor and Rightholder. 151 Thus, a preferential right can run with the land even if it is created in conjunction with the separation of a surface and mineral interest. 152 The court noted that the contract only purported to bind the [Initial] Grantors, and their respective heirs and assigns and failed to refer to the heirs, successors and assigns of the Initial Rightholders. 153 However, despite a lack of successors language, the court conclude[d] that it is a stretch to read into the subtleties of the deed s text an intent to make the right of first refusal a personal right only. 154 In the alternative, the court held that the preferential right was properly assigned by the Initial Rightholders to the Second Rightholders. 155 Thus, even if the 144 MPH Prod. Co. v. Smith, No CV, 2012 Tex. App. LEXIS 3989, at *2 (Tex. App. Texarkana May 18, 2012, no pet.) (mem. op.) (citing Inwood N. Homeowners Ass n v. Harris, 736 S.W.2d 632, 635 (Tex. 1987)). 145 See Wise, supra note 2 at Id. at MPH, 2012 Tex. App. LEXIS, at * Id. at * Id. at * Id. at * Id. at * Id. 153 Id. at * Id. at * Id. at *18. 15

16 preferential right did not run with the land, the benefit of the right could still be asserted by the Second Rightholder. 156 F. REMEDIES Because a preferential right is a contractual provision, the grantor s failure to abide by its terms typically constitutes a breach of contract. Thus, the holder of a preferential right will usually assert a breach of contract action if the grantor fails to provide satisfactory notice of a triggering event. Similarly, the rightholder will usually assert a breach of contract action if the grantor refuses to convey the burdened property following the holder s satisfactory acceptance after receipt of notice. After asserting and establishing a breach of contract action, the holder may ask the court for a remedy of specific performance, requiring that the grantor convey the burdened property to the holder in exchange for the consideration stated in the third party s bona fide offer. Generally, specific performance is available to require performance of a contract only when no alternative remedy, such as damages, would adequately compensate the harmed party. 157 For the sale of real property pursuant to a preferential right provision, the holder will be entitled to specific performance if he demonstrates that he is ready, willing and able to pay the agreed price for the property and perform the essence of the agreement and offer to do so. 158 For sales of personal property, specific performance will typically be granted only when the property has a special, peculiar, or unique value or character, and the plaintiff would not be adequately compensated for his loss by an award of money damages. 159 The rightholder will only be able to obtain specific performance against a third-party purchaser that had actual or constructive notice of the preferential right. 160 Alternatively, the holder can request an award of damages for breach of contract. A successful plaintiff in a breach of contract action is entitled to expectation damages, which are supposed to place the injured party as nearly as possible in the position that he would have occupied had the defaulting party performed the contract. 161 The holder of a preferential right, like the holders of ordinary options to purchase, will not be able to recover damages unless he prove[s] that he was ready, willing, and able to perform, though the holder need not tender performance. 162 In addition, the holder can assert various theories of recovery in tort against either the grantor or third party. If the grantor intentionally conceals or misrepresents that the burdened property is being sold to a third party, a claim for fraud or misrepresentation may be available. 163 If the third party induced the grantor to breach the preferential right provision, the holder can assert a claim for tortious interference with contract. 164 Moreover, in the context of oil and gas 156 Id. at * See e.g., Madariaga v. Morris, 639 S.W.2d 709, 711 (Tex. App. Tyler 1982, writ ref d n.r.e.). 158 Riley, 882 S.W.2d at 188 (quoting Scott v. Vandor, 671 S.W.2d 79, 86 (Tex. App. Houston [1st Dist.] 1984, writ ref d n.r.e.)). 159 Madariaga, 639 S.W.2d at Abraham Inv. Co., 968 S.W.2d at Koch, 918 F.2d at Id. 163 See Wise, supra note 2 at Id. at

17 joint operating agreements, one commentator posits that the breach of a preferential right provision may constitute breach of a fiduciary duty. 165 Because some jurisdictions treat a joint operating agreement as creating a partnership despite disclaimers, fiduciary duties may run between each of the parties to the joint operating agreement. 166 Moreover, the commentator suggests that case law developed in response to preferential rights disputes involving commercial leases would not adequately describe the owner s duty in an oil and gas dispute. 167 G. DEFENSES In order to defeat a breach of contract claim arising from the breach of a preferential right provision, the grantor can raise any of the affirmative defenses typically available to the defendant in breach of contract litigation. The statute of frauds is one possible affirmative defense that the grantor may raise. The statute of frauds in Texas applies to sales of real estate, 168 leases of real estate for longer than one year, 169 and sales of oil, gas, and mineral interests. 170 Sales of goods for greater than $500 are also subject to the statute of frauds. 171 Promises or agreements subject to the statute of frauds are voidable unless they are evidenced by writing, signed by the seller. 172 For real property, the signed writing must also have a legally sufficient description of the real property to be effective, or it must reference another existing writing that identifies the property. 173 By granting a preferential right to purchase property, the grantor is effectively conveying an interest in property to the holder of the right. 174 Consequently, the agreement to grant a preferential right to purchase property must satisfy the signed writing requirement of the statute of frauds if the burdened property is one of the enumerated properties subject to the statute of frauds. 175 Texas courts consistently hold that preferential rights, exercisable upon the grantor s desire to sell for a price equal to a bona fide offer, are not an unreasonable restraint on alienation. 176 However, a preferential right to purchase at a fixed price may constitute an unreasonable restraint on alienation. 177 Courts will construe the provisions of a preferential right so as to avoid any unreasonable restraint on alienation. 178 In Hicks v. Castille, the court construed a preferential right provision to purchase a four-acre tract of land as not prohibiting the grantor from selling a portion of those four acres. 179 The court noted that by adopting any other construction, it would be enforcing what appears to be an unreasonable restraint on alienation: 165 Strange, supra note 3 at Id. at Id. at TEX. BUS. & COM. CODE ANN (b)(4). 169 Id. at 26.01(b)(5). 170 Id. at 26.01(b)(7). 171 Id. at 2.201(a). 172 Id. at 26.01(a). 173 Reiland v. Patrick Thomas Props., 213 S.W.3d 431, (Tex. App. Houston [1st Dist.] 2006, pet. denied). 174 Dunlap-Swain Tire Co. v. Simons, 450 S.W.2d 378, 382 (Tex. Civ. App. Dallas 1970, writ ref d n.r.e.). 175 See id. 176 Forderhause v. Cherokee Water Co., 623 S.W.2d 435, 439 (Tex. Civ. App. Texarkana 1981), rev d on other grounds, 641 S.W.2d 522, 525 (Tex. 1982). 177 Id. 178 Hicks, 313 S.W.3d at Id. 17

18 an outright prohibition of indeterminate duration from selling any portion of the land in question less than four acres. 180 In Texas, preferential rights do not violate the rule against perpetuities, even if the preferential right is unlimited in duration. 181 The grantor may also defend himself by invoking the statute of limitations. The limitations period for a lawsuit seeking specific performance to require the conveyance of real property is four years from the date the cause of action accrues. 182 Generally, accrual of a cause of action occurs when a wrongful act causes a legal injury, even if the fact of injury is not discovered until later, and even if all resulting damages have not yet occurred. 183 However, the discovery rule applies to certain causes of action, and when applicable, provides that limitations begin to run from the date the plaintiff discovers or should have discovered, in the exercise of reasonable care and diligence, the nature of the injury. 184 In Gilbreath v. Steed, the Tyler Court of Appeals suggested that the discovery rule should not be applied in the context of a breach of a preferential right provision. 185 The court held that, whether or not the discovery rule applied, the preferential rightholder s claim was barred by the statute of limitations. 186 Thus, the court did not have to decide whether the discovery rule applied. 187 However, in dicta, the court noted that [the holder] has cited no authority, nor are we aware of any, that supports her proposition that sale of... property... in disregard of a third party s right of first refusal tolls the limitations period on the right of first refusal once it has become ripe. Instead, [the holder s] right of first refusal ripened into an option when [the grantor] elected to sell the property. 188 The grantor may further defend himself by invoking waiver. The doctrine of waiver can be asserted when the holder of a preferential right intentionally relinquishes [the preferential right] or engages in intentional conduct inconsistent with claiming that right. 189 Waiver can be established either through an express renunciation or [s]ilence or inaction, for so long a period as to show an intention to yield the known right. 190 III. CONSENTS TO ASSIGN In any given oil and gas transaction, there is likely to be at least one lease, easement or contract containing a consent-to-assign provision. This section of the paper will address consentto-assign provisions in several respects. First, it will briefly discuss consents to assign in the landlord-tenant context for historical background. Second, it will highlight four types of consent-to-assign provisions that may be encountered in oil and gas transactions and discuss 180 Id. 181 Forderhause, 641 S.W.2d at 526; Weber v. Tex. Co., 83 F.2d 807, 808 (5th Cir. 1936) (applying Texas law); Jarvis, 2013 Tex. App. LEXIS at * TEX. CIV. PRAC. & REM. CODE ANN (a)(1). 183 Gilbreath v. Steed, No , 2013 Tex. App. LEXIS 5947, at *10 (Tex. App. Tyler May 15, 2013, no pet.) (mem. op.). 184 Id. at * Id. at * Id. 187 Id. 188 Id. 189 Tenneco, 925 S.W.2d at Id. 18

19 their effects. Lastly, this paper will lay out the requirements for consent-to-assign provisions in state leases. A. CONSENTS TO ASSIGN IN LANDLORD-TENANT LAW Although it is not clear that legal principles applicable to consent to assignment provisions contained in landlord-tenant contracts are controlling with respect to consent to assignment provisions in oil and gas leases, since consent to assignment provisions are commonly found in landlord-tenant contracts, the following review of such legal principles may be instructive, and helpful, in evaluating the issues presented in the instant facts. Because a landlord s consent to assignment is statutorily required in Texas, 191 consent to assignment provisions that require that a landlord/lessor give consent not to be unreasonably withheld are treated as covenants which, if breached, could be grounds for actions for damages. 192 Texas courts do not have a settled legal definition for what constitutes a reasonable reason to withhold consent. 193 However, in determining whether a landlord/lessor is acting unreasonably in withholding a consent to an assignment, courts have examined various factors, including the intended use of the property, the financial status of the proposed assignee, and the evidence supporting the commercial reasonableness of the denial. 194 Furthermore, reasonableness should be determined from the landlord tenant lease terms, and any demand to change the terms of such lease in exchange for consent is deemed unreasonable. 195 Courts in other states have also applied reasonably prudent person standards and reasonable business person standards to determine reasonableness. 196 If a landlord/lessor unreasonably withholds consent under one of the above applicable standards, a tenant/lessee has a cause of action for breach of the covenant to reasonably consent. 197 Furthermore, at least one court in another state has held that a tenant/lessee no longer needs to obtain consent if a landlord/lessor previously withheld consent unreasonably. 198 In that case, the court held that a landlord/lessor who withholds consent without giving any consideration to the financial stability of the proposed assignee and ignores reasonable efforts by tenant/lessee to obtain consent waives its right to withhold consent. 199 Under this rule, a landlord/lessor s unwillingness to reasonably consider a tenant/lessee s good faith effort to obtain consent voids the consent requirement. In the absence of a covenant not to unreasonably withhold consent, Texas courts have been unwilling to read in an implied covenant that the landlord/lessor act reasonably in withholding consent. 200 However, the justification for not implying a covenant not to 191 TEX. PROP. CODE ANN (Vernon 1984). 192 Reynolds v. McCullough, 739 S.W.2d 424, 429 (Tex. App. San Antonio 1987, writ den.) 193 Burlington Northern and Santa Fe Rwy. Co. v. South Plains Switching, Ltd. Co., 174 S.W.3d 348, 352 (Tex. App. Fort Worth [2 nd Dist] 2005). 194 Burlington, 174 S.W.3d at B.M.B. Corp. v. McMahan s Valley Stores, 869 F.2d 865, 869 (5 th Cir. 1989). 196 Ernst Home Center, Inc. v. Sato, 910 P.2d 486 (Wash. App. [Div. 1] 1996); Tenet Healthsystem Surgical, L.L.C. v. Jefferson Parish Hospital Svc. Dist. No. 1, 426 F.3d 728 (5 th Cir. 2005). 197 B.M.B., 869 F.2d at Roundup Tavern, Inc. v. Pardini, 68 Wash. 2d 512, (1966). 199 Id. 200 Reynolds, 739 S.W.2d at 429, discussing TEX. PROP. CODE ANN (Vernon 1984). 19

20 unreasonably withhold consent comes from deference to a state property statute that allows a landlord to withhold consent to an assignment. 201 As such, and as noted above, it is unclear whether a court would find an implied covenant of reasonableness for a consent provision existed in an oil and gas lease, which is considered a fee interest and would not be governed by the landlord-tenant statute. No cases addressing this issue could be found. In the absence of statutory limitations like the one found in Texas, courts in other states have applied a standard of good faith and fair dealing for landlord-tenant contracts to read in a requirement that any nonconsent be reasonable, even if the consent provision did not explicitly require reasonableness. 202 In this regard, even consent requirements without reasonableness standards may be subject to some good faith constraints on a lessor s ability to withhold consent, although it is unclear whether such a constraint would be applied to an oil and gas lease in Texas. B. CONSENTS TO ASSIGN BETWEEN OIL AND GAS LESSOR AND LESSEE In Texas, an oil and gas lease is a lease in name only, as Texas oil and gas leases create determinable fee interests, which are distinguishable from leases in the landlord-tenant context. As a general rule, attempted restraints on alienation of a fee are void. Thus, while consents in oil and gas leases are generally treated similarly to landlord-tenant leases, any consent provision in an oil and gas lease is likely unenforceable if the penalty for breach is forfeiture, or if the provision completely restricts future conveyances. If a lease contains such a provision, a court will probably construe the consent provision against the party seeking termination. 203 Depending upon the language, consent-to-assign provisions may be construed as either covenants or conditions subsequent. As such, the provisions must be carefully analyzed in order to ascertain the risks, effects, and duties that arise thereunder. Breach of a covenant typically results in a cause of action for damages, whereas breach of a condition subsequent typically results in the underlying lease or assignment being forfeited or voided, respectively. Courts tend to disfavor conditions subsequent because a failure of the grantee to perform as promised is not a sufficient ground for forfeiture of the estate granted in the absence of additional circumstances. 204 If the consent-to-assign provision can be read as a covenant, a court will likely interpret it as such. Though this paper focuses on Texas law, it should be noted that Louisiana courts are more likely to enforce a consent-to-assign provision with forfeiture. Louisiana case law upholds cancellation as a remedy for breach. 205 In one case, the Louisiana Supreme Court affirmed the cancellation of a lease where a commercial lessee breached the consent-to-assign provision by subletting property across from the recently-built Superdome to be used as a parking facility. 206 The Court cancelled the lease, allowing the lessor to execute a new lease on the property, which had increased in value substantially Id. 202 Weisner v. 791 Park Avenue Corp., 180 N.Y.S. 2d 734 (1958), rev d on other grounds, 190 N.Y.S.2d 70 (1959). 203 Considine, supra note 5, at Haskins v. First City Nat l Bank of Lufkin, 698 S.W.2d 754, 757 (Tex. App. Beaumont 1985, no writ) (quoting Anderson v. Anderson, 620 S.W.2d 815 (Tex. Civ. App. Tyler 1981, no writ)). 205 See Aimee L. Williams, Restrictions on Assignment: Consent to Assign, Preferential Rights to Purchase and Maintenance of Uniform Interest Provisions, 49TH ANN. INST. ON MINERAL L. 224, 248 (2002). 206 Ill. Cent. Gulf R.R. Co. v. Int l Harvester Co., 368 So.2d 1009, 1012 (La. 1979). 207 See id. 20

21 Consent-to-assign provisions can be written in countless ways, but this section discusses the following four general categories, all of which have been discussed in published cases. A provision can be classified as a Category 1, or soft consent, if it states that consent to assign is required, but that consent shall not be unreasonably withheld. By contrast, a Category 2 consent provision requires prior written consent, but contains no language requiring that the consent shall not be unreasonably withheld. The last two categories are rare, but are discussed herein to illustrate the importance of carefully evaluating consent language, and the legal consequences of using certain provisions. Category 3 consent provisions require consent, the lack of which voids the underlying assignment. A Category 4 consent provision is created by language stating that consent is required and that lack of consent results in a forfeiture of the lease. 1. Category 1: Consent Shall Not Be Unreasonably Withheld An example of a Category 1 consent provisions is as follows: The rights of lessee shall not be assigned without the written consent of lessor, which consent shall not be unreasonably withheld. Category 1 consent provisions are quite common, and are both valid and enforceable. 208 Whether withholding consent is reasonable is a question of fact. 209 Courts have found that withholding consent due to economic concerns is not unreasonable. 210 However, there is very little guidance on what other facts might be considered reasonable bases for withholding consent. If a rightholder does withhold consent, and the parties seeking to transfer rights under a lease seek legal action claiming that the consent was unreasonably withheld, it should be noted that since the putative assignee is not a party to the contract containing the consent provision, only the party seeking to assign the contract would have standing to sue the party withholding consent. 211 Due to courts reluctance to void contracts, the breach of a Category 1 is highly unlikely to result in the termination of the underlying lease or invalidation of the improper assignment. If a rightholder withholds consent but a lessee assigns the oil and gas lease despite the lack of consent, the rightholder is instead limited to a cause of action for breach of contract against the assignee. However, the breach of contract claim typically results in a no harm, no foul situation, generally due to the difficulty on the part of the rightholder of proving damages for the assignor s breach. 212 As such, damages seldom result from breach of this type of consent provision. 213 It is possible that a lessor could insert a monetary damages clause for breaches of contract resulting from unpermitted assignment of a lease without consent, and a court may allow such monetary damages if they are reasonable and not punitive, and if the parties acknowledge in the agreement that such monetary damages are a fair estimate of damages that would otherwise be difficult to ascertain. However, no cases with a lease containing such a clause could be found. 208 Cross, supra note 4 at See Ridgeline, Inc. v. Crow-Gottesman Shafer #1, 734 S.W.2d 114, 116 (Tex. App. Austin 1987, no writ). 210 Mitchell s, Inc. v. Nelms, 454 S.W.2d 809 (Tex. Civ. App. Dallas 1970, writ ref d n.r.e.) (commercial real estate lessor did not unreasonably withhold consent to sublease where lessor would not have received adequate rent). 211 Oliver Res. PLC v. Int l Fin. Corp., 62 F.3d 128, 132 (5th Cir. 1995) (applying Texas law). 212 Id. at Palmer v. Liles, 677 S.W.2d 661, 665 (Tex. App. Houston [1st Dist.] 1984, writ ref d n.r.e.); Cross, supra note 4 at

22 In the absence of any stipulated damages, the lessor will likely be unable to prove actual damages, thus breach of a Category 1 consent provision will probably result in a take-nothing judgment. 2. Category 2: Prior Written Consent Required, No Reasonableness Language An example of a Category 2 consent provision is as follows: The rights of lessee shall not be assigned without the written consent of lessor. A Category 2 consent (or hard consent) is one that requires the lessee to seek the lessor s consent prior to assigning the lease, but lacks a clause stating that consent shall not be unreasonably withheld. Such consent provisions are common and generally enforceable. When interpreting such consent provisions in the oil and gas context, courts have directly adopted the law under the landlord-tenant context. Category 2 consents are distinguishable from Category 1 consents because they ostensibly allow a holder to withhold consent for any reason, whether or not such action is reasonable. Courts take such provisions at face value, and have been unwilling to imply a covenant that the consent cannot be unreasonably withheld if such a covenant is not included in an agreement. 214 As a result, a rightholder under a Category 2 consent will have a stronger cause for breach of contract than under Category 1 against an assignor who assigns the lease without proper consent, since a Category 2 consent allows the rightholder to avoid the question of reasonableness regarding the withheld consent. However, like a breach of a Category 1 consent, breach of a Category 2 provision would likely result in a cause of action for damages and a take-nothing judgment, since actual damages resulting from the lessee s breach will be difficult for the lessor to prove. As with Category 1 consents, courts are generally reluctant to allow forfeiture of the lease, so a party breaching the consent provision does not risk termination of the lease or invalidation of the assignment. 3. Category 3: Lack of Consent Voids the Assignment An example of a Category 3 consent provision is as follows: The rights of lessee are not assignable without the prior written consent of lessor, and an attempted transfer without prior written consent of lessor shall be void ab initio and without any effect. Category 3 consent provisions are not uncommon, but there are very few cases discussing the enforceability of such provisions. A Category 3 consent-to-assign provision appears to avoid the issues surrounding a forfeiture consent clause, while still restricting assignability. 215 Unfortunately for lessors, a Category 3 consent provision may not yield the desired results. In fact, such a restriction on the assignability of a fee interest is akin to the language rejected by the Eastland Court of Appeals in Soper v. Medford. 216 In that case, the court found language stating that the underlying property was never to be sold or traded off without consent to be void as repugnant to the grant of a fee interest. 217 It is unclear whether a court might allow a consent provision similar to Category 3 but which limits the consent so it cannot be unreasonably withheld. It is possible that parties could 214 Reynolds, 739 S.W.2d at 429, discussing TEX. PROP. CODE ANN (Vernon s 1984); Williams, supra note 205 at Cross, supra note 4 at Soper v. Medford, 258 S.W.2d 118, (Tex. Civ. App. Eastland 1953, no writ). 217 Id. at

23 draft a hybrid Category 1/Category 3 consent provision that could arguably be less of an absolute restraint on alienation than the provision in Soper, and thus may be seen as enforceable. However, there has been no case law regarding such a provision, and in light of the lack of authority regarding what constitutes reasonable withholding of consent, there may be little practical difference between such a provision and the provision in Soper. In this regard, the provision would likely still be considered unenforceable. 4. Category 4: Lessee s Failure to Obtain Consent Results in Forfeiture of the Lease An example of a Category 4 consent provision is as follows: In the event Lessee, its successors or assigns, should attempt to assign any interests without the written consent of the Lessors, this lease shall ipso facto terminate as to the interest so assigned, as well as all of the remaining interest owned by the person making such assignment. As stated above, generally, consent provisions in oil and gas leases that provide forfeiture as a penalty for breach will not be enforced. 218 Because oil and gas leases are considered fee simple determinable interests, and attempted restraints on the alienation of a fee are void as a general rule, consents to assignment of oil and gas leases are not enforceable if they establish forfeiture as a penalty for breach or completely restrict future conveyances. 219 Texas courts have been unwilling to enforce forfeiture or automatic termination clauses (in consent provisions or otherwise), with one court holding that a forfeiture clause did not provide an enforceable penalty. 220 In Outlaw v. Bowen, the Amarillo Court of Appeals refused to enforce a forfeiture clause in a mineral deed. 221 The deed in Outlaw attempted to maintain the uniformity of the underlying royalty interest by restricting the transfer of less than the whole interest, stating that no conveyance or assignment of [the underlying] royalty shall ever be made except in whole and that any attempt to convey or assignany portion less than the whole thereof, either by grantee, her heirs or assigns, shall operate to forfeit the entire royalty hereby conveyed to the grantor herein, and any such conveyance or a portion thereof shall be null and void. 222 The court stated that the forfeiture provision was void as a restraint on alienation. 223 In coming to its decision, the court utilized language indicating it did not consider forfeiture of fee simple title to be an enforceable penalty. 224 Since an oil and gas lessee holds a fee simple determinable as opposed to a fee simple interest, it is unclear whether a court would void a Category 4 consent-to-assign provision in an oil and gas lease in its entirety in light of Outlaw. Theoretically, fee simple title exists until the end of time; an oil and gas lease exists until the lease ceases to produce in paying quantities. Forfeiture of a perpetual estate is a more heinous penalty than forfeiture of an estate that will eventually terminate. As such, a Category 4 consent in an oil and gas lease is unlikely to be considered void on its face as the court held in Outlaw. Instead, a court will likely consider the 218 Cross, supra note 4 at See Knight v. Chicago Corp., 183 S.W.2d 666 (Tex. Civ. App. San Antonio 1944), aff d, 188 S.W.2d 564 (Tex. 1945); see also Cross, supra note 4 at Outlaw v. Bowen, 285 S.W.2d 280, 283 (Tex. Civ. App. Amarillo 1955, writ ref d n.r.e.); see also 5 Tex. Wesleyan L. Rev. at 226, noting that a forfeiture restraint in a consent requirement would be unreasonable under Restatement (Second) of Property 4.2 (1981). 221 Outlaw, 285 S.W.2d Id at Id. 224 Id. 23

24 consent provision valid, but avoid enforcing any language requiring lease forfeiture or termination. Although there have been cases in other states that have resulted in lease termination for breach of consent provisions, 225 Texas courts interpret restrictive provisions as strictly as possible against a lessor who seeks termination of the lease. 226 As the Texas Supreme Court held in Knight v. Chicago Corp. when it affirmed a San Antonio Court of Civil Appeals decision rejecting a provision similar to the above Category 4 example in an oil and gas lease, if there is any uncertainty in the language so as to make it ambiguous or of doubtful meaning that lease termination is the only remedy, then the court will avoid declaring a termination. 227 The consent provision in Knight was designed to prolong the productive life of the lease by preventing any dilution of the working interest without the lessor s written consent. 228 Per the lease terms, an assignment of an undivided interest or an override would ipso facto terminate the lease. 229 In dicta, the San Antonio Court of Civil Appeals rejected the ipso facto language as creating a condition subsequent. 230 The court supported its decision not to give effect to the termination clause by quoting 74. Construction of Instruments in American Jurisprudence, which states that [A] provision restraining the grantee from offering or attempting to alien is ordinarily void for uncertainty and cannot be restrained. This attitude of the courts is in accord with the general rule that conditions subsequent in conveyances are not to be favored, since they tend to impair the fee or estate granted. 231 In this regard, consent provisions in Texas are generally enforceable only to the extent that they do not stipulate that breach voids the lease or that assignability is expressly barred. However, the unenforceability of the consent provision in Knight was not determinative in the outcome of either the court of appeals case or the Texas Supreme Court case affirming the court of appeals decision, and the Knight courts indicated that it may enforce a consent provision with a forfeiture penalty if the penalty was clearly and expressly provided in the lease. 232 As such, while Knight has not been interpreted to mean that lease termination provisions are ineffective per se, strict interpretation against termination in the case of any ambiguity, as favored by the court, make lease termination highly unlikely. C. STATE LEASES 1. Texas Public Lands and the Relinquishment Act The consent provisions contained in state leases ought to be strictly adhered to because of the severity of the penalty for breach. 233 In general, oil and gas leases on Texas public lands are assignable. 234 However, any assignment must be filed with the General Land Office (the Kuntz, Law of Oil and Gas 51.2(b). 226 Knight v. Chi. Corp., 183 S.W.2d 666 (Tex. Civ. App. San Antonio 1944), aff d, 188 S.W.2d 564 (Tex. 1945). 227 Knight, 188 S.W.2d at Knight, 183 S.W.2d at Id. 230 See id. at Knight, 183 S.W.2d at 671, quoting 41 Am.Jur See Knight, 188 S.W.2d at Considine, supra note 5 at TEX. NAT. RES. CODE ANN (West 2012). 24

25 GLO ). 235 Failure to file the assignment with the GLO may result in a forfeiture of the lease, which may be reinstated upon a showing of satisfactory evidence of future compliance. 236 Under the Relinquishment Act, the surface owner acts as an agent of the State in leasing minerals on public lands. 237 Prior to assigning the lease to an owner of the soil, both the lessee and the owner of the soil must notify the GLO of their intent to assign the lease. 238 If the lease is assigned to an owner of the soil without the GLO s prior consent, the lease is void as of the time of assignment. 239 To further complicate the matter, the statute gives an extensive definition of who qualifies as an owner of the soil. Thus, a Relinquishment Act lessee should beware of assignments to people in the following categories: (1) a nominee of the owner of the soil; (2) a corporation or subsidiary in which the owner of the soil is a principal stockholder or is an employee of such a corporation or subsidiary; (3) a partnership in which the owner of the soil is a partner or is an employee of such a partnership; (4) a principal stockholder or employee of the corporation which is the owner of the soil; (5) a partner or employee in a partnership which owns the soil; (6) a fiduciary for the owner of the soil, including but not limited to a guardian, trustee, executor, administrator, receiver, or conservator for the owner of the soil; or (7) a family member of the owner of the soil or related to the owner of the soil by marriage, blood, or adoption. 240 If title passes to any of the listed persons without the GLO s approval, the lease is void. Additionally, the owner of the soil is required to pay a penalty to the state for the attempted assignment. 241 Payment of the penalty does not revive the lease Louisiana State Leases By comparison, Louisiana s consent provisions in state leases are considerably more stringent than those found in Texas state leases. Louisiana law provides that transfers or assignments of state leases are invalid unless approved by the State Mineral and Energy Board 235 Id. at Id. at (lessee loses its interest in the lease, but the owner of the soil does not lose its agency). 237 Id. at (a). 238 Id. at (b). 239 Id. at (c). 240 Id. at (e). 241 Id. at (d). 242 Id. at (d)(1). 25

26 (the Board ). 243 Failure to obtain the Board s approval within sixty days of the execution of the assignment subjects the assigning party to a penalty of $100 per day. 244 The statute states that the Board may waive the penalty, but one commentator advises against relying on such a waiver. 245 Until the Board approves the assignment, Louisiana courts refuse to recognize that the purported assignee has any rights in the property. 246 Thus, one must pay close attention when assigning state leases in Louisiana. IV. CONCLUSION There are a number of different issues presented by preferential rights to purchase and consents to assign. Not surprisingly, the particular language of a preferential right or consent to assign will directly affect the enforceability of such provisions. By recognizing and identifying the different clauses that may be used in preferential right and consent provisions and noting the issues that may arise therefrom, parties to oil and gas leases and similar instruments can avoid unintended or unanticipated restrictions on the use and assignability of oil and gas properties. Familiarization with common language used in such provisions and courts treatment thereof can therefore aid in the drafting of clear and enforceable restrictions to transfer and prevent unnecessary disputes between grantors and rightholders. 243 LA. REV. STAT. ANN. 30:128A (2012). 244 Id. at 30:128B. 245 Williams, supra note 205 at Id. (citing Transworld Drilling Co. v. Tex. Gen. Petroleum Corp., 480 So.2d 323, 325 (La. App. 4 Cir. 1985)). 26