Does Context Matter When Interpreting An Agreement (Lease, Mortgage, Whatever)?

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Last week, we signaled that we’d be writing about the wisdom of saving drafts or “redlines” created during the negotiation process. In reality, that analysis may have been appropriate 50 years ago, but it would be wasted in 2015. That’s because someone is saving a copy even if she or he thinks otherwise. Basically, it’s very hard to really lose an electronic document. You’d need to see that “both” sides of a deal have obliterated every early draft and that everyone who ever received a copy did the same. And that means making all of the archived copies on email servers disappear. Basically, it ain’t going to happen. So, what was Ruminations really promising to discuss?

For those who kind of understand what lawyers call the Parol Evidence Rule, here’s a short synopsis of what will be a relatively long blog posting. For others, please slog through. A basic attribute of the Parol Evidence Rule, when it applies, is that you can’t use prior discussions or writings to change the meaning of something in an executed agreement that, on its face, is unambiguous. You can use that earlier information to choose between or among ambiguous meanings. But, if there are no choices because a court finds something to be unambiguous, the earlier stuff will be ignored. That makes sense. If you know what a word, phrase or entire provision means on its face and there is no doubt as to that meaning, why should anyone go back and look at something that could change the meaning? So, the Parol Evidence Rule says: “You can’t go back again.” [Our apologies to Thomas Wolfe for this variant adaptation of his words.]

Last week, we highlighted the word, “context.” Today, we’ll explain why.

We are going to talk about a lease, mortgage or other agreement’s common boilerplate provision, variously called the “complete agreement,” “merger” or “integration” clause. It might look like this:

This Agreement sets forth the entire agreement between the parties relating to the subject matters in this Agreement, and fully supersedes any and all prior oral or written agreements or understandings between the parties, if any, pertaining to the subject matter of this Agreement.

It looks pretty simple, open, and shut: if the agreement (such as a lease or mortgage) says what the consequences will be if “X” happens, it doesn’t matter if one party or the other can find an earlier writing – e.g., a letter of intent or a set of email messages – that contradicts the actually executed agreement. And basically that’s true. But, saying “basically” signals that it isn’t always true that a court won’t consider and rely upon earlier writings or proven oral agreements even if the executed agreement in front of it says something to the contrary.

Many earlier Ruminations blog postings have pointed out that if a provision of an agreement is found by a court to be ambiguous (reasonably capable of more than one meaning), the court may utilize pre-agreement writings or proven oral agreements in deciding what the executed agreement really means. That shouldn’t be surprising because the classic “merger” clause (like the one above) really doesn’t bar such use.

In legal jargon, earlier agreements, writings or oral, and earlier documents such as letters and drafts, are referred to as “parol” evidence even though “parol” comes from the Middle French – “parole” and meant only “oral.” And, there is a “Parol Evidence Rule” that says that parol evidence (extrinsic material – stuff “outside” the agreement) cannot be used to contradict the terms of a later written agreement. Though the rule is riddled with exceptions, such as being set aside where such parol evidence could show that the written agreement was procured by fraud or that there was a scrivener’s error or that there was a “mutual mistake,” the Parol Evidence Rule still has “legs.”

None of that is what we had in mind last week when we started to tell the story of the PNP Petroleum I, LP v. Taylor case, a more complete story of which can be found by looking at the May, 2014 Texas Court of Appeals decision (click HERE to see it) or by looking at last week’s posting by clicking HERE.

Basically, an oil and gas tenant asked a lower Texas court to use the redlined copy of an early lease draft to interpret a disputed lease extension provision, but the lower court, finding no ambiguity in a critical trade term (“Shut-In Royalty”), invoked the Parol Evidence Rule. Basically, it said that it unambiguously understood what a “Shut-In Well” was because it was a well-known and accepted term in the oil and gas leasing trade. So, according to the court, there was no need to look outside the executed oil and gas lease in front of it in order to make a ruling (against the tenant). The redlined draft was an “earlier” document and with the lease’s “merger” clause in effect, had no “horse in the race” where it wasn’t needed to interpret the terms: “Shut-In Well” or “Shut-In Royalty.” If that oil and gas terminology isn’t familiar to you, take a look at last week’s posting by clicking HERE.

Make no mistake as you read on. The Parol Evidence Rule is alive and well. If the agreement in front of the court in unambiguous (to the court) and covers the dispute between the warring parties, the court won’t look at the earlier documents PERHAPS. Those earlier documents can’t be used to “interpret” what is unambiguous. They can’t be used to “show the parties’ motives or intentions apart from” the agreement. BUT, they might be usable to show “the CONTEXT in which the agreement was reached.” Take note of that word: “context.” Last week, we dropped it into our posting and today we’ll explain why.

The Texas Court of Appeals reversed the lower court and gave the tenant in the PNP Petroleum I, LP case a victory. Yes, it was allowed to renew its oil and gas lease even though the wells on its leased land were seemingly incapable of producing oil or gas. And, so, even though when oil and gas people say that a “Shut-In Well” has to be capable of producing oil and gas, and the lease in question made the existence of a “Shut-In Well” a prerequisite to a lease term extension, the tenant “won.”

It won because the appellate judges gave “life” to a redlined copy of the disputed lease provision. Here’s what its relevant provision looked like:

SHUT-IN ROYALTY (Saving) If, at the expiration of the primary term – or at any time thereafter, there is located on the leased premises a well or wells not capable of producing oil/gas in paying quantities or being used as a salt-water injection well(s), and such gas is not otherwise produced and sold in paying quantities for lack of a suitable market and this lease is not otherwise being maintained in force and effect, Lessee may pay [to extend the term of the lease]. The Shut-In Well royalty payment will extend the term of this lease for a period of one (1) year. Lessee may extend this lease for one (1) additional year by the payment of a like sum of money. …

[For those unfamiliar with how such a redlined copy works, the underlined words were added to the proposed text and the words that are struck-through were deleted.]

If you haven’t yet read last week’s posting, then you’ll not know the following. The lower court saw “Shut-In Well” and “Shut-In Royalty” and told all of us that, without question, in the oil and gas industry, to qualify as a “Shut-In Well,” the well had to be capable of producing oil or gas, but wasn’t doing so because, at the time, there was no market for its output. Thus, to the court, there was no dispute that to qualify for a lease extension, the wells on the property had to be capable of producing oil or gas in commercial quantities. The ones operated by the tenant could not do so. Also, since there was no ambiguity whatsoever in the mind of the lower court (or, for that matter, in the mind of the Texas Court of Appeals), the Parol Evidence Rule barred use of the redlined copy to show what the parties intended by using the term “Shut-In” for a “well” or a “well royalty.”

As we said, the Texas Court of Appeals agreed that there was no ambiguity – that the lower court “nailed” the definition – and also that the Parol Evidence Rule was alive and well. But, then came this little thing called, “context.”

Prior case law, in particular the 2011 Texas Supreme Court decision in Houston Exploration Co. v. Wellington Underwriting Agencies, Ltd., informed this set of appellate court judges that:

Whether a contract is ambiguous is a question of law that must be decided by examining the contract as a whole in light of the circumstances present when the contract was entered.

In deciding if a contract is ambiguous, a court should review the contract “in light of the surrounding circumstances.”

There is an obvious tension between this principle and the equally well-settled rule that “parol evidence is not admissible to render a contract ambiguous.”

Distinguishing “surrounding circumstances” from “parol evidence” is no easy task.

What are surrounding circumstances to one court is parol evidence to another, and as a result the case law on this issue is less than consistent at times. [Note: keep that thought in mind for later.]

There are, however, some central principles in this area. First, the Parol Evidence Rule “does not prohibit consideration of surrounding circumstances that inform, rather than vary from or contradict, the contract text.

The Houston Exploration case also involved deletions from originally proposed text. But, in that case (one involving an insurance policy), the deletions were visible on the face of the issued policy itself. In this, the PNP Petroleum I case, the deletions were in an earlier document. That didn’t stop the Court of Appeals from referring to that document in order to understand the CONTEXT under which the parties used the unambiguous “Shut-In” terms. Basically, the earlier document showed the appellate judges that the parties DID NOT INTEND the well-recognized industry definition of a “Shut-In Well” to be used in THEIR agreement. The earlier drafts showed that the parties actually deleted the key requirement that the wells had to be capable of producing oil or gas.

To most readers, it would seem that Rumination (as usual) has used a lot of words to say something that both seems pretty obvious and “feels” right. Well, we would agree completely if there wasn’t the little old, time-honored, Parol Evidence Rule, a rule that could actually bar access to relevant interpretation information in an arbitrary way. Perhaps the Parol Evidence Rule, on balance, makes for predictable (but possibly wrong) outcomes and for judicial efficiency, and that those benefits outweigh “truth” whatever that may be. Of course, we recognize, that parties aided by the Parol Evidence Rule in any given instance will, for at least that instance, think it is the best thing since sliced bread. Turn the tables, however, and you might see a miraculous conversion on that issue.

The problem as we see it with the Parol Evidence Rule is that so many courts, over so many years, have shown great discomfort with it. As a result, it is riddled with exceptions. This “state of law” has led to unpredictability, and unpredictability is not very good for commerce. And, after all, most agreements are written for commercial purposes. Parties are entitled to predictability in their agreements, and they aren’t getting it from courts. But, there is something parties can do to help themselves. We’ll bring that up after the next two paragraphs when we sum up today’s (to the great relief of those hardy souls who have stuck with us to this point).

We cited some text from the Houston Exploration case because it was the supporting decision behind the tenant’s victory in the PNP Petroleum I case. Well, the Houston Exploration case was also central in an August 21, 2014 decision from the United States District Court for the Western District of Texas, the Lind v. International Paper Company case, a copy of which can be found by clicking HERE.

This Lind decision refers to both the case we have been dissecting and the rules for finding “context” from text in earlier documents. But, the Lind decision also highlights how much discretion a court has to decide that those earlier “documents do not qualify as surrounding circumstances.” So, as we quoted above, “Distinguishing ‘surrounding circumstances’ from ‘parol evidence’ is no easy task.” Surrounding circumstances include “the commercial or other setting in which the contract was negotiated and other objectively determinable factors that give a context to the transaction between the parties.” [11 Richard A. Lord, Williston on Contracts §32.7 (4th ed. 1999).]

Here’s our thought for today. Given that the parties agreed to delete “capable of producing oil/gas in paying quantities,” a key part of the “industry” definition, why didn’t they just say that the presence of a well “not producing oil or gas FOR ANY REASON” would be sufficient to allow the tenant to renew the lease (for at least a couple of years? Yes, here we go again: “Say what you mean, and mean what you say.” The folks who draft agreements shouldn’t be the rainmakers for a law firm’s litigation practice.

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