Often, when two parties want to explore the idea of working together on a new venture or transaction, they will execute a letter agreement that sets out the general terms of the due diligence or other exploratory work that will be performed to determine the viability of the venture or transaction. A well-drafted letter will include a clause in which the parties acknowledge and agree that, notwithstanding the initial work to be performed and discussions between the parties, neither is legally bound to consummate the deal unless and until they execute a definitive agreement that sets out the complete terms of the proposed venture or transaction. Yet, during the interim period, it is not uncommon for the parties to reach agreements in principle on key terms and/or work closely together to reach out to third parties to test the viability of the proposed deal. To some extent, the parties, through their course of conduct, may act as though they have reached agreement on the proposed deal, and the question arises whether they have become legally bound to what was supposed to be a non-binding arrangement unless and until certain conditions precedent were satisfied. A recent opinion issued by the Texas Supreme Court squarely answers this question.
In Energy Transfer Partners LP et al. v. Enterprise Products Partners LP et al.,1 the Texas Supreme Court addressed the issue of whether the express terms of a contract can prevent the formation of a partnership. In a decision handed down on January 31, 2020, the Court held that “parties can contract for conditions precedent to preclude the unintentional formation of a partnership” under Texas law.2
In 2011, Energy Transfer Partners, L.P. (ETP) and Enterprise Products Partners, L.P. (Enterprise) explored the possibility of converting a natural gas pipeline to an oil pipeline and extending it to Cushing, Oklahoma.3 Such a project would require a significant investment from both ETP and Enterprise and the commitment of a substantial number of customers during the open season.4 Throughout their discussions, the parties entered into a confidentiality agreement, a letter agreement with an attached non-binding term sheet, and a reimbursement agreement. These agreements contained disclaimer language stating that neither party would be legally bound to the venture unless and until each party had received approval from its board of directors and the parties had executed definitive agreements.5 After an unsuccessful open season, Enterprise notified ETP that Enterprise no longer wanted to pursue the project with ETP, and instead Enterprise entered into a co-ownership arrangement with another company for a similar project involving a different pipeline. ETP subsequently sued Enterprise on the theory that a partnership had been formed between the two entities through their conduct, despite the express language of their written agreements to the contrary, and that Enterprise breached its duty of loyalty as a partner to ETP.
In large part, ETP relied on statutory provisions set out in the Texas Business Organizations Code (the TBOC) that specify certain factors that should be considered in determining whether two parties have created a partnership even if the parties did not intend to create one.6 ETP argued that these statutory provisions govern partnership formation and that a party should refrain from engaging in the conduct described in the statutory provisions in order to prevent the formation of an unwanted partnership.7 The trial court agreed and awarded ETP over $500 million in damages, but the court of appeals reversed this decision.8 The Texas Supreme Court then affirmed the decision of the court of appeals.9
According to the Court, the TBOC provides a non-exclusive, statutory default test to determine if a partnership has been created, whether or not “the persons intend[ed] to create a partnership.”10 However, section 152.003 of the TBOC allows for “principles of law and equity” to supplement this default test.11 And according to the Court, there is “perhaps no principle of law […] as deeply engrained in Texas jurisprudence as freedom of contract” – in this case, the parties agreed certain conditions precedent had to be satisfied before a legally binding partnership was formed.12 This freedom of contract overrode the statutory default test for partnership formation.13 The Court noted that a party can waive the conditions precedent it had previously agreed to, but there was no evidence that Enterprise had waived these conditions.14
Practitioner’s Takeaway
The Texas Supreme Court’s decision has restored certainty in the contracting process by reaffirming a party’s right to rely on the express terms of its contracts. Further, this decision allows a party to explore possible transactions and commercial avenues with other parties without the threat of creating an unwanted or premature partnership.15 For sophisticated parties, this decision ensures that properly drafted conditions precedent that disclaim the formation of a partnership will not be overridden by the conduct of either party.
- No. 17-0862, 2020 WL 500259, at *1 (Tex. Jan. 31, 2020).
- Id. at *6.
- Id. at *1-2.
- Id. at *1.
- Id. at *2.
- Id. at *6.
- Id.
- See Enterprise Products Partners, L.P. v. Energy Transfer Partners, L.P., 529 S.W.3d 531, 534 (Tex. App. – Dallas 2017).
- Energy Transfer Partners LP, No 17-0862, at *8.
- Energy Transfer Partners LP, No 17-0862, at *3; see also Tex. Bus. Orgs. Code Ann. section 152.052(a) (2020).
- Id. at *4-5; see also Tex. Bus. Orgs. Code Ann. section 152.003 (2020).
- Energy Transfer Partners LP, No 17-0862, at *6.
- See id. at *5-6.
- See id. at *7.
- It should be noted, however, that the Court suggested that such an arrangement in which partnership formation was subject to conditions precedent would not be binding on third parties and the Court expressly refrained from considering the effects of such an arrangement on such third parties. See id. at *n.34.
Client Alert 2020-062
