Texas Supreme Court Rules That Trustee Is Not Liable For Fraud In Leasing Minerals Due To “Red Flags” And Express Contradictory Language That Negated Justifiable Reliance

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In JPMorgan Chase Bank, N.A. v. Orca Assets G.P., a trustee leased minerals to a leasee. No. 15-0712, 2018 Tex. LEXIS 250 (Tex. March 23, 2018). That leasee did not immediately record the lease. The trustee’s agent then signed a letter of intent to lease tracts from the same area. When the new lease signed leases on the same property, the original leasee contacted the new leasee and informed it of the title defect. The trustee then offered to refund the bonus payments to the new leasee, but that tender was refused. Rather, the new leasee sued the trustee for fraud and other related claims for $400,000,000 arising from statements that the acreage was open for lease. The trial court ruled for the trustee and concluded that the unambiguous terms of the letter of intent and the subsequent leases precluded the new leasee’s contract claim and ruled as a matter of law that it could not establish the justifiable-reliance element of its fraud and negligent-misrepresentation claims. The court of appeals affirmed the trial court’s contract ruling, but it reversed on fraud and negligent misrepresentation. The court of appeals held that the negation-of-warranty provision did not clearly and unequivocally disclaim reliance on prior representations.

The Texas Supreme Court reversed the court of appeals and affirmed the trial court’s ruling for the trustee. The trustee admitted that the statement regarding the acreage being “open” was made and that it was false. Rather, it argued that the evidence disproved the justifiable reliance element for the fraud and negligent misrepresentation claims. Regarding this element, the Court stated:

Justifiable reliance usually presents a question of fact. But the element can be negated as a matter of law when circumstances exist under which reliance cannot be justified. In determining whether justifiable reliance is negated as a matter of law, courts “must consider the nature of the [parties’] relationship and the contract.” “In an arm’s-length transaction[,] the defrauded party must exercise ordinary care for the protection of his own interests. . . . [A] failure to exercise reasonable diligence is not excused by mere confidence in the honesty and integrity of the other party.” And when a party fails to exercise such diligence, it is “charged with knowledge of all facts that would have been discovered by a reasonably prudent person similarly situated.” To this end, that party “cannot blindly rely on a representation by a defendant where the plaintiff’s knowledge, experience, and background warrant investigation into any representations before the plaintiff acts in reliance upon those representations.”

Id. The Court then discussed the concept of “red flags” as evidence that negates justifiable reliance. The Court previously held that “a person may not justifiably rely on a misrepresentation if ‘there are “red flags” indicating such reliance is unwarranted.'” Id. (citing Grant Thornton, LLP v. Prospect High Income Fund, 314 S.W.3d 913, 923 (Tex. 2010)). The Court used this “red flags” analysis to a non-professional fraud case. The Court stated that the trustee argued that the following “red flags” preclude justifiable reliance: (1) its agent’s statement that he “would have to check” whether the property was open for lease; (2) its insistence on the stricter negation-of-warranty provision; (3) its refusal to accept responsibility for verifying title; (4) the letter of intent itself; (5) its agent’s statement that other lessees were not doing careful title work; (6) the new leasee’s knowledge that competitors might delay recording their leases; (7) the new leasee’s knowledge that it ceased checking property records after signing the letter of intent; and (8) the new leasee’s landman’s “doubts” at the closing, manifested by her request that the trustee confirm once more whether the property was “open.” The Court stated:

We are not prepared to say that any single one of these factors could preclude justifiable reliance on its own and as a matter of law. We especially reject the notion that the mere use of the negation-of-warranty and no-recourse provision in the letter of intent and the leases could wholly negate justifiable reliance. Oil-and-gas leases, like other instruments of conveyance, often negate warranties of title. As the courts did in Grant Thornton and Lewis, we must instead view the circumstances in their entirety while accounting for the parties’ relative levels of sophistication.

Id. The Court then held that both parties were sophisticated, and after marching through the circumstances, the Court held that these “red flags” were sufficient to negate justifiable reliance. The Court also held that the lease expressly contradicted the false statements, thus proving that there was no justifiable reliance. Regarding the standard for this analysis, the Court stated:

In reaching its conclusion, the court of appeals held that for a contradiction to preclude justifiable reliance, both the contractual clause and the extra-contractual representation it supposedly contradicts must explicitly speak to the same subject matter with sufficient specificity to correct and contradict the prior oral representation. Such a requirement is simply too strict to be workable as it essentially requires the contract and extra-contractual representation to use precisely the same terms.

Id. The Court concluded that the evidence showed that the new lease did not justifiably rely on the false statement that the acreage was open:

Viewed in context with the numerous “red flags,” Orca’s sophistication in the oil-and-gas industry, and the direct contradiction between the representation and the letter of intent, Orca cannot maintain its claim of justifiable reliance. Orca, composed of experienced and knowledgeable businesspeople, negotiated an arm’s-length transaction and then placed millions of dollars in jeopardy—all while operating under circumstances that similarly situated parties would have regarded as imminently risky. Orca needed to protect its own interests through the exercise of ordinary care and reasonable diligence rather than blindly relying upon another party’s vague assurances. Its failure to do so precludes its claim of justifiable reliance as a matter of law.

Id. The Court made it a point to expressly state that “either ‘red flags’ alone or direct contradiction alone can negate justifiable reliance as a matter of law. In this case, however, both theories apply. And either would be sufficient to preclude justifiable reliance.” Id. n. 2. The court reversed and rendered for the trustee.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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