Texas Supreme Court: Contracting Parties Can Negate The Formation Of A Partnership Through Contractual Conditions Precedent In Their Preliminary Agreements

Energy & Infrastructure Alert

The Texas Supreme Court issued an important ruling on Friday, January 31, 2020, on the formation of partnerships where parties have provided by contract specific conditions that must be satisfied before a partnership will be deemed created. In Energy Transfer Partners v. Enterprise Products Partners, the Court held “that parties can conclusively negate the formation of a partnership under Chapter 152 of the [Texas Business Organizations Code] through contractual conditions precedent.” The decision resolves uncertainty under Texas law regarding whether entities at the early stage of negotiating business relationships will be held to form partnerships without definitive documentation. The Court’s ruling reinforces the importance of carefully drafted conditions precedent in preliminary agreements.

As forecasted by its observation that “perhaps no principle of law is as deeply engrained in Texas jurisprudence as freedom of contract,” the Court showed great respect for the parties’ ability to define when a partnership will come into being. In a very broadly worded opinion, the Court ruled: “An agreement not to be partners unless certain conditions are met will ordinarily be conclusive on the issue of partnership formation as between the parties.” On the record before the Court in that case, the Court found that “ETP and Enterprise did so as a matter of law.”

The Texas Supreme Court recognized that parties can waive the limits set out in the contract regarding partnership formation. But the Court also made very clear that such waiver will not be lightly found. The Court explained, “where waiver of a condition precedent to partnership formation is at issue, only evidence directly tied to the condition precedent is relevant.” That will make it very hard to show waiver.

The Court went further to emphasize how high a bar it will be to show waiver. The Court held that evidence of the parties working together, and even holding themselves out as one entity, will not by itself amount to waiver: “Evidence that would be probative of expression of intent under § 152.051(a)—such as the parties statements that they are partners, one party holding the other party out as a partner on the business’s letterhead or name plate, or in a signed partnership agreement —is not relevant. Nor is evidence that would be probative of any of the other § 152.052(a) factors. Otherwise, a party in ETP’s position could claim waiver in virtually every case.”

And in the case before it, the Court found, “there is no evidence that Enterprise waived the conditions.” The Court said the “only record evidence that ETP points to [in support of a showing of waiver]—the parties held themselves out as partners and worked closely together on the Double E project—is not relevant to the issue of waiver of definitive, board-approved agreements.”

The jury in the case had previously awarded ETP over $500 million in damages after finding, notwithstanding the contract terms, ETP and Enterprise had created a partnership through their post-contract course of conduct. The Texas Supreme Court agrees with the Texas Court of Appeals that, under the terms of the contract, no partnership was formed, and that judgment should have been entered for Enterprise. Importantly, the Supreme Court’s decision solidifies the law in Texas: Contract terms regarding partnership formation will govern, and only in rare circumstances will waiver be found under a very stringent test. In preliminary agreements between parties contemplating potential joint ventures or other transactions, companies that wish to avoid the risk of a finding of a statutory partnership without definitive documentation should include carefully drafted conditions precedent.

Read the full opinion here.