Invest in Texas: A Powerful Defense of Limited Liability
The Texas Supreme Court’s In re First Reserve Management opinion establishes robust protections for investors in Texas companies. But before we dig into the substance, let’s talk about background. How did we get here?
Chris: Sure, the case centers on explosions at a petrochemical processing plant in Port Neches, Texas, on Thanksgiving Eve in 2019, which forced tens of thousands of people to evacuate the area.
As you might imagine, the explosions spurred a wave of lawsuits against the operator of the plant — TPC Group — and some of its contractors. More than 2,000 cases involving more than 7,000 litigants, mostly local residents and businesses, consolidated in multidistrict litigation. They alleged various injuries, including personal injuries and property damage. But at this early stage, we had yet to get involved in the court proceedings.
Mike: Right. More than a year into the litigation, the plaintiffs amended their complaint to add two private equity investor groups as defendants. Plaintiffs alleged that these groups were the ultimate owners of TPC at the time of the explosions, and our client — First Reserve Management — was one of them.
But unlike the extensive, highly specific allegations against TPC and its contractors, the allegations against the investors were generic and conclusory. The plaintiffs did nothing to distinguish the defendants from one another, lumping them together simply as “owners,” and made no factual allegations to support a cause of action.
What did the plaintiffs allege?
Mike: Two types of claims — one known as “alter ego,” and the other as “negligent undertaking.” Both stemmed from allegations that the investors had each appointed two members of the five-member board governing TPC.
Chris: Yes. In the alter ego claim, the plaintiffs alleged that the investors were so involved with TPC’s operations that the court should disregard their limited liability protections, and hold them directly liable for TPC’s conduct. This is often known as piercing the corporate veil.
In the negligent undertaking claim, the plaintiffs said that the investors took on responsibility for safety at the TPC plant, and were negligent in carrying out that responsibility, by failing to authorize spending on maintenance that the plaintiffs say would have prevented the explosions.
And you took issue with both sets of claims.
Mike: We did — and filed a motion to dismiss them for having no basis in law or fact. Our arguments were simple: First Reserve is a separate legal entity from TPC, and its conduct was consistent with investment practices that are customary in private equity, so it can’t be held directly liable for anything TPC did or didn’t do.
That’s almost Corporate Law 101.
Chris: Agreed. So, while we were disappointed that the trial court denied our motion, the legal realist in me wasn’t especially surprised. History has shown that, at the initial pleading stages, many trial courts have allowed these types of claims to proceed, even under basic, rote allegations — and that’s what happened here.
Mike: We then filed a petition with the court of appeals, arguing that trial court had abused its discretion in denying our motion. But that too was denied. Had this petition been granted, the trial court would have been compelled to dismiss the plaintiffs’ claims against our client.
So things were looking pretty grim.
Chris: They really were. At this point, we’re looking at discovery, depositions, and probably some trials. But this was when Mike stepped in to save the day, by persuading the Texas Supreme Court to take up the case.
Mike: Well, it certainly wasn’t all me. Our arguments were sound, and we were fortunate to have strong support from several amici — or “friends of the court” — who filed briefs explaining how important these issues are to the Texas business community.
What were the key arguments?
Mike: In many ways, they were similar to those we made in our motion with the trial court. On the alter ego claims, we explained how nothing in the plaintiffs’ pleadings justifies disregarding First Reserve’s corporate structure to impose liability. As decades of case law shows, that extraordinary measure is reserved for when an entity abuses its corporate structure to commit fraud or similarly egregious misconduct.
Chris: And on the negligent undertaking claims, we argued that engaging in industry-standard investment practices does not amount to undertaking the types of duties that could invite direct liability in this context. First Reserve was simply exercising the rights that equity ownership affords it.
Okay, so about the Court’s opinion — there was an unusual wrinkle here.
Chris: There was. During the case, TPC filed for bankruptcy protection in Delaware. And as part of TPC’s reorganization plan, the bankruptcy court held that the alter ego claims belonged to TPC’s estate, and enjoined the plaintiffs in our case from prosecuting those claims. For that reason, the Court declined to address the alter ego claims.
Mike: But on the negligent undertaking claims, the Court couldn’t have been more definitive: The plaintiffs failed to plead a valid negligent undertaking claim against First Reserve. And as long as an investor and its portfolio company remain separate legal entities, the investor can engage in industry-standard investment practices without exposing itself to liability for the portfolio company’s conduct.
That’s big for the investment community.
Mike: Absolutely. The opinion essentially outlines several safe harbors, explaining how investors can protect themselves from liability under the negligent undertaking doctrine in Texas.
Thanks to this opinion, investors won’t have to worry about being taken to court for merely holding ownership interest in a portfolio company, appointing directors to its board, or engaging in industry-standard investment practices — like monitoring the portfolio company’s performance, supervising finance and capital budget decisions, or articulating general policies and procedures.
Chris: Another important point is that, for a negligent undertaking claim to be valid, it must be predicated on an affirmative course of action. This means that investors cannot be found liable for not doing something — like spending money — or for promising to do something, unless they fulfill that promise or an injured party relies on it.
Say an investor were to stray outside these safe harbors — and something goes wrong at one of its portfolio companies — does the investor need to worry about getting sued?
Mike: Not necessarily. But investors should understand that the farther they stray from the safe harbors, the less they can rely on the opinion. The more granular their control of a portfolio company, the easier it becomes for plaintiffs to bring a negligent undertaking claim if a problem at the portfolio company leads to injury or damages.
You both must be pleased with the outcome.
Chris: We are — both for our client, and for the Texas investment environment in general. But our work on this issue might not be over. The Delaware Bankruptcy Court’s injunction against prosecuting the alter ego claims is currently under appeal. And if the plaintiffs win that appeal, those claims could be reinstated.
Mike: That said, we’ve done a mountain of research and analysis on alter ego liability in Texas, and if the Texas Supreme Court were to take up the alter ego claims, we’d feel very comfortable arguing the issue before the Court.
Any final thoughts?
Chris: Yes. As much as the Court’s decision was a victory on the substance, it also was a victory for procedure. Instead of having to engage in discovery for thousands of claims, litigate for years, and possibly appeal a decision to protect our client’s rights, we were able to do so at the pleadings stage. We think that’s a critical point.
Mike: Super important. Texas trial courts have frequently required plaintiffs to defend similar actions through discovery, but this decision could help investors extricate themselves from similar litigation claims more quickly — and at far less expense.
Chris: When the stakes are high, a dispute can test what we take for granted as fundamental legal principles, and in this case, the principle of limited liability was put to a tough test. We’re pleased that the Texas Supreme Court delivered a full-throated endorsement of this principle — one that should strengthen investor confidence in doing business in Texas long into the future.
|Meet the Lawyers
Hometown: Baton Rouge, Louisiana
Law school: University of Texas
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Hometown: Dallas, Texas
Law school: Yale
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This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.