The Texas Water Code and Piercing the Veil of a Texas Limited Liability Company

Earlier this year, the Supreme Court of Texas dealt a blow to those who rely on the limited liability company (“LLC”) to offer a modicum of liability protection. In its 8-0 decision delivered February 23, 2018, the Court held in State v. Morello that an owner or operator of an LLC could be held personally liable for civil penalties resulting from a violation of the Texas Water Code.[1]

This seems contrary to the very nature of an LLC. As the San Antonio Court of Appeals stated succinctly in Barrera v. Cherer, “[a] limited liability company is considered a separate legal entity from its members.”[2] Authorized originally in Texas by the Texas Limited Liability Company Act (TLLCA), effective August 26, 1991, LLC’s were specifically created to limit the liability of their members.[3] As the current Texas Business Organizations Code states:

Except as and to the extent the company agreement specifically provides otherwise, a member or manager is not liable for a debt, obligation, or liability of a limited liability company, including a debt, obligation, or liability under a judgment, decree, or order of a court.[4]

In certain rare circumstances, the courts have found that the veil of a limited liability company may be pierced in order to hold a member or manager personally liable.

These circumstances include:

1. If a member or manager of the LLC uses the LLC as a sham to perpetrate an actual fraud “for the direct personal benefit of the holder, beneficial owner, subscriber, or affiliate;”[5]
2. If a member of manager of the LLC uses the LLC as his or her “alter ego;”[6] or
3. If a member or manager of the LLC uses the LLC as part of an unfair device to achieve an inequitable result.[7]

In any of the above, courts have pierced the veil of liability protection surrounding an LLC to hold the company’s members personally liable.

With State v. Morello, the Texas Supreme Court added another category to the list of instances when a member may be held personally liable despite the existence of an LLC: violations of the Texas Water Code.

In Morello, Bernard Morello purchased property with pre-existing environmental obligations.[8] Specifically, the Texas Commission on Environmental Quality (TCEQ) required the owner of this property to adhere to a compliance plan in order to close hazardous wastewater impoundments on the site.[9] After learning of the environmental requirements attached to the site, Morello formed White Lion Holdings, L.L.C. specifically to hold title to the property subject to the compliance plan.[10]

Within months after White Lion became the record owner of the property and the hazardous waste permits attached to it, the TCEQ sent both White Lion and Morello compliance plan violation notifications.[11] After two years of repeated notices, the State finally sued both White Lion and Morello in April of 2006.[12] In 2013, the trial court granted the State’s Motion for Summary Judgment against White Lion and severed its claim against Morello.[13] Within one year, the State moved for summary judgment against Morello based on Section 7.101 of the Texas Water Code, which states:

A person may not cause, suffer, allow, or permit a violation of a statute within the commission’s jurisdiction or a rule adopted or an order or permit issued under such a statute.[14]

Importantly, the State based its claim against Morello in his individual capacity on the following facts:

1. The State alleged that Morello himself personally and substantially made decisions about White Lion’s facility;[15] and, furthermore,
2. The State claimed that Morello personally removed several pieces of the hazardous treatment equipment on the property.[16]

The State’s argument rested on the language of Section 7.101. It claimed that Morello’s personal actions “amounted to causing, suffering, allowing, or permitting a violation of law under Water Code section 7.101.”[17] At trial, Morello raised the defense of agency, which the trial court quickly disposed of by granting the State’s Motion for Summary Judgment.[18]

The Court of Appeals reversed, basing its decision on Section 101.114 of the Texas Business Organizations Code cited above.[19] That Court held that a member of an LLC could be held individually liable if he or she knowingly participated in tortious or fraudulent acts.[20] In this case, the Court held, the State failed to meet that burden.[21]

The Texas Supreme Court disagreed with the Austin Court of Appeals.[22] The key passage in the Court’s opinion follows:

Morello was not held liable for a debt, obligation, or liability of White Lion as he asserts is prohibited by the Business Organizations Code…. Rather, he was held individually liable based on his individual, personal actions.[23]

The Court centered its analysis on the Legislature’s intent in passing the Texas Water Code. Specifically, the Court asked: “Does the language used by the Legislature in the Water Code apply to Morello’s personal actions? We conclude that it does.”[24]

The key here is the Water Code, not the Business Organizations Code. While Texas’ LLC statute does provide liability protection to its members, it does not sanction the utilization of the LLC form of business entity to hide environmental violations. Because the language of the Water Code is broad, it alone is enough to pierce the veil of an LLC.[25] As the Court stated, “under the plain language of the statute, if Morello caused or permitted a violation of White Lion’s permit, the State could assess a penalty against him regardless of whether White Lion or others might also be subject to penalties arising from violations and regardless of who had obligations under the permit.”[26]

Morello’s status as a member of an LLC was irrelevant in this case. The State could have taken him to task even if he had been an unrelated third party so long as the State could prove that he himself caused, suffered, allowed, or permitted a violation of a TCEQ permit.

What this means for the future of Texas water law remains to be seen. Has the Court created a watchdog organization, effectively putting every person on notice that he or she must not cause, suffer, allow, or permit a violation of the Water Code, or else each person could be held liable? In its Morello opinion, the Court did not limit its holding. Rather, it emphasized the broad nature of liability under the Water Code. Thus, unless the Legislature chooses to act by placing limits on liability within the Water Code, the Morello decision will stand.

DISCLAIMER: The foregoing information is not legal advice. It is general in nature and not applicable to all situations. The reader should not rely on these general statements and should consult with knowledgeable persons before taking any actions.