In Personam Jurisdiction over Out-of-State Investors. Cornerstone Healthcare Holding v. Nautic Management

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Alicia Owens
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1 In Personam Jurisdiction over Out-of-State Investors Cornerstone Healthcare Holding v. Nautic Management T. Ray Guy, Matthew Leung, and Amanda Prugh i Texas is a great state in which to live, a wonderful place to visit, and a business-friendly locale for providing goods or services and profiting while doing so. We Texas trial lawyers even consider our state a perfectly acceptable indeed, preferable place to try lawsuits. We nevertheless acknowledge that an investor from another state may not share our affection for litigating time-consuming lawsuits in a jurisdiction far from its home. A cursory reading of the Texas Supreme Court s recent opinion in Cornerstone Healthcare Group Holding, Inc. v. Nautic Mgmt. VI, L.P. 1 could lead one to conclude that even an indirect investment in a Texas company will subject an out-of-state parent corporation or shareholder to the general in personam jurisdiction of Texas courts. We believe that such a conclusion would overstate the effect of the Cornerstone decision; the Court did not explicitly overturn the long-settled rule that an out-of-state corporate parent or investor cannot, absent more, be forced to defend litigation in Texas courts by reason of the minimum contacts with Texas of even a wholly-owned subsidiary. However, the decision does have significant adverse jurisdictional implications, in tort litigation concerning the purchase of Texas assets or corporate stock, for a private equity firm whose fund enabled the acquisition of such stock or assets. The Cornerstone lawsuit arose from the acquisition of a Texas hospital chain, Reliant Hospital Partners, LLC ( Old Reliant ), by an out-of-state investment group with funding by three nonresident private-equity funds (the Funds ). Executives of Plaintiff Cornerstone, a Texas hospital company, presented the investment opportunity to the group; immediately after the acquisition closed, the executives resigned from Cornerstone and joined the new acquisition vehicle. Cornerstone sued (among others) its former executives as well as the Funds and their investment manager, 2 alleging that the investor group conspired with the former Cornerstone executives to usurp a Cornerstone corporate opportunity and committed tortious interference in doing so. 3 To acquire Old Reliant, the Funds and the general partner structured the transaction as follows: 1. The Funds entered into an LLC agreement with Reliant Holding Company, a newly formed subsidiary of the Funds organized in Delaware; 1 Cornerstone Healthcare Grp Holding, Inc. v. Nautic Mgmt. VI, L.P., 493 S.W.3d 65, 68 (Tex. 2016), cert. dismissed sub nom. Nautic Mgmt. VI, LP v. Cornerstone Healthcare Grp Holding, Inc., 137 S. Ct. 615, 196 L. Ed. 2d 492 (2016). 2 Nautic Management VI, L.P. was the general partner of two of the funds and manager of the third. 3 Id.

2. Reliant Holding Company would own 100% of Reliant Pledgor, LLC, a newly formed LLC organized in Delaware; 3. Reliant Pledgor, LLC would own 100% of Reliant Opco Holding Corp.

2 2. Reliant Holding Company would own 100% of Reliant Pledgor, LLC, a newly formed LLC organized in Delaware; 3. Reliant Pledgor, LLC would own 100% of Reliant Opco Holding Corp., a newly formed corporation organized in Delaware; 4. Reliant Pledgor, LLC and Reliant Opco Holding Corp. would own 99.9% and 0.1%, respectively, of Reliant Acquisitions, LLC, a newly formed LLC organized in Delaware; and 5. Reliant Acquisitions, LLC would ultimately acquire Old Reliant and, afterward, change its name back to Reliant Hospital Partners, LLC. 4 The formation of the subsidiaries, funding of the transaction, execution of the agreements, and ultimate acquisition of the target company all occurred roughly concurrently with the closing. 5 The Funds and their investment manager filed special appearances challenging personal jurisdiction. The district court concluded that it had jurisdiction over the investment manager but not over the Funds. The Fifth Court of Appeals reversed as to the manager and affirmed as to the Funds, concluding that Texas courts lacked jurisdiction over any of them. Cornerstone had not attempted to pierce the corporate veil, and there was no evidence that the Funds or the investment manager had done anything that would justify piercing the veil so as to subject them to jurisdiction based on the contacts of Reliant Acquisitions, the subsidiary that ultimately purchased Old Reliant. 4 Id. 5 Id. at 69, 72 2

3 The Texas Supreme Court nonetheless reversed and concluded that specific personal jurisdiction existed over the Funds. 6 The Court gave lip service to the rule that so long as a parent and subsidiary maintain separate and distinct corporate entities, the presence of one in a forum state may not be attributed to another, 7 but disagree[d] with respondents that the Funds use of a subsidiary to purchase the hospitals effectively ends the inquiry. 8 In addition to the fact that the target company and its assets were located in Texas, 9 the Court highlighted three additional facts that it found significant: Timing between formation, funding, and closing: The formation of the subsidiaries and the funding of the transaction occurred after the Funds and investment manager decided to acquire Old Reliant and very close in time to when the transaction ultimately closed. 10 Lack of Discretion by Subsidiaries: The LLC agreement governing the Funds and their direct subsidiary required the subsidiary to use the Fund s capital to effect the consummation of the transaction contemplated by the [Reliant] Asset Purchase Agreement and left no discretion to the subsidiary on how it could spend the capital. 11 Direct Transfer of Capital from Funds to Target: While the agreements stated that the Funds capital would go through each subsidiary before being sent to the target company, in reality the capital went directly from the Funds to the acquiring entity s disbursement agent, and the disbursement agent, in turn, paid the target company directly. 12 The Court found that these facts demonstrated that the Funds targeted, spearheaded, and directed the transaction, and ultimately stood to profit from it, 13 and thus concluded that the Funds and the investment manager purposely availed themselves of Texas and should be subject to personal jurisdiction in Texas. 14 The problem for private equity firms is that each of the three factors found significant by the Court is present in virtually every private-equity-funded purchase of stock or assets. The acquisition vehicle will have been formed at or near the time of the closing because there will be no need for a shell company if the transaction doesn t close. The acquiring company is inevitably directed indeed, is formed to purchase the stock or assets of a specific target. Funds will normally bypass any intervening subsidiaries because they typically won t even have 6 See id. at 68, Id. at 72 (citing PHC-Minden, LP v. Kimberly-Clark Corp., 235 S.W.3d 163, 172 (Tex. 2007)). 8 Id. 9 The Court noted that in a case decided the same day, Searcy v. Parex Res., Inc., 496 S.W.3d 58, 62 (Tex. 2016), reh'g denied (Sept. 23, 2016), it concluded that Texas courts lacked jurisdiction over a Canadian company sued for tortious interference with the plaintiff s agreement to purchase shares of a Bermuda corporation s subsidiary that owned Columbian oil and gas operations. Cornerstone, 493 S.W.3d at Cornerstone, 493 S.W.3d at 69, Id. at Id. at 69, Id. at Id. at 74. 3

4 a bank account into which to receive an immediate parent s cash infusion or from which to transfer the funds down the chain. Again, the Cornerstone Court did not purport to change the rule that contacts with Texas by a subsidiary are not ordinarily attributed to its investor parent for purposes of personal jurisdiction; indeed, the Court in Cornerstone explicitly disclaimed any such change, 15 and the Supreme Court reaffirmed that principle in its most recent opinion analyzing personal jurisdiction. 16 Instead, the Cornerstone Court analyzed the parent s (or investors ) contacts with Texas, signaling that a parent or other investment vehicle that specifically targets Texas companies or assets for acquisition by forming subsidiaries for that purpose, requiring those subsidiaries to effectuate the purchase, and funding the purchase will be subject to the in personam jurisdiction of Texas state courts for claims arising out of the acquisition. The conclusion seems questionable; if owning equity in a Texas company doesn t subject an out-ofstate parent or investor to Texas jurisdiction, it wouldn t seem that the essential act of funding such ownership should constitute the requisite minimum contacts for doing business in Texas especially since courts universally recognize that parent corporations routinely direct and control, through board membership, the activities of their subsidiaries. 17 But the reality is that after Cornerstone, private equity funds or other investors can expect to be subject to personal jurisdiction in Texas courts if their funding is specifically directed toward the acquisition of Texas companies or assets, and thus arguably enables torts committed during, and in connection with, that transaction. That foregoing summation signals one important limitation on the Cornerstone holding. The Court was called upon to consider, and its opinion addressed, jurisdiction in the context of torts allegedly committed during the planning and consummation of the acquisition that was funded by the Funds. Stated another way, Cornerstone argued for, and the Court found, specific, rather than general, personal jurisdiction over the Funds. Specific jurisdiction puts a defendant within the purview of Texas courts for disputes arising out of or involving the specific contacts at issue. In Cornerstone, this meant that the district court would have had jurisdiction only over claims that arose from the Funds acquisition-related contacts with Texas. If those contacts had been held to give rise to general jurisdiction, the Funds could have found themselves subject to the jurisdiction of Texas courts for any claim whatsoever, including claims arising out of New Reliant s post-acquisition operations for example, malpractice committed by one of New Reliant s medical professionals or even for claims asserted by other plaintiffs involving other facts entirely unrelated to New Reliant. The Cornerstone Court was not asked to go that far, and did not do so. 15 Id. at M & F Worldwide Corp. v. Pepsi-Cola Metro. Bottling Co., Inc., , 2017 WL , at *6 (Tex. Mar. 3, 2017) (summarizing PHC-Minden, LP v. Kimberly-Clark Corp., 235 S.W.3d 162, (Tex. 2007) as holding that the contacts of distinct legal entities, including parents and subsidiaries, must be assessed separately for jurisdictional purposes unless the corporate veil is pierced ). 17 See e.g., Gibraltar Savings v. LD Brinkman Corp., 860 F.2d 1275, 1287 (5th Cir.1988); Volkswagenwerk Aktiengesellschaft v. Beech Aircraft Corp., 751 F.2d 117, 120 (2d Cir. 1984). 4

5 In short, Cornerstone signals that Texas courts will hereafter be deemed to have jurisdiction over investors in Texas companies or assets in the limited situation in which the plaintiff s claims involve and arise out of the acquisition that was enabled by the investors funding. i T. Ray Guy is a partner, and Matthew Leung and Amanda Prugh associates, in the Litigation group in the Dallas office of Weil, Gotshal & Manges LLP. 5

REVERSE, RENDER, and, DISMISS; and Opinion Filed June 18, In The Court of Appeals Fifth District of Texas at Dallas. No.

REVERSE, RENDER, and, DISMISS; and Opinion Filed June 18, 2014. S In The Court of Appeals Fifth District of Texas at Dallas No. 05-13-00859-CV NAUTIC MANAGEMENT VI, L.P., Appellant V. CORNERSTONE HEALTHCARE