Electric utilities operated by Texas municipalities (Munis) are attractive wholesale customers for power generators, as Munis are willing to enter into the coveted long-term power purchase agreements (PPAs) that enable the financing of new generation capacity. Because Munis are governmental entities, however, there has been a longstanding question regarding the extent to which “governmental immunity” may restrict a generator’s ability to recover damages when its counterparty to the PPA is a Muni. Until last month the answer to this question was uncertain, with different districts of the Texas Courts of Appeals reaching different conclusions under remarkably similar facts.[1] But with a pair of recent opinions the Texas Supreme Court finally resolved this uncertainty: generators and their financing parties and investors can breathe easier knowing that even though Munis are governmental entities, they do not benefit from governmental immunity in connection with wholesale PPAs.[2]

Governmental Immunity in Texas

The concept of governmental immunity is derived from the idea that the political subdivisions of a sovereign – in this case, the State of Texas – share in the inherent immunity of that sovereign. Accordingly, whether based on the legal fiction that “the King can do on wrong” or the desire to “protect the public treasury,” because the sovereign cannot be sued without its consent, its political subdivisions are likewise immune from suit unless that immunity is waived.[3] Over time, however, sovereign and governmental immunity fell out of favor, and many jurisdictions gradually muted their impact. In fact, through common law and statutory waivers, many states have almost entirely eliminated sovereign and governmental immunity in the context of claims for breach of contract.[4] Despite this trend, however, finding a waiver of governmental immunity under Texas law still presents challenges. Under Texas law immunity is waived only if the State, either in a constitutional provision or by legislative enactment, clearly consents to suit.[5] Likewise, because its immunity is derived from the sovereign’s immunity, which can only be waived by the sovereign, Texas governmental entities are generally unable to waive their immunity by agreement or conduct.[6]

To establish the waiver of a Muni’s governmental immunity in the context of power purchase agreements, generators have traditionally relied on section 271.152 of the Texas Local Government Code, which applies to contracts for goods and services.[7] Unfortunately, it is unclear whether a generator relying on the statutory waiver would be able to recover damages based on the forward value of the PPA. Because the waiver limits damages to the “balance due and owed”, it could be argued that a generator’s recovery would only include the amount owed for power previously delivered.[8] If so applied, the statute’s limitation would prevent the generator from recovering damages under common formulations that account for changes in the forward price of power, which could in turn seriously harm the generator’s financial condition.

Uncertainty in Extent of Governmental Immunity

To overcome limitations on damages associated with statutory-based waivers of immunity, or in the absence of a statutory waiver, some plaintiffs have argued that immunity does not apply when the governmental entity acts in a “proprietary” rather than “governmental” capacity. Although Texas courts routinely recognized such a distinction under Texas law in the context of tort claims, until recently many have questioned whether or not the proprietary versus governmental function dichotomy applied in the context of a contract claim.[9] While some Texas courts have applied the dichotomy in the context of contract disputes, others, citing potential conflicts with chapter 271 of the Texas Local Government Code and a lack of clear guidance from the Texas Supreme Court, have held that immunity applies even when a governmental entity acts in a proprietary capacity.[10] With its recent issuance by a pair of opinions that addressed the proprietary versus governmental function dichotomy, however, the Texas Supreme Court resolved the split among the Texas courts.

Resolution of Uncertainty by Texas Supreme Court

The first of the two cases on which the Texas Supreme Court opined, Wasson Interests, Ltd. v. City of Jacksonville (“Wasson Interests”), affirmed the existence of the proprietary function exclusion from immunity under Texas law in the context of a contract claim.[11] In its opinion, the Texas Supreme Court rejected the Tyler court of appeals’ conclusion that prior decisions imposed a “default rule” of immunity. On the contrary, as the Texas Supreme Court explained, the appellate court misunderstood the court’s earlier pronouncements on the issue: by noting in an prior opinion that it did not then need to address the proprietary function distinction, the court did not mean to preclude its availability.[12] Having rejected the lower court’s conclusion, the court turned its analysis to the “related yet distinct roles of the judiciary and legislature” in questions of immunity in order to reach its holding. Specifically, the court clarified that while the ability to waive immunity rests with the legislature, defining the “applicability and boundaries” of that immunity is the responsibility of the judiciary.[13] In other words, courts must first determine whether or not immunity applies before they can ask whether the immunity is waived – if immunity does not apply, then there is nothing to waive. As support for the holding, the court explained that because a governmental entity derives its immunity from the sovereignty of the state, the entity “is cloaked in the state’s immunity . . . . only when it acts as a branch of the state.”[14] When engaged in a proprietary function a governmental entity acts for its own benefit, and therefore no longer derives its authority from the state or benefits from the state’s sovereign immunity.

Although its holding in Wasson Interests established the proprietary function distinction as a limit on the availability of governmental immunity in the context of a contract claim, the facts of that case did not allow the court to address the line between proprietary and governmental functions.[15] While courts must still visit this second question in a variety of other situations, in its second opinion the Texas Supreme Court definitively answered that the operation of a public utility is a proprietary function. The case, Wheelabrator Air Pollution, Inc. v City of San Antonio acting through the City Public Service Board of San Antonio (“Wheelabrator”), involved a dispute under a contract for the design and construction of pollution controls at a generating facility owned by CPS Energy, the electric and gas utility operated by the City of San Antonio.[16] Following its decision in Wasson Interests, the threshold issue in Wheelabrator was whether the operation and maintenance of a public utility was a proprietary function undertaken by the City of San Antonio – if acting in a proprietary capacity, then governmental immunity from suit would not be available and questions of waiver would be irrelevant. Citing various authority, including past opinions and the Texas Tort Claims Act (which specifically defines the operation of a public utility as a proprietary function), the court easily concluded that “CPS Energy is not shielded by governmental immunity.”[17]

Why the Texas Supreme Court Decisions Matter

Together, Wasson Interests and Wheelabrator should provide significant comfort to power generators interested in entering into long-term PPAs with Munis, and to the financing parties and investors that may rely on such PPAs to support the project. By establishing that Munis do not benefit from governmental immunity from suit, the cases provide greater certainty that if a generating company brings suit against its Muni counterparty under the agreement, it will not be saddled with the “amounts due and owing” limitation of section 271.152 of the Texas Local Government Code if it tries to recover damages based on the market value of the PPA.