CORPORATE FIDUCIARY DUTIES AND
Escobedo, Tippit & Cardenas, LLP
3900 N. 10th Street, Suite 950
McAllen, Texas 78501
State Bar of Texas
BUSINESS DISPUTES 2014
Table of Contents
Statutory and Common Law Duties
Texas common law recognizes that directors, as fiduciaries, owe three duties to a corporation: duty of obedience, duty of loyalty (or fairness) and duty of care. The Texas Business Organizations Code (“the Code”) does not specifically define a corporate director’s fiduciary duties. At most, various TBOC sections define the scope of the board of directors’ general responsibilities. See, e.g. TEX. BUS. ORGS. CODE ANN. §§ 3.101; 21.401 (Vernon 2006)
Duty of Obedience
The director’s duty of obedience forbids ultra vires acts; that is, acts that are beyond the scope of the powers of the corporation as set out in the law of the state of incorporation or the corporation’s charter. In order to impose personal liability on a director for ultra vires or illegal acts, the director must have either participated in the act or had actual knowledge of the act. Resolution Trust Corp. v. Norris, 830 F.Supp. 351, 357 (S.D. Tex. 1993). Further, the director is not personally liable for the ultra vires act unless the act in question was also illegal. Gearhart Industries, Inc. v. Smith International, Inc., 741 F.2d 707, 719-20 (5th Cir. 1984).
Duty of Loyalty
The duty of loyalty requires that a director act in good faith and not allow his personal interests to prevail over the interests of the corporation. Gearhart, 741 F.2d at 719-20. A director violates this duty when he “makes a personal profit from a transaction by dealing with the corporation or usurps a corporate opportunity.” Landon v. S&H Marketing Group, 82 S.W.3d 666, 672 (Tex. App. – Eastland 2002, no pet.). Transactions in which a corporate fiduciary derives personal profit are subject to the closest examination. International Bankers Life Insurance Company v. Holloway, 368 S.W.2d 567, 577 (Tex. 1963).
Whether a director is “interested” with respect to a particular transaction is a question of fact. International Bankers, 368 S.W.2d at 576-78. A director is considered “interested” if he does any of the following: (1) makes a personal profit from a transaction by dealing with the corporation or usurps a corporate opportunity; (2) buys or sells assets of a corporation; (3) transacts business in his director’s capacity with a second corporation of which he is also a director or is significantly financially associated; or (4) transacts business in his director’s capacity with a family member. Gearhart, 741 F.2d at 719-20; See also TEX. BUS. ORGS. CODE ANN. §§ 1.003, 1.004 (Vernon Supp. 2010). The burden of proof is on the interested director to show that the action under consideration is fair to the corporation. International Bankers, 368 S.W.2d at 576.
The Texas Legislature has enacted legislation with respect to interested director transactions. See TEX. BUS. ORGS. CODE ANN. § 21.418 (Vernon Supp.2010). The statute provides three methods whereby an interested director’s contract or transaction can be validated:
Upon the affirmative, good faith vote of a majority of disinterested directors provided that the material facts of the contract or transaction is disclosed to or known by the board;
Upon the affirmative, good faith vote of the shareholders provided that the material facts of the contract or transaction is disclosed to or known by the shareholders; or
The contract or transaction is fair as to the corporation as of the time that it is authorized, approved, or ratified by the board of directors or shareholders.
Duty of Care and the Business Judgment Rule
The Fifth Circuit analyzed a director’s duty of care under Texas law in Meyers v. Moody, 693 F.2d 1196, 1209 (5th Cir. 1983); the court held that “Texas law imposes on corporate officers and directors a duty to exercise due care in the management of the corporation’s affairs.”
Then, in the Gearhart case, without mentioning the Meyers case, the Fifth Circuit applied a different standard. The Court first noted that “[u]nder the law of most jurisdictions, the duty of care requires a director to be diligent and prudent in managing the corporation’s affairs.” Gearhart, 741 F.2d at 720. The Court cited McCollum v. Dollar, 213 S.W. 259 (Tex. Comm’n App. 1919, holding approved) as the leading case in Texas defining a director’s standard of care. Id. The McCollum case held that a director must handle his corporate duties with such care as “an ordinarily prudent man would use under similar circumstances.” Id. at 261. The Gearhart Court then cited Cates v. Sparkman, 73 Tex. 619, 11 S.W.846 (1889) as setting the following standard:
[I]f the acts or things are or may be that which the majority of the company have a right to do, or if they have been done irregularly, negligently, or imprudently, or are within the exercise of their discretion and judgment in the development or prosecution of the enterprise in which their interests are involved, these would not constitute such a breach of duty, however unwise or inexpedient such acts might be as would authorize interference by the courts at the suit of a shareholder.
Id. at 622.
The Fifth Circuit Court in Gearhart determined the following:
Even though Cates was decided in 1889, and despite the ordinary care standard announced in McCollum v. Dollar, supra, Texas courts to this day will not impose liability upon a noninterested corporate director unless the challenged action is ultra vires or is tainted by fraud…. Such is the business judgment rule in Texas.
Id. at 721.
The Gearhart opinion stated that the “business judgment rule is a defense to the duty of care” and “precludes judicial interference with the business judgment of directors absent a showing of fraud or an ultra vires act.” Id. at 723, n. 9. This would appear to protect even grossly negligent conduct but as discussed infra some courts have excluded gross negligent conduct from the protection of the business judgment rule.
After Gearhart, federal district courts have been inconsistent in the application of the rule. Numerous courts interpreted the business judgment rule in litigation that was brought by the Federal Deposit Insurance Corporation (FDIC) and the Resolution Trust Corporation (RTC) after the savings and loan crisis of the 1980s and 1990s. In these cases, federal district courts rejected the government’s argument that directors could be liable for acts of mismanagement that amounted to ordinary negligence but did hold that the business judgment rule did not protect gross negligence or an abdication of responsibilities resulting in a failure to exercise any judgment. See RTC v. Norris, 830 F.Supp. 351, 356 (S.D. Tex 1993); FDIC v. Schreiner, 892 F.Supp. 869, 881-82 (S.D. Tex. 1995). In FDIC v. Brown, 812 F.Supp. 722, 724 (S.D. Tex. 1992), the court appears to expand the business judgment rule beyond a defense:
…the business judgment rule as adopted and applied by Texas courts is not merely a defense to a claim of negligence or breach of fiduciary duty against a corporate director. It is a rule of substantive law that requires a plaintiff seeking damages on behalf of a corporation against its disinterested directors to plead and prove (1) that the conduct of the directors complained of was either ultra vires or fraudulent or (2) that the directors had a personal interest in the transactions complained of.
Despite these statements, the Court did hold that the business judgment rule would not protect directors from liability for gross negligence and would not protect directors in situations in which he abdicated his responsibility and failed to exercise any judgment. Id. at 725-26.
One district court rejected this notion and followed the Gearhart opinion, concluding that the cases that espoused a gross negligence exception to the business judgment rule are a result of the special treatment that banks receive under Texas law. Floyd v. Hefner, 2006 U.S. Dist. LEXIS 70922, *71-72 (S.D. Tex. 2006).
The business judgment rule has not been codified; however, the Code does provide the following:
In discharging a duty or exercising a power, a governing person, including a governing person who is a member of a committee, may, in good faith and with ordinary care, rely on information, opinions, reports, or statements, including financial statements and other financial data, concerning a domestic entity or another person and prepared or presented by:
an officer or employee of the entity;
a certified public accountant;
an investment banker;
a person who the governing person reasonably believes possesses professional expertise in the matter; or
a committee of the governing authority of which the governing person is not a member.
A governing person may not in good faith rely on the information described by Subsection (a) if the governing person has knowledge of a matter that makes the reliance unwarranted.
TEX. BUS. ORGS. CODE ANN. § 3.102 (Vernon 2006)
Legislative safe harbors have been provided relating to the duty of care as well. Section 7.001(b) provides:
The certificate of formation or similar instrument of an organization to which this section applies may provide that a governing person of the organization is not liable, or is liable only to the extent provided by the certificate of formation or similar instrument, to the organization or its owners or members for monetary damages for an act or omission by the person in the person’s capacity as a governing person.
TEX. BUS. ORGS. CODE ANN. § 7.001(b) (Vernon Supp. 2010)
An officer of a corporation is considered an agent of the corporation and owes the same duties of obedience, loyalty and care as directors. Gearhart, 741 F.2d at 719. Courts will often address the application of these duties to both directors and officers. See e.g. Cates, 11 S.W. at 849 (“The breach of duty or conduct of officers and directors which would authorize…the court’s interference….”)
There is a similar provision in the Code that allows officers, in the discharge of their duties, to rely on materials and opinions provided by other officers, employees of the corporations, lawyers, accountants and other professionals. See TEX. BUS. ORGS. CODE ANN. § 3.105. (Vernon 2006)
Majority or Controlling Shareholders
Generally, a shareholder does not owe fiduciary duties to another shareholder, even shareholders in a closely held corporation. Cardiac Perfusion Services, Inc. v. Hughes, 380 S.W.3d 198, 213-214 (Tex. App. – Dallas 2012, aff’d in part,rev’d in part, remanded2014 Tex. LEXIS 532, 57 Tex. Sup. Ct. J. 914 (Tex. 2014)). A majority shareholder does owe some form of fiduciary duty to the actual corporation. Hoggett v. Brown, 971 S.W.2d 472, 488, fn. 13 (Tex. App. – Houston [14th Dist.] 1997, pet. denied). The Hoggettcourt further stated that a “co-shareholder in a closely held corporation does not as a matter of law owe a fiduciary duty to his co-shareholder” and “whether such a duty exists depends on the circumstances.” Id. See also Flanary v. Mills, 150 S.W.3d 785, 794 (Tex. App. – Austin 2004, pet. denied) (“person is justified in placing confidence in the belief that another party will act in his or her best interest only where he or she is accustomed to being guided by the judgment or advice of the other party, and there exists a long association in a business relationship, as well as personal relationship.”); Redmon v. Griffith, 202 S.W.3d 225, 237 (Tex. App.–Tyler 2006, pet. denied) (the circumstances were sufficient to raise a fiduciary duty considering the extensive amount of control by the majority shareholder in the closely held corporation combined with the allegations of oppressive conduct); Allen v. Devon Energy Holdings, LLC, 367 S.W.3d 355, 389 (Tex. App. – Houston [1st Dist.] 2012, pet. granted, judgm’t vacated w.r.m.) (a controlling shareholder of a closely held corporation owes a formal fiduciary duty to a minority shareholder when the controlling shareholder or the corporation is purchasing the minority shareholder’s shares); Vejara v. Levior Int’l., LLC, 2012 Tex. App. LEXIS 8975, *12 (Tex. App. – San Antonio, Oct. 31, 2012, pet. denied) (holding that while not a majority shareholder, Vejara exhibited the same type of control and intimate knowledge of the company’s affairs as was cited in the Devon Energy case and, therefore, held that Vejara did owe an informal fiduciary duty to the company and/or the majority shareholder)
In Willis v. Donnelly, 199 S.W.3d 262, 276 (Tex. 2006), the supreme court refrained from addressing the issue of whether a majority shareholder in a closely held corporation owes a fiduciary duty to a minority shareholder. The supreme court stated that a fiduciary duty could be owed by a majority shareholder in a closely held corporation in a situation where the majority shareholder dominated control over the corporation or where the shareholders operated the business like a partnership rather than a corporation. Id. However, the court held that the facts of the case did not support such a duty because the plaintiff (an employee) never actually became a shareholder of the corporation. Id. at 277.
In Ritchie v. Rupe, 2014 Tex. LEXIS 500, *49-50 (fn27), 57 Tex. Sup. J. 771 (Tex. 2014), the supreme court, citing the Willis case, stated that “this Court has never recognized a formal fiduciary duty between majority and minority shareholders in a closely-held corporation… and no party has asked us to do so here.” The court further stated that it has recognized that fiduciary duties are owed by the officers and directors to the corporation. Id. The issue of a formal fiduciary duty being owed by the majority shareholder to the minority shareholder was not before the supreme court because “[no] party in this case has asked us to alter the nature of that duty.” Id. at 50. The court made it clear that the “fiduciary duty alleged in this case is an informal fiduciary duty”, not a formal fiduciary duty. Id.
A controlling shareholder in Texas can take comfort in the fact that the Texas Supreme Court has not clearly held that he owes a fiduciary duty to a minority shareholder. However, as discussed supra, other Texas courts have recognized that such a duty can exist under certain circumstances. Under the right circumstances, a minority shareholder can sue a controlling shareholder directly for breach of fiduciary duty. As seen infra, different rules apply to a shareholder suing a director or officer for breach of fiduciary duties.
Since a director’s and officer’s fiduciary duties run to the corporation and not to shareholders, claims against directors and officers for breaches of these duties can generally only be brought in a shareholder’s derivative suit on behalf of the corporation. Gearhart, 741 F.2d at 721. In a shareholder derivative suit, “the individual shareholder steps into the shoes of the corporation and usurps the board of directors’ authority to decide whether to pursue the corporation’s claims.” In re Crown Castle Int’l Corp., 247 S.W.3d 349, 355 (Tex. App. – Houston [14th Dist.] 2008, original proceeding).
There are strict procedural requirements for bringing a derivative action. See TEX. BUS. ORGS. CODE ANN. §§ 21.551 – 21.562. (Vernon Supp. 2010)
Section 21.553 requires a written demand and notice period for derivative actions; it provides:
A shareholder may not institute a derivative proceeding until the 91st day after the date a written demand is filed with the corporation stating with particularity the act, omission, or other matter that is the subject of the claim or challenge and requesting that the corporation take suitable action.
The waiting period required by Subsection (a) before a derivative proceeding may be instituted is not required if:
(1) the shareholder has been previously notified that the demand has been rejected by the corporation;
(2) the corporation is suffering irreparable injury; or
(3) irreparable injury to the corporation would result by waiting for the expiration of the 90-day period.
TEX. BUS. ORGS. CODE ANN. § 21.553 (Vernon Supp. 2010)
The Texas Supreme Court has made it very clear that the written demand is required in every such case. In re Harold R. Schmitz, 285 S.W.3d 451, 458 (Tex. 2009) (interpreting predecessor statute Texas Business Corporation Act. Article 5.14). While refusing to set a bright line standard for the sufficiency of such a demand, the supreme court rejected a two-sentence demand letter. Id. The court stated that whether a demand was sufficient would depend on the circumstances of the corporation, the board and the subject complaint. Id. The Court further held that the demand cannot be made by an anonymous shareholder; the shareholder must be identified, although the demand does not have to come directly from the shareholder. Id. at 456.
The Code provides for different rules to apply to derivative actions against a “closely held corporation”. Section 21.563 provides the following:
In this section, “closely held corporation” means a corporation that has:
fewer than 35 shareholders; and
no shares listed on a national securities exchange or regularly quoted in an over-the-counter market by one or more members of a national securities association.
Sections 21.552-21.559 do not apply to a closely held corporation.
If justice requires
a derivative proceeding brought by a shareholder of a closely held corporation may be treated by a court as a direct action brought by the shareholder for the shareholder’s own benefit; and
a recovery in a direct or derivative proceeding by a shareholder may be paid directly to the plaintiff or to the corporation if necessary to protect the interests of creditors or other shareholders of the corporation.
TEX. BUS. ORGS. CODE § 21.563 (Vernon Supp. 2010)
As noted supra, sections 21.552 – 21.559 are the strict procedural requirements that apply to derivative actions; as per section 21.563, these procedures do not apply to closely held corporations. One court interpreting section 21.563(c) held that the trial court’s discretion to treat such an action as a direct action did not mean the action was no longer a derivative proceeding. Swank v. Cunningham, 258 S.W.3d 647, 664 (Tex. App. – Eastland 2008, pet. denied).
It is important to note that a claim for shareholder oppression must be distinguished from a claim brought by a shareholder alleging breach of a fiduciary duty by a controlling shareholder. A shareholder oppression claim is brought without an allegation of a breach of a fiduciary duty. However, both claims are often brought together in one action and have at times been confused by the courts.
Patton v. Nicholas
In Patton v. Nicholas, 279 S.W.2d 848 (Tex. 1955), the supreme court dealt with a suit by a minority shareholder for an accounting and liquidation of a solvent corporation. It was alleged that the president, director and majority shareholder maliciously forced the minority shareholders to resign and suppressed the payment of dividends by the corporation. Id. at 852-53. The court found that the defendant had maliciously suppressed the payment of dividends which was a “wrong akin to breach of trust, for which the courts will afford a remedy.” Id. at 854. The Court reversed the trial court’s order of liquidation but did state that liquidation might by appropriate in “more extreme cases”. Id. at 857. It is important to note that the receivership statutes in effect at the relevant time applied only to an insolvent corporation; TEX. BUS. CORP. ACT ANN. art. 7.05 discussed infra became effective in 1955, the same year as the Patton decision but was not applicable to the case. The court indicated that the relief granted must be tailored to fit the wrongful conduct in the particular case. Id. at 857. The minority shareholders were granted injunctive relief in the form of the corporation being required to issue reasonable dividends in the present and future. Id.
Since the court never used the term “shareholder oppression”, it cannot be said that the Patton case recognized a cause of action for shareholder oppression. The court noted numerous times that the actions by the defendant were malicious (“malicious suppression of dividends”). Id. at 854.
Article 7.05 & Section 11.404 – the Receivership Statutes
TEX. BUS. CORP. ACT ANN. art. 7.05 (the predecessor statute to TEX. BUS. ORGS. CODE ANN. § 11.404) became effective in 1955 and provided that in an action by a shareholder, a receiver could be appointed for the assets and business of an insolvent corporation (or one that was in imminent danger of insolvency) to conserve the assets and business of the corporation and to avoid damage to parties at interest, but only if all other remedies available, either at law or in equity, were determined by the court to be inadequate. Other than insolvency, a receiver would be appointed upon proof that the “acts of the directors or those in control of the corporation [were] illegal, oppressive or fraudulent.”
Article 7.05 was codified in 2010 as TEX. BUS. ORGS. CODE ANN. § 11.404 which provides in part:
(a) Subject to Subsection (b), a court that has jurisdiction over the property and business of a domestic entity under Section 11.402(b) may appoint a receiver for the entity’s property and business if:
(1) in an action by an owner or member of the domestic entity, it is established that:
(A) entity is insolvent or in imminent danger of insolvency;
(B) the governing persons of the entity are deadlocked in the management of the entity’s affairs, the owners or members of the entity are unable to break the deadlock, and irreparable injury to the entity is being suffered or is threatened because of the deadlock;
(C) the actions of the governing persons of the entity are illegal, oppressive, or fraudulent;
(D) the property of the entity is being misapplied or wasted; or
(E) with respect to a for-profit corporation, the shareholders of the entity are deadlocked in voting power and have failed, for a period of at least two years, to elect successors to the governing persons of the entity whose terms have expired or would have expired on the election and qualification of their successors;
(b) A court may appoint a receiver under Subsection (a) only if:
(1) circumstances exist that are considered by the court to necessitate the appointment of a receiver to conserve the property and business of the domestic entity and avoid damage to interested parties;
(2) all other requirements of law are complied with; and
(3) the court determines that all other available legal and equitable remedies, including the appointment of a receiver for specific property of the domestic entity under Section 11.402, are inadequate.
TEX. BUS. ORGS. CODE ANN. § 11.404 (Vernon Supp. 2010) (emphasis added)
One of the differences from its predecessor statute is that section 11.404 applies to all “domestic entities” covered by the Code not just to corporations like Article 7.05. A receiver appointed under the Code has the same powers and duties as provided by other laws, and as specified by the court. Id. § 11.406. The term “governing persons” includes directors but does not include officers acting in the capacity as an officer. TEX. BUS. ORGS. CODE ANN. § 1.002(35).
Davis v. Sheerin
A key case interpreting former statute TEX. BUS. CORP. ACT ANN. art. 7.05 was Davis v. Sheerin, 754 S.W.2d 375 (Tex. Civ. App. – Houston [1st Dist.] 1988, pet. denied). In Davis, a minority shareholder sued a majority shareholder and an officer in a closely held corporation for breaches of fiduciary duties and conspiring to deprive the minority owner of his ownership interest in the corporation. Id. at 377. The trial court ordered a buy-out of the minority owner’s stock, the appointment of a receiver and the payment of future dividends. Id. at 378. Citing Patton, the defendant argued on appeal that the buy-out remedy was not available under Texas law. Id. at 379. Despite stating that Article 7.05 did not expressly provide for the remedy of a “buy-out” for an aggrieved minority shareholder, the court upheld the buy-out stating “Texas courts, under their general equity power, may decree a ‘buyout’ in an appropriate case where less harsh remedies are inadequate to protect the rights of the parties.” Id. at 380; See also Advance Marine, Inc. v. Kelly, No. 01-90-665-CV, 1991 Tex. App. LEXIS 1614, *2 (Tex. App. – Houston [1st Dist.] June 27, 1991, no writ). The Davis court further acknowledged that Article 7.05 and Texas case law did not define oppressive conduct. Davis, 754 S.W.2d at 381. Relating to proof of oppressive conduct, the Court noted that the determination of whether the defendant’s acts were oppressive is not a question of fact for the jury but rather usually a question of law for the court. Id. at 380. The jury would, however, determine whether the acts occurred at all, assuming those facts are in dispute. Id. The Davis court adopted the following definitions of oppression:
Majority shareholders’ conduct that substantially defeats the minority’s expectations that objectively viewed, were both reasonable under the circumstances and central to the minority shareholder’s decision to join the venture; or
Burdensome, harsh, or wrongful conduct; a lack of probity and fair dealing in the company’s affairs to the prejudice of some members; or a visible departure from the standards of fair dealing and a violation of fair play on which each shareholder is entitled to rely.
Id. at 381-82; See also Willis v. Bydalek, 997 S.W.2d 798, 801 (Tex. App. – Houston [1st Dist.] 1999, pet. denied). The first definition is known as the “Reasonable Expectations” test and the Court based it on New York law. The second is known as the “Fair Dealing” test and the court derived that test from Oregon law.
While citing both definitions, the Davis court appeared to base its holding on the Reasonable Expectation test. Davis, 754 S.W.2d at 382. Further, without any explanation, the court stated that the defendant’s conduct did not “fall under the protection of the business judgment rule.” Id. at 383. The court upheld the trial court’s conclusion that the conspiracy to deprive the minority shareholder of his interest and the breaches of fiduciary duty constituted oppression. Id. The Davis court further upheld the trial court’s order requiring a buyout of the minority’s interest at the amount determined by the jury to be fair value. Id.
It should be noted that the supreme court in Richie disapproved of both of these definitions and created a new definition of oppression. Ritchie v.Rupe, 2014 Tex. Lexis at *33-34.
Ritchie v. Rupe – Dallas Court of Appeals
The Dallas Court of Appeals (“Dallas Court”) recognized a minority shareholder oppression cause of action in the Ritchie case. Ritchie v. Rupe, 339 S.W.3d 275 (Tex. App. – Dallas 2011, reversed and remanded 2014 Tex. LEXIS 500, 57 Tex. Sup. Ct. J. 771 (Tex. 2014). Given the fact that the Ritchie case is a seminal case in this area of the law, the facts of the case and the appellate court’s opinion will be discussed in depth.
The corporation at issue in this case was Rupe Investment Corporation (“RIC”), an investment holding company founded by Dallas Gordon Rupe, Jr (“Pops”) and Robert Ritchie. Id. at 280. The minority shareholder was Ann Caldwell Rupe (“Rupe”), as trustee for the Dallas Gordon Rupe, III, 1995 Family Trust (“Buddy’s Trust”). Id. Dallas “Buddy” Gordon Rupe III was the son of the founder of RIC. Id. at 281. Rupe sued RIC and the following directors in their individual capacities (hereafter at times referred to as “appellants”):
Paula Dennard (“Dennard”), daughter of founder Pops and chairman of RIC’s board of directors;
Lee Ritchie (“Ritchie”), son of founder Robert Ritchie and RIC’s president and director; and
Dennis Lutes (“Lutes”), RIC director and one of its attorneys.
Id. at 281-83.
The main dispute that gave rise to the litigation was Rupe’s efforts to sell the stock owned by Buddy’s Trust to third parties. Id. at 282. Rupe hired retired capital fund manager, George Stasen, to help sell the stock. Id. Stasen met with Ritchie and Dennard and asked for their cooperation with his efforts to sell the stock. Id. Stasen testified that Ritchie told him that no member of RIC’s management would meet with prospective buyers; this testimony was backed up by a fax from Ritchie to Rupe stating that “it would be inappropriate for me or any other officer or director of [RIC] to meet with your prospects or otherwise participate in any activities relating to your proposed sale of stock.” Id. Stasen testified that it would be extraordinarily difficult to sell the stock to a third party without the ability of the prospective purchaser meeting with RIC’s management. Id.
During the trial, the court allowed Rupe to amend her petition to change the capacity in which Ritchie, Dennard and Lutes were sued from their individual capacities to their capacities as directors of RIC and trustees of the various shareholder trusts. Id. at 283. The jury returned a verdict in Rupe’s favor, and the trial court signed a judgment ordering appellants to cause RIC to buy out the stock owned by Buddy’s trust for $7.3 million. Id. The trial court also filed findings of fact and conclusions of law, which included its conclusions that, as a matter of law, appellants had acted oppressively towards Rupe in several respects:
Refusing to cooperate with Rupe’s attempts to sell the stock to a third party;
Causing RIC to withhold books and records from Rupe;
Making redemption offers to Rupe that were not in accordance with RIC’s policy;
Making Rupe a conditional offer to be on the board in exchange for her not pursuing legal action against another RIC shareholder; and
Causing RIC to pay some of Dennard’s personal expenses.
Id. at 283, fn. 9.
It is important to note that Dallas Court’s sole basis for its oppression finding was the “appellants’ actions in connection with [Rupe’s] efforts to sell the Stock to third parties”. Id. at 281.
The appellants’ main argument before the Dallas Court (and later before the Texas Supreme Court) was that the court-ordered buyback of the stock was not an available remedy for shareholder oppression under Texas law. Id. at 285. The Dallas Court disagreed relying primarily on Article 7.05 and the Patton and Davis opinions. Relating to Article 7.05, the Dallas Court noted that the statute specifically states the receivership remedy is available “only … if all other remedies available either at law or in equity…are determined by the court to be inadequate.” Id. at 285-86 (original emphasis). The Dallas Court cited language from the Texas Supreme Court’s opinion in Patton discussing the “trial court’s discretion to fashion equitable relief in shareholder disputes.” Id. at 286. Not surprisingly, the Dallas Court relied upon the Davis opinion which recognized that a “buyout” is an available and sometimes appropriate remedy. Id. The Dallas Court noted that the Davis opinion had been followed in other cases including In re White, Hoggett, Stary v. DeBord, 967 S.W.2d 352 (Tex. 1988) (per curiam), Christians v. Stafford, No. 14-99-00038-CV, 2000 Tex. App. LEXIS 6423 (Tex. App. – Houston [14th Dist.] Oct. 26, 2000, no pet.). Id. at 287, fn. 16. As such, the Dallas Court concluded that Texas law authorizes a trial court, in an appropriate case, to order a buyout of an oppressed minority shareholder as an equitable remedy for shareholder oppression. Id. at 289.
The Appellants’ further alleged that their actions did not constitute shareholder oppression as a matter of law. Id. at 285. Appellants argued that shareholder oppression can only be committed by a majority shareholder and that it was undisputed that there was no majority shareholder in RIC. Id. at 290. The Dallas Court rejected this argument pointing out that Article 7.05 allow intervention when “the acts of the directors or those in control of the corporation are illegal, oppressive or fraudulent.” Id.(original emphasis). The Dallas Court then stated that it was “undisputed that [Dennard], Ritchie, and Lutes together control, either through direct ownership or by virtue of their positions as trustees of the shareholder trusts, 73.7 percent of the voting stock.” Id.
The Dallas Court then began its analysis of the oppression issue by stating that Article 7.05 did not define the term “oppression” but that the term is expansive and a narrow definition of it would be inappropriate. Id. at 289. The Dallas Court then cited the Davis definitions of shareholder oppression and analyzed the conduct of the appellants under both definitions. Id. at 289. Prior to that analysis, however, the Dallas Court did recite the business judgment balancing test pronounced in Bydalek (See Section II(J) infra) but then cited Davis for the proposition that “Courts take an especially broad view of the application of oppressive conduct to a closely held corporation, where oppression may be more easily found.” Id.
Under the “Reasonable Expectations” definition of shareholder oppression, the Dallas Court cited Sandor Petroleum Corp. v. Williams, 321 S.W.2d 614, 717 (Tex. Civ. App. – Eastland 1959, writ ref’d n.r.e) as providing a useful illustration of the general reasonable expectations of a holder of unrestricted stock, despite the fact that it was not a case dealing with shareholder oppression. Id. at 292-93. Relying on Sandor, the Dallas Court concluded that corporate policies that prohibit a shareholder from identifying potential buyers and providing potential buyers with sufficient information about the corporation would substantially defeat the shareholder’s “general reasonable expectation” of being able to market her unrestricted stock. Id. at 293-94.
The Dallas Court noted that under the “fair dealings” definition the focus was more on the conduct of the directors than on the reasonable expectations of the minority shareholder. Id. at 294. The “standards of fair dealing with respect to the owner of unrestricted stock in a corporation would include a requirement that they act fairly and reasonably in connection with a shareholder’s efforts to sell the stock to a third party.” Id. The Dallas Court concluded that appellants’ refusal to meet or allow any officer or director of RIC to meet with prospective buyers was oppressive under both the reasonable expectation and fair dealings definitions. Id. at 296-97.
Lastly, the appellants argued that their conduct as directors that the trial court found to be oppressive was protected from liability by the business judgment rule. Id. at 295. Citing the Gearhart case, the Dallas Court noted that the “business judgment rule protects a corporation’s directors from personal liability to shareholders for their actions in operating the corporation unless their actions are ultra vires or tainted by fraud.” Id. The Dallas Court held that the business judgment rule did not apply because this was not a derivative suit for breach of duty of care owed to the corporation. Id. According to the Dallas Court, “the directors of RIC were not held personally liable for the shareholder oppression; nor were the directors or those controlling the corporation directed to buy the Stock themselves.” Id. at 295-96. Therefore, the business judgment rule did not apply to this case. Id. at 296.
The Dallas Court held that the trial court did not abuse its discretion by ordering the buyout of stock as an appropriate equitable remedy. Id. at 309. However, the Dallas Court did conclude the trial court erred by instructing the jury not to include discounts in determining the fair market value of the stock. Id.
Ritchie v. Rupe – Texas Supreme Court
The Texas Supreme Court reversed the court of appeals’ judgment relating to the oppression claim. Ritchie, 2014 Tex. LEXIS at *2-3 (Tex. 2014). The court began its analysis by determining the meaning of “oppressive” as the Legislature used the word in Article 7.05 and its successor section 11.404. In a footnote, the court indicated that article 7.05 was the governing statute when the trial court rendered its judgment. Id. at *12, fn. 6. The court noted that Rupe had actually sought a receivership to liquidate RIC, not to rehabilitate it as provided for in Article 7.05. Id. at *11. However, since Rupe was relying on this statute as authority for the trial court’s judgment ordering RIC to buy out her shares, the supreme court proceeded to analyze it and its successor statute. Id.
Meaning of “Oppressive” Under the Statute
The supreme court stated that the Legislature has never defined the term “oppressive” in the Business Corporation Act or the Business Organizations Code. Id. at *19. The court noted that two aspects of receivership statute were particularly relevant. First, both former article 7.05 and section 11.404 are not limited to closely held corporations which meant that the court must “construe the statute in a manner that is meaningful and workable not only for the peculiarities of minority shareholders in a closely held corporation, but also for shareholders and owners of other business entities.” Id. at *23-24. Second, the statute places significant restrictions on the availability of a receivership; the court concluded that these requirements demonstrate the Legislature’s intent that receivership is a “harsh” remedy that is not readily available. Id. at *24.
The court noted that in addition to the statute’s three general requirements, a shareholder must also prove at least one of five specific grounds, one of which is the “illegal, oppressive or fraudulent” actions provision that Rupe relied. Id. at *25. The court concluded that all five grounds applied to “situations that pose a serious threat to the well-being of the corporation.” Id. at *25. Therefore, “illegal, oppressive or fraudulent” actions must be construed in a manner consistent with these types of serious situations. Id. at *25-26.
In determining the meaning of “oppressive”, the court considered that the statute is limited to “directors or those in control of the corporation” engaged in oppressive conduct. Id. at *26. The court noted that directors owe a fiduciary duty to the corporation and this duty includes the “dedication of [their] uncorrupted business judgment for the sole benefit of the corporation.” Id. Thus, the meaning of “oppressive” must accommodate the exercise of that business judgment. Id. at *27 The court, therefore, rejected the court of appeals conclusion that the business judgment rule did not apply. Id.
Lastly, the court noted that the Legislature grouped together three categories of conduct –actions that are “illegal,” actions that are “fraudulent,” and actions that are “oppressive.” Id. at *30. As such, the court concluded that the “meaning that the Legislature contemplated for the term ‘oppressive’ must be consistent with, though not identical to, the meanings intended for the accompanying terms ‘illegal’ and ‘fraudulent’.” Id.
Taking all of these factors into consideration, the supreme court concluded that neither the “fair dealing” test nor the “reasonable expectations” test sufficiently captured the Legislature’s meaning of “oppressive” actions as the term is used in article 7.05. Id. at *33. Cases which had found oppression based on either of these definitions alone were, therefore, disapproved of by the court. Id. at *34-35. The court then announced the new definition of “oppressive” for actions under former article 7.05 and section 11.404: “a corporation’s directors or managers engage in ‘oppressive’ actions … when they abuse their authority over the corporation with the intent to harm the interests of one or more of the shareholders, in a manner that does not comport with the honest exercise of their business judgment, and by doing so create a serious risk of harm to the corporation.” Id.at *35. Applying this new definition, the court concluded that the refusal of RIC’s directors to meet with Rupe’s potential buyers did not constitute an “oppressive action” for which Rupe could obtain relief under former article 7.05. Id.
Statutory Remedy for Oppression
Although the Dallas Court relied solely upon the director’s refusal to meet potential buyers, the supreme court noted that it need not consider whether other actions alleged by Rupe constituted “oppressive” conduct. Even if the conduct was oppressive, the court held that the statute does not authorize the buy-out remedy that Rupe obtained. Id. at *38. The court concluded that former article 7.05 and section 11.404 create a single cause of action with a single remedy: an action for appointment of a rehabilitative receiver. Id. at *39. The language in both statutes that “all other remedies available either at law or in equity…are determined by the court to be inadequate” is a restriction on the availability of the receivership, not an expansion of the remedies that the statute authorizes. Id. at *40. In other words, the court held that appointment of a rehabilitative receiver is the only remedy that former article 7.05 authorizes. Id. at *58.
No Common-law Cause of Action
While the Dallas Court based its decision solely under the receivership statute, since Rupe’s pleadings and briefs asserted a common-law claim for shareholder oppression, the supreme court analyzed whether to recognize such a cause of action. Id. at *58-59. The court stated that deciding whether to recognize a new cause of action requires a “cost-benefit analysis” to assure that the expansion of liability is justified. Id. at *59.
One of the factors of this analysis is the “foreseeability, likelihood and magnitude of potential injury.” After reviewing the case law and other authorities, the court concluded that “the foreseeability, likelihood and magnitude of harm sustained by minority shareholders due to abuse of power by those in control of a closely held corporation is significant, and Texas law should ensure that remedies exist to appropriately address such harm.” Id. at *64.
Another factor considered as part of its analysis was the “existence and adequacy of other protections”. Here, the supreme court detailed all the other statutory remedies that are available to protect against the subject conduct, including (1) declaration as a “close corporation”; (2) availability of derivative lawsuits involving a “closely held corporation”; (3) careful drafting of shareholder and buy-sell agreements and (4) the existence of various common-law causes of action which address misconduct by corporate directors and officers, including an accounting, breach of fiduciary duty, breach of contract, fraud and constructive fraud, conversion, fraudulent transfer, conspiracy, unjust enrichment and quantum meruit. Id. at *65-72.
To test the adequacy of these “other protections”, the court went through five (5) “kinds of conduct commonly cited as justifying the creating of liability for ‘shareholder oppression’”:
Denial of Access to Corporate Books & Records
Withholding or Refusing to Declare Dividends
Termination of Employment
Misapplication of Corporate Funds/Diversion of Corporate Opportunities
Manipulation of Stock Values
Id. at *73-92. As for the denial of access to the corporate books, the Court cited the sections of the Texas Business Organizations Code which address that shareholder’s right and provides for penalties for any violations. Id. at *73. As for the other four scenarios, the Court determined that each one of them could be addressed with the breach of fiduciary duty cause of action. Therefore, the court declined to recognize a common-law cause of action for “shareholder oppression.” Id. at *103.
Breach of Informal Fiduciary Duties
Rupe argued that the supreme court could affirm the trial court’s buy-out order based on the jury’s finding in her favor on her breach of fiduciary duty claim. Id. The supreme court noted that Rupe’s fiduciary duty claim was not based on the formal fiduciary duties that directors and officers owe to the corporation but was based on an informal fiduciary relationship that existed between her and Dennard, Ritchie and Lutes. Id. at 103-04. Because the Dallas Court based its decision solely on the oppression finding, the supreme court remanded the case to the Dallas Court to resolve Dennard, Ritchie and Lutes’ challenges to Rupe’s breach of fiduciary duty claim. Id. at 104. Since the Dallas Court found that the evidence did not support the jury’s valuation of Rupe’s shares, if the Dallas Court concludes that Rupe may recover on the breach of fiduciary duty claim and that a buyout order is available as a remedy, it will need to remand the case to the trial court. The remand to the trial court would involve the redetermination of the value of Rupe’s shares and whether buyout is equitable in light of the newly determined value of the shares. Id.
Cardiac Perfusion Services, Inc. vs. Hughes
The Dallas Court of Appeals (“Dallas Court”) notes in its opinion in this case that “[t]his case was tried and briefed before this Court issued its opinion in Ritchie [but] the parties agreed that our decision in Ritchie applies” to this case. Cardiac Perfusion, 380 S.W.3d at 202-203. Defendant Joubran founded Cardiac Perfusion Services (CPS) and hired Hughes as his first employee in 1991. Id. at 201. In 1992, Hughes was offered and purchased 10% of CPS’ shares. Id. Also in 1992, Hughes entered into a Buy-Sell Agreement which required shareholders of CPS to purchase the stock of another shareholder upon “the severance of [that] shareholder’s employment relationship with [CPS],” with the purchase price to be calculated at book value of the shares. Id. Hughes’ employment with CPS was terminated in 2006. Thereafter, CPS and Joubran sued Hughes for breach of fiduciary duty and tortious interference with contract. Id. Hughes counterclaimed against Joubran for oppressing him as the minority shareholder. Id. At the conclusion of the trial, the jury found in favor of Hughes on CPS’ and Joubran’s claims and in favor of Hughes on his minority suppression claims. Id. Based on the jury’s findings concerning the oppressive conduct, the trial court concluded that Joubran engaged in shareholder oppression and the most equitable remedy was to require Joubran and CPS to redeem Hughes’ shares at what the jury found the fair value to be: $300,000. Id. at 202.
CPS and Joubran argued on appeal that trial court erred when it ordered them to redeem the shares at fair value rather than at book value, as required by the terms of a Buy-Sell Agreement entered into between CPS and Hughes. Id. Hughes countered that the book value of his shares was reduced by Joubran’s oppressive conduct and that he had sued for shareholder oppression, not breach of contract. Id. at 204. Citing the Davis case, the Dallas Court noted that the term “shareholder oppression” is expansive and covers “a multitude of situations dealing with improper conduct.” Id. at 202. The Dallas Court reiterated the following procedural point it had highlighted in the Ritchie case: “When the facts are in dispute, the jury determines what acts occurred, but the trial court determines whether those acts constitute shareholder oppression and exercises its equitable authority to decide the appropriate remedy.” Id. The Dallas Court ruled against CPS and Joubran holding that “[i]n the context of a claim for shareholder oppression, courts have equitable power to order a buy-out at fair value.” Id. at 204. The Dallas Court noted that the trial court appropriately instructed the jury to value the shares using the “enterprise value” method the Dallas court had sanctioned in the Ritchie case. Id. at 204-05. But see Four Seasons Equip., Inc. v. White (In re White), 429 B.R. 201, 217 (Bankr. S.D. Tex. 2010) (holding that there was “little reason to substitute the Court’s own judgment as to the fair terms of the buy-out price [when] the formula was agreed to by the parties without coercion” in the shareholders’ agreement)
Cardiac Perfusion Services, Inc. vs. Hughes – Texas Supreme Court
Relying on its decision in Ritchie v. Rupe, the supreme court reversed the part of the trial court’s judgment which ordered the buy-out of Hughes shares for $300,000. Cardiac Perfusion Services, Inc. v. Joubran, 2014 Tex. LEXIS 532, *2, 57 Tex. Sup. J. 914 (Tex. 2014). The supreme court remanded the case in the interest of justice to provide Hughes with an opportunity to pursue a derivative action for breach of fiduciary duties. Id. at 7. The court expressed no opinion on whether Hughes could successfully pursue such a claim under the facts of the case. Id.
Argo Data v. Shagrithaya
In Argo Data Resource Corporation v. Shagrithaya, 380 S.W.3d 249 (Tex. App. – Dallas 2012, pet. denied), the Dallas Court of Appeals (“Dallas Court”) wrote its third opinion on shareholder oppression within a year and a half time period. Unlike the Ritchie and Cardiac Perfusion opinions, in the Argo Data case, the Dallas Court reversed and rendered a verdict and judgment in favor of the plaintiff which had found shareholder oppression. Id. at 257. ARGO, a software company, was co-founded by Martin and Shagrithaya, with Martin owing 53% of the company and Shagrithaya owning 47%. Id. at 258. Shagrithaya was in charge of developing the technology and Martin ran the business side. Id. Martin and Shagrithaya were the sole directors and officers. Id. Their compensation was decided on a year-to-year basis and neither had a written or oral agreement for employment or compensation. Id. Shagrithaya testified that it was his understanding that he and Martin would receive an equal salary, and for the first twenty-five years they did receive virtually equal compensation. Id. For more than twenty years, both men agreed not to issue dividends. Id. Thereafter, dividends were issued in 2004, 2007 and 2008, with Martin and Shagrithaya participating in these distributions in proportion to their ownership. Id. at 269.
In the late 1990s and early 2000s, Martin began expressing displeasure with Shagrithaya’s unwillingness to take on more responsibility for the management of ARGO. Id. at 259. Shagrithaya told Martin he wanted to remain in product development. Id. In 2006, Martin met with Shagrithaya and told him the he could not justify paying him $1 million a year. Id. Shortly after the meeting, Martin unilaterally cut Shagrithaya compensation to $300,000 for that year. Id. Thereafter, Shagrithaya met with Martin and told him that he was willing to “step down” from his position with ARGO. Id. Martin told Shagrithaya that the best option was to have ARGO buy him out and suggested that Shagrithaya retain independent counsel. Id. Shagrithaya’s counsel sent emails to ARGO’s legal counsel stating that his client wanted to sell all of his shares and listed three independent appraisers in order of preference. Id. The email also stated that it was expected that the appraisal be conducted without any minority discount so “that our clients can then negotiate a fair purchase price.” Id. at 259-60. Martin agreed to the appraiser listed as Shagrithaya’s first choice. Id. at 260.
During this same time period, as a result of an audit, the IRS determined that ARGO had unreasonably accumulated earnings and profits and was assessed an accumulated earnings tax. Id. In response, ARGO filed a formal protest which stated that “[ARGO’s] executive management had concluded prior to June 30, 2005, that Mr. Shagrithaya’s minority stock position would likely have to be redeemed to protect the stability of [ARGO’s] business…” Id. The letter further stated that “[t]he implementation of the phase-out of Mr. Shagrithaya began in earnest in 2003 with a restructuring of [ARGO’S] operational structure.” Id. Shagrithaya had no knowledge of the audit or the protest letter until several months after the protest was filed. Id. The IRS ultimately agreed with ARGO that it was not retaining excessive earnings even without including a buyout of Shagrithaya’s shares as a business expense. Id.
In April 2007, Martin informed Shagrithaya of the results of the valuation prepared by the appraiser, the total value of ARGO being $216 million. Id. The appraiser applied a 35% minority discount and valued Shagrithaya’s shares at $66 million. Id. Martin agreed to have ARGO purchase Shagrithaya’s shares for this amount but Shagrithaya refused the sale because he thought the minority discount should not apply since ARGO, not a third party, would be purchasing the shares. Id.
In November 2007, Shagrithaya requested, among other things, access to ARGO’s books and records to perform an audit which Martin provided. Id. at 262. As a result of the audit, it was discovered that Martin had purchased a Colorado condominium from ARGO without board approval, made payments to Martin’s wife equal to the lease payments on the Martin’s company car and had charged personal expenses to the company. Id. After ARGO conducted its own audit, Martin reimbursed ARGO in an amount greater than Shagrithaya’s auditor stated was owed. Id.
Thereafter, Shagrithaya filed suit against Martin asserting claims for “oppressive conduct,” breach of fiduciary duty and breach of contract; the petition was later amended to include ARGO as a defendant and to assert derivative claims on behalf of ARGO for Martin’s alleged misuse of corporate funds. Id. After a six week trial, the jury found in favor of Shagrithaya on all claims submitted, finding that ARGO should issue a $65 million dividend and that Shagrithaya was owed over $2 million in back compensation. Id. at 263. The trial court signed a judgment concluding that Martin had engaged in oppressive conduct, ordering a dividend in the amount of $85 million and awarded Shagrithaya $1.3 million for his breach of contract claim. Id. at 264.
The Dallas Court starts its analysis by stating that jurors as factfinders determine whether certain acts occurred but the determination of whether such acts constitute shareholder oppression is a question of law for the court. Id. at 264. The appellate court noted that it reviews questions of law de novo and that it is not obligated to give deference to the trial court’s legal conclusions. Id. The appellate court then reviewed each of the eleven acts included in the jury charge that allegedly supported Shagrithaya’s claim for shareholder oppression. Id. at 265.
The first act considered by the jury to be oppressive conduct was that Martin reduced Shagrithaya’s compensation by 70% without board approval. Id. at 266. The appellate court analyzed this claim under both the “reasonable expectations” test and “fair dealing” test set out in the Davis and Bydalek opinions. The Dallas Court held that, without an agreement pertaining to compensation, Shagrithaya’s expectation to maintain a level of compensation equal to Martin was not reasonable. Id. The court further concluded that the reduction in Shagrithaya’s compensation was not so burdensome, harsh or wrongful (“fair dealing” test) that it constituted shareholder oppression. Id. This action directly related to Shagrithaya’s position as an employee and not to his status as a shareholder. Id. The Dallas Court further noted that the board did eventually approve the compensation level. Id. The court cited the Patton decision for the proposition that the “inability to control board decisions is inherent in the position of a minority shareholder.” Id. at 267.
The next act found by the jury to be oppressive was the fact that Martin’s annual compensation had been kept at $1 million for 2 years without board approval. The Dallas Court decided that the absence of board approval did not cause Shagrithaya any harm because the board eventually retroactively approved the compensation. Id. The court noted that a minority shareholder can prove oppression by showing that another shareholder employed by the company is receiving compensation so far in excess of what is reasonable for his position that he is, in actuality, receiving a de facto dividend. Id. at 268. The appellate court found, however, that Shagrithaya did not present any evidence to support this type of allegation. Id.
The jury also found that Martin engaged in a plan to “retain ARGO’S earnings to buy Shagrithaya’s interest without disclosing this plan to Shagrithaya.” Id. The Dallas Court noted that this finding related to Shagrithaya’s separately asserted cause of action for malicious suppression of dividends. Id. As to that cause of action, the court noted that it was merely a form of minority shareholder oppression under the statutory cause of action rather than a separate common law claim. Id. at 269. The court held that Shagrithaya did not have specific reasonable expectations of receiving dividends because he testified that his plan with Martin was to retain all company earnings and reap the return on their investment when they sold the company. Id. at 270. As for general expectations, a shareholder may expect to share proportionately in the company’s earnings but has no general expectation of receiving a dividend because Texas law does not require corporations to issue dividends. Id. The Dallas Court noted that Shagrithaya did receive his proportional share of the $25 million in dividends that were issued by the company. Id. Under the fair dealings test, the court found that Martin’s suppression of dividends did not substantially defeat Shagrithaya’s expectations or prejudice his rights as a shareholder. Id. at 271.
The appellate court further found that Martin’s failure to disclose to the board (i.e. to Shagrithaya) that the IRS had assessed a retained earnings tax did not harm Shagrithaya’s interests in that the IRS ultimately reversed its decision. Id.
Next, the Dallas Court dealt with Martin’s offer for ARGO to purchase Shagrithaya’s shares for $66 million. The court noted that there are two ways to value a minority shareholder’s stock: enterprise value and fair market value. Id. The enterprise value is determined by assessing the value of the company as a whole and to assign to each share it’s pro rata portion of that overall value. Id. Enterprise value does not include a discount based on the stock’s minority status or lack of marketability. Id. The fair market value is the price at which the stock would change hands between a willing seller and a willing buyer, with both parties having reasonable knowledge of the relevant facts. Id. Fair market value of minority shares does include a minority discount. Courts have ordered majority shareholders to buy out a minority shareholder’s interest using enterprise value where the minority shareholder was forced to relinquish his ownership position in the company by the majority’s oppressive conduct, and absent threat of dissolution or court order, the majority was an unwilling buyer. Id. Applying these two standards, the appellate court decided that the fair market method was appropriate here because Shagrithaya was not forced to relinquish his ownership position, in fact he still owned 47% of the company. Id. at 271-72.
According to the Dallas Court, the jury’s finding that Martin required Shagrithaya to report to the President of ARGO without board approval is an employment matter and did not rise to shareholder oppression. Id. at 272. The alleged misuse of ARGO’s corporate assets by Martin also could not support a shareholder oppression finding because Martin repaid ARGO more than the amount Shagrithaya claimed was owed, therefore, any harm to Shagrithaya was remedied before trial. Id. The last allegation of shareholder oppression related to Martin’s failure to disclose to the board that he had retained a law firm to challenge the IRS tax assessment. Id. The Dallas Court concluded that ARGO as a whole benefited from this challenge and this action did not amount to shareholder oppression. Id. at 272-73.
Since the $85 million dividend awarded was also based on Shagrithaya’s claim for fraud, the appellate court reviewed the court’s findings on the fraud claim. Id. at 273. The fraud claim was based solely on Martin’s failure to disclose his plan to buy out Shagrithaya’s shares as the purpose for retaining earnings. Id. The court concluded that Shagrithaya did not present any evidence of how he was harmed by the withholding of this information. Id.
The Dallas Court held that the evidence did not support a finding of shareholder oppression (including malicious suppression of dividends) or fraud, and concluded that the trial court erred in ordering the equitable remedy of an $85 million dividend. Id. at 274. The appellate court reversed that portion of the trial court’s judgment and rendered that Shagrithaya take nothing by these claims. Id.
On February 14, 2012, Shagrithaya filed a Petition for Review with the Texas Supreme Court. His primary arguments are that his case involves all three forms of abuse previously recognized by Texas courts as shareholder oppression. See Petition for Review at 3. Shagrithaya also argued that the case required review because it dealt with basic questions about the role of appellate review in these cases. Id. Specifically, Shagrithaya argued that Dallas Court of Appeals reversed the trial court’s judgment while leaving virtually all the jury’s findings either intact or unaddressed. Id. On June 27, 2014, the supreme court denied the petition for review.
Oppression Suits in LLCs
The Texarkana Court of Appeals dealt with an LLC “member oppression” claim in Pinnacle Data Services, Inc. v. Gillen, 104 S.W.3d 188 (Tex. App. – Texarkana 2003, no pet.). The Court cited the Davis definitions of oppression and appeared to accept that oppression lawsuits applied in the LLC context. Id. at 196. The court held, however, that the minority member failed to bring forth any evidence to support its claim in response to defendant’s no evidence motion for summary judgment. Id.
In the Devon Energy Holdings case, Allen, a minority member of an LLC, sued the LLC and its majority owner for breach of fiduciary duties and shareholder oppression (among other causes of action). Devon Energy Holdings, 367 S.W.3d at 365. The LLC moved for a traditional summary judgment, which the trial court granted. Id. at 367-68. In reviewing the breach of fiduciary duty claim, the appellate court noted that it would review cases involving closely-held corporations because “Allen relies on these cases and Chief, as a closely-held LLC, operated much like a closely-held corporation.” Id. at 389. The appellate court held that “there is a formal fiduciary duty when (1) the alleged-fiduciary has a legal right of control and exercises that control by virtue of his status as the majority owner and sole-member-manager of a closely-held LLC and (2) either purchases a minority shareholder’s interest or causes the LLC to do so through a redemption when the result of the redemption is an increased ownership interest for the majority owner and sole manager.” Id. at 395-96. In relation to the shareholder oppression claim, the appellate court held that the trial court properly granted summary judgment on that claim because the complained-of actions were not similar to recognized examples of shareholder oppression. Id. at 399. In a footnote, the appellate court noted that it did not express an opinion on whether a member of an LLC may assert a claim for shareholder oppression. Id., fn. 59. See also Bulacher v. Enowa, LLC, 2010 U.S. Dist. LEXIS 27784 *5, (N.D. Tex. March 23, 2010) (holding claims of minority owner of LLC were sufficient to state a claim for oppression under Texas law).
In Ritchie, the supreme court noted that Section 11.404 applies to any “domestic entity.” Ritchie, 2014 Tex. LEXIS at *23. While Section 11.404 undoubtedly applies to LLCs, the limitation on the shareholder oppression cause of action detailed in the Ritchie case would also apply.