Shareholder Oppression in Texas

Texas LawIn Ritchie v. Rupe, 443 S.W.3d. 856 (Tex. 2014), the Texas Supreme Court declined to recognize the widely-accepted common law cause of action for minority shareholder oppression in closely held corporations. The Court held that the appointment of a rehabilitative receiver is the only remedy authorized under TEX. BUS. ORGS. CODE § 11.404 for "oppressive actions" engaged in by a corporation's directors or managers "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.” Ritchie v. Rupe, 443 S.W.3d at 871.

Importantly, however, the Court made it clear that "lesser remedies may remain available as an alternative to receivership in Texas law." Ritchie v. Rupe, 443 S.W.3d 856 at n. 28.

          [W]e have not abolished or even limited the remedies available under the common law or other statutes for the kinds of conduct that give rise to rehabilitative receivership actions … [T]he actions that give rise to oppressive-action receivership claims typically also give rise to common-law claims as well, opening the door to a wide array of legal and equitable remedies (including an equitable buyout) not available under the receivership statute alone. Those remedies, whether lesser or greater, are not displaced by the rehabilitative receivership statute, which merely adds another potential remedy available in extraordinary circumstances when lesser remedies are inadequate.

          Ritchie v. Rupe, 443 S.W.3d 856 at n. 28.

The Court next turned its attention to the types of conduct most commonly associated with various "squeeze-out" or "freeze-out" tactics used by those in control of a closely held corporation "to deprive minority shareholders of benefits, to misapproriate those benefits to themselves, or to induce minority shareholders to relinquish their ownership for less than it is otherwise worth." Id. at 879. Such conduct includes: (1) denial of access to corporate books and records, (2) withholding or refusing to declare dividends, (3) termination of employment, (4) misapplication of corporate funds and diversion of corporate opportunities, and (5) manipulation of stock values. Id. 

The Court then concluded:

          Our review of the case law and other authorities also convinces us that it is both foreseeable and likely that some directors and majority shareholders of closely held corporations will engage in such actions with a meaningful degree of frequency and that minority shareholders typically will suffer some injury as a result. Although the injury is usually merely economic in nature, it can be quite substantial from the minority shareholder's perspective, as it often completely undermines their sole or primary motivation for engaging with the business. (footnote omitted). We thus conclude that the foreseeability, likelihood, and magnitude of harm sustained by minority shareholders due to the 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 when the underlying actions are wrongful.      

           Ritchie v. Rupe,  443 S.W.3d at 879.

The Court also noted that there are various common law causes of action that already exist which address misconduct by corporate directors and officers: (1) an accounting, (2) breach of fiduciary duty, (3) breach of contract, (4) fraud and constructive fraud, (5) conversion, (6) fraudulent transfer, (7) conspiracy, (8) unjust enrichment, and (9) quantum meruit. Id. at 882.

The Court further recognized that:

           A minority shareholder's loss of employment with a closely held corporation can be particularly harmful because a job and its salary are often the sole means by which shareholders receive a return on their investment in the corporation.

           Ritchie v. Rupe,  443 S.W.3d at 885.

The Court specifically noted that the improper termination of a key employee may be an example of an "extreme circumstance" that "could violate the directors' fiduciary duties to exercise their 'uncorrupted business judgment for the sole benefit of the cororation' ...." Id. at 886. The utility of this breach of fiduciary duty derivative claim is especially important in closely held entities where controlling persons unlawfully implement this squeeze-out tactic for economic leverage in attempting to coerce a buyout of the minority’s shares at an unfair price.

       There may be situations in which, despite the absence of an employment agreement, termination of a key employee is improper, for no legitimate business purpose, intended to benefit the directors or individual shareholders at the expense of the minority shareholder, and harmful to the corporation. Though the ultimate determination will depend on the facts of a given case, such a decision could violate the directors' fiduciary duties to exercise their "uncorrupted business judgment for the sole benefit of the corporation ...." Holloway, 368 S.W.2d at 577; (citation omitted). As we have already discussed, a shareholder may enforce these duties through a derivative action, see TEX. BUS. ORGS. CODE §§ 21.551-563, and the Legislature's special rules would apply if the matter involved a closely held corporation. Id. §§ 21.563(b), 21.751-763. We also note that such actions could potentially be "oppressive" under section 11.404, and thus justify the appointment of a rehabilitative receiver. See TEX. BUS. ORGS. CODE § 11.404(a)(1)(C); (citation omitted)

       Ritchie v. Rupe, 443 S.W.3d at 886. 

It is also important to note that there are two very practical and useful statutory remedies that may be effectively employed in litigation by aggrieved minority shareholders in Texas.  First, “[i]f justice requires, (1) 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 (2) a recovery in a direct or derivative proceeding by a shareholder may be paid directly to the plaintiff….” Tex. Bus. Orgs. Code §21.563(c)(1)(2).  Second, on termination of a derivative proceeding, the court may order the corporation to pay the reasonable expenses of the plaintiff incurred in the proceeding, including attorney’s fees and costs in pursuing an investigation of the matter that was the subject of the proceeding, if the court finds that the proceeding has resulted in a substantial benefit to the corporation. Tex. Bus. Orgs. Code §21.561(a)(1)(2)(b) (1).