Texas Business Dispute Blog

Tuesday, January 19, 2016

The Danger From Within: Texas Appellate Court Sets Higher Bar For Companies to Succeed on Claims Made Against Disloyal Directors

By: Ladd Hirsch (Dallas)

It is no longer news to report that Texas has become a hostile forum for corporate (and other) plaintiffs who recover large jury awards.  For more than a decade, the press has featured numerous stories on Texas appellate courts (including the Supreme Court) overturning large jury verdicts after jury trials.  One of the most recent, notable examples is a decision by the appellate court in San Antonio, which disregarded detailed jury findings in reversing a verdict awarding substantial damages to a corporate plaintiff harmed by two of its disloyal, outside directors.  See Huff Energy Fund, LP, et. Al. v. Longview Energy Company, No. 04-12-003630-CV (Tex. App. – San Antonio, November 25, 2015).

The Longview Case

In Longview, the jury concluded that two outside directors had breached their fiduciary duty of loyalty by usurping a corporate opportunity to develop oil and gas properties in the Eagle Ford Shale and awarded the company $95 million in damages, along with a constructive trust in more than 40,000 acres of leaseholds.  On appeal, a split majority of seven appellate justices sitting en banc rejected the jury verdict and issued a ruling weakening the fiduciary duty of loyalty that directors owe to their companies.  The court applied Delaware law Longview is a Delaware company, but gave no indication that applying Texas law would have led to a different result.  The plurality opinion held that not a scintilla of evidence had been presented at trial to support the jury’s conclusion regarding the director’s breach of loyalty.

The reversal of the jury’s verdict by the appellate court resulted in a 38-page dissenting opinion (joined by one justice and a concurrence).  The dissent accused the majority of adopting the wrong standard of review and misapplying Delaware law regarding the corporate opportunity doctrine.   In addition, the dissent concluded that the majority opinion had disregarded evidence favorable to the plaintiff related to the secretive and deceptive conduct of its outside directors.   Finally, the dissent took the majority to task for disregarding “fair notice” pleading standards that have existed in Texas for 170 years to suddenly impose heightened rules for pleading claims in lawsuits.  This issue concerned the claim that Longview (the plaintiff) had allegedly not stated clearly enough that it was bringing a claim for breach of fiduciary duty based on competition.

The investment opportunities in the Eagle Ford Shale were at the heart of the dispute, but the plurality opinion concluded that the outside directors had not breached their fiduciary duties usurping this opportunity.  Specifically, the court held that a corporate opportunity had not been established at trial, because “an opportunity must be something more than a desire to invest—especially when the investment is in an area as large as the Eagle Ford Shale.”   Id. at p. 12.  The court stated: “To conclude Longview had an expectancy in a loosely-defined ‘strategy’ would effectively preclude Longview’s directors from investing in ‘any and every business opportunity that may’ arise in the Eagle Ford shale.”

Finally, the court held that the outside directors’ purchase of property rights in the Eagle Ford Shale had not hindered or defeated Longview’s business plans.  The court stated: “Because Longview’s own description of its opportunity is that it was a strategy or interest in investing ‘in a resource play,’ we do not believe Riley-Huff Energy’s acquisition of acreage in the Eagle Ford hindered or defeated Longview’s plan to also acquire acreage in the Eagle Ford.  This is particularly true given the fact that the availability of Eagle Ford leases spread over millions of acres and thousands of miles, and several oil and gas companies other than Longview and Riley—Huff Energy were in competition for leases in the Eagle Ford.”  

Avoiding Theft of Valuable Corporate Opportunities

Longview will be filing a petition for writ with the Texas Supreme Court.  Even before the Court decides whether to grant the petition, however, business owners will want to consider steps to avoid the loss of their company’s corporate opportunities taken by fiduciary insiders -- its officers, directors and managers.  The following are some specific ways that business owners can take action to protect their companies from “the danger within.”

  1. The Loyalty Oath = Written Assurances

    The company’s bylaws or its Company Agreement (for an LLC) should contain clear, written assurances signed by all fiduciaries in which they agree that: (i) they will not compete against the company while they are employed by or serve as directors or managers and (ii) they will not take, use, sell or assign any corporate opportunities of the company for their personal benefit during their employment and/or business relationship, as well as after they depart.  These written assurances should be drafted with care to describe the company’s line of business and the specific types of business opportunities that belong solely to the company and are off-limits to its fiduciaries.   If officers, directors and/or managers decline to accept this type of loyalty oath, they are raising a red flag that serious problems lie ahead. 

     

  2. Signed, Confidentiality Agreements

    All fiduciaries should be required to sign confidentiality agreements in which they agree not to take, use, sell or assign any of the company’s trade secrets, proprietary or confidential information for their own personal benefit.  These restrictions should apply while the officers are employed or the directors serve on the board of the company, as well as after they depart. The confidentiality agreement should also provide a description of the type of specific trade secrets, proprietary or confidential information that belong to the company. 

     

  3. Agreement to Be Subject to Injunctive Relief

    The company’s bylaws or its LLC Company Agreement should also reflect that all of its fiduciaries agree that they will be subject to both temporary and permanent injunctive relief in the following circumstances:   (i) they attempt to compete against the company in its line of business while employed or while they serve as a director or manager of the company, (ii) if they seek to take, use, sell or assign any of the company’s corporate opportunities for their personal benefit during their employment and after their business relationship ends, and (iii) if they use, misuse or threaten to take for themselves or otherwise misuse any of the company’s trade secrets, confidential or proprietary information.    

     

  4. Identify Corporate Opportunities in Writing

When the company’s board of directors or its managers are considering specific business opportunities at or in preparation for business meetings, the documents that describe and reflect these opportunities should be labelled as such.  In other words, the documents that disclose the company’s corporate opportunities should contain a legend stating as follows: 

This document reflects specific corporate opportunities that the Company is considering.  This information is highly confidential and proprietary to the Company.  Therefore, it should not be discussed with anyone outside the Company in the absence of specific, written authorization from the Company.  Further, the information set forth in this document is subject to the specific provisions of the bylaws (or LLC Agreement), which preclude all company officers, managers and directors from taking, using, selling or assigning any of the company’s corporate opportunities for their personal benefit.      

Conclusion

The legal landscape in Texas now makes it risky for business owners to assume that a legal remedy will be available when the company’s officers, managers and directors choose to act in a disloyal manner.  As is so often the case, the best protection and safest course for the company is to “get it in writing.”   The company should require all of its fiduciaries (officers, key employees, managers and directors) to provide written loyalty assurances in which they commit not to misuse or exploit any of the company’s valuable opportunities for themselves. 


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