Texas Business Dispute Blog

As we discussed in our post on February 5, 2015, the wise investor recognizes the critical importance of a “corporate prenup” and will therefore insist on securing some form of buy-sell agreement before investing in a limited partnership, limited liability company, or closely held corporation.  The buy-sell agreement is a contractual exit strategy that benefits both majority and minority owners.  It provides majority owners with a contractual means to buyout the interests of minority owners and provides minority owners with the ability to cash-out of their investment. The importance of securing a buy-sell agreement became even more essential for minority owners last year, however, when the Texas Supreme Court decided in Ritchie v. Rupe to suddenly eliminate the right of minority shareholders to secure a court-ordered buyout as a remedy for oppression by the majority owners.

Whether you are a company founder, a corporate officer or director, general or limited partner or simply an investor, if you are involved in a private company, it pays to understand the basics of fiduciary duties. The phrase “fiduciary duty” may conjure up images of a dusty, wood-paneled trust and estates department, but it is a critical element in the healthy functioning of a private company.  Reduced to its essence, fiduciary duty reflects the commitment of anyone managing or controlling a business to do a good, honest job.  The legal elements of fiduciary duties take some explaining, but much of it is common sense.

Who pays the legal fees of private company shareholders when they battle each other in court, often in a fight for control of the business?  This is a key question, because the high cost of legal fees is critical, particularly in litigation among shareholders in private, closely-held Texas companies.  All shareholders are therefore striving for ways to pay for or recover their legal fees when they litigate against the other shareholders of the company.

Generally, the majority owners of the company control the business, which provides them with control over the corporate purse strings and the ability to pay their legal fees in any disputes they have with minority shareholders. This Post looks at the question of whether the exercise of control by majority owners in directing the company to pay their legal fees will hold up when it is challenged in court by minority shareholders. The short answer is that there is good news and bad news for both majority and minority shareholders under Texas law regarding the payment of legal fees in these shareholder conflicts..

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Summer must be here. In June 2014, the Texas Supreme Court issued a long-awaited decision impacting the rights of private company shareholders in Texas. See Ritchie v. Rupe. As summer begins this year, the Supreme Court has again issued a significant opinion regarding the rights held by minority shareholders in private companies. In its latest ruling, the Court tells the business and legal community: “We meant what we said when we said it in Ritchie last year.” See Sneed v. Webre, (No. 12-0045, Tex. Sup. Ct., May 29, 2015)

Shareholder deadlocks in private companies often result in protracted legal fights to break the impasse that are expensive and also highly disruptive to the business.  In some cases, these business conflicts can even lead to the forced dissolution of the company.  Just as importantly, these ownership battles are destructive to personal relationships because closely held businesses are frequently owned by family members or longtime friends.

Private companies are prone to shareholder deadlocks when there is no single owner (or no ownership group) who owns a large enough stake in the company to exercise control over the company’s business operations.  Shareholder deadlocks are readily avoidable, however, through advance planning.  Ben Franklin’s famous quote was never more apt than in the private company context:  “An ounce of prevention is worth a pound of cure.”

“From a relational standpoint, people enter closely-held businesses in the same manner as they enter marriage: optimistically and ill-prepared.”

Charles W. Murdock, The Evolution of Effective Remedies for Minority Shareholders and Its Impact Upon Valuation of Minority Shares, 65 NOTRE DAME L.REV. 425, 425 (1990).

A beautiful wedding ceremony offers no guaranty the couple will not ultimately end up in divorce.  Similarly, a great start to a new company does not mean the business owners won’t become deadlocked in the future over how the business should be run.  Many relationships become strained when family and friends go into business together and face the inevitable stress that confronts new and growing companies.  These conflicts can lead to an impasse when the business is owned on a 50-50 basis or when groups of family members or friends hold an equal ownership interest that precludes either side from exercising majority control.  This impasse is likely to have a serious, negative impact on the company’s operations. 

When the Texas Supreme Court decided last year (in a 6-3 decision) to jettison decades of appellate case law and deprive minority shareholders of the right to bring claims for shareholder oppression against majority owners, the case generated extensive comment, including in our previous Blog Posts.  See Ritchie v. Rupe, No. 11-0447, 2014 WL 2788335, at *10 (Tex. June 20, 2014); read more.  In reaching its decision in Ritchie, the Court reinterpreted a long-existing Texas statute in a novel way adverse to the interests of minority shareholders.   The far-reaching impact of the Ritchie decision continues to generate comment and also pointed criticism, most notably from the Yale Law Journal.

A married couple may enter into a new business venture as optimistically as they began their marriage.  Just as they walked to the altar without a marital prenup, however, they often fail to enter into agreements to provide for what happens to the company if they later divorce.  The lack of any agreement will create confusion and lead to disputes over who owns and controls the business once a divorce is filed.  These disputes can destroy the operations of the business and greatly diminish its value.

Business owners often desire to incentivize key employees by providing them with an equity stake in the business.  These majority owners believe that issuing equity ownership to key employees will instil in them pride of ownership in the firm, create a stronger focus on business goals, and enable the company to achieve higher levels of profitability.  This strategy for enhancing profits, however, is not without threats to the company’s future corporate governance and litigation risk.

Private company investments can produce hefty financial returns, which is why they are so attractive.  A private company investment can also be quite risky, however, particularly if, as discussed in our recent post, the investor failed to obtain any type of  buy-sell agreement (“corporate pre-nup”) at the time the investment was made and has no contractual exit right.  Given the substantial level of risk involved in making a private company investment, it is fortunate that a wealth of good information is available for investors in private companies – for free – on the Internet.  This post reviews five different websites that provide especially helpful information on a variety of financial and business topics for private company owners and investors to consider before and after making their investment in the company.

After the Texas Supreme Court issued a precedent setting series of decisions last June regarding the rights of minority shareholders in private Texas companies, the Court is again set to take up a case involving the rights of private company investors.  The Court’s decision will further shape the legal contours of minority shareholder rights in Texas.  See Webre v. Sneed, 358 S.W.3d 322 (Tex.App.—Houston [1st Dist.], rev. granted March 21, 2014).