Texas Supreme Court Issues New Opinion Upholding Right of Minority Shareholders to Bring Claims in Derivative Lawsuits

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) 

In Ritchie, the Court eliminated court-ordered buyouts as a remedy for minority share-holders who claim they were oppressed by majority owners.  The Court justified its decision by suggesting that minority shareholders have many other types of claims available, and therefore do not need to rely on a cause of action for oppression.  One of the key claims the Court cited was available was a shareholder derivative lawsuit based on breaches of fiduciary duty that are committed by the company’s officers and directors. 

After Ritchie, we predicted that the battleground would shift in lawsuits between minority and majority owners to shareholder derivative litigation in which minority shareholders would be filing claims alleging fiduciary violations by officers and directors who are also (majority share-holders).   This was a logical prediction based on the Court’s statements in Ritchie suggesting that derivative claims are a powerful weapon available to minority shareholders, particularly in Texas close corporations.  In Sneed, the Court hammered this point home.

  • “It is critical to recognize, and indeed outcome determinative in this case, that article 5.14’s standing, demand and mandatory dismissal requirements do not apply to shareholder derivative lawsuits brought on behalf of closely held corporations.”

Sneed, at 2015 Tex. Lexis 477, page 7.

Sneed arose in an interesting procedural posture.  The plaintiff shareholder held his minority stock interest in a parent company, Texas United, and his claims were against a director and officers and employees of the wholly owned subsidiary, United Salt.  Therefore, one of the key questions presented was whether “double derivative” liability existed, i.e., whether a parent company shareholder has standing to bring shareholder derivative claims against the officers and directors of the subsidiary of the parent company, and if so, what role the business judgment rule would play in derivative litigation of this type.

The Court held that a parent company shareholder does have the standing necessary to bring derivative claims against the subsidiary’s officers and directors.  Specifically, the Court concluded that the Texas legislature’s removal of standing, demand and mandatory dismissal requirements in Article 5.14 of the Texas Business Organizations Code applicable to close corporations meant that the business judgment rule has no application when a parent company shareholder seeks to bring double derivative claims against executives of the subsidiary.

The court stated, “Accordingly, we reaffirm that when a shareholder of a closely held corporation brings derivative proceeding ‘in compliance with our corporation laws and our derivative action rule, . . . he has standing to pursue the corporation’s claim.’” citing to Eye Site, Inc. v. Blackburn, 796 S.W.2d 160, 163 (Tex. 1990). 

Specifically, in regard to double derivative actions, the Court held that the definition of shareholder provided by Article 5.14(A)(2) includes a beneficial owner such as the shareholder of a parent corporation who has beneficial or equitable ownership in a wholly owned subsidiary.  The Court noted that if it were to reach a different holding, the holders of a corporation could decide to create a wholly-owned subsidiary to circumvent the Legislature’s intent to make it easier for shareholders to assert derivative proceedings on behalf of closely held corporations.

The Court also made clear that while the business judgment rule is not a procedural bar that prevents a minority shareholder from having standing, it continues to serve as a defense on the merits to claims by minority shareholders.   “[T]he pronouncement of the business judgment rule in Cates, with respect to breaches of duty goes ‘in reality to the right of the plaintiff to relief rather than to the jurisdiction of the court to afford it.’” citing Dubai Petroleum Co., 12 S.W.3rd at 76-77 (Tex. 2000).

In sum, the Supreme Court cut back sharply on minority shareholder rights in Ritchie, but in Sneed, the Court sent a strong signal that it would not make further inroads (at least for now) on the rights of private company minority shareholders in Texas.  The Court will permit minority shareholders to file derivative lawsuits based on breaches of fiduciary duties.  This includes the right of parent company shareholders to bring claims for fiduciary violations committed by the officers or directors of subsidiary companies.  When the court considers the plaintiff’s derivative claims on the merits, however, the minority shareholders will need to be able to overcome the business judgment rule defense.