The times are changing for minority shareholders of private companies in Texas, but not necessarily for the better. The Texas Supreme Court recently issued three long-awaited rulings in cases presenting claims by minority shareholders in private businesses, and these decisions were not favorable to minority owners. Our next two Blog Posts therefore assess the significant impact of the Court’s recent decisions on the legal rights of owners and investors in Texas private companies. In this first post, we focus on how the Court’s rulings have altered the existing legal landscape. In our second post, we forecast where we expect the battle lines to be drawn in future conflicts between majority and minority owners, and review the legal avenues that are still available to minority investors who contend they are being harmed by the improper actions of majority owners or those in control of the company.
As a preliminary matter, our opinions in these posts flow from our extensive work on behalf of both majority owners and minority investors in Business Divorce matters. We are therefore sensitive to the business and legal concerns on each side of the ownership divide.
The Supreme Court’s three recent decisions are summarized as follows:
- Ritchie v. Rupe, — S.W.3d — , 2014 WL 2788335 (Tex. June 20, 2014). The trial and appellate courts in Rupe held that the company’s majority owners had engaged in shareholder oppression by, among other things, refusing to meet with potential buyers that sought to purchase the minority owner’s stock. In a 6-3 decision, a majority of the Texas Supreme Court reversed the lower court’s buy-out order and made three primary holdings: (1) the only statutory remedy for “oppressive” actions is a rehabilitative receivership and a buy-out remedy was not available under the Texas statute; (2) the definition of “oppressive” actions in the Texas statute includes a failure to satisfy the business judgment rule; and (3) there was no common-law cause of action for shareholder oppression in Texas.
- Cardiac Perfusion Servs., Inc. v. Hughes, — S.W.3d –, 2014 WL 2896002 (Tex. June 27, 2014) (per curiam). Following Rupe, the Texas Supreme Court reversed the lower court decisions that approved a buy-out of the minority owner’s stock after a finding that the majority owner committed multiple acts that constituted shareholder oppression. Although the Cardiac Perfusion Court reversed the decision based on the now defunct buy-out remedy, it also remanded the case (in the interests of justice) to allow the minority shareholder to pursue a derivative suit under Section 21.563(c) of the Texas Business Organizations Code.
- Argo Data Resource Corp. v. Shagrithaya, 380 S.W.3d 249 (Tex. App.—Dallas 2012, pet. denied). Without opinion, the Supreme Court denied the minority shareholder’s petition for review of the decision from the Fifth Court of Appeals in Dallas that: (a) certain actions of the majority shareholder did not constitute shareholder oppression; and (b) the majority shareholder did not breach his fiduciary duty to the corporation.
This Blog post reviews the results and the major impacts of these decisions on Texas law.
The Changing Times – A Quick Summary of Ritchie v. Rupe
The Ritchie v. Rupe appeal had been pending before the Supreme Court for more than three years. We previously discussed Rupe on this Blog in these Posts from September 2013 , February 2014, and April 2014.
In brief summary, Rupe involved a claim by Ms. Rupe, a minority shareholder who had inherited stock in a family business from her deceased husband. When tensions in the family mounted, she attempted to sell her minority stock interest to third parties — but the majority owners refused to meet with prospective buyers. With no public market for her stock, Ms. Rupe filed suit claiming she had been oppressed because the majority owners had responded to her efforts to sell her minority interest by refusing to meet with potential purchasers, refusing to provide her access to company records and offering her a low ball price for her shares. In a trial lasting more than two weeks, the jury concluded the majority owners had engaged in oppressive conduct and the trial court ordered a buyout of Ms. Rupe’s interest for $7.3 million. The Dallas Court of Appeals upheld the oppression finding, but remanded the case for a new trial regarding the buyout price because the jury had been instructed not to consider discounts that often apply to the value of a minority interest in a private company (for lack of marketability and control).
The Impact of Ritchie v. Rupe on Minority Investors or Owners in Texas
A six-member majority of the Texas Supreme Court reversed the lower courts’ decision in Rupe in a 54-page opinion that radically alters the status quo between majority owners and minority investors. The majority opinion is notably hostile to minority shareholders, and it was strongly contested by Justice Eva Guzman in a 30-page dissenting opinion joined by two other dissenting justices. The majority tossed out the jury’s verdict, disregarded the trial court’s judgment and Dallas Court of Appeals’ opinion, and gave short shrift to extensive Texas appellate precedent from the past quarter century. Indeed, the majority opinion left a gap in the law, which the majority opinion acknowledges is harmful to minority shareholders, but which the Court declined to fix.
Impact #1: “Oppressive” Conduct Defined: The Rupe majority examined the definition of “oppressive” conduct used by the Texas Legislature in the receivership statute in former article 7.05 of the Texas Business Corporations Act and section 11.404 of the Texas Business Organization Code. The Texas statute permits the appointment of a receiver if “the actions of the governing persons are illegal, oppressive, or fraudulent.” See Tex. Bus. Org. Code § 11.404(a)(1)(C). The Rupe Court then examined the legislative meaning of “oppressive” and determined conduct is oppressive only when: (1) the majority owner(s) “abuse their authority over the corporation with the intent to harm the interests of one or more of the shareholders;” (2) it is “inconsistent with the honest exercise of business judgment and discretion by the board of directors;” and (3) by doing so “create a serious risk of harm to the corporation.”
The Court in Rupe placed the focus of the oppression analysis on harm to the corporation rather than to the individual shareholder. In doing so, Rupe noted that the minority owner was “undoubtedly . . . in a difficult situation” in seeking to sell her shares, however, it held that no oppression occurred because the majority owners had a valid business reason for refusing to meet with potential buyer and the company was not exposed to a “serious risk of harm.”
As the dissent in Rupe pointed out, however, the majority owner could take certain actions – like paying personal expenses from corporate funds, making a low-ball offer, or refusing to pay dividends — that would obviously harm the minority owner, yet can be justified by majority owners as a benefit to the corporation.
Impact #2: Remedy Limited to Receivership: The majority in Rupe held that the Texas receivership statute “creates a single cause of action with a single remedy” — the appointment of a rehabilitative receiver. In this manner, Rupe foreclosed the availability of a court-ordered buy-out under the statute. Both Rupe and Cardiac Perfusion involved cases where the trial court ordered a buy-out of the minority owner’s stock. This holding has drawn the most fire from the dissent and critics – with justification. The Texas receivership statute permits the appointment of a receiver only if “all other remedies available either at law or equity . . . are determined by the court to be inadequate.” For decades before Rupe, numerous Texas trial and appellate courts construed this language to mean that it should first consider an equitable remedy and then, only if that is inadequate, appoint a receiver.
The three dissenting justices in Rupe criticized the majority’s statutory construction limiting the remedy solely to appoint of a receiver, explaining that it effectively removed the language (“all other remedies available at law or equity”) from the statute. The dissent stressed that the statutory language confirmed that the Legislature “prefers” lesser legal and equitable remedies – but it did not extinguish them entirely. More pointedly, the dissent also said that it was not aware of any state “that has interpreted their shareholder oppression statute as foreclosing all remedies except receivership,” like the majority in Rupe.
Impact #3: No Common-Law Claim: The majority in Rupe determined that it would not create a common-law claim for minority shareholder oppression. The primary reasoning here is that the conduct giving rise to shareholder oppression claims – withholding dividends, termination of employment, or misapplication of corporate funds – can be remedied through alternative means that may overlap with the fiduciary duties owed to the corporation.
Impact #4: Court Leaves Statutory Gap: Surprisingly, the majority in Rupe openly acknowledges that its decision (restricting minority shareholder to the remedy of receivership and barring any common-law claim) “leaves a gap” in the protection that Texas law affords to minority shareholders. These six justices acknowledged there was still a “possibility” that a proper case might justify the Court’s recognition of a common-law claim for shareholder oppression in order to protect minority owners, but gave no specifics on what the facts would warrant relief that this Court would ever sustain.
Impact #5: Shareholders Must Protect Themselves: The majority in Rupe emphasized that minority shareholders should protect themselves before investing (or acquiring the minority stake) by negotiating “shareholder agreements that contain buy-sell, first refusal, or redemption provisions that reflect their mutual expectations and agreements.” The dissent noted it would be “ideal[ ] for minority shareholders to reach such agreements, however, it compared the formation of a business relationship to a marriage where, from a relationship standpoint, the parties enter “optimistically and ill-prepared.” Further, in Rupe, the minority owner inherited her shares from her husband who acquired them in a family-owned business in which the parties saw little need for shareholder agreements.
Impact #6: Overturned Precedent: The Court’s six-person majority cast aside more than 25 years of Texas precedent (from more than 10 different appellate courts), which had consistently upheld a buy-out remedy as valid under the receivership statute. See, e.g., Davis v. Sheerin, 754 S.W.2d 375, 380 (Tex. App.¬—Houston [1st Dist.] 1988, writ denied) (“Texas courts, under their general equity power, may decree a [buyout] in an appropriate case . . . .”); In re White, 429 B.R. 201 (Bankr. S.D. Tex. 2010) (applying Texas law) (concluding equitable relief and buy-out of minority owner’s shares was appropriate). The dissent in Rupe noted at least three additional cases in Texas that approved a trial court’s power to order the equitable remedy of a buy-out.
The second decision impacted by Rupe was the Court’s own decision from 1955 in Patton v. Nicholas, 279 S.W.2d 848 (Tex. 1955) requiring majority owners to declare dividends to the minority owners for up for five years. The majority in Rupe stated that Patton was “not a ‘shareholder oppression’ case,” the dissenting justices noted that the result in Patton (requiring court-ordered dividend) did not depend on a showing of harm to the company (a requirement for a derivative claim) and has been followed by state courts throughout the United States.
Impact #7: Texas Becomes Outlier: The majority opinion in Rupe leaves Texas as an outlier in terms of the legal protection afforded to minority owners. To start, the Supreme Court rejected the “reasonable expectations” standard for oppression even though it is followed by the high courts in Alaska, Iowa, Maryland, Montana, New Jersey, New Mexico, North Carolina, North Dakota, Rhode Island, and Washington. Second, although more than 30 states have statutes addressing shareholder oppression, Texas is now believed to be the only state interpreting its statute as foreclosing all remedies for minority owners except for receivership. By contrast, states like Oregon, North Dakota, Iowa, and South Dakota have all approved an equitable buy-out remedy in the context of oppressive actions in a private company:.
- Landstrom v. Shaver, 561 N.W.2d 1, 8-9 (S.D. 1997) (explaining South Dakota oppression statute gives trial court equitable power that “may include the entry of an order requiring the wrongdoers to buy the stock of the complaining shareholder” and went on to state “[i]t makes little sense to leave the trial courts with two draconian options of helplessly dismissing outright a proven cause of action or ordering the dissolution of corporation . . .”)).
- Balvik v. Sylvester, 411 N.W.2d 383, 389 (N.D. 1987) (“Although [the oppression statute] mentions only dissolution as a remedy for oppressive conduct, we agree with those courts which have interpreted their similar statutory counterparts to allow alternative equitable remedies not specifically stated in the statute.”).
- Sauer v. Moffitt, 363 N.W.2d 269, (Iowa App. 1984) (holding that Iowa oppression statute allows the trial court “to fashion other equitable relief” in approving the partial liquidation and redemption of the minority owner’s shares).
- Delaney v. Georgia-Pacific Corp., 564 P2d 277, 288 (Or. 1977) (“[T]his is an appropriate cause for relief in the form of a requirement that [the majority shareholder] purchase plaintiffs’ stock at a fair price.”).
The Court’s decision in Rupe is being hailed by some as a victory for the rights of business owners and reviled in other circles as bad for both minority investors and businesses because the Court’s decision will make it more difficult to attract private investment capital.
Was the result in Rupe really that bad for minority investors? Yes and no. Minority shareholders are now faced with a much steeper legal landscape in asserting claims. In defining “oppressive” conduct under the statute, the Court reinvigorated the business judgment as an element of the statutory claim and adopted a more onerous standard for minority owners to establish oppressive conduct by majority owners. Even if the standard is met, the trial court is authorized to grant just one remedy (receivership).
Yet, the outcomes in Rupe, Cardiac Perfusion and Argo Data did not extinguish the potential for conflicts between minority investors and majority owners, and these cases did not eliminate all legal claims by oppressed minority shareholders. Indeed, the majority in Rupe expressly noted its rejection of the common-law claim for shareholder oppression was “because of the adequacy of other existing legal protections.” Our next Blog post will evaluate the post-Rupe claims and remedies still available to minority investors in private Texas companies, who contend they are being exploited by overreaching majority owners.