The seven-year anniversary of the Texas Supreme Court’s decision in Ritchie v. Rupee has come and gone, and the court’s holding from 2014 remains the law: Minority shareholders in Texas private companies do not have a cause of action to pursue claims for oppressive conduct against the company’s majority shareholders. Although a bill surfaced in the Texas Legislature a couple of years after Ritchie that would have created this cause of action, it went nowhere, which leaves Texas among a minority of states that have no claim for minority shareholder oppression. As this post points out, however, minority shareholders do have several other claims available to assert against the company’s majority owners, which provide them with real clout when disputes arise with their business partners.
The Arrows that Remain in the Quiver
This post does not review each of these causes of action in depth, but the array of claims that remain available to minority shareholders include the following causes of action.
Breach of Fiduciary Duty
Majority owners who hold control positions in the company, e.g., officers, directors and managers, owe fiduciary duties to the company, including the duty of loyalty. Therefore, if control persons engage in self-dealing or otherwise abuse their authority in managing the company, they will be committing breaches of their fiduciary duties and they are liable for the harm they cause the business to sustain.
The minority shareholder will need to bring these fiduciary duty claims on a derivative basis on the company’s behalf, which may include claims for both damages and injunctive relief. One critical note is that the Texas derivative statutes include a number of helpful features for minority shareholders in closely held companies that do not exist in other states. In most other states, minority shareholders have to comply with numerous procedural hurdles that make it difficult for them to prosecute derivative lawsuits. Under the Business Organizations Code in Texas (TBOC), however, minority owners in closely held corporations and limited liability companies can more simply and directly file claims for the company on a derivative basis against the company’s officers, directors and managers who abuse their authority (see TBOC §§ 21.563, 101.463). Under the statute, closely held means a company with fewer than 35 shareholders or members that is not listed on an exchange or quoted in an over-the-counter market.
Some of the important procedural advantages that benefit minority shareholders in filing derivative actions under Section 21.563 of the TBOC are summarized below:
- Unlike in normal derivative practice, shareholders under this statute do not have to make written demands on the company before they file suit.
- There is no “proper plaintiff’ requirement, i.e., the minority shareholder does not have to show that he/she will fairly represent the company’s interests;
- In typical derivative practice, any recovery obtained in the lawsuit goes to the company, but under the statute as applied to closely held companies, the trial court may award any recovery directly to the minority shareholder(s) who filed suit “where justice so requires”; and
- Finally, there is a bounty hunter aspect to the litigation, and minority shareholders are permitted to recover their legal fees if the court concludes that the lawsuit “has resulted in a substantial benefit to the corporation.”
Breach of Contract
Certain types of conduct may give rise to multiple claims, and conduct by the control group that constitutes a breach of fiduciary duty may also give rise to a breach of contract claim. The minority shareholder and his/her counsel should therefore closely review the corporation’s bylaws or the terms of the LLC operating agreement to determine if the officers, managers or directors abided by terms of these governance documents. When managers disregard the terms of the company’s own documents, this conduct gives rise to strong claims for breach of contract and the potential for recovery of damages and legal fees. Not all breaches are of equal import, but minority shareholders will want to consider whether the control persons complied with all of the following provisions that may be included in the company’s governance documents:
- Timely issuance of annual and quarterly financial reports and annual audits;
- Issuance of all required distributions and related K-1 reporting;
- Appointment and voting on new directors, officers, and/or managers as required;
- Documenting the admission of new shareholders or members and updating the company’s documents to properly reflect all record owners and interests held; and
- Scheduling and holding board meetings, shareholder meetings and providing minutes of these meetings to all interested parties.
Appointment of a Receiver to Rehabilitate or Dissolve the Company
While this relief is rarely granted, minority shareholders do have the right under the statute to request a district court to appoint a receiver when the majority owners engage in conduct that is ‘illegal, oppressive or fraudulent” (see TBOC § 11.404). This is known as a rehabilitative receivership, and the receiver is appointed to specifically address and rehabilitate the company by addressing the improper conduct. This is a high standard for a shareholder to meet, and the legal standard is discussed at length in the Ritchie case, but courts have been reluctant to impose this type of a receivership.
If the minority shareholder is able to secure the appointment of a receiver as set forth above, and the receivership remains pending a year later without the resolution of the conditions that required the receiver to be appointed, the shareholder can seek to have the company dissolved at that point (see TBOC § 11.405).
Receivership is viewed as a draconian remedy, and it should therefore be seen as available only in cases where the conduct of majority owners toward minority shareholders has been of an extreme or an unconscionable nature.
Another claim that should be considered by minority shareholders is a claim for common law fraud or fraud arising under the Texas Securities Act and related regulations. If the minority shareholder’s investment was induced through fraudulent statements made by majority owners, the shareholder may have a claim for fraudulent inducement that would permit him to recover his or her investment, as well as other damages and legal fees. In this regard, the investigation of potential claims should focus on specific/actionable representations made by majority owners that clearly presented false information at the time they were made rather than merely statements of future prediction or general assurances (known as “puffing”) that did not misrepresent any specific facts about the company, its financial information or status.
While minority shareholders in private companies in Texas cannot bring claims against the majority owners based on oppressive conduct, the majority owners who manage and control the business are by no means immune from lawsuits based on their misconduct. When majority owners manage their companies, they owe fiduciary duties to the business, including the duty of loyalty, and they are therefore subject to derivative lawsuits filed by minority shareholders based on self-dealing or any improper abuses of power that harm the company. In addition, majority owners have to adhere to the requirements of the company’s governance documents, and they cannot misrepresent facts to the shareholders, or they will create liability for their own false and fraudulent conduct. A fair summary here by virtue of their equity holdings, majority owners call the shots at their company, but they still have to follow the rules of the road if they want to avoid becoming the target of lawsuits based on abuse of power.