Originally published by Winstead.
It’s my party, and I’ll cry if I want to
Cry if I want to, cry if I want to
You would cry too if it happened to you.
—Its My Party, by Lesley Gore
Almost five years have passed since the Texas Supreme issued its decision in Ritchie v. Rupe[1] in 2014 abolishing shareholder oppression as a claim under common law by minority shareholders in private Texas companies. Specifically, in Ritchie, the Supreme Court eliminated a court-ordered buyout as a remedy for minority investors complaining of oppressive conduct by the company’s majority owners. The legal landscape remains bleak for minority shareholders, and when the five year anniversary of Ritchie arrives in June, minority shareholders still have no legal remedy to secure a buyout of their ownership interest if they failed to obtain a buy-sell agreement or other contract exit right at the time of their investment in the company.
In this blog post, we will review efforts made to address the problems that were created by the Supreme Court’s holding in Ritchie, both legislatively and in the courts, consider how the predictions the Court made in Ritchie have played out, and discuss the state of the current legal battlefield between minority shareholders and majority owners in Texas private companies.
No Legislative Fix for Ritchie Has Been Adopted or is Pending
In the aftermath of the Ritchie decision, the Texas legislature took a run at creating a statutory fix to address the lack of a legal remedy for oppressed minority shareholders. In 2015, the year after Ritchie was issued, Rep. Ron Simmons, a second-term Republican from Denton County, introduced Bill 3168 in the Business and Industry Committee of the Texas House. This proposed Bill would have applied solely to closely-held entities rather than to all private Texas companies, and the provisions of Bill 3168 were broader than the pre-Ritchie state of the law.
More specifically, as originally proposed, Bill 3168 would have granted broad statutory powers to Texas trial courts, including the right to appoint a “fiscal agent” to report periodically to the court on the operations of the business. This new type of statutory agent is different than a receiver and would likely be more akin to a monitor. In addition, the Bill intended to provide the oppressed minority shareholder with more than a buyout right as it authorized shareholders to pursue a claim for a dividend to share in the retained earnings stockpiled by the company, as well as the right to recover damages from the majority owner and/or board members who engaged in oppressive conduct that was shown to be harmful to the minority shareholder.
As with many potential legislative initiatives, however, Bill 3168 was never reported out of Committee, it was never voted on by the full Texas legislature and it does not appear to have been resubmitted in subsequent legislative sessions after 2015. In short, the legislative fix that was proposed for Ritchie proved to have been fairly short-lived, and it has not resurfaced. The Supreme Court’s decisive rulings in Ritchie therefore seem here to stay.
Breach of Fiduciary Duty Does Not Authorize a Buy-Out Remedy
The Supreme Court did leave open the possibility in Ritchie that a breach of fiduciary duty by the company’s majority owners could authorize a buyout of the minority interest as a remedy. At the trial of the Ritchie case, the jury found that the company’s majority owners had breached informal fiduciary duties they owed to her, but the Supreme Court remanded all issues related to fiduciary breach to the Dallas Court of Appeals for further consideration. Therefore, on remand, it seemed that the appellate court would decide whether the majority owners’ breach of their fiduciary duties to the minority shareholder as found by the jury would give rise to a buy-out remedy requiring the majority owners to purchase the shareholder’s interest in the company Unfortunately, the Court of Appeals reconsidered the jury’s finding of fiduciary breach based on the existence of an informal fiduciary duty, and the Court decided that no fiduciary duty existed. Ritchie v. Rupe, No. 05-08-00615-CV (Jan. 12, 2016) (mem. op.).
Thus, the Court of Appeals was able to avoid deciding whether a fiduciary breach claim would give rise to a buy-out remedy by finding that no fiduciary breach had taken place, because no informal fiduciary duty ever arose as a matter of law. And in the five years since Ritchie was decided, no appellate court decision in Texas has held that a breach of fiduciary duty committed by the controlling/majority shareholders, directors or managers of the company authorizes the court to order a buyout of the minority owner’s shares or minority LLC interest in the company. Stated another way, the door that the Ritchie court left open—a fiduciary breach by majority owners authorizing court-ordered buyout of minority interest as a remedy—remains open. But, five years after the Ritchie decision, it seems even less likely that a trial or appellate court will seize the opportunity to impose a buy-out remedy for the first time in response to a breach of fiduciary duty by the controlling members of a private company.
No Receiverships Granted Based on Oppression Since Ritchie
At least in theory, the Supreme Court in Ritchie provided for minority shareholders to have one remaining remedy upon establishing that the company’s control persons had engaged in oppressive conduct. This surviving remedy was the appointment of a “rehabilitative receiver,” which the Court decided was the exclusive remedy the Texas legislature intended to provide to minority shareholders based on the statutory wording regarding oppression. See Section 11.402 of the Texas Business Organizations Code. Of note, the 6-3 decision by the Court in Ritchie rejected 25 years of previous jurisprudence by numerous Texas appellate courts construing this provision, which had universally concluded that it authorized trial courts to award a buyout and other lesser remedies rather than appointing a receiver as the sole remedy for oppression.
As the Court might have anticipated, the receivership remedy for oppression has proven to be illusory or even non-existent. In the five years since Ritchie was decided, we were not able to find a single reported decision in which a receiver was appointed at the request of a minority shareholder based on a finding of shareholder oppression. The only exception may be one post-Ritchie case in which a receiver was appointed by the state court, but the case a host of other claims, including fraud and misappropriation of trade secrets. The court cited to Ritchie to hold that because the Supreme Court determined that the appointment of a receiver was the exclusive remedy for oppression, the shareholder was not entitled to recover any compensatory damages based on this claim. In re Mandel, 578 Fed. App’x 376 (5th Cir. 2014).
In sum, the court appointment of a receiver to preside over a profitable company based on a finding of shareholder oppression by the majority owners seems unlikely, if not a legal unicorn. The net effect is that the Court’s Ritchie decision turned the oppression provision into a toothless legal statute that leaves minority shareholders with no clear, viable remedy to address oppressive conduct by the company’s majority owners. The Court thus allowed a wrong to be committed by majority owners—shareholder oppression—with no true remedy to address the harm.
Derivative Claims Remain Chief Weapon Wielded by Minority Shareholders
Based on the foregoing discussion, the Supreme Court’s Ritchie decision has to be acknowledged as a significant setback for minority shareholders who have oppression claims against the members of the company’s control group. As one saving grace, however, the Court correctly pointed to the Texas derivative statutes in its opinion, which provide shareholders with notable advantages that do not exist in other states. Shareholders in these other states have to run the gauntlet of a bevy of procedural impediments that make it difficult for them to both file and pursue derivative lawsuits. By contrast in Texas, the Business Organizations Code (TBOC) provides a straightforward path for minority investors in closely held corporations and limited liability companies to file claims on a derivative basis against the company’s officers, directors and managers who abuse their authority. See TEX. BUS. ORG. CODE §§ 21.563, 101.463. The term closely held is defined by the statute as a company with fewer than 35 shareholders or members and that is not listed on an exchange or quoted in an over-the-counter market. Id.
Some of these important procedural advantages for minority shareholders in derivative lawsuits filed under Section 21.563, of the TBOC, are summarized below:
- The shareholder is not required to make written demand on the company before filing suit. Under most derivative statutes, a written demand to the company is an absolute condition to filing suit and the company first has the right to respond;
- The shareholder in making the demand for action is required to establish that he/she will fairly represent the interests of the company. This “proper plaintiff” requirement does not exist or apply in the TBOC for closely held companies;
- Any recovery obtained in a typical derivative case is paid to the company, but under the TBOC, the trial court is authorized to award the amount of any recovery that is obtained directly to the plaintiff shareholder “where justice so requires,” and
- Finally, minority shareholders can recover their legal fees under TBOC 21.561(b) in the derivative proceeding if the court finds that the case “has resulted in a substantial benefit to the corporation.
After Ritchie, and based on the TBOC provisions reviewed above, derivative claims are the most effective legal weapon that remains available to minority shareholders who contend the company’s majority owners breached their fiduciary duties. The key distinction here, however, is that the shareholder oppression claim permitted shareholders to bring a direct (non-derivative) claim against the company’s majority owners based on harm that their oppressive conduct had caused the shareholders to suffer. When shareholders bring a claim for breach of fiduciary duty, however, they must present evidence of harm not to themselves, but to the company, because the company’s officers, directors and managers owe these fiduciary duties to the company and not to the shareholders or members.
This distinction is, perhaps, most important in considering dividends or distributions that are withheld by the company. Under the oppression doctrine, a shareholder could contend that the withholding of dividends/distributions by the company constituted oppressive conduct by the control group and unfairly deprived the shareholder of profits that he/she was entitled to receive. By contrast, a shareholder may well find it difficult to show that the company’s decision to retain earnings caused any harm to the business, and therefore, the company’s retention of earnings at the direction of its officers, directors and/or managers cannot be regarded as a breach of any of their fiduciary duties. Thus, the fiduciary claim is powerful, but it may apply to a more narrow scope of conduct by the controlling/managing members of the company.
Conclusion
The disappointment that minority shareholders experienced in June 2014 at the time the Ritchie decision was issued by the Supreme Court has not abated over time. The Court deprived minority shareholders of an important remedy to deal with oppressive conduct by the company’s majority owners—a court-ordered buyout—and did not replace it with any comparable tool. No legislative fix has been adopted, no new judicial remedy has been created and the potential for the appointment of a receiver under the TBOC has been largely, if not entirely, illusory.
While the Ritchie decision provides minority shareholders with no cause for celebration then or now, the favorable provisions of the TBOC that apply to derivative lawsuits by minority owners in closely held companies, have resulted in these lawsuits increasing during the past five years. This is a different claim than minority shareholder oppression, and it requires a showing of harm suffered by the company rather than harm to the individual shareholders. Given the rise in the filing of fiduciary/derivative claims since Ritchie was issued, however, we do expect to see favorable law develop for the benefit of minority shareholders in pursuing these claims.
[1] Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014).
Curated by Texas Bar Today. Follow us on Twitter @texasbartoday.
from Texas Bar Today http://bit.ly/2UOXVMO
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