Does a director of a Texas corporation owe informal fiduciary duties to the corporation’s shareholders? The Texas Supreme Court speaks.
Does a director of a Texas for-profit corporation owe informal fiduciary duties to the corporation’s shareholders?
On June 17, 2022, the Texas Supreme Court issued the monumental corporate fiduciary duty opinion: In re Estate of Poe, — S.W.3d —, 2022 WL — (Tex. June 17, 2022) [20-0178] (“Estate of Poe”).
Issue. This blog primarily addresses this issue from Estate of Poe: Under Texas law, does a director of a for-profit corporation owe informal fiduciary duties to a shareholder beyond those that exist by statute or arise from the corporation’s formation documents or other agreement?
Summary of Facts. The case stemmed from a struggle for control of a family-owned enterprise following the death of the patriarch, Dick Poe. Dick was the sole director of Poe Management, Inc. (PMI). His son, Richard, was the sole shareholder of PMI. Richard approved of Dick’s control and sole-directorship. Just before Dick died, he—unbeknownst to Richard—authorized PMI to issue 1,100 new shares, which Dick bought for $3.2 million. This made him the majority owner of PMI. PMI, in turn, was the general partner of several Poe-owned businesses. Days later, Dick died. As a result of his issuance of additional shares in PMI, control of the family enterprise was, upon his death, vested in the two co-executors of Dick’s estate rather than Richard, who was PMI’s only other shareholder.
Through direct and derivative claims, Richard challenged the share issuance as a breach of Dick’s fiduciary duty. Richard asserted that the share issuance was invalid because: (1) it was a self-dealing transaction by Dick, a PMI director, that violated Dick’s fiduciary duties to PMI; (2) it violated a fiduciary duty Dick owed to Richard, which arose by virtue of a “confidential relationship” between them; and (3) Dick lacked the mental competence to issue and purchase the PMI shares. Richard sued Dick’s estate (through the executors), Dick’s attorneys for allegedly breaching fiduciary duties to PMI, and the independent executors in their individual capacities (collectively, “Defendants”).
The Defendants asserted that all the relief Richard sought was barred because the share issuance was, allegedly, fair to PMI and deemed valid and enforceable by the statutory safe harbor contained in Tex. Bus. Org. Code § 21.418 (“Section 21.418”).
Trial and Jury Charge. The probate court bifurcated the trial into various phases. The first phase included the issues of (1) whether the share issuance breached an informal fiduciary duty Dick owed to Richard and (2) whether the share issuance was valid under Section 21.418. The parties disagreed on how to present these questions and the statutory safe harbor to the jury, and the opinion issued by the supreme court includes the four questions that were ultimately submitted to the jury. See Estate of Poe at pg. 7-9. The jury found that Dick owed and breached an informal fiduciary duty to Richard, and the jury failed to find that the share issuance was valid and enforceable in response to the question designed to address Section 21.418.
Court of Appeals. Once all phases of the trial were concluded, both sides appealed. The court of appeals found that the jury’s response to the question designed to address Section 21.418 was sufficient to uphold the declaration that the share issuance was invalid, and thus, the court did not address the informal fiduciary relationship question. See Estate of Poe at pg. 10.
Texas Supreme Court. The Texas Supreme Court was petitioned to review primarily, whether there was error in submitting the four separate but related questions regarding the fiduciary duty claims. The Court first addressed Texas law and the trial court’s duty and process for preparing and submitting questions to a jury on contested issues of fact. Then, the Court provided this strong summation of Texas law and the fiduciary duties owed by corporate officers and directors to the corporation and individual shareholders:
Under Texas law, the business and affairs of a corporation are managed through a board of directors. Tex. Bus. Org. Code § 21.401(a). Directors owe a fiduciary duty to their corporations in the actions they take as directors. A director’s fiduciary status creates three broad duties: duties of obedience, loyalty, and due care. These fiduciary duties run to the corporation, not to individual shareholders or even to a majority of shareholders. . . . [A] director’s fiduciary duty includes a duty to dedicate “uncorrupted business judgment for the sole benefit of the corporation.”
Our Court has recognized that an “informal” fiduciary duty may arise from “a moral, social, domestic or purely personal relationship of trust and confidence.” We have described the types of confidential relationships that can give rise to a fiduciary duty imprecisely as those “in which influence has been acquired and abused, in which confidence has been reposed and betrayed.” But we have always made clear that “we do not create such a relationship lightly.” And we have never recognized an informal fiduciary duty within the context of the operation or management of a corporation, in which the corporation’s directors have clearly defined duties to exercise their business judgment for the sole benefit of the corporation. . . .
The question in Ritchie [v. Rupe, 443 S.W.3d 856 (Tex. 2014)] was whether a minority shareholder in a closely held corporation could assert a statutory or common-law cause of action against the corporation’s directors for oppressing the minority shareholder’s rights. We concluded that Texas law does not recognize such a claim. In particular, we held that, “[a]bsent a contractual or other legal obligation, the officer or director has no duty to conduct the corporation’s business in a manner that suits an individual shareholder’s interests when those interests are not aligned with the interests of the corporation and the corporation’s shareholders collectively.” We instead noted that disputes in closely held corporations may be prevented and resolved through shareholders’ agreements and that the Legislature granted corporate founders and owners “broad freedom to dictate for themselves the rights, duties, and procedures that govern their relationship with each other and with the corporation.” And we adhered to our longstanding rule that directors’ fiduciary duties to the corporation include “the dedication of [their] uncorrupted business judgment for the sole benefit of the corporation.” . . .
[In Ritchie,] we did not recognize any such [informal fiduciary] duty existed under the facts of that case. Nor did we suggest that a corporation’s officers or directors could owe a fiduciary duty to an individual shareholder with respect to their operation or management of the corporation in conflict with the duty owed to the corporation. . . . We have never held, in Ritchie or elsewhere, that a corporation’s director, while owing formal fiduciary duties to the corporation requiring him to manage the corporation’s affairs for the sole benefit of the corporation, simultaneously owes an informal fiduciary duty to a shareholder to operate the corporation for that shareholder’s benefit or consistent with the shareholder’s best interest. On the contrary, Ritchie suggests those two duties are incompatible. We reaffirm this principle today and hold that a director cannot simultaneously owe these two potentially conflicting duties. By electing to form and own PMI as a corporation, the parties disclaimed the existence of duties regarding the management of the corporation’s affairs beyond those that exist by statute or arise from the corporation’s formation documents or other agreement.
Accordingly, we conclude the probate court erred in submitting Question 1 [about an informal fiduciary relationship] because, as a matter of law, a corporation’s director cannot owe an informal duty to operate or manage the corporation in the best interest of or for the benefit of an individual shareholder. A director’s fiduciary duty in the management of a corporation is solely for the benefit of the corporation.
Estate of Poe at pg. 15-19 (citations omitted throughout) (emphasis added).
Thus, the Texas Supreme Court found that the probate court erred in submitting the question of whether there was an informal fiduciary duty between Dick, as the sole director of PMI, and Richard, PMI’s sole other shareholder.
The Safe Harbor of Section 21.418(b) of the Texas Business Organizations Code.
Tex. Bus. Org. Code § 21.418(b) thus sets forth three distinct conditions under which a self-dealing transaction within a Texas corporation is deemed “valid and enforceable, and . . . not void or voidable”:
- the transaction was approved by a majority of disinterested directors with knowledge of material facts;
- the transaction was approved by a vote of shareholders with knowledge of material facts; or
- the transaction was “fair to the corporation when the contract or transaction [was] authorized, approved, or ratified.”
Id. at § 21.418(b)(1)-(2).
The burden of proving that a transaction falls within this safe harbor rests on the interested director. Estate of Poe at pg. 22. Section 21.418(e) states:
If at least one of the conditions of Subsection (b) is satisfied, neither the corporation nor any of the corporation’s shareholders will have a cause of action against [the interested director or officer] for breach of duty with respect to the making, authorization, or performance of the contract or transaction because the person had the relationship or interest [that makes him an interested director or officer] . . . .
In Estate of Poe, only the third condition was applicable, based on the evidence presented, because Richard was unaware of Dick’s issuance of shares. Thus, the probate court erred in presenting the other two conditions of the Section 21.418 safe harbor to the jury.
Ultimately, the Texas Supreme Court found that the probate court’s submission of the jury questions in issue was harmful and probably caused the rendition of an improper judgment. Therefore, the case was remanded to the probate court for a new trial. Estate of Poe at pg. 25-27.
Insights. The Texas Supreme Court in Estate of Poe presents another firm and unequivocal stance on the issue of purported informal fiduciary duties owed by a corporate director to shareholders: “A corporation’s director cannot owe an informal duty to operate or manage the corporation in the best interest of or for the benefit of an individual shareholder. A director’s fiduciary duty in the management of a corporation is solely for the benefit of the corporation.” Absent an express contract or legal obligation otherwise, no informal fiduciary duty exists between a director of a corporation and its shareholders.