Minority Shareholder Litigation
Minority shareholders are often in a weak position relative to shareholders who wield control, particularly in the case of “close corporations,” as there is no immediate market for minority shares. Minority shareholders may bare the loss of risk of their investment without a corporate obligation to declare and pay dividends. When controlling shareholders act in a manner that is abusive or oppressive to minority shareholders, the conduct may give rise to several causes of action.
Depending on the applicable state law and the factual circumstances, minority shareholders may have a cause of action for shareholder oppression in close companies. In general, the shareholder oppression cause of action allows minority shareholders to force a buyout of their shares when controlling shareholders act “oppressively.” However, this action is not generally available in all jurisdictions. For example, it does not apply to corporations governed by Delaware and Texas law. The courts of those states have held that, generally, a controlling stockholder does not owe general fiduciary duties to minority shareholders or have a fiduciary duty to buy back a minority stockholder’s shares.
Shareholder Oppression in Texas
In Ritchie v Rupe, the Texas Supreme Court held that Texas does not have a shareholder oppression statute that allows minority shareholders to seek a buyout of their minority stakes. In that case, Rupe had inherited a minority stake and sought a buyout of her shares. The majority shareholders offered her $1.7 million which she refused (a jury later valued her shares at $7.3 million). Ritchie refused to meet with Rupe’s prospective third-party buyers. The lower courts held that this refusal deprived Rupe of her “reasonable expectation of being able to market her unrestricted stock.”
Because Rupe would likely have recovered a much greater price for her shares if a buyout remedy applied, this case represents a good example of the predicament faced by minority shareholders in close corporations who want to liquidate their interests. When controlling shareholders act oppressively by denying requests for information, declining to pay dividends, and taking actions that would discourage third parties from buying existing shares, this predicament is worsened.
The Supreme Court held in Ritchie that a buy-out remedy for shareholder oppression is not available pursuant to Section 11.402 of the Texas Business Organizations Code (the “TBOC”). The court explained that the TBOC only allows for the appointment of a rehabilitative receiver in limited circumstances. Applying the business judgment rule to Section 11.402 of the TBOC, the Texas Supreme court held that a shareholder’s conduct is considered oppressive only when:
- The shareholder abuses authority over the corporation
- With the intent to harm the interests of one or more of the shareholders
- In a manner that does not comport with the honest exercise of their business judgment
- By doing so create a serious risk of harm to the corporation
Appointment of a Rehabilitative Receiver
Section 11.402 of the TBOC provides that a court may appoint a receiver for a domestic business entity upon an owner’s petition if the actions of the entity’s governing persons are “illegal, oppressive, or fraudulent” and if the court determines that all other available legal and equitable remedies are inadequate. The majority in Ritchie interpreted these provisions to create a single cause of action for minority oppression with a single remedy: an action for the appointment of a rehabilitative receiver. Accordingly, convincing a court to appoint a rehabilitative receiver requires meeting a high burden. The rehabilitative receiver’s role is complete when the situation is resolved. However, if it does not conclude within one year, the minority shareholder who sought the appointment can seek to have the company dissolved. TBOC, § 11.405.
Other Legal & Equitable Remedies to Address Squeeze-Out Tactics
There are several types of conduct in which controlling shareholders can engage that harm minority shareholder in a closely held corporation. As expressed by the Ritchie Court:
“Those in control of a closely held corporation may use various “squeeze-out” or “freeze-out” tactics to deprive minority shareholders of benefits, to misappropriate those benefits for themselves, or to induce minority shareholders to relinquish their ownership for less than it is otherwise worth. The types of conduct most commonly associated with such tactics include (1) denial of access to corporate books and records, (2) withholding payment of, or declining to declare, dividends, (3) termination of a minority shareholder’s employment, (4) misapplication of corporate funds and diversion of corporate opportunities for personal purposes, and (5) manipulation of stock values.”
Ritchie v. Rupe, 443 S.W.3d 856, 879 (Tex. 2014).
Common Law Causes of Action | Access to Information
The Ritchie Court’s reasoning was based in part on the fact that controlling persons have fiduciary duties to the company and must act in the best interest of only the Company. The Court suggested that a duty to buy out minority shareholders could conflict with the duty to act in the best interest of the company, which conduct could feel oppressive to a minority shareholder. As noted by the Ritchie Court, minority shareholders have frequently asserted causes of action against companies or their officers and directors for the following causes of action: (1) an accounting, (2) breach of fiduciary duty, (3) breach of contract, (4) fraud and constructive fraud, (5) conversion, (6) fraudulent transfer, (7) conspiracy, (8) unjust enrichment, and (9) quantum meruit.
Moreover, Texas statutes and those of other states give shareholders rights to access company books and records. When used strategically, these statutes can be a useful springboard for investigating potentially unlawful conduct and to launch litigation or private efforts to obtain a fair price for a minority stake.
Derivative Actions & Breach of Fiduciary Duty
Majority owners who act as officers, directors, and managers, owe fiduciary duties to companies, including the duty of obedience, loyalty, and due care. If control persons abuse their authority in managing the company to favor certain shareholders instead of broadly acting in the best interest of the corporation, they may be sued for breaches of their fiduciary duties and they held liable for harm caused to the business, and in some cases to specific shareholders. For more information regarding fiduciary duty litigation, see Fiduciary Duty Litigation.
For breaches of fiduciary duties, corporate law provides shareholders the right to sue directors and officers “derivatively,” on behalf of the corporation. In connection with closely held corporations, some statutes like the TBOC, reduce barriers faced by minority shareholders in bringing derivative suits. For instance, with a close company there is no need prove that the minority shareholder “fairly and adequately” represents the interests of the corporation. TBOC, § 21.552(2). Further, derivative claimants need not first make a “demand” upon the corporation. TBOC, §§ 21.563(b), 21.552-560. Also, the court may treat a derivative action on behalf of a closely held corporation “as a direct action brought by the shareholder for the shareholder’s own benefit,” to award any recovery directly to that shareholder when justice requires. TBOC, § 21.563(c). This contrasts with the general rule in derivative suits, which holds that any damages recovered belong to the corporation. Finally, another way derivative suits are advantaged by the TBOC in the close corporation context is that derivative claimants 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 & Fraud
Typically, the same conduct that gives rise to a claim for breach of fiduciary duty, will also give rise to claims for breach of contract. When evaluating a shareholder claim against controlling persons, it can be advantageous two review the bylaws, certificates of incorporation, and other company agreements and documents to determine whether the company has breached commitments and obligations to the shareholders, such as commitments to pay dividends, to hold meetings and elections, and to furnish certain financial information.
Additionally, minority shareholders can claim under common law that their investments were induced by a company or its officers and executive by fraud, whether under the common law or under federal and state securities laws. Generally, statutes allow shareholders to recover legal fees and damages or rescission of their investment in connection with this type of misrepresentational fraud.
Why Freeman Law?
Although minority shareholders are not entitled in all jurisdictions (or Texas) to demand buyouts based on oppressive conduct, minority shareholders have several tools in litigation to pursue justice based on the misconduct of controlling shareholders. Although majority owners do get to carry the ball under corporate law, they still must follow the rules if they want to avoid being penalized with lawsuits and damage awards. Before investing as a minority shareholder, we advise that you discuss contractually available investment protections with qualified counsel. If you believe you may benefit from a potential minority shareholder or if you need a strong defense from a shareholder lawsuit, call our corporate litigation team today.
We are well-suited to represent you in connection with your rights as a minority shareholder and in any minority shareholder litigation for the following reasons:
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We are a sophisticated boutique trial firm, hyper focused on advancing our clients’ litigation interests in business litigation. Our trial attorneys have been recognized nationally and internationally, including being named to U.S. News and World Report’s Best Lawyers in America list, Super Lawyers, and recognized by Chambers & Partners as among the leading attorneys in the United States, as well as recognized as the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas.
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Our litigation attorneys include former government trial attorneys, former law clerks to federal judges, law professors, and dual-credentialed CPAs with deep experience in complex financial reporting, accounting, and fraud. Nearly one-third of our attorneys serve as law professors at tier-one law schools.
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