Do Minority Shareholders Have Protection From Oppression in Texas?

What changed in 2014

Before 2014, Texas appellate courts had built a broad common-law doctrine of minority shareholder oppression, and trial courts sometimes ordered the majority to buy out a squeezed minority at fair value. In Ritchie v. Rupe, No. 11-0447 (Tex. June 20, 2014), the Supreme Court of Texas ended that line of cases. The Court held three things. First, it declined to recognize or create a Texas common-law cause of action for minority shareholder oppression. Second, it read the statute that authorizes relief for 'oppressive' acts, former article 7.05 of the Business Corporation Act and now section 11.404 of the Business Organizations Code, as creating a single cause of action with a single remedy: appointment of a rehabilitative receiver. Third, it held that the statute does not authorize courts to order a corporation to buy out a minority shareholder's interest, and reversed a buyout order.

The Court also narrowed the word itself. Directors or managers engage in 'oppressive' actions under the statute when they abuse their authority over the corporation with the intent to harm the interests of one or more shareholders, in a manner that does not comport with the honest exercise of their business judgment, and by doing so create a serious risk of harm to the corporation. A refusal to buy a minority holder's shares, or to meet with her prospective buyers, was held not to meet that definition.

What the receivership statute still offers

Section 11.404 lets an owner of a Texas entity ask a district court to appoint a receiver for the entity's property and business if the actions of the governing persons are illegal, oppressive or fraudulent, if the entity is insolvent or nearly so, if the governing persons are deadlocked and irreparable injury is threatened, if company property is being misapplied or wasted, or, for corporations, if shareholders have been deadlocked for two years over electing directors. The court must also find that a receiver is necessary to conserve the property and avoid damage to interested parties and that all other legal and equitable remedies are inadequate. The receiver runs the company temporarily; when the condition is remedied, management is restored. That is the whole of the statutory 'oppression' remedy in Texas. It is rarely what a minority owner wants, and the inadequate-remedies requirement means a court will usually point to the other claims below first. Details are in asking a court to appoint a receiver or dissolve a Texas company.

The claims that survived

Ritchie did not leave minority owners without remedies. It redirected them to claims with defined elements. In a squeeze-out, these are the ones that usually apply:

• Breach of the shareholders' agreement, bylaws or company agreement. Distributions not paid as the agreement requires, votes taken without the required approval, a buy-sell clause ignored, employment ended in breach of a term. Contract claims carry damages and, for written contracts, attorney's fees.
• Breach of fiduciary duty. Officers and directors owe the corporation a duty not to usurp corporate opportunities and to exercise uncorrupted business judgment for its sole benefit. Ritchie confirmed that the Court has never recognized a formal fiduciary duty between majority and minority shareholders as such, but an informal fiduciary relationship can arise from a relationship of trust and confidence that predates and exists apart from the business, and the Court remanded Rupe's fiduciary claim for decision. Partners owe each other statutory duties of loyalty and care under sections 152.204 to 152.206. The map of who owes what is in what fiduciary duties partners and LLC managers owe in Texas.
• Derivative claims. Excess salaries, self-dealing leases and diverted opportunities harm the company, and an owner can sue in the company's name. For companies with fewer than 35 owners, sections 21.563 and 101.463 let the court treat the claim as the owner's own and pay the recovery directly to the owner. The procedure is in suing on behalf of the company.
• Interested transactions. Section 21.418 protects a contract between the corporation and a director or officer only if the material facts were disclosed and disinterested directors or shareholders approved it in good faith, or it was fair to the corporation. A majority owner's undisclosed lease of his own building to the company at above-market rent fails that test.
• Records. A shareholder who has held shares six months or holds five percent may inspect books and records on written demand for a proper purpose (section 21.218), and the corporation pays the fees if it wrongly refuses (section 21.222). LLC members have section 101.502. Records are how every other claim gets proved.
• Fraud and fraudulent inducement. When the minority invested on representations that turned out to be false.

Example

Suppose a 25 percent shareholder in a Fort Worth equipment-rental corporation is removed from the board, sees the two majority shareholders double their salaries the same quarter distributions stop, and learns the company now rents its yard from an LLC the majority owns. There is no 'oppression' claim for the package. There is a derivative claim for the excess compensation and the above-market rent, treated as her direct claim under section 21.563; a section 21.418 challenge to the undisclosed lease; a section 21.218 records demand to prove both; and, if the facts support intent to harm her outside honest business judgment with serious risk to the company, a section 11.404 receivership application as a last resort. Pleaded that way, the case has elements a court can apply.

Where that leaves the buyout you actually want

Most minority owners want one of two things: to be paid fairly or to be let out. Texas law gets them there indirectly. The derivative and fiduciary claims put money at stake for the majority personally; the records demand ends the information advantage; the receivership petition, where the facts support it, threatens the majority's control. Together they make a negotiated buyout the majority's cheapest option. The pricing of that deal, and the few situations in which a statute does require a buyout, are in how a partner buyout is priced and enforced in Texas.

LLC members and partners

Ritchie was a corporation case, but its logic applies to LLCs: section 11.404 covers all domestic entities, and no Texas statute creates an LLC oppression claim or a court-ordered buyout. LLC members have an advantage in the records statute, which has no ownership threshold, and a disadvantage in that the LLC chapter does not define duties and lets the company agreement restrict or eliminate them (section 101.401). General partners are better placed than either: the statute gives them duties of loyalty and care and lets a withdrawing partner be paid fair value for the interest.

Protecting a minority position before the fight

Because the courts will not supply a buyout right, the agreement must. Minority owners who are still negotiating terms should ask for: a put right at an appraised price on defined triggers; mandatory distributions of a percentage of profits or at least of tax liability; supermajority approval for related-party transactions and compensation of owner-employees; information rights beyond the statute; and a dispute clause with a tie-breaker. The clauses are cheaper than the lawsuit they prevent.

When to involve a litigator

As soon as distributions stop or information dries up. The surviving claims depend on evidence that is in the majority's hands, and a records demand made early, in the statutory form, is what changes that. A litigator maps the facts to the available claims, calendars the four-year limitations periods for fiduciary and fraud claims, and frames the demand so the majority understands what a lawsuit would cost them personally. Tina Wysk represents minority and majority owners in these disputes in Dallas state and federal courts. See shareholder and partnership disputes.