June 26, 2014 -- Minority shareholders in close corporations have essentially lost their right to sue for shareholder oppression in Texas.
Reaction to the decision in Lee Ritchie, et al v. Ann Rupe has been one of alarm among commercial litigators, but nearly non-existent in the media.
Mark Curriden of The Texas Lawbook has practically had a monopoly on the story. He wrote two versions of the opinion that ran in the Dallas Morning News and the Houston Chronicle on June 23. No other major daily in the state ran a story, even though this is hands down the most important business-related decision to come from the high court over the past year.
Legal community impressions:
Appellate lawyer Richard Smith of Lynn Tillotson Pinker & Cox in Dallas told Curriden, "This is a hugely important decision for family businesses and other small companies. This is a decision that puts minority shareholders in a much weakened position when their personal interests clash with the decisions of the majority."
Robert Gilbreath at Hawkins Parnell Thackston & Young in Dallas told Curriden, "The court's decision in this case will dramatically curtail, if not virtually eliminate shareholder oppression claims in Texas." Gilbreath represented the defendants who ran the company.
Hawkins Parnell Thackston & Young, on its own website, said, "After more than 50 years of silence on shareholder oppression claims, the Texas Supreme Court issued a 54 page opinion rejecting such claims except to the extent they seek the limited statutory remedy of a rehabilitative receivership."
The Supreme Court split 6-3 on this one. Justice Eva Guzman wrote the dissent and was joined by Justices Don Willett and Jeff Brown. Justice Jeffrey Boyd wrote for the majority.
The underlying case dealt with the misfortunes of Ann Rupe. She married into her husband Buddy Rupe's family and was disliked by the in-laws. Buddy and Ann tried to get their son, Guy Rupe, added as a beneficiary to the family trust, which owned 47 percent of Rupe Investment Corp. Paula Dennard, Buddy's sister, and her children blocked that move.
After Buddy's death, Rupe inherited 18 percent of RIC. She fell on hard times. She faced foreclosure of her home and had a tax debt problem. She asked RIC to buy her shares, but was offered only $1 million, this from a company that had $152 million in annual sales by 2007.
Later, RIC president Lee Ritchie offered $1.7 million to be paid over seven years. At the time, he warned Rupe that RIC would be the only purchaser of her stock.
Rupe knew the offer was still far below market value. She retained investment banker George Stasen to market her stock to third parties. But Ritchie was hostile toward Stasen.
Ritchie required potential buyers accept confidential agreements that weren't subject to negotiation and granted RIC sole discretion of the disclosure of information. Even worse, Ritchie would not agree to meet with any potential investor.
Rupe sued for shareholder oppression. At trial, Stasen said potential buyers laughed at him because without meetings with RIC executives they couldn't perform due diligence.
"There was no way I could ever sell anything ... because there wasn't enough information in the package and everybody wanted to be able to meet Lee Ritchie and talk to the executives," Stasen testified
The jury heard from witnesses and experts for eight days and then found the RIC officers engaged in oppressive conduct and determined Rupe should receive a fair value for her shares, which it calculated was $7.3 million.
The court of appeals upheld the trial court judgment, agreeing that a stock buyout was the most appropriate remedy.
What is "OPPRESSION"?
It would not be an exaggeration to say the most civil court judges and lawyers in Texas were shocked with how the majority defined oppression.
Guzman opened her dissent by noting the majority ruling makes Texas the first of 37 states with a shareholder oppression law on the books to preclude remedies that are less drastic than appointment of a rehabilitative receiver.
To come up with a definition he was happy with, Boyd went to the Texas Business Organizations Code in Texas law and noted that a shareholder seeking a receivership order had to prove the actions of the company governors were "illegal, oppressive or fraudulent."
Boyd said the Legislature never defined 'oppressive,' but concluded the term should be construed in a manner consistent with the severity one would attach to the other two terms, illegal and fraudulent. It was not enough, Boyd argued, for Rupe to show that she was not treated fairly or that anyone in her position would reasonably expect to be treated better.
"Considering all of the indicators of the Legislature’s intent, we conclude that a corporation’s
directors or managers engage in oppressive actions ... when they abuse their 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, and by doing so create a serious risk of harm to the corporation," Boyd said.
In plain speak, Boyd was saying the directors' actions must risk harm to the company, not just a minority shareholder.
Boyd recognized his position created a gap through which unjust acts against minority shareholders would be protected, but he blamed the gap on the Legislature.
"Although the Legislature has made a broad range of equitable remedies available for violations of other statutory causes of action, ... it has not done so here," Boyd said.
He then tried to claim that his position still provided remedies for victims. He said Rupe wouldn't be in the position she is in if her husband had safeguarded his rights through a shareholder agreement in the first place. Boyd noted that abuse by the majority shareholders in a close corporation is a known and foreseeable risk.
He noted that the Legislature does make it easier for shareholders in close corporations to bring derivative suits, and that they still have a long list of common law causes of action, such as breach of fiduciary duty and unjust enrichment.
Guzman's dissent, however, makes clear that Boyd's list of remedies is little more than a farce.
"No other existing remedy the court discusses adequately protects minority shareholders from
such oppression. The remedy that comes closest to affording some relief to the oppressed minority
shareholder is a common-law claim for breach of fiduciary duty. But the Court’s logic expressly and
impliedly negates such a claim," Guzman writes.
Going back to Boyd's reliance on the Business Judgment Rule for his definition of oppression, she said pressuring a shareholder to sell at a bargain benefits the company. The same can be said for a refusal to pay dividends, or directors refusing to meet propective buyers out of fear they'll say something that could be a basis for a securities fraud suit.
"Each such act that potentially oppresses a minority shareholder can benefit the corporation and be justified under the business judgment rule. But after today, the business judgment rule will allow essentially all minority shareholder oppression that does not harm the corporation," she said.
Guzman criticized the majority for reading one provision of the statute in a way that rendered two other provisions in the statute meaningless--"interested parties" and "all other legal and equitable remedies."
"The shareholder oppression statute not only addresses but also prefers lesser legal and equitable remedies than receivership--it does not extinguis them," Guzman wrote.
Up until Friday's opinion, Texas trial and mid-level appellate courts considered lesser legal and equitable remedies. This has been practiced precedent for decades. Reviewing this history, Guzman said New York shaped the definitions of oppression in the United States.
"The first New York court to squarely address the issue observed that 'whether the controlling shareholders discharged petitioner for cause or in their good business judgment is irrelevant;' rather, what was relevant was the minority shareholder's 'reasonable expectations.' The reasonable expectations test for oppression has been further refined as 'when the majority's conduct substantially defeats the expectations that objectively viewed were both reasonable under the circumstances and were central to the minority shareholder's decision to join the venture.'
"And this test is firmly established in Texas jurisprudence, with the Amarillo, Corpus Christi, Dallas, El Paso, Fort Worth, Houston (1st and 14th Districts), San Antonio, Texarkana, and Tyler courts of appeals having applied the test in shareholder oppression cases," Guzman said.
But the reasonable expectations test doesn't apply in cases where shares are inherited. Rupe never had an opportunity to negotiate a shareholder agreement.
"Due to such circumstances, New York courts developed a test for finding oppression if the conduct of the majority becomes burdensome, harsh and wrongful," Guzman continued.
Supreme courts in five other states have applied that second test, as have some courts of appeals in Texas, she said.
"These two definitions of oppression are firmly established in Texas and national jurisprudence and allow courts the flexibility to craft remedies for the varying types of oppression. There is no valid basis to overturn this mountain of jurisprudence, leave Texas out of step with other jurisdictions whose statutes are similar to ours, and chill investment in closely held corporations," she said.
"The court's inclusion of the (business judgment) rule in the definition of oppression negates the very protection the oppression statute afforded until today."
Dallas attorney Jeffrey Levinger handled Rupe's appeal.
Brad Parker, president of the Texas Trial Lawyers Association in Austin, and Peter Kelly of Kelly, Durham & Pittard in Houston prepared the associations friend of the court brief.
They told the court, "Minority shareholders, particularly if dissident, are forever at the mercy of majority shareholders, and can be outvoted at every turn. But they are still shareholders, and they have
at least some rights. They should not be subject to the mere caprices of the majority, and they should have some reasonable way--other than an involuntary abandonment of their interests--of escaping their dire straits.
Texas courts provide some protection, including the common law "reasonable expectations" principle, they said. The statutory alternative includes placing a closely-held corporation in receivership, or ordering its sale.
"Petitioners find even these modest protections repugnant, and have urged this court to reexamine the “reasonable expectations” standard for determining oppression, even though that standard has been a fixture of Texas law for nearly 25 years, has not been criticized or questioned by any court, and has been applied evenhandedly."
Well, not anymore.