Shareholder Oppression

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Expansion of Shareholder Oppression Doctrine in Texas

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Reasonable Expectation that Management will Meet with Prospective Purchasers of Shareholder’s Stock

In Ritchie v. Rupe, 339 S.W.3d 275 (Tex.App.-Dallas 2011, pet. filed), the Texas Fifth Court of Appeals held that a minority shareholder in a closely held corporation can have a reasonable expectation that management will meet with prospective purchasers of her stock.  Significantly, the Supreme Court of Texas has since granted petition for rehearing and review.  If the petition for review is granted, it will be the first shareholder oppression case heard by the Court.

In Ritchie, there was no shareholders’ agreement in place restricting the minority shareholder’s right to sell.  Initially, the shareholder, in an effort to sell, offered the stock to the corporation, but rejected the amount that the corporation was willing to pay as substantially below market.  The shareholder then began to seek third-party purchasers through a broker, but the broker was informed that company management would not meet with any prospective purchasers.  This made the stock virtually unmarketable, since it was unlikely that anyone would buy stock in a closely held corporation without first evaluating and obtaining information from management.

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Economic Duress and Minority Shareholder Oppression

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If a majority shareholder terminates a minority shareholder’s employment or forces him to sell his shares in the company at a below-market price, the majority shareholder could be vulnerable to a claim of oppression.  But, what happens if the majority shareholder is able to obtain a signed agreement from the minority shareholder in which the minority surrenders its rights in return for some – but far less than fair market – consideration?  Typically, an agreement giving the minority shareholder some severance rights or compensation for his shares will contain a general release provision, which would provide that the minority shareholder releases all claims he may have against the majority shareholder.

Often the minority shareholder – having lost his job and means of support or being compelled to sell his interest in his business – will be under significant pressure to accept an offer that provides him some continuing income or compensation – even if it is much less than what he might legally be entitled to or could negotiate for is he were not under duress.

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Avoiding Shareholder Oppression Claims

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The Threat:

Being a defendant in a shareholder oppression case can pose a significant threat to a closed corporation and its majority shareholders. Not only can the majority or the corporation be forced to buy out the shares of the minority at what the court determines to be “fair value,” the litigation itself can be a significant distraction and drain on company finances and managerial resources.

“Fair value” often involves an appraisal process, expert reports and expert testimony at a trial – and great uncertainty as to what the court will ultimately decide.  “Fair value” is a technical legal terms that is a legislative and judicial creation; it is not the same as “fair market value” and it can often be substantially different from what the minority’s shares can fetch in the open market or the amount of financing a company can obtain to buy these shares. 

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Protection of Minority Shareholder Rights and Shareholder Oppression Doctrine in Texas

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What can minority shareholders do in under Texas law to protect themselves against unfair treatment, including “squeeze-outs”, “freeze-outs” and the taking of disproportionate benefits by the majority? 

Texas recognizes both the shareholder oppression doctrine and “breach of fiduciary duty” theories in close corporations to protect the rights of minority shareholders.

The Dissolution Statute:

The Texas corporate dissolution statute, Article 7.05 of the Texas Business Corporation Act, provides for the appointment of a receiver and the possibility of dissolution when an aggrieved shareholder establishes “illegal, oppressive, or fraudulent” conduct by directors or those in control. 

Of significance, Texas Courts have used this statute as a basis to fashion a broad range of remedies less harsh than dissolution, where they find that minority shareholder rights have been abused.

What is Oppressive Conduct?

Though illegal and fraudulent conduct is fairly easy to identify, oppressive conduct is less readily definable.  One of the leading cases in Texas, Davis v. Sheerin, adopts the language of New York’s Matter of Kemp for oppression, and defines “oppressive conduct” as follows:

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Case Law Update: What are Acts of Shareholder Oppression?

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In Stephanie (Younger) Waters v. G&B Feeds, Inc. and Wiliam Younger, No. SD29745, March 4, 2010, the Missouri Court of Appeals upheld the trial court's finding of shareholder oppression, showing that a pattern of oppressive acts is key to the cause of action.  The trial court recited a medley of actions taken by Appellant-Defendant which the trial court considered to be acts of shareholder oppression:


[h]e assumed control of the corporation and the operation of its business without lawful authority and in complete disregard for the rights of [Respondent]. He borrowed money and refinanced debts on his own without consultation with [Respondent]. He testified that throughout the term of the business he purchased livestock feed at cost for [his] herd of 500-600 head of livestock, a substantial savings over a period of six years. However, the court has no evidence, other than [Bill’s] testimony, as to any such amounts paid for feed. He declined the opportunity to pay [Respondent] $70,000[.00] for her stock, the amount she had paid for it, and thus be in a position to have complete ownership of the corporation and the lawful right to operate the corporation business as he was doing without lawful right. He refused to cooperate in the sale of the business property to the ultimate financial detriment of both shareholders. He retained all rental receipts from the storage units and gave no accounting therefore. He has totally failed to give a proper accounting of his stewardship of the business affairs.

 

The Court of Appeals went on to hold that there was "sufficent evidence supporting the trial court's determination that [Appellant-Defendant] breached his fiduciary duty to Respondent in his dealings with her and in his operation of the affairs of [the company]"  and upheld the trial court's finding of minority shareholder oppression.

For the entire decision, click here.

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Shareholder Oppression in New York

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Applicable Statute

New York State’s corporate dissolution statute, NY Business Corporations 1104-a, provides for the involuntary dissolution of a corporation when the “directors or those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders” in a company that is not publicly traded.

New York courts have held that oppressive conduct is distinct from illegal or fraudulent conduct, and thus also a reason for corporate dissolution. 

What is Oppressive Conduct?

In an “oppression” case, the first inquiry of a New York court will be to determine whether the complained of acts are actually “oppressive.”  Though the dissolution statute does not define what oppressive acts are, one of the leading cases on the subject, Matter of Kemp & Beatley, Inc., interprets them as actions which “substantially defeat shareholder expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner’s decisions to join the venture.”  This standard is widely followed.

Oppressive conduct is most often found when there are a number of actions that, when taken together, have the effect of denying the minority shareholder benefits from the company that he or she had the reasonable expectation of.  Often the Court will look at what is motivating the majority’s actions and whether there is an effort to “freeze out” or “squeeze out” the minority. 

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Limitations on Majority Rule in the Management of Business Entities

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The general rule in the corporate governance of business entities -- including corporations, limited liability companies and partnerships -- is that absent an agreement or statutory requirement to the contrary, majority rule governs.  Indeed, majority equity owners often assume that they can do pretty much anything they want with regard to the business entity. 

However, this is an erroneous assumption.  Over the years, many legal principles have evolved which limit the freedom of the majority  to do as they wish.