On June 20, 2014, the Texas Supreme Court issued its opinion in Ritchie v. Rupe, 2014 Tex. LEXIS 500 (Tex. 2014). In Ritchie, a minority shareholder in a closely held corporation attempted to force the majority shareholders to buy-out the minority shareholder’s interest in the corporation by bringing a claim of shareholder oppression under § 11.404 of the Texas Business Organizations Code (TBOC), the Texas receivership statute. Under this provision, when actions of governing persons of an entity are illegal, oppressive or fraudulent, a court has authority to appoint a rehabilitative receiver.

Oppressive Conduct

Interpreting the receivership statute, the Texas Supreme Court held that actions by governing persons are oppressive only when the following is true:

(1)    The governing persons abuse their authority over the corporation;

(2)    This abuse is done with the intent to harm the interests of the shareholders;

(3)    The abuse is carried out in a manner that does not comport with the honest exercise of the director’s business judgment; and

(4)     The abuse creates a serious risk of harm to the corporation.

By incorporating the business judgment rule and requiring a showing of both intent and actual risk of harm to the corporation, the Court’s definition makes it difficult for shareholders to demonstrate oppression. Indeed, actions by a board that harm a minority shareholder’s interest may not create any risk of harm to the corporation itself. For instance, “freeze outs” and “squeeze outs” may benefit a corporation while they are simultaneously harmful to the interests of a minority shareholder.

Inadequacy of Other Remedies

Additionally, the Court held that a court can exercise the authority of appointment only if it determines that all other available remedies are inadequate. For instance, if in addition to the claim for oppressive conduct the facts also provide a basis for a breach-of-fiduciary-duty claim, the court must first determine whether remedies are available under this additional claim. If so, the inadequacy of such remedies must be demonstrated before the shareholder can rely on the receivership statute.

Exclusive Remedy—the Appointment of a Rehabilitative Receiver

Furthermore, the Court held that the appointment of a rehabilitative receiver is the only remedy for oppressive actions under the receivership statute. Thus, even if shareholders demonstrate oppression and the inadequacy of alternative remedies, they cannot force a buy-out as the plaintiffs in Ritchie attempted to do. This contrasts to the receivership statutes of most states, which include court ordered buy-outs and the appointment of liquidating receivers as remedies for shareholder oppression.

Creating a Common Law Cause of Action for Shareholder Oppression is “Simply Bad Jurisprudence”

Finally, the Court refused to recognize a separate common-law cause of action for “shareholder oppression.” The Court did note the foreseeable and significant harm that is likely to occur when governing persons of a closely held corporation abuse their power. However, the Court determined that the extensive statutory, contractual and common-law protections that already exist under Texas law are adequate to protect the legitimate interests of a minority shareholder. Additionally, because, according to the Court, the most developed common law standards for oppression—the “reasonable expectations” and “fair dealing” tests—are so vague, “creating new and independent legal remedies for ‘oppressive’ actions is simply bad jurisprudence.”

Conclusion

By importing the business judgment rule and the elements of intent and actual risk of harm into the definition of oppression, Ritchie makes it difficult for minority shareholders to demonstrate oppressive conduct. This is especially true considering the Court’s refusal to recognize a common law claim of oppression. Furthermore, even if oppressive conduct can be demonstrated, a claim exists under the receivership statute only if no other adequate remedies exist. Finally, even if all of these requirements can be met, the only remedy available for oppression pursuant to § 11.404 is the appointment of a rehabilitative receiver. The minority shareholder will not be able to force a buy-out of its interest under the receivership statute. After Ritchie, the rights and remedies set forth in shareholder agreements will be important sources of protection for minority shareholders in a closely held corporation.

 

Topics:  Business Judgment Rule, Buyouts, Closely Held Businesses, Court-Appointed Receivers, Minority Shareholders, Oppression Remedy, Shareholders

Published In: Civil Procedure Updates, Civil Remedies Updates, General Business Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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