Many Texas lawyers and their private company clients continue to refer to the claim for shareholder oppression as if it remains a viable cause of action under Texas law. And yet, for all practical purposes, the claim for minority shareholder oppression met its demise more than five years ago in 2014 in Ritchie v. Rupe[1]. In this landmark decision, the Texas Supreme Court held that a court-ordered buyout of the minority owner’s interest in a private company was not a remedy that was available under either Texas statutes or common law in response to oppressive conduct by the company’s majority owner(s).

The myth of the claim for shareholder oppression in Texas persists, because there is a lingering reference to oppression in the Texas Business Code [2], and because there is a strong continuing need for this type of remedy in response to majority owners who engage in conduct that is oppressive to minority shareholders or LLC members. [3] In Rupe, the Supreme did leave open the possibility that a court-ordered buyout could be a remedy for a breach of fiduciary duty committed by majority owners. The door that was left open to this remedy in Rupe, however, is not one that lower courts have been willing to walk through in granting or upholding a buyout remedy for the minority investor based on the majority owner’s breach of fiduciary duty.

Looking past the myth of claims for shareholder oppression, the legal remedy most often pursued by minority shareholders since Rupe is a claim for breach of fiduciary duty that is filed on a derivative basis. These derivative claims are the subject of this post.

Derivative Claims Remain Chief Weapon Wielded by Minority Shareholders

A shareholder derivative lawsuit based on breaches of fiduciary duty by the company’s majority owner is the chief legal weapon that remains available to minority owners (shareholders and LLC members) after Rupe. Minority owners have grounds to bring this claim when majority owners put their own self-interest ahead of the company’s best interests, which constitutes a breach of their duty of loyalty. In a derivative suit, therefore, the minority shareholders seek recovery for harm the company suffered as a result of the majority owners’ self-dealing.

Under the Texas Business Organizations Code (TBOC), minority investors in closely held corporations and limited liability companies (those with no more than 35 shareholders) have a straightforward path to file claims on a derivative basis against officers, directors and managers who abuse their authority. See TEX. BUS. ORG. CODE §§ 21.563, 101.463. The statute includes few procedural barriers to the filing of derivative suits, which contrasts with the much more onerous rules that apply in derivative actions filed by LLC members or shareholders in companies that are not closely-held.

The Texas Approach to Derivative Claims For Closely-Held Companies

Some highlights of the Texas closely-held company derivative statute are:

• The derivative plaintiff does not have to make a demand for payment or request relief from the majority owner before the suit is filed, which is a typical requirement in most states before a derivative suit can to go forward.
• Derivative plaintiffs can request that any amount awarded in the lawsuit be paid directly to them “when justice so requires” rather than having the recovery go to the company. That changes the ordinary rule in derivative cases, which requires that the funds recovered in the lawsuit to be paid to the company.
• Derivative plaintiffs can recover their legal fees if the court finds the claims provided the company with a substantial benefit. Further, the benefit that is obtained for the company in the lawsuit does not have to be financial, i.e., requiring the company to begin holding regular corporate governance meetings could be a substantial benefit.

The elimination of the oppression claim in Rupe and the TBOC’s favorable provisions for derivative lawsuits by minority owners in closely held companies have resulted in a noticeable increase in the filing of derivative lawsuits during the past five years. Perhaps the single most important difference between shareholder oppression claims and derivative claims is that in the latter, the shareholder is required to show that the company rather than the shareholder is the party that has been harmed by the majority owner’s conduct.

This distinction is, perhaps, most important in considering dividends or distributions that are withheld and the profits retained by the company. Under the principles of the shareholder oppression doctrine, a shareholder could contend that the majority owner’s decision to refuse to issue dividends or distributions by the company was oppressive conduct that unfairly deprived the shareholder of profits that he/she was entitled to receive. This was harm to the shareholder because it deprived him/her of a reasonably expected economic benefit.

When the shareholder in a derivative case has to show harm to the company to establish a claim against the majority owner/control group, however, it is likely to be more difficult to establish that the decision to retain earnings/profits at the direction of the company’s officers, directors and/or managers was a breach of any duty. In fact, these control persons will argue strongly that the decision to retain earnings improves the company’s financial position, and is therefore a strategic business decision that in no way can be viewed as a breach of any of their fiduciary duties. Thus, while the claim for breach of fiduciary claim is a powerful weapon, it may serve as a basis for a more limited set of claims related to the company’s control group.

Conclusion
While the urban myth regarding shareholder oppression claims may continue to persist, the actual claim was largely eliminated by the Supreme Court’s decision in Rupe. The Court’s opinion eliminating a court-ordered buyout as a remedy for minority shareholders under the oppression doctrine was significant as requiring a buyout has not yet been applied by lower Texas courts as a remedy for other claims, such as breach of fiduciary duty. The result is that minority investors in closely-held companies will have to rely on filing derivative lawsuits in response to oppressive/abusive conduct by majority owners. Importantly, for these derivative claims to be successful against majority owners, minority investors will need to focus on the type of self-dealing misconduct by the majority owners that hurts the company rather than on any actions that are harmful only to the individual investor.
—————————
[1] Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014).

[2] Texas law expressly authorizes a trial court to appoint a receiver to “rehabilitate” a corporation if, inter alia, “the acts of the directors or those in control of the corporation are illegal, oppressive or fraudulent.” TEX. BUS. CORP. ACT art. 7.05(A)(1)(c) (expired Jan. 1, 2010).[12] 286*286. However, this remedy is available “only… if all other remedies available either at law or in equity … are determined by the court to be inadequate.” Id. art. 7.05(A) (emphasis added).

[3] The Supreme Court in Rupe concluded that the only available remedy for shareholder oppression by the company’s majority owner is the appointment of a “rehabilitative receiver,” who will be appointed to rehabilitate the company in terms of resolving conflicts between the company’s owners. Since the Rupe decision, however, trial courts have granted receivers only very rarely.