TOO MUCH FUN
Too much fun, what’s that mean?
It’s like too much money, there’s no such thing
It’s like a girl too pretty with too much class
Being too lucky, a car too fast
No matter what they say, I’ve done
But I ain’t never had too much fun
By Daryle Singletary
The lyrics of country songs share the heart of personal stories in a way like no other music genre. In the chorus above from his song “Too Much Fun,” Daryle Singletary croons that there is no such thing as too much money. His chorus got me to thinking whether the concept of too much money has any role to play in the operation of private companies. Specifically, would a Texas court ever hold that the officers and directors of a private company had breached their fiduciary duty by retaining excessive earnings? Or, have Texas judges taken Daryle’s words too much to heart and concluded that there is no such thing as too much money when it comes to the amount of profits that a company can retain and choose not distribute to its owners?
The ARGO Data Decision
Perhaps the leading Texas case on this subject is the Argo Data decision issued by the Dallas Court of Appeals, which was later upheld by the Texas Supreme Court. Argo Data Res. Corp. v. Shagrithaya, 380 S.W.3d 249 (Tex. App.—Dallas 2012), pet. denied, (Tex. June 27, 2014). In ARGO Data, the jury found that the majority owner had defrauded the minority shareholder by causing the company to stockpile more than $140 million in earnings under false pretenses. Specifically, the jury found that the majority owner had defrauded and oppressed the minority stockholder by falsely stating that the company’s earnings were being retained for business purposes when the majority owner’s true motive (which he kept secret) was to use these funds to buy out the minority shareholder. The trial court therefore ordered the majority owner to declare a one-time dividend of $85 million to be shared by the two shareholders in direct proportion to their ownership interest in the business.
The Dallas Court of Appeals reversed the trial court’s decision based on a judicial fiction and in surprising disregard of the business realities that apply to private company ownership. Although the majority owner had retained earnings on false pretenses, the appellate court held that the majority owner’s misconduct had actually increased the value of the minority shareholder’s ownership stake in the company. Id. at 269. The appellate court thus concluded that, in effect, the majority owner’s fraudulent conduct in stockpiling the company’s earnings did the minority shareholder a favor. What the appellate court ignored was the practical reality that the minority shareholder has no means to monetize his stock ownership regardless of its increased value, because he cannot force a dividend and no one will agree to step into his shoes and pay him the full value of his interest. Thus, the appellate court left the minority shareholder trapped with no way to realize the value of his interest.
A key to the appellate court’s decision in Argo Data was the fact that the majority owner had belatedly begun declaring dividends. For 25 years, the majority owner declined to declare any meaningful dividends, but he finally declared a large dividend shortly before the trial date as a trial strategy. The jury wasn’t fooled by this last minute tactic by the majority owner on the eve of trial, but the appellate court embraced this strategy. The appellate court’s opinion never mentions that the majority owner refused to declare a dividend until a lawsuit was filed against him and not until the trial loomed ahead after a year of litigation. The Supreme Court declined to address the timing of the dividend when it upheld this ruling after largely eradicating the claim for shareholder oppression under Texas law. See Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014).
The Future of Claims Based on Excessive Retained Earnings
More than 50 years ago, the Texas Supreme Court case held that suppressing dividends in a profitable company could give rise to a remedy. See Patton v. Nicholas, 279 S.W.2d 848 (Tex. 1955). The Patton case has never been overruled, but in light of the more recent holding in ARGO Data, it seems unlikely that the Court’s decision in Patton has continuing vitality today.
In most cases, Texas courts are unwilling to challenge the decisions of business owners because companies typically have good reasons for retaining earnings. These business reasons include the following: the need to make capital improvements, the acquisition of a competitor, the development of new products, the payment of self-insured premiums and expansion into new markets. This is not an exhaustive list and courts generally accept the business owner’s strategy under the application of the business judgment rule, which gives judicial deference to decisions by officers and directors when they act reasonably and in the absence of self-dealing.
In effect, hoarding company earnings does not hurt anyone according to ARGO Data, and as a result, there is no remedy for the minority shareholder who believes that the majority owner is suppressing dividends. While a minority shareholder can bring a claim today based on the majority owner’s actions in refusing to declare dividends, the majority owner can prevail on this claim as long as he finally begins to declare dividends before the trial of the case begins. Once the majority owner issues dividends, the courts will accepts the business judgment rule as a full defense. The court can also engage in the judicial fiction of ARGO Data and hold that retaining earnings always benefits the minority shareholder by adding to the value of his ownership stake.
If a minority shareholder wants assurance that a reasonable amount of the company’s earnings will be distributed as the profits are earned, the minority investor needs to confirm the existence of a dividend plan in writing at the time of his or her investment. Without a written agreement, the chorus by Daryle Singletary tells the story. Too much money doesn’t exist in country music or when majority owners of private Texas companies decide to retain earnings.