Tis the season to say, out with the old and in with the new. But for minority shareholders with ownership in private Texas companies during 2016, not much changed. Minority shareholders remained without access to a buyout remedy under Texas law, which resulted in minority owners pursuing traditional claims against majority owners, as well as seeking relief under more novel causes of action.
This is the second in a two part series on significant legal issues that affected private company business owners during 2016. We consider in this post how the absence of a claim for minority shareholders that would permit them to secure a buyout remedy has resulted in a spike in claims filed against majority owners for breaching the fiduciary duties they owe to their companies, and also caused minority owners to consider other legal remedies to pursue against majority owners. The previous post in this series, which covered the adoption of the new federal Defend Trade Secrets Act, can be accessed here.
Ritchie v. Rupe Controls
As discussed in previous posts, in June 2014, the Texas Supreme Court significantly altered the legal landscape governing the rights of minority shareholders. Before the Court’s decision in Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014), minority shareholders in private Texas companies who lacked a contract exit right, but who had been subjected to oppressive conduct by majority owners, could file suit seeking a court-ordered buyout of their minority interest based on a claim for minority shareholder oppression.
In Ritchie, however, the Supreme Court changed existing case law by holding that neither Texas statutes nor case precedent would permit a trial court to order a buyout of minority interests as a remedy for oppressive conduct by the majority owners of the business. Instead, the Court ruled in Ritchie that appointment of a rehabilitative receiver was the sole remedy available to minority owners who claimed oppression by the majority owners. The Supreme Court did leave open the slim possibility in Ritchie that a minority shareholder’s claim for breach of fiduciary duty against a majority owner might, in some cases, authorize a buyout as a remedy. But no Texas appellate court since Ritchie has considered, much less approved, a remedy requiring a majority owner to purchase a minority shareholder’s stock based on the majority owner’s breach of fiduciary duty.
We have not compiled data on the total number of lawsuits filed by minority shareholders in 2016 against majority owners, but based on personal observation, it appears that the volume of shareholder suits is staying at pace or increasing since the Supreme Court issued Ritchie. What appears to be happening is that minority shareholders are continuing to file suits against majority owners, but pursuing different claims in these cases. It seems that the major impact of Ritchie has been to transform minority shareholder oppression claims against majority owners into breach of fiduciary duty lawsuits against company officers, directors and/or managers.
Taking the Shackles Off in a Brave New World
The oppression claim provided minority shareholders with a legally authorized exit from the business when they lacked a contractual buy-sell or other agreement with the majority owner. But the oppression claim was also important in another way. If the claim had merit, it would provide the minority shareholder with leverage that would potentially bring the majority owner to the table to negotiate the terms of a reasonable buyout of the minority owner’s interest.
In the absence of a buyout remedy, minority shareholders and their lawyers have pursued an array of alternative claims to obtain relief. These claims may provide the minority shareholder with some leverage that will lead to buyout discussions that resolve the disputes between the parties. A non-exhaustive list of these alternative shareholder claims is set forth below:
Breach of Fiduciary Duty Derivative Claims – following Ritchie, claims for breach of fiduciary duty are the most common claims that minority shareholders are asserting on a derivative basis against majority owners acting in their capacity as managers, officers and/or directors. In these cases, minority shareholders assert the claims derivatively in the name of the company alleging that the majority owners engaged in conduct harmful to the company. By all accounts, these claims and cases are on the rise.
Fraud Claims – these are direct (non-derivative) claims filed against majority owners in which minority shareholders contend that the majority owners made misrepresentations to induce their investment in the business and/or to keep them working at the business. These claims seek a return of the original investment with interest or seek compensation from lost opportunities the shareholder declined to pursue based on false promises that were allegedly made by the majority owners
Contract Claims – breach of contract claim are made by minority shareholders directly against the company based on employment agreements or other contracts that minority shareholders entered into with the business. If the majority owner directed the company to take actions that breached the company’s contractual obligations with the minority shareholders, the shareholders may have strong contract claims against the company.
Privacy Violations – one of the newer, creative, claims that minority shareholders are bringing against majority owners is for privacy violations. More specifically, minority shareholders are contending that majority owners improperly accessed their laptops or other devices without permission to extract personal information in violation of the Federal Stored Communications Act, 18 U.S.C. §§ 27.01 et seq. (“SCA” or the “Act”). Violators of the Act are subject to statutory penalties of $1,000 for each violation and payment of the plaintiff’s legal fees
None of the foregoing claims provides a remedy for minority shareholders that would authorize them to obtain a buyout of their ownership interest in the company. Depending on the specific facts at issue, however, one or more of these claims may provide the minority shareholder with leverage that will facilitate a negotiation with the majority owner leading to a buyout of the shareholder’s stake in the business.
Looking to 2017 and Beyond
The next Texas legislative session begins on January 10, 2017. Minority shareholders may hope for the adoption of a legislative remedy that revises the Supreme Court’s holding in Ritchie. In this regard, a bill filed in the last legislative session would have authorized trial courts to order majority owners to purchase a minority owner’s stock upon proof of oppression, but that bill never made it out of committee. While the possibility of a new statute authorizing court-ordered buyouts of minority interests may again resurface next year, initial indications are that legislative priorities will focus on issues related to immigration, guns and the regulation of personal status.
If the post-Ritchie world of no buy-out remedy remains in place in 2017, minority shareholders will not stay down for the count. They will continue to rely on both derivative lawsuits and the assertion of direct claims against majority owners in efforts to obtain some form of relief and leverage in seeking a negotiated exit from the business.