David F. Johnson presented his paper “Business Divorce: Minority Shareholder Rights In Texas” to the State Bar of Texas’s Business Disputes Course on September 2-3, 2021. This presentation addressed shareholder oppression claims in Texas, minority shareholder rights (such as contractual rights, stock rights, disclosure rights, distribution rights, employment rights, and receivership rights), fiduciary duties in
Presentation: Breach of Fiduciary Duty Claims Against Trustees/Managers of Closely-Held Businesses
David F. Johnson presented “Breach of Fiduciary Duty Claims Against Trustees/Managers of Closely-Held Businesses” with Kenneth J. Fair of Wright Close & Barger, LLP, on July 22, 2021, for Strafford Webinars to a national audience. This presentation covered various issues involved in a trustee owning an interest in a closely-held business when disputes arise. The
Partnership Agreement Was Invalid Where IT Was Entered Into Between A Fiduciary And Principal And Was Otherwise Unfair And The Principal Did Not Owe Fiduciary Duties As A Partner Where There Was No Enforceable Partnership
In Adam v. Marcos, an attorney and his client agreed to a joint venture/partnership. No. 14-18-00450-CV, 2021 Tex. App. LEXIS 2060 (Tex. App.—Houston March 18, 2021, no pet. history). The attorney sued the client for breaching the agreement. The trial court ruled for the client on the attorney’s breach of the partnership agreement claim and a breach of fiduciary duty claim. The court of appeals affirmed. The court of appeals first held that the partnership agreement was presumptively invalid because the attorney owed fiduciary duties to the client when it was entered into:
Contracts between attorneys and their clients negotiated during the existence of the attorney-client relationship are closely scrutinized. Because the relationship is fiduciary in nature, there is a presumption of unfairness or invalidity attaching to such contracts. The burden is on the attorney to prove the fairness and reasonableness of the agreement. Moreover, as a fiduciary, Marcos had the burden to establish that Adam was informed of all material facts relating to the agreement. Additional important factors in determining the fairness of a transaction involving a fiduciary include whether the consideration was adequate and whether the beneficiary obtained independent advice.
Id. The court of appeals held that the jury’s finding of breach of duty by the attorney supported invalidating the partnership agreement: “Because the jury found that Marcos failed to fulfill his fiduciary duties to Adam in regard to the alleged partnership agreement, and the evidence supports that finding, the presumption that the contract was invalid applies. Thus, the trial court did not err in holding the agreement was invalid and unenforceable.” Id.
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BBVA USA Receives Holiday Gift From Dallas Appellate Court: The Decision Includes Guidance for Private Company Owners
Last week, the Dallas Court of Appeals overturned a $98 million trial court judgment, which was based on a jury finding that BBVA USA (BBVA) had defrauded one of its commercial borrowers.[1] See BBVA, et al. v. Bagwell, et al., Dallas App. Ct., No. 05-18-00860, December 14, 2020). [2] The appellate court concluded the jury’s verdict had to be reversed because, as a matter of law, BBVA’s borrower could not have justifiably relied on allegedly false statements that had been made to the borrower by a representative of the bank. The Court’s holding and its focus on the element of “justifiable reliance” as a contractual defense to a fraud claim provides valuable guidance for private company majority owners in regard to their relationship with their minority business partners.
In light of the Bagwell decision, this post reviews key provisions that majority owners may want to include in their company governance documents to avoid future claims that may be made against them by their minority co-owners for fraud and/or for breach of the fiduciary duties that majority owners owe to the company acting in their capacity as governing persons. These provisions can be included in the company’s governance documents—in the by-laws of the corporation or in a company agreement for LLC’s—and they concern matters that frequently become the subject of disputes between private company co-owners.
Withholding of Profits Distributions/Dividends
One frequent area of conflict between majority owners and minority investors concerns the issuance of profits distributions. Private companies are typically “pass through” entities in regard to income taxes, which means that the business does not pay any taxes on the income that it generates and all taxes on the company’s income are paid by the business owners based on the percentage of their ownership interest. While majority owners may routinely issue distributions to the company’s owners to cover the amount of their tax liability that is attributable to income generated by the company, majority owners will want to retain flexibility to decide whether or not to issue profits distributions and, if so, in what amounts.
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Navigating Safe Harbors: Review of the Protections Provided to Governing Persons by the Texas Interested Party Statute and the Business Judgment Rule
Under Texas law, when the owners of closely held companies have co-investors, they need to exercise care in managing their business. This need for caution is due in large part to a Texas statute that makes it easier for minority shareholders or minority members of LLC’s (“Minority Owners”) in closely held companies to file derivative lawsuits alleging claims for breach of fiduciary duties against the company’s officers, directors and/or managers (“Control Persons”). See Tex. Bus. Org. Code (“TBOC”) §§ 21.551 and 101.451-463. This derivative Texas statute removes substantial procedural barriers that would otherwise exist for Minority Owners in filing a derivative lawsuit, and it has been the subject of our previous posts. (Read: Shareholder Oppression Claims)
When Minority Owners file derivative claims for breach of fiduciary duties against the company’s Control Persons, however, the Control Persons have significant defenses available to them under Texas law. These “safe harbor” defenses were highlighted in a recent decision by the Austin Court of Appeals, which dismissed most of the shareholders’ claims. See Roels v. Valkenaar, No. 03-19-00502-CV Tex App. Lexis 6684 (Tex. App. – Austin, August 20, 2020, no pet. history). This post reviews the appellate court decision in Roels, and the court’s analysis of the minority shareholders’ claims for breach of fiduciary duty and the available defenses to these claims is helpful for both Control Persons and shareholders to understand.
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Under Texas Law, You Can Have Your Cake, But Not Always Eat it Too: Choice of Forum Clauses Are Enforceable, Choice of Venue Has Limits
Small, private companies are often viewed as a key to the growth of the GDP in the U.S. Even small companies quickly realize, however, that they are competing for business not just in their own neighborhood, but as part of a global marketplace. Therefore, when companies enter into contracts with other firms doing business in different states or countries, they often include terms in their agreements to select both the state in which to litigate any future disputes between them (choice of forum), as well as the county in which the litigation will take place (choice of venue). This post considers whether these choice of forum and choice of venue provisions the parties opt to include in their contracts will be deemed enforceable under Texas law.
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Don’t Wait to Jump Off the Bandwagon: Cutting Ties With a Bad Business Partner (Part 2)
As we have noted in previous posts, it can become critical for the majority owner of a private company to remove a business partner who holds a minority ownership stake in the business and who is causing major dysfunction in the company. See “The Devil You Know: Pick Business Partners Wisely and Plan For Problems Ahead” By the same token, a minority investor may desire to exit the business when the majority owner is taking actions that benefit himself to the detriment of the company. This is the second of two posts that discusses issues involved in separating from bad business partners, and it reflects the perspective of both majority owners and minority investors. (Read Part 1)
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When to Pull The Plug: Is It Time to Say Goodbye to Your Business Partner? (Part 1)
Experience teaches us that all relationships have ups and downs, including those existing between business partners. When the relationship becomes strained between partners in a private company, however, the majority owner of the business must decide whether these problems are fixable, or whether the best decision is to remove the partner who holds a minority ownership stake in the company. This is Part 1 of 2 posts, and it focuses on identifying some of the most common characteristics of difficult business partners. When these vexing attributes exist in a business partner with a minority ownership interest in the company, the majority owner needs to consider whether to buy out the partner’s stake, or at least end his/her involvement in the day-to-day operations of the company. In Part 2, we will discuss the process for the company’s majority owner to remove a difficult partner from the business, and we will also look at strategies that enable minority investors to exit the business and secure a buyout of their ownership interest in the company when serious conflicts arise with the majority owner.
Continue Reading When to Pull The Plug: Is It Time to Say Goodbye to Your Business Partner? (Part 1)
Feuding Business Partners in Private Companies: Considering Arbitration to Resolve Partnership Disputes
It is common for private company co-owners to have disagreements while they operate their business, but they typically work through these disputes themselves. In those rare instances where conflicts escalate and legal action is required, business partners have two options—filing a lawsuit or participating in an arbitration proceeding. Arbitration is available, however, only if the parties agreed in advance to arbitrate their disputes. Therefore, before business partners enter into a buy-sell contact or join other agreements with their co-owners, they will want to consider both the pros and the cons of arbitration. This post offers input for private company owners and investors to help them decide whether litigation or arbitration provides them with the best forum in which to resolve future disputes with their business partners.
Arbitration is often touted as a faster and less expensive alternative to litigation with the additional benefit of resulting in a final award that is not subject to appeal. These attributes may not be realized in arbitration, however, and there are other important factors involved, which also merit consideration. At the outset, it is important to emphasize that arbitrations are created by contract, and parties can therefore custom design the arbitration to be conducted in a manner that meets their specific needs. The critical factors to be considered are: (i) speed—how important is a quick resolution to the dispute, (ii) confidentiality—how desirable is privacy in resolving the claims, (iii) scope—how broad are the claims to be resolved, (iv) expense—how important is it to limit costs, and (v) finality—is securing a final result more desirable than preserving the right to appeal an adverse decision.
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The Plight of Oppressed Private Company Minority Investors: No Legal Escape Available Without a Buy-Sell Agreement in Place
The legal front remains forbidding for private company minority investors who seek to secure a buyout of their ownership stake based on claims for oppression against the company’s majority owners. It has been six years since the Texas Supreme Court eliminated a court-ordered buyout as an available remedy for minority shareholders claiming oppression, and no other legal avenue exists that provides minority owners with a buyout of their interest based on claims for mistreatment by business owners who manage the company. See Ritchie v. Rupe.[1] The best advice for minority investors therefore is simply this—before investing in a private business, minority owners need to insist on securing a buy-sell agreement.
We have written extensively about the terms of buy-sell agreements in previous posts (Read Here). A buy-sell contract provides investors with the right to obtain a buyout of their minority ownership interest in the company at a future time.
No Buy—Out For Breach of Fiduciary Duty
When minority owners have claims for misconduct by majority owners, these claims most commonly include: (1) breach of contract, (2) fraud, and (3) breach of fiduciary duty. None of these claims permit the trial court, however, to award the minority owner with the remedy of a buyout of his/her or its minority interest. Instead, the remedy for these claims is typically the recovery of actual damages. In the case of fraud, if the minority owner can prove that he/she was fraudulently induced to make the investment in the company, the court could rescind the transaction and require the majority owner to return the investor’s purchase price. Instances of outright fraudulent inducement are relatively rare, however, and this will not be a claim or remedy available to most investors. The fiduciary duty claim against the majority owner in control of the company does give rise to a potential shareholder derivative action, however, which is discussed below.
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