Following Supreme Court arguments last month, the final chapter in the long-running legal battle between Energy Transfer Partners LP (“ETP”) and Enterprise Products Partners (“Enterprise”) is finally coming to an end. ETP is requesting the Texas high court to reinstate the $535 million judgment it obtained after a jury trial against Enterprise in 2014. The case presents critical issues regarding the manner in which a Texas partnership can be formed, and the importance of these questions for business owners and the size of the judgment have made this a closely watched legal conflict since the jury issued its verdict more than 5 years ago.

This post reviews the issues at stake in the ETP litigation and explains our prediction that the Supreme Court will not reverse the decision issued by the Dallas Court of Appeals in 2017, which unanimously overturned the jury’s verdict and held that no partnership ever arose between ETP and Enterprise.  We expect the Court to rule that in light of the written conditions the parties had expressly agreed in writing must be met before a partnership would be formed between them, the contention that a partnership arose by their conduct is a dog that won’t hunt.

In the Beginning – A Brief Case Summary

The ETP case against Enterprise stems from a dispute over a highly profitable pipeline, which the parties considered pursuing together as a joint venture.  The dispute and claims arose when Enterprise changed course and signed on to do the pipeline deal with Enbridge, based in Canada.  ETP claimed that it had been jilted by its business “partner” in breach of Enterprise’s fiduciary duties, argued successfully to the jury that the parties had entered into a partnership agreement based on their conduct and oral statements.  The jury agreed and awarded damages of more than $300 million to ETP, but the figure grew to $535 million figure by the time that the final judgment was entered in the case. Continue Reading ETP v. Enterprise: Texas Partnership Created by Conduct — A Dog That Won’t Hunt

Recognized by Texas Bar Today’s Top 10 Blog Posts

Minority investors who purchase an ownership interest in a private Texas company are advised to secure an exit strategy confirmed in a Buy/Sell Agreement at the time they make their investment.  But investors who look closely at the specific terms of their Agreement may find that the contract contains an unwelcome surprise if it includes “good faith” obligations that have been accepted by the majority owner or by the company.  While good faith may sound attractive on paper, a recent Texas Supreme Court decision holds that a promise to act in good faith does not reflect a binding commitment and is not enforceable.  See Dallas Forth Worth International Airport Board v. Vizant Technologies, LLC,  2019 WL 2147262 (Tex. May 17, 2019).

The specific terms of Buy/Sell Agreements between owners and investors in private Texas companies are of critical importance, and this post reviews how the Supreme Court’s decision in the Vizant case earlier this year may impact the rights of owners/investors.

The Vizant Case Holding

The Vizant case did not involve a dispute between business co-owners, but the Court’s decision is nevertheless significant to contracts between business partners.  In the lawsuit, Vizant Technologies sued the D/FW Airport Board (the “Board”) contending that the Board had failed to follow through on a good faith promise in a consulting agreement, which potentially provided additional compensation for Vizant.  In the contract, Vizant agreed to provide consulting services related to credit-card processing for a capped fee of $50,000, but the terms of the contract also included a “good faith” promise.  Specifically, the Board had agreed to make a good faith effort to increase the amount of the fees to be paid to Vizant if the consulting services that it provided under the contract exceeded the amount of the fee cap. Continue Reading Tricks Not Treats: Good Faith Promises to Perform Don’t Hold Up in Shareholder Buy/Sell Agreements Under Texas Law

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.

Post-Rupe Shareholder Derivative Claims 

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. Continue Reading Shareholder Oppression Claims: Looking Past the Urban Myth to Remedies that Continue to Survive Under Texas Law

By Ricky Torlincasi and Ladd Hirsch

Historically, the sale of a private company carried with it a significant risk of claims by the purchaser. Months or even years after the sale closed, purchasers would frequently contend that the seller’s representations and warranties in the purchase agreement had been breached. This claim would support demands by the purchaser for the seller to forfeit some or all of the purchase price held back in escrow, and give rise to other claims, as well. The often contentious relationship that existed between company buyers and sellers began to change, however, when representation and warranty insurance (“R&W Insurance”) emerged and began to gain acceptance.

Although it was almost unheard of ten years ago, R&W Insurance is now widely used in today’s seller-friendly merger and acquisition (“M&A”) market. This post therefore provides an overview of R&W Insurance, explains how R&W Insurance works, and reviews how this type of policy allows buyers and sellers to an M&A transaction to allocate risk for their mutual benefit.

Role of R&W Insurance

At its most basic level in this context, R&W Insurance is an insurance policy issued to the buyer of a private company, and it protects the buyer from unanticipated losses that result from a breach of the seller’s representations and/or warranties in the purchase agreement. Some R&W policies are issued to company sellers, but more often the buyer is the insured party.

The concept of R&W Insurance is not new, but it has gained a much broader market acceptance over the past decade due to a number of factors, including, seller-friendly market conditions and an increase in the number of new insurers entering the market.   The existence of multiple insurers providing R&W Insurance has led to lower costs (premiums), better policy terms, and a quicker underwriting process allowing the policies to be issued more promptly. Continue Reading Reps & Warranties Insurance: A Game Changer for Business Owners Providing the Opportunity for a Virtually Risk-Free Sale of the Company

By Kelly Knotts and Ladd Hirsch

Fiduciary. The term applies broadly to cover all types of companies, as well as spouses in marriage, and is defined as “of, relating to, or involving a confidence or trust.” In the private business context, the company’s shareholders or members trust that their directors, managers and officers will make good faith decisions and act with loyalty to the business. When company leaders breach this trust and violate their fiduciary duties, however, they may become personally liable for any damages resulting from their improper conduct. This post focuses on the fiduciary duties that apply to private company leaders and reviews the legal guideposts that will help these company leaders, as well as the company’s shareholders and members better understand what constitutes compliance with these fiduciary obligations.

The Core Fiduciary Duties

Regardless of the entity structure, Texas law imposes fiduciary duties on company directors, managers and officers, which they owe to their company. Apart from Texas law, the fiduciary duties owed by company leaders are also typically addressed in the company’s bylaws, agreements, or regulations. What precisely are the fiduciary duties that Texas law imposes on business leaders, and do they vary based on the role as director, officer, or manager? The remainder of this post takes a closer look at these fiduciary duties.

  1. The Duty of Care

When making decisions for the company, the directors, managers, and officers are expected to exercise and adhere to the standard for the “duty of care.” Under Texas law, this duty is generally described as the obligation to use the amount of care an ordinarily careful and prudent person would use in similar circumstances. Gearhart Indus., Inc. v. Smith Intern., Inc., 741 F.2d 707, 720 (5th Cir. 1984). The decisions that company directors, manager, and/or officers make on behalf of the company involve a certain amount of risk as they seek to act for the benefit of the company. Recognizing that directors, managers and officers must make decisions for the company that cannot be fairly judged with the benefit of hindsight, Texas law applies the “Business Judgment Rule” to protect company leaders in their decision-making process. The Business Judgment Rule specifically precludes directors, managers, and officers from being held liable for business decisions that turn out poorly provided that they acted in an informed manner an on a good faith basis. To overcome the Business Judgment Rule as a defense, a shareholder or member who desires to assert a claim against a governing person at the company is typically required to show that this company leader engaged in self-dealing or other bad faith conduct. “. . . the Texas business judgment rule precludes judicial interference with the business judgment of directors absent a showing of fraud or an ultra vires act. If such a showing is not made, then the good or bad faith of the directors is irrelevant.” Gearhart Indus., Inc. v. Smith Int’l, Inc., 741 F.2d 707 (5th Cir. 1984);

The Texas Business Organizations Code does permit a company to limit or even eliminate a director’s personal liability for money damages to the company or its shareholders or members for breaches of their duty of care. Tex. Bus. Orgs. Code § 7.001. These so called “exculpation clauses” do not eliminate the fiduciary duty of care, but by limiting or eliminating the remedy of a cash payment for the breach of this duty, the practical effect is the same (a breach of the duty of care could give rise to non-monetary damages even when the company’s governing documents include an exculpation provision). Continue Reading Making the Right Choice: The Obligation to Comply With Fiduciary Duties By The Directors, Managers and Officers of Private Texas Companies

By Zack Callarman and Mark Johnson

Our previous posts have stressed the critical importance of buy-sell agreements for both majority owners and minority investors in private companies (Read here). For majority owners, securing a buy-sell agreement avoids the potential of becoming “stuck” in business with a difficult co-owner without the ability to force a buyout of this minority investor’s ownership stake. For at least some majority owners of private Texas companies, however, another option exists. This option is commonly known as a “freeze-out,” “cash out” or “squeeze-out” merger.

What is a Freeze-Out/Squeeze-Out Merger?

A freeze-out/squeeze-out merger is a merger of two or more business entities that results in one or more of the equity holders of one of the pre-merger entities being cashed out as a result of the merger (i.e., not allowed to own equity in the post-merger surviving company).

Mergers are governed by state corporate law, and most states have several similar, but separate, merger statutes for corporations, LLC’s and other forms of business entities recognized under state law that govern mergers of those entities under various different circumstances. In that regard, it is worth noting that a “freeze-out/squeeze-out” merger is not a distinct type of merger governed by its own separate statute, but rather is a “characterization” given to a merger reflective of the purpose behind the merger, irrespective of the specific merger statute under which the merger is effectuated.

The Requisite Authorization and Approval for a Freeze-Out/Squeeze-Out Merger

Under state corporate law, mergers typically must be authorized and approved by both the equity holders and the directors of each of the entities participating in the merger. In the case of corporations, that means that typically both the directors and the shareholders must authorize and approve the merger, whereas in the case of LLC’s that means that typically the members and the managers must authorize and approve the merger. The actual level of that approval (i.e., unanimous consent vs. 2/3rds consent vs. majority consent) is governed by the applicable state merger statute together with the operative provisions of the entity’s organizational documents. By way of example, under Texas law, unless the entity’s governing documents provide otherwise, (i) the affirmative vote of at least two-thirds of the outstanding voting shares is required to authorize and approve a merger of a corporation, and (ii) the affirmative vote of the holders of at least a majority of the outstanding voting membership interests is required to authorize and approve a merger of an LLC.

So, the gating question for any individual or group wanting to possibly effectuate a freeze-out/squeeze-out merger is: Do you have the requisite vote under applicable law and under the entity’s governing documents to authorize and approve the merger?

The Fair Market Value Presumption
It is important to remember that while a freeze-out/squeeze-out merger may well enable the “majority” to force one or more minority holders out of the company, a freeze-out/squeeze-out merger does not entitle the majority to steal, or cheat the minority holders out of, their equity interests. The minority members who are being frozen or squeezed out should receive fair value for their interests. Otherwise, the majority proponents of the freeze-out/squeeze-out merger will likely be vulnerable to claims by the minority interest holders for oppression, breach of fiduciary duties, etc.

In the case of corporations, the “fair market value” presumption is governed by statute. In many (but not all) mergers involving corporations, under state corporate law, the effected shareholders, including any minority shareholders who will be frozen or squeezed out as a result of the merger, have statutory “dissenter’s rights” or “appraisal rights”. In short, a shareholder with “dissenter’s rights” or “appraisal rights” who objects to the amount that he is going to receive in exchange for his equity interests as a result of the merger is entitled to go to court and appeal the valuation. The court then has the power to revise the amount that the shareholder will receive based on its determination of fair market value.

Curiously, LLC statutes do not typically include dissenter’s rights provisions. However, given (i) the well–established fair market value presumption that exists in the context of corporate mergers, together with (ii) the strong “fiduciary duties” overlay that exists under statutory and common law with respect to the duties and obligations of members of LLC’s with respect to their fellow members, prudence dictates that the majority proponents of a freeze-out/squeeze-out merger make every effort to honor the fair market value presumption in any freeze-out/squeeze-out merger they effectuate.

Logistics of a Freeze-Out/Squeeze-Out Merger
So, assuming that the majority proponents of a freeze-out/squeeze-out merger have the requisite vote under applicable law and under the entity’s governing documents to authorize and approve the merger, how do they do it? The answer to that question will again depend in part on the form of the entities involved, the governing corporate statutes, and the organizational documents of the entities involved, but with those qualifications, the answer is pretty simple: The majority proponents form a new entity with whatever ownership and capital structure they desire, and then they merge the existing entity (i.e., the entity in which the soon-to-be frozen or squeezed out equity holders hold an interest) into the new entity. Under the terms of the merger agreement, among other things, the new entity will be the surviving entity, and the equity interests of the frozen or squeezed out minority interest holders will be redeemed for cash in an amount equal to the fair market value of the redeemed equity interests.

Conclusion

The freeze-out merger is a legal avenue that may not be widely known by majority owners of private companies, but it is used with some regularity in Texas and is rarely disallowed by the governance documents of most companies. There should be a note of caution for majority owners in deploying this technique, however, because if dissenter’s rights apply and are exercised by the minority investors in response, the freeze-out merger may result in a time-consuming and a costly appraisal process.

Zack Callarman (Associate) and Mark Johnson (Shareholder) are members of Winstead’s Corporate, Securities/Mergers & Acquisitions Practice Group.

 The fact of the matter is that co-founders spend most of their time fighting . . . But no one talks about it. Los Angeles venture capitalist Mark Suster. (Fighting Co-Founders Doom Startups)

Recognized by Texas Bar Today’s Top 10 Blog Posts

Setting up a private company on a 50-50 owned basis is typically a bad idea, but many founders of new businesses continue to embrace this perilous ownership structure.  We wrote last year about problems that plague 50-50 owned businesses (The Potential Pitfalls of a 50% Ownership Stake in a Privately-Held Company), and a google search on the topic produces articles such as: “50/50 Partnerships; Never a Good Idea,” and “Why You Shouldn’t Enter into a 50-50 Partnership.”  Venture capitalist Mark Suster explained in a column called the The Co-Founder Mythology that most people form 50/50 partnerships, “because they’re afraid to to start alone.”  Mr. Suster advises entrepreneurs to “take the leap” in starting their new company, but to do so without entering into a 50-50 ownership with a co-founder.  Mr. Suster states:  “. . . I meet far more people who had problems with [their current partner-ship] than founders who didn’t have problems.  People just don’t talk about it publicly or in blogs.”  (The Co-Founder Mythology)

50-50 Owned Businesses – High Risk for Failure

The evidence backs up Mr. Suster’s negative views regarding the problems with 50-50 owned businesses.  In 2013, Noam Wasserman, a Harvard Business School professor, published The Founder’s Dilemmas after studying 10,000 different business founders.  According to Prof. Wasserman’s book, 65% of high-potential startup companies fail as a result of conflict among the co-founders.  Pairs and groups bring a variety of skills, but there is also more potential for conflict—over the company’s leadership, finances, strategy, credit and blame.  (Fighting Co-Founders Doom Startups) Continue Reading Can the Golden Goose and Its Eggs Be Shared: Resolving Conflicts Between Private Company Co-Founders

As we noted in a previous post (Read Here), the disruption and dysfunction caused by a bad business partner who holds a substantial minority stake in the company can lead to the ultimate failure of the business.[1]  This is especially true when the company founder has no buy-sell agreement in place that will allow him/her to redeem the minority investor’s interest in the company. When the majority owner has no contract right to force the minority investor to exit the business, the owner’s options are essentially limited to: (i) going out of business and dissolving the company, (ii) selling the business to a third party (iii) or selling the majority owner’s interest to another party who will step into the owner’s shoes and take on the task of dealing with the minority investor.

None of these “end the business” options are likely to satisfy a company founder who worked very hard to bring the company to life. This post therefore considers options for the majority owner of the company to consider when no buy-sell agreement exists with the minority investor who has become a major stumbling block in the path to the company’s continued success.

Setting the Stage for the Exit of the Bad Business Partner

The bad business partner may believe that he/she has the upper hand in negotiations with the majority owner. Specifically, at the same time the minority investor is wreaking havoc at the company, the investor is refusing to be bought out or is demanding a grossly inflated price for the purchase of his/her minority stake in the business. In this situation, the majority owner may appear to be “stuck” with no recourse to force the exit of this bad partner and fix the problems the investor is causing at the company. Continue Reading Partnership Blues: Can a Bad Business Partner be Removed by the Company’s Majority Owner When No Buy-Sell Agreement Exists?

Navigating a successful business exit when a marriage ends in divorce often presents challenges for both parties. Leaving aside the emotional tensions present in divorce, resolving conflicts regarding the ownership of business interests in the marital estate is also daunting. This post therefore reviews options for divorcing spouses in their divorce proceeding. If couples can ratchet down the emotions and the acrimony, the tools discussed in this post may help allow the couple to optimize the financial outcome of their divorce settlement and preserve the value of the company they own or in which they share a large ownership stake.

The Valuation Dilemma

The most contentious business issue in many divorce proceedings is the value of the business that must be divided as part of the divorce settlement. Valuation is an inexact science, and the divorcing couple can easily spend hundreds of thousands of dollars on expert and legal fees battling it out over the value of one or more private companies included in the marital estate. This challenging issue is not subject to any easy fix. But there are some options the couple may want to consider before engaging in an expensive and time-consuming valuation battle.

(a) Marital Agreements.   Couples can eliminate the private company valuation battle by entering into a marital agreement that specifies what specific assets will be shared on divorce, or what amounts will be paid, and the agreement can also specific how the value of any assets will be determined. While a pre-nup is more common, couples can also agree to enter into a post-nup that details a property division and removes any conflict regarding the valuation of specific assets. Texas statutes set forth strict requirements to follow for marital agreements be enforceable. See Chapter 4 of the Texas Family Code

(b) Designated Valuation Expert. The couple can agree to pre-select and designate a valuation expert they both trust to conduct the valuation for them and to be bound by whatever value is determined by this mutual, trusted expert. Alternatively, there are variations on this approach, which give the couple the right to retain valuation experts if they don’t like the value that is determined by the designated expert and the results of these additional experts will then be averaged to determine the final value.  Continue Reading Family Law Post–Maximizing Private Company Value in Divorce: Achieving a Successful Business Divorce When the Marriage Fails

Entrepreneurs launching new companies today take on a significant gamble, because statistics show that roughly 30% of all new start-ups fail within two years, and only half survive for a full five years.  Many businesses fail due to the owners’ inability to meet the challenges of the marketplace, but some start-ups shut down when conflicts arise within the ownership group.  Companies can go under over these ownership disputes even when their governance documents include dispute resolution provisions—if these terms fall short of keeping the business intact.

Given the many business risks that business entrepreneurs face, they should not also have to accept the gamble that a future serious conflict with their co-owners will torpedo the business.   This post therefore focuses on dispute resolution terms that are designed to resolve ownership disputes, but which will preserve the continued operation of the business.  While not fool-proof, the best mechanism for resolving ownership conflicts in our experience on a prompt, confidential and cost-effective basis is through a set of well-crafted fast track arbitration provisions.  These arbitration terms are included in the company agreement (LLC’s), in the bylaws (corporations) or in the limited partnership agreement (limited partnerships), and they are discussed below.

Faster – Prompt Date for Final, Evidentiary Hearing

Litigation will often drag on for months and, in some cases, years, and at great cost.  By contrast, arbitration is a dispute resolution procedure that is created by agreement of the parties, and as a result, the parties can choose to adopt a specific timetable in their arbitration provision that requires the final arbitration hearing to take place on a prompt schedule.  The manner in which a fast-track schedule for the arbitration hearing plays out is described below.

After one of the parties files a demand for arbitration, the arbitration company, which is typically either AAA or JAMS, will assist the parties in selecting the arbitrator, or if the parties opted for a panel, a panel of three arbitrators, to preside over the dispute.  Once the arbitrator or the arbitration panel is appointed, a scheduling conference will be held promptly, and the date for the arbitration hearing will be set at that time.  If the parties require the hearing date to take place within a specified period in the arbitration provision, e.g., 60 or 90 days, the arbitrator or panel will enforce the parties’ agreement and adopt the schedule to which they agreed.  In short, the parties will get what they bargained for, a prompt hearing with no delays/continuances.   Continue Reading Dispute Resolution for Business Partners: The Arbitration Option—Know When to Hold ‘Em, When to Fold ‘Em, and When to Walk Away