In Dunn v. Chappelle (In re Alta Mesa Res., Inc.), a bankruptcy trustee sued the officers and directors of a limited partnership and related entities for operating a drilling program despite having lower than expected results. No. 19-35133, 2022 Bankr. LEXIS 2928 (U.S. Bankr. Ct. October 13, 2022). The defendants filed a motion to dismiss. The court granted it in part and denied it in part. The court first analyzed the partnership agreement and held that officers of the partnership’s parent corporation did not owe fiduciary duties to the partnership:

The Agreement forms a limited partnership under the laws of Texas and specifically provides that Texas law will govern. Under Texas law, “except as provided by . . . a partnership agreement, a general partner of a limited partnership . . . has the liabilities of a partner in a partnership without limited partners.” Tex. Bus. Orgs. Code Ann. § 153.152 (2021). In other words, subject to the terms of a limited partnership agreement, the general partner of a limited partnership has the same duties of a partner in a general partnership. Those duties include the duty of loyalty and the duty of care. Tex. Bus. Orgs. Code Ann. § 152.204 (2021)… Only the general partner owes fiduciary duties to Alta Mesa. Nowhere does the Agreement state that directors or officers of AMR owe fiduciary duties to Alta Mesa. Similarly, the Texas Business Organizations Code does not impose such a duty on the directors of a parent corporation.

Id. The court then analyzed whether the officers of the general partner owed fiduciary duties to the limited partnership:

The Texas Business Organizations Code states that “a partnership may have elected or appointed officers.” Tex. Bus. Orgs. Code Ann. § 151.004 (2021). An officer “shall perform the duties in the management of the entity and has the authority as provided by the governing documents of the entity.” Tex. Bus. Orgs. Code Ann. § 3.103 (2021)…

Dunn argues that the defendants’ control over Alta Mesa means that they had fiduciary duties to Alta Mesa. While Texas law supports this theory, the issue is whether Dunn has sufficiently plead factual allegations to plausibly support it. The Fifth Circuit found in Harwood that “[A]n officer of a corporate general partner who is entrusted with the management of the limited partnership and who exercises control over the limited partnership . . . owes a fiduciary duty to the partnership . . . . We emphasize that it is not only the control that the officer actually exerts over the partnership, but also the confidence and trust placed in the hands of the controlling officer. . . .” FNFS, LTD. v. Harwood (In re Harwood), 637 F.3d 615, 622 (5th Cir. 2011).

Dunn pleads numerous factual allegations that demonstrate the high degree of control that Chappelle, Ellis, and Turner exercised over the operations of Alta Mesa. Dunn alleges that they were involved in the decision-making process at every stage of the drilling program from the testing that began before the merger to the decision to install ESPs when production fell below projected levels. They were charged with presenting information on the program to the board of AMR and to investors. There is no indication that the board did anything to interfere with the officers’ control until almost a year after they approved the drilling program. Unlike the defendant in Harwood, the defendants did far more than “hold themselves out” as officers of Alta Mesa. They actually were officers of Alta Mesa, and exercised power in that capacity. The totality of the circumstances, if proven, would support a finding of a fiduciary relationship. To clarify, the Court does not base its analysis on the directors’ positions or purported positions as officers of Alta Mesa GP. That fact is merely another marker of the control the defendants exercised over Alta Mesa in their capacity as officers of Alta Mesa directly. Dunn’s complaint sufficiently alleges facts to support the claim that Chappelle, Ellis, and Turner owed fiduciary duties, looking to the totality of the nature of their relationship to Alta Mesa.

Id.

The court then held that the trustee pleaded sufficient allegations of breach of the duty of loyalty by alleging that the officers provided insufficient information about the drilling program:

The Texas Business Organizations Code codifies the internal affairs doctrine and provides that Texas law “governs the formation and internal affairs of an entity” formed under a certificate filed under the laws of Texas. Tex. Bus. Orgs. Code Ann. § 1.101 (2021). Texas limited partnerships, as entities formed by filing certificates, are subject to the internal affairs doctrine. Tex. Bus. Orgs. Code Ann. § 152.802 (2021). Therefore, Texas law governs the dispute as to whether the officers of a Texas limited partnership breached fiduciary duties to the partnership. Herington v. Univar Solutions Inc., 2021 U.S. Dist. LEXIS 165986, 2021 WL 3828702, at *2 (S.D. Tex. May 20, 2021) (“The internal affairs doctrine applies to breach of fiduciary duty claims.”). The two primary fiduciary duties in Texas are the duty of care and the duty of loyalty. Gearhart Indus., Inc. v. Smith Int’l, Inc., 741 F.2d 707, 719 (5th Cir. 1984). In Texas, the business judgment rule is treated as a “rule of substantive law that requires a plaintiff . . . to plead and prove (1) that the conduct . . . was outside the exercise of judgment and discretion the rule is meant to protect, or (2) that the directors had a personal interest in the transactions complained of.” Resol. Tr. Corp. v. Norris, 830 F. Supp. 351, 356 (S.D. Tex. 1993). Therefore, Dunn must plead around the business judgment rule in alleging the officers breached either their duty of care or their duty of loyalty to survive dismissal….

To abide by the duty of care, directors generally must “inform themselves, before making a business decision, of all material information reasonably available to them.”… A poor decision that leads to a bad outcome is not a breach; failing to properly gather and analyze information while making that decision is a breach.

The Complaint indicates that Chappelle, Ellis, and Turner went to great effort to inform themselves and had intricate knowledge of how the wells were performing. They did not breach their duty of care simply because their decisions turned out poorly. Alternatively, Dunn alleges that having gathered and analyzed all the information necessary to make an informed business decision, Chappelle, Ellis, and Turner failed to disclose that information to the AMR directors and investors and even actively withheld and hid that information from the AMR directors. (ECF No. 50 at 39-43). Like Northstar, Dunn raises the issue of the duty of loyalty rather than the duty of care.

“The duty of loyalty dictates that a director must act in good faith and must not allow his personal interests to prevail over the interests of the corporation.” Gearhart, 741 F.2d at 719. The business judgment rule does not apply to self-dealing transactions. Northstar, 616 B.R. at 739. Because the duty of loyalty is most commonly called into question in instances involving self-dealing, the business judgment rule does not typically apply to the duty of loyalty. Here, there are no allegations that the officers were self-interested, and there is little case law addressing what constitutes “good faith” in this context. The duty of loyalty in Texas includes duties of candor and disclosure. Chapman v. Arfeen, No. 09-16-00272-CV, 2018 Tex. App. LEXIS 7132, 2018 WL 4139001, at *15 (Tex. App.—Beaumont Aug. 30, 2018, pet. denied); see also McBeth, 565 F.3d at 178 (reasoning that, as fiduciaries, partners in a limited partnership owe one another a duty of disclosure). Deciding whether to share specific information is itself a business decision. Schlumberger Tech. Corp. v. Swanson, 959 S.W.2d 171, 181 (1997). Because disclosure is a business decision, to the extent the allegations of breach of the duty to disclose do not allege self-dealing, the business judgement rule applies. A complaint successfully pleads around the business judgment rule where the facts support an inference that the officers acted dishonestly or deceptively in the withholding of information. Chapman, 2018 Tex. App. LEXIS 7132, 2018 WL 4139001, at *15 (citing Sneed v. Webre, 465 S.W.3d 169, 178 (Tex. 2015)).

Dunn alleges not only that Chappelle, Ellis, and Turner withheld information from the board, but further suggests they intentionally manipulated data presented to the AMR board and to investors to obscure the fact that the drilling program’s performance fell below projections. Specifically, the complaint alleges that Chappelle and Turner decided to present “cleaned up” data. They cut off a graph comparing well production to type curves right before the point where the graph showed actual production falling below the type curves. They also recalculated average production from the wells by removing the poorest performing wells from that calculation. Additionally, the complaint alleges that Ellis knew the patterns were underperforming and did not inform the board, and he participated in presentations of manipulated data to the investors and the board knowing the data had been similarly “cleaned up.” These factual allegations involve dishonesty and deception and call into question whether the officers acted in good faith or, as the trustee alleges, in an effort to save their jobs. Motive will be a matter for trial. But, the complaint sufficiently overcomes the business judgment rule’s presumption to plausibly plead a breach of the duty of loyalty with respect to defendants Chappelle, Ellis, and Turner.

Id.

 

David Johnson co-authored a paper entitled “Voir Dire (In a Post COVID World)” with Jason Smith of the Law Offices of Jason Smith for the State Bar of Texas’s Business Disputes Course, held in Austin, Texas, on September 15-16, 2022. The paper covered the waterfront of voir dire topics in Texas litigation, including preservation of error, selecting the array, size of the jury, jury shuffle, questions to the venire, comments by venire members, challenges for cause, preemptory challenges, and Batson issues. Most trial attorneys will say that selecting a jury is the most important part of a trial. This paper provides important guidance to trial attorneys on what is allowed or not allowed in the selection process and what is necessary to preserve error.

Read David’s Paper

In Trench Tech Int’l, Inc. v. Tech Con Trenching, Inc., the son of an owner of a company, who was an employee, downloaded design plans and other information and went to another company who used that information. No. 4:19-cv-00201-O, 2022 U.S. Dist. LEXIS 100280 (N.D. Tex. June 6, 2022). The company and the company that owned it sued the son for trade secret misappropriation and breach of fiduciary duty. The defendant moved for summary judgment, and the federal district court denied the motion. Regarding the breach of fiduciary duty claim, the defendant argued that he was only an employee of the first company and not its owner and therefore did not owe fiduciary duties to the owner. The court disagreed:

Trench Tech asserts a claim against Smith for breach of fiduciary duties, and it asserts claims against Tech Con, Conlon, and Smith for conspiracy to have Smith and Jeremy breach their fiduciary duties. Defendants argue that they are entitled to summary judgment on Trench Tech’s breach-of-fiduciary-duty claims because (1) Trench Tech cannot establish a fiduciary relationship with Smith or Jeremy, and (2) the claims are barred by the statute of limitations. First, Defendants argue that Trench Tech cannot establish a fiduciary relationship. Under Texas law, “[a]n informal relationship may give rise to a fiduciary duty where one person trusts in and relies on another, whether the relation is a moral, social, domestic, or purely personal one.” But “to impose such a relationship in a business transaction, the relationship must exist prior to, and apart from, the agreement made the basis of the suit.” Trench Tech has presented sufficient evidence for a jury to find that Smith and Jeremy owed fiduciary duties to Trench Tech. They were longtime employees of the family business and entrusted with confidential material. “Texas courts have long recognized that entrustment of trade secrets gives rise to a fiduciary relationship.” Defendants recycle their argument that Smith and Jeremy worked for Trench-Tech, Ltd., not Trench Tech International, and thus they owed no fiduciary duties to Trench Tech International. Once again, Defendants cite no authority restricting fiduciary duties to employer-employee relationships. The formalities of Trench Tech’s entity formation do not preclude a jury finding that Smith and Jeremy owed and breached fiduciary duties to Trench Tech.

Id. The court also held that the statute of limitations did not bar the plaintiff’s breach of fiduciary duty claim.

In In re Mijares, a plaintiff claimed that a defendant defrauded him and breached fiduciary duties owed to him by charging improper, excessive, and unauthorized expenses to their medical practice, causing the plaintiff’s distributions from the practice to be reduced during the roughly six years that they practiced medicine together. Case No. 19-33121-hdh7, Adv. Proc. No. 19-03243,2022 Bankr. LEXIS 1542 (N.D. Tex. Bankr. June 1, 2022). The plaintiff sought a declaration that his claims for fraud and breach of fiduciary duty were not dischargeable pursuant to sections 523(a)(2)(A) and (a)(4) of the Bankruptcy Code. The court found that the plaintiff held a valid claim against the defendant for fraud and that such claim was not dischargeable.

Regarding the plaintiff’s breach of fiduciary duty claim, the court held:

Under Texas law, to prevail on a breach of fiduciary duty claim, a plaintiff must show (1) a fiduciary relationship between the plaintiff and the defendant, (2) that the defendant breached his fiduciary duty to the plaintiff, and (3) that the defendant’s breach resulted in injury to the plaintiff or benefit to the defendant.

It is not clear whether there was a fiduciary relationship directly between the Plaintiff and the Defendant. Courts generally hold that a managing member of a limited liability company does not necessarily owe fiduciary duties to other members. Although “the Texas statute governing limited liability companies implies that certain duties may be owed, it does not define any such duties, but rather allows the contracting parties to specify the breadth of those duties in the company agreement.”

Per the Company Agreement, both the Plaintiff and the Defendant served as Manager-Members. Article VIII of the Company Agreement provides various rights, duties, and powers of the Managers. Per this section, the Managers “shall have the full, sole, exclusive and complete discretion in the management and control of the business, operations and affairs of the Company; shall make all decisions that are necessary to carry out the business of the Company . . . .” The same section goes on to require that “[a]ll decisions and actions by the Managers shall be made in the best interests of the Company.” Thus, the Company Agreement makes it clear that the Defendant owed a fiduciary duty to MD Request but does not resolve the issue of whether the members owed fiduciary duties to each other because it neither disclaims nor expressly imposes such duties.

Nevertheless, Texas law recognizes that an informal fiduciary relationship, “may arise where one person trusts in and relies upon another, whether the relationship is a moral, social, domestic, or purely personal one.” The existence of a fiduciary duty is a fact-specific inquiry that takes into account the contract governing the relationship as well as the particularities of the relationships between the parties. Some courts have taken into account the “unequal” positions of power of members in a limited liability company, such as when one member exercises superior control over the company.

Both parties testified during trial that the Defendant almost exclusively handled the finances for MD Request. The Defendant did the calculations and remitted payments to the Plaintiff. Through an established course of dealing for the better part of six years, the Plaintiff placed a special confidence in the Defendant to compensate the Plaintiff accurately and honestly for his revenue, which was to be measured as his monthly collections less his half of the shared expenses.

Based on these facts, the Court believes there is a reasonable argument that the Defendant owed fiduciary duties directly to the Plaintiff, but the Court need not make that determination since the Court has already determined the Plaintiff has a claim for fraud, and the damages for breach of fiduciary duty would be the same as those previously identified for fraud.

Id.

Settlors often place some or all of the ownership in a closely-held business in a trust. A trustee managing a trust with an interest in a closely held business has difficult management issues to address and this often raises disputes. This presentation will address: (1) considerations in placing closely-held business interests in trusts, (2) considerations that a trustee should undertake in managing a closely-held business interest, (3) managing an ownership interest versus being a controlling person in the entity and the risks associated with holding both roles, (4) best practices for addressing conflicts of interest and for avoiding breaches of fiduciary duties, (5) attorney-client communication and privilege issues, (6) disclosure obligations to beneficiaries, (6) directed trust issues, and (7) co-trustee issues.

Date: Tuesday, September 27, 2022
Time: 10:00 – 11:00 a.m. Central Time
Cost: Complimentary
Speaker: David F. Johnson

Continuing Education Credit Information:
This course has been approved by the State Bar of Texas Committee on MCLE in the amount of 1 credit hour. This course has also been approved for 1.25 CTFA credit by the American Bankers Association, attendees can self report.

Who should attend:
In-house counsel and other litigation contacts, trust officers, risk management contacts, and wealth advisors

Register for the webinar.

In Power v. Power, one brother sued the other brother for breach of fiduciary duty related to their partnership in real estate investing. No. 05-19-01557-CV, 2022 Tex. App. LEXIS 2926 (Tex. App.—Dallas May 3, 2022, no pet. history). The trial court found for the plaintiff, and the defendant appealed. Continue Reading Partner Had Capacity To Sue Other Partner For Breach Of Fiduciary Duty

In In re Estate of Poe, shortly before his death, Dick, who was the sole director of Poe Management, Inc. (PMI), authorized the corporation to issue new shares that he bought for $3.2 million. No. 20-0178, 2022 Tex. LEXIS 544 (Tex. June 17, 2022). This made Dick the majority owner of PMI, which was the general partner of several Poe-owned businesses. Continue Reading Texas Supreme Court Holds That A Director Of A Corporation Cannot Hold An Informal Fiduciary Duty To A Stockholder

It is not uncommon for an attorney to execute all or part of his or her client’s wishes, which may be in breach of a fiduciary duty owed by the client to a third party. The third party can certainly sue the client for breaching fiduciary duties. But can the third party also sue the attorney for participating in the client’s actions? Continue Reading Suing Attorneys In Texas For Participating in Fiduciary Breaches

In this presentation David F. Johnson covers trust issues that arise in divorce disputes, such as spouses creating an irrevocable trust, fraud claims to void a trust, conflict of interest issues raised by the same attorney drafting both spouse’s estate/trust documents, characterization of trust assets and distributions as separate or community, settlor standing to complain about trust administration issues, trust construction issues, adoption-in and adoption-out issues, spouse/settlor liability for controlling a trust, capacity issues raised by spouses being involved as trustees and director/officer of a closely held business, spouses’ co-trustee management issues, and the new Texas trust code provisions dealing with the effect of dissolution of marriage on certain transfers in trusts.

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