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In R.P. Small Corp. v. Land Dep’t, Inc., the plaintiff sued the defendant for breaching fiduciary duties due to a confidential relationship regarding oil and gas development. No. H-20-14902021 U.S. Dist. LEXIS 133695 (S. D. Tex. July 19, 2021). The plaintiff alleged that the defendant took advantage of his relationship, lied about his qualifications and experience, and overbilled and had self-dealing transactions. The defendant filed a motion to dismiss based on the economic loss rule, arguing that the plaintiff’s claims all arose from oral and written contracts. The federal district court denied the motion to dismiss. The court first discussed the economic loss rule:

Under Texas law, the “economic loss rule generally precludes recovery in tort for economic losses resulting from a party’s failure to perform a contract when the harm consists only of the economic loss of a contractual expectancy.” In determining if the economic loss rule applies, Texas courts look to both the “source of the alleged duty and the nature of the claimed injury.” “[A] party may elect a recovery in tort if the duty breached stands independent from the contractual undertaking, and the alleged damages are not solely the result of a bargained-for contractual benefit.” This is because “‘[t]ort obligations are in general obligations that are imposed by law—apart from and independent of promises made and therefore apart from the manifested intention of the parties—to avoid injury to others.’”

Continue Reading Federal Courts Deny Motions To Dismiss Breach Of Fiduciary Duty Claims Due To The Economic Loss Rule

David F. Johnson presented his paper “Litigating Self-Interested Transactions Involving Fiduciaries” to the State Bar of Texas’s Fiduciary Litigation Course on December 2-3, 2021, in San Antonio, Texas. This presentation discussed a fiduciary’s duty of loyalty, the right to compensation and other benefits, the concept of self-interested transactions, the presumption of unfairness that attaches to…

In Hotze v. In Mgmt., LLC, family members sued each other over control of a family business. No. 14-18-00995-CV, 2021 Tex. App. LEXIS 5821 (Tex. App.—Houston [14th Dist.] July 22, 2021, no pet. history). Three of the brothers ended up with greatly increased control of the company after debt the company owed to a partnership formed by the three brothers was partially converted into company stock. Id. Two other brothers and other associated parties filed two lawsuits, bringing both individual and derivative claims, which were consolidated for trial. “A key issue in the case was whether the promissory note between Troika and CECO authorized a partial conversion of debt for stock.” Id. The trial court concluded that it did, and instructed the jury to that effect. The two brothers appealed.
Continue Reading Court Holds That Promissory Note Did Not Allow Partial Conversion To Equity

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…

In Villareal v. Saenz, two co-owners of a limited liability company sued each other regarding conduct surrounding a business divorce. 5-20-CV-00571-OLG-RBF, 2021 U.S. Dist. LEXIS 94183 (W.D. Tex. May 18, 2021). After the parties asserted allegations against each other, they entered into a release agreement. The parties agreed that “Saenz would assign his entire interest to ZroBlack LLC to Villarreal.” After the release, Saenz refused to return certain property to the company. Villarreal sued for breach of fiduciary duty and other claims.
Continue Reading Exiting Member of LLC May Still Owe Fiduciary Duties

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.
Continue Reading 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

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.
Continue Reading BBVA USA Receives Holiday Gift From Dallas Appellate Court:  The Decision Includes Guidance for Private Company Owners 

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.
Continue Reading Navigating Safe Harbors: Review of the Protections Provided to Governing Persons by the Texas Interested Party Statute and the Business Judgment Rule

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.
Continue Reading 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

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)
Continue Reading Don’t Wait to Jump Off the Bandwagon: Cutting Ties With a Bad Business Partner (Part 2)