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.
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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.
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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.
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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.
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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).
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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

 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)

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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)
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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.
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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.  
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It’s my party, and I’ll cry if I want to
Cry if I want to, cry if I want to
You would cry too if it happened to you.
Its My Party, by Lesley Gore

Almost five years have passed since the Texas Supreme issued its decision in Ritchie v. Rupe[1] in 2014 abolishing shareholder oppression as a claim under common law by minority shareholders in private Texas companies.  Specifically, in Ritchie, the Supreme Court eliminated a court-ordered buyout as a remedy for minority investors complaining of oppressive conduct by the company’s majority owners.  The legal landscape remains bleak for minority shareholders, and when the five year anniversary of Ritchie arrives in June, minority shareholders still have no legal remedy to secure a buyout of their ownership interest if they failed to obtain a buy-sell agreement or other contract exit right at the time of their investment in the company.

In this blog post, we will review efforts made to address the problems created by the Supreme Court’s holding in Ritchie, both legislatively and in the courts, consider how the predictions the Court made in Ritchie have played out, and discuss the state of the current legal battlefield between minority shareholders and majority owners in Texas private companies.

No Legislative Fix for Ritchie Has Been Adopted or is Pending

In the aftermath of the Ritchie decision, the Texas legislature took a run at creating a statutory fix to address the Court’s removal of a buyout legal remedy for oppressed minority shareholders.  In 2015, the year after Ritchie was issued, Rep. Ron Simmons, a second-term Republican from Denton County, introduced Bill 3168 in the Business and Industry Committee of the Texas House.  This proposed Bill would have applied solely to closely-held entities rather than to all private Texas companies, and the provisions of Bill 3168 were broader than the pre-Ritchie state of the law.

More specifically, as originally proposed, Bill 3168 would have granted broad statutory powers to Texas trial courts, including the right to appoint a “fiscal agent” to report periodically to the court on the operations of the business.  This new type of statutory agent is different than a receiver and would likely be more akin to a monitor. In addition, the Bill intended to provide the oppressed minority shareholder with more than a buyout right as it authorized shareholders to pursue a claim for a dividend to share in the retained earnings stockpiled by the company, as well as the right to recover damages from the majority owner and/or board members who engaged in oppressive conduct that was shown to be harmful to the minority shareholder.
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