The Rights and Duties of Co-Owners in Texas Private Companies
By Ladd Hirsch
In the book of Genesis, Cain provides a timeless response when he is asked about the status of his brother, Abel: “Am I my brother’s keeper?” Cain’s question is not answered, however, which has left biblical commentators to question the import of this passage for 2,000 years. In the business context, Texas courts have faced a similar question: do majority shareholders in private companies have a duty to protect the company’s minority shareholders?
Texas Recognizes Claims for Shareholder Oppression
Texas law offers some protection to private company minority shareholders who claim they were oppressed by the majority owners, but only in limited circumstances and the legal standards may be changing. The “minority shareholder oppression” scenario exists only in private companies because no market typically exists for private company shares. The lack of marketability of private company shares makes it possible for controlling shareholders to “squeeze out” minority owners and prevent them from realizing monetary benefits from their stock ownership.
The Texas Supreme Court has not ruled on whether minority shareholder oppression is a valid claim under Texas law, but since 1988, Texas appellate courts have upheld oppression claims by minority shareholders. Davis v. Sheerin, 754 S.W.2d 375 (Tex. App.—Houston [1st Dist.] 1988, writ denied). The Davis court held the Texas Business Organizations Code (Section 11.404) authorizes courts to grant equitable remedies to minority shareholders when those in control act in a manner that is “illegal, oppressive or fraudulent.” Whether the minority shareholder was oppressed is a question of law for the court after the jury decides what acts took place.
Davis defined minority shareholder oppression as:
- conduct by the majority shareholder that substantially defeats the minority’s expectations that, objectively viewed, were both reasonable under the circumstances and central to the minority shareholder’s decision to join the venture; or
- burdensome, harsh and wrongful conduct; a lack of probity and fair dealing in the company’s affairs to the prejudice of some members; or a visible departure from the standards of fair dealing and a violation of fair play on which each shareholder is entitled to rely. Davis, 754 S.W.2d at 381-82; see also Gimpel v. Bolstein, 477 N.Y.S.2d 1014, 1017-18 (N.Y. Sup. 1984).
Two recent developments are notable. First, the Houston Court of Appeals held this year that majority LLC members owe a fiduciary duty when they redeem a minority owner’s interest and increase their ownership percentage. See v. Devon Energy Holdings LLC, -- S.W. 3d --, 2012 WL 880623, at *21-22 (Tex. App.—Houston [14th Dist.] Mar. 9, 2012, pet. filed). After Allen, sole member-managers of LLCs owe minority members a fiduciary duty to make full disclosure when the majority seeks to buy out the minority owner’s interest in the company.
The second development concerns a shareholder oppression case in which the Texas Supreme Court has requested merits briefing. Ritchie v. Rupe, 339 S.W.3d 275 (Tex. App.—Dallas 2011, pet. filed). The Texas Supreme Court initially denied a Petition for Review in Rupe without a requesting a Response. But on March 2, 2012, the Court granted the Motion for Rehearing and, has requested briefs on the merits by August 7, 2012. In Rupe, the Dallas Court of Appeals concluded that shareholder oppression is a valid claim and upheld a buyout of the minority after finding that the majority owners acted oppressively by refusing to meet with a potential buyer of the minority’s shares, thereby precluding a sale. The appellate court remanded the case, however, to require reconsideration of the buyout award amount, holding that the jury was improperly instructed to disregard discounts that generally apply to a third-party's purchase of a minority interest in a private company.
The majority owners in Rupe petitioned the Supreme Court to overturn Davis, arguing that trial courts cannot grant equitable remedies to minority shareholders and requesting the Court to hold that the business-judgment rule protected them. Rupe counters that the Court should not jettison twenty-five years of appellate cases upholding shareholder oppression claims, that trial courts are empowered to remedy oppressive conduct, and that the business-judgment rule does not permit majority owners to unfairly exploit their power. If the Supreme Court does address the oppression claim in Rupe, it will be the first time, and its opinion will be critical in addressing the rights and duties of co-owners in private Texas companies.
Ladd Hirsch is a business litigation partner with the firm of Diamond McCarthy LLP. His practice focuses on handling complex business litigation matters, including, business divorce cases. He can be reached at LHirsch@diamondmccarthy.com.