Shareholder Oppression Summary: Texas

A close corporation is usually marked by characteristics such as relatively few shareholders, substantial participation by shareholders in the management of the corporation, and limited or no market for the corporation’s stock. Because of these unique characteristics, the majority shareholder of a close corporation has the ability to significantly impact the minority shareholder’s interests. Commonly referred to as a “freeze-out” or “squeeze-out” of the minority shareholder, denying any return on investment, as well as any input into the management of the business may leave the minority shareholder with no benefit of continued investment, yet no market to sell his shares and escape the situation. As a result, the law in Texas has developed ways to resolve these problems, including statutory provisions, as well as common law developments in fiduciary duties and in the doctrine of shareholder oppression.

The Business Corporations Act. Article 7.05 of the Business Corporations Act provides for the appointment of a receiver for the assets and business of a corporation, in an action by a shareholder where it is established that the acts of the directors or those in control of the corporation are illegal, oppressive or fraudulent, and there are no other adequate remedies available at law or in equity.

Article 7.06 of the Business Corporations Act provides that the court may order the liquidation of the assets and business of the corporation when circumstances demand, if all other remedies are inadequate and if the corporation in receivership presents no plan to the court within twelve (12) months, which the court finds will remedy the problem that necessitated the receivership.

These statutes thus provide a statutory action for shareholder oppression, which could lead to the appointment of a receiver and the possibility of liquidation when the aggrieved shareholders establish that “the acts of the directors or those in control of the corporation are illegal, oppressive or fraudulent.” Business Corporations Act Art. 7.05(A)(1)(c). It is important to note, however, that the statute does not define “oppressive” conduct.

Shareholder Oppression. The doctrine of shareholder oppression is designed to protect minority shareholders of closely held corporations from the improper actions of the majority. Though the doctrine has not yet been explicitly adopted by the Texas Supreme Court,[1] the appellate courts have repeatedly recognized and applied it in their decisions.

Thus, if shareholder oppression is a recognizable action, we must first determine what constitutes “oppressive conduct.” In Davis v. Sheerin, 754 S.W.2d 375, 380 (Tex. App.--Houston [1st Dist.] 1988, writ denied), the Court defined "oppressive conduct" as follows:

  • majority shareholders' conduct 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, or 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.

In finding oppressive conduct, it is a fact question as to what acts were performed, yet the determination of whether those facts constitute oppressive conduct toward a minority shareholder is a question of law for the judge. Davis, 754 S.W.2d at 380; Willis, 997 S.W.2d at 801. Further, courts must exercise caution in determining what shows oppressive conduct. Willis, 997 S.W.2d at 801 (citing McCauley v. Tom McCauley & Son, Inc., 724 P.2d 232, 237 (N.M. 1986)). The minority shareholder's reasonable expectations must be balanced against the corporation's need to exercise its business judgment and run its business efficiently. Willis, 997 S.W.2d at 801 (citing Landstrom v. Shaver, 561 N.W.2d 1, 8 (S.D. 1997)). Therefore, despite the existence of the minority-majority fiduciary duty, a corporation's officers and directors are still afforded a rather broad latitude in conducting corporate affairs. Willis, 997 S.W.2d at 801 (citing Masinter v. WEBCO Co., 262 S.E.2d 433, 438 (W.Va. 1980)).

Obviously, these rules lend themselves to a determination of shareholder oppression on a case by case basis. Thus, an examination of individual cases is instructive.

In Davis, the majority shareholder refused to recognize the minority shareholder's 45% ownership interest in the corporation. The majority claimed that the minority had previously relinquished his stockholdings to the majority as a gift. The jury disagreed and found that the majority shareholder had conspired to deprive the minority shareholder of his ownership interest in the corporation. Referencing the first definition of "oppressive conduct," the Davis court stated that the majority's actions would "not only . . . substantially defeat any reasonable expectations [the minority shareholder] may have had . . . but would totally extinguish any such expectations." Davis, 754 S.W.2d at 382. In addition, the jury found that the majority shareholder had breached his fiduciary duty by making profit-sharing contributions solely for his own benefit, and by wasting corporate funds on his own attorneys' fees. As a result of these findings, the Davis court affirmed the lower court's conclusion that "oppressive conduct" had occurred. After noting that a court "could order less harsh remedies" than liquidation under its "general equity powers," the Davis court upheld an order requiring the majority shareholder to buy out the stockholdings of the minority shareholder at a jury-determined "fair value." Id. at 382-83.

In Willis v. Bydalek, the First Court of Appeals again confronted a statutory action for shareholder oppression. In Willis, a minority shareholder was fired from his employment with a close corporation. The corporation paid no dividends, but the evidence indicated that the business had always been unprofitable. In conducting its shareholder oppression analysis, the Willis court cited the two definitions of "oppressive conduct" that were noted in Davis. After balancing "[the majority's] business judgment in the face of four profitless years of operation against the [minority's] reasonable expectations of participating in the business," the Willis court concluded that no oppressive conduct had occurred. As the court stated, "we hold [that the majority] did not oppress [the minority] by firing him when (1) the jury found no wrong besides a [firing], (2) the corporation and [the majority shareholder], personally, always lost money, both before and after the [firing], and (3) the [minority shareholders] were at-will employees. Though the court expressly stated “We are not holding that firing an at-will employee who is a minority shareholder can never, under any circumstances, constitute shareholder oppression; we simply hold that under these particular facts, it does not.” Willis, 997 S.W.2d at 803. The court does seem to indicate that firing alone is not oppressive conduct, absent an employment agreement. Id.

The Willis case also describes several other cases whose facts were found to be oppressive. In In re Topper, 433 N.Y.S.2d 359, 361-62 (N.Y. 1980), the corporation flourished, but the majority shareholders never paid dividends, and they removed the minority shareholder as an officer and fired him. In McCauley v. Tom McCauley & Son, Inc., 724 P.2d 232, 237 (N.M. 1986), the corporation could have paid, but did not pay, dividends; the majority shareholders received corporate benefits denied the minority shareholder, whom they falsely accused of wrong; and the corporation's records and books were inaccurately and inequitably kept. In Baker v. Commercial Body Builders, Inc., 507 P.2d 387, 390-91, 398 (1973), the majority shareholder prevented the minority shareholder from reviewing the corporate books, took a salary increase while denying one to the minority shareholder, and removed the minority shareholder as officer and director and ceased notifying him of meetings.

Breach of Fiduciary Duty. Texas cases also allow shareholders to challenge oppressive conduct as a breach of fiduciary duty. There are two types of fiduciary relationships--a formal fiduciary relationship that arises as a matter of law, such as principal/agent or partners, and an informal fiduciary relationship arising from a confidential relationship "where one person trusts in and relies upon another, whether the relation is moral social, domestic or merely personal." Crim Truck & Tractor Co. v. Navistar Int'l Transp. Corp., 823 S.W.2d 591, 593-94 (Tex. 1992); Hallmark v. Port/Cooper, 907 S.W.2d 586, 592 (Tex. App.-Corpus Christi 1995, no writ). When a fiduciary relationship is found, the fiduciary duty requires the fiduciary to place the interest of the other party before his or her own. Id.

A director's fiduciary duty runs only to the corporation, not to individual shareholders or even to a majority of the shareholders. Gearhart Indus., Inc. v. Smith Int'l Inc., 741 F.2d 707, 721 (5th Cir.1984); Schautteet v. Chester State Bank, 707 F.Supp. 885, 888 (E.D. Tex. 1988). Similarly, a co-shareholder in a closely held corporation does not as a matter of law owe a fiduciary duty to his co-shareholder. Kaspar v. Thorne, 755 S.W.2d 151, 155 (Tex. App.--Dallas 1988, no writ); Schoellkopf v. Pledger, 739 S.W.2d 914, 920 (Tex. App.--Dallas 1987), rev'd on other grounds, 762 S.W.2d 145 (Tex. 1988). However, though a majority shareholder's fiduciary duty ordinarily runs to the corporation, Schautteet, 707 F.Supp. at 889, in certain limited circumstances, a majority shareholder who dominates control over the business may owe such a duty to the minority shareholder. See e.g., Patton v. Nicholas,, 279 S.W.2d 848 (1955) (injunction issued against majority shareholder maliciously suppressed dividends); Davis v. Sheerin, 754 S.W.2d 375 (Tex. App.-- Houston [1st Dist.] 1988, writ denied) (court-ordered buy-out of minority shareholder where majority shareholder engaged in oppressive conduct); Duncan v. Lichtenberger, 671 S.W.2d 948 (Tex. App.--Fort Worth 1984, writ ref'd n.r.e.) (minority shareholders entitled to reimbursement of monetary contribution to corporation where majority shareholder completely excluded minority shareholders from management of business); Thompson v. Hambrick, 508 S.W.2d 949 (Tex. App.--Dallas 1974, writ ref'd n.r.e.) (fact issue existed as to whether majority shareholders wrongfully obtained premium for selling control of the corporation) Morrison v. St. Anthony Hotel, 295 S.W.2d 246 (Tex. App.--San Antonio 1956, writ ref'd n.r.e.) (former minority shareholder entitled to sue majority shareholder for malicious suppression of dividends).

In Patton v. Nicholas, 279 S.W.2d 848 (Tex. 1955), T.W. Patton was the 60% owner of a close corporation. The other two shareholders, J.W. Nicholas and Robert R. Parks, each owned 20% of the company's stock. The corporation continuously earned profits and the net worth of the corporation steadily increased. Patton, however, refused to declare a dividend. Nicholas and Parks eventually sued, alleging that Patton had committed fraud and abuse of his controlling position. At trial, the jury found in part that Patton "wrongfully dominated and controlled the Board of Directors so as to prevent the declaration of dividends," and that Patton "did this for the sole purpose of preventing Nicholas and Parks from sharing in the profits to be derived from the operation of the corporation." In affirming these jury findings, the Patton court noted that "the malicious suppression of dividends is a wrong akin to a breach of trust, for which the courts will afford a remedy." The court crafted a mandatory injunction requiring the corporation to pay a reasonable dividend "at the earliest practical date" as well as in future years. Id.

In Duncan v. Lichtenberger, 671 S.W.2d 948 (Tex. App.--Fort Worth 1984, writ ref'd n.r.e.), Waldron Duncan owned 60% of a close corporation that operated a night club. C.F. Lichtenberger and D.M. Hogness each owned 20% of the corporation's shares. When the company began to experience financial difficulties, Duncan discharged Lichtenberger and Hogness from their corporate positions. Although Duncan continued to receive management fees and officer compensation, Lichtenberger and Hogness "never received any compensation as corporate officers and no dividends were ever distributed to shareholders." In response to Duncan's actions, Lichtenberger and Hogness asserted that Duncan had breached a fiduciary duty owed directly to them. The jury agreed, and damages were awarded to the two minority shareholders. The Duncan court upheld the jury's findings, observing that "[t]he breach of a fiduciary duty is the type of wrong for which the courts of this State will afford a remedy. Id.

Remedies. Once the court determines oppressive conduct and/or breach of fiduciary duty has occurred, the court should “[tailor] the remedy to fit the particular case.” Patton, 279 S.W.2d at 857. Though Article 7.06 of the Business Corporations Act allows for liquidation in certain circumstances, Texas courts have held that less harsh remedies may be fashioned under their general equity powers. Davis, 754 S.W.2d at 380. Again, we have a rule requiring a case by case determination. Some equitable remedies have included: an ordered buy-out of the minority’s ownership interest at the fair value of the stock as in Davis, 754 S.W.2d at 383; reimbursement of the minority’s investment as in Duncan, 671 S.W.2d at 953; injunctive relief as in Patton, 279 S.W.2d at 848, where the court ordered reasonable dividends to be paid; and a constructive trust over the corporate property as in Willis v. Donnelly, 118 S.W.3d at 32.

As the Texas Supreme Court stated in Patton, “we agree with the practically unanimous judicial opinion that liquidation of solvent going corporations should be the extreme or ultimate remedy, involving as it usually will, accentuation of the economic waste incident to many receiverships and most forced sales.” Patton, 279 S.W.2d at 857. Thus, while liquidation is possible, it should be a last resort in most instances.

Other Considerations. Conspiracy. A civil conspiracy is “a combination by two or more persons to accomplish an unlawful purpose or to accomplish a lawful purpose by unlawful means.” Firestone Steel Products Co. v. Barajas, 927 S.W.2d 608, 614 (Tex. 1996). Conspiracy will usually be pled in order to reach fringe participants, in addition to the main wrongdoer, with joint and several liability.

Breach of Contract. This may become an issue if the minority shareholder had an employment agreement but was terminated nevertheless.

Fraud. Fraud is particularly relevant when the actor fails to disclose something he/she had a duty to disclose. A duty to disclose may arise in four situations: (1) when there is a fiduciary relationship; (2) when one voluntarily discloses information, the whole truth must be disclosed; (3) when one makes a representation, new information must be disclosed when that new information makes the earlier representation misleading or untrue; and (4) when one makes a partial disclosure and conveys a false impression. Formosa Plastics Corp. v. Presidio Engineers and Contractors, Inc., 941 S.W.2d 138, 146-47 (Tex.App.--Corpus Christi, 1995), rev'd on other grounds, 960 S.W.2d 41 (1997); Ralston Purina, 850 S.W.2d at 635-36. As already discussed, a majority shareholder who dominates control over the business may owe a fiduciary duty to the minority shareholder, thus leaving the majority shareholder particularly susceptible to failure to disclose claims.

[1] As of the time of this writing, Case No. 11-0447 Ritchie et al v. Rupe et al is pending before the Texas Supreme Court and was scheduled for oral argument on February 26, 2013.  This is a shareholder oppression case and offers a significant chance at the Court establishing the parameters for shareholder oppression in Texas for the first time.