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| Application of the Texas Business Judgment Rule in Shareholder Oppression |
| Resources >> State Law >> Texas >> App. of the Texas Business Judgment Rule in Shareholder Oppression |
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Author:
Eric Fryar
Eric Fryar
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Ritchie v. Rupe, No. 05-08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 (Tex. App.—Dallas 2011, ____). Read opinion.
The Dallas Court of Appeals recently affirmed a judgment of shareholder oppression based on the majority shareholder’s refusal to
cooperate with the minority shareholder’s efforts to sell her shares to third parties, thus constructively defeating her reasonable expectation
of the free transferability of her shares. The majority defended their actions as protected by the business judgment rule. Ritchie v. Rupe,
No. 05-08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 at *12. The court of appeals rejected that defense and wrote an opinion that
raises several interesting issues regarding the intersection of the business judgment rule and the shareholder oppression doctrine.
The business judgment rule protects a corporation's non-interested officers and directors from personal liability for their actions in operating
the corporation unless their actions are ultra vires or tainted by fraud. See Gearhart Indus., Inc. v. Smith Int'l, Inc., 741 F.2d 707, 721 (5th
Cir. 1984). The application of the business judgment rule in Texas jurisprudence is particularly strong, and the defense is unavailable only if
the challenged action is ultra vires or tainted by fraud or self-dealing. See Langston v. Eagle Pub. Co., 719 S.W.2d 612, 616-17 (Tex. App.-
Waco 1986, writ ref’d n.r.e.); Gearhart Indus., 741 F.2d at 721 (citing Cates v. Sparkman, 73 Tex. 619, 11 S.W. 846, 849 (1889)). An officer
or director is “interested” if he or she (1) makes a personal profit from a transaction by dealing with the corporation or usurps a corporate
opportunity, (2) buys or sells assets of a corporation, (3) transacts business in his or her officer's or director's capacity with a second
corporation of which he or she is also an officer or director or is significantly financially associated, or (4) transacts corporate business in his
or her officer's or director's capacity with a family member. Floyd v. Hefner, 556 F.Supp. 2d 617, 649 (S.D. Tex. 2008); Landon v. S & H
Mktg. Group, Inc., 82 S.W.3d 666, 673 (Tex. App.—Eastland 2002, no pet.). Furthermore, plaintiffs are required to plead and prove the
elements to overcome the protection of the business judgment rule. F.D.I.C. v. Schreiner, 892 F. Supp. 869, 880-81 (W.D. Tex. 1995).
Initially, the Ritchie court stated that the business judgment rule simply did not apply because a shareholder oppression action is not a
derivative suit seeking personal liability against the officers or directors for breaching duties owed to the corporation, and the relief actually
granted by the trial court had been a order requiring the corporation (not the directors) to buy the plaintiff’s shares. Ritchie v. Rupe, No. 05-
08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 at *13. This holding merely dodges the issue as the court’s continued discussion
implicitly concedes. In the oppression context, Texas courts have clearly held that business decisions protected by the business judgment
rule and that mere “dissatisfaction with corporate management” will not establish oppression. See Davis v. Sheerin, 754 S.W.2d 375, 382-83
(Tex. App.—Houston [1st Dist.] 1988, writ denied); see also Texarkana College Bowl, Inc. v. Phillips, 408 S.W.2d 537, 539 (Tex. Civ. App.—
Texarkana 1966, no writ). In Allchin v. Chemic, Inc., 2002 WL 1608616 (Tex. App.—Houston [14th Dist.] 2002, no pet.), the court of appeals
affirmed a directed verdict on the oppression claim, and held that the allegations of the plaintiff, which were principally complaints about his
treatment as an employee and about the competence and performance of the other shareholder in his job responsibilities, did not support a
finding of a pattern of oppressive conduct. The plaintiff’s pattern of oppressive conduct consisted of “not providing as much training as
Allchin expected (although Wadiak provided training material and opportunities to work in the field); failing to use his talent and best effort to
maximize Chemic's success (e.g., drinking and not working a sufficient number of hours); failing to participate materially and contribute to
the operation of the business ("[l]ack of self-control/leadership in the corporation"); failing to allow Allchin to participate and contribute to the
management of the company (e.g., hiring an employee Allchin did not want to hire); and, using Chemic for personal gain (no examples
provided).” The court held: “Allchin's complaints reflect disagreements about policy, and, as such, do not support a claim of shareholder
oppression warranting a buy-out.” Id.
Moreover, in determining whether the challenged conduct is oppressive, the court is required to “exercise caution, balancing the minority
shareholder's reasonable expectations against the corporation's need to exercise its business judgment and run its business efficiently.”
Ritchie v. Rupe, No. 05-08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 at *8; see also Willis v. Bydalek, 997 S.W.2d 798, 801 (Tex.App.
-Houston [1st Dist.] 1999, pet. denied) (recognizing that “a corporation's officers and directors are still afforded a rather broad latitude in
conducting corporate affairs” and referring to need to balance minority shareholders' reasonable expectations against the policy of the
business judgment rule).
The defendants in the Ritchie case argued that their decision not to communicate with potential investors was a legitimate business decision
based on the fact that such communications would potentially expose the corporation to future litigation resulting from information that it
might provide to prospective investors. Clearly the defendants had no personal interest in the minority shareholder’s potential sale, and it is
difficult to see what self-interest would be furthered by thwarting the sale. This was not a situation in which the majority was trying to squeeze
out the minority or to force a sale at a lower price by excluding competition. Therefore, under the typical application of the business
judgment rule, the defendants’ business judgment would not be subject to judicial scrutiny. However, in the shareholder oppression context,
according to the Ritchie court, the business judgment rule operates differently. In shareholder oppression, the business judgment rule does
not provide a true defense; rather, the court is required to balance the interests protected by the business judgment rule against the
interests protected by the shareholder oppression doctrine. As the Ritchie court noted, “the corporation's interest in managing its affairs …
does not include the right to ‘substantially defeat’ the reasonable expectation of a minority shareholder.” Id. at *13.
The Ritchie court did not state rules for the application of the business judgment rule in the shareholder oppression context, but several
principles are apparent from the court’s analysis of the issue. At the outset, the business judgment rule would not be a consideration at all
for the vast majority of oppressive acts, where the challenged conduct not only harms the minority but benefits the majority because such
conduct would be self-interested. Similarly, conduct by the majority that was fraudulent or violated specific legal rights or was beyond the
authority of the majority and was thus ultra vires would also be outside the business judgment rule. For those situations in which the rule
does apply, however, the Ritchie court’s analysis would clearly place the burden on the majority shareholder to prove that the corporation’s
need to exercise its business judgment under the specific circumstances outweighed the minority shareholder’s reasonable expectation
interests. See id. First, the majority must demonstrate that the corporation’s interests at issue outweighed the minority shareholder’s
interests. There must be proof a material effect on “the operation of the business.” Id. at *15. The Ritchie court held that the defendants
failed to meet this burden because the “general and nonspecific fear of litigation with third parties” was insufficient to outweigh the
substantial negative effects on plaintiff’s interests. Id. at *14. Second, the majority must prove that there were not other means available to
achieve its business objective with less harm to the minority shareholder’s interests. The Ritchie court rejected the defendants’ business
judgment defense in part because “there are several means by which the corporation can protect itself from litigation short of a flat refusal
to meet with potential buyers.” Id.
Ritchie v. Rupe, No. 05-08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 (Tex. App.—Dallas 2011, ____). Read opinion.
The Dallas Court of Appeals recently affirmed a judgment of shareholder oppression based on the majority shareholder’s refusal to
cooperate with the minority shareholder’s efforts to sell her shares to third parties, thus constructively defeating her reasonable expectation
of the free transferability of her shares. The majority defended their actions as protected by the business judgment rule. Ritchie v. Rupe,
No. 05-08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 at *12. The court of appeals rejected that defense and wrote an opinion that
raises several interesting issues regarding the intersection of the business judgment rule and the shareholder oppression doctrine.
The business judgment rule protects a corporation's non-interested officers and directors from personal liability for their actions in operating
the corporation unless their actions are ultra vires or tainted by fraud. See Gearhart Indus., Inc. v. Smith Int'l, Inc., 741 F.2d 707, 721 (5th
Cir. 1984). The application of the business judgment rule in Texas jurisprudence is particularly strong, and the defense is unavailable only if
the challenged action is ultra vires or tainted by fraud or self-dealing. See Langston v. Eagle Pub. Co., 719 S.W.2d 612, 616-17 (Tex. App.-
Waco 1986, writ ref’d n.r.e.); Gearhart Indus., 741 F.2d at 721 (citing Cates v. Sparkman, 73 Tex. 619, 11 S.W. 846, 849 (1889)). An officer
or director is “interested” if he or she (1) makes a personal profit from a transaction by dealing with the corporation or usurps a corporate
opportunity, (2) buys or sells assets of a corporation, (3) transacts business in his or her officer's or director's capacity with a second
corporation of which he or she is also an officer or director or is significantly financially associated, or (4) transacts corporate business in his
or her officer's or director's capacity with a family member. Floyd v. Hefner, 556 F.Supp. 2d 617, 649 (S.D. Tex. 2008); Landon v. S & H
Mktg. Group, Inc., 82 S.W.3d 666, 673 (Tex. App.—Eastland 2002, no pet.). Furthermore, plaintiffs are required to plead and prove the
elements to overcome the protection of the business judgment rule. F.D.I.C. v. Schreiner, 892 F. Supp. 869, 880-81 (W.D. Tex. 1995).
Initially, the Ritchie court stated that the business judgment rule simply did not apply because a shareholder oppression action is not a
derivative suit seeking personal liability against the officers or directors for breaching duties owed to the corporation, and the relief actually
granted by the trial court had been a order requiring the corporation (not the directors) to buy the plaintiff’s shares. Ritchie v. Rupe, No. 05-
08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 at *13. This holding merely dodges the issue as the court’s continued discussion
implicitly concedes. In the oppression context, Texas courts have clearly held that business decisions protected by the business judgment
rule and that mere “dissatisfaction with corporate management” will not establish oppression. See Davis v. Sheerin, 754 S.W.2d 375, 382-83
(Tex. App.—Houston [1st Dist.] 1988, writ denied); see also Texarkana College Bowl, Inc. v. Phillips, 408 S.W.2d 537, 539 (Tex. Civ. App.—
Texarkana 1966, no writ). In Allchin v. Chemic, Inc., 2002 WL 1608616 (Tex. App.—Houston [14th Dist.] 2002, no pet.), the court of appeals
affirmed a directed verdict on the oppression claim, and held that the allegations of the plaintiff, which were principally complaints about his
treatment as an employee and about the competence and performance of the other shareholder in his job responsibilities, did not support a
finding of a pattern of oppressive conduct. The plaintiff’s pattern of oppressive conduct consisted of “not providing as much training as
Allchin expected (although Wadiak provided training material and opportunities to work in the field); failing to use his talent and best effort to
maximize Chemic's success (e.g., drinking and not working a sufficient number of hours); failing to participate materially and contribute to
the operation of the business ("[l]ack of self-control/leadership in the corporation"); failing to allow Allchin to participate and contribute to the
management of the company (e.g., hiring an employee Allchin did not want to hire); and, using Chemic for personal gain (no examples
provided).” The court held: “Allchin's complaints reflect disagreements about policy, and, as such, do not support a claim of shareholder
oppression warranting a buy-out.” Id.
Moreover, in determining whether the challenged conduct is oppressive, the court is required to “exercise caution, balancing the minority
shareholder's reasonable expectations against the corporation's need to exercise its business judgment and run its business efficiently.”
Ritchie v. Rupe, No. 05-08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 at *8; see also Willis v. Bydalek, 997 S.W.2d 798, 801 (Tex.App.
-Houston [1st Dist.] 1999, pet. denied) (recognizing that “a corporation's officers and directors are still afforded a rather broad latitude in
conducting corporate affairs” and referring to need to balance minority shareholders' reasonable expectations against the policy of the
business judgment rule).
The defendants in the Ritchie case argued that their decision not to communicate with potential investors was a legitimate business decision
based on the fact that such communications would potentially expose the corporation to future litigation resulting from information that it
might provide to prospective investors. Clearly the defendants had no personal interest in the minority shareholder’s potential sale, and it is
difficult to see what self-interest would be furthered by thwarting the sale. This was not a situation in which the majority was trying to squeeze
out the minority or to force a sale at a lower price by excluding competition. Therefore, under the typical application of the business
judgment rule, the defendants’ business judgment would not be subject to judicial scrutiny. However, in the shareholder oppression context,
according to the Ritchie court, the business judgment rule operates differently. In shareholder oppression, the business judgment rule does
not provide a true defense; rather, the court is required to balance the interests protected by the business judgment rule against the
interests protected by the shareholder oppression doctrine. As the Ritchie court noted, “the corporation's interest in managing its affairs …
does not include the right to ‘substantially defeat’ the reasonable expectation of a minority shareholder.” Id. at *13.
The Ritchie court did not state rules for the application of the business judgment rule in the shareholder oppression context, but several
principles are apparent from the court’s analysis of the issue. At the outset, the business judgment rule would not be a consideration at all
for the vast majority of oppressive acts, where the challenged conduct not only harms the minority but benefits the majority because such
conduct would be self-interested. Similarly, conduct by the majority that was fraudulent or violated specific legal rights or was beyond the
authority of the majority and was thus ultra vires would also be outside the business judgment rule. For those situations in which the rule
does apply, however, the Ritchie court’s analysis would clearly place the burden on the majority shareholder to prove that the corporation’s
need to exercise its business judgment under the specific circumstances outweighed the minority shareholder’s reasonable expectation
interests. See id. First, the majority must demonstrate that the corporation’s interests at issue outweighed the minority shareholder’s
interests. There must be proof a material effect on “the operation of the business.” Id. at *15. The Ritchie court held that the defendants
failed to meet this burden because the “general and nonspecific fear of litigation with third parties” was insufficient to outweigh the
substantial negative effects on plaintiff’s interests. Id. at *14. Second, the majority must prove that there were not other means available to
achieve its business objective with less harm to the minority shareholder’s interests. The Ritchie court rejected the defendants’ business
judgment defense in part because “there are several means by which the corporation can protect itself from litigation short of a flat refusal
to meet with potential buyers.” Id.
| Last Updated: 4/3/11 |