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| Protecting the Rights of Business Owners |
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| The Right to Transfer Shares as a Reasonable Expectation |
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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 held that, absent valid restrictions on alienability or limitations imposed by contract, all shareholders
have the reasonable expectation of the right to sell their shares to whomever they please at any price they wish. See Ritchie v. Rupe, No.
05-08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 at *10 (Tex. App.—Dallas 2011, ____). The court held that the right to sell is a
“general reasonable expectation” and is presumed as a matter of law to belong to all shareholders and to be “both reasonable under the
circumstances and central to the decision to invest in the corporation,” absent evidence to the contrary. Id. at *9.
The court reasoned that every property owner, including the owner of stock in a corporation, has the right of free alienation of property. Id.
(citing TEX. CONST. art. I, § 26 interp. commentary (West 2007) (“The framers of the Texas Constitutions, beginning with that of the
Republic, have believed in an unrestrained power to convey or transfer property, and thus have written into the Bill of Rights this provision
against perpetuities, primogeniture and the entailment of estates.”)); see Hicks v. Castille, 313 S.W.3d 874, 881-82 (Tex. App.—Amarillo
2010, pet. denied) (alienability is a legal incident of property); see also Thompson v. Hambrick, 508 S.W.2d 949, 953-54 (Tex. Civ. App.—
Dallas 1974, writ ref'd n.r.e.) (applying the rule to stock). Unrestricted shares are freely transferable. Sandor Petroleum Corp. v. Williams,
321 S.W.2d 614, 617 (Tex. Civ. App.—Eastland 1959, writ ref'd n.r.e.) (“Generally speaking, corporate shares of stock are property which
may be freely sold and delivered.”).
Texas Business Organizations Code §20.209 provides that all shares are transferrable, “except as otherwise provided by this code.” Section
20.210 permits restrictions on transfer to be imposed by a corporations certificate of formation (articles of incorporation), bylaws, written
agreement among two or more shareholders, or written agreement between the corporation and one or more shareholders (subject to
certain disclosure requirements). Section 20.211 provides for the validity of most types of restrictions on transferability of shares. However,
the code imposes two significant limitations. The first is that restrictions on transfer must be reasonable. BOC §§21.211(a); 21.213(a)(2).
The Texas Supreme Court in Ling & Co., Inc. v. Trinity Sav. & Loan Ass'n, 482 S.W.2d 841, 844 (Tex. 1972), upheld the reasonableness of
a requirement to notify all shareholders prior to any transfer of shares. However, the Court noted that the reasonableness requirement
does impose limits: “Conceivably the number of stockholders might be so great as to make the burden too heavy upon the stockholder who
wishes to sell and, at the same time, dispel any justification for contending that there exists a reasonable corporate purpose in restricting the
ownership. But there is no showing of that nature in this summary judgment record.” See also Tenneco, Inc. v. Enter. Prod. Co., 925 S.W.2d
640, 646 (Tex.1996) (“Sound corporate jurisprudence requires that courts narrowly construe rights of first refusal and other provisions that
effectively restrict the free transfer of stock.”); Dixie Pipe Sales, Inc. v. Perry, 834 S.W.2d 491, 493 (Tex. App.—Houston [14th Dist.] 1992,
writ denied) (“The reasonableness of [a transfer] restriction is ordinarily to be determined by applying the test of whether the provision is
sufficiently necessary to the particular corporate enterprise to justify overruling the usual policy of the law in opposition to restraints on the
alienability of personal property.”).
The other major restriction is that any limit on the transferability of shares must be imposed before the shares are issued, unless the
shareholder votes in favor of the restriction or is a party to an agreement imposing a restriction. BOC §21.210(b). Majority shareholders can
act oppressively by attempting to impose new restrictions on minority shareholders by amending the articles or bylaws. This was the
situation in Sandor Petroleum Corp. v. Williams, 321 S.W.2d 614 (Tex. Civ. App.—Eastland 1959, writ ref'd n.r.e.). In that case, a
corporation had issued unrestricted stock to its four founding shareholders for valuable consideration. Sandor, 321 S.W.2d at 616-17.
When a dispute over management arose, one of the shareholders offered his stock for sale. Id. The other three shareholders (who were
also directors) then adopted a new bylaw containing restrictions on the transfer of stock, canceled the unrestricted share certificates, and
issuing new share certificates containing the newly adopted transfer restrictions. Id.
The court in Sandor recognized the minority shareholder owned the stock free of any restriction on transfer and “[h]is ownership of the stock
and his right to sell or transfer it was a vested right and interest, subject only to the right of the corporation to manage and regulate its
affairs under the laws of this state and under the provisions of its charter and bylaws.” Sandor, 321 S.W.2d at 617. The court rejected the
argument that newly adopted transfer restrictions could be imposed on existing unrestricted stock, explaining that “[s]uch a restriction on
previously un- restricted stock would unreasonably restrain and prohibit its sale and transfer and could result in depriving the owner of the
full value of his stock.” Id. at 618. The court concluded the corporation's right to manage its affairs did not include the right to adopt policies
that impair the vested rights of holders of unrestricted stock to seek to sell their stock:
Id. at 618-19. The Sandor court affirmed an award of damages for conversion to the minority shareholder based on the cancellation of his
original share certificates.
The Dallas Court of Appeals in Ritchie v. Rupe, No. 05-08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 at *11, found the Sandor case
instructive, except that the majority shareholders in Ritchie had not taken any action overtly to prohibit the minority shareholder from
attempting to sell her stock. Rather, the majority shareholders and directors simply refused to communicate with prospective purchasers
solicited by the minority shareholder. The minority shareholder’s broker testified that any prospective purchaser would expect to meet with
management as part of normal due diligence and that the refusal by the majority shareholders to meet with prospective purchasers had
made it impossible to market the shares. The court of appeals held that this refusal on the part of the majority substantially defeated the
minority shareholder’s reasonable expectation of the free transferability of her shares. Id. at *11. In addition to the substantive legal right to
sell her shares, the court also focused on the realities of attempting to sell a minority interest in a closely-held corporation:
Id. The court held that the majority’s refusal to cooperate with the minority shareholder’s attempts to sell, “constructively prohibit[ed] the
shareholder from performing these activities” and therefore “would substantially defeat the shareholder's general reasonable expectation of
being able to market her unrestricted stock.” Id. This holding is somewhat striking in that the majority is not only prohibited from interfering
with the right to sell, but the court imposes an affirmative obligation on the majority to cooperate.
Independently, the court held that the second prong of the shareholder oppression definition imposes affirmative obligations on the
majority. In addition to protecting a shareholder’s reasonable expectations, the shareholder oppression doctrine also prohibits
“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.” The court
noted: “The second definition of shareholder oppression will often overlap the reasonable expectations definition because the standards of
fair dealing on which all shareholders are entitled to rely will often include conduct necessary to meet the reasonable expectations of
shareholders.” Id. at *11. Therefore, the court held that the majority’s duty of fair dealing necessarily encompassed an obligation to
cooperate in the minority shareholder’s attempts to realize her reasonable expectation of the right to sell her stock: “Because a holder of
unrestricted stock in a closely held corporation has a general reasonable expectation of being able to market her stock to third parties, it is
also reasonable to expect that the corporation and its management (as part of the standards of fair dealing on which all shareholders are
entitled to rely) will consent to a shareholder's reasonable requests for cooperation with respect to her efforts to sell the stock.” Id. at *12.
The court was quick to point out, however, “the rights of the minority shareholder and the concomitant obligations of the directors or those in
control of the corporation are not unlimited.” Id. at *14. The affirmative duties imposed on the majority are only to act reasonably and fairly
and to avoid conduct that substantially defeats reasonable expectations.
Id. Furthermore, the court recognized the right to impose reasonable restrictions on the access to and use of business information and
reasonable limitations on the corporation’s cooperation, including limiting the time spent with potential investors and requiring them to sign
confidentiality agreements. 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 held that, absent valid restrictions on alienability or limitations imposed by contract, all shareholders
have the reasonable expectation of the right to sell their shares to whomever they please at any price they wish. See Ritchie v. Rupe, No.
05-08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 at *10 (Tex. App.—Dallas 2011, ____). The court held that the right to sell is a
“general reasonable expectation” and is presumed as a matter of law to belong to all shareholders and to be “both reasonable under the
circumstances and central to the decision to invest in the corporation,” absent evidence to the contrary. Id. at *9.
The court reasoned that every property owner, including the owner of stock in a corporation, has the right of free alienation of property. Id.
(citing TEX. CONST. art. I, § 26 interp. commentary (West 2007) (“The framers of the Texas Constitutions, beginning with that of the
Republic, have believed in an unrestrained power to convey or transfer property, and thus have written into the Bill of Rights this provision
against perpetuities, primogeniture and the entailment of estates.”)); see Hicks v. Castille, 313 S.W.3d 874, 881-82 (Tex. App.—Amarillo
2010, pet. denied) (alienability is a legal incident of property); see also Thompson v. Hambrick, 508 S.W.2d 949, 953-54 (Tex. Civ. App.—
Dallas 1974, writ ref'd n.r.e.) (applying the rule to stock). Unrestricted shares are freely transferable. Sandor Petroleum Corp. v. Williams,
321 S.W.2d 614, 617 (Tex. Civ. App.—Eastland 1959, writ ref'd n.r.e.) (“Generally speaking, corporate shares of stock are property which
may be freely sold and delivered.”).
Texas Business Organizations Code §20.209 provides that all shares are transferrable, “except as otherwise provided by this code.” Section
20.210 permits restrictions on transfer to be imposed by a corporations certificate of formation (articles of incorporation), bylaws, written
agreement among two or more shareholders, or written agreement between the corporation and one or more shareholders (subject to
certain disclosure requirements). Section 20.211 provides for the validity of most types of restrictions on transferability of shares. However,
the code imposes two significant limitations. The first is that restrictions on transfer must be reasonable. BOC §§21.211(a); 21.213(a)(2).
The Texas Supreme Court in Ling & Co., Inc. v. Trinity Sav. & Loan Ass'n, 482 S.W.2d 841, 844 (Tex. 1972), upheld the reasonableness of
a requirement to notify all shareholders prior to any transfer of shares. However, the Court noted that the reasonableness requirement
does impose limits: “Conceivably the number of stockholders might be so great as to make the burden too heavy upon the stockholder who
wishes to sell and, at the same time, dispel any justification for contending that there exists a reasonable corporate purpose in restricting the
ownership. But there is no showing of that nature in this summary judgment record.” See also Tenneco, Inc. v. Enter. Prod. Co., 925 S.W.2d
640, 646 (Tex.1996) (“Sound corporate jurisprudence requires that courts narrowly construe rights of first refusal and other provisions that
effectively restrict the free transfer of stock.”); Dixie Pipe Sales, Inc. v. Perry, 834 S.W.2d 491, 493 (Tex. App.—Houston [14th Dist.] 1992,
writ denied) (“The reasonableness of [a transfer] restriction is ordinarily to be determined by applying the test of whether the provision is
sufficiently necessary to the particular corporate enterprise to justify overruling the usual policy of the law in opposition to restraints on the
alienability of personal property.”).
The other major restriction is that any limit on the transferability of shares must be imposed before the shares are issued, unless the
shareholder votes in favor of the restriction or is a party to an agreement imposing a restriction. BOC §21.210(b). Majority shareholders can
act oppressively by attempting to impose new restrictions on minority shareholders by amending the articles or bylaws. This was the
situation in Sandor Petroleum Corp. v. Williams, 321 S.W.2d 614 (Tex. Civ. App.—Eastland 1959, writ ref'd n.r.e.). In that case, a
corporation had issued unrestricted stock to its four founding shareholders for valuable consideration. Sandor, 321 S.W.2d at 616-17.
When a dispute over management arose, one of the shareholders offered his stock for sale. Id. The other three shareholders (who were
also directors) then adopted a new bylaw containing restrictions on the transfer of stock, canceled the unrestricted share certificates, and
issuing new share certificates containing the newly adopted transfer restrictions. Id.
The court in Sandor recognized the minority shareholder owned the stock free of any restriction on transfer and “[h]is ownership of the stock
and his right to sell or transfer it was a vested right and interest, subject only to the right of the corporation to manage and regulate its
affairs under the laws of this state and under the provisions of its charter and bylaws.” Sandor, 321 S.W.2d at 617. The court rejected the
argument that newly adopted transfer restrictions could be imposed on existing unrestricted stock, explaining that “[s]uch a restriction on
previously un- restricted stock would unreasonably restrain and prohibit its sale and transfer and could result in depriving the owner of the
full value of his stock.” Id. at 618. The court concluded the corporation's right to manage its affairs did not include the right to adopt policies
that impair the vested rights of holders of unrestricted stock to seek to sell their stock:
- Williams had a vested property right in the value of his stock. The right of the corporation to regulate and to manage its affairs does
not include the power to impair that vested contractual right and to take from holders of unrestricted stock the value of their stock.
The amended bylaw of the Sandor Petroleum Corporation so restricting the sale of its previously unrestricted stock was, therefore,
unauthorized and invalid in so far as it denied appellee's right to sell at a price which he could have secured on the open market.
Id. at 618-19. The Sandor court affirmed an award of damages for conversion to the minority shareholder based on the cancellation of his
original share certificates.
The Dallas Court of Appeals in Ritchie v. Rupe, No. 05-08-00615-CV, ___ S.W.3d ____, 2011 WL 1107214 at *11, found the Sandor case
instructive, except that the majority shareholders in Ritchie had not taken any action overtly to prohibit the minority shareholder from
attempting to sell her stock. Rather, the majority shareholders and directors simply refused to communicate with prospective purchasers
solicited by the minority shareholder. The minority shareholder’s broker testified that any prospective purchaser would expect to meet with
management as part of normal due diligence and that the refusal by the majority shareholders to meet with prospective purchasers had
made it impossible to market the shares. The court of appeals held that this refusal on the part of the majority substantially defeated the
minority shareholder’s reasonable expectation of the free transferability of her shares. Id. at *11. In addition to the substantive legal right to
sell her shares, the court also focused on the realities of attempting to sell a minority interest in a closely-held corporation:
- Despite the general reasonable expectation of being able to sell unrestricted shares at a mutually acceptable price, often no ready
market exists for the stock in a closely held corporation, especially if it represents a non-controlling, minority interest. In that context,
unless the minority shareholder reaches an agreement to sell her stock back to the closely held corporation or to someone already
involved in its ownership or management, to sell her stock she must market it to third parties. Because often no ready market exists,
to sell her stock to third parties she must market her stock by (1) identifying potential third-party buyers through means such as
advertising, networking through brokers and others, and meeting with potential buyers, and then (2) providing to those potential
buyers sufficient information about the corporation and its businesses, assets, and management as to allow them to conduct a
reasonable investigation as to the proposed transaction.
Id. The court held that the majority’s refusal to cooperate with the minority shareholder’s attempts to sell, “constructively prohibit[ed] the
shareholder from performing these activities” and therefore “would substantially defeat the shareholder's general reasonable expectation of
being able to market her unrestricted stock.” Id. This holding is somewhat striking in that the majority is not only prohibited from interfering
with the right to sell, but the court imposes an affirmative obligation on the majority to cooperate.
Independently, the court held that the second prong of the shareholder oppression definition imposes affirmative obligations on the
majority. In addition to protecting a shareholder’s reasonable expectations, the shareholder oppression doctrine also prohibits
“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.” The court
noted: “The second definition of shareholder oppression will often overlap the reasonable expectations definition because the standards of
fair dealing on which all shareholders are entitled to rely will often include conduct necessary to meet the reasonable expectations of
shareholders.” Id. at *11. Therefore, the court held that the majority’s duty of fair dealing necessarily encompassed an obligation to
cooperate in the minority shareholder’s attempts to realize her reasonable expectation of the right to sell her stock: “Because a holder of
unrestricted stock in a closely held corporation has a general reasonable expectation of being able to market her stock to third parties, it is
also reasonable to expect that the corporation and its management (as part of the standards of fair dealing on which all shareholders are
entitled to rely) will consent to a shareholder's reasonable requests for cooperation with respect to her efforts to sell the stock.” Id. at *12.
The court was quick to point out, however, “the rights of the minority shareholder and the concomitant obligations of the directors or those in
control of the corporation are not unlimited.” Id. at *14. The affirmative duties imposed on the majority are only to act reasonably and fairly
and to avoid conduct that substantially defeats reasonable expectations.
- For example, and in the context of a minority shareholder's efforts to sell her stock, the majority shareholders, directors, or those in
control of the corporation need not seek potential purchasers for the minority shareholder's stock or otherwise market the stock on
her behalf. They need not agree to requests that would unduly disrupt or affect the operation of the business or intrude into issues
reserved for corporation's officers and directors. And a shareholder cannot request the corporation's management to speak or act in
a manner that would tend to inflate the value of the stock and the corporation, and the shareholder may not request that management
mislead potential investors.
Id. Furthermore, the court recognized the right to impose reasonable restrictions on the access to and use of business information and
reasonable limitations on the corporation’s cooperation, including limiting the time spent with potential investors and requiring them to sign
confidentiality agreements. Id.
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