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Elements of Breach of Trust Cause of Action

Proving the elements of the breach of trust cause of action. A shareholder's remedy for a corporation's breach of quasi-fiduciary duties to its shareholders.

breach of trust

Proving Breach of Trust 

As stated in Cates v. Sparkman, equitable relief is available in an action brought directly by the minority shareholder against the corporation to remedy a broad category of wrongful corporate conduct defined as follows: (1) “injurious practices, abuse of power, and oppression on the part of the company or its controlling agency,” (2) “clearly subversive of the rights of the minority, or of a shareholder,” and (3) “without such [an equitable remedy], would leave the latter remediless.” From this statement, and based on the holding of Yeaman v. Galveston City Co. and other cases defining shareholder rights and corporate trustee duties, we can derive the three elements that a plaintiff must establish to be entitled to equitable relief based on breach of trust: (1) Intent to harm the minority; (2) impairment of minority ownership rights; and (3) no adequate alternative remedy.

Breach of Trust Elements: Intent to Harm the Minority

A plaintiff asserting a breach of trust claim would be required, first, to prove corporate action with the intent to harm or disadvantage the minority, conduct that Cates characterized as “injurious practices, abuse of power, and oppression on the part of the company or its controlling agency.”  The controlling fact in the cause of action recognized in Patton v. Nicholas was the “malicious purpose” or “wrongful state of mind” in connection with the corporate decision not to declare dividends.  It would not seem necessary to prove common law malice, defined as “ill-will, spite, or evil motive.”  Rather, what is at issue is the violation of the corporation’s duty of impartiality or fairness, which would require proof of an intention to harm the interests of the minority or to favor the interests of the majority at the expense of the minority.  However, proof that the decision was influenced by personal animosity against or hostile relations with the minority would certainly be sufficient.

The element of intent flows from the corporation's duty of impartiality. Under trust law, the duty of impartiality imposes both a negative duty prohibiting a trustee from acting for the purpose of favoring one beneficiary or harming another and an affirmative duty to consider the varying interests of all beneficiaries and to make decisions fairly and impartially with regard to competing or inconsistent interests. Therefore, the intent element would likely be defined as acting with the purpose of impairing the interests of the plaintiff or favoring the interests of another shareholder to the relative disadvantage of the plaintiff or acting with reckless disregard of the interests of the plaintiff. Yeaman v. Galveston City Co. does not discuss the intent element, but the language of the Court certainly implies that it is concerned with intentional impairment of shareholder interests. Nevertheless, in Yeaman, the original shareholder never exchanged his original certificates for share certificates in the corporation. The corporation, meanwhile, did not hear anything from the original shareholder or his heirs for the next 72 years. The Court's statement of the facts is certainly consistent with the corporation having acted in cancelling the plaintiffs' share ownership without any evil intention toward the shareholders. The standard of "reckless disregard of the interests of the plaintiff" argued for here is perhaps a higher burden than the Yeaman Court would have imposed, but seems a reasonable interpretation of the duty as recognized in trust law.

However, there will certainly be instances where a decision has multiple purposes, some legitimate and some not legitimate. Because breach of the duty of impartiality is a sort of discrimination, courts would probably look to other causes of action based on discriminatory intent. In employment discrimination claims, the plaintiff need only prove that the improper motive was a motivating factor--not necessarily the only motivating factor--in order to prove a prima facia case. Given the difficulty of proving intent, it would seem that the "a motivating factor" standard would be the most appropriate in proving the intent element of breach of trust. This analysis is also consistent with Ritchie v. Rupe's description of the fiduciary duties that the officers and directors owe to the corporation. Ritchie repeatedly states that officers and directors breach their fiduciary duties to the corporation when they fail to act solely in the best interests of the company--indicating that officers and directors may be liable to the corporation if they act to benefit themselves or the majority shareholder even though they may also be acting to further the corporation's interests. In a claim brought be or on behalf of a corporation against a self-dealing director, the corporation proves a prima facie case by demonstrating the self-interest; the burden of proof then shifts to the self-dealing director to prove entire fairness to the corporation. The same standard should apply when the shareholder sues for breach of trust: Once a lack of impartiality is shown, then the burden of proof reverses, and the corporation may establish good faith and fair dealing as an affirmative defense.

In extreme cases, like Boehringer v. Konkel and Davis v. Sheerin, where a majority shareholder causes a corporation to functionally cancel a minority shareholder’s ownership interest, there should be little question that the minority shareholder has an individual claim. Less extreme cases, however, such as the underlying dispute in Ritchie v. Rupe, are more difficult. In a lawsuit like Ritchie, the plaintiff would likely allege that the corporation adopted a policy not to meet with potential purchasers with the specific intent and purpose of interfering with the minority shareholder's right to transfer ownership of her shares. It would not be sufficient to claim that the corporation violated the duty of impartiality because only the plaintiff was trying to sell her shares, and only she was disadvantaged by the effect of the policy. The policy would affect all shareholders the same. Under the particular circumstances, its negative effects were felt more by one shareholder than others, but none of the shareholders were benefitted at the expense of any other shareholder. The plaintiff's entitlement to an equitable remedy would depend upon the establishment of the fact that the corporate “policy” was a pretext and that the true purpose and intent had been a malicious desire to harm a single shareholder.

The intent element of breach of trust will always be a fact question for the jury.

Breach of Trust Elements: Impairment of Minority Ownership Rights

The second element of the breach of trust claim would be that the corporation’s act taken with the purpose of harming his interests did in fact cause injury. The injury would not necessarily be financial but would require a showing that the effect of the corporate decision was “clearly subversive of the rights of the minority, or of a shareholder.” The requisite injury would be an impairment of fundamental ownership rights, such as the rights of recognition of ownership, voice, information, transferability, or proportional share in profits, or of the corporate trustee violated a duties of impartiality or fair dealing or other duties to the shareholder arising from the trust relationship.

Generally, the second element of the breach of trust cause of action would be a legal question for the court. The plaintiff must show a wrongful state of mind with respect to the decision for corporate action, but must also demonstrate an effect that causes injury. Because the injury is one of impairing legal rights and interests, the issue would almost always be one of law. However, as was the practice under the equitable cause of action in the former shareholder oppression doctrine, while the question of violation of shareholder rights will be a legal one for the court, there may be factual disputes regarding what actions took place. Those factual disputes would be submitted to the jury.

Breach of Trust Elements: No Adequate Alternative Remedy

The final element, also one for the court, would be the absence of an adequate alternative remedy. In order to invoke the remedial powers of a court in equity, the plaintiff must prove the absence of an adequate remedy at law—that, as the Cates opinion stated, “without such [an equitable remedy], would leave the [shareholder] remediless.”  The existence of an adequate remedy at law bars equitable relief.  Therefore, if the plaintiff can be made whole through application of a statutory or legal remedy, such as recovery of damages through a derivative suit or the enforcement of statutory inspection rights, equity will not provide an additional remedy. The equitable remedies are available only in the absence of an adequate remedy at law.  It is the plaintiff’s burden to plead and prove that there is no adequate remedy at law.

This approach would also be consistent with the policy articulated in Ritchie v. Rupe of protecting the interests of shareholders first by protecting the well being of the corporation (primarily through derivative suits). The Ritchie Court concluded that the availability of the derivative claim remedy for breach of fiduciary duties by officers and directors was "sufficient" to protect the interests of minority shareholders. We have argued that it is not, and the Ritchie Court conceded that it may be leaving a gap in the law that will need to be addressed by further development. Technically, a derivative action is also an equitable remedy, not an alternative remedy at law. Nevertheless, because the derivative remedy is now codified in statute, and because legal tort remedies are pursued through the derivative action, and because the Ritchie Court clearly stated the public policy favoring corporate remedies over individual ones, a plaintiff would need to prove that relief available through a derivative action would be inadequate in order to proceed individually on a claim of breach of trust.

The fact that the “complainant may have a remedy at law, however, is not conclusive that such remedy is adequate and does not foreclose his right to equitable relief.”  The legal remedy must be “complete and adequate.”  Equitable relief will be available when “the legal remedy is not as complete as, less effective than, or less satisfactory than the equitable remedy.”  In Davis v. Sheerin, the court recognized that damages awarded in a derivative suit would make the plaintiff whole for some of the wrongdoing, but would not remedy the total exclusion and disregard of the plaintiff’s ownership interest and would not remedy the pattern of oppression and likelihood of its continuation.  In determining the completeness and adequacy of legal remedies, courts should determine whether those in control of the corporation are acting for the purpose of harming the minority shareholder and the likelihood that they will continue to do so, as the Supreme Court did in Patton v. Nicholas.

An important corollary is that “[e]quity looks with favor upon a complete disposition of controversies in one action rather than in multiple suits. Equity abhors a multiplicity of actions.”  If the only prospect the minority shareholder has to protect his rights is a never-ending series of derivative damages claims and statutory enforcement actions, the court of equity would step in to provide a more permanent remedy. “If equity jurisdiction can interfere to prevent a multiplicity of suits, the condition of this record presents such facts or conditions as to call for the exercise thereof. It would be a paradox to say that equity jurisdiction can be exercised to prevent a multiplicity of suits and at the same time say that a legal remedy is complete and adequate, although it leads to such multiplicity. To our minds, if a remedy at law, though otherwise complete and adequate, leads to a multiplicity of suits, that very fact prevents it from being complete and adequate.”

In many cases, the derivative and statutory remedies discussed in the Ritchie opinion would be adequate. In many cases they would not. In a typical shareholder oppression lawsuit involving firing the plaintiff, no dividends, and excessive compensation to the majority shareholder, the plaintiff’s claim would involve conduct that potentially breached both officer/director duties to the corporation and corporate duties to the minority shareholder. Under Ritchie v. Rupe, the plaintiff could assert derivative claims to recover the overpayments to the majority shareholder as damages and for injuctive relief to compel payment of dividends. Depending on the case, those remedies might be adequate to make the plaintiff whole, in which case the plaintiff would have no equitable remedy for the violation of the corporation’s duties to himself. However, in most cases where a court would have granted a remedy under the shareholder oppression
doctrine, the plaintiff would be able to argue that his legal remedies described by the Ritchie Court are inadequate because they provide no remedy that would fully compensate the minority shareholder for the harm caused by the loss of his ownership rights, provide no protection against the majority shareholder’s malicious intent to harm the minority and the likelihood of future repetition, and will necessarily lead to a multiplicity of actions.

Houston Business Lawyer Eric Fryar About the author: Houston Business Lawyer Eric Fryar is a published author and recognized expert in the field of shareholder oppression and the rights of small business owners. Eric has devoted his practice almost exclusively to the protection of shareholder rights over the last 25 years. Learn more

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This post represents our opinion regarding the relevant shareholder oppression and minority ownership rights law. However, not everyone agrees with us, and the law is changing quickly in this area. This page may not be up to date. Be sure to consult with qualified counsel before relying on any information of this page. See Terms and Conditions.

 

 

 

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