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Business Judgment Rule Definition in the Shareholder Oppression Doctrine

The Ritchie v. Rupe court of appeals decision provided the business judgment rule definition under the former Shareholder Oppression Doctrine.

business judgment rule definition and application

Defining the Application of the Business Judgment Rule

The Ritchie v. Rupe court of appeals opinion was a significant examination of the former Shareholder Oppression Doctrine. It was reversed by the Supreme Court, but its definition of how the business judgment rule applied in dealing with fundamental shareholder rights will be important as the lower courts develop other legal theories to protect these same expectations, rights, and interests and fill the gaps left by the Supreme Court.

The Dallas Court of Appeals' opinion in Ritchie v. Rupe 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. The court of appeals rejected that defense and wrote an opinion that raises several interesting issues and attempts to define the intersection of the business judgment rule and the shareholder oppression doctrine.

Business Judgment Rule: Traditional Definition

The business judgment rule definition has traditionally been defined as protecting a corporation's non-interested officers and directors from personal liability for their actions in operating the corporation in the honest exercise of their business judgment, even if their decisions are wrong, unwise, or negligent. The definition of the business judgment rule in traditional Texas jurisprudence is particularly strong, and the defense has been held to be available only if the challenged action is ultra vires or tainted by fraud or self-dealing, unless the officer or director is involved in a self-interested transaction. [Note: these holding are based on an incorrect reading of Cates v. Sparkman] 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. Furthermore, plaintiffs are required to plead and prove these elements to overcome the protection of the business judgment rule.

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.  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 may be protected by the business judgment rule and that mere "dissatisfaction with corporate management" will not establish oppression. In Allchin v. Chemic, Inc., 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."

Ignoring or Balancing the Business Judgment Rule?

Moreover, the Ritchie court held, 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." 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." 

The Ritchie court did not state rules for the definition 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. 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." 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.  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."

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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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