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Abuse of Power in Closely Held Corporations

Why do majority shareholders commit corporate abuse of power?

Exploring the former Shareholder Oppression Doctrine and the future of minority shareholder rights andlegal protection against shareholder oppression.

Corporate abuse of power
Future of Shareholder Oppression and Corporate Abuse of Power Against Minority Shareholders in Texas

On June 20, 2014, the Texas Supreme Court’s decision in Ritchie v. Rupe initiated a seismic shift in Texas law governing abuse of power in closely-held corporations and limited liability companies. After almost 30 years of steady appellate court development of a judicial remedy for corporate abuse of power--cases that held that the law prohibited oppressive conduct against minority shareholders and recognized the court’s power to force the purchase the an oppressed minority shareholder’s stock for a fair value--the Texas Supreme Court completely overturned the shareholder oppression doctrine. The Court announced that there was no common law cause of action for minority shareholder oppression and that Texas courts had no power to order a buy-out under the statutory receivership remedy. Three dissenting Justices accused the majority of “extinguish[ing] meaningful protections for minority shareholders.” A host of academic articles and continuing legal education papers from practitioners both decried and applauded the demise of the shareholder oppression doctrine. Their gloomy assessment: “In the wake of Ritchie, minority shareholders are already having a much tougher time in the courts.”

On this page and the pages that follow, we explore the former shareholder oppression doctrine and the direction forward charted by the Supreme Court. We set out

Corporate Abuse of Power after Ritchie v. Rupe:

What protection is left in Texas against corporate abuse of power? Did the majority opinion in Ritchie v. Rupe declare open season on minority shareholders in Texas? Actually, the answer is quite clearly the opposite. The Supreme Court made clear that a great deal of protection is left for minority shareholders, and that there are several potential areas that are ripe for development. In the majority opinion, the Supreme Court cataloged the most common tactics that majority shareholders utilize to “sqeeze-out” or “freeze-out” minorities:

  1. denial of access to corporate books and records
  2. withholding payment of, or declining to declare, dividends
  3. termination of a minority shareholder’s employment
  4. misapplication of corporate funds and diversion of corporate opportunities for personal purposes
  5. manipulation of stock values.

The Supreme Court specifically held that “the foreseeability, likelihood, and magnitude of harm sustained by minority shareholders due to the abuse of power by those in control of a closely held corporation is significant, and Texas law should ensure that remedies exist to appropriately address such harm when the underlying actions are wrongful.”

Common-Law Remedies Protect Against Corporate Abuse of Power.

The Supreme Court struck down the shareholder oppression doctrine because the doctrine was deemed unnecessary.

The Texas Supreme Court did an extensive analysis of the adequacy of statutory and common-law remedies already available to oppressed shareholders, and the negative policy consequences of creating new duties that do not already exist, the Court “decline[d] to recognize a common-law cause of action for ‘shareholder oppression’” that would impose new “common-law dut[ies] on directors in closely held corporations not to take oppressive actions against an individual shareholder even if doing so is in the best interest of the corporation.” The Court concluded that existing common-law duties and remedies “are sufficient.”        

The Court expressly recognized that “our conclusion leaves a ‘gap’ in the protection that the law affords to individual minority shareholders,” and the Court did “not foreclose the possibility that a proper case might justify our recognition of a new common-law cause of action to address a ‘gap’ in protection for minority shareholders,” nevertheless, for now, minority shareholders must seek the protection of those common-law causes of action that existed prior to the advent of the shareholder oppression doctrine in Texas.

“our conclusion leaves a ‘gap’ in the protection that the law affords to individual minority shareholders”

 

The Way Forward for Texas Shareholder Oppression Law.

We must take the Supreme Court at its word regarding the state and direction of the law. The majority opinion clearly indicated that the Court is not abandoning the role of the common law in protecting the interests of minority shareholders from corporate abuse of power by controlling shareholders. Rather, the Court rejected the “shareholder oppression doctrine” as developed in the appellate courts in favor of the application and development of more traditional approaches utilizing statutory remedies and contractual, tort, and fiduciary causes of action. It would be a fairer, and hopefully more accurate, assessment of the new direction charted by the Supreme Court to conclude that the Court is not abandoning minority shareholders so much as a challenging the bench and bar to address wrongdoing by means of existing, well-established legal concepts instead of inventing ad hoc remedies. The law continues to recognize and protect significant minority shareholder rights, including recognition, information, voice, transferability, and share in profits. The law imposes significant duties on corporations, including the duties to preserve shareholder interests, impartiality, and accountability. The law provides meaningful causes of action and legal remedies that may be developed to fill in the gaps left by the Ritchie v. Rupe opinion, including breach of trust, stock conversion, dilution, dividend claims, breach of fiduciary duty, derivative actions, fraud, receivership, and rights of dissent.

 

Texas law does not condone corporate abuse of power, even after Ritchie v. Rupe.

 

In the following sections, we explore of the legal protections remaining and developing for minority
shareholders, including effective shareholder agreements, minority shareholder rights recognized and protected by the law, individual shareholder claims, such as breach of trust, stock conversion, dividend actions, ultra vires, dilution, and breach of fiduciary duties based on relationships of trust and confidence, and fraud. We also take an in-depth look at officer and director fiduciary duties and the derivative lawsuit mechanism to enforce those duties.

Houston_Business_Lawyer_Eric_Fryar.jpg 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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