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Patton v. Nicholas: Shareholder's Right to Have Dividends Declared

In Patton v. Nicholas, the Texas Supreme Court issued a landmark decision enforcing shareholders rights to have dividends declared.

Patton v. Nicholas: Ordering Dividends Declared

dividends declared

The courts of appeals’ opinions that developed the shareholder oppression doctrine  relied heavily on the significant 1955 Texas Supreme Court opinion in Patton v. Nicholas.  The Supreme Court in Ritchie v. Rupe held this reliance was misplaced.  Nevertheless, the Ritchie opinion made it abundantly clear that Patton is still good law. 

 

Re-examining Patton v. Nicholas: Facts

The Patton case involved a company called the Machinery Sales & Supply Company in Dallas, which was initially a profitable sole proprietorship owned by the defendant in the case.  The two plaintiffs were “young salaried employees,” who were each rewarded with a 10% interest in the profits of the company in 1940, which was increased to 20% each in 1943.  In 1944, the defendant’s attempt to revoke the arrangement was met with the plaintiffs’ insistence that they were partners.  Patton v. Nicholas ordered dividends declared

Ultimately, the parties entered into a written settlement agreement in August 1945, providing for the incorporation of the business, the issuance of the stock 60% to the defendant and 20% to each of the plaintiffs, and providing that all three would be directors and officers for the initial year and setting their salaries for that year. All of this was put into place by October 1945, and within days, “hostilities were resumed.”  The defendant berated the plaintiffs in front of subordinate employees and circulated reports criticizing the plaintiffs among the employees that the Supreme Court characterized as “not only quite inappropriate and offensive . . . but also a threat that their tenure of office and employment would probably be short.”  Both plaintiffs resigned in December 1945 and started a competing business as the settlement agreement expressly permitted them to do.  No dividends were declared over the next six years; the defendant received a generous, but not excessive, salary, while the plaintiffs received nothing at all.  During this time, “the net worth of the corporation steadily increased, the surplus coming up from zero to about $130,000.”  In January 1946, the defendant wrote to a third party that “he intended to use his power as majority stockholder arbitrarily to the prejudice of the respondents. The letter also referred to the respondents in defamatory terms such as ‘crooked.’”  Employees testified at trial that the defendant had made statements to the effect that he would see to it that no dividends would be paid so long as the plaintiffs were stockholders, that he bore strong personal ill will toward the plaintiffs, and that “he would not buy the stock of respondents for even a small fraction of its value or sell his own at any price.”  The plaintiffs were not re-elected as directors, and were replaced with individuals who were “plainly little more than nominees and representatives” of the defendant.

The plaintiffs filed suit in 1951 and went to trial on the primary theory that “they were [fraudulently] induced to effect a dissolution of their partnership and transfer money, property and assets of the partnership to the corporation and that the consideration for such had failed, and that the corporation was nothing more or less than a vehicle of fraud to effect and bring about malicious diversion, confiscation, etc., of [plaintiffs’] properties and assets, and that said corporation has been a continuing fraud, and that the corporate entity should be disregarded and set aside and an accounting of all properties, moneys and assets be immediately carried out through a receivership with power to liquidate and divide the business.”  The plaintiffs also made claims for damages caused to them by the defendant’s mismanagement and refusal to declare dividends.

“The verdict included findings that the parties were partners just before the settlement was made; that [defendant] made the settlement ‘with the intention of wrongfully excluding’ the respondents ‘from the management, control, operation, and sharing of profits in the business’; . . . that he ‘wrongfully dominated and controlled the Board of Directors so as to prevent the declaration of dividends’; that he did this ‘for the sole purpose of preventing [plaintiffs] from sharing in the profits to be derived from the operation of the corporation’ as well as ‘for the sole purpose of depreciating the value of the shares of the stock in said corporation, owned by [plaintiffs], to a lower value than such shares of stock would otherwise have’; that he was ‘guilty of mismanagement of the corporation’ (mismanagement being defined in the charge as ‘bad, improper, or unskillful management, resulting in injury to the corporation’); . . . that [defendant] ‘was acting with malice toward [plaintiffs] in the acts of mismanagement and domination of the Board of Directors; but that he did not cause himself to be paid an excessive salary in the years 1949 and 1950.”  Damages issues were submitted on “the depreciation in value, if any, of the [plaintiff’s] stock” and “the loss of dividends, if any, that should have been paid during such period of time.”  The jury awarded $110,610 in actual damages and $10,000 in exemplary damages.  The trial court rendered a judgment on the fraud claim and entered an order that the corporate entity should be disregarded and dissolved and a receiver appointed to liquidate and divide accordingly.  The trial court disregarded the damages award on the grounds that the plaintiffs were “forced into an election between standing on the agreement and asking for damages, or voiding the agreement and disregarding the corporate entity and asking a return of the property.”  The court of appeals affirmed.

Re-examining Patton v. Nicholas: Holdings

The Texas Supreme Court rejected out of hand the “rescission for fraud” theory on which the trial court’s judgment had been based and was affirmed by the court of appeals in part because the plaintiffs “expressly disclaim seeking rescission of that agreement.”  The Court held that the plaintiff’s theory of the case did not state a fraud claim and that “their real complaint is less that the petitioner misrepresented his true state of mind, than that he later and wrongfully suppressed dividends or mismanaged the corporation or both.”  Therefore, the Court recast the judgment as one for mismanagement and suppression of dividends and the order of a liquidating receiver as based on those claims. The Court held that the mismanagement claims were not supported by the evidence.  The Court also held that the finding of general domination and control of the board of directors by the majority shareholder did not state a claim for relief.

“But the finding of his control of the board for the malicious purpose of, and with the actual result of, preventing dividends and otherwise lowering the value (if meaning current sale value in the market place) of the stock of the respondents, is something else.”  The Court noted that the “evidence as to the wrongful state of mind” was “quite adequate” and that the connection between the malicious intent and the refusal to have dividends declared was “enough.”  The Court found the “statement of the petitioner about purchasing their stock could not unreasonably be interpreted as indicating a purpose to acquire it eventually for much less than its value.”  “We do believe that, coupling all the circumstances indicating the petitioner’s intent to eliminate the respondents from every connection with the business, and at an unfair sacrifice on their part, with the fact that no dividends were paid in the face of an accumulation of surplus . . . the findings of malicious suppression of dividends must be sustained,” along with the implied findings that, but for the “wrongful conduct of the [defendant] and the corporation under his dominance, dividends in some substantial amount would have been declared”—although there was no finding as to the amount.

The Supreme Court stated that a “minority stock interest is far from ‘change left on the counter’” and held that wrongful conduct against that minority interest through “the malicious suppression of dividends is a wrong akin to breach of trust, for which the courts will afford a remedy.”  However, the “character of the remedy is another question.”  The trial court had ordered a receiver to liquidate the corporation and distribute its assets on the ground that the incorporation had been fraudulent and should be disregarded, which the court of appeals held was within its power and authority to do.  Approaching the liquidation as an equitable remedy for malicious suppression of dividends, the issue was more complex. The defendant contended that liquidation of a solvent corporation was either “wholly beyond the power of courts” or at least “wholly improper in cases like the present one.”  After a lengthy discussion of Texas statutory and case law and authorities from other jurisdictions,  the Court concluded “that Texas courts, under their general equity powers, may, in the more extreme cases of the general type of the instant one, decree liquidation and accordingly appoint a receiver . . . for this purpose [liquidation] or the less drastic purpose of ‘rehabilitation.’”  The Court noted the “experience of most lawyers having a substantial business practice will include instances, particularly in the case of small and closely held corporations . . . in which liquidation is about the only adequate remedy for the abused minority stockholder. On the other hand we agree with the practically unanimous judicial opinion that liquidation of solvent going corporations should be the extreme or ultimate remedy, involving as it usually will, accentuation of the economic waste incident to many receiverships and most forced sales.”  “Wisdom would seem to counsel tailoring the remedy to fit the particular case.”

Ordering Dividends Declared

Therefore, the Supreme Court vacated the liquidation and receiver and ordered the trial court to substitute a new decree “which will probably give adequate protection to the respondents and at the same time afford both parties a chance to normalize their relationships.”  The new decree would include a mandatory injunction requiring the corporation and “its dominant officer and stockholder to declare and pay at the earliest practical date a reasonable” and “substantial” dividend, the amount of which would be determined by the court and to pay dividends in the future in amounts “not clearly inconsistent with good business practice.”  The trial court was to retain continuing jurisdiction for up to five years “for the more adequate and convenient protection of the rights of the respondents”  and to punish any “bad faith toward the decree or toward the respondents or either of them in their position of minority stockholders” both with the power of contempt and the option to order the liquidation of the corporation.  “We regard this latter provision as fair and even necessary, considering the malicious character of the misconduct heretofore involved and the consequent possibility of its repetition.”

The Supreme Court affirmed the denial of damages, but for a different reason than the trial court and the court of appeals. The Court held first that “there could be no even temporary devaluation of the stock in the ordinary sense, since it evidently never had a market,” and there was no evidence of any price for which the plaintiffs could have sold the stock.  Furthermore, because the plaintiffs still owned their shares, the equitable relief fashioned by the court would likely make the plaintiffs whole.  The refusal to declare dividends might have resulted in a real loss had the plaintiffs sold their shares, but the order requiring payment of dividends would result in the plaintiffs receiving the withheld dividends, and any damage award would constitute a double recovery.  There being no actual damages, the award of exemplary damages was also disregarded. 

Post script: On remand, the trial court entered an order consistent with the Supreme Court’s opinion and appointed a special master to determine the amount of the initial dividend.  Based on the special master’s report, the trial court entered a judgment requiring the declaration and payment of $112,000 in dividends.  The defendant immediately appealed again, and the court of appeals affirmed and ordered that the declared dividends accrue interest until paid.  The Supreme Court refused the writ holding no reversible error.

Ritchie’s Treatment of Patton v. Nicholas

The appellate opinions that developed the former shareholder oppression doctrine in Texas looked chiefly to Patton as authority for the existence and flexibility of the courts’ inherent general equitable powers to fashion and order the buy-out remedy.  The Patton opinion was also very influential and widely-cited in leading cases developing the shareholder oppression doctrine in other jurisdictions prior to its recognition in Texas.  In Ritchie v. Rupe, the Texas Supreme Court was at pains to re-interpret Patton so as to deny that the opinion supported the development of a shareholder oppression cause of action and to demonstrate that the opinion was in fact consistent with the Ritchie holding. The Ritchie Court stated: “But Patton involved neither a claim for oppression nor a court-ordered buyout of stock.”  That statement is essentially accurate. The specific claim in Patton that the Supreme Court upheld was “malicious suppression of dividends,” which shareholder oppression cases have universally held to be a type of shareholder oppression,  but which did not involve the reasonable expectations analysis at issue in the oppression doctrine cases. Also, Patton did not order a buy-out, nor was one requested. The legal proposition for which the shareholder oppression doctrine cases cited Patton as authority was that the court had broad, general equitable powers to fashion an appropriate remedy and that the scope of those powers included the buy-out remedy. If the court has general equitable powers to liquidate a corporation, or to appoint a receiver to rehabilitate the corporation, or to order the controlling shareholder to vote to have dividends declared and retain jurisdiction for five years to make sure that he did so, then a court could certainly order a corporation or a majority shareholder to purchase the minority shareholder’s shares. Nothing in Ritchie throw any doubt on  that conclusion.

The difficulty for the Ritchie analysis was not Patton’s holding regarding the remedy, but the legal basis for imposing that remedy. Equitable remedies must be connected to a legal right and a cause of action for violation of that right.  What was the legal right and the cause of action in Patton? If Patton recognized the existence in Texas common law of a minority shareholder’s legal right to have dividends declared (under some circumstances) and the shareholder’s individual standing to bring a lawsuit for the violation of that right, then Texas law would have already recognized a common-law cause of action for oppression (of sorts), and the Ritchie court’s public policy discussion as to whether it should create such a new cause of action would have been beside the point. The majority in Ritchie solved that problem by assuming, with minimal analysis of the Patton opinion, that the plaintiff in Patton had brought a derivative claim for violation of the defendant’s fiduciary duties to the corporation.  Does that conclusion follow from a fair reading of the Patton opinion?

Patton v. Nicholas Was Not a Derivative Action

The Ritchie Court argues that “the cases on which we relied [in Patton]”—Cates v. Sparkman  and Becker v. Directors of Gulf City Street Railway & Real–Estate Co. —“indicate that we treated that claim as being brought by the shareholders on behalf of the corporation.”  The Patton opinion refers to Cates and Becker twice: first, as authority for the proposition “Undoubtedly the malicious suppression of dividends is a wrong akin to breach of trust, for which the courts will afford a remedy. A minority stock interest is far from ‘change left on the counter’-to quote the petitioner’s own written comment about the settlement,”  and, second, noting that the language in Cates and Becker “seems to recognize a minority right to receivership in cases of gross or fraudulent mismanagement, although without particular reference to whether liquidation or something else is to follow.”  Neither reference gives the slightest hint that the action in Patton was brought derivatively or needed to be. We have given a detailed examination of Cates elsewhere on this site. It was not a derivative action, although it discussed derivative actions. Its holding was not based on the failure to bring the claim derivatively but the failure to allege misconduct that violated a duty to the individual shareholder. Cates acknowledged that minority shareholders had the ability both to bring claims on behalf of the corporation in a representative capacity, when it refused to do so, and in certain instances to bring their own claims against the company to vindicate violation of their own rights when they otherwise would be left without a remedy. No language in Cates mentions suppression of dividends, breach of trust, or receivers, but the overall tenor of the case is clearly that minority shareholder rights are valuable and will be protected by the law.

Becker is a different case and warrants close scrutiny given the importance that Ritchie placed on that opinion in interpreting Patton. Becker was brought by 33 shareholders of the Gulf City Street-Railway and Real-Estate Company, of Galveston, Texas.  The lawsuit alleged that the directors of their company had illegally consolidated that corporation into the Galveston City Railroad Company, also of Galveston, and “by means of which they had fraudulently and unlawfully seized and taken possession of the rights, properties, and franchises of the Gulf City Street-Railway and Real-Estate Company [and had] appropriated and converted the same to their own use and benefit . . . contrary to law and the terms and conditions of the charter.”  The plaintiffs sought to unwind the merger, to restore the property to their original corporation, and to have a receiver appointed to obtain and restore the corporation’s property. The original and amended petition sought only relief on behalf of the plaintiffs individually, but a second amended petition added claims on behalf of the original corporation.  The Texas Supreme Court noted that “the petition was of a somewhat dual character. The plaintiffs asked for the receiver in their own rights as stockholders, and for a recovery for the benefit of the company. This latter ground was set up to obviate the objections made by the demurrers which were sustained in this particular to the first amended petition.”  The claims for recovery on behalf of the corporation were clearly derivative claims, but the request for a receivership was at first an individual claim and appears to have remained so (in the alternative). The defendants argued that the derivative claims were time-barred because the second amended petition was filed more than two years after the merger. The Supreme Court held, in essence, that the second amended petition related back to the original petition because the relief sought by the plaintiffs always recognized the rights of the original corporation to its property and had sought a receiver to restore that property to the original corporation from the consolidated corporation.  “Their avowed and manifest object was to restore the company to its original charter basis, and to the enjoyment and use of its property and franchises in accordance with the charter.”  Therefore, the receivership sought in Becker was very different from that sought in Patton, which was for the purpose of liquidation and thus adverse to the corporation. In addition to the holding under the relation back doctrine, the Becker Court also noted that limitations would have been tolled, analogizing the corporation to a trustee for its shareholders: “It may also be noted that in cases of trusts and appropriation of trust property the statute of limitation will not begin to run until the repudiation of the trust is manifest, nor where the fraud of the trustees is concealed, so that it cannot be discovered by reasonable diligence.”  Twenty-three years later, the Texas Supreme Court made this implicit comparison of corporation to trustee explicit in Yeaman v. Galveston City Co.,  in which the Court held that the relationship between corporation and shareholders “has all the nature of a direct trust,”  and that the corporation is held to many of the same duties as a trustee, including that “statutes of limitation have no application until there is a clear and unequivocal disavowal of the trust, and notice of it brought to the cestui que trust.”  Therefore, Becker does mention the concept of trust duties and clarifies the context for Patton’s citation of that case in support of the proposition that “malicious suppression of dividends is a wrong akin to breach of trust.”

Did the plaintiffs in Patton plead derivative claims? Absolutely nothing in either the reported court of appeals opinion or the Supreme Court opinion states that any claim was brought derivatively or on behalf of the corporation. Neither opinion states that any of the duties at issue were duties owed to only the corporation, as opposed to the minority shareholders. However, there is also no clear statement to the contrary. In the court of appeals, the defendant challenged the “failure of the trial court to segregate the two causes of action, alleging that appellees sued individually and on behalf of the corporation,”  but it is unclear whether this was merely the defendant’s characterization or was actually how the causes of action were pleaded. The court of appeals, without any further explanation, rejected any error as harmless because “the entire controversy is interwoven.”  The Supreme Court’s opinion stated that the minority shareholders’ case “must be one for mismanagement of the corporation or misconduct in the handling of its affairs to [the minority shareholders’] prejudice or that of the corporation itself or both,”  leaving open the possibility that the claims relating to mismanagement were either entirely direct or entirely derivative or a mixture, and never indicating that it made any difference one way or the other. Claims for mismanagement (assuming they survive the business judgment rule) do ordinarily belong to the company and may only be asserted by shareholders derivatively.  So it is possible that the damages claim for mismanagement was presented derivatively. But what is clear beyond cavil, however, is that the plaintiffs in Patton did assert the individual claims, and what matters for this analysis is whether the Supreme Court imposed the mandatory injunction to pay dividends on the basis of those individual claims or solely on the basis of a derivative claim.

The Ritchie Court characterizes the plaintiff’s claims as “a suit in which a corporation’s two minority shareholders alleged that Patton—the corporation’s majority shareholder, president, and controlling board member—committed fraud and breached his duties to the corporation.”  The fraud claim was clearly an individual claim.  That claim was based on the defendant’s inducing the plaintiffs to incorporate their partnership, concerned only pre-incorporation events, and had nothing to do with duties to the corporation. The relief that the plaintiff’s sought on their fraud claim was a receivership to liquidate the corporation. An action for liquidating receiver is an individual action brought by a shareholder, not a derivative action.  A corporation may not seek a liquidating receivership for itself, nor may its directors seek one on its behalf, nor may a shareholder seek one derivatively.  The Patton Court rejected the fraud claim as a basis for the receivership and undertook to determine whether a court had the equitable power to appoint a liquidating receiver on the basis of the remaining claims. The Texas authorities cited by the Court suggested the availability of a receiver in “extreme cases of mismanagement.”  However, the Court ultimately held that there was no evidence to support the claim of mismanagement.  Therefore, the specific claims that the Supreme Court noted may have been brought derivatively were emphatically not the basis of the equitable relief awarded.

Turning to the dividends claim, the Court found authority in other jurisdictions to appoint a receiver in egregious cases of withholding of dividends.  The principal cases relied on in the Patton opinion were the Michigan Supreme Court case of Miner v. Belle Isle Ice Co.  and the Fourth Circuit case of Tower Hill-Connellsville Coke Co. of W. Virginia v. Piedmont Coal Co.  Neither of these cases were brought on behalf of the corporation. In Miner, a minority shareholder sued the corporation and the remaining shareholders seeking a receiver to wind up the affairs of the company following seven years of receiving no dividends, while the remaining shareholders received large salaries and rents from the corporation.  The Court’s opinion makes absolutely clear that the party harmed was the minority shareholder, not the corporation, and the party for whom the relief was granted was the minority shareholder, not the corporation:

Who has any right to complain if ample and complete justice is awarded to Miner [the minority shareholder]? Who should be permitted to stand between him and an adequate remedy? This corporation has utterly failed of its purpose, not because of matters beyond its control, but because of fraudulent mismanagement and misappropriation of its funds. Complainant [the minority shareholder] has a right to insist that it [the corporation] shall not continue as a cloak for a fraud upon him, and shall no longer retain his capital to be used for the sole advantage of the owner of the majority of the stock, and a court of equity will not so far tolerate such a manifest violation of the rules of natural justice as to deny him the relief to which his situation entitles him. I think a court of equity, under the circumstances of this case, in the exercise of its general equity jurisdiction, has the power to grant to this complainant ample relief, even to the dissolution of the trust relations. Complainant is therefore entitled to the relief prayed. A receiver will be appointed, and the affairs of this corporation would up.

This point was even more pronounced in Tower Hill, where the corporation was the only defendant in a case brought by individual shareholders seeking a liquidation.  On appeal, the directors, whose withholding of dividends resulted in the receivership, argued that they were necessary and indispensable parties and should have been joined—which would have resulted in defeating the court’s diversity jurisdiction—and the Fourth Circuit held “the defendant corporation itself was the only indispensable party.”  The court stated that the lawsuit was “an earnest effort by these plaintiffs to rescue at least some part of their investment from an arbitrary, unjust, and tyrannical domination by a ruthless majority—a majority that acts entirely without regard to that trust relationship that exists between a controlling majority and a minority in a stock company.”  The claim asserted was clearly a claim by the individual shareholders against, not on behalf of, the corporation:

Against the corporate defendant, the plaintiff sought an annulment of its charter, with incidental injunctional relief pending a hearing and decision of that main issue. This was an attack upon the existence of the corporation in which it was vitally interested, which it had to defend, and to which the stockholders and directors were in no sense necessary parties. It was clearly separable from the claim of damages against the individual defendants for acts which they did as directors and stockholders of the old corporation, in which the new corporation was not interested, and to which it could not be required to respond.

     . . . .

In this case the action of which the plaintiffs have reason to complain is the action of the corporation. This action, while controlled by the majority of the stockholders, is the act of the corporation, and not their action, and relief is asked against the corporation and not against them. No rights of theirs will be affected by the action of the court, but only the rights of the corporation. After dissolution is decreed, they can come in and receive the portion of the assets belonging to them and make themselves parties to the suit pro hac vice, but this does not defeat the jurisdiction, for this is what happens in every receivership case.

The Right to Have Dividends Declared Belongs to the Individual Shareholder

Furthermore, under Texas law, the right to dividends is a right belonging to the individual shareholder, not the corporation. In Moroney v. Moroney,  the court held: “Indeed, in every profitable corporate venture, the rights of the stockholder are of great importance, and at all times will be properly protected, whether in a court of law or equity, according to the exigencies of the situation. The chief value of corporate stock is its right to receive dividends. So important is this right that courts of equity will, in a proper case, compel a payment of dividends.”  Dividends once declared are a debt that the corporation owes to the individual shareholder.  An action to compel the declaration of dividends is based on the shareholder’s fundamental right to share in the net profits of the corporation, a right incident to the ownership of his stock and belonging to the shareholder individually.  When dividends are suppressed, the injured party is the shareholder, and that injury is separate and distinct from any injury that the corporation might suffer arising from the same conduct.  Even if the corporation had its own claim for breach of the directors’ duties, that claim would not be the same claim and would not affect the existence of the shareholder’s claim for his own injury.  Therefore, the action to compel declaration of dividends is an action brought by the individual shareholder, not by the corporation or on its behalf. 

The conclusion of the Patton Court was that the remedy of a liquidating receiver, a remedy that the corporation could not request and to which it would be the adverse party, could be awarded for the violation of the rights of the minority shareholder to have dividends declared, a right that the corporation does not have. The order to declare dividends, an order no one in Patton requested and which would not in any event have benefitted the corporation, was made within the Court’s equitable power to fashion a less drastic remedy as a substitute for the liquidating receivership. The judgment rendered by the trial court, which the Supreme Court affirmed as modified, was against the majority shareholder and the corporation, not in favor of the corporation.  The injunction that the Supreme Court ordered on remand was against the majority shareholder and the corporation, not in favor of the corporation.  The relief granted in the new order did not benefit the corporation in any way, but provided specific and substantial benefits to the individual minority shareholders. The trial court was ordered to retain jurisdiction for up to five years and to liquidate the corporation if the majority shareholder “in any manner operated with bad faith toward the decree or toward the respondents or either of them in their position of minority stockholders.”  The relief granted in Patton was not on the basis of a derivative claim, and the Ritchie dissent properly took the majority to task for attempting to rewrite the opinion.

In its effort to support the proposition that the derivative claim is sufficient to address most of the evils that the shareholder oppression doctrine sought to remedy and to claim that Patton is consistent with its holding, the majority opinion in Ritchie goes so far as to misstate the liability holding in Patton, claiming that Patton held “majority shareholder liable when he used ‘his control of the board for the malicious purpose of . . . preventing dividends and otherwise lowering the value . . . of the stock of the [minority shareholders].’”  The language quoted was not the holding of Patton; it was a determination that evidence was sufficient to support the finding that the defendant had used his “control of the board for the malicious purpose of, and with the actual result of, preventing dividends and otherwise lowering the value” of the stock of the plaintiffs.  The legal remedy that this finding supported was not liability of the majority shareholder to the corporation for such malicious activity toward the corporation, but an injunction against both the majority shareholder and the corporation compelling the corporation to pay dividends to the shareholders—backed up by the penalty of liquidating the corporation if the “corporation has been in any manner operated with bad faith toward the decree or toward the respondents or either of them in their position of minority stockholders.”

Implications of Ritchie's Reading of Patton: Is the Shareholder Oppression Doctrine Still Valid?

In fairness to the majority in Ritchie, however, perhaps we should assume that description of Patton was not an intentional mischaracterization of the opinion but an explanation of how the principles laid down in Patton should be applied going forward—that Ritchie’s treatment of the Patton opinion was not descriptive but prescriptive. Perhaps the Ritchie majority meant that the claims in Patton should have been derivative claims, that the holding was otherwise correct but should have made clear that such a claim must be prosecuted derivatively (again, in fairness, a point not raised by any party in Patton). If that is true, then one would have to conclude that it would have to have been a very weird derivative claim indeed. In arguing that the derivative action remedy is sufficient to protect shareholders from wrongful withholding of dividends, the Ritchie Court stated: “Patton demonstrates that when a corporate director violates the duty to act solely for the benefit of the corporation and refuses to declare dividends for some other, improper purpose, the director breaches fiduciary duties to the corporation, and the minority shareholders are entitled to relief, either directly to the corporation or through a derivative action.”  Further, the Ritchie opinion argued: “As Patton itself demonstrates, the very conduct the dissent claims does not harm the corporation in fact can give rise (and has given rise in the past) to a breach-of-fiduciary-duty claim against the corporate controller who engaged in such conduct to benefit himself at the expense of the corporation,”  because “refusal to pay dividends, paying majority shareholders outside the dividend process, and making fire-sale buyout offers certainly can harm the corporation, for instance, by lowering the value of its stock.” The difficulty in understanding that proposition is that the corporation, as such, does not have any claim or interest in the value of its shares because the corporation does not own its stock. The shareholders own the stock, and the corporation owns what the stock represents. When a shareholder sells stock, the shareholder keeps the money, and the corporation is unaffected by any gain or loss that the shareholder realizes on the transaction as a result of changes in the value of the shares. When action is taken to reduce the value of shares as to the shareholder, the corporation does not have a claim. There is no corporate remedy for devaluation of its shares. The theory of cases like Commonwealth of Massachusetts v. Davis is that when corporate property is damaged or stolen, incidentally resulting in the loss of value to the shares, then the corporation has a remedy for the harm that caused the devaluation, but the measure of damages is for the actual harm inflicted on the corporation (lost profits, property damage, etc.), not the resulting depreciation in the value of the shares suffered by the shareholders.  Moreover, from the corporation’s perspective, whether profits remain in the corporation or are distributed to the shareholders as dividends is immaterial—arguably, the corporation as an entity would always be far better off to stockpile its cash resources and never declare dividends.  So far from holding that the injunction remedy was available because of harm done to the corporation from loss of value of the corporation’s stock, the Patton Court expressly held that the value of the shares never diminished, not even temporarily.  The Patton Court held that there was no evidence of damage to the corporation in any regard. There is no question that the majority shareholder in Patton breached his duty to act solely for the benefit of the corporation by refusing to declare dividends for reasons having nothing to do with the corporation's best interests,  but a breach of fiduciary duty claim requires resulting harm to the corporation or benefit to the defendant as well as a breach of duty to be actionable.  Leaving corporate profits in the corporation might harm the minority shareholders, but it would neither harm the corporation nor necessarily benefit the majority shareholder. Moreover, if the suit is successful, the corporation does not benefit from the relief; rather, the shareholder benefits at the expense of the corporation when the corporation pays out its cash reserves.

Taking the Ritchie opinion at face value, then the Court must have been holding that, going forward, Texas law works something like this: Party A (majority shareholder controlling the board) owes duties to Party B (corporation) but not to Party C (minority shareholder). If Party A commits an act that is a breach of duty to Party B that harms Party C but does not harm Party B, then Party B has a cause of action against Party A but no damages, and Party C has damages but no cause of action. Nevertheless, Party A may be sued by of on behalf Party B for the harm done to Party C, and the court may award an equitable remedy compensating Party C that does not benefit Party B. If so, then Ritchie has fundamentally changed the nature of derivative suits from a vehicle by which the shareholder may obtain relief for the corporation to one in which the shareholder may obtain relief for himself using the corporation as a proxy. Take a minority shareholder, who is frozen out of a company by the majority’s cutting off all economic benefit for a malicious reason and not for the good of the company. Under Ritchie’s reading of Patton, the aggrieved minority shareholder could bring a derivative action based on the breach of the duty to act solely for the benefit of the company, offer no evidence of any harm to the company, and receive equitable relief which provides significant, specific benefits to the minority shareholder and no benefits to the company. Depending on the case, the shareholder might receive a mandatory injunction requiring the company to pay dividends in an amount set by the court and five years of court supervision to prevent any act of bad faith by the majority shareholder toward the minority shareholder. Or, again depending on the case, the court might use its general equitable power to fashion a different, more appropriate remedy—say, a compulsory buy-out of the minority shareholder’s stock at a fair value determined by the court. If that is really what the Ritchie opinion means, then the shareholder oppression doctrine did not go away after all. Almost every the shareholder oppression case decided over the last 30 years was correct, save for one relatively minor thing: For some reason, those claims needed to be brought procedurally as derivative actions, instead of direct claims—with the added benefit that attorney’s fees will now be recoverable from the corporation whenever the plaintiff is successful.  If that is what the Ritchie decision really means, then the pronouncments of the death of the shareholder oppression doctrine were greatly exaggerated.

Patton v. Nicholas Establishes an Individual Shareholder Remedy That Fills in the "Gaps" left by Ritchie v. Rupe

It would be far better to read Patton as it is actually written and recognize that in certain limited situations, individual minority shareholders have protectable legal interests arising from the fact that they are shareholders and independent of any officer/director duties to the corporation, and Texas common law already recognizes, and has for over a century, that equitable relief is available in an action brought directly by the shareholder in his individual capacity for his own benefit to protect those interests. The cause of action affirmed in Patton is precisely the kind of claim anticipated by Cates—a claim for “injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such [an individual, equitable remedy], would leave the latter remediless.” 

Finally, it is worth noting that the majority shareholder in Patton was something of an underachiever when it comes to shareholder oppression. Like the majority shareholder in Boehringer v. Konkel, he acted out of malicious motives specifically aimed at harming and squeezing out the minority shareholders. He made their lives hell and forced them to resign, cutting off all economic benefits of share ownership, and refused to declare dividends. However, the Patton majority shareholder left all the profits in the company where they were available for later distribution. In Boehringer, the majority shareholder made sure the profits went into his pocket through increasing his salary. But for the existence of a claim based on some duty to the minority shareholder, the fact that the majority shareholder is acting for the purpose of harming the minority shareholder—the deciding factor in Patton—that evil intent would not be actionable. After all, the decision to declare or not to declare dividends is something that the majority “has the right to do”  and is accorded heavy deference by the courts, and of what legal significance can it possibly be that the majority shareholder is acting out of desire to hurt someone to whom he owes no duty? The minority shareholder in either case might be able to bring a derivative action to restore to the corporation property wrongfully taken, but that would ignore the need for prospective relief due to “the malicious character of the misconduct heretofore involved and the consequent possibility of its repetition” that the Patton Court found so compelling.  The legal rights of minority shareholders, the legal duties owed to them, and the legal and
equitable remedies available to them, that are already firmly established in Texas common law and are available for development and extension by our courts, may not be as flexible as the “reasonable expectations” approach under the shareholder oppression doctrine, but they are substantial and offer Texas courts the opportunity accept the invitation made by the Ritchie Court to develop meaningful protections that fill in the gaps left by the Ritchie opinion through development of traditional, established causes of action and remedies that “already exist.’

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

 

Next: Morrison v. St. Anthony Hotel >

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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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