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Willis v. Donnelly Confronts the Fiduciary Duty of Shareholders

In Willis v. Donnelly, the Texas Supreme Court failed to rule on fiduciary duty of shareholders, shareholder oppression, and shareholders rights.

A case analysis and historical review.

Willis v. Donnelly Considers Fiduciary Duty of Shareholders.

Willis v. Donnelly, 199 S.W.3d 262 (Tex. 2006).

Willis v. Donnelly was the first shareholder oppression case to reach the Texas Supreme Court. The appellate decision dealt more with the issues of fiduciary duties of shareholders than it did with the shareholder oppression doctrine. The Supreme Court had the opportunity to reject the doctrine but did not. However, several issues are significant dealing with the rights and fiduciary duties of shareholders.

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Willis v. Donnelly Background.

Willis v. Donnelly arose out of the founding of the Urban Retreat day spa. Michael Willis, a Houston entrepreneur, decided to create a high-end salon. He formed two corporations for the purpose of pursuing the concept. He recruited Dan Donnelly, who owned a successful hair salon, and they entered into a letter agreement in which Donnelly would transfer staff and customers from his existing business to the Urban Retreat, would work in and manage the business as a salaried employee, and receive stock equal to a 25% ownership when the Urban Retreat’s gross revenues reached the level of Donnelly’s former company.  The letter agreement also contained a “Termination” provision that required Donnelly to sell back his shares in the event that his employment was terminated. Willis provided all the startup capital, which turned out to be significantly more than anticipated, and when the Urban Retreat’s gross revenues reached the level that triggered Donnelly’s right to be issued shares, the company was still not profitable.  Willis delayed issuing Donnelly his shares, and Donnelly eventually consented to the delay so that Willis could receive the tax benefits of the current losses under the corporation’s subchapter S status.

During the period of time after Donnelly became entitled to the shares, Willis acted contrary to Donnelly’s interests in a number of ways: He characterized his capital infusions as loans; he transferred all the stock to his wife; he purchased the property on which the spa was located (although the corporation had an option to purchase the same property); and he increased the rent. Finally, Willis fired Donnelly without ever having issued Donnelly his shares.

Donnelly sued both for breach of the letter agreement in not issuing his shares and for breach of fiduciary duties based on his status as a minority shareholder. The jury found in favor of Donnelly on all issues and found his damages under both theories to be $1.7 million.  Willis appealed the judgment on the jury verdict with regard to the breach of contract claim on the grounds that Willis was not a signatory to the contract, that Donnelly had waived performance, and limitations. On these issues, the court of appeals held that Willis was individually liable for the corporation’s breach of contract because the jury had found that he had ratified the contract.  The court of appeals also held that there was evidence to support the jury’s negative finding on waiver and that limitations did not begin to run until the firing, because the contract had not been clearly repudiated until that time.

Court of Appeals Upholds Fiduciary Duties of Shareholders.

With regard to the breach of fiduciary duties claim, the court of appeals held that Willis owed Donnelly fiduciary duties as a minority shareholder and that Willis had engaged in oppressive conduct.  The court held that the evidence was sufficient to find that Donnelly was a minority shareholder, based on the letter agreement and on statements made by Willis recognizing that Donnelly was an owner.  This is the most puzzling part of the opinion. The existence of the breach of contract logically precludes Donnelly from being a shareholder.  The court’s analysis of the existence of fiduciary duties of shareholders seems to indicate that the court considered the creation of the ownership interest to be self-executing or that equity required the court to treat the stock as if it had been issued; however, either of these possibilities would have precluded a money judgment for breach of contract. The court held that the record was more than sufficient to prove a breach.  The remedy analysis is also puzzling. While the court clearly held that the majority shareholder had committed oppression,  the remedy imposed was an award of damages proximately caused by the breach and not a buy-out at fair value.  The evidence supporting the award of damages was the value of the real estate that was the subject of the majority shareholder’s usurpation of corporate opportunities and the value of the capital invested that was mischaracterized as a loan —both claims that belong solely to the corporation and damage that belong solely the corporation.

The Supreme Court Reverses.

The Texas Supreme Court reversed. The Court held that the Donnelly’s breach of contract claim could be asserted only against the corporation, not the majority shareholder.  The Court reversed the judgment for breach of fiduciary duties on the grounds that fiduciary duties of the majority shareholder would arise solely as a result of Donnelly being a minority shareholder and that Donnelly was never a shareholder when any of the conduct complained occurred: “[T]he breach of fiduciary duty claim in the pending case fails because all the alleged breaches of fiduciary duty occurred before Donnelly became a shareholder and before he was entitled to shareholder status. There can be no liability for alleged breaches of a duty that occurred before the duty arose.” 

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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