Call for an appointment 888-481-9995

Implications of Ritchie v. Rupe for Minority Shareholders in Texas

What is the future for minority shareholders in Texas after Ritchie v. Rupe? Addressing the implications of that decision and filling the gaps.

Implications of Ritchie for Minority Shareholders

Implications of Ritchie v. Rupe for Shareholders:

When the Texas Supreme Court struck down the Shareholder Oppression Doctrine in Ritchie v. Rupethe majority opinion “recognize[d] that our conclusion leaves a “gap” in the protection that the law affords to individual minority shareholders.”  What is that "gap," and how will courts  address it going forward?

What Exactly Is the “Gap”?

The need for a duty to individual minority shareholders

To the extent that the matter was unclear prior to the Ritchie opinion,  the Texas Supreme Court made it abundantly clear that officers and directors of a corporation, are not in a legal relationship with the individual minority shareholders and owe their duties only to the corporate entity, not to the minority shareholders as such;  and, by necessary implication, the majority shareholders (who dictate the actions of the directors and officers) are not in a legal relationship with the minority shareholders and owe no duties to the other shareholders.  What is left completely unexplained is whether the individual shareholders are owed any duties whatsoever by anyone. This unanswered question may or may not be a “gap” in the law, but it is certainly a glaring hole in the jurisprudential scheme described in the Ritchie opinion. Does it mean anything legally to be a minority shareholder--a part owner of a corporation? If so, what duties, if any, are owed to individual minority shareholders by virtue of the shareholder status, and by whom, and how are such duties enforced? In other words, does the law protect the interests of individual shareholder to any greater extent than it does persons with no legal relationship to the corporation?

Officers and Directors Owe No Duties to Shareholders

Ritchie holds that an “officer or director has no duty to conduct the corporation’s business in a manner that suits an individual shareholder’s interests when those interests are not aligned with the interests of the corporation and the corporation’s shareholders collectively.”  This seems a relatively uncontroversial proposition, and the Court relies on a line of authority distinguishing direct injury to the corporation from the resulting indirect injury felt by all of the shareholders. This concept, as originally developed by the Texas Supreme Court, concerned the fact that injury to the corporation “ordinarily” harms the shareholder only indirectly:

Ordinarily, the cause of action for injury to the property of a corporation or the impairment or destruction of its business, is vested in the corporation, as distinguished from its stockholders, even though it may result indirectly in loss of earnings to the stockholders. Generally, the individual stockholders have no separate and independent right of action for injuries suffered by the corporation which merely result in the depreciation of the value of their stock. This rule is based on the principle that where such an injury occurs each shareholder suffers relatively in proportion to the number of shares he owns, and each will be made whole if the corporation obtains restitution or compensation from the wrongdoer.

Shareholders may not sue for injury to the corporation.

There are strong policy reasons to make the corporation the only party that can seek redress for harm done to it, which only incidentally affects the shareholders, such as the need to prevent multiple lawsuits based on the same injury and the need to make sure that all shareholder share proportionally in any recovery for the injury.  But the Supreme Court's characterization of the law leaves out the very important exception to the general rule: Texas courts have always firmly held that “a stockholder may sue for violation of his own individual rights regardless of whether the corporation also has a cause of action.”  A minority shareholder may sue for breach of a contract involving and even benefitting the corporation if the shareholder is himself a party but not for a breach of contract to which the corporation alone is a party.  A minority shareholder may sue for corporate mismanagement if the “manager’s misconduct violates some duty owed the stockholder independently.”  “Rather, it is the nature of the wrong, whether directed against the corporation only or against the stockholder personally, which determines who may sue.”  To recover individually, “a stockholder must prove a personal cause of action and personal injury.” This analysis begs the questions, of course, what duties are owed to shareholders individually that might give rise to a personal cause of action?

In a typical minority shareholder oppression scenario, the misconduct is specifically directed at the minority shareholder, with the primary injury being suffered by the minority shareholder, and only incidentally by the corporation, if at all. Assume the classic definition of shareholder oppression: that a majority shareholder wants to eliminate or marginalize the minority shareholder. If the corporation’s profits are being distributed among the shareholders by means of wages, the majority shareholder uses his control over the board of directors to terminate the minority shareholder’s employment, to ensure no dividends are declared, to cut off all information and participation in corporate affairs, and, usually, to raise the majority shareholder’s own compensation. Clearly, the intent and effect is to benefit the majority and harm the minority shareholder, to eliminate (or misappropriate) the value of the shares to the minority shareholder. 
What duties are owed to shareholders that might create a "personal cause of action?"

Has the corporation been incidentally harmed as well? Maybe. Maybe not. If the majority shareholder is an effective employee and manager, the corporation’s business may not suffer at all. If the increase in the majority shareholder’s compensation is equal to or less than what had been paid to the minority shareholder, then the corporation is in the same or perhaps slightly better shape economically. The value of the stock of the corporation as a whole, as opposed to that of the minority shareholder, is unaffected. The majority shareholder might even be able to argue with a straight face that the minority shareholder was troublesome, distracting, and not very talented, so that things will run much more smoothly and efficiently without the minority’s meddling in corporate affairs. If the majority shareholder is correct as a factual matter, then the corporation really is better off.

Oppression Always Harms the Shareholder: Is the Shareholder Owed Any Legal Duty?

In a typical shareholder oppression case, the question is not whether the minority shareholder has suffered “personal injury”; the question is whether the minority shareholder has a “personal cause of action.”  The Ritchie Court refused to “impos[e] a common-law duty 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.”  However, in an actual case of shareholder oppression, the best interests of the corporation are completely beside the point. Those interests neither motivate the oppressor, nor are they necessarily implicated one way or the other by the oppression. The Supreme Court did not adopt a rule that the best interests of the corporation trumps the best interests of the minority shareholder when the two are in conflict. Rather, the Supreme Court held that the majority shareholder in his control over the corporation has “no duty” to minority shareholders, and thus eliminated the possibility of any personal cause of action, “even if [the oppressive conduct is] motivated by malice toward the stockholder individually.”  The Supreme Court leaves “the legitimate interests of a minority shareholder” to be safeguarded only “by protecting the well-being of the corporation.”  That protective scheme will often, perhaps usually, prove illusory.

Shareholders Do Have Legal Rights

However, this description of the law in the majority opinion in Ritchie is not the actual holding of the case. The Court specifically recognizes that existing law does protect minority shareholder rights and that such protection is "sufficient" without the addition of a shareholder oppression doctrine. The Court specifically notes the existence of statutory remedies to protect the right of minority shareholders to corporation information. These are rights belonging to the individual shareholder and remedies that are separate from derivative actions. The Court relied on early landmark Supreme Court Cases, such as Cates v. Sparkman and Patton v. Nicholas, and made clear that the Ritchie opinion was in no way meant to be inconsistent with the common-law development of individual shareholder rights and corporate duties owed to shareholders that existed prior to the advent of the shareholder oppression doctrine. In the following articles on this website, we will examine closely the pre-shareholder oppression doctrine case law to identify such rights and duties that will serve to fill in the gaps left by the majority opinion in Ritchie.

Need for individual shareholder remedy

The Need for an Individual Remedy for Shareholders

Returning to the basic concept of minority shareholder oppression: “Oppressive” conduct is specifically targeted at an individual shareholder or group of shareholders. The purpose of that conduct is to diminish the value of the minority shareholder’s share ownership—or rather to misappropriate the value of that ownership for the majority shareholder’s benefit. If a majority shareholder is successful in actually eliminating the minority shareholder by either denying that he is an owner at all or inducing him to sell for a fraction of the value of his shares, the beneficiary of this wrongful conduct is the majority shareholder whose ownership in the enterprise necessarily increases as a result. In neither case is the corporation as a whole necessarily harmed nor benefitted. The Supreme Court conceded that such unjust enrichment to the majority shareholder resulting from the majority’s use of its power over corporation may be significantly harmful to the minority shareholder and that “Texas law should ensure that remedies exist to appropriately address such harm when the underlying actions are wrongful.”  Yet the Supreme Court provides a legal scheme in which the minority shareholder’s only remedy is an indirect one,  depending on the wrong directed at the minority shareholders also coincidentally harming the corporation. That seems an exceptionally odd result and one that is not consistent with longstanding Texas jurisprudence, which has always held that “[t]here are certain rights, powers, and privileges that accrue to a stockholder in a corporation.”

If the law recognizes no legal relationship between either the officers and directors or the controlling shareholders, on the one hand, and the minority shareholders, on the other, which would give rise to a legal duty to the minority shareholders, then nothing that the director or controlling shareholder does with the intent to harm the minority shareholders is actionable. If the oppressive scheme involves some incidental theft from the corporation, then the corporation may recover damages (directly or through a derivative action), and the minority shareholder gets his proportional share. But the malicious intent toward the minority shareholder, the fixed purpose of depriving him of his ownership interest, and the likelihood that those efforts will continue are legally irrelevant to the corporation’s claim for damages. The minority shareholder would not have standing to request any relief to protect himself. Presumably, the trial court would not have jurisdiction to award such relief in favor of a non-party. The key fact on which the judgment was affirmed in Davis v. Sheerin, the conspiracy to deprive the minority shareholder of his ownership,  was not found in that case to have caused any actual harm.  It is difficult to imagine a claim that the corporation could bring that would address such conduct or any relief that could be granted to the corporation that would make the minority shareholder whole. In Davis, the court of appeals specifically held that injunctions and damages that might be granted for the breach of fiduciary duties to the corporation were inadequate to remedy the harm caused to the minority shareholder by the oppression.

If the directors and controlling shareholders owe no duties to the minority shareholders, what about the corporation? Does the minority shareholder’s stock certificate and status as an owner grant him any protection from corporate acts taken to harm his interests? Logic would seem to dictate that each shareholder must be in some sort of a legal relationship with the corporation, in which the individual shareholder has invested his capital and of which he holds ownership interests. Does the corporation owe any legal duties to its owners? The answer must be “yes”—otherwise there would be no difference from the standpoint of the corporation between being an owner and not being an owner. Clearly, there are certain statutory obligations that a corporation must observe toward its shareholders;  however, those statutory duties are largely a codification of common law duties already recognized by courts as arising from the legal relationship between the corporation and its shareholders.  While Texas law has long been clear that the remedy for wrongful conduct in the management or control of a corporation belongs to the corporation and may not be asserted directly by the shareholders, Texas law has always been equally clear that there are exceptions in which the rights and remedies belong to the shareholders individually—“where the wrongdoer violates a duty arising from contract or otherwise, and owing directly” to the shareholder. 

Inadequacy of Piecemeal Approach

Under the legal scheme described in the Ritchie opinion, a minority shareholder faced with a coordinated and Inadequacy of Piecemeal Approach to Shareholder Remediesintentional course of conduct, taken with the specific purpose of depriving him of the value of his share ownership and appropriating that value to the majority shareholder, must break that pattern of oppressive conduct down into its component parts and pursue a remedy for each act in isolation. Not only is this approach cumbersome and inefficient, it ultimately denies the minority shareholder an adequate remedy. The ultimate purpose of the majority shareholder is to steal from the minority shareholders; however, that seemingly wrongful purpose is irrelevant to the analysis because the majority shareholder owes no duty to the minority shareholders as such. Furthermore, the business judgment rule ordinarily does not shield self-dealing from judicial scrutiny, but because the majority is stealing from the minority, rather than the corporation, the business judgment rule will continue to apply.

Assume a typical squeeze out scenario: Two shareholders—one 49.9% and one 50.1%—organize a corporation, agreeing that whatever profits they are able to generate will be paid out as salary, which will be roughly equal. The two individuals have a falling out, and the majority shareholder decides to deprive the minority shareholder of all value so as to induce him either to sell or simply to disappear. Therefore, the majority shareholder takes action to exclude the minority shareholder from any voice or participation in management and to deny the minority shareholder any information about what is going on in the corporation. The majority shareholder terminates the minority shareholder’s employment, or makes his life a “living hell” so as to force his resignation. Thereafter, the majority refuses to pay dividends and instead continues to pay out all profits in the form of salary—to himself.

Under the Ritchie scheme, the minority shareholder could force the majority to hold annual shareholder meetings by petitioning the district court every thirteen months for an order requiring such a meeting.  It does not appear that the minority shareholder would be able to recover his attorney’s fees or expenses for such an effort, and the minority shareholder would be without any remedy for the majority’s refusal to consider anything the minority shareholder had to say—no matter how malicious the majority’s intent.

The minority shareholder could also make a written request for inspection of corporate records.  The majority could refuse and require a jury trial each time by merely asserting that the minority shareholder had an improper purpose.  Assuming the minority shareholder was successful, after several years of litigation, the minority shareholder would be permitted to inspect corporate records and would recover his attorney’s fees. However, the statute does not provide for prospective relief, and the minority shareholder would be required to start the process all over again as the information he has acquired becomes dated and the majority continues to keep him in the dark.

Because the minority shareholder’s only way to obtain his proportionate share of the profits generated has been through salary, he would want to bring a claim for the loss of employment. However, that claim would be futile because the minority shareholder is an at-will employee.  The Supreme Court suggested that there might be grounds for a derivative claim if the minority shareholder could prove that the decision to terminate his employment was not made solely for the benefit of the corporation;  however, the decision to terminate would most certainly be protected by the business judgment rule—if the majority could articulate a business reason for the termination, the court would not be permitted to interfere.

Alternatively, the minority shareholder might seek to force the payment of dividends. However, generally speaking, a minority shareholder has no specific right to dividends, and the decision to pay dividends is almost completely protected by the business judgment rule.  Furthermore, because the majority shareholder is paying out all profits in the form of salary, there is no surplus from which dividends may be paid.

If the minority shareholder cannot compel payment of his proportional share of the profits by means of damages for wrongful termination or compelling payment of dividends, he may bring a derivative suit for the majority’s excessive compensation. Unfortunately, a claim for excessive compensation is extremely difficult to prove. Compensation decisions are inherently subjective. Courts are extremely deferential to compensation decisions.  The factors include: (1) the employee’s qualifications; (2) the nature, extent and scope of the employee’s work; (3) the size and complexities of the business; (4) a comparison of salaries paid with gross income and net income; (5) the prevailing general economic conditions; (6) comparison of salaries with distributions to stockholders; (7) the prevailing rates of compensation for comparable positions in comparable concerns; (8) the salary policy of the corporation as to all employees; and (9) in the case of small corporations with a limited number of officers, the amount of compensation paid to a particular employee in previous years.  The issue that will be presented to the jury is whether the majority shareholder is paying himself more than the market rate for other presidents of successful companies. As a practical matter, most defendants are able to justify almost any salary based on a comparison to the market because of the wide range of executive salaries, and the majority shareholder will justifiably be able to argue that, since the minority shareholder doesn’t work here any more, the majority shareholder is doing more work, and the salary reflects the results he is achieving for the corporation. If the minority shareholder is successful, then he will be entitled to his 49.9% of the amount of excessive compensation in damages—which will almost certainly be less than he would have been paid but for the oppression.  Take an easy example: Say the majority shareholder is paid $50,100 annually and the minority shareholder is paid $49,900. The majority shareholder fires the minority shareholder and immediately increases his own compensation by $49,900 to $100,000. The jury finds that the $49,900 increase is excessive compensation in breach of fiduciary duties to the corporation. What has the minority shareholder lost? $49,900 annually. What does the minority recover in the derivative action? $24,900, or 49.9% of the excessive compensation. The majority keeps the rest and continues to be unjustly enriched.

Furthermore, the damages award will not be prospective. Although the minority shareholder would likely be compensated for his attorneys’ fees, he will be faced with going through the same process all over again if the unrepentant majority shareholder continues the same practice.

Question of the Business Judgment Rule

One other significant question is the extent to which the business judgment rule thwarts even the inadequate remedies described above. This issue was made all the more uncertain by the Supreme Court’s recent decision in Sneed v. Webre.  The Ritchie scheme “to protect the legitimate interests of a minority shareholder by protecting the well-being of the corporation”  depends entirely on the Court’s repeated citation of International Bankers v. Holloway that the director's duty of loyalty to the corporation is the “duty to act solely for the benefit of the corporation.” Decisions that violate that duty, even if malicious and oppressive, do not necessarily involve self-dealing and dishonesty toward the corporation, and would encompass decisions to commit oppressive conduct toward minority shareholders. If Ritchie is articulating the duty of loyalty owed to the corporation, the such oppressive conduct should not be sheilded by the business judgment rule. The Ritchie opinion strongly indicates that any use of control over the corporation for reasons other than furthering the bests interests of the corporation would be actionable, but Ritchie does not explain whether the business judgment rule would preclude judicial scrutiny of such decisions. The Sneed decision reiterates that duty,  but expressly does not decide “which duties are subject to the business judgment rule.”  It does make clear, however, that “the business judgment rule applies as a defense to the merits of a shareholder’s derivative lawsuit that asserts claims against the corporation’s officers or directors for breach of duties that result in injury to the corporation.”  Sneed leaves the question highly ambiguous as to whether the business judgement rule would negate the protections that the Ritchie Court had held were "sufficient" to protect the interests of minority shareholders. Thus, even under the legal protections articulated by the Ritchie opinion, oppressive conduct that violates the duty to act solely for the benefit of the corporation might still escape judicial scrutiny. 

Need for the Buy-Out Remedy for Oppressed Minority Shareholders

None of the remedies discussed by the Supreme Court address the continuing pattern of misconduct. None provide a way out of a situation for which the Supreme Court admits that the law should provide a remedy. What made the shareholder oppression doctrine work as an effective means of dealing with oppressive conduct was not the protection of “reasonable expectations” or the requirement of “fair dealing,” both of which may very well be protected by other causes of action, but was the compulsory buy-out remedy, which provided a way to end a pattern of oppressive conduct and to restore completely to the oppressed minority shareholder what had been wrongfully taken. The buy-out remedy allowed the minority shareholder to escape an oppressive situation. The remedy was entirely fair, as the Davis v. Sheerin court noted, because it ultimately gave the majority shareholder exactly what he wanted but just required payment of fair compensation.  As the dissent in Ritchie argued, “No other existing remedy the Court discusses adequately protects minority shareholders from such oppression.” 

Derivative actions against individual components of a pattern of oppression do not consider the overall harm of the scheme as a whole. The plaintiff’s termination of employment might be seen by the court as unfortunate and unfair, but the employment at will doctrine gives majority in control of the corporation the absolute right to do so. The refusal to declare dividends might harm the minority shareholder but can be justified as the business judgment of the majority with which courts will not interfere. The overly generous salary that the majority shareholder pays himself can probably be justified as not above the wide range of salaries paid to executives in private corporations. Any damages awarded on the basis of such claims would not include damages anticipated to occur in the future based on conduct that has not yet happened. The shareholder oppression doctrine allowed the court to look at the entire pattern of the defendant’s behavior and conclude that the termination, refusal to pay dividends, and compensation decisions were all made with the purpose and effect of denying the minority shareholder the benefits of stock ownership. The shareholder oppression doctrine allowed the court to take into consideration more intangible factors, such as bad faith denial of share ownership, denial of any voice in corporate affairs, and disrespect of someone who is supposed to be an owner in the business, which are all but impossible to compensate.  The shareholder oppression doctrine allowed the court to consider whether the defendant’s actions were likely to continue in the future. In many cases, the only practical way to protect the minority shareholder is to allow the minority shareholder to transfer back to the corporation or to the majority the stock that the oppressive actions of the majority has rendered valueless and to require the majority to pay a fair price for what he has taken. As one court has stated: “From the controlling shareholders’ point of view, the buy-out may be more costly, but such a remedy provides an effective means of fairly compensating the aggrieved shareholder here. The buy-out remedy fits the situation . . . .”

Derivative suits may award damages for past wrongs and injunctive relief to curb some misconduct, but it is difficult to imagine a court ordering a buy-out of an individual shareholder in a derivative action brought for the benefit of the corporation. A court may have the equitable power to fashion a buy-out remedy, but there is no logical connection between any claim brought for the benefit of the corporation and a remedy that causes the corporation to buy out a single minority shareholder. 

Ritchie's "Gap" for Texas Shareholders

The Ritchie "Gap"

  • No Duty to Individual Shareholders

  • No Shareholder Cause of Action

  • No Buy-Out Remedy

Future Legal Development of Minority Shareholder Protection

The Supreme Court stated that numerous statutory and contractual protections and other common-law remedies currently exist to protect against oppressive conduct.  The Court specifically stated that “we do 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.”  The Court also noted that numerous traditional common-law causes of action already exist that may address oppressive conduct. “Relying on the same actions that support their oppression claims, Texas minority shareholders have also asserted causes of action for: (1) an accounting, (2) breach of fiduciary duty, (3) breach of contract, (4) fraud and constructive fraud, (5) conversion, (6) fraudulent transfer, (7) conspiracy, (8) unjust enrichment, and (9) quantum meruit.”  The majority opinion repeatedly cites classic shareholder oppression doctrine cases with approval regarding claims asserted other than oppression.

The Court made clear that “we have not abolished or even limited the remedies available under the common law or other statutes for the kinds of conduct that give rise to rehabilitative receivership actions, whether under the oppressive-actions prong or other prongs. . . . [T]he actions that give rise to oppressive-action receivership claims typically also give rise to common-law claims as well, opening the door to a wide array of legal and equitable remedies not available under the receivership statute alone. Those remedies, whether lesser or greater, are not displaced by the rehabilitative receivership statute, which merely adds another potential remedy available in extraordinary circumstances when lesser remedies are inadequate.”  Therefore, in light of the Ritchie decision, there is a new urgency in re-examining what legal rights and remedies “already exist”  to protect individual minority shareholders against oppressive conduct. 

Recent attempts to address shareholder oppression in the Texas Legislature have been unavailing. Therefore, oppressed minority shareholders must seek what protection remains in the common law.

Existing legal protection of minority shareholder rights and causes of action, such as breach of trust and stock conversion, may furnish the possibility of a buy-out remedy to fill in the "gaps" left by the Ritchie Court.

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: Individual Shareholder Claims >

 

Share the content
Retain Fryar Law Firm for an Initial Consultation Click Here
Future of Shareholder Oppression Law

Follow Us

Tell Me More About Fryar Law Firm

Fryar Law Firm knows the needs of shareholders after Ritchie.
Request our brochure WORKING WITH FRYAR LAW FIRM

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.

 

 

 

Fryar Law Firm Top 50 Verdicts in the Nation 2015Fryar Law Firm Largest 2015 Fraud Verdict in Texas
Filling In The Gaps Part 1 Published! Download your Copy Today
Retain Fryar Law Firm for an Initial Consultation Click Here