A fundamental right of property ownership is the right to sell, transfer, assign, or give it away. The “ownership of the stock and [the] right to sell or transfer it” is a “vested right and interest, subject only to the right of the corporation to manage and regulate its affairs under the laws of this state and under the provisions of its charter and bylaws.” For this reason, the general policy of the law opposes restraints on the alienation of personal property, including stock. Absent valid restrictions, unrestricted shares are freely transferable.
In Sandor Petroleum Corp. v. Williams, the plaintiff was issued two stock certificates for 1,250 shares each in consideration for assisting the corporation in obtaining certain oil and gas leases. Thereafter, a disagreement regarding the management of the corporation arose between the plaintiff and Mr. Sabo, who was an officer and director and presumably a controlling shareholder, and the plaintiff indicated his wish to sell his shares. The plaintiff first offered to sell his shares to Sabo and then later made the same offer to another officer/director; both refused. At about the same time, the board held a special meeting and amended the bylaws, restricting the sale and transfer of stock and giving the corporation the “option to purchase any of its stock offered for sale at a price to be fixed by appraisers.” The corporation then cancelled the plaintiff’s stock certificates and reissued new certificates that stated the restriction on transfer, as required by law. The plaintiff refused the new certificates and continued to attempt to market his shares; however, the corporation notified the prospective buyers that it would not recognize a sale or transfer on its books unless the restrictions contained in the amended bylaw were first complied with. The plaintiff sued the corporation and Sabo, individually, for conversion of his stock, and the trial court entered a judgment for $27,500, the value of the stock found by the jury.
The court of appeals held: “[C]orporate shares of stock are property which may be freely sold and delivered.” “However, reasonable restrictions upon the sale and transfer of shares may be imposed by agreement between stockholders, by statutory enactment and by corporate charters or bylaws or amendments thereto.” At the time Sandor was decided the relevant provisions of the Texas Business Corporations Act provided that restrictions on the sale or transfer of shares, “which do not unreasonably restrain or prohibit transferability,” may be set forth either in the articles of incorporation or bylaws, including specifically a right of first refusal. Furthermore, the board of directors had the power to amend or adopt new bylaws. Therefore, the appellees argued that they had validly adopted an amendment to the bylaws that imposed a valid restriction on transfer, and these completely legal and authorized acts could not constitute “conversion” of stock.
Prior to the amendment of the bylaws, there “was no provision in the articles of incorporation, in the original bylaws or in the shares for a restriction on the sale or transfer of the stock except a provision that a transfer must be made on the stock transfer books of the corporation.” The court reasoned that the issue was not whether the amendment of the bylaws was valid or whether the restrictions were reasonable but whether the corporation could, without the owner’s consent, “restrict the sale of its previously unrestricted stock.” The court rejected the notion that the plaintiff’s agreement to the original bylaws, which permitted the board to amend its provisions, constituted consent to whatever amendment the board chose to pass; rather, “this bylaw should be interpreted in light of the existing law and the articles of incorporation. Neither the law nor the articles of incorporation are consistent with a restriction depriving the holder of previously unrestricted stock of its full value.” The court noted that “Appellants have cited no case and we have not been able to find one holding such a restriction on previously unrestricted stock to be valid. Therefore, the court held that amending the bylaws to restrict the transferability of previously unrestricted stock constituted conversion—the “wrongfully asserting and exercising an authority over a right in the stock which was adverse to and destructive of the vested property right and interest” of the plaintiff.
The appellees also argued that the plaintiff had not proved a demand and refusal in that, after the restrictions on the transfer were adopted, neither the plaintiff, nor any assignee of his, ever presented the certificates for transfer. The court rejected that argument on the grounds that a formal demand “would have been a useless thing” because the corporation had already stated unequivocally that it would not recognize any transfer that did not comply with the transfer restrictions. “[D]emand and a refusal was not necessary to constitute a conversion. It was shown that a demand would have been useless or unavailing if it had been made.”
The Sandor opinion was relied on by the court of appeals in Ritchie v. Rupe as the primary authority for its conclusion that interference with the right of alienation of unrestricted stock constituted shareholder oppression, which would certainly seem to be a fair reading of the Sandor opinion. However, the conversion in Sandor also involved the actual cancellation of the share certificates. Would interference with the right of alienation that does not involve the actual cancellation of the certificate would constitute conversion? While the Sandor appellate opinion did state: “Actually the cancellation of his original shares was in effect a taking of his stock and was an unauthorized and unlawful act amounting to conversion,” the court’s reasoning clearly indicates that the cancelling of the certificate was only an incidental factor. The court almost exclusively focuses its analysis on the transfer restrictions, which were “an unauthorized alteration of the condition” of the stock. The appellees apparently argued that their actions could not constitute conversion because they always recognized the plaintiff as a shareholder and the cancellation was merely the substitution of a “a new certificate to [the plaintiff] in lieu of the old ones in compliance with a valid bylaw.” The court rejected that argument and focused on the plaintiff’s loss of a “vested property right and interest” in having unrestricted stock. “[R]estricting the sale of its previously unrestricted stock was, therefore, unauthorized and invalid in so far as it denied appellee’s right to sell at a price which he could have secured on the open market.”
In Schwartz v. NMS Industries, Inc., the plaintiffs had received unregistered shares in a public company and had an agreement with the company to register a portion of those shares. Subsequently, the corporation refused to register the shares, leaving the shareholders without the ability to sell their shares on the open market. The Fifth Circuit, applying Texas law, held: “By maintaining the restrictive legend on the shares, NMS prevented Schwartz and Rosenbaum from selling the stock, and, in effect, converted the shares.”
How would the plaintiff in Ritchie have fared under the tort of stock conversion? As its authority for the proposition that restrictions on the transferability of stock are "oppressive," the court of appeals relied extensively on the 1959 court of appeals opinion in Sandor Petroleum v. Williams, which was a stock conversion case. The tort of stock conversion was one of the alternative causes of action specifically highlighted by the Supreme Court in Ritchie.
Would Ritchie v. Rupe have been affirmed based on a conversion claim? Perhaps. The reasoning of the appellate opinion in Ritchie was certainly consistent with Sandor with respect to the interference with a fundamental property right of the plaintiff. However, the actual interference in Ritchie did not involve the attempt to impose formal transfer restrictions on previously unrestricted stock. Rather, the court of appeals concluded that the defendants “acted oppressively toward [the plaintiff] by refusing to meet or allow any officer or director of RIC to meet with prospective purchasers of the Stock because that conduct in this case substantially defeated Ann's general reasonable expectation of marketing the Stock.” This holding does not translate cleanly into the conversion context. An act of control or dominion must be positive and affirmative (“mere non-feasance will not do”).
The court of appeals held that “[b]ecause often no ready market exists [for the sale of shares in a closely-held corporation], to sell her stock to third parties [a minority shareholder] must market her stock by (1) identifying potential third-party buyers through means such as advertising, networking through brokers and others, and meeting with potential buyers, and then (2) providing to those potential buyers sufficient information about the corporation and its businesses, assets, and management as to allow them to conduct a reasonable investigation as to the proposed transaction.” The Sandor court recognized a property right inherent in ownership of unrestricted stock to be the “right to sell at a price which he could have secured on the open market.” In Sandor, the plaintiff had actually been negotiating with prospective purchasers of his stock, and the defendants “by letter advised such prospective purchasers that the corporation would not recognize a sale of Williams’ stock and would not enter a transfer on its books unless the requirements of the amended bylaw were first complied with.” The court held that this active interference with efforts to sell, “wrongfully asserting and exercising an authority over a right in the stock,  was adverse to and destructive of the vested property right and interest of Williams therein.” The defendants in Ritchie do not appear to have actively interfered, but merely failed to cooperate. “Generally, before there can be a conversion of property, there must be an act of malfeasance and not a mere nonfeasance; a positive wrong and not the mere omission of what was right.” Nevertheless, the Ritchie court reasoned that “[c]orporate policies that constructively prohibit the shareholder from performing these activities” would interfere with a right to sell at a price the shareholder could secure on the open market. The Ritchie court concluded that conduct at issue was active—not a mere failure of corporate officers to do something that the plaintiff desired, but an actual policy adopted, it seems, in specific response to the plaintiff’s efforts to market her shares.
If Ritchie had been tried as a conversion case, one would expect expert testimony that meeting with a potential purchaser would be a customary practice of management that one would expect, absent a specific policy prohibiting such contact or a specific decision to interfere with the plaintiff’s attempts to sell. The court of appeal’s opinion cites testimony, which although not expert testimony regarding customary corporate practices, comes extremely close. On the basis of the evidence, the court of appeals held that it would be “reasonable to expect that the corporation and its management . . . will consent to a shareholder’s reasonable requests for cooperation with respect to her efforts to sell the stock.” The Ritchie opinion does not discuss the content of information that the plaintiff was expecting management to convey to potential purchasers. It would be helpful in establishing a conversion case if the information being requested was the sort of information that the corporation had a duty to provide to shareholders in any event, so that the refusal to meet with potential purchasers also constituted a violation of the duties to provide information to the shareholder.
The Ritchie court held that “there is substantial evidence that refusing [plaintiff’s] request to meet with
potential purchasers had the practical effect of precluding her from the opportunity to market the Stock to third parties.” Conversion may be constructive. Therefore, if the jury had found that the defendants intended their conduct to assert control over the plaintiff’s right to sell her property, then it is quite likely that a court would have held that the conduct of the defendants in Ritchie interfered with the stockholder’s rights in the property and “wrongfully assert[ed] and exercise[ed] an authority over a right in the stock which was adverse to and destructive of the vested property right and interest” of the plaintiff.
|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||
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.