On June 20, 2014, the Texas Supreme Court issued its opinion in Ritchie v. Rupe, in which the Court addressed the rights and remedies of minority shareholders of Texas companies. In the following guest post Kara Altenbaumer-Price, Vice President, Management & Professional Liability Counsel for USI Southwest / USI Northwest, takes a look at the decision and analyzes its implications.
I would like to thank Kara for her willingness to publish her post on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this blog. If you would like to submit a guest post, please contact me directly. Here is Kara’s guest post:
The Texas Supreme Court ruled in late June that minority shareholders in private companies in Texas cannot sue for shareholder oppression, even when majority shareholders attempt push them out of the business, dilute their shares, or otherwise act to lower the value of their investment. While some have heralded the decision as pro-business and an effort to keep the courts out of Texas boardrooms, others suggest that the case will discourage investment in Texas companies.
The ruling in Ritchie v. Rupe, which applies to businesses incorporated in Texas, held that not only does the Texas Business Organizations Code not prohibit oppression of minority shareholders, there is no common-law cause of action for minority shareholder oppression in Texas. Intermediate appellate courts in Texas had allowed such claims to be brought, but this was the first time the question had been addressed by the Texas Supreme Court. The Court’s ruling means that except in very narrow circumstances—addressed below—minority shareholders cannot sue unless they can allege that the complained-of actions were fraudulent, a breach of fiduciary duty, or another cause of action other than shareholder oppression.
The facts in Ritchie v. Rupe involved a minority shareholder who inherited 18 percent of private company stock following the death of her husband. The majority shareholders had offered to purchase the shares for $1 million, but because the company had sales in excess of $150 million and assets in excess of $50 million, her attorney encouraged her to decline the “absurd” offer. Although the offer was ultimately raised to $1.7 million through negotiations, the minority shareholder continued to refuse what she believed was a too-low offer. She then found a third-party buyer to whom she wanted to sell the stock, but the majority shareholders objected and refused to meet with the potential third-party buyer for fear it would put the company at risk for securities fraud. This left the minority shareholder unable to market or monetize her shares. She sued, alleging that the majority shareholders engaged in “oppressive” conduct toward her. At trial, the company was ordered to purchase her shares at a jury-determined fair market value of $7.3 million. The majority shareholders appealed.
The Texas Supreme Court ruled that her claims were not valid under Texas common law or the Texas Business Organizations Code. Instead, the Court held that the only time a shareholder oppression claim could be brought against a private company in Texas is when a rehabilitative receiver has been appointed. Even within this narrow context of receivership, the standard for proving a shareholder oppression claim would be extremely high; a shareholder would have to show that he or she was intentionally harmed by officers and directors. As a practical matter, it is unlikely that forcing the company into rehabilitative receivership would benefit the minority shareholder seeking to get greater value for his or her shares. As a result, this is a hollow consolation at best.
As one Texas appellate lawyer described it, this ruling puts Texas “on an island.” Most states either overtly allow suits for minority shareholders oppression or don’t prohibit them. From a litigation perspective, the ruling is certainly positive for private companies in that it will very likely reduce the amount of shareholder litigation against them, or at the very least, make them more likely to prevail on suits that are filed on other grounds. While there are still avenues for minority shareholders to sue, as noted above, it may not make logical sense for them to sue for fear of even further reducing the value of their investment by pushing for rehabilitative receivership or because claims like fraud or breach of fiduciary duty are difficult to prevail on.
This ruling should not, however, cause private companies to abandon their D&O insurance for a number of reasons. First, as noted above, minority shareholders can still sue Texas companies; they just won’t be able to bring this relatively common cause of action unless they also seek to place the company into rehabilitative receivership. Plaintiffs lawyers are resourceful, and private companies will still need to defend themselves from disgruntled shareholders. Second, sophisticated investors—even if minority investors—will be likely to add minority shareholder protections contractually into their investor agreements as prerequisite to investing in a Texas corporation. They would be able to sue pursuant to these contractual provisions. Third, the Texas Legislature meets in a little less than six months and has the ability to change the Business Organizations Code to overrule the Court’s decision by statute. Finally—and most importantly—unlike public company D&O insurance, the coverage afforded under private company D&O insurance is very broad and can cover many non-investor claims, including those arising from vendors, business partners, lenders, and other third parties. It would be wise, however, for Texas private companies to use this reduced threat of shareholder litigation as leverage in renewal negotiations with carriers to push for improved terms and conditions or pricing.