A Minority Shareholder’s RightsFrom the Beatles Perspective:

It's a Long and Winding Road; You Can't Buy Love (or Sell Your Stock); But If You Let it Be,

When You're 64, You'll Still be Wishing for Yesterday

DBA BUSINESS LITIGATION SECTIONApril 10, 2012Dallas, Texas

By: Ladd A. Hirsch*Diamond McCarthy LLP

LHirsch@diamondmccarthy.com

*With appreciation and assistance fromGreg Taylor, Beatles aficionado and lifelong fan.

4

The Oppression Problem

• Majority shareholders control the board/company

• Majority group can take “oppressive” actions that harm (freeze out) minority shareholders

Examples of oppressive conduct by majority shareholders:

– Terminate employment – Remove minority shareholders from management– Refuse to declare any dividends– Deny minority shareholders access to information– Siphon off earnings (inflated salary and bonuses)

• NO EXIT EXISTS (Cannot Monetize Investment)

7

Why Claims For  Oppression Are Increasing(Economic Downturn = More Private Companies)

• Fewer public offerings (IPO market is small)• Absence of government regulation or oversight for private companies (No SOX)

• Private companies are often successful• Like Beatlemania, merger mania has subsided

8

Oppression Claim Starts With Private Corporation, Typically Closely Held

BUS. ORG. CODE SECTION 27.702

• Small number of shareholders

• Substantial owner participation in the management of the business

• Absence of any significant market for the company’s stock

9

Oppression Action: Texas Statute

• The Texas Statutory Action for Oppression

– BOC 11.404: Receiver and eventual possibility of liquidation on the grounds of “oppressive” conduct by “governing persons of the entity”

– BOC 11.401, 404: Refers to power court’s power over property and business of “domestic entity.”

10

Oppression Action: Texas Case Law

“Oppressive” conduct: Davis v. Sheerin, Houston 1988; Richie, et al. v. Rupe, 339 S.W.2d 275 (Tex. App.—Dallas 2011, pet. denied)

• Oppression should be deemed to arise only when the majority's conduct substantially defeats the expectations that objectively viewed were both reasonable under the circumstances and were central to the minority shareholder's decision to join the venture.

• Burdensome, harsh and wrongful conduct, a lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members, or a visible departure from the standards of fair dealing and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely.

13

Split Authority In Delaware Re: ViabilityOf Shareholder Oppression Claims

2010 Federal Court explained Nixon “did not entirely preclude the possibility of a direct cause of action for minority shareholders.”

2011 Bankruptcy Court cited Litle with approval and emphasized that “Delaware courts have recognized oppression as a cause of action”

2004 Massachusetts court upheld oppression claim and noted the “sweeping dicta” in Nixon did not preclude a cause of action.

2005 Delaware court recognized Litle as “the only Delaware case that squarely addressed the issue of [shareholder] oppression”

2000 Fifth Circuit describes Nixon as “very strong dicta” on shareholder oppression issue.

2000 Delaware court applied Litle where defendant froze dividends “to effectuate an oppressive squeeze-out”

Nixon v. Blackwell (Del. 1993)(rejecting minority shareholders’claim for breach of fiduciary duty)

Litle v. Waters (Del. Ch. 1992)(upholding shareholder oppression claim related to squeeze-out plan)

15

No Safe Harbor for Majority Owners

• Business Judgment Rule: Does not bar shareholder oppression claims, although it remains a defense

• At Will Employee: Termination of “at will” employee can be an oppressive action

• Shareholders Owe No Duties to Each Other:Majority (controlling) shareholders may owe fiduciary duties to minority shareholders

16

Business Judgment RuleMistake v. Misconduct

• An officer or director “shall not be held liable for an honest mistake of judgment if he acted with due care, in good faith, and in furtherance of a rational business purpose.”– FDIC v. Wheat, 970 F.2d 124, 130-131 (5th Cir. 1992);

• “Under the business judgment rule, a shareholder cannot institute a derivative suit on the corporation’s behalf by merely showing that the board’s refusal to act was unwise, inexpedient, negligent, or imprudent.”– Pace v. Jordan, 999 S.W.2d 615, 623 (Tex. App.—Houston [1st Dist.] 1999,

pet. denied).

18

Business Judgment RuleIn Closely Held Corporations

• Prof. Doug Moll, Univ. of Houston: Oppression doctrine is implicitly premised on the notion that more than mere “surface inquiry” is required into conduct of majority

• Rupe quoting Davis: “Courts take an especially broad view of the application of oppressive conduct to a closely [ ] held corporation where oppression may be more easily found.”

20

The Oppression Action

The Successful Claim for Shareholder Oppression Typically Has the Following Characteristics:

– Company has history of profitability

– Majority/control group has given itself preferential treatment – self-dealing exists

– Retained earnings are not justifiable – company is hoarding cash to avoid distributions to minority owners

– Minority owners are not sharing in the benefits of success

21

Shagrithaya v. Martin, et al.Dallas State District Court

Case Tried to Jury: Sept. – Nov. 2009Judgment: March 2010 (On Appeal)

Shareholder Oppression:A Real World Case Study

22

23

24

25

26

27

28

29

30

Factors To Consider InEvaluating Oppression Claim

• Are minority’s economic expectations objectively reasonable based on expectations at time of investment

• Did minority have access to material information

• Does minority have the right to participate in the company’s business decisions

• Has majority received preferential treatment or engaged in corporate waste

31

Operation Of The“Non-Oppressive” Private Company

• Board/shareholders meet regularly

• Financial Information is provided periodically

• Dividend/distribution policy exists – no phantom income without tax distribution

• Minority Owners have a voice and participate (but do not control)

33

Buyout Of Minority For “Fair Value”:Issues (Rupe Decision)

• Upheld buyout, but remanded for retrial on valuation of minority interest

• What is “fair value”: – different than “fair market value”

• Minority discount (opposite of control premium)

• Lack of marketability for minority interest• Timing of fair value determination

– At time the oppression began– At time suit filed– At time of trial

35

Derivative Actions

• Lawsuit by minority shareholder against majority filed in the name of the company –avoids defense based on alleged lack of any fiduciary duty

• Multiple procedural hurdles –– Ownership at time of injury and suit– Adequate representative of shareholders– Demand/Futility

36

Derivative ActionsClosely Held Companies

• Statutory boost for derivative claims by minority shareholders –procedural rules waived (BOC §21.563)

• Minority shareholder may bring suit to recover for his own account – where justice requires

37

Post- Davis v. SheerinRecent Cases Of Interest

• Not a complete return to Business Judgment Rule, but a step back from willingness to find oppression of minority shareholders.

• “Courts must exercise caution in determining what shows oppressive conduct.”– Willis v. Bydalek, 997 S.W.2d 798 (Tex. App.—Houston [1st Dist.] 1999, pet.

denied)

38

Post- Davis v. SheerinRecent Cases Of Interest

• Summary judgment not appropriate in oppression case where minority shareholder has offered objective evidence his expectations were defeated. Feldman v. Kim, Cause No. 14-11-00184-CV, 2012 WL 50623, at *3 (Tex. App. –Houston [14th Dist.] Jan. 10, 2012, no pet. h.)

• Shareholder oppression claim not the same as claim for breach of fiduciary duty.

• Controlling LLC member may owe fiduciary duty to minority member in case of redemption. Allen v. Devon et. al, --- S.W.3d ----, 2012 WL 876771 (Tex. App.--Hous. [1st Dist.] 2012, no pet. history) (insert description)

40

LADD HIRSCHDiamond McCarthy LLP

(214) 389‐5323LHirsch@diamondmccarthy.com