T E X A Sweb1.amchouston.com/flexshare/003/BusinessLaw/Journal/TJBL_Is… · t e x a s j o u r n a l o f b u s i n e s s l a w vol. 47, no. 1 winter 2017 does halliburton ii allow

T E X A S

J O U R N A L

o f

B U S I N E S S

L A W Vol. 47, No. 1 Winter 2017

DOES HALLIBURTON II ALLOW DEFENDANTS TO PROVE A LACK OF “CORRECTIVENESS” TO DEFEAT CLASS CERTIFICATION? Roger B. Greenberg & Zach Wolfe TEXAS MARGIN TAX: IS IT TIME FOR THE CURTAIN CALL? Nikki L. Laing FILLING IN THE GAPS: SHAREHOLDER OPPRESSION AFTER RITCHIE V. RUPE: PART 1 Eric Fryar RECENT BUSINESS DEVELOPMENTS

- OFFICIAL PUBLICATION OF THE BUSINESS LAW SECTION OF THE STATE BAR OF TEXAS - IN ASSOCIATION WITH SOUTH TEXAS COLLEGE OF LAW HOUSTON

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TEXAS JOURNAL OF BUSINESS LAW

Volume 47 Winter 2017 Number 1 CONTENTS: DOES HALLIBURTON II ALLOW DEFENDANTS TO PROVE A LACK OF “CORRECTIVENESS” TO DEFEAT CLASS CERTIFICATION? Roger B. Greenberg & Zach Wolfe ............................................................................... 1 TEXAS MARGIN TAX: IS IT TIME FOR THE CURTAIN CALL? Nikki L. Laing ............................................................................................................. 11 FILLING IN THE GAPS: SHAREHOLDER OPPRESSION AFTER RITCHIE V. RUPE: PART I Eric Fryar ................................................................................................................... 47 RECENT BUSINESS DEVELOPMENTS Derivative Suits of Arbitration Clauses in Engagement Letters ............................... 199 UCC Article 4 Preemption of Fraud & Breach of Contract Claims ........................ 203 Unilateral Termination of Agreements to Arbitrate Disputes ................................. 209 Challenges to the Formation of an Arbitration Agreement ...................................... 213

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COPYRIGHT

Copyright © 2017, Business Law Section of the State Bar of Texas (U.S. ISSN 1547-3619)

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TEXAS JOURNAL OF BUSINESS LAW Volume 47 Winter 2017 Number 1

South Texas College of Law Houston 2016–2017 EDITORIAL ADVISORY BOARD

Editor

W. DAVID EAST Professor of Law

Faculty Advisors

W. DAVID EAST Professor of Law

BRUCE A. MCGOVERN

Associate Dean and Professor of Law

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TEXAS JOURNAL OF BUSINESS LAW Volume 47 Winter 2017 Number 1

South Texas College of Law Houston 2016–2017 STUDENT EDITORIAL BOARD

TEXAS JOURNAL OF BUSINESS LAW

Managing Editor

DOMONIQUE BROADUS

Articles Editors

AMY HEDGECOCK BRIAN MERKA

BRYAN RAMIREZ DAVID TEASDALE TYLER WILLIAMS

Associate Editors

CARLOS AGUAYO ERIN K. AMATO MORGAN BIRD

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STEPHEN CALEB MCVICKER YOLANDA ORDONEZ

MATTHEW PARR RAFAEL QUESADA

WILLIAM W. READE III

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MORGAN BROOKE RUSSELL HARRISON TATUM RANDALL TOWNS CLAYTON TRICE ALEXA VITUCCI

WILLIAM RIVERS WALLACE HEIDI WEELBORG

The State Bar of Texas Business Law Section Journal Committee

RYAN NAYAR (Chairman), Houston Robyn Preussel Phillips, Houston

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TEXAS JOURNAL OF BUSINESS LAW Volume 47 Winter 2017 Number 1 BUSINESS LAW SECTION Irene Kosturakis BMC Software, Inc. 2101 CityWest Boulevard Houston, Texas 77042 Chair

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JOURNAL COMMITTEE CHAIR FACULTY ADVISORS Ryan Nayar W. David East Akin Gump Strauss Hauer & Feld L.L.P. Bruce McGovern 1111 Louisiana Street, 44th Floor South Texas College of Law Houston Houston, TX 77002 1303 San Jacinto Street Houston, TX 77002

DOES HALLIBURTON II ALLOW DEFENDANTS TO PROVE A LACK

OF “CORRECTIVENESS” TO DEFEAT CLASS CERTIFICATION?

Roger B. Greenberg1 & Zach Wolfe2

In Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”), the U.S. Supreme Court held that defendants in federal securities fraud cases may defeat class certification by proving a lack of “price impact” at the class certification stage.3 This holding gave defendants in such cases a significant new opportunity to defeat class certification. But lower courts so far have not given Halliburton II the robust application that Halliburton and other corporate defendants may have hoped for.4

The Halliburton case itself shows the limited impact Halliburton II has had to date. On remand from Halliburton II, the district court held that Halliburton proved a lack of price impact for all alleged misrepresentations and corrective disclosures except one: an announcement of an adverse jury verdict in an asbestos case.5 Therefore, the district court granted class certification, but only as to that single misrepresentation.6 The Fifth Circuit granted Halliburton leave to appeal this decision, and the Fifth Circuit heard oral argument on August 31, 2016.7

The issue in the pending appeal before the Fifth Circuit is narrow but important: When a defendant in a securities fraud class action attempts to rebut the Basic presumption by proving a lack of price impact, is the “correctiveness” of the alleged corrective disclosure an issue the district court should consider?8 The plaintiffs in Halliburton argue that correctiveness is a class-wide merits issue like materiality, loss causation, and falsity of the alleged misrepresentation. At the class certification stage, plaintiffs argue, the court should assume the correctiveness of the alleged corrective disclosure, focusing only on whether the corrective disclosure caused a price impact.

Halliburton, on the other hand, argues that correctiveness is necessarily part of the price impact issue. Correctiveness may be a class-wide issue, Halliburton argues, but so is price impact, and the whole point of Halliburton II was to allow defendants to attempt to rebut price impact at the class certification stage. If the Fifth Circuit agrees, it will be one step towards the more expansive application of Halliburton II that corporate defendants hoped for.

1 Sponsel Miller Greenberg P.L.L.C., Houston, Texas. 2 Fleckman & McGlynn, P.L.L.C., The Woodlands, Texas. 3 Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398, 2417 (2014) [Halliburton II]; Basic Inc. v.

Levinson, 485 U.S. 224 (1988). 4 For the background to Halliburton II and a detailed discussion of the opinion, see our previous article in this

journal at Vol. 46, No. 1. 5 Erica P. John Fund, Inc. v. Halliburton Co., 309 F.R.D. 251, 256, 279–80 (N.D. Tex. 2015) [EPJF II]. 6 Id. at 280. 7 Erica P. John Fund, Inc. v. Halliburton Co., No. 15-90038, 2015 WL 10714013, at *1 (5th Cir. Nov. 4, 2015). 8 Merriam-Webster tells us “correctiveness” is not a word, but it communicates the concept at issue here so

conveniently that we will give ourselves permission to use it.

2 TEXAS JOURNAL OF BUSINESS LAW [VOL. 47:1

I. BACKGROUND: “MERITS” VS. “PREDOMINANCE” ISSUES IN SECURITIES FRAUD CLASS ACTIONS

The root of the problem in the pending Halliburton appeal is that the issues in a securities fraud class action do not neatly divide into “merits” issues and “class certification” issues. Yet courts must draw lines between the elements defendants can dispute at the class certification stage and the elements that must be assumed to be true.

While drawing these lines is difficult, this is what we know from U.S. Supreme Court decisions:

Issue Case Defendants Can Challenge at

Class Certification?

Efficient Market Halliburton I9 Yes Loss Causation Halliburton I No Materiality Amgen10 No Price Impact Halliburton II11 Yes Correctiveness Halliburton III ?

Based on these decisions, Halliburton argues that correctiveness is part of price impact and different from loss causation and materiality. Plaintiffs, on the other hand, argue that correctiveness is a merits issue much closer to loss causation and materiality.

There is, of course, a simple argument for not allowing defendants to challenge correctiveness at the class certification stage: A lack of correctiveness is an issue common to the entire class, such that a finding of no correctiveness would defeat the claims of the entire class. Therefore, the argument goes, correctiveness is a merits issue that cannot be addressed at class certification.

The problem for plaintiffs is that this argument is too simple. The same argument can be made for price impact, yet Halliburton II made it clear that defendants can challenge price impact. So it is not enough merely to ask whether the issue is common to the entire class. The challenge for the plaintiffs in the pending appeal is to persuade the Fifth Circuit that the inquiry permitted by Halliburton II should be quite narrow: assuming the alleged corrective disclosure was in fact corrective, did it impact the stock price?

II. THE DISTRICT COURT’S OPINION APPLYING HALLIBURTON II

After the Supreme Court decided Halliburton II and the case was remanded to the district court, District Court Judge Lynn ordered the Fund and Halliburton to provide additional

9 Erica P. John Fund v. Halliburton Co., 131 S. Ct. 2179 (2011) [Halliburton I]. 10 133 S. Ct. 1184 (2013) [Amgen]. 11 134 S. Ct. 2398 (2014).

2017] DOES HALLIBURTON II ALLOW DEFENDANTS TO PROVE CORRECTIVENESS? 3

briefing on price impact as it relates to class certification. Each side filed an expert report, additional briefing, and a Daubert motion to exclude the other side’s expert (naturally). After holding an evidentiary hearing and considering the conflicting expert testimony, Judge Lynn wrote a detailed opinion concluding that Halliburton proved a lack of price impact for all alleged misrepresentations and corrective disclosures except one, involving an announcement of an adverse jury verdict in an asbestos case. Therefore, the district court granted class certification, but only as to that single misrepresentation.12

The district court opinion contains the most detailed analysis yet of the issues that arise from litigating price impact at the class certification stage under Halliburton II, including the following:

How will expert event studies be used at the class certification stage? As expected, the events after remand suggest that dueling expert “event studies” will become the norm at the class certification stage after Halliburton II. Both sides submitted event studies, i.e., regression analyses, to show that Halliburton’s stock price was, or was not, affected on days when an alleged misrepresentation or corrective disclosure reached the market.13

Halliburton’s expert, Lucy Allen, found no price impact after any of the alleged misrepresentations or corrective disclosures, with the exception of one date (December 7, 2001), when her analysis indicated that the price reaction was caused by factors other than Halliburton’s disclosure of an adverse asbestos verdict.14

The Fund’s expert, Chad Coffman, found that there were six relevant dates to evaluate price impact, ending with the December 7, 2001 asbestos verdict announcement. Presuming that the Fund’s allegations were true—that Halliburton made material misrepresentations or omissions, “with scienter, regarding its asbestos liability and its accounting on fixed-price contracts”—Coffman found that the market price changed significantly in response to each of these six events.15

What is the role of Daubert motions in the price impact battle? The experts who did the event studies, Allen and Coffman, disagreed on methodology on several grounds. Both sides filed Daubert motions, arguing that the other side’s expert’s methodology was unreliable. The district court denied both Daubert motions, finding that the arguments about reliability of methods were “inextricably intertwined” with the merits arguments about price impact.16

Who has the burden of production and persuasion? While the Supreme Court in Halliburton II was clear that a defendant can defeat class certification by proving a lack of price impact, the Court did not address the burden of proof. Citing Federal Rule of Evidence 301, Halliburton argued that it is sufficient for the defendant to offer some evidence challenging price impact, in which case the presumption of reliance disappears and the plaintiff then has the burden of persuasion on price impact. The district court rejected this argument,

12 EPJF II, 309 F.R.D. 251, 256, 280 (N.D. Tex. 2015). 13 Id. at 257. 14 Id. at 263. 15 Id. at 263. 16 Id. at 256.


reasoning that in effect, this would require the plaintiff to prove price impact directly, a proposition the Supreme Court refused to adopt. The court held that the defendant has the burden of persuasion on the price impact issue.17

What is the proper control period for measuring price impact? An event study should take into account how the company’s stock price moves relative to industry indices during a specified “control period.” Halliburton’s expert made adjustments to the Fund’s expert’s control period, which the district court found were appropriate to achieve internal consistency.18

What is the appropriate stock price index to use as a control? To determine whether a corrective disclosure had a price impact, an event study must use a control to adjust for general movement in the company’s industry. Based on Halliburton’s two main lines of business, Halliburton’s expert used an S&P Energy Index and a Fortune Engineering & Construction Index as a control. The Fund’s expert argued that these indices were not specific enough. He constructed a peer index composed of companies including Baker Hughes and Schlumberger that analysts considered to be Halliburton’s peers. The district court found that the specific peer index better explained Halliburton’s stock price movement and was the more appropriate control to use to measure the statistical significance of the price reaction on the six dates at issue.19

Is the use of a two-day window appropriate? On some of the dates at issue, the Fund’s expert used a two-day window to measure price impact, citing widespread use of a two-day window in financial literature and in Halliburton’s own expert’s analysis. But the district court found that use of a two-day window was inappropriate in an efficient market.20

III. THE DISTRICT COURT’S VIEW OF CORRECTIVENESS UNDER HALLIBURTON II

All of the issues discussed above can be important, but perhaps the most significant issue raised by the district court’s application of Halliburton II was whether the defendant can refute price impact by arguing that the alleged corrective disclosures were not in fact corrective. Halliburton argued that a defendant can rebut the Basic presumption of reliance by showing that there was no correction that affected the market price, while the Fund argued that for the purpose of the price impact question the court assumes that the alleged corrective disclosure was in fact corrective of an earlier fraud.

Citing the Supreme Court’s reasoning in Halliburton I21 (loss causation), Amgen22 (materiality), and Halliburton II23 (price impact), the district court agreed with the Fund “that class certification is not the proper stage for the court to determine, as a matter of law, whether

17 Id. at 259–60. 18 Id. at 264–65. 19 Id. at 267–68. 20 Id. at 268–69. 21 131 S. Ct. 2179 (2011). 22 133 S. Ct. 1184 (2013). 23 134 S. Ct. 2398 (2014).


the relevant disclosures were corrective.” The district court also found that this argument was “a veiled attempt to assert the “truth on the market” defense, which pertains to materiality and is not at issue at the class certification stage.”24

IV. THE FIFTH CIRCUIT’S INTERVENING OPINION IN LUDLOW

After the district court certified the class in Halliburton, the Fifth Circuit issued its opinion in Ludlow v. BP P.L.C.25 Ludlow was a securities fraud class action against BP arising from the Deepwater Horizon blowout. The district court denied certification of a pre-spill class, but granted certification of a post-spill class. Both sides appealed, and the Fifth Circuit affirmed.26

With respect to the post-spill class, the Ludlow plaintiffs alleged that BP misrepresented the magnitude of the crisis, inflating the stock price, and that the stock price fell when certain “corrective events” revealed the truth.27 To establish a damage model, the plaintiffs relied on an event study performed by an expert, Chad Coffman (the same expert used by the plaintiffs in Halliburton).28

The question in Ludlow was whether the plaintiffs put forward a proper class-wide damage theory as required by Comcast Corp. v. Behrend.29 The district court judge expressed some concerns about the merits of the expert’s damage theory, but he found it sufficient for plaintiffs to put forward a coherent class-wide approach to damages, regardless of the merits of the approach. BP argued that the district court erred by failing to determine whether the corrective events Coffman relied on were tied to the specific misrepresentations he says they were.30 In other words, BP challenged the “correctiveness” of the alleged corrective events put forward by the plaintiffs’ damage expert.

The Fifth Circuit disagreed with BP. The Fifth Circuit reasoned that BP’s challenge to the connection between the alleged misrepresentations and the alleged corrective events raised issues similar to loss causation and materiality. Citing Halliburton I (loss causation) and Amgen (materiality), the Fifth Circuit held that the district court did not err by refusing to address whether it was proper for the damages expert to include certain corrective events in his damage model. “[W]hether certain corrective disclosures are linked to the alleged misrepresentations in question is undeniably common to the class,” the court said, making it inappropriate to determine that issue at the class certification stage.31

V. THE OPINION GRANTING HALLIBURTON LEAVE TO APPEAL

After the district court issued its order granting class certification, Halliburton filed a motion for leave to appeal, raising the question of “whether a defendant in a federal securities

24 EPFJ II, 309 F.R.D. at 260–61. 25 800 F.3d 674 (5th Cir. 2015). 26 Id. at 677. 27 Id. at 680. 28 Id. at 683–84. 29 133 S. Ct. 1426 (2013). 30 Ludlow, 800 F.3d at 686. 31 Id. at 687–88.


fraud class action may rebut the presumption of reliance at the class certification stage by producing evidence that a disclosure preceding a stock-price decline did not correct any alleged misrepresentation.”32 The Fifth Circuit Court of Appeals, Judges Jolly, Dennis, and Prado, granted leave to appeal.

Judge Dennis wrote an opinion “reluctantly” concurring in the decision to grant Halliburton leave to appeal. In his view, consideration of correctiveness at the class certification stage would be contrary to Halliburton I, Amgen, and Ludlow. “Thus, as I read Halliburton II,” he wrote, “it did not render the corrective nature of a disclosure a class certification issue because, even though it bears on the issue of price impact, it does not affect the issue of predominance at the class certification stage.” Nevertheless, Judge Dennis concurred in allowing the appeal because he thought it appropriate for the court to clarify Halliburton II for the benefit of the courts and future litigants.33

VI. KEY ISSUES IN THE BRIEFING AND ORAL ARGUMENT TO THE FIFTH CIRCUIT

The briefing and oral argument in Halliburton’s latest appeal to the Fifth Circuit shows the difficulty of determining how “correctiveness” fits into the framework established by Halliburton I, Amgen, Halliburton II, and most recently, Ludlow. Halliburton argues that when the plaintiff’s price impact theory is based on a price drop following a corrective disclosure, then correctiveness is inherently part of price impact under Halliburton II. The Fund, on the other hand, seeks to reconcile Halliburton II with Halliburton I and Amgen by arguing that correctiveness—like loss causation and materiality—is a class-wide merits issue that should not be resolved at the class certification stage. These arguments raise many difficult questions, including the following:

1. Is correctiveness evidence price-impact evidence?

Halliburton: “[I]f Halliburton’s evidence concerning correctiveness is price-impact evidence, there can be no doubt the district court erred by refusing to consider it at the class-certification stage.”34 Price declines happen for numerous reasons. The fact that the stock price declines following the release of negative information proves nothing if the negative information did not actually correct an earlier misrepresentation.35

The Fund: Halliburton II allows consideration of evidence concerning price impact, but the price impact inquiry authorized by Halliburton II is quite narrow. The Supreme Court’s concern was that parties were already routinely offering event studies to prove or disprove market efficiency at the class certification stage, and it made no sense to bar defendants from using the same event studies as direct evidence of the absence of price impact. The Court permitted defendants to show that a corrective disclosure had no price impact through an event

32 Erica P. John Fund, Inc. v. Halliburton Co., No. 15-90038, 2015 WL 10714013, at *1 (5th Cir. Nov. 4,

2015). 33 Id. at *2–3. 34 Brief of Halliburton Co. and David J. Lesar at 27, Erica P. John Fund, Inc. v. Halliburton Co., No. 15-11096

(5th Cir. Aug. 31, 2016) [Halliburton’s Brief]. 35 Id. at 28.


study, because such a showing would rebut the presumption of class-wide reliance and show that individual issues of reliance predominate.36 “Nowhere in Halliburton II does the Court indicate that Defendants may rebut the presumption of reliance by showing a disclosure was not corrective.”37

2. Is correctiveness like loss causation, which cannot be considered at class certification under Halliburton I?

The Fund: “Halliburton’s attempt to graft an analysis of whether a disclosure is corrective onto the price impact inquiry erroneously seeks to introduce loss causation at class certification in direct violation of Halliburton I.” Halliburton is erroneously reading Halliburton II to eviscerate Halliburton I, when nothing in Halliburton II supports this interpretation.38

Halliburton: Even if the same evidence was relevant to loss causation in Halliburton I, Halliburton’s correctiveness evidence must be considered because it goes directly to the price impact inquiry authorized by Halliburton II.39

3. Is correctiveness like materiality, which cannot be considered at class certification under Amgen?

The Fund: In Amgen, the Supreme Court held that materiality may not be considered at the class certification stage, because it is a merits issue common to the entire class. Correctiveness is similar to materiality in this respect.40

Halliburton: Materiality is a discrete issue that can be resolved in isolation from the other prerequisites of the Basic presumption and thus can be “wholly confined to the merits stage.”41

4. Is correctiveness a “truth-on-the-market” defense in disguise?

The Fund: The Amgen court found that defendants may not rebut the Basic presumption by presenting a truth-on-the-market defense because such a defense is just a way of showing the misrepresentations were not material.42 The district court correctly found that “Halliburton’s arguments regarding whether the disclosures were corrective are, in effect, a veiled attempt to assert the ‘truth on the market’ defense, which pertains to materiality.”43

Halliburton: “[W]hether a disclosure is corrective has nothing to do with whether the earlier misrepresentation was material.” “A disclosure’s correctiveness turns solely on its relationship to the prior misrepresentation.” “A truth-on-the-market defense, by contrast, asserts that the truth entered the market before the misrepresentation, thus making it impossible

36 Brief of the Lead Plaintiff-Appellee and the certified class at 28–29, Erica P. John Fund, Inc. v. Halliburton Co., No. 15-11096 (5th Cir. Aug. 31, 2016) [Fund’s Brief].

37 Id. at 30. 38 Id. at 32–33. 39 Halliburton’s Brief, supra note 34, at 31. 40 Fund’s Brief, supra note 36, at 33–34. 41 Halliburton’s Brief, supra note 34, at 37 (citing Halliburton II, 134 S. Ct. 2398, 2416 (2014)). 42 Fund’s Brief, supra note 36, at 34 (citing Amgen, 133 S. Ct. 1184, 1197–99 (2013)). 43 Id. at 34–35 (citing EPFJ II, 309 F.R.D. 251, 260–61 (N.D. Tex. 2015)).


for the misrepresentation to materially mislead investors.”44 Halliburton’s position is not that the market learned the truth before the alleged misrepresentations were made, but that the disclosure of the asbestos verdict did not correct any prior misrepresentation.45

5. Does Ludlow support the district court’s refusal to consider correctiveness?

The Fund: The Fifth Circuit has already rejected Halliburton’s correctiveness argument in Ludlow. Ludlow found that the plaintiffs’ argument was “in tension with Halliburton I’s holding that no proof of loss causation is required at the class certification stage.” In addition, Ludlow reasoned that Amgen foreclosed the defendant’s argument because “whether certain corrective disclosures are linked to the alleged misrepresentations in question is undeniably common to the class.” The Fund’s position is that the same reasoning applies to Halliburton’s correctiveness argument.46

Halliburton: “Ludlow addressed only the consideration of damages at class certification and has nothing to say about price-impact rebuttal under the reliance element.” The case before the Fifth Circuit, in contrast, deals exclusively with price-impact rebuttal.47

One problem with Halliburton’s attempt to distinguish Ludlow is that, as the Fund pointed out in its brief, Judge Dennis already rejected Halliburton’s narrow reading of Ludlow in his concurring opinion granting leave to appeal.48 Although Judge Dennis is not on the panel assigned to hear Halliburton’s appeal, the Fund argued that he was not alone in this view, citing some district court opinions that adopt a similar interpretation of Halliburton II.

6. Does barring the defendant from challenging correctiveness at the class certification stage lead to absurd results?

Halliburton: Refusing to consider whether an alleged corrective disclosure was actually corrective will lead to absurd results, because it allows plaintiffs to rely on a price drop following any release of negative information, even if the information has nothing to do with an earlier misrepresentation.49

The Fund: The results are not so absurd. Plaintiffs have to clear the initial hurdle of pleading loss causation, which includes pleading a plausible case for price impact and correctiveness. Plus, defendants get another opportunity to challenge correctiveness at the summary judgment stage.

VII. CONCLUSION

The oral argument in the Fifth Circuit on August 31, 2016 touched on all of these

44 Halliburton’s Brief, supra note 34, at 38. 45 Id. at 39. 46 Fund’s Brief, supra note 36, at 35–36. 47 Halliburton’s Brief, supra note 34, at 41–42. 48 Fund’s Brief, supra note 36, at 36. 49 Halliburton’s Brief, supra note 34, at 44.


questions. The panel of Judges Davis, Higginson, and Elrod grappled with where to draw the line between “merits” issues like loss causation and materiality, which defendants cannot challenge at class certification, and price impact, which defendants are now allowed to challenge under Halliburton II. Not surprisingly, the panel was interested in the parties’ views on whether the Fifth Circuit’s decision in Ludlow resolves the issue.

If the oral argument presented any surprise, it was the panel questioning the premise that the district court refused to consider Halliburton’s correctiveness evidence. The arguments in both sides’ briefs assumed that Judge Lynn refused to consider Halliburton’s evidence that the disclosure of the asbestos verdict was not really a “corrective” disclosure. But the panel seemed not so sure. Judge Higginson questioned Halliburton’s argument that Judge Lynn did not consider whether the asbestos disclosure was simply a revelation of new bad news. “But she did,” he said, and pointed out that the judge broke down Halliburton’s expert’s argument and rejected it.50 “I don’t see that in fact she didn’t address it.”51

This was one question where the parties seemed to agree. Judge Lynn stated 13 times in her opinion that she did not consider Halliburton’s correctiveness argument, Halliburton’s counsel argued, and even the Fund did not take the position that Judge Lynn actually considered that argument.52 While the Fund’s counsel said that Judge Lynn heard all of Halliburton’s evidence, he urged the court to reach the correctiveness issue regardless, for the sake of the clarity of the law.53

As this line of questioning shows, there are several options open to the Fifth Circuit. The Court of Appeals could sidestep Halliburton’s legal argument and affirm on the ground that the district court did consider Halliburton’s correctiveness evidence and rejected it, resolving the factual issue against Halliburton. On the other hand, the court could address the legal issue raised by Halliburton and affirm on the ground that correctiveness is not properly part of the price impact inquiry under Halliburton II.

What if the court decides that Halliburton II does authorize defendants to challenge correctiveness at the class certification stage? In that case, the court could either reverse and render judgment for Halliburton or reverse and remand. In oral argument, Judge Elrod specifically asked Halliburton’s counsel whether the court should remand to the district court to consider whether the disclosure at issue was corrective.

Of course, whatever the Fifth Circuit does, it could potentially lead to a third appeal to the U.S. Supreme Court. The Halliburton litigation saga that began 14 years ago seems far from over, and its outcome will continue to shape the future of securities fraud class actions.

50 Oral argument at 8:11, http://www.ca5.uscourts.gov/OralArgRecordings/15/15-11096_8-31-2016.mp3 (last

visited Dec. 30, 2016). 51 Id. at 16:37. 52 Id. at 8:30, 16:50. 53 Id. at 34:40.


TEXAS MARGIN TAX: IS IT TIME FOR THE CURTAIN CALL?

Nikki L. Laing

I. INTRODUCTION ............................................................................................. 12II. DEBUT OF THE MARGIN TAX IN 2008 ....................................................... 13

A. A Solution Based on Good Intentions ........................................................ 13B. The Not-So-Basic “Basics” of the Margin Tax Calculation ....................... 14

III. THE REVIEWS ARE IN ................................................................................... 15A. Reaction to the Margin Tax ........................................................................ 15B. Dismal Financial Performance .................................................................... 17

IV. CONSTITUTIONAL CHALLENGES IN THE TEXAS SUPREME COURT ............................................................................................................. 17A. Allcat ........................................................................................................... 18

1. Unconstitutional Tax on Natural Person’s Share of Partnership Income? ................................................................................................. 18

2. Income Tax? .......................................................................................... 193. Constitutional When Imposed on Single-Owner Unincorporated

Associations? ........................................................................................ 23B. Nestlé .......................................................................................................... 24

1. Equal and Uniform Taxation Clause of the Texas Constitution ........... 262. Fourteenth Amendment’s Equal Protection Clause .............................. 263. Fourteenth Amendment’s Due Process Clause ..................................... 264. Dormant Commerce Clause .................................................................. 26

V. SIGNIFICANT LOWER-COURT CASES ....................................................... 27A. Can “Net Gain” Be a Negative Number? ................................................... 27B. If It Walks Like a Duck and Quacks Like a Duck . . . ................................ 32C. Cost of Goods Sold ..................................................................................... 36

1. If You Can’t Touch, Hold, or Feel It, Is It a “Good”? .......................... 362. Does Combined Group’s COGS Deduction Include Service-Only

Subsidiary’s Costs? ............................................................................... 393. What Exactly Can Be Included in COGS Deduction? .......................... 40

a. Labor or Materials Furnished to Project Involving Real Property .......................................................................................... 40

b. Labor Costs Attributable to Installation of Goods ......................... 41VI. FINAL ACT & CURTAIN CALL? ................................................................... 43

A. Effect on Texas Economy ........................................................................... 43B. #ENDTHEMARGINTAX .......................................................................... 44

VII. CONCLUSION .................................................................................................. 45


I. INTRODUCTION1

On January 1, 2008, the business landscape changed dramatically for tens of thousands of Texas-based businesses.2 This change was the result of legislation that made significant revisions to the Texas franchise tax (now commonly called the “margin” tax) by expanding its scope to include entities that never before had been subject to the tax and significantly altering how the tax is calculated.3 To put it mildly, the margin tax has not been well received,4 and it is doubtful that it will reach its tenth anniversary.5

Since the margin tax’s premiere, it has met with poor reviews and been the subject of much criticism,6 as discussed below in Section III. To make matters worse, revenue from the margin tax has repeatedly failed to meet projections,7 and the tax has been blamed for impeding the growth of the Texas economy.8

The margin tax has survived constitutional challenges in two Texas Supreme Court cases,

1 This article expands on the author’s article, An Income Tax by Any Other Name Is Still an Income Tax: The

Constitutionality of the Texas “Margin” Tax as Applied to Partnerships and Other Unincorporated Associations, 62 BAYLOR L. REV. 573 (2010).

2 See ROBERT W. HAMILTON ET AL., 19 TEXAS PRACTICE SERIES: BUSINESS ORGANIZATIONS § 4.3 (2d ed. 2004 & Supp. 2009–2010) (“Beginning with returns due in 2008, the Texas franchise tax is calculated under a completely new system, and entities not previously subject to the franchise tax (such as limited partnerships) are subject to the tax.”); Cynthia M. Ohlenforst et al., Taxation, 60 SMU L. REV. 1311, 1311 (2007) (“In 2006, Texas legislators enacted the most substantial franchise tax reform the state has seen since 1907 . . . .”); Ira A. Lipstet, Franchise Tax Reformed: The New Margin Tax Including 2007 Legislative Changes and Final Comptroller Rules, 42 TEX. J. BUS. L. 1, 1 (2007) (“[T]he Texas Legislature enacted extensive and significant changes to the franchise tax in May 2006 by way of legislation frequently referred to as ‘HB 3.’”).

3 See HAMILTON ET AL., supra note 2; see also Jennifer Patterson, The Margin Tax is Born, 71 TEX. B.J. 21, 21 (2008) (“The revised franchise tax was dubbed the ‘margin tax’ both to describe its base, the gross profit margin of a business, and to distinguish it from the former franchise tax on taxable capital and earned surplus. Unlike the old franchise tax imposed only on corporations and limited liability companies, the margin tax is imposed on almost all businesses. Only sole proprietorships, general partnerships owned by natural persons, and certain nonprofit and investment entities are excluded from the tax.”); Cynthia M. Ohlenforst et al., Taxation, 61 SMU L. REV. 1131, 1135 (2008) (noting that the revised franchise tax is sometimes labeled the “margin tax” since the tax is imposed on a business’s “margin”); Lipstet, supra note 2 (“The new version of the franchise tax is also referred to as the ‘margin tax’ because it changes the base of taxation from taxable capital or taxable earned surplus to a new concept of ‘taxable margin.’”).

4 See Section A, infra. 5 See Section VI, infra, discussing the overall dislike of the margin tax, research suggesting that it is hampering

the Texas economy, calls for elimination of the margin tax, and recent legislation indicating the impending repeal of the franchise tax.

6 See Scott Drenkard, Special Report No. 226: The Texas Margin Tax: A Failed Experiment, TAX FOUND. 1, 2 (Jan. 14, 2015), http://taxfoundation.org/sites/taxfoundation.org/files/docs/TaxFoundation_SR226.pdf (observing that “one element of the state’s fiscal structure that has created serious controversy is the state’s Margin Tax”).

7 See Section B, infra. 8 See Section A, infra.

2017] TEXAS MARGIN TAX: IS IT TIME FOR THE CURTAIN CALL? 13

summarized below in Section IV, and it is still under attack. In addition, lower courts have issued a number of decisions that have impacted the application of the margin tax, some of which are examined later in Section V.

The margin tax saga appears to be nearing its finale. Section VI, below, looks at the effect the margin tax has had on the Texas economy, as well as at calls from many (including taxpayer groups, economists, academics, and lawmakers) to eliminate it. Last year, Governor Abbott signed into law House Bill 32, which states that “[i]t is the intent of the legislature to promote economic growth by repealing the franchise tax.”9 Interestingly, this bill was called the “Franchise Tax Repeal Act of 2015” in a prior version,10 but its name was changed to the “Franchise Tax Reduction Action of 2015” in the enrolled version.11

II. DEBUT OF THE MARGIN TAX IN 2008

A. A Solution Based on Good Intentions

Although the Texas franchise tax has been in existence since 1893,12 its current incarnation is the product of the legislature’s response to the Texas Supreme Court’s 2005 mandate for school finance reform.13 While an examination of the history of the Texas franchise tax and its many transformations throughout the years is outside the scope of this article,14 the portion of the tax’s history that is relevant to this article is summarized as follows.

Briefly stated, the revised franchise tax was intended to provide a long-term and stable solution to a serious school finance problem.15 Following a 2005 Texas Supreme Court case which declared the State’s system for funding public schools to be in violation of the Texas Constitution, lawmakers were faced with the task of revamping the system within a short timeframe.16 After working feverishly for several months to determine the best alternative for

9 Act of June 15, 2015, 84th Leg., R.S., ch. 449 §1(b). House Bill 32 also instructs the comptroller to “conduct

a comprehensive study . . . to identify the effects of economic growth on future state revenues” and issue a report that identifies “revenue growth allocation options to promote efficiency and sustainability in meeting the revenue needs of this state . . . upon repeal of the franchise tax.” Id. at §5.

10 http://www.capitol.state.tx.us/tlodocs/84R/billtext/pdf/HB00032S.pdf#navpanes=0 (last visited October 31, 2016).

11 Act of June 15, 2015, 84th Leg., ch. 449, §1(a). 12 In re Nestle USA, Inc., 387 S.W.3d 610, 611–12 (Tex. 2012). 13 See In re Allcat Claims Serv., L.P., 356 S.W.3d 455, 457–59 (Tex. 2011) (discussing the school funding case

Neeley v. West Orange–Cove Consol. Indep. Sch. Dist., 176 S.W.3d 746, 753–54 (Tex. 2005) and the events that followed).

14 For in-depth coverage of the history of the margin tax, see Alyson Outenreath, Call to the Texas Legislature: The Franchise Tax Needs Substantive Changes, Not Just Rate Reductions, 47 ST. MARY’S L.J. 351, 353–54, 355–61 (2015); Josh Haney & Bruce Wright, Fiscal Notes: The History of the Texas Franchise Tax, TEX. COMPTROLLER OF

PUB. ACCOUNTS, 1, 1–6 (May 2015), https://www.comptroller.texas.gov/economy/fiscal-notes/2015/may/fn.pdf; Byron F. Egan, Choice of Entity Decision Tree, Presentation at the State Bar of Texas 13th Annual Advanced Business Law Course, 3, 413–15 (Nov. 2015); Jimmy Martens & Amanda Traphagan, Margin of Error: Fixing the Texas Franchise Tax After Allcat, 30 J. ST. TAX’N 37, 37 (2012); Cynthia M. Ohlenforst, The New Texas Margin Tax: More Than a Marginal Change to Texas Taxation, 60 TAX LAW 959, 959–62 (2007).

15 See In re Allcat, 356 S.W.3d at 458. 16 See id. at 457–59; see also Haney & Wright, supra note 14, at 4; Outenreath, supra note 14, at 353–54.


financing public education within the time limit set by the courts, the 79th Legislature enacted the amendments to the Texas Tax Code that overhauled the structure of the Texas franchise tax into the version that took effect on January 1, 2008, and still exists today.17

B. The Not-So-Basic “Basics” of the Margin Tax Calculation

To understand taxpayers’ reaction to the margin tax and the various legal attacks against the tax discussed later in this article, it is helpful to be somewhat familiar with the basics of the margin tax calculation.18 Prior to 2008, the “old” Texas franchise tax applied only to corporations and limited liability companies—partnerships and other noncorporate entities such as professional associations were not subject to the tax.19 In contrast, the margin tax, which took effect on January 1, 2008, is imposed on partnerships and other unincorporated entities in addition to corporations and limited liability companies.20 Under the “old” franchise tax, an entity’s franchise tax liability was calculated based on either capital or earned surplus.21 Beginning in 2008, an entity’s liability is calculated as a percentage of its “taxable margin.”22

Determining an entity’s margin tax liability can be an extremely complex task.23 However, a simple outline of how the margin tax is calculated follows. Generally speaking, the first component of the margin tax calculation is an entity’s “total revenue.”24 Once an entity’s “total revenue” is determined (which is not as clear-cut as the label indicates!), one of three deductions may be subtracted from “total revenue” to arrive at the second component of the margin tax calculation: the entity’s “margin.”25 Some entities can calculate “margin” by subtracting “cost of goods sold” from “total revenue.”26 Entities that are allowed the cost-of-goods-sold deduction are usually (but not always) businesses that sell or manufacture products (in contrast to providing services).27 Some entities can calculate “margin” by subtracting “compensation” from “total revenue.”28 Businesses that choose the compensation deduction

17 See id. 18 Some basic margin tax concepts are discussed in this subsection to assist readers who may be unfamiliar with

the tax. This section in no way provides comprehensive coverage of all of the components of the margin tax, and it omits a myriad of factors and exceptions that may apply when calculating margin tax.

19 See HAMILTON ET AL., supra note 2. 20 TEX. TAX CODE ANN. § 171.0002(a) (West 2015); see HAMILTON ET AL., supra note 2; Ohlenforst, supra

note 2, at 1319 (“A significant change to the tax is its application for the first time to partnerships.”). The revised franchise tax applies to nearly all types of partnerships and unincorporated associations, except for sole proprietorships and general partnerships “the direct ownership of which is entirely composed of natural persons” and “the liability of which is not limited under a statute of this state or another state.” TAX § 171.0002(b).

21 Eric L. Stein, Texas Revised Franchise Tax, 2400-2d Tax Mgmt. Multistate Tax Portfolios 2400.02.A.1 (2009) (“The revised franchise tax is calculated based on a taxable entity’s ‘taxable margin,’ instead of the former tax base of taxable capital and taxable earned surplus.”).

22 Id.; see TAX § 171.002; see TAX § 171.101. 23 See Drenkard, supra note 6, at 4 (full-page diagram of the margin tax liability calculation). 24 See TAX §§ 171.101(a)(1)(B), 171.1011(c). 25 See id. § 171.101(a)(1). Alternatively, an entity with total revenue of $20 million or less may choose the “E-

Z Computation” set forth in § 171.1016. See notes 31–33, infra. 26 See TAX §§ 171.101(a)(1)(B)(ii)(a)(1), 171.1012. 27 See id. § 171.1012; see also Section C. infra, discussing cases pertaining to the cost-of-goods-sold deduction. 28 See TAX §§ 171.101(a)(1)(B)(ii)(a)(2), 171.1013.


are typically service providers.29 Alternatively, rather than computing the statutorily-defined cost-of-goods-sold or compensation deductions to calculate “margin,” an entity can simply deduct a flat 30 percent from its “total revenue.”30

After determining an entity’s “margin,” an apportionment factor is applied to the “margin” to reach the third component of the margin tax calculation: the entity’s “taxable margin.”31 Finally, once an entity’s “taxable margin” is calculated, one of two tax rates is applied to the entity’s “taxable margin” to arrive at the entity’s margin tax liability.32 The tax rate in effect for 2016 is 0.375 percent for retailers and wholesalers and 0.75 percent for all other businesses.33

As may be evident from the preceding outline of the “basic” margin tax calculation, what began as the Texas legislature’s idea for a way out of the 2005 school finance dilemma quickly morphed into a major headache for taxpayers and the comptroller alike.34

III. THE REVIEWS ARE IN

A. Reaction to the Margin Tax

The drastic changes to the franchise tax discussed above came as a surprise to many Texans.35 The margin tax was collected for the first time in May 2008, and “[a]t that point, many taxpayers awoke to its implications for the first time.”36 The margin tax has had a significant effect on thousands of individuals who conduct business via partnerships and unincorporated associations.37 Professionals and small-business owners who had operated for years as partnerships or professional associations were suddenly faced with Texas tax bills in

29 See id. § 171.1012(a)(3)(B)(ii) (excluding services from the definition of “goods” for purposes of the cost-of-

goods-sold deduction). 30 See id. § 171.101(a)(1)(A)(i) (defining an entity’s margin as “70 percent of the taxable entity’s total

revenue,” which is mathematically the same as deducting 30 percent of total revenue). 31 Id. § 171.101(a)(2)–(3). To keep this outline of the margin tax calculation simple, it will not include the

“other allowable deductions” referenced in subsection (a)(3). Id. at (a)(3). For an entity that has chosen the “E-Z Computation,” the apportionment factor is applied directly to the entity’s total revenue. See id. § 171.1016(b)(2).

32 Id. § 171.002(a)–(b). For an entity that has chosen the “E-Z Computation,” the statutory rate is applied directly to the entity’s total revenue that is apportioned to the state of Texas. See id. § 171.1016(b).

33 Id. § 171.002(a)–(b). For taxpayers choosing the “EZ Computation,” the rate is .331 percent. Id. § 171.1016(b).

34 See Haney & Wright, supra note 14, at 1, 5. “[G]iven the sweeping nature of the changes to the franchise tax, virtually every facet of the new system soon faced administrative and legal challenges.” Id.

35 Letter from Carole Keeton Strayhorn, Tex. Comptroller of Pub. Accounts, to Rick Perry, Tex. Governor (May 2, 2006) (on file with author) (writing that the revised franchise tax legislation will “require 200,000 Texas businesses that currently do not pay taxes to either file or pay taxes,” and that “[m]ost of that astounding number of Texans will not realize they are in this group of new taxpayers until they are told before the tax is due in May of 2008”).

36 Billy Hamilton, Déjà Vu All Over Again—Texas Considers Property and Business Tax Reform, 51 ST. TAX

NOTES 523 (2009). Billy Hamilton was the deputy comptroller at the Texas Office of the Comptroller of Public Accounts from 1990 until 2006. Id.

37 Id. (noting that the new tax, as applied to partnerships and other non-corporate business entities, “made literally thousands of businesses statewide into new taxpayers, and generally they were a disgruntled lot”).


2008 for the first time in the history of the State.38 In addition to the cold reception from businesses that had not previously been subject to the Texas franchise tax, the new margin tax quickly drew criticism from taxpayers and experts across the board.39 One reason for the criticism of the new margin tax is that Texas is known for being “tax-friendly toward businesses,” and Texans are generally not receptive toward new taxes.40 It has been noted that “[i]n a state that views all taxes with disdain, few levies have drawn more scorn than the Texas [margin] tax.”41

Aside from Texans’ general anti-tax attitude, the margin tax has been severely criticized for being complex in its structure and unfair in its application.42 The calculation of the tax has been described as being “overly burdensome,”43 with its “unique structure . . . [being] . . . a problem for taxpayers, legislators, and judges.”44 “The costly, complex nature of the margin tax makes it highly unpopular.”45 Commentators have referred to the “contortions” required to calculate the margin tax46 and observed that taxpayers “often [devote] more time and resources in determining [the margin] tax bill than what is required to pay the tax itself.”47 One recent report found the margin tax to be inferior to business tax structures found in most other states.48 Along with criticism of the complicated structure of the margin tax, objections to the margin tax have run the gamut from complaints that it is unfair49 to allegations that it is

38 See supra notes 35–37 and accompanying text. 39 See Drenkard, supra note 6, at 2 (noting that the margin tax “has attracted criticism from experts in the field,

attracted lawsuits from businesses that must comply with it, and attracted legislative changes as political pressure around the tax continues to mount”).

40 Outenreath, supra note 14, at 352–53; see Haney & Wright, supra note 14, at 1 (describing the margin tax as “controversial . . . given the Legislature’s consistent focus on maintaining Texas’ business-friendly reputation”).

41 Loren Steffy, Margin of Error, TEX. MONTHLY (May 2015), http://www.texasmonthly.com/politics/margin-of-error/.

42 See Drenkard, supra note 6, at 14 (calling the margin tax “one of the worst business taxes in the country”). 43 Scott Drenkard, Businesses Love Texas, Except this One Tax that Holds the State Back, TAX FOUND. (Jan. 8,

2016), http://taxfoundation.org/blog/businesses-love-texas-except-one-tax-holds-state-back; see also Final Report of the TCCRI State Taxation Task Force, TEX. CONSERVATIVE COAL. RES. INST., 1, 9 (2013), http://www.txccri.org/wp-content/uploads/2013/01/Franchise-Tax-Report.pdf (describing the margin tax as being “unnecessarily burdensome”).

44 Drenkard, supra note 6, at 2. 45 Vance Ginn, Ph.D. and The Honorable Talmadge Heflin, Economic Effects of Eliminating Texas’ Business

Margin Tax, TEX. PUB. POLICY FOUND., at 4 (Mar. 2015), http://www.texaspolicy.com/library/doclib/MarginTax-CFP.pdf.

46 Drenkard, supra note 43. 47 Ginn & Heflin, supra note 45, at 5. 48 The Tax Foundation’s 2016 State Business Tax Climate Index assigned a rank of 41 to the Texas margin tax,

with a rank of 1 being the best and a rank 50 being the worst. See Jared Walczak, et al., 2016 State Business Tax Climate Index, TAX FOUND.; but see Maria Garnett, Fiscal Notes: Starting a New Business, TEX. COMPTROLLER OF

PUB. ACCOUNTS, 1, 3 (Feb. 2016), http://comptroller.texas.gov/fiscalnotes/feb2016/starting.php (discussing a number of other reports giving more favorable reviews of Texas’ tax climate); see also Raymond J. Keating, Small Business Tax Index 2015: Best to Worst State Tax Systems for Entrepreneurship and Small Business, SMALL BUSINESS &

ENTREPRENEURSHIP COUNCIL, 3, 4 (Apr. 2015), http://www.sbecouncil.org/wp-content/uploads/2015/04/BTI2015SBECouncil.pdf (assigning Texas a rank of 3 (with a rank of 1 being the best and 50 being the worst) on its 2015 Small Business Tax Index).

49 See generally Joseph Henchman, Texas Margin Tax Experiment Failing Due to Collection Shortfalls, Perceived Unfairness for Taxing Unprofitable and Small Businesses, and Confusing Rules, TAX FOUND. 1, 2 (Aug. 17, 2011), http://taxfoundation.org/sites/taxfoundation.org/files/docs/ff279.pdf.


unconstitutional.50 Unfortunately, the more than 400 bills that have been authored relating to the margin tax since its inception have done little to remedy its shortcomings to the satisfaction of most critics.51

B. Dismal Financial Performance

Regrettably for the state’s coffers, the position held by opponents of the margin tax has been bolstered by its poor financial performance.52 Since its inception, the margin tax has “performed considerably below the state’s expectations.”53 It has been deemed a “failure”54 and called the “most counterproductive part of the [Texas] tax code.”55 According to some researchers, the “margin tax is a poor and inefficient mechanism for generating state revenues, placing a tremendous burden on entrepreneurs and small businesses that affects all Texans.”56

Ultimately, rather than solving the state’s school finance crisis as Texas lawmakers had envisioned, the margin tax has frustrated taxpayers across the country, attracted endless criticism, and disappointed stakeholders across the board.57

IV. CONSTITUTIONAL CHALLENGES IN THE TEXAS SUPREME COURT

The margin tax has weathered several state and federal constitutional challenges asserted in two Texas Supreme Court cases.58

50 See infra Section IV. 51 See the Bill Search feature of Texas Legislature Online,

http://www.capitol.state.tx.us/Search/BillSearch.aspx (last visited Nov. 7, 2016). 52 See Final Report of the TCCRI, supra note 43, at 14–15; Michael J. Chow, Phasing Out the Texas Business

Franchise Tax: The Impact on Private Sector Employment, NFIB RES. FOUND. (Mar. 8, 2013), https://s3.amazonaws.com/NFIB/AMS%20Content/Attachments/2/1-67446-PIPLUS_TX_FRANCHISE_TAX.pdf.

53 Haney & Wright, supra, note 14, at 5. 54 Sarah Tober, Franchise Tax Still a Thorn in Small Business Side in Texas, NAT’L FED’N OF INDEP. BUSINESS

(Mar. 30, 2016), http://www.nfib.com/content/news/tax-help/franchise-tax-still-a-thorn-in-small-business-side-in-texas-73486/ (quoting NFIB Executive Director Will Newton); Ginn & Heflin, supra note 45, at 4.

55 Ryan H. Murphy, Policy Report No. 357: Benefits to the Poor of Texas Franchise Tax Repeal, NAT’L CTR. FOR POLICY ANALYSIS, 1, 3 (June 2014), http://www.ncpa.org/pdfs/st357.pdf.

56 See Ginn & Heflin, supra note 45. 57 See Steffy, supra note 41 (writing that “many lawmakers criticize it for generating less revenue than it was

supposed to.”). 58 The constitutional challenges in the cases discussed in Section IV were taken directly to the Texas Supreme

Court under the special provision included in the legislation revising the Texas Franchise Tax Act, which gives the supreme court exclusive and original jurisdiction over a challenge to the constitutionality of the margin tax. See Act of May 2, 2006, 79th Leg., 3d C.S., ch. 1, §24(a), 2006 Tex. Gen. Laws 1, 40 (“The supreme court has exclusive and original jurisdiction over a challenge to the constitutionality of this Act or any part of this Act and may issue injunctive or declaratory relief in connection with the challenge.”).


A. Allcat

1. Unconstitutional Tax on Natural Person’s Share of Partnership Income?

The first constitutional challenge was brought to the Texas Supreme Court in July of 2011 by a limited partnership and its partner in In re Allcat Claims Serv., L.P.59 In Allcat, a limited partnership became subject to the margin tax under the new law that went into effect in 2008.60 Some of the partners were natural persons.61 The petitioners in Allcat claimed that the imposition of the margin tax on the portion of the partnership’s margin that represented its natural-person partners’ shares of partnership income violated the Texas Constitution.62

The petitioners’ claim was based on Article VIII, Section 24 of the Texas Constitution, which states the following:

A general law enacted by the legislature that imposes a tax on the net incomes of natural persons, including a person’s share of partnership and unincorporated association income, must provide that the portion of the law imposing the tax not take effect until approved by a majority of the registered voters voting in a statewide referendum held on the question of imposing the tax.63

The petitioners in Allcat asserted that the margin tax is unconstitutional because it taxes a natural person’s share of partnership income but Texas voters did not approve the tax.64 In support of its assertion that the margin tax imposes a tax on a natural person’s share of partnership income in violation of the Texas Constitution, the petitioners advanced a two-pronged argument.65 The first prong of the petitioners’ argument was that the margin tax constitutes an “income tax” because the margin tax calculation accords with the common dictionary definition of income tax, the definition of income tax found in the Texas Tax Code, and the concept of income tax as defined in case law.66 The second prong of the petitioners’ argument was that the margin tax constitutes a tax on a natural person’s share of partnership income because it indirectly imposes a tax on the share of partnership income that is allocated to a partnership’s natural-person partners.67 In presenting these arguments to the Court, the petitioners faced the difficult (if not impossible!) task of reconciling accounting concepts with legal principles.

The Court declined to address the first prong and decide whether the margin tax is an

59 See generally 356 S.W.3d 455, 457 (Tex. 2011). 60 Id. at 459. 61 Original Petition at 3, In re Allcat, 356 S.W.3d 455 (No. 11-0589). 62 In re Allcat, 356 S.W.3d at 459. The petitioners in Allcat also brought a claim based on the equal and

uniform taxation clause of the Texas Constitution, which was rejected for lack of jurisdiction. See id. At 470–71. 63 TEX. CONST. art. VIII, § 24(a). 64 Original Petition, supra note 61, at 5. 65 See id. at 6–12. See also Brief of Amici Curiae Nikki Laing, CPA et al. in Support of Plaintiffs at 16–33, In

re Allcat, 356 S.W. 3d 455 (No. 11-0589). 66 Original Petition, supra note 61, at 6–9. 67 Id. at 9–12.


income tax.68 As for the second prong, the Court analyzed the issue in the context of the aggregate versus entity theories of partnership law.69 The Court noted that “under Texas law the entity theory applies to partnership income and profits. Individual partners do not own any of either while they remain in the partnership’s hands and have not been distributed to the partners.”70 The Court further reasoned that, “while a partner’s interest in the partnership represents the right to receive the partner’s share of partnership profits when they are distributed, it does not follow that for purposes of the Texas franchise tax such right constitutes a partner’s ‘share’ of any partnership income or profits while the partnership retains the income and profits without having distributed any of them to the partner.”71 Based on this reasoning, the Court found that the margin tax constitutes a tax imposed on a partnership as an entity and not on its partners.72 Because the Court found that the margin tax was not imposed on the natural partners in Allcat, the Court held that the margin tax does not violate the Texas Constitution’s prohibition (absent voter approval) of a net-income tax on a natural person’s share of partnership income.73

2. Income Tax?

The Allcat case did not answer the question of whether the margin tax constitutes an income tax.74 The Texas Constitution prohibits, absent voter approval, a “tax on the net incomes of natural persons, including a person’s share of partnership and unincorporated association income.”75 Upon the introduction of the margin tax, many tax experts classified it as an income tax.76 As one commentator stated, “[a]lthough the State of Texas vigorously

68 In re Allcat, 356 S.W.3d at 463, 469 n.10. 69 See id. at 463–70. 70 Id. at 468. 71 Id. at 468–69. 72 Id. at 470. The Court based its decision on legal concepts such as property ownership and entity versus

aggregate theories of partnership law. However, in the author’s view, accounting concepts should have been considered, as well. In the author’s opinion, “income” can be thought of as purely an accounting concept separate from concepts of property law and claims of ownership—an intangible figure that results from subtracting certain deductions (which may consist of actual cash outlays or artificially-timed expenses such as depreciation or amortization) from revenues (which may consist of actual cash receipts or artificially-timed income recognition) and is used for purposes of calculating items such as taxes and allocations. The term “income” is an intangible number that is used for accounting purposes. “Income” is not equivalent to tangible cash or property that is actually possessed by a partnership or distributed by a partnership to a partner. Therefore, property-law or entity-theory concepts are not necessarily relevant in the analysis of an issue involving a tax on “income.”

73 Id. at 457, 470. 74 See supra notes 66, 68 and accompanying text. 75 TEX. CONST. art. VIII, § 24(a). “‘Natural person’ means a human being or the estate of a human being. The

term does not include a purely legal entity given recognition as the possessor of rights, privileges, or responsibilities, such as a corporation, limited liability company, partnership, or trust.” TEX. TAX CODE ANN. § 171.0001(11-a) (West 2015).

76 See Lipstet, supra note 2, at 3 n.7 (noting that “the Financial Accounting Standards Board (FASB) has apparently concluded that the margin tax is, for purposes of FASB Statement No. 109 (Accounting for Income Taxes) and financial accounting reporting purposes, an income tax.”); Stein, supra note 21, at 2400.04 (writing that “[t]he revised franchise tax has the characteristics of an income tax since it is determined by applying a tax rate to a base which takes into account both revenues and expenses, namely cost of goods sold or compensation.”); L. A. Lorek, Business Tax in Eye of the Beholder, SAN ANTONIO EXPRESS-NEWS, Apr. 5, 2006 (quoting Richard Joseph, Ph.D., JD, and director of the University of Texas professional accounting program, as saying, “With all the deductions the


defends its position that the margin tax is not an income tax, for all practical purposes, the margin tax is, in effect, a veiled income tax.”77

To understand why the margin tax is considered by some to be a veiled income tax, a condensed explanation of its calculation is necessary. As mentioned previously in Section B, to determine Texas margin tax liability, a taxable entity begins by determining its total revenue.78 The Texas Tax Code instructs that a taxable entity’s total revenue for margin tax purposes is determined by using numbers reported on the entity’s federal income tax return.79 Therefore, an entity’s Texas margin tax is calculated using figures taken directly from the entity’s federal income tax return.80 Once a taxable entity determines its total revenue (using figures directly from its federal income tax return), the entity then subtracts certain expenses that it reported on its federal income tax return81 and other statutorily-defined deductions and exemptions to arrive at its “taxable margin.”82 After an entity has computed its taxable margin, it multiplies its taxable margin by the applicable tax rate in order to calculate the amount of margin tax it owes to the State of Texas.83

Compare how the taxable margin is calculated with how net income is calculated, considering that net income is defined as “[t]otal income from all sources minus deductions,

proposed tax bill allows businesses to take, the new franchise tax begins to look more like an income tax . . . .”); Brad J. Brookner & Russell D. Brown, Sweeping Texas Franchise Tax Changes: The Margin Tax, TAX ADVISER, 550–51 (Sept. 2006) (stating that “[w]hile H.B. 3 states that the modified tax is ‘not an income tax,’ the current view of the authors’ firm [(Deloitte Tax LLP)] is that the margin tax is a tax on income . . . .”); Andrew Essington, Texas Margin Tax: The Impact on Investment Real Estate, http://www.ainorthtexas.org/store/Essington.pdf (last visited Nov. 7, 2016) (stating that the “[m]argin tax is effectively a state income tax to the ownership entity.”).

77 Jeff Slade, Drilling Down the Texas Margin Tax: A Gusher or Dry Hole of Taxes for the Oil & Gas Industry?, 36 TEX. TAX LAW 28, 28 (2008). See also Cynthia M. Ohlenforst et al., Taxation, 59 SMU L. REV. 1565, 1577 (2006) (observing that the margin tax “was designed to . . . avoid being categorized as a net income tax” and that “[a]lthough there was significant support for the plan in some quarters, others attacked the plan . . . [by] . . . claiming that the tax on gross receipts net of deductions constituted a net income tax of individual partners in limited partnerships, thereby running afoul of the Texas constitutional prohibition on a net income tax on individuals.”).

78 See TAX §§ 171.101(a)(1)(B), 171.1011(c). 79 Id. § 171.1011(c)(1) (“[F]or the purpose of computing its taxable margin . . . the total revenue of . . . a

taxable entity treated for federal income tax purposes as a corporation [is] an amount computed by [adding]: (i) the amount reportable as income on line 1c, Internal Revenue Service Form 1120; (ii) the amounts reportable as income on lines 4 through 10, Internal Revenue Service Form 1120 . . . .”); see also id. § 171.1011(c)(2) (“[F]or a taxable entity treated for federal income tax purposes as a partnership, an amount computed by [adding]: (i) the amount reportable as income on line 1c, Internal Revenue Service Form 1065; (ii) the amounts reportable as income on lines 4, 6, and 7, Internal Revenue Service Form 1065; (iii) the amounts reportable as income on lines 3a and 5 through 11, Internal Revenue Service Form 1065, Schedule K; (iv) the amounts reportable as income on line 17, Internal Revenue Service Form 8825; (v) the amounts reportable as income on line 11, plus line 2 or line 45, Internal Revenue Service Form 1040, Schedule F . . . .”).

80 Id. § 171.1011(c)(1)–(2). 81 See id. §§ 171.101(a), 171.1011(c). 82 Id. §§ 171.1012–.1013. As discussed supra in note 31 and accompanying text (but not relevant to the

analysis of whether the margin tax constitutes an income tax) an apportionment factor is applied to the margin of entity doing business in multiple states. See id. § 171.101(a)(2)–(3).

83 Id. § 171.002(a)–(b). For an entity that has chosen the “E-Z Computation,” the statutory rate is applied directly to the entity’s total revenue that is apportioned to the state of Texas. See id. § 171.1016(b).


exemptions, and other tax reductions.”84 In addition, compare the calculation of the margin tax to the Texas Tax Code’s definition of income tax: “a tax imposed on or measured by net income including any tax imposed on or measured by an amount arrived at by deducting expenses from gross income, one or more forms of which expenses are not specifically and directly related to particular transactions.85

As an illustration, assume a Texas service provider (law firm, accounting firm, doctor’s office, janitorial service, etc.) has total revenues of $3 million and payroll expenses of $2 million. Following is a simplified example of how the entity’s margin tax would be calculated on its 2016 franchise tax report:86

Total Revenue as Reported to IRS $3,000,000 Less: Deductible Payroll Expenses -2,000,000 Taxable Margin 1,000,000 Multiplied by tax rate .075 % Franchise Tax 7,500

Now, here is a simplified example of how the entity’s income tax would be calculated for both federal income tax and financial-reporting purposes:87

Total Revenue as Reported to IRS $3,000,000

84 BLACK’S LAW DICTIONARY (10th ed. 2014). The author would point out that nothing in the dictionary

definition of net income requires that all possible deductions be subtracted from total income in order to arrive at net income

85 See TAX § 141.001. This is the only definition of income tax found in the Texas Tax Code. Although this definition is not included in the Franchise Tax chapter of the Tax Code, it is found in the Multistate Tax Compact chapter, the purposes of which are to “[f]acilitate proper determination of state and local tax liability of multistate taxpayers,” “[p]romote uniformity or compatibility in significant components of tax systems,” and “[f]acilitate taxpayer convenience and compliance in the filing of tax returns and in other phases of tax administration.” Id. Note that the term income tax has been defined in this manner in the Tax Code since 1982, and “[w]ords and phrases that have acquired a technical or particular meaning, whether by legislative definition or otherwise, shall be construed accordingly.” TEX. GOV’T CODE ANN. § 311.011(b) (West 2015). Contrast the Tax Code’s definition of income tax to its definition of gross receipts tax: “‘Gross receipts tax’ means a tax . . . which is imposed on or measured by the gross volume of business, in terms of gross receipts or in other terms, and in the determination of which no deduction is allowed which would constitute the tax an income tax.” TAX § 141.001. As with the dictionary definition of “net income,” the author would point out that nothing in the Texas Tax Code’s definition of income tax requires every expense incurred by an entity to be deducted from gross income in order for a tax to constitute an income tax.

86 Note that this is an extremely simplified illustration showing the tax liability of a service provider taxed at .75 percent (in contrast to a retailer or wholesaler, who would be taxed at 0.375 percent), as computed by the franchise tax calculator available at the Texas Comptroller’s website. See Franchise Tax Calculation, TEX. COMPTROLLER, https://www.comptroller.texas.gov/forms/hb3calc.pdf (last visited October 19, 2016). The scope of this Article does not allow for a detailed explanation of all aspects of the margin tax calculations, such as the optional “E-Z Computation.” See TAX § 171.1016. Readers should consult additional sources for guidance on specific calculations, such as Chapter 171 of the Texas Tax Code, the Texas Comptroller of Public Accounts website, Franchise Tax, https://www.comptroller.texas.gov/taxes/franchise/ (last visited Oct. 19, 2016), and the sources cited in this Article.

87 See IRS Form 1120 (2015), INTERNAL REVENUE SERVICE, https://www.irs.gov/pub/irs-pdf/f1120.pdf; see also IRS Form 1040 (2015), INTERNAL REVENUE SERVICE, https://www.irs.gov/pub/irs-pdf/f1040.pdf and IRS Form 1040, Schedule C (2015), INTERNAL REVENUE SERVICE, https://www.irs.gov/pub/irs-pdf/f1040sc.pdf (all last visited Nov. 7, 2016).


Less: Deductible Payroll Expenses 2,000,000 Taxable Income 1,000,000 Multiplied by tax rate .15 % Federal Income Tax 150,000

Is there a meaningful difference between the two calculations for purposes of classifying the type of tax imposed on the service provider? The Financial Accounting Standards Board (FASB), the board that sets national accounting standards, did not see a difference.88 Shortly after the new franchise tax regime was signed into law, upon inquiries from constituents, national accounting firms, and other interested parties, FASB staff “concluded that the Texas Franchise Tax is an income tax because the tax is based on a measure of income.”89 Furthermore, the FASB’s Technical Application and Implementation Activities Committee (TA&I Committee) determined that “the Texas Franchise Tax [is] an income tax that should be accounted for under Statement 109 and that there [will] not be diversity in the conclusions reached by preparers, auditors, and regulators on whether the Texas Franchise Tax [is] an income tax.”90

Perhaps realizing the similarities between margin tax and income tax calculations, the Texas legislature apparently attempted to dispel any constitutional misgivings up front by stating in the original margin tax legislation that it “is not an income tax.”91 However, merely labeling the tax as a margin tax instead of an income tax does not make it so.92 Experts have recognized that the structure of the margin tax fits the definition of an income tax, calling it “a hybrid of a gross receipts tax and an income tax”93 and “a badly designed business profits tax.”94 Experts have also noted that the margin tax “is imposed on firms’ profits” and “has

88 See Lipstet, supra note 2, at 3 n.7 (“[T]he Financial Accounting Standards Board (FASB) has apparently concluded that the margin tax is, for purposes of FASB Statement No. 109 (Accounting for Income Taxes) and financial accounting reporting purposes, an income tax.”).

89 Minutes of the August 2, 2006 Board Meeting on Potential FSP: Texas Franchise Tax, Financial Accounting Standards Board, http://www.fasb.org/jsp/FASB/Page/08-02-06_texas_franchise_tax.pdf.

90 Id. Because the TA&I Committee did not anticipate disparity in the treatment of the margin tax as an income tax for financial-reporting purposes, at a meeting in 2006, the FASB declined to pursue a project to provide formal guidance to taxpayers regarding the proper treatment of the Texas Revised Franchise Tax. See id.; see also Byron F. Egan, Choice of Entity Decision Tree After Margin Tax and Texas Business Organizations Code, 42 TEX. J. BUS. L. 71, 106 (2008).

91 See Act of May 2, 2006, 79th Leg., 3d C.S., ch. 1, §21, 2006 Tex. Gen. Laws 1, 38 (H.B. 3, which implemented the current margin tax structure, states: “The franchise tax imposed by Chapter 171, Tax Code, as amended by this Act, is not an income tax . . . .”).

92 See John Gamino, So-called ‘Margin Tax’ Violates Truth in Labeling, HOUS. BUS. J., Jan. 22, 2007, http://houston.bizjournals.com/houston/stories/2007/01/22/editorial4.html; see also Bishop v. District of Columbia, 401 A.2d. 955, 958 (D.C. 1979) (“As to the characterization of a tax, it is fundamental that the nature and effect of a tax, not its label, determine if it is an income tax or not.”); see also Ohlenforst, supra note 14, at 977 (“Legislators worked diligently to draft a tax that will not, they hope, be an income tax for purposes of the . . . Texas constitutional amendment that prohibits the imposition of an income tax on the net income of natural persons unless the tax is approved in a statewide referendum. . . . It appears clear, however, that for generally accepted accounting purposes, the margin tax will be considered an income tax that should be accounted for under FASB Statement No. 109, Accounting for Income Taxes.” (footnotes omitted)).

93 Drenkard, supra note 6, at 7 n.17. 94 John L. Mikesell, Gross Receipts Taxes in State Government Finances: A Review of Their History and

Performance 4 (Tax Foundation Council On State Taxation, Background Paper No. 53, 2007),


taken on the features of a distortionary income tax on business.”95 Although the Texas Supreme Court managed to skirt the income tax question in Allcat,96 the issue has again reared its head in the recent case Graphic Packaging Corp. v. Hegar, discussed later in Section V.B. Business owners, advisors, and academics across the country are watching the Graphic case intently to see how the Texas Supreme Court will answer this question.

3. Constitutional When Imposed on Single-Owner Unincorporated Associations?

In addition to leaving the income tax question open, the Allcat case did not address the constitutionality of the margin tax as applied to a professional association (PA) or limited liability company (LLC) that has a natural person as its sole owner and is disregarded for federal income tax purposes.97 LLCs and PAs both fall under the “unincorporated association” umbrella of art. VII, § 24(a) of the Texas Constitution.98 Therefore, the prohibition against a “tax on the net incomes of natural persons, including a person’s share of . . . unincorporated association income” is applicable in the context of LLCs and PAs.99 If the margin tax meets the definition of an income tax,100 query how the margin tax, when imposed on a single-member LLC owned by a natural person and taxed as a disregarded entity for federal income tax purposes, is not prohibited absolutely by the constitution as an income tax on a natural person’s income.101

Although Texas does not have a personal income tax that is labeled as such by the legislature, it can be argued that the margin tax operates as a personal income tax when imposed on a flow-through entity owned entirely by one person.102 This concept is reflected in

http://taxfoundation.org/sites/taxfoundation.org/files/docs/bp53.pdf. Professor Mikesell points out that the Texas margin tax is not included in his paper on gross receipts tax because it is more characteristic of a business profits tax than a gross receipts tax. Id.

95 Tax Reform in Texas: Lowering Business Costs, Expanding the Economy, THE BEACON HILL INSTITUTE 3–4 (Nov. 2012), http://www.beaconhill.org/BHIStudies/TexasFranchise/TXFranchiseTaxReportFinal2.pdf.

96 See supra notes 66, 68 and accompanying text. 97 See HAMILTON ET AL., supra note 2, at § 4.4 (“[T]he treatment of . . . LLCs under the Texas franchise tax

differs sharply from their treatment under the Internal Revenue Code. The federal ‘check -the -box’ regulation authorizes . . . LLCs with two or more members to elect to be taxed either as partnerships under subchapter K or as C or S corporations. Thus, . . . limited liability companies . . . are treated quite differently [under the Internal Revenue Code and] under the Texas franchise tax. The very popular single member LLC . . . is [taxed] as a ‘nothing’ [under Federal law] but is [fully] subject to the Texas franchise tax.” (footnote omitted)). Accord Ohlenforst et al., supra note 2, at 1321 (“Significantly, limited liability companies that are disregarded and treated as sole proprietorships for federal income tax purposes are not treated as exempt sole proprietorships for margin tax purposes.”).

98 See TEX. BUS. ORGS. CODE ANN. §§ 1.002(14), (46) & 301.003(2) (West 2015). 99 TEX. CONST. art. VIII, § 24(a). 100 See supra notes 76–97 and accompanying text. 101 When an entity owned by a natural person is taxed as a disregarded entity for federal income tax purposes,

all of the entity’s income is attributable to the entity’s owner and reported on the owner’s personal federal income tax return. See Treas. Reg. §§ 301.7701-1(a)(1), -2(a)–(c), -3(a)–(c). Since the entity’s income is entirely attributable to and reportable by the entity’s owner, it can be argued that a tax imposed by a state on the income of the entity operates in exactly the same manner as a tax imposed on the income of the owner.

102 The term “flow-through” entity (also sometimes referred to as a “pass-through” entity) describes the tax treatment of an entity whereby income from the entity flows through to the owner(s) and tax on the entity’s income is imposed directly on its owner(s). Generally speaking, in the case of a flow-through entity, the entity’s income is not


a recent report ranking the business tax climate of the fifty states.103 In the report, states that do not have an individual income tax were typically assigned a perfect score in the “Individual Income Tax” category.104 Since Texas does not have an individual income tax, one would expect Texas to receive a perfect score in the Individual Income Tax category.105 However, in contrast to other states that do not have an individual income tax, Texas did not receive a perfect score in the Individual Income Tax category.106 One of the report’s authors explained that the reason for this is structure of the margin tax and the fact that it is imposed on flow-through entities.107 Texas received a lower score than other states that do not have an individual income tax because of the individual-income-tax nature of the margin tax when it is imposed on flow-through entities owned by natural persons.108

B. Nestlé

A few months after the Allcat petition was filed, another constitutional challenge was brought to the Texas Supreme Court by Nestlé USA, Inc., Switchplace, LLC, and NSMBA, LP.109 Due to some procedural hiccups leading up to the filing of the case, the case was dismissed for want of jurisdiction.110 After following correct procedural steps,111 Nestlé USA, Inc. (Nestlé) re-filed its case with the Texas Supreme Court.112

Nestlé is a Delaware Corporation that, along with thirty-two affiliates, manufactures and distributes food and beverages in the United States.113 Nestlé and its thirty-two affiliates are required to report as a combined group for purposes of the margin tax.114 Generally speaking, an entity subject to the margin tax can choose to deduct either cost of goods sold or compensation from its total revenue.115 As a combined group, Nestlé and its affiliates were all required to choose the same method for the entire group—either the cost of goods sold deduction or the compensation deduction—even if it resulted in no deduction being allowed

recognized at the entity level. Instead, it is recognized by the entity’s owner(s). See I.R.C. § 1366. 103 See Walczak, et al., supra note 48, at 29. 104 See id. (explaining that “[s]tates that do not impose an individual income tax generally receive a perfect

score” in the Individual Income Tax Component of the report). 105 See id. 106 See id. at 28–29. 107 See id. at 29, 31, 33; see also Drenkard, supra note 6, at 11 (explaining that “the Margin Tax hurts the

state’s score in the individual income tax component of the Index as well (the state ranks 6th, instead of a perfect ranking of 1st), because the Margin Tax applies to S corporations and LLCs.”).

108 See id; but see Keating, supra note 48, at 5 (where Texas received a perfect score in the personal income tax category).

109 See generally In re Nestle USA, Inc., 359 S.W.3d 207 (Tex. 2012). 110 See id. at 209, 212 (dismissing the case because the petitioners had failed to pay their taxes under protest or

request a refund from the Comptroller as required by the Texas Tax Code prior to bringing the case to the Texas Supreme Court).

111 See Relator’s Petition at 5, In re Nestle USA, Inc., 387 S.W.3d 610 (Tex. 2012) (No. 12-0518), 2012 WL 3233215.

112 See generally In re Nestle, 387 S.W.3d 610. 113 See Relator’s Petition, supra note 111, at 4 and app. 6. 114 Relator’s Petition, supra note 111, at 4. 115 See TEX. TAX CODE ANN. § 171.101(a)(1)(B)(ii) (West 2015). Alternatively, an entity can deduct a flat 30

percent from its total revenue using the EZ Computation method. See id. § 171.101(a)(1)(A)(i).


for some entities in the group.116

As a company, Nestlé engages in manufacturing, wholesale, and retail activities throughout the United States. However, since none of Nestlé’s manufacturing facilities are located in Texas, it conducts only wholesale and retail activities in Texas.117 Retailers and wholesalers are taxed differently than manufacturers under the margin tax. Under the laws in effect at the time of the Nestle case, the rate of the margin tax was one-half percent of an entity’s taxable margin for entities primarily engaged in retail or wholesale trade and one percent of an entity’s taxable margin for all other types of businesses.118 So, businesses engaged primarily in retailing or wholesaling were taxed at a lower rate than businesses engaged primarily in manufacturing. Nestlé and its affiliates do not conduct any manufacturing activities in Texas.119 However, for purposes of the margin tax, Nestlé’s manufacturing activities that take place outside of Texas are taken into account when determining whether Nestlé is subject to the half-percent retailer/wholesaler rate or the one-percent manufacturer rate.120

For the reasons described above, as well as other components of the margin tax that Nestlé viewed as being arbitrary among taxpayers and not reasonably related to the privilege of doing business in Texas, Nestlé asserted that the margin tax is unconstitutional on four grounds.121 First, Nestlé contended that the margin tax violates the Equal and Uniform Taxation clause of the Texas Constitution122 because “it taxes taxpayers disparately based on classifications that have no reasonable relationship to the value of the privilege of doing business in Texas.”123 Second, Nestlé asserted that the margin tax violates the Fourteenth Amendment’s Equal Protection Clause by treating similarly-situated taxpayers differently in how the tax base is calculated and in how the tax rate is applied, with such differences having no rational basis and insufficient relationship to the value of the privilege of doing business in Texas.124 Third, Nestlé argued that the margin tax violates the Fourteenth Amendment’s Due Process Clause by imposing a higher tax rate on entities that are classified as “manufacturers” based solely on manufacturing activities that take place outside of Texas than on entities classified as “wholesalers” and “retailers,” with no difference in the benefits received from Texas by the higher-taxed entities classified as “manufacturers.”125 Finally, Nestlé claimed that the margin tax violates the dormant Commerce Clause because it discriminates against interstate commerce and is not fairly related to the services provided by Texas.126

116 Relator’s Petition, supra note 111, at 9. See also, TAX. § 171.1014. 117 See Relator’s Petition, supra note 111, at 4–5. 118 Id. at 4; see TAX § 171.002(a)–(b). 119 Relator’s Petition, supra note 111. 120 See TAX §§ 171.1012, 171.1014; Relator’s Petition, supra note 111, at 15. 121 See In re Nestle USA, Inc., 387 S.W.3d 610, 612 (Tex. 2012). 122 TEX. CONST. art. VIII, § 1(a). 123 Relator’s Petition, supra note 111. 124 Id. at 13. 125 Id. at 14. 126 Id. at 15.


1. Equal and Uniform Taxation Clause of the Texas Constitution

Nestlé was unsuccessful on all four assertions. As for Nestlé’s first argument, the Court pointed out that the Equal and Uniform Taxation clause requires “only that taxation—not taxes—must be equal and uniform, indicating that it is the process, not each individual result, that must satisfy the requirement.”127 In addition, the Court said, “It is important to note that classifying taxpayers for purposes of an occupation tax is not an exception to the Equal and Uniform Clause but a consequence of it.”128 Holding that the margin tax does not violate the Equal and Uniform Clause of the Texas Constitution, the Court concluded that the margin tax’s classifications are permitted under the Clause and that the structure of the tax is reasonably related to the value of the privilege of doing business in Texas.129

2. Fourteenth Amendment’s Equal Protection Clause

The Court held that, since Nestlé fell short of establishing the elements for a successful Equal and Uniform Taxation challenge, its second argument based on Equal Protection necessarily failed because the Equal and Uniform Clause of the Texas Constitution places a stricter standard on a state’s tax laws than the Equal Protection Clause of the Fourteenth Amendment does.130

3. Fourteenth Amendment’s Due Process Clause

Next, the Court quickly dispensed with Nestlé’s third argument based on Due Process by citing to a 1939 United States Supreme Court case involving the Texas franchise tax, which held that “the franchise tax did not violate due process because in ‘a unitary enterprise, property outside the state, when correlated in use with property within the state, necessarily affects the worth of the privilege within the state.’”131

4. Dormant Commerce Clause

The Court delivered the final nail in the coffin by rejecting Nestlé’s fourth argument based on the dormant Commerce Clause. In response to Nestlé’s claim that the margin tax discriminates against interstate commerce because its tax rates are based on an entity’s non-Texas activities (such as when an entity is taxed at the higher manufacturer rate due to its manufacturing activities that occur entirely outside of Texas), the Court explained that “[t]axes do not discriminate when the differing rate stems ‘solely from differences between the nature of their businesses, not from the location of their activities.’”132 The Court concluded that, because the margin tax’s rates are based on an entity’s activities and not on the location of those activities, the rates do not discriminate against interstate commerce.133 Responding to

127 In re Nestle USA, Inc., 387 S.W.3d 610, 618 (Tex. 2012). 128 Id. at 620. 129 Id. at 621–24. 130 See id. at 624. 131 Id. (quoting Ford Motor Co. v. Beauchamp, 308 U.S. 331, 336 (1939)). 132 Id. at 625 (quoting Amerada Hess Corp. v. Dir., Div. of Taxation, N.J. Dep’t of Treasury, 490 U.S. 66, 78

(1989)). 133 See id.


Nestlé’s claim that the margin tax is not fairly related to the services provided by Texas, the Court reasoned that “the franchise tax need not precisely align the tax rate with the value of the Privilege [of doing business in Texas]. It is enough that manufacturing outside of the state will often increase the value of doing business within the state.”134

V. SIGNIFICANT LOWER-COURT CASES

Although Allcat and Nestle removed some major hurdles faced by those seeking to implement and enforce the margin tax, seemingly endless challenges still remain.135 Some significant cases which have impacted the application of the margin tax are discussed next.136

A. Can “Net Gain” Be a Negative Number?

As discussed briefly in Section B, supra, the margin tax is calculated by applying the appropriate tax rate to an entity’s taxable margin.137 The taxable margin of an entity that does business in multiple states is generally computed by multiplying the entity’s margin138 by the statutory apportionment factor.139 The apportionment factor is “a fraction, the numerator of which is the taxable entity’s gross receipts from business done in [Texas] . . . and the denominator of which is the taxable entity’s gross receipts from its entire business.”140 Put simply, the numerator of the apportionment factor is the entity’s gross receipts attributable to its activities in Texas, and the denominator of the apportionment factor is the entity’s total receipts from its entire business, sometimes referred to as “everywhere receipts.”141 The following is a demonstration of the basic calculation of entity’s tax liability using the apportionment factor from Section 171.106 of the Texas Tax Code:

134 Id. 135 See Haney & Wright, supra note 14, at 1 (referencing the “countless lower court decisions and

administrative hearings” that have stemmed from the margin tax). 136 There have been many other significant cases in addition to those examined in this article, including those

dealing with the flow-through problem, see, e.g., Titan Transp., L.P. v. Combs, 433 S.W.3d 625 (Tex. App.—Austin 2014, pet. denied); Allcat Claims Serv., L.P. v. Combs, No. D-1-GN-11-002294 (201st Dist. Ct., Travis County, Tex. Aug. 1, 2011); and those clarifying which types of businesses qualify for the lower retail tax rate, see, e.g., Rent-A-Ctr., Inc. v. Hegar, 468 S.W.3d 220 (Tex. App.—Austin 2015, no pet.), to name but a few. In addition, the discussion below does not address thorny nexus issues, which are outside the scope of this Article.

137 See TEX. TAX CODE ANN. § 171.002(a)–(b) (West 2015). For 2016, the tax rate is .375 % for retailers and wholesalers and .75 % for all other businesses.

138 See supra notes 24–33 and accompanying text for the basic calculation of an entity’s margin. 139 See TAX § 171.101(a)(2). 140 Id. § 171.106(a). 141 Upjohn Co. v. Rylander, 38 S.W.3d 600, 604 n.5 (Tex. App.—Austin 2000, pet. denied) (explaining that

“Texas uses an apportionment formula in the form of a fraction to calculate a corporation’s Texas business as follows: Texas receipts/Everywhere receipts.”); see also Franchise Tax Frequently Asked Questions: Apportionment, TEX. COMPTROLLER OF PUB. ACCOUNTS, https://www.comptroller.texas.gov/taxes/franchise/ (last visited Oct. 25, 2016) (explaining that the apportionment factor is calculated “by dividing Texas Gross Receipts by Everywhere Gross Receipts”).


Margin142x

Texasreceipts143 Everywherereceipts144

=TaxableMargin145x

TaxRate146 =TaxLiability147

The denominator of the factor (i.e., an entity’s “everywhere receipts”) includes receipts from the sale of tangible personal property, receipts from services, rentals, and royalties, and receipts from other business.148 However, the sale of an investment or capital asset by the entity is treated differently.149 According to the statute, “[i]f a taxable entity sells an investment or capital asset, the taxable entity’s gross receipts from its entire business for taxable margin includes only the net gain from the sale.”150 The interpretation of this statutory exception is at the heart of a case that was recently decided by the Texas Supreme Court.151

In Hallmark Mktg. Co., LLC v. Combs, the taxpayer was a company with nationwide retail activities.152 The taxpayer was subject to the margin tax due to its business activities in Texas.153 The taxpayer had substantial gross receipts from its business activities, but recognized huge losses in the sale of investments and capital assets during the year that was the subject of the case.154 To calculate the denominator of the apportionment factor, the taxpayer added up its gross receipts from its business activities.155 The taxpayer did not subtract its investment and capital losses from the denominator because the statute directs “that ‘only the net gain from the sale’ of investment or capital assets are included” in the denominator.156 The taxpayer reasoned that, since its investment and capital transactions resulted in a loss rather than a gain, the resulting negative number should not be included in the denominator.157

The Texas comptroller disagreed with the taxpayer’s interpretation of the statute.158 The

142 See supra notes 24–30 and accompanying text. 143 See TAX § 171.106(a). 144 See id.; see also id. § 171.105. 145 See supra note 31 and accompanying text. 146 See supra notes 32–33 and accompanying text. 147 See id. 148 See TAX § 171.105(a). 149 See id. at (b). 150 Id. 151 See generally Hallmark Mktg. Co. v. Combs, No. 13-14-00093-CV, 2014 WL 6090574 (Tex. App.—

Corpus Christi Nov. 13, 2014), rev’d sub nom. Hallmark Mktg. Co. v. Hegar, No. 14-1075, 2016 WL 1516774 (Tex. Apr. 15, 2016).

152 See id. 153 “A franchise tax is imposed on each taxable entity that does business in this state.” TAX § 171.001(a). 154 Hallmark Mktg. Co., 2014 WL 6090574, at *3 (noting that in 2008 Hallmark had gross receipts totaling

more than $4.5 billion and capital losses of more than $600 million). 155 Id. 156 Id. 157 Id. 158 Id.


comptroller’s calculation of the denominator of the taxpayer’s apportionment factor was quite different from the taxpayer’s. In computing the denominator of the taxpayer’s apportionment factor, the comptroller added up the taxpayer’s gross receipts from business activities and then subtracted the taxpayer’s huge investment and capital losses.159

Because the comptroller subtracted the investment and capital losses from the denominator of the apportionment factor, making the number in the denominator smaller than the number that the taxpayer had used for the denominator, the resulting fraction was larger than the fraction used by the taxpayer in determining its apportionment factor.160 As a result of the higher apportionment factor under the comptroller’s interpretation of the statute, the taxpayer owed more franchise tax than the taxpayer had originally calculated and a deficiency was assessed.161

The district court granted summary judgment in favor of the comptroller.162 On appeal, the taxpayer argued (among other things) that the investment and capital losses should not be subtracted from the denominator of the apportionment factor because the plain language of the statute provides that “only the net gain” from the sale of investments or capital assets is included in the denominator of the apportionment factor.163 The taxpayer reasoned that the ordinary meaning of the word “only” as used in the statute operates to “exclude its net loss, which is not a net gain, from the denominator” of the apportionment factor.164

While the taxpayer’s plain-language argument primarily focused on four crucial words in the statute (“only the net gain”), the comptroller’s position was based on a broader view of the statute in relation to the tax code as a whole, the intent of the legislature, rules adopted by the comptroller, and general consistency in the application of the tax laws.165 For example, the comptroller argued that, because taxpayers are required to include investment and capital losses in “total revenue from entire business” under Section 171.1011 of the Texas Tax Code, taxpayers are also required to include those losses in “gross receipts from entire business” under Section 171.104.166 Reasoning that “[n]othing in the statute requires a net gain to be positive,”167 the comptroller pointed to a Texas case and a Wisconsin apportionment statute for support.168 Perhaps most convincing to the appellate court was the comptroller’s reference to a Comptroller Rule pertaining to apportionment which states that “net gains and losses from

159 See id. 160 See id. (comparing the apportionment factor calculated by the comptroller (6.49%) to the apportionment

factor originally calculated by the taxpayer (5.54%)). 161 Id. at *1, *3. 162 See id. at *1. 163 See Appellant’s Brief at *4, *6, Hallmark Mktg. Co., 2014 WL 6090574 (No. 13-14-00093-CV); TEX. TAX

CODE ANN. § 171.105(b) (West 2015). 164 Appellant’s Brief, supra note 163, at *9. 165 See Appellees’ Brief at *4–5, *7–14, Hallmark Mktg. Co., 2014 WL 6090574 (No. 13-14-00093-CV). 166 Id. at *7–9. 167 Id. at *10. 168 See id. at *10–12 (citing Calvert v. Electro-Sci. Inv’rs, Inc., 509 S.W.2d 700, 702 (Tex. Civ. App.—Austin

1974, no writ) and WIS. STAT. ANN. § 71.45(2)(b)(l) (West 2015)). The comptroller also pointed to a recent 7th Circuit Posner opinion, which suggested that “net gain” could be a negative number in some situations. See In re Fort Wayne Telsat, Inc., 665 F.3d 816, 821, 823 (7th Cir. 2011).


sales of investments and capital assets must be added to determine the total gross receipts from such transactions. . . . If the combination of net gains and losses results in a net loss, the taxable entity should net the loss against other receipts, but not below zero.”169

In affirming the district court’s judgment in favor of the comptroller, the Thirteenth Court of Appeals170 found that “tax code section 171.105(b) is ambiguous but . . . Rule 3.591 is a reasonable construction of the statute and is in accord with the statute’s plain language.”171

Upon grant of review by the Texas Supreme Court, the taxpayer asserted that the Comptroller Rule is not entitled to deference because it conflicts with the unambiguous language of Section 171.105(b) of the Texas Tax Code.172 The taxpayer contended that the portion of Comptroller’s Rule 3.591 stating that a net loss from sales of investments and capital assets should offset other receipts to determine total gross receipts conflicts with the plain language of Section 171.105(b) of the Texas Tax Code, which states that “gross receipts . . . includes only the net gain from the sale” of investments and capital assets.173

In contrast to the taxpayer’s interpretation of the statute, the comptroller argued that, because the statute’s phrase “net gain” is “subject to multiple understandings,” deference should be given to the comptroller’s interpretation of this phrase in Rule 3.591.174 Alternatively, the comptroller suggested that the word “only” as used in the statute is meant to modify the word “net” and not the word “gain,” with the phrase being spoken aloud as follows: includes only net gain.175 In other words, the purpose of the word “only” in the statute is to distinguish “gain” from “net gain,” and clarify that net gain—not the entire gain prior to deducting basis, expense of sale, etc.—from the sale of investments and capital assets will be included in the denominator of the apportionment fraction.176

The comptroller also argued that “account[ing] for [the taxpayer’s] loss in determining its ‘taxable margin’ but not when calculating its apportionment fraction artificially inflates the denominator in the apportionment formula which is intended to reasonably represent the proportion of business conducted everywhere.”177 Along those same lines, the comptroller reasoned that “if an entity takes a loss into consideration when calculating its total revenue under section 171.1011, it must also account for that loss when calculating its apportioned margin under section 171.105.”178 In addition, the comptroller asserted that, reading the statute

169 TEX. ADMIN. CODE ANN. tit. 28, § 3.591 (West 2016). 170 The case was transferred from the Third Court of Appeals by order of the Texas Supreme Court for docket

equalization. See Hallmark Mktg. Co., 2014 WL 6090574, at *1 n.1 (citing TEX. GOV’T CODE ANN. § 73.001 (West 2015)).

171 Hallmark Mktg. Co., 2014 WL 6090574, at *4–5. 172 See Petitioner’s Brief on the Merits at *22–24, Hallmark Mktg. Co., LLC v. Hegar, 488 S.W.3d 795 (Tex.

2016) (No. 14-1075). 173 Id.; TEX. TAX CODE ANN. § 171.105(b) (West 2015). 174 Response to Petition for Review at *13, Hallmark Mktg. Co., LLC, 488 S.W.3d 795 (No. 14-1075). 175 Oral arguments in the Texas Supreme Court, Dec. 9, 2015,

http://www.search.txcourts.gov/Case.aspx?cn=14-1075&coa=cossup (last visited Nov. 7, 2016). 176 Id. 177 Response to Petition for Review, supra note 174, at *17. 178 Id. at *3.


in the context of other relevant portions of the tax code and considering the intent of the legislature, the taxpayer should be required to subtract the losses from the sale of investments and capital assets from the denominator of the apportionment fraction.179

On April 15, 2016, the Texas Supreme Court reversed the Thirteenth Court of Appeals, holding that the phrase “only the net gain” found in Section 171.105(b) of the Texas Tax Code “necessarily excludes a net loss.”180 Addressing the appellate court’s finding that the phrase “net gain” is ambiguous, the Texas Supreme Court explained that the issue of whether the phrase “net gain” is ambiguous is irrelevant in the Hallmark case because the taxpayer in Hallmark “suffered only a net loss.”181 The Court further stated that “[t]he statute requires inclusion of ‘only the net gain,’ and under no reading can ‘net gain’ include a net loss.” Accordingly, we cannot defer to the comptroller’s rule requiring inclusion of a net loss in Hallmark’s apportionment-factor denominator because it conflicts with the plain language of Tax Code section 171.105(b).”182

Along with other issues raised by the parties, the Court disposed of the comptroller’s argument that the phrase “‘net gain’ can be read expansively enough to include a net loss.”183 Reading the phrase “net gain” to include a net loss, said the Court, would impermissibly “add to the statute’s plain language” and “effectively write the word ‘only’ out of the statute.”184

The Court also rejected the comptroller’s claim that other sections of the Texas Tax Code, when examined in concert, require that net losses from the sale of investments and capital assets be included in the denominator of the apportionment factor.185 In doing so, the Court explained that Section 171.105(b) pertains to a “specific issue—what to do with the proceeds from the sale of an investment when calculating the apportionment-factor denominator—and lays out a clear rule: include ‘only the net gain from the sale.’”186 The Court acknowledged that, if there were a conflict among Section 171.105(b) and the other more general sections of the Tax Code referenced by the comptroller, the more specific section (i.e., Section 171.105(b)) would control.187 However, the Court observed that, since the general statutes cited by the comptroller did not conflict with Section 171.105(b)’s “only net gain” provision, the general statutes have no impact on Section 171.105(b).188 Therefore, Section 171.105(b) “means just what it says—’only the net gain from the sale’ of investments should be included in the apportionment-factor denominator.”189

In summary, the parties in Hallmark considered the following question: Can “net gain” ever be a negative number in the context of the “everywhere receipts” component of the Texas

179 Id. at *6–7. 180 Hallmark Mktg. Co., LLC v. Hegar, 488 S.W.3d 795 (Tex. 2016). 181 Id. at 799. 182 Id. at 799–800. 183 Id. at 799. 184 Id. 185 Id. at 800. 186 Id. 187 See id. 188 Id. 189 Id. at 801.


franchise tax apportionment factor?190 According to the Texas Supreme Court, “the answer is obvious and easy: No.”191

B. If It Walks Like a Duck and Quacks Like a Duck . . .

Is the margin tax an “income tax”?192 Some commentators believe the margin tax falls within the general definition of an income tax.193 As discussed previously, the Texas Supreme Court declined to address this question in the Allcat case,194 but the issue has again come to the forefront in a recent apportionment case.195

In Graphic Packaging Corporation v. Hegar, the taxpayer was a Georgia corporation that sold packaging products nationwide, including within the borders of Texas.196 Because the taxpayer engaged in retail and wholesale activities in Texas, the taxpayer was subject to the margin tax.197

As discussed earlier in this Article, the margin tax liability for an entity that does business in multiple states is determined in part by applying an apportionment factor (to account for the entity’s business activities in Texas) to the entity’s margin to arrive at the entity’s taxable margin.198 However, rather than use the “single-factor” 199 apportionment formula set forth in Chapter 171 of the Texas Tax Code (the “Franchise Tax” formula) discussed above in Section A to determine taxable margin, the taxpayer in Graphic used the “three-factor”200 apportionment formula found in Chapter 141 of the Texas Tax Code (the “Multistate Tax Compact” formula).201

Before looking at the taxpayer’s rationale for using the Multistate Tax Compact three-factor apportionment formula rather than the Franchise Tax single-factor apportionment formula, a comparison of the two formulas is helpful. The Franchise Tax apportionment formula divides a taxpayer’s gross receipts from business done in Texas by a taxpayer’s gross

190 Or, as the Court put it, “can net gain sometimes mean net loss if losses outstrip gains?” Id. at 799. 191 Id. (stating that “[h]owever net gain is calculated, a statutory net gain cannot simultaneously be a net loss”). 192 It is sometimes incorrectly stated that the Texas Constitution prohibits a state income tax (absent voter

approval). However, the Texas Constitution’s prohibition applies only to an income tax on natural persons. See TEX. CONST. art. VIII, § 24(a) (prohibiting a tax (absent voter approval) on the “net incomes of natural persons, including a person’s share of partnership and unincorporated association income”). Contrary to the perception of some, the Texas Constitution’s prohibition on a state income tax does not apply to the taxation of business entities. Therefore, a state income tax on businesses is not prohibited by the Texas Constitution. See id.

193 See supra notes 76–95 and accompanying text. 194 See supra notes 64–68 and accompanying text. 195 See generally Graphic Packaging Corp. v. Hegar, 471 S.W.3d 138 (Tex. App.—Austin 2015, pet. filed). For

a similar case pending in the Third Court of Appeals at the time of publication, see EMC Corp. v. Hegar, No. D-1-GN-14-000851 (353 Dist. Ct., Travis County, Tex. Feb 18, 2015), appeal docketed, No. 03-15-00113-CV, 2016 WL 4269975 (Tex. App.—Austin 2016).

196 Graphic Packaging Corp., 471 S.W.3d at 139. 197 See TEX. TAX CODE ANN. § 171.001(a) (West 2015). 198 See supra notes 137– 147 and accompanying text. 199 See Graphic Packaging Corp., 471 S.W.3d at140; see also TAX § 171.106. 200 Id. 201 Id.; see TAX § 141.001.


receipts from all sources everywhere.202 It considers only one aspect of the taxpayer’s business activities—gross receipts—hence, the “single-factor” label.203 It does not incorporate any other aspects of the entity’s business activities that may be relevant to a fair apportionment of the entity’s tax liability among Texas and other states in which the entity does business.204

In contrast, the Multistate Tax Compact formula takes three business activities into account in its calculation.205 In addition to accounting for an entity’s Texas sales in relation to the entity’s total sales occurring everywhere206 as is accounted for in the Franchise Tax formula, the Multistate Tax Compact formula accounts for an entity’s ownership or use of property in Texas in relation to the entity’s ownership or use of property everywhere,207 as well as the amount of payroll that the entity pays in Texas in relation to the total amount of payroll that the entity pays everywhere.208 Following is a very basic example comparing the Franchise Tax single-factor apportionment formula with the Multistate Tax Compact three-factor apportionment formula:

FranchiseTax(Chapter171) Single-FactorApportionmentFormula209

MultistateTaxCompact(Chapter141) Three-FactorApportionmentFormula210

Texasreceipts Everywherereceipts

TexasProperty+TexasPayroll+TexasSales AllPropertyAllPayrollAllSales

3

In Graphic, it was desirable for the taxpayer to use the Multistate Tax Compact three-factor formula because it produced a more favorable result for the taxpayer than using the Franchise Tax single-factor formula.211 The three-factor formula produced a more favorable result because the taxpayer engaged in retail and wholesale activities in Texas, but it did not conduct any manufacturing activities in Texas.212 Since the Graphic taxpayer did not own or

202 See TAX §§ 171.106(a), 171.103, 171.105. 203 See Graphic Packaging Corp., 471 S.W.3d at 140. 204 See ETC Mktg., Ltd. v. Harris Cty Appraisal Dist., 476 S.W.3d 501, 511 (Tex. App.—Houston [1st Dist.]

2015, pet. filed) (explaining that the “central purpose behind the apportionment requirement is to ensure that each State taxes only its fair share of an interstate transaction”); see also Home Interiors & Gifts, Inc. v. Strayhorn, 175 S.W.3d 856, 863 (Tex. App.—Austin 2005, pet. denied) (noting that the “fair apportionment requirement attempts to ensure that no State taxes more than its fair share of an interstate transaction”).

205 “All business income shall be apportioned to this state by multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator of which is three.” TAX § 141.001, art. IV.9.

206 Id. at art. IV.15. 207 Id. at art. IV.10. 208 Id. at art. IV.13. 209 Id. § 171.106. 210 Id. § 141.001, arts. IV.9, IV.10, IV.13, IV.15. 211 Graphic Packaging Corp. v. Hegar, 471 S.W.3d 138, 140 (Tex. App.—Austin 2015, pet. filed). 212 Id.


operate any manufacturing facilities in Texas, using the three-factor formula, which equally weighs factors for a taxpayer’s Texas property (which was zero for the Graphic taxpayer) and a taxpayer’s Texas Payroll (which was zero for the Graphic taxpayer) with a taxpayer’s Texas Sales, produced a lower tax liability than the single-factor formula, which calculates the tax liability based only on Texas receipts and does not take into account a taxpayer’s Texas property or Texas payroll.213

The Graphic taxpayer based its use of the three-factor formula on the premise that the margin tax constitutes an “income tax” on businesses as defined in the Multistate Tax Compact.214 Under the Multistate Tax Compact, a business entity that is subject to a state income tax in multiple states can choose to apportion its income either in accordance with the laws of the taxing state or by using the three-factor Multistate Tax Compact formula.215 The Multistate Tax Compact defines “income tax” as “a tax imposed on or measured by net income including any tax imposed on or measured by an amount arrived at by deducting expenses from gross income, one or more forms of which expenses are not specifically and directly related to particular transactions.”216Concluding that the margin tax constitutes an “income tax” for purposes of the Multistate Tax Compact, the Graphic taxpayer chose to use the Multistate Tax Compact apportionment formula rather than the formula found in the Franchise Tax chapter of the Texas Tax Code.217

The Texas comptroller did not agree with the taxpayer’s position and denied the taxpayer’s use of the Multistate Tax Compact’s apportionment formula.218 In district court, the comptroller won its motion for summary judgment on the issue of whether the taxpayer properly elected to use the Multistate Tax Compact’s apportionment formula rather than the apportionment formula set forth in the Franchise Tax chapter of the Texas Tax Code.219 On appeal, the crux of the case was whether the margin tax falls within the Multistate Tax Compact’s definition of “income tax.”220

One of the taxpayer’s arguments was that the margin tax falls within the meaning of “income tax” found in the Multistate Tax Compact when a taxpayer uses the cost-of-goods-sold method to calculate its margin tax liability (as the taxpayer did in this case) “because a taxpayer may determine its tax base (its margin) . . . by subtracting its cost of goods sold, including indirect costs, and those indirect costs are ‘expenses’ that are ‘not specifically or

213 Id.; compare TAX § 141.001 with TAX § 171.106. 214 Graphic Packaging Corp., 471 S.W.3d at 141–42. 215

Any taxpayer subject to an income tax whose income is subject to apportionment and allocation for tax purposes pursuant to the laws of a party state or pursuant to the laws of subdivisions in two or more party states may elect to apportion and allocate his income in the manner provided by the laws of such state or by the laws of such states and subdivisions without reference to this compact, or may elect to apportion and allocate in accordance with Article IV.

TAX § 141.001, art. III.1. 216 Id. at art. II.4. 217 Graphic Packaging Corp., 471 S.W.3d at 140, 142. 218 Id. at 140–41. 219 Id. at 141. 220 Id. at 143.


directly related to a particular transaction.’”221 The taxpayer reasoned that, looking at the plain language of the Multistate Tax Compact’s definition of “income tax,” the margin tax clearly qualifies as an income tax “because its computation begins with gross receipts, which then are reduced by a myriad of exclusions and expense deductions, including indirect (overhead) expenses, at least some of which are not specifically and directly related to particular transactions”222 Some examples of indirect expenses given by the taxpayer included utilities, insurance, and administrative expenses.223

In response, the comptroller argued (among other things) that the margin tax is not an income tax, observing that “[t]he Legislature made this distinction clear when it revised the franchise tax to its current form: ‘The franchise tax imposed by Chapter 171, Tax Code, as amended by this Act, is not an income tax.’”224 The comptroller also cited a case where the court defined net income as the “‘excess of all revenues and gains for a period over all expenses and losses of the period’”225 and pointed out that “‘margin’ never involves deducting ‘all expenses and losses.’”226 Because taxpayers do not deduct all expenses to arrive at the margin, the comptroller reasoned that the margin is not equivalent to net income.227

The Third Court of Appeals affirmed in favor of the comptroller, finding that the margin tax does not meet the Multistate Tax Compact’s definition of “income tax.”228 The court’s reasons included the fact that there are methods for determining margin other than deducting expenses from total revenue and, even when the margin is determined by deducting expenses under the cost-of-goods-sold or compensation methods, these methods only allow certain expenses to be deducted.229 The court also noted that Section 171.106(a) of the Texas Tax

221 Id. at 143–44. 222 Brief for Appellant at 50, 53, Graphic Packaging Corp., 471 S.W.3d 138 (No. 03-14-00197-CV). 223 Id. at 52, 55. 224 Brief of Appellees at 21, Graphic Packaging Corp., 471 S.W.3d 138 (No. 03-14-00197-CV) (quoting Act of

May 2, 2006, 79th Leg., 3d C.S., ch. 1, § 21, 2006 Tex. Gen. Laws 1, 38). In contrast to the comptroller’s reliance on the label give to the margin tax by the legislature, the Council on State Taxation observed in its amicus brief filed in this matter, “While the Texas Legislature can opine on whether the franchise tax is subject to that federal law, ultimately it is up to the courts to decide whether the franchise tax meets that definition.” Brief of Council on State Taxation as Amicus Curiae Supporting Appellant at 14, Graphic Packaging Corp., 471 S.W.3d 138 (No. 03-14-00197-CV).

225 INOVA Diagnostics, Inc. v. Strayhorn, 166 S.W.3d 394, 401 n.7 (Tex. App.—Austin 2005, pet. denied) (quoting BLACK’S LAW DICTIONARY 1040 (6th ed. 1990)).

226 Brief of Appellees, supra note 224, at 22. 227 Id. Query whether a distinction exists between subtracting “all expenses” from gross revenue (the standard

on which the comptroller insists) and subtracting all deductible expenses under applicable state or federal law. Under the Internal Revenue Code, taxpayers are not allowed a deduction for all expenses—only certain expenses enumerated in the Code. Some types of expenses are required to be capitalized rather than deducted in the period they are incurred. Some valid business expenses may not be deducted in full (for example, business meals limited to 50-percent deduction, business travel expense limited to a deduction based on mileage despite the actual cost of the transportation, compensation paid to employees in excess of the amount the IRS considers to be “reasonable,” etc.). Under the definition on which the comptroller relies, a taxpayer could subtract from gross revenue all of the taxpayer’s expenses for which the Internal Revenue Code allows a deduction and still not meet the comptroller’s definition of “net income” simply because federal law did not allow a deduction for all of the taxpayer’s expenses!

228 See Graphic Packaging Corp., 471 S.W.3d at 144–47. 229 See id. at 144.


Code expressly states that the Franchise Tax formula must be used “[e]xcept as provided by this section” and reasoned that, since the Multistate Tax Compact formula is not listed as an alternative in Section 171.106, it is not a permissible alternative.230 In addition, the court pointed to the statement made by the legislature at the time the margin tax was enacted: “‘[T]he franchise tax imposed by Chapter 171, Tax Code, as amended by this Act, is not an income tax.’”231

The taxpayer’s petition for review in the Texas Supreme Court is pending as of the time that this article is being published. Given the level of attention garnered by this case in the court below,232 the impact of the Court’s decision on the issues raised in this case will certainly extend beyond the Graphic taxpayer.233

C. Cost of Goods Sold

As mentioned in Section B, the margin tax is calculated by applying the relevant tax rate to an entity’s taxable margin.234 To calculate an entity’s margin, the entity generally figures its “total revenue” and then deducts either its “compensation” expenses or its “cost of goods sold.”235 There have been numerous challenges relating to the Cost of Goods Sold (COGS) deduction.236 What is a “good” for purposes of the COGS deduction? Who can take the COGS deduction? What is included in the COGS deduction? A few recent cases involving the COGS deduction are discussed next.

1. If You Can’t Touch, Hold, or Feel It, Is It a “Good”?

Can a two-hour experience purchased by a customer qualify as a “good” for purposes of the COGS deduction? The Third Court of Appeals recently answered this question in the affirmative. In American Multi-Cinema, Inc. v. Hegar,237 the taxpayer, which owned and

230 See id. at 145. “Had the legislature intended for chapter 141’s three-factor formula to be an alternative for

apportioning margin for franchise tax purposes, it could have included it as one of the expressed alternatives in section 171.106.” Id.

231 Id. at 146 (quoting Act of May 2, 2006, 79th Leg., 3d C.S., ch. 1, § 21, 2006 Tex. Gen. Laws 1, 38). 232 At least four amicus briefs were submitted to the Third Court of Appeals in this matter. See Brief of

Council on State Taxation as Amicus Curiae Supporting Appellant, Graphic Packaging Corp., 471 S.W.3d 138 (No. 03-14-00197-CV); Brief of the Interstate Commission for Juveniles, the Association of Compact Administrators of the Interstate Compact on the Placement of Children, and Jeffrey Litwak as Amici Curiae Supporting Appellant, Graphic Packaging Corp., 471 S.W.3d 138 (No. 03-14-00197-CV); Brief of States of Oregon, Alaska, California, Colorado, Hawaii, Michigan, Minnesota, Montana, New Mexico, and Washington as Amici Curiae Supporting Appellees, Graphic Packaging Corp., 471 S.W.3d 138 (No. 03-14-00197-CV); Brief of Multistate Tax Commission as Amici Curiae Supporting Appellees, Graphic Packaging Corp., 471 S.W.3d 138 (No. 03-14-00197-CV).

233 See Brief of EMC Corporation as Amicus Curiae Supporting Petitioner at 1, Graphic Packaging Corp., 471 S.W.3d 138 (No. 03-14-00197-CV), http://www.search.txcourts.gov/SearchMedia.aspx?MediaVersionID=f3080400-f587-49cd-9de3-c948a5393868&coa=cossup&DT=BRIEFS&MediaID=c08b1dfd-76e3-4c86-bbbb-6ed98054b6a7 (last visited Nov. 7, 2016).

234 See TEX. TAX CODE ANN. § 171.002(a)–(b) (West 2015). 235 See supra notes 25–31 and accompanying text for the basic calculation of an entity’s margin. 236 See Titan Transp., L.P. v. Combs, 433 S.W.3d 625, 627–29 (Tex. App.—Austin 2014, pet. denied); Combs

v. Newpark Res., Inc., 422 S.W.3d 46, 47–48 (Tex. App.—Austin 2013, no pet.). 237 See generally Am. Multi-Cinema, Inc. v. Hegar, No. 03-14-00397-CV, 2015 WL 1967877 (Tex. App.—


operated movie theaters, claimed the COGS deduction for its “costs of exhibiting films and other content (exhibition costs)” on its first two annual franchise tax returns filed under the new margin tax system.238 On audit, the Texas comptroller disallowed the deduction of the taxpayer’s exhibition costs on the grounds that the taxpayer does not sell “goods” for purposes of Texas Tax Code statutes pertaining to the deduction for cost of goods sold, resulting in a substantially higher franchise tax liability than originally calculated by the taxpayer.239

In district court, the primary issue in dispute was whether the taxpayer’s exhibition of movies in theaters to its customers constitutes “goods” under the Texas franchise tax laws.240 At a bench trial, the comptroller argued that the taxpayer’s exhibition of movies in its theaters “does not fall within the meaning of ‘tangible personal property’ because it is either ‘intangible property’ or a movie-viewing ‘service,’” both of which are expressly excluded from the definition of “tangible personal property” under the Texas Tax Code.241 The comptroller reasoned that “[the taxpayer] does not sell the film, but the right to watch the film at a certain time and place.”242 As support for the taxpayer’s position, the taxpayer pointed to the plain language of the statutory definition of tangible personal property (“personal property that can be seen . . . or that is perceptible to the senses in any other manner”)243 and argued that the movies shown in its theaters fall squarely within the definition because the movies can be seen and heard by customers (i.e., the movies are perceptible to the senses).244

The trial court found that when the taxpayer shows movies in its theaters, “it produces personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to

Austin Apr. 30, 2015, no pet.) (mem. op). 238 Id. at *1. The franchise reports at issue in this case were for tax years 2008 and 2009. Id. The controlling

statute in this case was subsequently amended to allow movie theaters to claim the COGS deduction for exhibition costs. See Act of June 14, 2013, 83d Leg., R.S., ch. 1232, § 10, 2013 Tex. Sess. Law Serv. 3105, 3109 (current version at TAX § 171.1012(t)). Section 171.1012(t) of the Texas Tax Code now provides that

[i]f a taxable entity that is a movie theater elects to subtract cost of goods sold, the cost of goods sold for the taxable entity shall be the costs described by this section in relation to the acquisition, production, exhibition, or use of a film or motion picture, including expenses for the right to use the film or motion picture.

TAX § 171.1012(t). While the amendment provides an avenue for movie theaters to claim the COGS deduction for exhibition costs, it does not expressly classify the exhibition of movies as “goods.”

239 Am. Multi-Cinema, Inc., 2015 WL 1967877, at *1, *3. 240 Id. at *1; Under the Texas Tax Code, “‘Goods’ means real or tangible personal property sold in the ordinary

course of business of a taxable entity.” TAX § 171.1012(a)(1). “Tangible personal property” is defined as:

(i) personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner; and (ii) films, sound recordings, videotapes, live and prerecorded television and radio programs, books, and other similar property embodying words, ideas, concepts, images, or sound, without regard to the means or methods of distribution or the medium in which the property is embodied, for which, as costs are incurred in producing the property, it is intended or is reasonably likely that any medium in which the property is embodied will be mass-distributed by the creator or any one or more third parties in a form that is not substantially altered.

Id. at (a)(3)(A). “Tangible personal property” does not include intangible property or services. Id. at (a)(3)(B). 241 Am. Multi-Cinema, Inc., 2015 WL 1967877, at *5. 242 Id. 243 TAX § 171.1012(a)(3)(A)(i). 244 Am. Multi-Cinema, Inc., 2015 WL 1967877, at *5.


the senses in any other manner for sale in its ordinary course of business.”245 The trial concluded that this constituted the production of “goods for sale in the ordinary course of business under Section 171.1012, and [the taxpayer] may therefore include the costs of exhibiting movies and other content to its paying customers in its cost-of-goods-sold deduction under Section 171.1012 of the Texas Tax Code.”246

On appeal, the comptroller argued that “exhibiting films does not constitute a ‘good’ because [the taxpayer] does not sell ‘tangible personal property’ but intangible property, or a film-watching service, or non-property.”247 The comptroller contended that the tickets purchased by the taxpayer’s customers were merely licenses, pointing out that “[the taxpayer’s] customers leave [the] theaters with experiences and memories but without a copy of the film.”248 Finding that the language of the statute that defines “goods” is not ambiguous, the Third Court of Appeals looked to the plain meaning of the statute.249 The court observed that the statute “defines ‘tangible personal property’ broadly to mean ‘personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner’” and that the definition of tangible personal property “does not have a take-home requirement.”250 The court also noted that the comptroller’s characterization of the taxpayer’s exhibition of movies as “intangible property” or “services” directly conflicts with portions of the statute.251 Accordingly, the Third Court of Appeals concluded that the trial court did not err in ruling that the taxpayer was entitled to claim a COGS deduction for its exhibition costs and affirmed in favor of the taxpayer.252

The comptroller filed a motion for rehearing in the Third Court of Appeals,253 and depending on the disposition of that motion, commentators predict this case may be headed to the Texas Supreme Court.254 The outcome of this case could have broader implications than

245 Id. at *4. 246 Id. 247 Id. 248 Id. at *5. 249 Id. at *4–5. 250 Id. 251 Id. at *6. The courted referred to the following portion of Section 171.1012 of the Texas Tax Code:

‘Tangible personal property’ means . . . films, sound recordings, videotapes, live and prerecorded television and radio programs, books, and other similar property embodying words, ideas, concepts, images, or sound, without regard to the means or methods of distribution or the medium in which the property is embodied, for which, as costs are incurred in producing the property, it is intended or is reasonably likely that any medium in which the property is embodied will be mass-distributed by the creator or any one or more third parties in a form that is not substantially altered.

TEX. TAX CODE ANN. § 171.1012(a)(3)(A)(ii) (West 2015). 252 Am. Multi-Cinema, Inc., 2015 WL 1967877, at *6, *10. 253 See Appellees’/Cross-Appellants’ Motion for Rehearing and for Reconsideration En Banc, Am. Multi-

Cinema, Inc., 2015 WL 1967877 (No. 03-14-00397-CV), http://www.search.txcourts.gov/SearchMedia.aspx?MediaVersionID=08c16541-ebea-442e-b2bd-a188f48dae7b&coa=coa03&DT=Motion&MediaID=dc7fd779-f237-4b9b-bbf9-74cdde282fa4 (last visited Nov. 7, 2016).

254 See, e.g., Josh Haney, Fiscal Notes: Franchise Tax Lawsuit Could Cost Texas $1.5 Billion a Year, TEX. COMPTROLLER OF PUB. ACCOUNTS (June–July 2015), https://www.comptroller.texas.gov/economy/fiscal-notes/2015/june/amc-decision.php.


what first meets the eye. Beyond the impact that it would obviously have on movie theaters operating in Texas, the court’s interpretation of the statutory definition of goods could be extended to a number of businesses traditionally considered to be in the service industry.255 The Texas comptroller’s office has estimated that such a result could put quite a dent in the state’s margin tax revenue.256 For now, all eyes are on the Third Court of Appeals to see whether the comptroller’s request for rehearing will be granted.

2. Does Combined Group’s COGS Deduction Include Service-Only Subsidiary’s Costs?

When determining cost of goods sold for a combined group, is each affiliate’s business considered in isolation or in the context of the combined group’s business as a whole? This question was answered by the Third Court of Appeals in Combs v. Newpark Resources, Inc.257 The taxpayer’s primary business activity in Newpark involved the “manufacture, sale, injection, and removal of ‘drilling mud,’” with the taxpayer’s several subsidiaries providing various types of support operations, such as manufacturing, sales, and hazardous waste removal.258 One of the subsidiaries engaged only in service-providing activities and did not sell any goods in the ordinary course of business.259

The taxpayer was required to file a single franchise tax return for itself and its subsidiaries as a combined group.260 In preparing the report, the taxpayer had to select the same deduction (generally the choice is to deduct cost of goods sold or compensation) for the entire group.261 The taxpayer chose the cost-of-goods-sold deduction for the combined group.262 In doing so, the taxpayer included expenses incurred by its service-only subsidiary in the combined group’s cost-of-goods-sold deduction, even though the subsidiary would not have qualified for the cost-of-goods-sold deduction if it were a stand-alone company.263

The Comptroller argued that, because the taxpayer’s subsidiary provided only services and did not independently qualify for a cost-of-goods-sold deduction, the taxpayer was not allowed to include the subsidiary’s expenses in the combined group’s overall cost-of-goods-sold

255 See id. (positing that “[u]nder the Court of Appeals’ interpretation, a clean house could be considered

‘perceptible,’ so housecleaning might be classified as tangible personal property”). 256 See id. (estimating that “the cumulative fiscal impact due to the expanded COGS deduction could rise to

$1.5 billion each year” and pointing out that since taxpayers can amend franchise tax returns for up to four years back, the state could be looking at refunds totaling $6 billion).

257 See generally Combs v. Newpark Res., Inc., 422 S.W.3d 46 (Tex. App.—Austin 2013, no pet.). 258 Id. at 48. 259 Id. at 50. 260 Id. at 48. 261 Id.; see supra notes 25–29 and accompanying text for a brief look at the cost-of-goods-sold and

compensation deductions. 262 Newpark Res., Inc., 422 S.W.3d at 48–49. 263 Id. at 49–51. Newpark included its subsidiary’s expenses in the cost-of-goods-sold deduction on grounds

that the subsidiary had furnished labor to a project for the construction or improvement of real property. See id. at 53–57; see also TEX. TAX CODE ANN.§ 171.1012(i) (West 2015). The taxpayer’s inclusion of the subsidiary’s expenses on this basis was challenged by the Comptroller, but the court held in favor of the taxpayer on this issue. Newpark Res., Inc., 422 S.W.3d at 57.


deduction.264 Ruling in favor of the taxpayer, the court noted that, according to the plain language of the statute, the determination of whether an entity that is a member of a combined group qualifies for the cost-of-goods-sold deduction must be made by viewing the combined group’s activities as a whole and not the single entity’s activities in isolation.265

3. What Exactly Can Be Included in COGS Deduction?

a. Labor or Materials Furnished to Project Involving Real Property

An entity that is not typically considered a manufacturer or seller of “goods” under the general definition of the statute may be able to claim a COGS deduction if the entity furnishes “labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance . . . of real property.”266 In Hegar v. CGG Veritas Services (U.S.), Inc., the taxpayer was a geoseismic company that acquired seismic data, processed the data to generate images of the subsurface of the earth, and sold sound recordings and images to oil and gas exploration and production companies.267 On the taxpayer’s initial franchise tax return filed under the new margin tax regime, the taxpayer claimed a COGS deduction of more than a half billion dollars.268 The Texas comptroller disallowed the entire COGS deduction on the grounds that the taxpayer was a service provider.269

In district court, the taxpayer argued that it qualified for the COGS deduction because “the costs it included in calculating its COGS deduction were incurred exclusively for the ‘construction, repair, or industrial maintenance of oil and gas wells, which are real property’ and therefore includable in the COGS deduction pursuant to Tax Code subsection 171.1012(i).”270 The comptroller maintained that the taxpayer “provides only services to oil and gas exploration and production companies and does not sell anything that meets the statutory definition of ‘goods.’”271

Finding, among other things, that the taxpayer’s “customers are generally oil and gas exploration and production companies” who “purchase, license, and use [the taxpayer’s] seismic and sound recordings and images to determine where to explore and drill for oil and gas” and that the services and products furnished by the taxpayer “are an integral, essential, and direct component of the oil and gas drilling process,” the district court concluded that the comptroller improperly denied the taxpayer’s COGS deduction because the taxpayer

264 Newpark Res., Inc., 422 S.W.3d at 50–51. The Comptroller apparently found it reasonable to force a group

of entities to pick one kind of deduction for the whole group based on the group’s business activities—even when some members of the group would not independently qualify for that deduction under the tax code—and then deny the group any kind of deduction for the non-qualifying members’ expenses.

265 Id. at 51–53. 266 TAX § 171.1012(i). 267 Hegar v. CGG Veritas Services (U.S.), Inc., No. 03-14-00713-CV, 2016 WL 1039054, at *2, *4 (Tex.

App.—Austin Mar. 9, 2016, no pet.). 268 Id. at *1–2. 269 Id. 270 Id. at *2. The taxpayer’s alternate argument was that that the audio and visual recordings it sells qualify as

“goods” under Section 171.1012(a)(3)(A). See id. The trial court did not rule on this issue. See id. 271 Id.


“furnished labor and materials to projects for the construction, improvement, remodeling or repair of oil and gas wells” (i.e., real property).272

On appeal, the comptroller argued that “even if [the taxpayer’s] activities qualify as ‘labor and materials’ within the meaning of subsection 171.1012(i), they are too far removed from the construction of an oil and gas well to qualify for [the COGS] deduction.”273 However, the Third Court of Appeals held that there was sufficient evidence on the record to uphold the district court’s conclusion that “the seismic data acquisition and processing [the taxpayer] performs for its oil and gas exploration and production company customers is ‘labor furnished to a project for the construction of real property,’” and affirmed in favor of the taxpayer.274 The comptroller was initially expected to file a petition for review in the Texas Supreme Court, but decided against doing so.275

b. Labor Costs Attributable to Installation of Goods

Generally, an entity can include in its COGS deduction “all direct costs of acquiring or producing the goods,” which includes (among other things) “labor costs,” “cost of materials that are an integral part of specific property produced,” and “cost of materials that are consumed in the ordinary course of performing production activities.”276 The Texas Tax Code defines “production” to include “construction, installation, manufacture, development, mining, extraction, improvement, creation, raising, or growth.”277 A recent case successfully challenged the Texas comptroller’s interpretation of the statutory definition of “production.”278

In Autohaus, LP, LLP v. Combs, the taxpayer was an automotive dealership based in Plano, Texas.279 On its 2009 Texas franchise tax report, the taxpayer claimed a COGS deduction that included costs that the taxpayer incurred in repairing vehicles (“repair costs”).280 These repair costs consisted of both the cost of materials and the cost of labor for installing automotive parts.281 Among other things, the comptroller disallowed the taxpayer’s deduction for the labor portion of the repair costs attributable to repairs performed on customer-owned vehicles.282

272 See id. at *1, *4. 273 Id. at *4. 274 Id. at *4–5. 275 On May 31, 2016, the comptroller informed the Texas Supreme Court that it did not intend to file a petition

for review in this case. See Letter from Ken Paxton, Attorney General of Texas, to Blake A. Hawthorne, Clerk of the Supreme Court of Texas, http://www.search.txcourts.gov/SearchMedia.aspx?MediaVersionID=571b44bc-2079-493b-a656-970415e2d389&coa=cossup&DT=OTHER&MediaID=3d849f78-fcc8-4170-a42f-5dec4a9384a1 (last visited Nov. 7, 2016).

276 TEX. TAX CODE ANN. § 171.1012(c) (West 2015). 277 Id. at (a)(2). 278 See Autohaus, L.P. v. Combs, No. D-1-GN-13-000989 (419th Dist. Ct. Travis County, Tex. Mar. 22, 2013).

This case is currently pending in the Third Court of Appeals. See Hegar v. Autohaus, L.P., No. 03-15-00427-CV (Tex. App.—Austin).

279 Plaintiff’s Original Petition at 2, Autohaus, L.P. v. Combs (No. D-1-GN-13-000989.). 280 See Plaintiff’s Motion for Summary Judgment and Incorporated Brief at 1–2, Autohaus, L.P. v. Combs (No.

D-1-GN-13-000989). 281 See id. at 2. 282 Plaintiff’s Original Petition, supra note 279, at 3; Defendants’ Response to Plaintiff’s Motion for Summary


In district court, the comptroller asserted that the taxpayer could not include labor costs for repair work to customer-owned automobiles in its COGS deduction based on Section 171.1012 of the Texas Tax Code and Comptroller Rule 3.588.283 To support its assertion, the comptroller argued (among other things) that Section 171.1012 of the Texas Tax Code is ambiguous with respect to “mixed transactions” (i.e., those involving “both the sale of a good and the provision of a service”) such as a transaction that involves both selling a replacement automobile part to a customer and installing the part in the customer’s automobile.284 Building on its position that Section 171.1012 of the Texas Tax Code is ambiguous with respect to “mixed transactions,” the comptroller maintained that “Subsections (b)(7) and (c)(7) of Rule 3.588 clarify that where there is a mixed transaction involving the service that includes the installation of a product owned by a business into property already owned by a customer, the installation labor retains its character as a service to the customer and so is not deductible as a cost of goods sold.”285

The taxpayer countered that the language of Section 171.1012(a)(2) setting forth the definition of the term “production” is clear and unambiguous.286 The statute provides that the term “production” includes “construction, installation, manufacture, development, mining, extraction, improvement, creation, raising, or growth.”287 The Comptroller Rule interpreting Section 171.1012(a)(2) defines “production” as “[c]onstruction, manufacture, installation occurring during the manufacturing or construction process, development, mining, extraction, improvement, creation, raising, or growth.”288 The taxpayer pointed out that, in contrast to the statutory definition of “production,” the Comptroller Rule’s definition of “production” limits the “installation” component of production to “installation occurring during the manufacturing or construction process.”289 The taxpayer contended that, because the “Texas Tax Code’s definition of ‘production’ is clear and unambiguous . . . and since Texas Comptroller Rule 3.588(b)(7) . . . attempts to alter an unambiguous statue” by defining “production” differently from the statute, the Rule “is invalid and not entitled to deference.”290

The district court rendered judgment in favor of the taxpayer, ruling that “Texas Comptroller Rule 3.588(b)(7) as it applies to the term ‘production’ is unconstitutional and invalid” and that the taxpayer “is entitled to include all of its labor costs associated with Repair

Judgment, Defendants’ Cross-Motion for Summary Judgment, and Defendants’ Plea to the Jurisdiction at 88, Autohaus, L.P. v. Combs (No. D-1-GN-13-000989) (filed June 17, 2014).

283 Defendants’ Response to Plaintiff’s Motion for Summary Judgment, Defendants’ Cross-Motion for Summary Judgment, and Defendants’ Plea to the Jurisdiction, supra note 282, at 12–22.

284 Id. at 13–15. 285 Id. at 15. Subsection (b)(7) of Rule 3.588 provides as follows: “Production—Construction, manufacture,

installation occurring during the manufacturing or construction process, development, mining, extraction, improvement, creation, raising, or growth.” TEX. ADMIN. CODE ANN. tit. 34, § 3.588(b)(7) (West 2015). Subsection (c)(7) provides as follows: “Mixed transactions. If a transaction contains elements of both a sale of tangible personal property and a service, a taxable entity may only subtract as cost of goods sold the costs otherwise allowed by this section in relation to the tangible personal property sold.” Id. § 3.588(c)(7).

286 See Plaintiff’s Motion for Summary Judgment and Incorporated Brief, supra note 280, at 6. 287 TEX. TAX CODE ANN. § 171.1012(a)(2) (West 2015). 288 tit. 34, § 3.588(b)(7) (emphasis added). 289 Id.; See Plaintiff’s Motion for Summary Judgment and Incorporated Brief, supra note 280, at 8. 290 Plaintiff’s Motion for Summary Judgment and Incorporated Brief, supra note 280, at 8. The taxpayer also

asserted that the comptroller’s denial of the COGS deduction and subsequent assessment of tax violated several provisions of the Texas and United States Constitutions. See id. at 14–17.


Costs . . . involved in the installation of automotive parts in its costs of goods sold deduction.”291 Having been appealed by the comptroller, Autohaus is pending in the Third Court of Appeals at the time this article is being written. Given the subject matter of Autohaus, the scope of its outcome could reach well beyond the Autohaus taxpayer and the specific Comptroller Rule that is at issue in this case.

VI. FINAL ACT & CURTAIN CALL?

As discussed previously, the margin tax has met with poor reviews from taxpayers and experts. It has performed dismally and failed at its intended role as the solution to the school funding problem that Texas faced in 2005. Attacks on the tax have consumed untold government resources as staff at the offices of the comptroller and attorney general defend countless challenges with no end in sight.292 Adding insult to injury, the margin tax has been faulted for putting a damper on the Texas economy.293

A. Effect on Texas Economy

A recent report by the National Center for Policy Analysis concluded that the margin tax “directly discourages business and investment by taxing the difference between a business’s revenue and certain costs.”294 Researchers at the National Federation of Independent Business Research Foundation and the Tax Foundation have reached similar conclusions.295 The results of studies performed by the Beacon Hill Institute and Texas Public Policy Foundation correspond with the findings of other researchers.

In 2012, researchers at the Beacon Hill Institute for Public Policy Research at Suffolk University conducted a study to project the impact on the Texas economy of abolishing the margin tax.296 According to the institute’s report, the margin tax “exerts a negative effect on investment, job creation and output that would otherwise take place in its absence.”297 Using a computable general equilibrium modeling program to calculate the “dynamic revenue effects” that would result five years following the elimination of the margin tax, the institute found that eliminating the margin tax would lead to a “significant improvement in the state economy.”298

The institute’s report projected that the change would create tens of thousands of new

291 Order Granting Plaintiff’s Motion for Summary Judgment at 1, Autohaus, L.P. v. Combs (No. D-1-GN-13-000989) (issued July 22, 2014); Final Judgment at 1, 3, Autohaus, L.P. v. Combs (No. D-1-GN-13-000989) (issued April 29, 2015).

292 See Haney & Wright, supra note 14, at 6 (noting that the margin tax “still faces numerous pending legal challenges, touching on everything from how the state calculates the portion of a company’s activity that occurs in Texas to which expenses can be deducted from a firm’s total revenue” and predicting that the margin tax “will continue to be subject to legislative changes and court challenges for the foreseeable future.”).

293 See Drenkard, supra note 43 (observing that “Texas’ tax code has a lot of desirable elements. . . . What holds the state back, though, is its franchise tax, most commonly called the Margin Tax”).

294 See Murphy, supra note 55, at 3. 295 See Chow, supra note 52; Drenkard, supra note 43. 296 See Tax Reform in Texas, supra note 95. The study, which was published in 2012, is based on a model that

simulated the economic effects of eliminating the margin tax beginning in the year 2013. Id. 297 Id. at 4. 298 Id. at 6.


jobs, increase Texans’ real disposable income, and add billions in investments to the state’s economy.299 This projected positive effect on the Texas economy following repeal of the margin tax would come as a result of “businesses [having] more money to make profitable investments in Texas, thus increasing investment and employment, incomes and retail sales which, in turn, push sales, property and other tax collections higher.”300

Last year, the Texas Public Policy Foundation developed an econometric model to study the effects of eliminating the margin tax.301 Their analysis indicates that “margin tax substantially depresses real personal income and private sector nonfarm job growth” and “eliminating the margin tax would free resources that would substantially boost the economy after the first year,” which would result in the creation of tens of thousands of new jobs and significantly increase Texans’ incomes.302

B. #ENDTHEMARGINTAX303

It appears that the margin tax may be in its final act.304 Given the poor financial performance of the margin tax and researchers’ findings that the tax is hampering the Texas economy, it comes as no surprise that there have been numerous calls for the repeal of the margin tax. One commentator has stated that “it would be in the state’s best interest to eliminate the tax entirely in order to reduce the complexity and costliness of the state’s tax code.”305 In a report issued by the 2011–12 Texas Conservative Coalition Research Institute’s State Taxation and Revenue Task Force (chaired by State Senator Dan Patrick, State Senator Ken Paxton, and State Representative Jim Murphy), lawmakers were urged to “break with the past and advocate for repeal of the Texas franchise tax.”306 The results of a 2013 economic simulation performed by the National Federation of Independent Business Research Foundation showed that phasing out the margin tax would benefit the Texas economy because it would “allow taxable business entities to retain more of their pre-tax income to finance business expansion, build cash reserves, enhance worker compensation, and provide better returns to shareholders.”307 One economist recently predicted that ending the margin tax would give Texas “one of the most competitive tax climates in the country.”308 Earlier this year, lawmakers were encouraged by the Texas Conservative Coalition Research Institute to “stay the course” on a path toward eliminating the margin tax.309

299 Id. 300 Id. at 5. 301 Ginn & Heflin, supra note 45, at 10. 302 Id. at 12. 303 TWITTER, https://twitter.com/hashtag/ENDthemargintax?src=hash (last visited Nov. 7, 2016). 304 See supra notes 9–11 and accompanying text. 305 Morgan Scarboro, Texas Legislature Passes $2.56 Billion Tax Cut Package, TAX FOUND. (Jun. 1, 2015),

http://taxfoundation.org/blog/texas-legislature-passes-256-billion-tax-cut-package (noting that eliminating the margin tax would “increase Texas’ Business Tax Climate ranking from 10th in the country to an impressive 3rd”).

306 See Final Report of the TCCRI, supra note 43, at 10. 307 Chow, supra note 52. 308 Drenkard, supra note 6, at 11. 309 Written Testimony to the Senate Committee on Finance, TEX. CONSERVATIVE COAL. RES. INST. (Mar. 30,

2016), http://txccri.org/wp-content/uploads/2016/04/Senate-Finance-Testimony-Franchise-Tax-3.30.16.pdf.


Is it time for the curtain to close on the margin tax? Some Texas lawmakers appear to think so. “Nearly 100 bills and resolutions relating to the franchise tax were filed in the 2015 legislative session, 13 of which would repeal it entirely.”310 While the 2015 legislative session did not result in the elimination of the margin tax, it did result in the passage of a bill that significantly reduces the tax burden on taxpayers starting with the 2016 tax year. 311 In the same bill, the legislature clearly signaled intent to repeal the margin tax.312

VII. CONCLUSION

The Texas margin tax was introduced to taxpayers in 2008 with the hope that it would resolve the state’s serious school finance problems. Instead of welcoming the margin tax as a practical solution for funding Texas’ public schools, taxpayers, experts, and other parties impacted by the tax have been outspoken in their disdain for the new tax structure. The critics have been harsh and the tax has garnered opponents from across the country. In addition to the margin tax being the target of widespread dislike, it has underperformed financially and is considered to be responsible for hindering the growth of the Texas economy.

The future of the margin tax is uncertain in light of the numerous legal attacks against it, its disappointing financial performance, and its impact on the Texas economy. Although there have been numerous attempts to fix many of the problems that exist in the structure of the tax, it might be best to scrap it altogether rather than continue futile piecemeal repairs. With little reason to celebrate the approaching tenth anniversary of the debut of the margin tax, its repeal may be the best gift for taxpayers and the comptroller alike. Many would likely agree that it is “time to end this complex, inefficient tax that places a substantial burden on businesses, individuals, and families across the income spectrum and unleash Texas’ entrepreneurial spirit so that all Texans, including the working poor, will enjoy the benefits of more jobs and greater economic prosperity.”313 Indeed, it appears the final curtain may be descending on the saga of the Texas margin tax. Perhaps it is time for the Texas margin tax to take a final bow and exit stage left.

310 Haney & Wright, supra note 14, at 6. 311 See Act of June 15, 2015, 84th Leg., R.S., ch. 449, §1(b) (cutting the tax rate for retailers and wholesalers

to.375 percent and to .75 percent for all other business, as well as reducing the EZ Computation rate to .331 percent). 312 See id. 313 Ginn & Heflin, supra note 45, at 4.


FILLING IN THE GAPS: SHAREHOLDER OPPRESSION AFTER RITCHIE V. RUPE:

PART 1

Eric Fryar*

I. TEXAS SHAREHOLDER OPPRESSION AFTER RITCHIE V. RUPE: WHAT’S LEFT? ................................................................................................ 49

II. THE PROBLEM OF OPPRESSION IN CLOSELY-HELD CORPORATIONS ............................................................................................. 52A. Structure of the Corporation ....................................................................... 52B. Distinguishing Ownership in Closely-Held Corporations .......................... 53C. Oppressive Conduct in Closely-Held Corporations .................................... 55

III. RISE AND FALL OF THE SHAREHOLDER OPPRESSION DOCTRINE ....................................................................................................... 58A. The Shareholder Oppression Doctrine—R.I.P. .......................................... 58

1. The “Oppression Statute” ...................................................................... 582. Advent of a New Legal Theory ............................................................. 58

(a) Davis v. Sheerin .............................................................................. 59(1) Facts ........................................................................................ 59(2) Holdings .................................................................................. 61(3) Defining the shareholder oppression cause of action ............. 63

(b) Boehringer v. Konkel ...................................................................... 643. The Shareholder Oppression Cause of Action ...................................... 664. Buy-Out Remedy .................................................................................. 68

B. The Texas Supreme Court’s Ruling in Ritchie v. Rupe .............................. 701. The Court of Appeals’ Opinion ............................................................ 702. The Supreme Court Opinion ................................................................. 71

C. Implications of Ritchie: Defining the “Gap” .............................................. 741. The need for a duty to individual shareholders ..................................... 742. The need for an individual remedy ....................................................... 773. Inadequacy of Piecemeal Approach ...................................................... 784. Need for the Buy-Out Remedy ............................................................. 815. Future development ............................................................................... 83

IV. REDISCOVERING INDIVIDUAL COMMON-LAW SHAREHOLDER CLAIMS ............................................................................................................ 84A. Re-examining Stinnett v. Paramount-Famous Lasky Corp. of N.Y. ........... 85B. Re-examining Cates v. Sparkman ............................................................... 88

1. Facts ...................................................................................................... 892. Holdings ................................................................................................ 903. Subsequent Treatment ........................................................................... 96

C. Re-examining Patton v. Nicholas ............................................................... 991. Facts ...................................................................................................... 992. Holdings .............................................................................................. 101


3. Ritchie’s Treatment ............................................................................. 104D. Re-examining Morrison v. St. Anthony Hotel ........................................... 116E. Question of Duty ....................................................................................... 120

V. RECOGNIZING INDIVIDUAL RIGHTS OF MINORITY SHAREHOLDERS .......................................................................................... 122A. Stock Ownership as Personal Property ..................................................... 122B. The Stockholder’s Bundle of Property Rights .......................................... 124

I. Recognition of Ownership .................................................................. 126II. Voice. .................................................................................................. 126III.Information. ......................................................................................... 128IV.Right of Alienation .............................................................................. 128V. Proportional Share in the Profits. ........................................................ 129

VI. RECOGNIZING DUTIES THAT CORPORATIONS OWE TO EVERY SHAREHOLDER ............................................................................................ 130A. Beneficial Nature of Stock Ownership ..................................................... 130

1. Corporation Is a Trustee for the Stockholders .................................... 1302. Rediscovering Corporate Trustee Duties ............................................ 1313. Yeaman v. Galveston City Corp. ......................................................... 132

B. Legal Duties Arising from the Trust Relationship .................................... 1371. Corporate Trustee Duties .................................................................... 137

a. Duty to Acknowledge and Preserve Ownership Rights ............... 138b. Duty of Impartiality ...................................................................... 138c. Duty to Disclose and Account ...................................................... 140

2. Objections to this Analysis ................................................................. 1423. Limited Scope of the Corporate Duties ............................................... 147

VII. DEFINING THE BREACH OF TRUST CAUSE OF ACTION .................... 149A. Corporate Acts of Oppression ................................................................... 149B. Elements of Breach of Trust ..................................................................... 150

1. Intent to Harm the Minority ................................................................ 1502. Impairment of Minority Ownership Rights ........................................ 1513. No Adequate Alternative Remedy ...................................................... 151

C. Remedies for Breach of Trust ................................................................... 1531. Mandatory Injunctions ........................................................................ 1532. Damages .............................................................................................. 1553. Rescission and Restitution .................................................................. 1554. Buy-Out ............................................................................................... 156

D. Other Issues ............................................................................................... 1601. Joint and Several Liability of Controlling Shareholders ..................... 1602. Statute of Limitations .......................................................................... 1613. Burden of Proof ................................................................................... 1624. Business Judgment Rule ..................................................................... 162

VIII. OTHER SHAREHOLDER CAUSES OF ACTION ARISING FROM CORPORATE TRUST DUTIES ..................................................................... 164A. Ultra Vires ................................................................................................. 164

1. Elements .............................................................................................. 1642. Remedies ............................................................................................. 166

B. Fraud in the Purchase of Minority Shares ................................................ 1671. Duty Owed to Minority Shareholders ................................................. 167

2017] TEXAS SHAREHOLDER OPPRESSION AFTER RITCHIE V. RUPE: PART I 49

2. Constructive Fraud Cause of Action ................................................... 1733. Remedy ............................................................................................... 175

C. Accounting ................................................................................................ 177D. Dividend Actions ...................................................................................... 180

1. Suppression of Dividends Claim ......................................................... 180(a) Stockpiling Cash ........................................................................... 181(b) Manipulation ................................................................................ 183(c) Re-examining ARGO Data Res. Corp. v. Shagrithaya ................ 184

2. Challenging “No Dividend” Policy ..................................................... 1903. Defacto Dividends ............................................................................... 1914. Statute of Limitations on Dividend Claims ......................................... 196

IX. CONCLUSION ................................................................................................ 197

I. TEXAS SHAREHOLDER OPPRESSION AFTER RITCHIE V. RUPE: WHAT’S LEFT?

On June 20, 2014, the Texas Supreme Court’s decision in Ritchie v. Rupe1 initiated a seismic shift in Texas law governing the protection of minority shareholders in closely-held corporations and limited liability companies.2 After almost thirty years of steady appellate court development of a judicial remedy for oppressive conduct against minority shareholders, recognizing the trial court’s power to force an oppressive controlling shareholder to purchase the oppressed minority shareholder’s stock for a fair value,3 the Texas Supreme Court suddenly announced that no common law cause of action for oppression existed4 and that Texas courts had no power to order a buy-out under the statutory remedy for oppression.5 Three dissenting Justices accused the majority of “extinguish[ing] meaningful protections for minority shareholders.”6 A host of academic articles7 and continuing legal education papers

1 Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014). 2 The law protecting minority interests in partnerships, both general and limited, is not affected by the decision. 3 See, e.g., Kohannim v. Katoli, 440 S.W.3d 798, 811–13 (Tex. App.—El Paso 2013, pet. denied); Boehringer

v. Konkel, 404 S.W.3d 18, 24 (Tex. App.—Houston [1st Dist.] 2013, no pet.); ARGO Data Res. Corp. v. Shagrithaya, 380 S.W.3d 249, 258 (Tex. App.—Dallas 2012, pet. denied); Cardiac Perfusion Servs. Inc. v. Hughes, 380 S.W.3d 198 (Tex. App.—Dallas 2012), rev’d in part, 436 S.W.3d 790 (Tex. 2014); Ritchie v. Rupe, 339 S.W.3d 275, 280 (Tex. App.—Dallas 2011), rev’d, 443 S.W.3d 856; Redmon v. Griffith, 202 S.W.3d 225, 234 (Tex. App.—Tyler 2006, pet. denied); Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d 687, 699–701 (Tex. App.—Fort Worth 2006, pet. denied); Pinnacle Data Servs., Inc. v. Gillen, 104 S.W.3d 188, 196 (Tex. App.—Texarkana 2003, no pet.); Willis v. Bydalek, 997 S.W.2d 798, 801 (Tex. App.—Houston [1st Dist.] 1999, pet. denied); Davis v. Sheerin, 754 S.W.2d 375, 378 (Tex. App.—Houston [1st Dist.] 1988, writ denied).

4 Ritchie, 443 S.W.3d at 891. 5 Id. at 872. 6 Id. at 893 (Guzman, J., dissenting). 7 See, e.g., Shareholder Litigation, 26 BUS. TORTS REP. 267, 267 (2014) (labeling the Ritchie holding as

“astonishing”); James Dawson, Ritchie v. Rupe and the Future of Shareholder Oppression, 124 YALE L. J. FORUM 89, 90 (Oct. 20, 2014), http://www.yalelawjournal.org/forum/ritchie-v-rupe (arguing that the Supreme Court “gutted the cause of action for shareholder oppression in Texas” and that the opinion was “wrongly decided,” “bad law,” “bad policy,” and is “is likely to disincentivize investment in close corporations, ramp up the frequency of shareholder


from practitioners8 both decried and applauded the demise of the shareholder oppression doctrine. The gloomy assessment: “In the wake of Ritchie, minority shareholders are already having a much tougher time in the courts.”9

What protection is left for Texas minority shareholders? Did the majority opinion in Ritchie v. Rupe declare open season on minority shareholders in Texas? Actually, the answer is quite clearly in the negative. The Supreme Court made clear that quite a bit of protection is left for minority shareholders, and that there are several potential areas that are ripe for development. In the majority opinion, the Supreme Court cataloged the most common tactics that majority shareholders utilize to “squeeze-out” or “freeze-out” minorities.10 The Supreme Court specifically held that “the foreseeability, likelihood, and magnitude of harm sustained by minority shareholders due to the abuse of power by those in control of a closely held corporation is significant, and Texas law should ensure that remedies exist to appropriately address such harm when the underlying actions are wrongful.”11 After an extensive analysis of the adequacy of statutory and common-law remedies already available to oppressed shareholders,12 and the negative policy consequences of creating new duties that do not already exist,13 the Court “decline[d] to recognize a common-law cause of action for ‘shareholder oppression’”14 that would impose new “common-law dut[ies] 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.”15 The Court concluded that existing common-law duties

oppression, and imperil the financial health of many small businesses”); ELIZABETH STONE MILLER & ROBERT A. RAGAZZO, 20 TEXAS PRACTICE SERIES: BUSINESS ORGANIZATIONS § 30:32 (3d ed. 2015) (“As a result of Ritchie, Texas has gone from being one of the jurisdictions most protective of minority shareholder rights in closely held corporations to one of the least protective jurisdictions.”) [hereinafter TEX. PRAC.: BUS. ORGS.]. See also Lyndon Bittle & Kelli Hinson, Texas Turns a Corner: Resolving Shareholder Disputes in Closely Held Businesses After Ritchie v. Rupe, 67 BAYLOR L. REV. 339, 341 (2015), www.baylor.edu/content/services/document.php/253483.pdf (“The Ritchie opinion prompted immediate reactions by parties and commentators, ranging from sighs of relief to dismay and condemnation.”).

8 See, e.g., Ricardo G. Cedillo, Shareholder Oppression in Texas After Ritchie and Sneed, State Bar of Tex. Prof. Dev. Program, Damages in Civil Litigation Course (2016); Elizabeth Stone Miller, The Demise of the Shareholder Oppression Doctrine in Texas: Pursuit of Claims by Minority Shareholders (and LLC Members) After Ritchie v. Rupe, State Bar of Tex. Prof. Dev. Program, Choice & Acquisition of Entities in Texas (2015); Thomas M. Fulkerson & Amy Moss, Drafting Shareholders’ Agreements in a Post-Ritchie v. Rupe World, State Bar of Tex. Prof. Dev. Program, Advanced Business Law Course (2015); Eric T. Stahl, Current Status of Derivative Litigation in Closely Held Corporations and LLCs Post-Sneed and Ritchie, State Bar of Tex., Prof. Dev. Program, Advanced Fiduciary Litigation Program (2015).

9 Dawson, supra note 7, at 94. See also Bittle & Hinson supra note 7, at 411 (“The Texas Supreme Court’s decision in Ritchie v. Rupe altered the landscape of Texas law governing disputes between shareholders in closely held companies.”).

10 See Ritchie, 443 S.W.3d at 879 (listing “(1) denial of access to corporate books and records, (2) withholding payment of, or declining to declare, dividends, (3) termination of a minority shareholder’s employment, (4) misapplication of corporate funds and diversion of corporate opportunities for personal purposes, and (5) manipulation of stock values” as most common squeeze-out techniques).

11 Id. 12 Id. at 879–89. 13 Id. at 889–91. 14 Id. at 891. 15 Id. at 889.


and remedies “are sufficient.”16 The Court expressly recognized that “our conclusion leaves a ‘gap’ in the protection that the law affords to individual minority shareholders,”17 and the Court did “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,”18 nevertheless, for now, minority shareholders must seek the protection of those common-law causes of action that existed prior to the advent of the shareholder oppression doctrine in Texas.

We must take the Supreme Court at its word regarding the state and direction of the law. The majority opinion clearly indicated that the Court is not abandoning the role of the common law in protecting the interests of minority shareholders from oppressive conduct by controlling shareholders. Rather, the Court rejected the “shareholder oppression doctrine” as it had been developed in the appellate courts in favor of the application and development of more traditional approaches utilizing statutory remedies and contractual, tort, and fiduciary causes of action. It would be a fairer, and hopefully more accurate, assessment of the new direction charted by the Supreme Court to conclude that the Court is not abandoning minority shareholders so much as a challenging the bench and bar to address wrongdoing by means of existing, well-established legal concepts instead of seeking to innovate ad hoc remedies.

The purpose of this article is to take a fresh look at Texas law governing corporations in light of the Ritchie v. Rupe opinion and to focus on causes of action and legal duties that long predated the shareholder oppression doctrine, and that should be developed to fill in the gaps left by the Supreme Court’s holding. This article takes up the Supreme Court’s challenge by reexamining two lines of authority that were very well-established in Texas case law prior the advent of the shareholder oppression doctrine and that have been largely neglected after the shareholder oppression cause of action came to dominate this area of the law. Part One of this article analyzes how the shareholder oppression doctrine worked and what exactly are the “gaps” left by the Ritchie decision and then focuses on one line of cases, which had analyzed the legal relationship between shareholder and corporation and recognized that the corporation functions as a sort of trustee to the shareholder and owes quasi-fiduciary duties in connection with the shareholder’s ownership interests. The enforcement of these recognized quasi-fiduciary duties through the court’s equitable powers should, in a proper case, make available to an oppressed minority shareholder effective legal remedies, including the equitable remedy of a court-ordered buy-out. Part Two of this article re-examines the common-law tort cause of action for conversion as Texas courts have applied it to wrongful interference with ownership interests in stock and argues that this well-established cause of action already provides substantial protection to minority shareholders’ interests, that the logical development of the existing case law would extend the stock conversion cause of action to more egregious examples of oppressive conduct, and that the damages remedy for stock conversion is the functional equivalent of a court-ordered buy-out.

16 Id. at 888. 17 Id. at 889. 18 Id. at 890.


II. THE PROBLEM OF OPPRESSION IN CLOSELY-HELD CORPORATIONS

A. Structure of the Corporation

The corporate structure allows the owners of a business to shield themselves from liability for debts incurred by the business, to securitize their ownership, to separate the ownership and control of a business so as to allow the existence of owners who are purely investors and are not required to manage the affairs of the business, and to make the business structure permanent and not subject to the whims of each of the participants. “A principal economic function of corporate organization is separation of ownership from control, so that entrepreneurs need not supply all the capital, and those who supply capital may diversify their investments and need not furnish managerial skills.”19 The corporate structure allows those with operations talent to manage and those with capital perform the investment function.20

A corporation is a separate legal person, distinct from the shareholders.21 As such, the shareholders are the equitable owners of corporate property, but the corporation is the legal owner.22 Shareholders do not directly control the corporation; rather, corporations are managed by directors, who are elected by the shareholders.23 Because ownership is divided into multiple shares, except in situations where one person owns all of the shares or two persons own equal number of shares, it is a mathematical certainty that there will always be at least one person with a minority ownership interest in the corporation.

Directors are elected by the holders of a majority of the shares of the corporation and may be removed at any time, with or without cause, by a vote of the majority of the shares of the company.24 Therefore, whoever controls the majority of the shares, controls who runs the company.25 A shareholder may only own 51% of the shares, but because of the doctrine of

19 Hoagland ex rel. Midwest Transit, Inc. v. Sandberg, Phoenix & von Gontard, P.C., 385 F.3d 737, 747 (7th

Cir. 2004). 20 TEX. PRAC.: BUS. ORGS., supra note 7, at § 30:1. 21 See Graham v. La Crosse & M.R. Co., 102 U.S. 148, 160–61 (1880) (“A corporation is a distinct entity. Its

affairs are necessarily managed by officers and agents, it is true; but, in law, it is as distinct a being as an individual is, and is entitled to hold property (if not contrary to its charter) as absolutely as an individual can hold it.”); Trustees of Dartmouth Coll. v. Woodward, 17 U.S. 518, 636 (1819) (“A corporation is an artificial being, invisible, intangible, and existing only in contemplation of law.”); TransPecos Banks v. Strobach, No. 08-14-00059-CV, 2016 WL 1169139, at *4 (Tex. App.—El Paso Mar. 23, 2016, pet. filed) (“A corporation is a separate legal entity from its shareholders, officers, and directors.”).

22 Sneed v. Webre, 465 S.W.3d 169, 191 (Tex. 2015); Humble Oil & Ref. Co. v. Blankenburg, 235 S.W.2d 891, 894 (Tex. 1951); Aransas Pass Harbor Co. v. Manning, 63 S.W. 627, 629 (Tex. 1901).

23 See TEX. BUS. ORGS. CODE ANN. § 21.401(a)(2) (West 2013) (“The board of directors of a corporation shall . . . direct the management of the business and affairs of the corporation.”). See TEX. PRAC.: BUS. ORGS., supra note 7, at § 30:1 (“Shareholders elect directors who then have the responsibility for managing the corporation’s affairs. Once the directors are elected, shareholders have little say in management other than to vote on certain fundamental transactions.”); id. § 30:2 (“A shareholder, as such, has little right to participate in management, save the right to elect directors, and vote on fundamental transactions.”).

24 BUS. ORGS. §§ 21.301–.303, 21.405, 21.409. 25 D. Moll, Shareholder Oppression in Texas Close Corporations: Majority Rule (Still) Isn’t What It Used to

Be, 9 Hous. BUS. & TAX L. J. 33, 35 (2008), www.hbtlj.org/v09p1/v09p1mollar.pdf.


majority rule, that shareholder can place himself in 100% control of 100% of the corporate assets.26

The traditional attributes of corporate personhood, centralized management, perpetual existence, limited liability, and free transferability of ownership interests, work well for large, public organizations with numerous owners and are largely responsible for the popularity and growth of the corporate form among large entities.27

B. Distinguishing Ownership in Closely-Held Corporations

A “closely-held” corporation is owned by a small number of shareholders whose shares are not publicly traded.28 Closely-held corporations are typically characterized by substantial shareholder participation in the running and management of the corporation.29 Sections 21.701 through 21.732 of the Texas Business Organizations Code provide special provisions and duties for “close corporations”;30 however, these statutory provisions apply only to corporations that elect to be statutory close corporations,31 and very few do so. Therefore, the law applicable to almost all Texas corporations makes no distinction between large publicly-held and small closely-held corporations, even though the risks and benefits of stock ownership are vastly different as between those two types of organizations.

In public corporations, shareholders generally own stock with essentially no involvement in the business and management of the corporation. Shareholders participate in the financial success of the business both by receipt of dividends and increased market value of their shares, while taking absolutely no risk from their ownership of the business other than the loss of the price initially paid for their shares.32 In public corporations, with a broad and diverse shareholder base, the principles of centralized control and majority rule rarely present a

26 TEX. PRAC.: BUS. ORGS., supra note 7, at § 30:1 (“Because directors are elected by shareholder vote, the

board of a close corporation is typically controlled by the shareholder (or shareholders) holding a majority of the voting power.”).

27

The traditional attributes of corporate status are: centralized management; perpetual existence; limited liability; and free transferability of ownership interests. Each of these corporate attributes is positive in the context of the public corporation. Indeed, these attributes are largely responsible for the popularity and growth of the corporate form among large entities. . . . However, as described in the next section, these attributes of corporate existence pose substantial problems, and may operate to defeat expectations, in the close corporation (i.e., a corporation with a small number of shareholders and no public market for shares).

Id. 28 Ritchie v. Rupe, 443 S.W.3d 856, 878 (Tex. 2014). 29 Moll, Shareholder Oppression in Texas, supra note 25, at 34. 30 TEX. BUS. ORGS. CODE ANN. §§ 21.701–.732 (West 2015). 31 Id. §§ 21.702(a), 21.705. 32 See Moll, Shareholder Oppression in Texas, supra note 25, at 34 (“In the traditional public corporation, a

shareholder is normally a ‘passive’ investor who neither contributes labor to the corporation nor takes part in management responsibilities. A shareholder in a public corporation simply invests money and hopes to receive a return on that money through capital appreciation and/or dividend payments.”); Exadaktilos v. Cinnaminson Realty Co., 400 A.2d 554, 560 (N.J. Super. Ct. Law Div. 1979) (“Large corporations are usually formed as a means of attracting capital through the sale of stock to investors, with no expectation of participation in corporate management or employment. Profit is expected through the payment of dividends or sale of stock at an appreciated value.”).


significant opportunity for abuse of an individual minority shareholder. Furthermore, shareholders of public companies are also protected by a web of regulations requiring disclosure and financial controls imposed by state and federal law and by the stock exchanges on which the shares are traded. However, the vast majority of corporations in this country are not large public organizations, but are so-called “closely-held corporations,” which are largely unregulated, and in which the dynamics of management–owner interaction are very different.33

There are three practical differences between being a shareholder in a public corporation and in a closely-held corporation. First, as a much smaller enterprise, a closely-held corporation is much less likely to be able to afford independent, professional management and is much more likely to be operated and managed by some or all of its owners. 34 This situation creates inherent conflicts of interest among individual shareholders to a far greater extent than in a public corporation. In a closely-held corporation, those stockholders acting as officers and directors would be in a position to manage the enterprise so as to obtain a disproportionate share of the benefits of ownership, to the detriment of the other shareholders.35 Also, the fact that the shareholders are operating the business means that closely-held corporations may distribute profits as wages in addition to or instead of dividends. Second, public corporations with a large and diverse population of shareholders rarely have a shareholder in a position of majority control. The opposite is true for closely-held corporations. Again, the presence of majority control creates the opportunity and temptation to use that control to obtain a disproportionate share of the benefits of ownership. Finally, and most importantly, there is no public market for the shares of a closely-held corporation. Regardless of how valuable an ownership interest in a closely-held corporation might be in the abstract, a minority shareholder is not able to sell it, generally at all, and certainly not at anything approaching its full value. This situation means that capital appreciation is rarely an investment objective of a shareholder in a closely-held corporation, as there is no way to monetize it.36 A sale of the entire company can happen, but that scenario is generally a long time off and cannot be counted on by a minority shareholder as an exit strategy. A shareholder in a public corporation, however, can cash in on capital appreciation at any time by selling in the public markets and can also cut his losses and walk away from the investment if he becomes dissatisfied with management.37 A minority shareholder in a closely-held corporation is trapped if the

33 Moll, Shareholder Oppression in Texas, supra note 25 (“Conventional corporate law norms of majority rule and centralized control can lead to serious problems for the close corporation minority shareholder.”).

34 Id. at 34–35 (“A shareholder in a public corporation simply invests money and hopes to receive a return on that money through capital appreciation and/or dividend payments. By contrast, in a close corporation, a shareholder typically expects an active participatory role in the company, usually through employment and a meaningful role in management.”). See also Donahue v. Rodd Electrotype Co., 328 N.E.2d 505, 512 (Mass. 1975) (“Many close corporations are really partnerships, between two or three people who contribute their capital, skills, experience and labor.”).

35 See TEX. PRAC.: BUS. ORGS., supra note 7, at § 30:2 (“In a public corporation, there is always a danger that directors will act to benefit themselves at the expense of shareholders generally. In a close corporation, the danger is that a majority shareholder or group will act to benefit themselves at the expense of minority shareholders.”).

36 Moll, Shareholder Oppression in Texas, supra note 25, at 35 (“A shareholder in a close corporation also invests money in the venture and, like all shareholders, he hopes to receive a return on that money. Because there is no active market for the company’s shares, however, any financial return is normally provided by employment compensation and dividends, rather than by sales of stock at an appreciated value.”).

37 Id. at 38 (“In a public corporation, a minority shareholder can escape abusive majority conduct by selling his shares into the market and by correspondingly recovering the value of his investment. This ability to liquidate provides


shareholders in control of the company succumb to the temptation to take his share of the profits, to deny him a voice, to ignore his requests for information, or to effectively (or actually) render him a non-owner.38 Conduct by the majority aimed at rendering a fellow shareholder effectively a non-owner might or might not be coupled with an effort to purchase his shares at a fraction of his proportional share of the value of the enterprise. This injury to the minority shareholder in a closely-held corporation, involving the loss or impairment or some or all of the privileges and benefits of owning a company, is what has been termed in modern jurisprudence as “shareholder oppression.”

C. Oppressive Conduct in Closely-Held Corporations

A wielding of this power by any group controlling a corporation may serve to destroy a stockholder’s vital interests and expectations. As the stock of closely-held corporations generally is not readily salable, a minority shareholder at odds with management policies may be without either a voice in protecting his or her interests or any reasonable means of withdrawing his or her investment.39

The corporation is ultimately subject to the control of the owner(s) of a majority of its shares; therefore, any person, family, or group of individuals controlling the majority of the shares, as a practical matter, exercises total power over the corporation. These majority shareholders almost always vote themselves and persons strongly aligned with them to all or most of the positions on the board of directors.40 In closely-held corporations, where the number of shares and shareholders is small, the existence of a single person or a small, strongly aligned group of persons, owning or controlling a majority of the shares is the norm. Minority shareholders in these corporations are not able to elect officers or directors to protect their interests, and they are not able to prevail on any matter submitted to a vote of the shareholders, and thus have only that amount of influence over the corporation which the majority permits.

Because of the close involvement and personal relationships among the small groups of shareholders of closely-held corporations,41 the opportunities are greatly increased for interpersonal conflict to arise among the shareholders or between management and particular shareholders. As the Supreme Court noted in Ritchie v. Rupe: “Occasionally, things don’t work out as planned: shareholders die, businesses struggle, relationships change, and disputes arise. When, as in this case, there is no shareholders’ agreement, minority shareholders who lack both contractual rights and voting power may have no control over how those disputes are resolved.”42 Because of the absence of a market in which to sell the shares, these shareholders are “locked-in” and vulnerable to a variety of types of misconduct designed to “squeeze” them

some protection to investors in public corporations from the conduct of those in control.”). 38 Id. at 38–39 (“In a close corporation, however, the minority shareholder’s investment is effectively trapped,

as there is no ready market for the stock of a close corporation. Thus, close corporation shareholders can be ‘locked-in’ to the company, yet ‘frozen-out’ from any business returns.”).

39 Matter of Kemp & Beatley, Inc., 473 N.E.2d 1173, 1179 (N.Y. 1984). 40 See Douglas Moll, Majority Rule Isn’t What It Used To Be: Shareholder Oppression in Texas Close

Corporations, 63 TEX. B.J. 434, 436 & n.4 (2000). 41 Id. at 436. 42 Ritchie v. Rupe, 443 S.W.3d 856, 878–79 (Tex. 2014).


out (that is, to force them to sell at an unfairly low price) or to “freeze” them out (that is, to render their share ownership meaningless).43

Minority shareholders may protect themselves contractually. “Shareholders of closely-held corporations may address and resolve such difficulties by entering into shareholder agreements that contain buy-sell, first refusal, or redemption provisions that reflect their mutual expectations and agreements.”44 Such agreements may define respective management and voting powers, the apportionment of losses and profits, the payment of dividends, and shareholders’ rights to buy or sell shares from or to each other, the corporation, or an outside party.45 However, shareholder agreements are relatively rare, and truly fair and comprehensive ones that solve future problems not anticipated at the founding of the company are rarer still. The dissenting opinion in Ritchie aptly noted: “[f]rom a relational standpoint, people enter closely-held businesses in the same manner as they enter marriage: optimistically and ill-prepared.”46 Owners of closely-held corporations are frequently linked by family or personal relationships, usually trust each other, and often regard such contractual protection as unnecessary.47

Controlling shareholders are in a position to abuse their power over minority shareholders by reducing or eliminating any economic benefits of ownership to the minority, by systematically violating the rights associated with share ownership, and otherwise by defeating the normal expectations of shareholders relating to the ownership of their shares. This conduct takes many forms and appears in many different factual situations. When times are good and the corporation is growing, the majority may act to appropriate a greater portion of the economic benefits to themselves at the minority’s expense. When times are bad, the majority may act to preserve for themselves a greater piece of the shrinking pie at the expense of the minority. At any time, the majority may wish to get rid of minority ownership positions. The actions of the majority may be motivated by greed or by a perception (valid or not) that the minority owner is not contributing. Often, the motivation for oppressive conduct stems from personal conflict among the majority and minority shareholders.

Such oppressive conduct may act to “squeeze out”48 a minority shareholder, forcing that shareholder to leave the corporation and sell his shares usually at an unfairly low price, or to “freeze out”49 the minority shareholder by structuring corporate governance and distribution of economic benefits so as to render the minority shareholder’s ownership essentially irrelevant. In either a freeze-out scenario or a squeeze-out attempt, the majority typically cuts off the minority shareholders from information about the corporation and from any participation in management. The majority will frequently manipulate the finances of the corporation so that profits are not distributed as dividends but rather are diverted to the majority through excessive

43 See Moll, Shareholder Oppression in Texas, supra note 25, at 36. 44 Ritchie, 443 S.W.3d at 871. 45 Id. at 878. 46 Id. at 894 (Guzman, J., dissenting) (quoting Charles W. Murdock, The Evolution of Effective Remedies for

Minority Shareholders and Its Impact Upon Valuation of Minority Shares, 65 NOTRE DAME L. REV. 425, 426 (1990)). 47 Douglas K. Moll, Minority Oppression & the Limited Liability Company: Learning (or Not) from Close

Corporation History, 40 WAKE FOREST L. REV. 883, 912 (2005). 48 Ritchie, 443 S.W.3d at 894 (Guzman, J., dissenting). 49 Id.


salaries, bonuses, or other personal benefits. When all of the shareholders work in the corporation and all corporate profits are paid out as salary and personal benefits, the majority will often terminate the minority shareholder’s employment (and thus cut off all economic benefits from stock ownership).50 The Supreme Court acknowledged that minority shareholders in closely-held corporations have no statutory right to exit the venture and receive a return of capital like partners in a partnership do, and usually have no ability to sell their shares like shareholders in a publicly-held corporation do; thus, if they fail to contract for shareholder rights in advance of difficulties, they will be uniquely vulnerable to potential abuse by a controlling shareholder or group.51 “Unhappy with the situation and unable to change it, [minority shareholders] are often unable to extract themselves from the business relationship, at least without financial loss.”52

Without legal protection, minority share ownership in a closely-held corporation can become essentially a joke—in other words: “There are 51 shares . . . . . that are worth $250,000. There are 49 shares that are not worth a ____.”53 The Texas Supreme Court acknowledged: “Closely-held corporations have unique attributes that may justify different protections under the law.”54 Prior to Ritchie, Texas courts had come to recognize that they must “take an especially broad view of the application of oppressive conduct to a closely-held corporation, where oppression may more easily be found,” and must use their equitable powers to protect the minority shareholders who find themselves on the receiving end of a “squeeze out” and do not have a ready market for their shares.55 The majority opinion in Ritchie clearly acknowledged:

Our review of the case law and other authorities also convinces us that it is both foreseeable and likely that some directors and majority shareholders of closely-held corporations will engage in such actions with a meaningful degree of frequency and that minority shareholders typically will suffer some injury as a result. Although the injury is usually merely economic in nature, it can be quite substantial from the minority shareholder’s perspective, as it often completely undermines their sole or primary motivation for engaging with the business. We thus conclude that the foreseeability, likelihood, and magnitude of harm sustained by minority shareholders due to the abuse of power by those in control of a closely-held corporation is significant, and Texas law should ensure that remedies exist to appropriately address such harm when the underlying actions are wrongful.56

50 See generally Moll, Shareholder Oppression in Texas, supra note 25, at 35–39 (distinguishing minority

shareholder status in close corporation from publicly held corporation). 51 Ritchie, 443 S.W.3d at 879. 52 Id. 53 Humphrys v. Winous Co., 133 N.E.2d 780, 783 (Ohio 1956). 54 Ritchie, 443 S.W.3d at 864 n.8. 55 Davis v. Sheerin, 754 S.W.2d 375, 381 (Tex. App.—Houston [1st Dist.] 1988, writ denied). 56 Ritchie, 443 S.W.3d at 879.


III. RISE AND FALL OF THE SHAREHOLDER OPPRESSION DOCTRINE

A. The Shareholder Oppression Doctrine—R.I.P.

1. The “Oppression Statute”

The term “oppression” in recent Texas case law was imported from the statute providing for the appointment of a receiver for rehabilitation of corporations, now codified at Section 11.404(a)(1)(C) of the Texas Business Organizations Code,57 which permits a district court to appoint a receiver at the request of an individual shareholder upon a showing that “the actions of the governing persons of the entity are illegal, oppressive or fraudulent.”58 Prior to Ritchie, very little case law existed interpreting this statute.

2. Advent of a New Legal Theory

In the 1980s, Texas courts began drawing on case law and statutory developments in other jurisdictions to fashion a new cause of action for “shareholder oppression.”59 Prior to Ritchie, the Texas Supreme Court never ruled on the existence of the cause of action, but ten of the fourteen Texas courts of appeals recognized shareholder oppression as an independent cause of action and none held to the contrary.60 In Willis v. Donnelly, the Texas Supreme Court had

57 The dissenting opinion in Ritchie repeatedly refers to Texas Business Organizations Code Section 11.404 as

the “Oppression Statute.” See id. at 893, 897–98 (Guzman, J., dissenting). The majority correctly takes the dissent to task for this characterization of the receivership provision: “We note that what the dissent calls ‘the oppression statute,’ the Legislature refers to as a rehabilitative receivership statute, only one prong of which includes oppression as one of three types of conduct addressed in that prong.” Id. at 889 n.57.

58 TEX. BUS. ORGS. CODE ANN. § 11.404(a)(1)(C) (West 2011). 59 This article attempts only a brief survey of the development of the shareholder oppression doctrine in Texas,

focusing primarily on the first and last significant appellate opinions and the Ritchie decision. For a much deeper historical analysis, see Bittle & Hinson, supra note 7, at 351–86.

60 First Court of Appeals, Houston: Boehringer v. Konkel, 404 S.W.3d 18 (Tex. App.—Houston [1st Dist.] 2013, no pet.); Allen v. Devon Energy Holdings, L.L.C., 367 S.W.3d 355 (Tex. App.—Houston [1st Dist.] 2012, pet. granted, judgm’t vacated w.r.m.); Joseph v. Koshy, No. 01-98-01432-CV, 2000 WL 124685, at *4 (Tex. App.—Houston [1st Dist.] Feb. 3, 2000, no pet.) (mem. op., not designated for publication); Willis v. Bydalek, 997 S.W.2d 798, 801 (Tex. App.—Houston [1st Dist.] 1999, pet. denied); Advance Marine, Inc. v. Kelley, No. 01-90-00645-CV, 1991 WL 114463, at *2 (Tex. App.—Houston [1st Dist.] June 27, 1991, no pet.) (mem. op., not designated for publication); Davis v. Sheerin, 754 S.W.2d 375, 383 (Tex. App.—Houston [1st Dist] 1988, writ denied). Second Court of Appeals, Fort Worth: Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d 687 (Tex. App.—Fort Worth 2006, pet. denied); Duncan v. Lichtenberger, 671 S.W.2d 948 (Tex. App.—Fort Worth 1984, writ ref’d n.r.e.). Fourth Court of Appeals, San Antonio: Chapa v. Chapa, No. 04-12-00519-CV, 2012 WL 6728242, at *5 (Tex. App.—San Antonio Dec. 28, 2012, no pet.) (holding that appointment of a receiver was proper in a shareholder oppression case); Guerra v. Guerra, No. 04-10-00271-CV, 2011 WL 3715051, at *6 (Tex. App.—San Antonio Aug. 24, 2011, no pet.) (mem. op). Fifth Court of Appeals, Dallas: ARGO Data Res. Corp. v. Shagrithaya, 380 S.W.3d 249 (Tex. App.—Dallas 2012, pet. filed); Cardiac Perfusion Servs., Inc. v. Hughes, 380 S.W.3d 198 (Tex. App.—Dallas 2012, pet. denied); Ritchie v. Rupe 339 S.W.3d 275, 285 (Tex. App.—Dallas 2011), rev’d, 443 S.W.3d 856. Sixth Court of Appeals, Texarkana: Pinnacle Data Servs., Inc. v. Gillen, 104 S.W.3d 188, 192 (Tex. App.—Texarkana 2003, no pet.). Seventh Court of Appeals, Amarillo: In re Trockman, No. 07-11-0364-CV, 2011 WL 554999 (Tex. App.—Amarillo


assumed “without deciding” that such a cause of action existed.61 These cases applied a new cause of action and a new equitable remedy to situations in which a majority shareholder uses his power over the corporation to the significant disadvantage of a minority shareholder. For purposes of illustration, we will examine the first and last significant decisions rendered under the shareholder oppression doctrine.

(a) Davis v. Sheerin

The Houston case of Davis v. Sheerin62 was the first Texas case to recognize and attempt a systematic formulation of a shareholder oppression cause of action. This opinion was acknowledged by the Supreme Court as the “seminal” Texas authority on shareholder oppression.63 One commentator has praised the Davis case as not only significant in Texas jurisprudence, but also as both influencing case law development in a number of other states64 and as having “earned a prime place in black-letter corporations law.”65

(1) Facts

In Davis v. Sheerin, a Texas corporation, W.H. Davis Co., was formed in 1955 and was owned by two shareholders, William Davis, 55%, and James Sheerin, 45%.66 Both Davis and Sheerin, together with Davis’s wife Catherine, were directors and officers; however, Davis was the president and managed the day-to-day running of the company, while Sheerin was involved as an investor only and did not work in the company. In 1985, Sheerin sued William and Catherine Davis claiming shareholder oppression. Sheerin sued both in his individual capacity

Feb. 21, 2012, orig. proceeding) (mem. op.). Eighth Court of Appeals, El Paso: Gonzalez v. Greyhound Lines, Inc., 181 S.W.3d 386, 392 n.5 (Tex. App.—El Paso 2005, no pet.). Twelfth Court of Appeals, Tyler: Redmon v. Griffith, 202 S.W.3d 225 (Tex. App.—Tyler 2006, pet. denied). Thirteenth Court of Appeals, Corpus Christi-Edinburg: Gibney v. Culver, No. 13-06-112-CV, 2008 WL 1822767 (Tex. App.—Corpus Christi April 24, 2008, pet. denied) (mem. op.); DeBord v. Circle Y of Yoakum, Inc., 951 S.W.2d 127, 133 (Tex. App.—Corpus Christi 1997), rev’d on other grounds sub nom., Stary v. DeBord, 967 S.W.2d 352 (Tex. 1998). Fourteenth Court of Appeals, Houston: Willis v. Donnelly, 118 S.W.3d 10, 34 (Tex. App.—Houston [14th Dist.] 2003), rev’d on other grounds, 199 S.W.3d 262 (Tex. 2006); Allchin v. Chemic, Inc., No. 14-01-00433-CV, 2002 WL 1608616, at *7 (Tex. App.—Houston [14th Dist.] July 18, 2002, no pet.) (mem. op., not designated for publication); Christians v. Stafford, No. 14-99-00038-CV, 2000 WL 1591000, at *2 (Tex. App.—Houston [14th Dist.] Oct. 26, 2000, no pet.) (mem. op., not designated for publication); Hoggett v. Brown, 971 S.W.2d 472, 488 n.13 (Tex. App.—Houston [14th Dist.] 1997, pet. denied); Alexander v. Sturkie, 909 S.W.2d 166, 170 n.2 (Tex. App.—Houston [14th Dist.] 1995, writ denied).

61 Willis, 199 S.W.3d at 277. 62 Davis, 754 S.W.2d 375. 63 Ritchie, 443 S.W.3d at 865. 64 See Dawson, supra note 7, at 89 (citing Baur v. Baur Farms, Inc., 780 N.W.2d 249 (Iowa Ct. App. 2010);

Bedore v. Familian, 125 P.3d 1168, 1172 n.20 (Nev. 2006); Lien v. Lien, 2004 S.D. 8, ¶ 30, 674 N.W.2d 816, 825 (S.D. 2004)).

65 Id. (citing ROBERT W. HAMILTON & JONATHAN R. MACEY, CASES AND MATERIALS ON CORPORATIONS, INCLUDING PARTNERSHIPS AND LIMITED LIABILITY COMPANIES, 500–07 (9th ed. 2005)).

66 Davis, 754 S.W.2d at 377.


and derivatively on behalf of the corporation67—although the appellate opinion does not indicate that the corporation was a party.68 The suit was filed initially because Davis refused to allow Sheerin to inspect the books and records of the corporation, claiming that Sheerin was not a shareholder.69

Davis claimed that Sheerin had relinquished his stockholdings in the 1960s as a gift to the Davises and refused to allow Sheerin to inspect corporate books unless he could produce a share certificate.70 The jury found that Sheerin did not make a gift of his stock to Davis and his wife, did not represent that he would do so, and did not agree to do so in the future.71 Additionally, the appellate court noted other undisputed evidence that the records of the corporation and tax returns continued to list Sheerin as a 45% shareholder well after the date of the alleged gift and that Davis and his son had made several attempts to purchase Sheerin’s shares during the 1970s and ‘80s.72 The jury found (1) that Davis and his wife had conspired to deprive Sheerin of his stock ownership in the corporation; (2) that Davis and his wife willfully breached fiduciary duties to the corporation by receiving “informal dividends” through contributions to a profit sharing plan for their benefit and to the exclusion of Sheerin; (3) that Davis and his wife willfully breached fiduciary duties by “wast[ing] corporate funds for payment of their legal fees in the dispute”; however the jury also found (4) that Davis and his wife did not convert Sheerin’s stock; (5) that Davis and his wife were not paid excessive compensation; (6) that Davis and his wife did not maliciously suppress dividends; (7) that Davis and his wife did not breach fiduciary duties by having the corporation make a variety of purchases and investments that Sheerin argued were improper; and (8) that Davis and his wife did not conspire to breach fiduciary duties.73 The jury also found that the conspiracy to deprive Sheerin of his share ownership was not a proximate cause of any damages.74 Finally, the jury found that the “fair value” of Sheerin’s stock was $550,000.75 Furthermore, the appellate court noted as significant the undisputed facts that the corporation’s attorney had written in 1979 that Davis’ wish to avoid payment of dividends might be characterized as a fraudulent effort to

67 Id. 68 Ordinarily, the corporation is a necessary party to a derivative suit. See Barthold v. Thomas, 210 S.W. 506,

507–08 (Tex. Comm’n App.1919, holding approved, judgm’t adopted); Providential Inv. Corp. v. Dibrell, 320 S.W.2d 415, 418 (Tex. Civ. App.—Houston 1959, no writ). See also Ross v. Bernhard, 396 U.S. 531, 538 (1970) (“A corporation is a necessary party in a derivative suit. The corporation is a necessary party to the action; without it the case cannot proceed.”).

69 Davis, 754 S.W.2d at 377. The lawsuit also involved claims arising from a separate real estate partnership, but those claims are not relevant to this discussion.

70 Id. The appellate opinion does not give any further explanation. Presumably, Davis knew that Sheerin could not produce a share certificate proving his share ownership. Given Davis’s theory of the case, the intended inference is that Sheerin gave Davis the share certificate in the 1960s when he allegedly made a gift of his ownership interest. However, if that were the case, one would expect that the endorsed share certificate would have been a key piece of evidence relied on by Davis at trial and would have warranted further comment in the opinion. More likely, Davis knew Sheerin could not produce a share certificate because no certificates had ever been issued, which is the almost universal practice in small, informally-organized corporations—and which makes Davis’s demand for a share certificate all the more evidence of his bad faith.

71 Id. at 382. 72 Id. 73 Id. 74 Id. at 381. 75 Id. at 378. Sheerin did not challenge this finding on appeal. Id. at 383.


deny a shareholder his dividends and that, shortly after the filing of the lawsuit, Davis and his wife held a meeting of the board of directors at which they noted in the minutes that “Mr. Sheerin’s opinions or actions would have no effect on the Board’s deliberations.”76

On the basis of these findings and the undisputed portions of the evidence, the Houston trial court entered a judgment that included the following relief: 77 (1) a declaratory judgment that Sheerin owned 45% of the stock in the corporation; (2) an order that Davis and his wife “buy out” Sheerin’s stock for the “fair value” of $550,000, as determined by the jury; (3) the appointment of a receiver for the corporation;78 (4) an injunction against contributions to the profit sharing plan unless a proportionate sum was paid to Sheerin; (5) a mandatory injunction for payment of dividends in the future; (6) award of damages to Sheerin individually for the informal dividends paid in the past by profit sharing contributions; (7) an award of costs incurred by Sheerin in enforcing his inspection rights ; and (8) an award of damages to Sheerin, on behalf of the corporation, for the amount the corporation paid for Davis’ attorney’s fees.79

(2) Holdings

On appeal, Davis challenged the buy-out order, the appointment of the receiver, and the order to pay dividends, but did not challenge the declaration of share ownership or the valuation.80 The First Court of Appeals affirmed the buy-out order,81 and the appointment of a receiver,82 but reversed the mandatory injunction to pay dividends.83

The principal issue on appeal was whether the buy-out remedy was available under Texas law. The plaintiff contended that the defendants should be ordered to purchase the plaintiff’s shares because the defendants had committed “oppression” against the plaintiff. At the time, Article 7.05(a)(1)(c) of the Texas Business Corporation Act (now Texas Business Organizations Code § 11.404(a)(1)(C)) provided that a court may appoint a receiver for the

76 Id. at 382. 77 Id. at 378. 78 The appointment of the receiver, the injunction against future preferential dividends, and the mandatory

injunction for the future payment of dividends are all seemingly at odds with the buy-out order. If Sheerin is going to be bought out, then the receiver would be unnecessary and the other relief would be meaningless. The court of appeals assumes that these portions of the judgment would apply only until “the ‘buy-out’ was completed and the damages paid.” Id. at 384. “We further note that appellants may avoid the necessity of the appointment of the receiver by immediate compliance with the court’s ‘buy-out’ order and payment of the damages awarded.” Id. See also id. (same reasoning with respect to the injunction against preferential informal dividends “as long as plaintiff remains a shareholder”); id. at 388 (Evans, J., concurring) (reasoning that the mandatory injunction on payment of dividends would be “as long as the appellee remains a shareholder”).

79 The award of attorney’s fees is somewhat unclear. The court of appeals’ opinion states that Sheerin received “an award of $192,600 to appellee, on behalf of the corporation, for recovery of corporate funds used for appellants’ attorney’s fees.” Id. at 378. This award was clearly on Sheerin’s derivative claim, and presumably the $192,600 is 45% of the gross amount misappropriated to which Sheerin would be entitled to receive as his proportionate share of the derivative claim.

80 Id. at 378. 81 Id. at 383. 82 Id. at 384. 83 Id. at 385.


assets and business of a corporation to conserve the assets and avoid damage to the parties (also to conduct an orderly liquidation under article 7.06), “but only if all other requirements of law are complied with and if all other remedies available either at law or in equity . . . are determined by the court to be inadequate and only in [certain specific] instances,” one of which is an action by a shareholder establishing “that the acts of the directors or those in control of the corporation are illegal, oppressive, or fraudulent.”

The First Court of Appeals noted that “oppressive” conduct is prohibited by Article 7.05(a)(1)(c) of the Texas Business Corporations Act, but that the only statutory remedy was the appointment of a receiver.84 The court also noted that no Texas case had ever ordered the remedy of a “buy-out,” but the court reasoned, based on authority in other jurisdictions85 and on the holding of the Texas Supreme Court in Patton v. Nicholas86 that the court had the inherent equitable power to fashion a remedy for oppressive conduct, other than receivership or liquidation.87 Therefore, court held that “Texas courts, under their general equity power, may decree a ‘buy-out’ in an appropriate case where less harsh remedies are inadequate to protect the rights of the parties.”88

Next the court discussed what constituted oppressive conduct. The court noted that neither Texas statutory nor common law provided a definition of “oppression.”89 Therefore, the court examined authority from other jurisdictions and adopted two different (but complimentary) definitions: First, “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,”90 and second, “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.”91

The court held that the record clearly substantiated a finding of oppression, notwithstanding “the absence of some of the typical ‘squeeze out’ techniques used in closely-

84 Id. at 378. 85 Id. at 379 (citing Alaska Plastics, Inc. v. Coppock, 621 P.2d 270, 276–77 (Alaska 1980); Sauer v. Moffitt,

363 N.W.2d 269, 275 (Iowa Ct. App. 1984); McCauley v. Tom McCauley & Son, Inc., 724 P.2d 232, 244 (N.M. Ct. App.1986) (granting the option of liquidation or “buy-out”); In re Wiedy’s Furniture Clearance Center Co., 487 N.Y.S.2d 901, 904 (N.Y. App. Div. 1985); Delaney v. Georgia-Pacific Corp., 564 P.2d 277, 289 (Or. 1977)). The Davis Court also looked to statutes providing for a buy-out remedy. Id. (citing ALASKA STAT. § 10.05.540(2) (1985); CAL. CORP. CODE § 2000 (West Supp.1988); CONN. GEN. STAT. ANN § 33-384 (West 1987); ILL. REV. STAT. ch. 32, para. 12.55 (Supp. 1988); IOWA CODE § 496A.94 (Supp. 1988); MINN. STAT. ANN. § 302A.751 (West 1985); N.M. STAT. ANN. § 53-16-16 (West Supp. 1987); N.Y. BUS. CORP. LAW § 1104-a (McKinney 1986); N.C. GEN. STAT. § 55-125.1 (1982); OR. REV. STAT. § 57.595 (1983); S.C. CODE ANN. § 33-21-155 (1987); W. VA. CODE § 31-1-134 (1988)).

86 279 S.W.2d 848, 857 (Tex. 1955). 87 Davis, 754 S.W.2d at 379. 88 Id. at 380. 89 Id. at 381. 90 Id. (citing In re Wiedy’s, 487 N.Y.S.2d at 903). 91 Id. at 382 (citing Baker v. Com. Body Builders, Inc., 507 P.2d 387 (Ore. 1973)).


held corporations, e.g., no malicious suppression of dividends or excessive salaries.”92 The Davis court stated that “conspiring to deprive one of his ownership of stock in a corporation, especially when the corporate records clearly indicate such ownership . . . not only would substantially defeat any reasonable expectations appellee may have had, . . . but would totally extinguish any such expectations.”93 Significantly, the court held that the oppressive conduct need not be the proximate cause of any damages,94 and that oppressive conduct did not fall under the protection of the business judgment rule.95

(3) Defining the shareholder oppression cause of action

The court of appeals’ opinion in Davis v. Sheerin did a remarkably good job in defining a new cause of action for shareholder oppression. The duty violated was purely statutory and arose from the prohibition in article 7.05(a)(1)(c) of the Texas Business Corporations Act96 against “oppressive” acts by “directors or those in control of the corporation.”97 This was a duty owed by the controlling shareholder directly to the minority shareholder, and a claim for violation of that duty was a claim brought directly by the shareholder in his individual capacity. In order to prove a violation of the duty not to act oppressively, the shareholder was required to prove acts that either (1) “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,”98 or (2) are “‘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 an violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely.’”99 These alternative definitions were meant to be “expansive” and “to cover a multitude of situations dealing with improper conduct.”100 “Oppressive” conduct included denial of share ownership, the denial of a voice in corporate affairs, and willful breaches of fiduciary duties to the corporation,101 together with more “typical ‘squeeze-out’ techniques used in closely -held corporations, e.g., [. . .] malicious suppression of dividends or excessive salaries.”102 The existence of oppressive acts was a jury question,103 but whether those acts constituted a violation of the duty not to oppress was a question of law for the court, and no jury question on oppression was to be submitted.104

The remedy for violation of the duty was either appointment of a receiver pursuant to the

92 Id. at 382–83. 93 Id. at 382. 94 Id. at 381. 95 Id. at 383. 96 TEX. BUS. ORGS. CODE ANN. § 11.404(a)(1)(C) (West 2011). 97 Davis, 754 S.W.2d at 381 (Article 7.05 of the Texas Business Corporations Act “provides a cause of action

based on oppressive conduct”). 98 Id. 99 Id. at 382. 100 Id. at 381. 101 Id. at 383 102 Id. at 382. 103 Id. at 380. 104 Id. at 381.


statute or a lesser equitable remedy crafted by the court, which could include an order that the majority shareholder purchase the minority shareholder’s stock at “fair value” or injunctive relief addressing specific conduct, such as injunctions prohibiting the payment of disproportionate “informal” dividends or requiring the payment of dividends.105 The decision to award equitable relief was made by the court and subject to review for abuse of discretion.106 A buy-out order was justified where the plaintiff proved (1) that the oppressive conduct constituted a pattern of such conduct likely to “continue in the future,”107 and (2) that other relief was not adequate.108 The price paid in the buy-out was “fair value” of the stock and was determined by the jury.109 A claim for shareholder oppression could be brought with other claims, including derivative claims, dividend claims, and claims for violation of statutory inspection rights.

The Davis court’s treatment of the new shareholder oppression cause of action was clarified in the next oppression case decided in Texas, which also came out of the First Court of Appeals, Willis v. Bydalek.110 The court of appeals reversed a shareholder oppression judgment for the plaintiff, holding that the sole act of oppressive conduct that the jury found, “wrongful lock out,” was no more than the firing of an at-will employee.111 The court of appeals did not hold that “firing an at-will employee who is a minority shareholder could never, under any circumstances, constitute oppression,” but only that under the circumstances of this case the sole act of firing an at-will employee could not constitute shareholder oppression.112 The court emphasized that only one act of oppressive conduct was proven and that a pattern of oppressive conduct was an important element in establishing oppression. The court also made clear that the finding of oppression must take into consideration other legal concepts, such as the business judgment rule and at-will employment, and was not an exception to those other doctrines.

(b) Boehringer v. Konkel

Boehringer v. Konkel113 was the last significant shareholder oppression case to be decided

105 Id. at 383. 106 Id. at 380. 107 Id. at 383. The bad faith or malicious intent of the majority shareholder was significant on this element. 108 Id. at 380 (“We conclude that Texas courts, under their general equity power, may decree a ‘buy-out’ in an

appropriate case where less harsh remedies are inadequate to protect the rights of the parties.”); id. at 383 (“However, based on appellants’ conduct denying appellee any interest or voice in the corporation, we find that these remedies are inadequate to protect appellee’s interest and his rights in the corporation.”).

109 Id. at 384. Because Davis did not appeal the jury’s finding of “fair value,” the court of appeals did not discuss the meaning or elements of that concept. However, it is reasonable to assume that the court intended to use the term consistently with its meaning when a shareholder is bought out as a result of exercising a right to dissent. See

TEX. BUS. ORGS. CODE ANN. § 10.362 (West 2015) (“In computing the fair value of an ownership interest under this subchapter, consideration must be given to the value of the domestic entity as a going concern without including in the computation of value any control premium, any minority ownership discount, or any discount for lack of marketability.”). The definition of “fair value” in the jury charge is not stated in the appellate opinion.

110 997 S.W.2d 798 (Tex. App.—Houston [1st Dist.] 1999, pet. denied). 111 Id. at 802. 112 Id. 802–03. 113 404 S.W.3d 18 (Tex. App.—Houston [1st Dist.] 2013), disapproved by, Ritchie v. Rupe, 443 S.W.3d 856

(Tex. 2014).


prior to the publication of the Supreme Court’s opinion in Ritchie was published.

Konkel and Boehringer were chemical engineers, and Konkel bought 49.9% of the stock in Boehringer’s closely-held corporation, which designed industrial processes and machinery and equipment used in refineries, chemical plants, biofuel facilities, and pharmaceutical production facilities.114 At the first shareholder meeting, both agreed that salaries would be set at $60,000 annually for both men and that Boehringer would act as president and Konkel as vice president.115 “From 2001 to 2004, the company was a two-man operation,” but beginning in 2005, the company grew substantially, acquiring office space, hiring employees, and earning significant revenues—growing to in excess of $1 million per year between 2005 and 2008, compared to 2004 sales of $550,000.116 “Shortly after this marked success, the relationship between Konkel and Boehringer deteriorated,” and “Konkel made between ten and twenty requests for corporate records from between 2001 and 2009,” which Boehringer ignored.117

“The situation reached its boiling point at the February 2, 2009 shareholder meeting, when Boehringer” told “Konkel that he was “‘going to make [Konkel’s] fucking life miserable.’”118 Following the meeting, “Boehringer sent a company-wide email stating that Konkel was no longer in management,” and Konkel resigned shortly thereafter, stating that his only remaining connection to the corporation was as a shareholder.119 “Later, Konkel learned that Boehringer had secretly awarded himself a pay raise in late 2008,” increasing his gross pay to $240,000 annually, compared to Konkel’s $48,000.120 Despite earnings which generated a tax liability to Konkel for 2008, Boehringer never issued to Konkel dividends from the 2008 earnings.121 On February 23, 2009, Konkel sued Boehringer for shareholder oppression.122

“The jury found that Boehringer had maliciously or wrongfully refused to allow Konkel to examine” corporate books, “used his position to award himself an excessive salary to Konkel’s detriment,” and wrongfully withheld dividends from Konkel in 2008.123 The trial court held that “shareholder oppression occurred as a matter of law” and ordered that “the corporation be liquidated, with proceeds split according to share” ownership after all debts were subtracted.124 Boehringer challenged legal and factual sufficiency of the evidence; the First Court of Appeals affirmed.125

The appellate court held: “The doctrine of shareholder oppression protects the close corporation minority stockholder from the improper exercise of majority control.”126 The

114 Id. at 22. 115 Id. 116 Id. at 22–23. 117 Id. at 23. 118 Id. 119 Id. 120 Id. 121 Id. at 23–24. 122 Id. at 24. 123 Id. 124 Id. 125 Id. at 22. 126 Id. at 25 (citing Moll, Majority Rule, supra note 40).


Court cited the “two non-exclusive definitions of shareholder oppression”:

1. majority shareholders’ conduct that substantially defeats the minority’s expectations that, objectively viewed, were both reasonable under the circumstances and central to the minority shareholder’s decision to join the venture; or

2. burdensome, harsh, or wrongful conduct; a lack of probity and fair dealing in the company’s affairs to the prejudice of some members; or a visible departure from the standards of fair dealing and a violation of fair play on which each shareholder is entitled to rely.127

On the specific factual findings, the court concluded that the jury could reasonably have found “that Boehringer maliciously or wrongfully refused to allow Konkel to examine” the books and records,128 that Boehringer used his position as president of the corporation to award himself an excessive salary to Konkel’s detriment,129 and “that Boehringer withheld issuance of a dividend and used his two-fold pay increase as a means of denying Konkel his proportionate participation in the company’s earnings.”130

The court held that “[a]n expectation of annual compensation through employment cannot be said to be a general expectation held by all shareholders of a corporation,”131 and that if Konkel were complaining about his own salary, he would be required “to provide proof of specific facts showing that his specific expectation of a certain level of compensation was reasonable under the circumstances and central to his decision” to invest; however, the court noted, “Konkel is not complaining about his own compensation, but that Boehringer’s raising of his own salary was detrimental to Konkel.”132 The court further held that “[a]s a shareholder, Konkel had a general and reasonable expectation to have the right to proportionate participation in the earnings of the company,” and that “the board resolution from the first shareholder meeting at which Konkel joined the company” proved his “reasonable expectation that corporate monetary benefits would be divided equally.”133 The court held that the evidence justified the finding that Boehringer had received “a de facto dividend to the exclusion of Konkel.”134

3. The Shareholder Oppression Cause of Action

By the time of the Ritchie v. Rupe decision, the shareholder oppression cause of action developed by the Texas courts of appeals may be summarized as follows: The shareholder oppression cause of action was an individual claim belonging to the shareholder personally and

127 Id. (citing Willis v. Bydalek, 997 S.W.2d 798, 801 (Tex. App.—Houston [1st Dist.] 1999, pet. denied). 128 Id. at 28. 129 Id. at 30. 130 Id. at 31. 131 Id. at 29 (citing ARGO Data Res. Corp. v. Shagrithaya, 380 S.W.3d 249, 266 (Tex. App.—Dallas 2012, pet.

denied)). 132 Id. 133 Id. at 30. 134 Id. at 31.


asserted in his individual capacity.135 The duties were imposed on the controlling shareholder or directors not to oppress the minority shareholder. Oppressive conduct could be proven in one of two ways: either by proof that the minority’s “reasonable expectations” had been substantially defeated or that the conduct was so bad as to constitute “burdensome, harsh, or wrongful conduct.”136 Reasonable expectations were “the minority’s expectations that, objectively viewed, were both reasonable under the circumstances and central to the minority shareholder’s decision to join the venture.”137 A plaintiff could prove “specific reasonable expectations,” which would be based on either an express agreement between minority shareholder and majority shareholder or one clearly implied by the facts and required “proof of specific facts giving rise to the expectations in a particular case and a showing that the expectation was reasonable under the circumstances of the case as well as central to the minority shareholder’s decision to join the venture.”138 “General reasonable expectations” were reasonable as a matter of law, and were recognized by the courts as expectations that arise from stock ownership; these expectations are common to all stockholders and require no proof.139 While every case paid lip service to “specific reasonable expectations,” all the shareholder oppression cases really based their holdings on “general reasonable expectations.” Early cases placed particular emphasis on the defendant’s state of mind and required proof of a “pattern” of conduct likely to continue into the future. Later cases seem to have dispensed with the pattern requirement, with court of appeals in Ritchie affirming based on one bad act and the Boehringer court stating that any one of the bad acts proven would have been sufficient.140 Finally, the determination of whether the defendant had committed oppression was made by the court, with the jury only asked whether the defendant committed the allegedly oppressive acts.

The cause of action was not without problems. Shareholder oppression had no elements, only “definitions.” Other than to point to the use of the word “oppressive” in the receivership statute, no court ever identified the source of the duty or defined the nature of the duty. Case law provided absolutely no guidance as to how much oppressive conduct was enough. As the Supreme Court would note in Ritchie, the doctrine has been heavily criticized for its lack of clarity and predictability.141 Courts were left to their own equitable judgment, subject only to review for abuse of discretion. Furthermore, oppressive conduct could be proven by self-dealing acts that were breaches of fiduciary duties to the corporation and not to the minority

135 Redmon v. Griffith, 202 S.W.3d 225, 234 (Tex. App.—Tyler 2006, pet. denied), disapproved by, Ritchie v.

Rupe, 443 S.W.3d 856 (Tex. 2014). 136 Boehringer v. Konkel, 404 S.W.3d 18, 25 (Tex. App.—Houston [1st Dist.] 2013, no pet.) (citing Willis v.

Bydalek, 997 S.W.2d 798, 801 (Tex. App.—Houston [1st Dist.] 1999, pet. denied)). 137 Id. 138 Id. at 26. 139 Id. 140 Id. at 32–33. 141 See Ritchie v. Rupe, 443 S.W.3d 856, 889–90 & n.60–61 (Tex. 2014) (citing Timothy J. Storm, Remedies

for Oppression of Non–Controlling Shareholders in Illinois Closely–Held Corporations: An Idea Whose Time Has Gone, 33 LOY. U. CHI. L.J. 379, 383–84, 435 (2002); Sandra K. Miller, How Should U.K. and U.S. Minority Shareholder Remedies for Unfairly Prejudicial or Oppressive Conduct Be Reformed?, 36 AM. BUS. L.J. 579, 617 (1999); Hunter J. Brownlee, The Shareholders’ Agreement: A Contractual Alternative to Oppression As A Ground for Dissolution, 24 STETSON L. REV. 267, 286 (1994)).


shareholder.142 Absent the shareholder oppression doctrine, a shareholder could only obtain relief for such acts through a derivative action brought for the benefit of the corporation. The willingness of the courts to allow such self-dealing misconduct to be dealt with directly by the shareholder through the shareholder oppression doctrine threatened to make the entire body of law regarding derivative suits irrelevant.

Nevertheless, the shareholder doctrine became universally accepted in Texas appellate courts, none of whom ever questioned its difficulties or attempted to address them.

4. Buy-Out Remedy

What gave the shareholder oppression doctrine its remedial teeth was the buy-out order. While the courts were free to fashion any appropriate remedy, almost all of them opted for a compulsory buy-out. The vulnerability of a minority shareholder to oppressive conduct (and the source of the temptation to the majority shareholder to engage in such conduct) was that the minority was “locked-in,” trapped with no ability to cut his losses, cash out, and walk away. The buy-out remedy fixed what was broken about the legal structure of closely-held corporations. The remedy was incredibly practical and logical. As the court in Davis had written, “[a]ppellants’ oppressive conduct, along with their attempts to purchase appellee’s stock, are indications of their desire to gain total control of the corporation. That is exactly what a ‘buy-out’ will achieve.”143 In effect, the majority, through its oppressive conduct, had wrongfully taken the value of the minority’s stock ownership. The shareholder oppression doctrine with its buy-out remedy merely forced the majority pay a fair price for what it had been wrongfully taken. In Davis v. Sheerin, the court held “An ordered ‘buy-out’ of stock at its fair value is an especially appropriate remedy in a closely-held corporation, where the oppressive acts of the majority are an attempt to ‘squeeze out’ the minority, who do not have a ready market for the corporation’s shares, but are at the mercy of the majority.”144

The typical measure of damages for loss of property, such as stock, would be fair market value. The problem with the notion of “fair market value” in the case of a minority interest in a closely-held corporation is that there is no market for the shares—and thus no way to determine a “market value.”145 Courts have generally acknowledged that the “true value” of a closely-held corporation is, at best, a subjective guess.146 However, Texas shareholder oppression cases used the term “fair value” as opposed to “fair market value.”

In the court of appeals’ opinion in Ritchie v. Rupe, the Dallas Court of Appeals fully developed the law governing the buy-out remedy. After holding that “Texas law authorizes the trial court, in an appropriate case, to order a buyout of an oppressed minority shareholder as an equitable remedy for shareholder oppression,”147 and rejecting the argument that the buy-out

142 See Redmon v. Griffith, 202 S.W.3d 225, 235 (Tex. App.—Tyler 2006, pet. denied); In re Trockman, No.

07-11-0364-CV, 2012 WL 554999, at *3 n.2 (Tex. App.—Amarillo Feb. 21, 2012, orig. proceeding) (mem. op.). 143 Davis v. Sheerin, 754 S.W.2d 375, 383 (Tex. App.—Houston [1st Dist.] 1988, writ denied). 144 Id. at 381. 145 See Ward v. Succession of Freeman, 854 F.2d 780, 783 n.1 (5th Cir. 1988); Sommers Drug Stores Co. Emp.

Profit Sharing Trust v. Corrigan Enters., Inc., 793 F.2d 1456, 1462 (5th Cir.1986). 146 See Kademian v. Ladish Co., 792 F.2d 614, 626 (7th Cir.1986). 147 Ritchie v. Rupe, 339 S.W.3d 275, 289 (Tex. App.—Dallas 2011), rev’d, 443 S.W.3d 856 (Tex. 2014).


order was “so harsh as to constitute an abuse of discretion,”148 the court dealt with mechanics of valuation. First, what is the valuation date? The court noted that the wrongful acts that were chiefly relevant to the claim occurred in February 2006, that the lawsuit was filed in July 2006, and that the plaintiff’s expert’s valuation was based on “last audited financial statements” dated as of June 30, 2006, and held that the trial court’s use of June 30, 2006 was not an abuse of discretion.149 This holding was consistent with the Fifth Circuit’s holding in Hollis v. Hill, a Texas shareholder oppression case governed by Nevada law, that the “presumptive valuation date for other states allowing buy-out remedies is the date of filing unless exceptional circumstances exist which require an earlier or later date to be chosen.”150

Next the court of appeals addressed the more difficult issue of applying minority discounts for lack of control and lack of marketability.151 In most contexts, appraisers believe that a minority interest in a closely-held corporation is worth less than the minority percentage of the market value of the business as a whole.152 The reason for this disparity in value is that no market exists for the minority shares, so that any buyer would be entirely dependent upon the declaration of dividends for a return on investment; and the purchaser, as a minority shareholder, would have no power to compel the distribution of dividends. Therefore, any purchaser of a minority interest would be given an incentive in the form of a discount to take these additional risks. The court of appeals held that there are two types of “fair value,” enterprise value and fair market value, with “enterprise value” being “determined by the value of the company as a whole and ascribing to each share its pro rata portion of that overall enterprise value,” and “fair market value” being defined as “the price at which the stock would change hands between a willing seller, under no compulsion to sell, and a willing buyer, under no compulsion to buy, with both parties having reasonable knowledge of relevant facts.”153 “Enterprise value does not include a discount based on the stock’s minority status or lack of marketability,” whereas “fair market value” of corporate stock does include those discounts.154 The court held that, in most shareholder oppression cases, enterprise value “has been seen as the appropriate valuation when a minority shareholder, with no desire to leave the corporation, has been forced to relinquish his ownership position by the oppressive conduct of the majority.”155 However, in Ritchie v. Rupe, the oppressive conduct chiefly complained of was the interference with the plaintiff’s ability to sell her minority interests to a third party; therefore, “[i]n crafting an equitable remedy for appellants’ oppressive conduct in connection with [plaintiff’s] efforts to sell the Stock, the trial court should have provided the relief prevented by appellants’ conduct, i.e., a sale at fair market value.”156

148 Id. at 298–99. 149 Id. 150 Hollis v. Hill, 232 F.3d 460, 472 (5th Cir. 2000). 151 Ritchie, 339 S.W.3d at 300. 152 See, e.g., SHANNON PRATT, VALUING A BUSINESS, 385 (5th ed. 2008) (“Control shares are normally more

valuable than minority shares because they contain a bundle of rights that minority shares do not enjoy.”). 153 Ritchie, 339 S.W.3d at 300. 154 Id. 155 Id. at 301. 156 Id.


B. The Texas Supreme Court’s Ruling in Ritchie v. Rupe

1. The Court of Appeals’ Opinion

The Fifth Court of Appeals’ 2011 opinion in Ritchie v. Rupe was the most detailed discourse and shareholder oppression up to that date, and also the most expansive of minority shareholder rights.157 Since the First Court of Appeals first recognized the buy-out as a remedy for oppressive conduct in Davis v. Sheerin in 1988, the Texas Supreme Court had declined to express an opinion regarding the shareholder oppression cause of action.158 Meanwhile, Texas courts of appeals continued ruling on shareholder oppression cases and had, over the intervening twenty-three years, created a significant body of jurisprudence on this subject. During that time, numerous petitions for review were filed to the Texas Supreme Court, and each time the Court denied those requests, but never refused review, which would have constituted an implicit recognition that the court of appeals’ opinion is “correct and the legal principles announced in the opinion are likewise correct.159 On March 2, 2012, the Texas Supreme Court granted Ritchie’s Motion for Rehearing on the initial denial of his petition for review. Oral arguments were heard on February 26, 2013, and more than nine amicus curiae briefs were filed in the matter. What was so special about Ritchie that warranted the Court’s attention after Ritchie’s second petition for review?

In that case, Ann Caldwell Rupe became trustee of the Dallas Gordon Rupe III Family Trust after her husband’s death.160 The trust held an 18% interest in Rupe Investment Corporation (RIC).161 Mrs. Rupe sought to market her interest to third parties, and hired a retired capital fund manager, George Stasen, to assist her. Stasen met with the RIC’s other shareholders regarding the sale who informed him that no one from RIC management would meet with any potential buyers. The plaintiff contended that this refusal rendered Mrs. Rupe’s interest essentially worthless, because, as Stasen testified, no buyer would purchase an interest in a closely-held corporation before speaking with corporate management.162 Mrs. Rupe’s shareholder oppression claim, as stated in the appellate opinion, centered on this act: managements’ refusal to meet with potential buyers of her shares. At trial, the jury found for Mrs. Rupe, and the trial court concluded that the refusal constituted oppressive conduct and ordered that her shares be purchased for $7.3 million.163

Unlike earlier cases that had based the buy-out remedy on a series of bad acts that support the “the likelihood that [this oppressive conduct] would continue in the future,”164 the Ritchie court of appeals’ opinion did not address the issue of a pattern, but instead focused on the fact that, because Mrs. Rupe’s shares were unrestricted, she had the general reasonable expectation

157 339 S.W.3d 275. 158 In Willis v. Donnelly, the Texas Supreme Court found that because Donnelly never became a shareholder,

the Willises could not have owed fiduciary duties to Donnelly. 199 S.W.3d 262, 278 (Tex. 2006). 159 TEX. R. APP. P. 56.1(c) (West 1997). 160 Ritchie, 339 S.W.3d at 282. 161 Id. 162 Id. 163 Id. at 281. 164 Davis v. Sheerin, 754 S.W.2d 375, 383 (Tex. App.—Houston [1st Dist.] 1988, writ denied), disapproved by,

Ritchie, 443 S.W.3d 856.


to “sell her stock to a party of her choosing at a mutually acceptable price.”165 Any corporate policy prohibiting a shareholder from marketing shares to third parties defeats that general reasonable expectation. The court did say that shareholders do not have the expectation that controlling shareholders or directors would either market the shares on the minority’s behalf or make any statements that would mislead potential investors.166

In their brief to the Texas Supreme Court, the petitioners argued that the “Texas shareholder oppression statute,” which allows the appointment of a receiver based on “illegal, oppressive, or fraudulent”167 conduct, should be the only remedy available.168 Petitioners also asserted that the “reasonable expectations test” is a flawed test that is not appropriate under the current statute and is not appropriate when a shareholder “acquire[s] her shares in a preexisting corporation by way of inheritance.”169

Respondents pointed out that the receivership statutes are measures of last resort, to be used only “if all other remedies available either at law or in equity . . . are determined by the court to be inadequate.”170 Respondents also pointed out that the “reasonable expectations test” is used in courts throughout the country to determine whether oppressive conduct has occurred. In addition, Respondents noted that the jury found that a relationship of trust and confidence existed and that Petitioners did not comply with their fiduciary duties arising from this relationship. A buy-out would be an appropriate remedy for the breach of fiduciary claim as well as shareholder oppression.171

2. The Supreme Court Opinion

In Ritchie v. Rupe,172 the Texas Supreme Court completely rejected the shareholder oppression doctrine as it had been developed in the Texas appellate courts. The Court first turned to the receivership statute as a source for the duties recognized by the shareholder oppression doctrine.173 The court held that the “construction of former article 7.05, like any other statute, is a question of law for the courts.”174 “To determine the meaning of ‘oppressive’ in the receivership statute, our text-based approach to statutory construction requires us to study the language of the specific provision at issue, within the context of the statute as a whole, endeavoring to give effect to every word, clause, and sentence.”175 The Court focused particularly on the other statutory grounds for imposing a receiver, concluded that all involved a “serious threat to the well-being of the corporation,” and held that “[w]e must construe

165 Ritchie, 339 S.W.3d at 291. 166 Id. at 297. 167 TEX. BUS. ORGS. CODE ANN. § 11.404(a)(1)(C) (West 2012). 168 Petitioner’s Brief on the Merits at 16, Ritchie, 443 S.W.3d 856 (No. 11-0447). 169 Id. at 15. 170 Respondent’s Brief on the Merits at 17, Ritchie, 443 S.W.3d 856 (No. 11-0447) (quoting TEX. BUS. CORP.

ACT arts. 7.05(A), 7.06(A) (West 2010)). 171 Id at 35. 172 443 S.W.3d at 866. 173 Id. at 863. 174 Id. 175 Id. at 867.


‘illegal, oppressive, or fraudulent’ . . . in a manner consistent with these types of situations.”176 The Court rejected the two definitions of oppressive that had been developed by the intermediate courts under the shareholder oppression doctrine and concluded:

Considering all of the indicators of the Legislature’s intent, we conclude that a corporation’s directors or managers engage in ‘oppressive’ actions under former article 7.05 and section 11.404 when they abuse their authority over the corporation with the intent to harm the interests of one or more of the shareholders, in a manner that does not comport with the honest exercise of their business judgment, and by doing so create a serious risk of harm to the corporation.177

The basis of the court of appeal’s holding of oppression, interference with the plaintiff’s ability to sell her shares, “does not meet that standard.”178

In the trial court, the plaintiffs had alleged additional oppressive conduct not relied on in the appellate opinion, but the Supreme Court held that remand was unnecessary because the plaintiff sought only a buy-out, and that remedy was not available under the receivership statute: “Former article 7.05 creates a single cause of action with a single remedy: an action for appointment of a rehabilitative receiver.”179 The Supreme Court rejected the argument that the provision in the receivership statute, requiring the court to find that all other remedies available at law or in equity are inadequate, implies the authority to order other appropriate equitable relief—”This provision is a restriction on the availability of receivership, not an expansion of the remedies that the statute authorizes.”180

Next, the Court turned to the question of whether an independent cause of action should be recognized in the common law for shareholder oppression.181 The Court held that such an inquiry requires “something akin to a cost-benefit analysis to assure that this expansion of liability is justified.”182 The factors include the foreseeability, likelihood, and magnitude of the risk of injury, the existence and adequacy of other protections against the risk, the magnitude of the burden of guarding against the injury and the consequences of placing that burden on the persons in question, and the consequences of imposing the new duty.183 After a thorough discussion of the vulnerabilities of minority shareholder and the risks and harm caused by oppressive conduct, the Court concluded “that the foreseeability, likelihood, and magnitude of harm sustained by minority shareholders due to the abuse of power by those in control of a closely held corporation is significant, and Texas law should ensure that remedies exist to appropriately address such harm when the underlying actions are wrongful.”184 However, that conclusion “does not end our analysis” because “[w]e must next consider the adequacy of

176 Id. at 868. 177 Id. at 871. 178 Id. 179 Id. at 872. 180 Id. 181 Id. at 877–78. 182 Id. at 878 (citing Roberts v. Williamson, 111 S.W.3d 113, 118 (Tex. 2003)). 183 Id. 184 Id. at 879.


remedies that already exist.”185

The Court then analyzed the existing remedies in each of five areas where oppressive conduct is most frequently present: denial of access to information,186 withholding of dividends,187 termination of employment,188 misappropriation of corporate funds and opportunities,189 and manipulation of stock values.190 As to denial of information, the Court noted that “[t]he Legislature has already dictated what rights of access a shareholder has to corporate books and records, and no party alleges that the Legislature’s statutory scheme is inadequate to protect shareholders in closely held corporations from improper denial of access to corporate records.”191 As to termination of employment, “our commitment to the principles of at-will employment compels us to conclude that the opportunity to contract for any desired employment assurances is sufficient.”192 Misappropriation may be remedied through derivative claims based on “the duty of loyalty that officers and directors owe to the corporation specifically [that] prohibits them from misapplying corporate assets for their personal gain or wrongfully diverting corporate opportunities to themselves,”193 which the Court reasoned might also be available to remedy withholding or refusing to declare dividends, termination of employment, and manipulation of corporate share values—”all relate to business decisions that fall under the authority of a corporation’s offices and directors. As such, they are subject to an officer or director’s fiduciary duties to the corporation.”194 Ultimately the Court concluded that “these legal duties are sufficient to protect the legitimate interests of a minority shareholder by protecting the well-being of the corporation.”195

The Court also noted the potential negative consequences of recognizing a new common-law cause of action for shareholder oppression—that the undefined usage of the term “oppressive” falls far short of providing any clear standards196 and that “[e]ven the most developed common-law standards for ‘oppression’—the ‘reasonable expectations’ and ‘fair dealing’ tests—have been heavily criticized for their lack of clarity and predictability.”197

The Court conceded:

We recognize that our conclusion leaves a “gap” in the protection that the law affords to individual minority shareholders, and we acknowledge that we could fill the gap by imposing a common-law duty on directors in closely held corporations not to take

185 Id. 186 Id. at 882. 187 Id. 188 Id. at 886. 189 Id. at 887. 190 Id. 191 Id. at 888. 192 Id. at 886. 193 Id. at 887. 194 Id. at 888. 195 Id. at 888–89. 196 Id. at 889. 197 Id. at 889–90.


oppressive actions against an individual shareholder even if doing so is in the best interest of the corporation. To determine whether imposing such a duty is advisable, however, we must consider the public policies at play, the consequences of imposing the duty, the duty’s social utility, and whether the duty would conflict with existing law or upset the Legislature’s careful balancing of competing interests in governing business relationships.198

The Court reasoned, “[t]here must be well-considered, even compelling grounds for changing the law so significantly. . . . We find no such necessity here, and therefore decline to recognize a common-law cause of action for ‘shareholder oppression.’”199

Finally, the Court noted that the plaintiff had also obtained jury findings of breach of fiduciary duties based on an informal fiduciary duty arising from the familial relationship among the parties and remanded the case for a determination of whether the plaintiff was entitled to a buy-out or other remedy based on that finding.200 On remand, the Dallas Court of Appeals held that there was legally insufficient evidence to support fiduciary duties based on a relationship of trust and confidence among the parties and reversed the trial court’s judgment and rendered judgment that Rupe take nothing.201

C. Implications of Ritchie: Defining the “Gap”

The Texas Supreme Court “recognize[d] that our conclusion leaves a ‘gap’ in the protection that the law affords to individual minority shareholders.”202 What is that gap, and how will courts address it going forward?

1. The need for a duty to individual shareholders

To the extent that the matter was unclear prior to the Ritchie opinion,203 the Texas Supreme Court made it abundantly clear that officers and directors of a corporation, are not in a legal relationship with the individual shareholders and owe their duties only to the corporate entity, not directly to the shareholders; 204 and, by necessary implication, the majority shareholders (who dictate the actions of the directors and officers) also owe no duties to the other shareholders.205 What is left completely unexplained is whether the individual

198 Id. at 889. 199 Id. at 891. 200 Id. at 892. 201 Ritchie v. Rupe, No. 05-08-00615-CV, 2016 WL 145581, at *1 (Tex. App.—Dallas Jan. 12, 2016, pet.

filed) (mem. op.). 202 Ritchie, 443 S.W.3d at 889. 203 Compare Hoggett v. Brown, 971 S.W.2d 472, 488 (Tex. App.—Houston [14th Dist.] 1997, pet. denied) (“A

director’s fiduciary duty runs only to the corporation, not to individual shareholders or even to a majority of the shareholders. Similarly, a co-shareholder in a closely-held corporation does not as a matter of law owe a fiduciary duty to his co-shareholder.”), with id. at 488 n.13 (“However, in certain limited circumstances, a majority shareholder who dominates control over the business may owe such a duty to the minority shareholder.”).

204 Ritchie, 443 S.W.3d at 889. 205 The general rule has always been that co-shareholders owe no duties to each other merely by virtue of

owning shares in the same corporation. See Kaspar v. Thorne, 755 S.W.2d 151, 155 (Tex. App.—Dallas 1988, no


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 shareholder, a part owner in a corporation? If so, what duties, if any, are owed to individual shareholders by virtue of the shareholder status, who owes those duties, and how are those duties enforced?

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.”206 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.207

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 shareholders.208 However, “a stockholder may sue for violation of his own individual rights regardless of whether the corporation also has a cause of action.”209 A 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.210 A shareholder may sue for corporate mismanagement if the “manager’s misconduct violates some duty owed the stockholder independently.”211 “Rather, it is the nature of the wrong, whether directed against

writ). 206 Ritchie, 443 S.W.3d at 889. 207 Massachusetts v. Davis, 168 S.W.2d 216, 221 (Tex. 1942). 208

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. Such action must be brought by the corporation, not alone to avoid a multiplicity of suits by the various stockholders and to bar a subsequent suit by the corporation, but in order that the damages so recovered may be available for the payment of the corporation’s creditors, and for proportional distribution to the stockholders as dividends, or for such other purposes as the directors may lawfully determine.

Id. 209 Schoellkopf v. Pledger, 739 S.W.2d 914, 918 (Tex. App.—Dallas 1987), rev’d on other grounds, 762

S.W.2d 145 (Tex. 1988). 210 Id. at 918–19. 211 Id. at 919.


the corporation only or against the stockholder personally, which determines who may sue.”212 To recover individually, “a stockholder must prove a personal cause of action and personal injury.”213

In a shareholder oppression scenario, the misconduct is specifically directed at the minority, with the primary injury being suffered by the minority, and only incidentally by the corporation, if at all. Assume that a majority shareholder wants to eliminate or marginalize the minority shareholder. If the corporation’s profits were 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, typically, to raise the majority shareholder’s compensation. Clearly, the intent and effect is to harm the minority shareholder—to eliminate the value of the shares to the minority shareholder. Has the corporation been harmed as well? Maybe. Maybe not. If the majority shareholder is an effective employee and manager, the corporation’s business may not suffer. 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, the corporation really is better off.

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.”214 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.”215 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 individual 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 the minority shareholder, and thus eliminated the possibility of any personal cause of action, “even if [the oppressive conduct is] motivated by malice toward the stockholder individually.”216 The Supreme Court leaves “the legitimate interests of a minority shareholder” to be safeguarded only “by protecting the well-being of the corporation.”217 That protective scheme will often, perhaps usually, prove illusory.

212 Id. at 918. 213 Wingate v. Hajdik, 795 S.W.2d 717, 719 (Tex. 1990). 214 See id. at 719. 215 Ritchie v. Rupe, 339 S.W.3d 275, 289 (Tex. App.—Dallas 2011), rev’d, 443 S.W.3d 856, 889 (Tex. 2014). 216 Schoellkopf, 739 S.W.2d at 919. 217 Ritchie, 443 S.W.3d at 888.


2. The need for an individual remedy

Returning to the basic concept of 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’s share ownership—or rather to misappropriate the value of that ownership for the majority’s benefit. If a majority owner 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 owner whose ownership in the enterprise necessarily increases as a result. In neither case is the corporation as a whole necessarily harmed or benefitted. The Supreme Court conceded that such unjust enrichment to the majority 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.”218 Yet the Supreme Court provides a legal scheme in which the minority shareholder’s only remedy is an indirect one,219 depending on the wrongful conduct directed at the minority shareholder 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.”220

If the officers and directors or the controlling shareholders owe no duties to the minority shareholder, then nothing that the director or controlling shareholder does with the intent to harm the minority shareholder can possibly be 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,221 was not found in that case to have caused any actual harm.222 It is difficult to imagine a claim that the corporation could bring that would address such conduct or any relief that could be granted

218 Id. at 879. 219 It should be noted, however, that in certain situations, a shareholder may request the court to treat the

derivative claim as a direct claim brought by the shareholder for the shareholder’s own benefit. Then damages are paid directly to the shareholder and the shareholder may be awarded attorney’s fees. TEX. BUS. ORGS. CODE. ANN. § 21.563 (West 2007).

220 Turner v. Cattleman’s Trust Co., 215 S.W. 831, 833 (Tex. 1919). 221 Davis v. Sheerin, 754 S.W.2d 375, 382 (Tex. App.—Houston [1st Dist.] 1988, writ denied) (“Even though

there were findings of the absence of some of the typical ‘squeeze out’ techniques used in closely held corporations, e.g., no malicious suppression of dividends or excessive salaries, we find that conspiring to deprive one of his ownership of stock in a corporation, especially when the corporate records clearly indicate such ownership, is more oppressive than either of those techniques.”).

222 Id. at 381 (“Appellants argue that the jury’s finding of conspiracy was rendered immaterial by its finding that the conspiracy was not the proximate cause of any damages. . . . We overrule this argument. The court’s judgment did not award damages based on a conspiracy cause of action. Instead, the court considered the various acts found by the jury and made a determination that such acts constituted oppressive conduct.”).


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.223

If the directors and controlling shareholders owe no duties to the minority, what about the corporation? Does the 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 he has invested his capital and of which he holds an ownership interests. Does the corporation owe any legal duties to its individual owners? The answer must be “yes”—otherwise there would be no difference between being an owner and not being an owner. Clearly, there are certain statutory obligations that a corporation must observe toward its shareholders;224 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.225 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,226 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 stockholder.227

3. Inadequacy of Piecemeal Approach

Under the legal scheme described in the Ritchie opinion, a minority shareholder faced with a coordinated and intentional 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

223 Id. at 383 (“In this case, the award of damages and certain injunctions might be sufficient to remedy the

willful breaches of fiduciary duty found by the jury, i.e., informal dividends to appellants by making contributions to the profit sharing plan and waste of corporate funds for legal fees. However, based on appellants’ conduct denying appellee any interest or voice in the corporation, we find that these remedies are inadequate to protect appellee’s interest and his rights in the corporation.”).

224 See, e.g., BUS. ORGS. § 21.173 (corporation required to keep specific information regarding shares issued); id § 21.219 (corporation must provide annual financial statements to shareholders upon request); id. § 21.221 (corporation liable to shareholder who suffers damages because of the failure to properly provide notice of shareholders’ meeting); id. § 21.354 (maintain and make available list of voting shareholders); id. § 21.455 (shareholders must approve sale of all or substantially all of corporation’s assets); id. § 21.460 (shareholder has right of dissent and appraisal regarding certain fundamental business transactions).

225 See e.g., Sneed v. Webre, 465 S.W.3d 169, 179 (Tex. 2015) (“The Legislature’s codification of shareholder derivative proceeding procedures . . . did not alter how the business judgment rule . . . applies to the merits of claims against a corporation’s officers or directors for breach of corporate duties.”); Hunter v. Fort Worth Capital Corp., 620 S.W.2d 547, 550 (Tex. 1981) (“Prior to the enactment of Article 7.12, Texas courts had long applied the trust fund theory to dissolved corporations, but only as embodied within the general framework of certain remedial statutes.”).

226 See Massachusetts v. Davis, 168 S.W.2d 216, 221 (Tex. 1942). 227 Id. at 222 (emphasis added). The Ritchie opinion suggests that the “or otherwise” exception indicates

instances of an informal fiduciary duty based on a relationship of trust and confidence. Ritchie v. Rupe, 443 S.W.3d 856, 888–89 n.58 (Tex. 2014). While that is certainly one example, no case has ever limited “or otherwise” to that one example.


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 is to steal from the minority; however, that seemingly wrongful purpose is irrelevant to the analysis because the majority shareholder owes no duty to the minority shareholder 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.228

Assume a 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 from any voice or participation in management and to deny the minority 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.229 It does not appear that the minority would be able to recover his attorney’s fees or expenses for such an effort, and the minority 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 could also make a written request for inspection of corporate records.230 The majority could refuse and require a jury trial each time by merely asserting that the minority had an improper purpose.231 Assuming the minority was successful, after several years of litigation, the minority 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.232 The Supreme Court suggested that there might be grounds for a derivative claim if the minority could prove that the decision to terminate his employment was not made

228 See Sneed, 465 S.W.3d at 173 (“The business judgment rule in Texas generally protects corporate officers

and directors, who owe fiduciary duties to the corporation, from liability for acts that are within the honest exercise of their business judgment and discretion.”) (emphasis added).

229 BUS. ORGS. § 21.351. 230 Id. § 21.218. 231 Uvalde Rock Asphalt Co. v. Loughridge, 425 S.W.2d 818, 820 (Tex. 1968). 232 Ritchie, 443 S.W.3d at 885 (“Texas is steadfastly an at-will employment state.”).


solely for the benefit of the corporation;233 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 shareholder has no specific right to dividends,234 and the decision to pay dividends is almost completely protected by the business judgment rule.235 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.236

If the minority 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.237 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.238 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 anymore, 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.239 Furthermore, the damages award will not be prospective.

233 Id. at 886 (“There may be situations in which, despite the absence of an employment agreement, termination of a key employee is improper, for no legitimate business purpose, intended to benefit the directors or individual shareholders at the expense of the minority shareholder, and harmful to the corporation. Though the ultimate determination will depend on the facts of a given case, such a decision could violate the directors’ fiduciary duties to exercise their ‘uncorrupted business judgment for the sole benefit of the corporation’ and to refrain from ‘usurp[ing] corporate opportunities for personal gain.’”).

234 ARGO Data Res. Corp. v. Shagrithaya, 380 S.W.3d 249, 273 (Tex. App.—Dallas 2012, pet. denied) (“A shareholder has no right to dividends.”).

235 Ritchie, 443 S.W.3d at 883; ARGO, 380 S.W.3d at 270; Bryan v. Sturgis Nat’l Bank, 90 S.W. 704, 705 (Tex. Civ. App. 1905, writ ref’d). See BUS ORGS. § 21.302.

236 BUS. ORGS. § 21.303. 237 Gibney v. Culver, No. 13-06-112-CV, 2008 WL 1822767, at *14 (Tex. App.—Corpus Christi Apr. 24,

2008, pet. denied) (mem. op.) (citing Mayson Mfg. Co. v. Comm’r, 178 F.2d 115, 119 (6th Cir. 1949) (“[T]he action of the Board of Directors of a corporation in voting salaries for any given period is entitled to the presumption that such salaries are reasonable and proper.”).

238 Id. at *13–14 (citing Rutter v. Comm’r, 853 F.2d 1267, 1271 (5th Cir. 1988)). 239 Take an easy example: Say the majority is paid $50,100 annually and the minority is paid $49,900. The


Although the minority shareholder would 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.

One other significant question is raised by the Supreme Court’s recent decision in Sneed v. Webre.240 The Ritchie scheme “to protect the legitimate interests of a minority shareholder by protecting the well-being of the corporation”241 depends heavily on the Court’s repeated assertion that a shareholder may bring a derivative action against the directors for violating the “duty to act solely for the benefit of the corporation.”242 Decisions that violate that duty, even if malicious and oppressive, do not necessarily involve self-dealing and dishonesty toward the corporation. 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,243 but expressly does not decide “which duties are subject to the business judgment rule.”244 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.”245 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 may still escape judicial scrutiny.

4. Need for the Buy-Out Remedy

The holding in Ritchie seems to have eliminated the buy-out remedy for oppressed minority shareholders. The Court held that the legislative intent of Section 11.404 of the Business Organizations Code and its predecessors did not provide for such a legal protection.246 The Court held that “‘‘[o]ur task is to effectuate the Legislature’s expressed intent’; it is not to impose our personal policy choices or ‘to second-guess the policy choices that inform our statutes or to weigh the effectiveness of their results.’”247 However, the Court neglected a cardinal rule of statutory interpretation. The Business Organizations Code adopts the rules of code construction in Chapter 311 of the Government Code,248 which presumes of

majority fires the minority and immediately increases his own compensation 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.

240 465 S.W.3d 169 (Tex. 2015). 241 Ritchie v. Rupe, 443 S.W.3d 856, 888 (Tex. 2014). 242 E.g., id. at 884; Sutton v. Reagan & Gee, 405 S.W.2d 828, 834 (Tex. Civ. App.—San Antonio 1966, writ

ref’d n.r.e.) (“All courts seem to agree that a director owes a duty to the corporation to exercise due care in the management of the corporation’s affairs.”).

243 Sneed, 465 S.W.3d at 178. 244 Id. at 178 n.7. 245 Id. at 178–79. 246 Ritchie, 443 S.W.3d at 872 (“Former article 7.05 creates a single cause of action with a single remedy: an

action for appointment of a rehabilitative receiver.”). 247 Id. at 866 (Tex. 2014) (quoting In re Allen, 366 S.W.3d 696, 703 (Tex.2012); and Iliff v. Iliff, 339 S.W.3d

74, 79 (Tex.2011)). 248 TEX. BUS. ORGS. CODE ANN. § 1.051 (West 2015).


every statute that “(1) compliance with the constitutions of this state and the United States is intended; (2) the entire statute is intended to be effective; (3) a just and reasonable result is intended.”249 The constitutional mandate of all corporate statutes in Texas is that “General laws . . . providing for the creation of private corporations . . . shall therein provide fully for the adequate protection of the public and of the individual stockholders.”250 In interpreting the statute so as to effectively eliminate legal protection from oppressive conduct, the Court hardly upheld the constitutional mandate to “provide fully for the adequate protection . . . of the individual stockholders” or for a “just and reasonable result.” The dissent justifiably criticized the Court for “ignoring the plain language of the statute and the great weight of authority” and holding “that an oppression statute abolishes the remedies it expressly prefers.”251

None of the remedies discussed by the Supreme Court address an intentional and continuing pattern of misconduct. None provide a way out of an oppressive 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.252 As the dissent in Ritchie argued, “No other existing remedy the Court discusses adequately protects minority shareholders from such oppression.”253

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 any benefits from 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

249 TEX. GOV’T CODE ANN. § 311.021 (West 2015). 250 TEX. CONST. art. XII, § 2. 251 Ritchie, 443 S.W.3d at 900 (Guzman, J., dissenting). 252 Davis v. Sheerin, 754 S.W.2d 375, 383 (Tex. App.—Houston [1st Dist.] 1988, writ denied) (“Appellants’

oppressive conduct, along with their attempts to purchase appellee’s stock, are indications of their desire to gain total control of the corporation. That is exactly what a ‘buy-out’ will achieve.”).

253 Ritchie, 443 S.W.3d at 905 (Guzman, J., dissenting).


the business, which are all but impossible to compensate.254 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 conduct 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 . . . .”255

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.256

5. Future development

The Supreme Court stated that numerous statutory and contractual protections and other common-law remedies currently exist to protect against oppressive conduct.257 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.”258 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

254 Davis, 754 S.W.2d at 383 (“In this case, the award of damages and certain injunctions might be sufficient to

remedy the willful breaches of fiduciary duty found by the jury, i.e., informal dividends to appellants by making contributions to the profit sharing plan and waste of corporate funds for legal fees. However, based on appellants’ conduct denying appellee any interest or voice in the corporation, we find that these remedies are inadequate to protect appellee’s interest and his rights in the corporation.”).

255 Stefano v. Coppock, 705 P.2d 443, 446 (Alaska 1985). 256 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 shareholder. Nevertheless, such a result might not be impossible. One authority noted: “Several older cases suggest that a forced buyout of a plaintiff may be utilized in derivative proceedings as an alternative to other remedies, such as setting aside a transaction.” 13 FLETCHER CYC. CORP. § 6038.10 (2015) (citing Am. Seating Co. v. Bullard, 290 F. 896, 900 (6th Cir. 1923)). See also Demarest v. Winchester Repeating Arms Co., 257 F. 162, 175 (D. Conn. 1919); Jones v. Missouri-Edison Elec. Co., 233 F. 49, 52 (8th Cir. 1916); Jones v. Missouri-Edison Elec. Co., 203 F. 945, 949 (8th Cir. 1913); Backus v. Brooks, 195 F. 452, 454–55 (2d Cir. 1912); Binney v. Cumberland Ely Copper Co., 183 F. 650, 653 (D. Me. 1910); In Duncan v. Lichtenberger, the court crafted an equitable remedy of rescission and restitution, returning to the minority shareholders their investment in the corporation, as a remedy for conduct that was clearly a breach of fiduciary duties to the corporation. 671 S.W.2d 948 (Tex. App.—Fort Worth 1984, writ ref’d n.r.e.). The Business Organizations Code provides that a derivative action in a closely-held corporation “may be treated by a court as a direct action brought by the shareholder for the shareholder’s own benefit.” TEX. BUS. ORGS. CODE ANN. § 21.563 (West 2007). Therefore, the possibility of a buy-out order in a proper case cannot be ruled out completely, however unlikely that result seems to be.

257 Ritchie, 443 S.W.3d at 879–80. 258 Id. at 890.


enrichment, and (9) quantum meruit.”259 The majority opinion repeatedly cites classic shareholder oppression doctrine cases with approval regarding claims asserted other than oppression.260

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.”261 Therefore, in light of the Ritchie decision, there is a new urgency in re-examining what legal rights and remedies “already exist”262 to protect individual minority shareholders against oppressive conduct.

IV. REDISCOVERING INDIVIDUAL COMMON-LAW SHAREHOLDER CLAIMS

A corporate stockholder may, however, have an action for personal damages for wrongs done to him as an individual stockholder ‘where the wrongdoer violates a duty arising from contract or otherwise, and owing directly by him to the stockholder.’ This principle, often mischaracterized an exception to the general rule that stockholders may not sue for personal injury resulting from a violation of the corporation’s rights, simply recognizes that a stockholder may sue for violation of his own individual rights regardless of whether the corporation also has a cause of action. It is not personal injury which gives rise to a personal cause of action by the stockholder, for an injurious wrong to the corporation perforce injures its stockholders. Rather, it is the nature of the wrong, whether directed against the corporation only or against the stockholder personally, which determines who may sue.263

259 Id. at 882 (citing Boehringer v. Konkel, 404 S.W.3d 18, 24 (Tex. App.—Houston [1st Dist.] 2013, no pet.));

ARGO Data Res. Corp. v. Shagrithaya, 380 S.W.3d 249, 262 (Tex. App.—Dallas 2012, pet. denied); Allen v. Devon Energy Holdings, L.L.C., 367 S.W.3d 355, 365 (Tex. App.—Houston [1st Dist.] 2012, pet. granted, judgm’t vacated w.r.m.); Strebel v. Wimberly, 371 S.W.3d 267, 274 (Tex. App.—Houston [1st Dist.] 2012, pet. denied); Adams v. StaxxRing, Inc., 344 S.W.3d 641, 643 (Tex. App.—Dallas 2011, pet. denied); Redmon v. Griffith, 202 S.W.3d 225, 231 (Tex. App.—Tyler 2006, pet. denied); DeWoody v. Rippley, 951 S.W.2d 935, 944 (Tex. App.—Fort Worth 1997, no writ); Davis, 754 S.W.2d at 377).

260 Id. at 882, 885. 261 Id. at 875 n.28. 262 Id. at 879. 263 Schoellkopf v. Pledger, 739 S.W.2d 914, 918 (Tex. App.—Dallas 1987), rev’d, 762 S.W.2d 145 (Tex.

1988).


A. Re-examining Stinnett v. Paramount-Famous Lasky Corp. of N.Y.

Stinnett v. Paramount-Famous Lasky Corp. of New York,264 involved a claim by shareholders of a corporation, not against the controlling shareholders or management, but against third parties arising from harm to the corporation. In 1923, the two plaintiffs, who held the lease to a movie theater in Dallas, Texas, formed a corporation for the purpose of engaging in the Class A theater business.265 The corporation secured a contract with the defendants for the distribution of films to show in the theater, but the plaintiffs were frustrated with their inability to obtain quality films, resulting ultimately in an altercation with one of the defendants, who threatened physical violence, declared that he would not renew the contract, and swore that he would see to it that the plaintiffs “did not get a decent picture to operate [the] theater.”266 As a result, in late 1925, the plaintiffs quit the theater business and sold the lease and the corporation. The plaintiffs sued the defendants for the destruction of their business on breach of contract and antitrust theories and received a favorable jury verdict and a judgment in the amount of $318,770.267 The defendants appealed, and the Waco Court of Appeals reversed the case on based solely on the fact that the harm was to the corporation and not to the plaintiffs individually:

The cause of action for injury to or destruction of the property of a corporation or the impairment or destruction of its business is nevertheless vested in the corporation, as distinguished from its stockholders. In such cases the injury to the corporation is direct and the injury to the holders of its stock remote. A recovery by the corporation inures to their benefit in proportion to their respective holdings and affords them compensation for the indirect or consequential loss sustained by them.268

The court of appeals remanded the case for new trial.269 The Texas Commission of Appeals affirmed the reversal and remand based on defective jury questions and evidentiary errors.270 However, the Court reject the defendants’ argument that “the undisputed evidence as a matter of law show that the sole cause of action against defendants belongs to the Capitol Amusement Company, a corporation, and that plaintiffs have no cause of action either in their individual capacities or as stockholders of the Capitol Amusement Company,” which had been the basis of the court of appeals’ decision.271

The Court acknowledged the “general rule [that] an action to redress or prevent injuries to the corporation cannot be maintained by a stockholder or the body of stockholders in their own names . . .[], but the action must be brought by, and in the name of, the corporation itself. This

264 37 S.W.2d 145 (Tex. Comm’n App. 1931, holding approved, judgm’t affirmed). 265 Id. at 146. 266 Id. at 147. 267 Id. at 147–48. 268 Paramount Famous Lasky Corp. v. Stinnett, 17 S.W.2d 125, 127–28 (Tex. Civ. App.—Waco 1929), aff’d,

37 S.W.2d 145. 269 Id. at 128. The opinion does not explain the reason for the remand. The grounds for the reversal would seem

to call of judgment to be rendered in favor of the defendants. 270 37 S.W.2d 145. 271 Id. at 149.


is true, although the injury to the corporation may incidentally result in the destruction or depreciation of the value of the stock. . . .[] The stockholders cannot as individuals recover on a cause of action vested in the corporation, although all unite in the action.”272 However, the Court also stated the exception to the general rule, that individual stockholder may maintain a direct action in their individual capacity for “wrongful acts which are not only wrongs against the corporation but also violations of duties arising from contracts or otherwise and owing directly to the injured stockholders.”273 This is the first case in Texas to state this often-repeated exception to the general rule.274 The plaintiffs argued that they had been injured individually by:

the ruthless and illegal acts of defendants that drove them out of the moving picture business, and that, by reason of such acts on the part of defendants, plaintiffs were not permitted to continue, either through a corporation or individually, in the moving picture business in which they had been successfully engaged for many years,275

and, particularly because they held the lease to the theater building individually, the plaintiffs contended, “that they were injured in a way that the corporation, which owned no physical assets and had no interest in the lease, could not have suffered injury.”276

The first opinion to state the exception that shareholder may sue individually for harm to the corporation when the wrongdoing also violates “a duty arising from contract, or otherwise, and owing directly by him to the stockholders” was the Sixth Circuit case of Ritchie v. McMullen,277 authored by Judge William Howard Taft,278 which was discussed at length in the

272 Id. 273 Id. 274 E.g., Sneed v. Webre, 465 S.W.3d 169, 188 (Tex. 2015); Murphy v. Campbell, 964 S.W.2d 265, 268 (Tex.

1997); Wingate v. Hajdik, 795 S.W.2d 717, 719 (Tex. 1990); Massachusetts v. Davis, 168 S.W.2d 216, 222 (Tex. 1942); BDO USA, L.L.P. v. Litex Indus., Ltd., No. 05-15-00358-CV, 2016 WL 3198503, at *8 (Tex. App.—Dallas May 26, 2016, no. pet. h.) (mem. op.); Aloysius v. Kislingbury, No. 01-13-00147-CV, 2014 WL 4088145, at *3 (Tex. App.—Houston [1st Dist.] Aug. 19, 2014, no pet.) (mem. op.) (not designated for publication); Murphy v. Am. Rice, Inc., No. 01-03-01357-CV, 2007 WL 766016, at *12 n.36 (Tex. App.—Houston [1st Dist.] Mar. 9, 2007, no pet.) (mem. op.); Goeth v. Craig, Terrill & Hale, L.L.P., No. 03-03-00125-CV, 2005 WL 850349, at *6 (Tex. App.—Austin Apr. 14, 2005, no pet.) (mem. op.); Villasana v. Patout, Cannon & Co., No. 01-98-00109-CV, 1999 WL 1018160, at *2 (Tex. App.—Houston [1st Dist.] Nov. 10, 1999, no pet.) (mem. op.) (not designated for publication) (“A corporate stockholder cannot personally recover damages for a wrong done solely to the corporation, even though she may be injured by that wrong.”); Gannon v. Baker, 807 S.W.2d 793, 798 (Tex. App.—Houston [1st Dist.]), rev’d in part, 818 S.W.2d 754 (Tex. 1991); Faour v. Faour, 789 S.W.2d 620, 622 (Tex. App.—Texarkana 1990, writ denied); Bush v. Brunswick Corp., 783 S.W.2d 724, 727 (Tex. App.—Fort Worth 1989, writ denied); Horton v. Robinson, 776 S.W.2d 260, 263 (Tex. App.—El Paso 1989, no writ); MBank Abilene, N.A. v. LeMaire, No. C14-86-00834-CV, 1989 WL 30995, at *14 (Tex. App.—Houston [14th Dist.] Apr. 6, 1989, no writ); Schoellkopf v. Pledger, 739 S.W.2d 914, 918 (Tex. App.—Dallas 1987), rev’d, 762 S.W.2d 145 (Tex. 1988); Cullum v. Gen. Motors Acceptance Corp., 115 S.W.2d 1196, 1201 (Tex. Civ. App.—Amarillo 1938, no writ); Gaubert v. United States, 885 F.2d 1284, 1291 (5th Cir. 1989), rev’d, 499 U.S. 315 (1991); Seibu Corp. v. KPMG L.L.P., No. 3-00-CV-1639-X, 2001 WL 1167317, at *6 (N.D. Tex. Oct. 2, 2001).

275 37 S.W.2d at 149. 276 Id. at 150. 277 79 F. 522, 533 (6th Cir. 1897). 278 Later President of the United States and 10th Chief Justice of the United States Supreme Court.


Stinnett opinion.279 Ritchie v. McMullen involved a shareholder who had borrowed large sums of money and pledged his stock in several corporations as collateral—corporations over which his creditors had control. The shareholder appealed the refusal by the trial court to permit the amendment of his answer to add counterclaims against the creditors for damage to the value of his pledged shares resulting from alleged intentional mismanagement of the corporations.280 The trial court had held that the amendment was improper because “that the wrongs committed were injuries to the corporations only, and that Ritchie, as a stockholder, could have no redress directly against the wrongdoers, and must find a remedy, if at all, in the enhancement in value to his stock caused by a recovery of damages by the corporations.”281 Judge Taft pointed out the paradox of the general rule: “As the very object of the conspiracy and wrongs done was to cause Ritchie to cease to be a stockholder, it might be difficult to point out how such an indirect remedy could benefit him after the wrong had been completed and he had parted with his ownership of the stock.”282 The court noted that generally shareholders have no claim for harm to the corporation that results in the depreciation of the value of their shares, but held: “But we are of opinion that this principle has no application where the wrongful acts are not only wrongs against the corporation, but are also violations by the wrongdoer of a duty arising from contract, or otherwise, and owing directly by him to the stockholders.”283 The court reasoned that the basis of the general rule was the absence of privity between individual shareholders and the officers and directors of the corporation, who owe their duties to the corporation, but here the shareholder was in privity with the officers and directors because of the pledge of stock, which carried with it a duty on the pledgee of reasonable care as to the value of the pledge: “A fortiori it is the bailor’s duty not to do any act with the intention of depreciating the value of the pledge. Hence, if Payne, Burke, and Cornell combined together, and wrongfully reduced the value of the stocks pledged, with the intention of buying them in at less than their value, they have done Ritchie an injury, for which he is entitled to compensation.”284 The court held that the directors would not be liable for negligent or ill-advised decisions that incidentally damaged the value of the pledged shares, “[b]ut, if such pledgee use his position as director and his vote as stockholder intentionally to depreciate the stock of his pledgor held in pledge with the dishonest purpose of acquiring ownership of the stock at forced sale, this is a direct injury done by him to his pledgor, and he cannot avoid direct liability to his pledgor for it, by pleading that the means by which he accomplished this wrong, and violated his duty as pledgee, involved an injury to the corporation, for which it may also recover damages.”285 Nor would the creditors be liable for voting their own shares in a manner that resulted in damage to the pledged shares, “unless the vote is shown to be malicious; i.e. with intent to injure the person complaining. But it is well settled that, ‘if any number of persons combine with intent to injure and defraud another, they cannot defend themselves against an action by showing that they did the act in the character of corporators under any charter whatever.[‘]”286

279 See 37 S.W.2d at 150. 280 See 79 F. at 529. 281 Id. at 533. 282 Id. 283 Id. 284 Id. 285 Id. at 534. 286 Id.


The Stinnett Court accepted the Sixth Circuit’s reasoning and held: “In applying these principles, we think it equally well settled that, if it appears from the pleadings and the proof that the wrongful acts are not only wrongs committed against the corporation, but also violations of duties arising from contracts or otherwise and owing directly to the injured stockholders, the stockholder should be permitted to file and maintain a suit for injuries sustained as a stockholder and as an individual.”287 Therefore, because the plaintiffs had alleged violation of the antitrust laws that arguably established a legal duty to themselves, they would be permitted to pursue an individual claim that involved actions that harmed the company. “We are in entire accord with the proposition that the well-recognized rules of law and equity should not be so strictly construed as to produce an irremediable situation or a total failure of justice, but, under proper pleadings and proof, those rules should, if necessary, be relaxed to promote the ends of justice and to furnish the litigant a forum in which to redress his alleged wrongs.”288 The Court did express skepticism as to whether the plaintiffs had actually established antitrust violations as to themselves, but because the case was to be remanded for new trial in any event, the Court merely noted the suggestion that, “in our opinion, plaintiffs have not, in the development of this phase of the case, sufficiently complied with the exceptions to the general rule herein stated.”289

B. Re-examining Cates v. Sparkman

In the landmark case of Cates v. Sparkman,290 the Texas Supreme Court upheld the dismissal of a minority shareholder’s lawsuit against the corporation and its directors and other shareholders for damages caused to the shareholder resulting from the decision to cease business operations and liquidate the corporation. The plaintiff filed suit claiming that the corporation and the other defendants breached duties owed to him as a shareholder. The defendants answered by general demurrer and special exceptions, and the trial court dismissed the lawsuit. The plaintiff appealed, and the Supreme Court affirmed the dismissal.

In the opinion, the Court wrote the classic statement of the business judgment rule in Texas:

It may be safely said that courts of equity have not, as a general rule, been disposed to exercise their jurisdiction through suits like the present to control or interfere in the management of the corporate or internal affairs of an incorporated company. The company’s business is left to the direction of the officers or managing board which, by the law creating it, may be clothed with the power and discretion to conduct its affairs in the manner which, in their judgment, is best calculated to promote its interests.291

. . . .

287 37 S.W.2d at 150–51. 288 Id. at 150. 289 Id. at 151. 290 11 S.W. 846 (Tex. 1889). 291 Id. at 848.


[I]f the acts or things [challenged by the plaintiff shareholder] are or may be that which the majority of the company have a right to do, or if they have been done irregularly, negligently, or imprudently, or are within the exercise of their discretion and judgment in the development or prosecution of the enterprise in which their interests are involved, these would not constitute such breach of duty, however unwise or inexpedient such acts might be, as would authorize the interference by the courts at the suit of a stockholder.292

The Cates opinion is significant in three respects: First, it is the “seminal”293 case in Texas describing the business judgment rule, has been cited consistently as authority for that legal doctrine for more than 125 years,294 and has recently been reaffirmed by the Texas Supreme Court as the leading Texas authority in that regard.295 Second, it describes the procedural elements necessary to bring a common-law shareholder’s derivative claim, which requirements have now been codified and superseded by statute.296 Third, it describes the kinds of claims that a shareholder may bring individually against the corporation for corporate actions that damage him personally as a shareholder. This last aspect of the opinion has been largely overlooked by Texas courts, but is of renewed importance in determining whether existing common law fills the gaps created when Ritchie eliminated shareholder oppression as an individual cause of action for damage done personally to minority shareholders.

1. Facts

Distinguishing the holding in Cates v. Sparkman regarding individual claims from the holding regarding derivative claims requires careful scrutiny of the procedural posture of the case, the Court’s reasoning, and the precise wording of the holding. The plaintiff in Cates was a shareholder in Wise County Coal Company and brought suit in his individual capacity against that corporation, together with its officers, directors, and the remaining shareholders. The plaintiff claimed to have been the owner of certain tracts of land and the lessee of others that contained valuable coal deposits. He and the other individual defendants entered into an agreement to form a corporation for the purpose of developing the deposits. The plaintiff conveyed the land and leasehold interests to the corporation in exchange for stock. The defendants were unsuccessful in raising sufficient capital, and “after the defendants had expended about $15,000 in money, employed hands, purchased machinery, and placed the plaintiff in charge of the mines, as superintendent, to develop the same, the work under the directors continued for about two months, when, against his prote[s]t, some of the hands were discharged; []. . .the work was then continued for four months; and, at the expiration of that time, the development of the mines was arrested, and the machinery sold to one [shareholder]

292 Id. at 849. 293 Sneed v. Webre, 465 S.W.3d 169, 182 (Tex. 2015). 294 See Gearhart Indus., Inc. v. Smith Int’l, Inc., 741 F.2d 707, 721 (5th Cir. 1984); TTT Hope, Inc. v. Hill, No.

H-07-3373, 2008 WL 4155465 (S.D. Tex. Sept. 2, 2008); F.D.I.C. v. Benson, 867 F. Supp. 512, 515 n.2 (S.D. Tex. 1994); Pace v. Jordan, 999 S.W.2d 615, 623 (Tex. App.—Houston [1st Dist.] 1999, pet. denied); Langston v. Eagle Publ’g Co., 719 S.W.2d 612, 617 (Tex. App.—Waco 1986, writ ref’d n.r.e.).

295 Sneed, 465 S.W.3d at 173, 178–88. 296 Id. at 186.


of the company.”297 The plaintiff, having given up his valuable minerals interests holdings, was left only with worthless stock.

The plaintiff’s suit was based on two legal theories: the defendants’ “fraudulent acts” to devalue his stock and obtain his coal mining assets, and “their failure to comply with their contract” under which he originally invested his assets into the corporation.298 On the fraud claim, plaintiff’s petition alleged that the conduct of the directors “from the beginning were done for the purpose, and with the intent, to defraud plaintiff out of his property,” that the decision to cease operations was “for the purpose of financially ruining plaintiff, and defrauding him out of his property,” and that the “object of said defendants was to depreciate said stock and acquire the whole of said property for a nominal consideration.”299 On the contract claim, the plaintiff’s petition alleged that “plaintiff has complied with his part of the agreement” and that “defendants had refused to comply with their part of said agreement; that, by such failure and refusal, they have damaged plaintiff.”300 The plaintiff requested the relief of canceling his shares and an award of damages.301

2. Holdings

Cates v. Sparkman was not a derivative suit. It was a direct claim by a shareholder in his individual capacity asserting the violation of legal duties owed directly to himself—fraud and breach of contract. In rejecting those claims, the Texas Supreme Court also explicitly recognized the existence and validity of such an individual claim and such duties, in “a proper case.”302 In order to understand the reasoning of the Court in the Cates opinion, it is necessary to look at Evans v. Brandon,303 a similar case decided by the Texas Supreme Court just eight years prior to Cates v. Sparkman.

In Evans, the plaintiff was a shareholder in Texas Banking and Insurance Company and brought suit against the members of the board of directors of that corporation, claiming that “in the conduct of the company’s business the defendants were so careless, negligent, reckless, and imprudent in making loans and discounts, permitting the same to be made by the subordinate officers of the bank, as to impair the capital of the company to the amount of $170,000, and cause a depreciation of more than $50 per share in the market value of the stock, including the shares held and owned by plaintiff.”304 The plaintiff sought damages in the sum of $3,760 for the depreciation in the value of his stock.305 The Supreme Court made short work of the plaintiff’s suit, holding: “On principle and authority, it is clear that the liability of directors for a breach of duty that injures the corporate property as a whole, is primarily to the corporation whose agents they are.”306 The Court held that the plaintiff could not assert these claims in his

297 Cates, 11 S.W. at 849. 298 Id. at 847. 299 Id. 300 Id. 301 Id. 302 Id. at 849. 303 Evans v. Brandon, 53 Tex. 56 (1880). 304 Id. at 57. 305 Id. at 58. 306 Id. at 60.


individual capacity:

A recovery by the corporation for such an injury would inure to the benefit of its stockholders, and in that way, they would be compensated for the indirect injury received. If the corporation refuses to sue, or is still under the control of the directors sought to be held responsible, a stockholder may maintain an equitable proceeding ‘to protect the interest of the corporation as the trustee for all its stockholders and creditors.’

A fatal defect in the plaintiff’s petition, both original and amended, is, that it seeks no recovery in behalf of the corporation, but seeks a direct recovery of damages for the plaintiff individually, the case stated not entitling him to such a recovery.307

It would seem that the plaintiff’s claim in the Cates case suffered the same “fatal defect.” The first of eleven special exceptions filed by the defendants was that “an action of this kind cannot be maintained against the directors for damages to corporate property or stock, except in the name of the company.”308 The Cates Court was clearly aware of the Evans decision, citing it twice.309 Had the Supreme Court in Cates believed that there were no legal duties owed to individual shareholders, and that shareholders could not bring suit in their individual capacities for damage to the value of their shares, the Court would simply have upheld the dismissal on the basis of the defendants’ first special exception and written a very short opinion, as it had done in Evans. It did not do so.

The Cates Court stated, “Applying to the petition the most liberal and reasonable construction of which its language is susceptible, there are but two aspects in which the case made by it can be properly considered.”310 The case was either a claim by an individual shareholder against the corporation seeking damages for loss of the value of his shares caused by the misconduct of the officers,311 or it was a claim by an individual shareholder against the corporation seeking cancellation of his shares and damages (i.e., rescission of the subscription agreement and restitution of the consideration) based on breach of the contract by which the plaintiff acquired his shares.312 Neither of these alternatives describes a derivative claim asserted on behalf of the corporation. In both instances, the Court recognizes that there are situations in which a plaintiff would be able to assert a direct claim on his own behalf for damage done to himself as a shareholder under either a claim for breach of legal duties owed by the corporation to the shareholder or for breach of a contract to which the shareholder is a party.

307 Id. at 60–61 (citations omitted). 308 Cates v. Sparkman, 11 S.W. 846, 847 (Tex. 1889). 309 Id. at 849–50. 310 Id. at 848. 311 Id. 312 Id. at 850. This notion that individual duties arise either from contract or other tort duty is repeated in

subsequent cases acknowledging that there are exceptions to the rule that shareholders may only sue derivatively for wrongful conduct that results in damage to the value of their shares. See, e.g., Massachusetts v. Davis, 168 S.W.2d 216, 222 (Tex. 1942) (noting the “exception to the above rule, where the wrongdoer violates a duty arising from contract or otherwise, and owing directly by him to the stockholder.”) (emphasis added).


The Court first analyzed the validity of the plaintiff’s “fraud” claim—”[t]reating it first as a suit in equity by an individual stockholder of shares in an incorporated company, against the latter [that is, against the company], to recover damages for the depreciation in the value of his stock and the corporate property, occasioned by the fraudulent practices and conduct of the officers and directors.”313 The plaintiff’s argument was that “such a suit may be brought when said officers have fraudulently conspired together to take advantage of plaintiff, or where they have fraudulently misapplied corporate property or funds, and the stockholder has suffered loss by depreciation in the value of his stock, or special damage, when the corporation refuses to sue, or the allegations are such as show a virtual refusal by the company to sue,”314 which is plainly wrong because these elements describe a derivative suit—an “equitable proceeding to protect the interest of the corporation as the trustee for all its stockholders and creditors,” as the Supreme Court had described in Evans.315

The Court’s analysis following this statement is somewhat confusing because the Court accepts without examination the plaintiff’s position that the individual claim for fraud against the company required satisfying the three elements necessary for a derivative claim. “The concurrence of three things is regarded as indispensable as the basis for such a suit: The company must refuse to sue; there must be a breach of duty; there must be injury to the stockholder.”316 However, the Court does this with the proviso that is determining whether the plaintiff’s petition satisfies its own theory because the authorities cited were not “altogether reconcilable.”317 The Court’s application of the rule is telling. The first element, demand futility, was “comparatively free from difficulty” as the plaintiff is claiming that the entire board was guilty of wrong-doing.318 The “more serious question arises” as to whether the plaintiff has adequately pleaded breach of duty and harm.319 In analyzing whether or not a breach of duty has been alleged, the Court clearly articulates the business judgment rule that actions that are “done irregularly, negligently, or imprudently, or are within the exercise of their discretion and judgment in the development or prosecution of the enterprise” are not a breach of duty “however unwise or inexpedient such acts might be,”320 and that shareholders may not bring a lawsuit just because they “might be dissatisfied with the progress of the work or enterprise in which the company was engaged, or the manner in which it might be conducted by the directors or board authorized to conduct it . . . upon the ground that the enterprise or work of the company was not being carried on, or was being delayed or arrested in a manner not, in his judgment, conducive to the interests of stockholders.”321 But, nowhere does the Court inquire as to whether the board members were disloyal to the corporation or “fraudulently misappropriate[d] the corporate property in any manner, or obtain[ed] any undue advantage, benefit, or property for themselves by contract, purchase, sale, or other dealings under cover of their official functions, or in any manner commit[ted] a breach of their

313 Cates, 11 S.W. at 848 (emphasis added). 314 Id. 315 Evans, 53 Tex. at 60. 316 Cates, 11 S.W. at 849. 317 Id. at 848 (“[Q]uestion then is, are the allegations sufficient to maintain this character of suit, when tested by

the rules condensed from a comparison of the authorities not altogether reconcilable in this class of cases.”). 318 Id. at 849. 319 Id. 320 Id. 321 Id.


obligations” to the corporation,322 which omission is surprising given that the petition specifically alleged that the “object of said defendants” was to “acquire the whole of said property for a nominal consideration” and that the defendants had “sold all tools and machinery to defendant Carpenter for less than their value.”323 However, the plaintiff did not sue for that alleged misappropriation of corporate property; he sued only for his own individual loss. The Court rejected the plaintiff’s petition as not stating a breach of duties based on the fact that the conduct about which he complained constituted nothing more than actions that “the majority of the company have a right to do,”324 not because the plaintiff had failed to allege a breach of duty to the corporation, but because the plaintiff had failed to allege any “illegal exercise of discretion subversive of the plaintiff’s rights.”325 Likewise, on the third element of harm, the Court concludes, not that the petition had failed to allege harm to the corporation, but that the petition had not adequately alleged individual harm to the plaintiff: “The value of the plaintiff’s stock is at no time clearly stated, nor what its value would have been if the undertaking had been successful.”326

It is important to keep in mind throughout the discussion that the case was not brought as a derivative action; it was brought individually by the plaintiff for damages suffered by him personally as a result of the loss of the mining assets he invested. The plaintiff asserted no claim for harm to the company, only for harm to the plaintiff. The plaintiff pleaded no cause of action on behalf of the company; rather, the company was a defendant from which the plaintiff was seeking damages. The Court makes clear in the second sentence of the opinion that it is analyzing the claim as “a suit in equity by an individual stockholder of shares in an incorporated company, against the latter [against the company], to recover damages for the depreciation in the value of his stock and the corporate property, occasioned by the fraudulent practices and conduct of the officers and directors”327—a claim by a shareholder against the corporation for damage done to the shareholder, not a claim by a shareholder on behalf of the corporation for damage done to the corporation. And, most importantly, the holding of the Court was not that the claim should have been brought derivatively, as had been the holding in Evans, but that the “the petition does not allege such facts as would authorize the suit by plaintiff, as an individual stockholder, against the company for damages in the depreciation of the value of his stock.”328

322 Id. at 848. 323 Id. at 849. 324 Id. 325 Id. This aspect of the opinion bears careful scrutiny. The holding is not that the business judgment rule

shields fraudulent conduct by the directors against a shareholder. The plaintiff’s theory was that the directors’ management of the entire business was done for the purpose of fraudulently inducing the plaintiff to trade his property for stock and then using their control over the corporation to render the stock worthless, shut down the corporation, and obtain its assets. Id. Interestingly, the opinion does not describe what happened to the minerals interests after the corporation shut down, although indicate that one of the defendant shareholders acquired the machinery. Nevertheless, the Cates opinion should not be read to state that the business judgment rule would be a defense to such a theory of liability. On the contrary, the Court clearly states that courts do not defer to corporate management on claims of fraud. See id. Rather, the holding should be understood to be that the facts pleaded in the plaintiff’s petition did not state a claim for fraud against the shareholder, but at best described a claim of negligent breach of the duty of care that directors owe to the corporation, and that the business judgment rule would bar such a claim for negligence.

326 Id. at 849–50. 327 Id. at 848. 328 Id. at 850. A claim “by plaintiff, as an individual stockholder, against the company for damages in the


In defining such individual claims, the Court states that the general policy not to interfere with the authority of the management of a corporation to conduct business329 is subject to certain exceptions.330 Two categories of such claims “justify the interposition of the courts.”331 First, there are derivative claims, which the Court defines as claims against officers and directors for harm to the corporation caused by “negligence or culpable lack of prudence, or a failure to exercise their functions, or fraudulently misappropriate[ing] the corporate property in any manner, or obtaining] any undue advantage, benefit, or property for themselves . . . or in any manner commit[ing] a breach of their obligations,”332 which claims must be brought by the corporation, no matter what the indirect loss may be suffered by the shareholder, or by a shareholder “suing representatively for all others similarly situated,” if, and only if, the corporation refuses to bring the suit.333 Second, in certain limited circumstances, an individual shareholder may bring a direct claim for “damage in the depreciation of his stock”:

The breach of duty or conduct of officers and directors which would authorize, in a proper case, the court’s interference in suits of this character is that which is characterized by ultra vires, fraudulent, and injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such interference, would leave the latter remediless.334

depreciation of the value of his stock” is not a quaint nineteenth-century way of saying “derivative suit.” An earlier passage in the opinion that unambiguously refers to a derivative suit characterizes such an action as an “equitable suit against the wrong-doing directors or officers for relief [that] can be maintained by an individual shareholder suing representatively for all others similarly situated.” Id. at 849. Other opinions by the same court written at about the same time refer to derivative actions as an “equitable proceeding [brought by a shareholder] ‘to protect the interest of the corporation as the trustee for all its stockholders and creditors.’” Evans, 53 Tex. at 60–61 (seeking “recovery in behalf of the corporation [and not] a direct recovery of damages for the plaintiff individually”); Becker v. Dirs. of Gulf City State Ry. & Real Estate Co., 15 S.W. 1094, 1097 (Tex. 1891) (suit seeking a recovery “for the use and benefit of the company”). The statement that the lawsuit in Cates was by “an individual stockholder against the company for damages” means exactly what it says.

329 Cates, 11 S.W. at 848. 330 Id. (“To justify the interposition of the courts there must exist, as a foundation for such suit, some action—a

threatened action of such board or officers which is beyond the power conferred by its charter—or such fraudulent transaction completed, contemplated among themselves, or with others, as will result in serious injury to the stockholders suing.”).

331 Id. 332 Id. at 848. 333 Id. at 848–49 (“Where the directors or officers, or some of them, cause a loss of corporate property by

negligence or culpable lack of prudence, or a failure to exercise their functions, or fraudulently misappropriate the corporate property in any manner, or obtain any undue advantage, benefit, or property for themselves by contract, purchase, sale, or other dealings under cover of their official functions, or in any manner commit a breach of their obligations, then the corporation is the party to bring the suit in equity; and whatever be the nature of the wrong in cases of this character, whether intentional or fraudulent, or resulting from carelessness, negligence, or imprudence, and whatever may be the indirect loss occasioned to individual stockholders, no equitable suit against the wrong-doing directors or officers for relief can be maintained by an individual shareholder suing representatively for all others similarly situated, unless the corporation, either actually or virtually, refuses to prosecute.”).

334 Id. at 849.


This often-quoted335 (or misquoted) sentence does not describe the limits of the business judgment rule applicable in derivative suits, nor does it describe the threshold requirements for a shareholder to bring a derivative action, and grammatically could not be so interpreted. The sentence describes those kinds of misconduct that would permit suit by a plaintiff, “as an individual stockholder, against the company for damages in the depreciation of the value of his stock.”336

The Court describes three kinds of situations in which an individual shareholder may assert such an individual claim. First, shareholders may sue directly for misconduct “characterized by ultra vires.”337 Second, shareholders may sue directly for “fraudulent” misconduct.338 Third, shareholders may sue directly for “injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such interference, would leave the latter remediless.” This third category cannot mean anything other than a direct action by the shareholder for breach of duties owed to the shareholder. These claims are based on misconduct on the part of “the company or its controlling agency” that are “clearly subversive of the rights of the minority, or of a shareholder”—not for harm to the company or violation of duties to the company but impairment of the “rights of the minority” or even of a single shareholder—and only in situations where, if the individual shareholder could not sue directly, he would be left “remediless.”

The Court reviews of the allegations in the plaintiff’s petition to determine whether the type of misconduct alleged states a “breach of duty authorizing a suit by an individual stockholder for damage in the depreciation of his stock.”339 The lawsuit was based on decisions by the directors in running the business, “[b]ut it is not alleged that this was done in any manner other than that which the directors may have had a right to do, or ought to have done,”340 and there was no allegation consistent with “fraud, oppression, or abuse of power.”341 The Court concludes that the “character of fraudulent practices, oppressive conduct, abuse of power, and an illegal exercise of discretion subversive of the plaintiff’s rights are not shown on the part of the officers and directors of the company which are held to be necessary to maintain a suit of this kind”342—again, “this kind” of suit, the Court states repeatedly, is an individual claim by a shareholder against the company. The Court holds: “As the case is presented, we are of the opinion that the petition does not allege such facts as would authorize the suit by plaintiff, as an individual stockholder, against the company for damages in the

335 Tow v. Bulmahn, No. 15-3141, 2016 WL 1722246, at *11 (E.D. La. Apr. 29, 2016); Resol. Trust Corp. v.

Norris, 830 F. Supp. 351, 356 (S.D. Tex. 1993); Villasana v. Patout, Cannon & Co., No. 01-98-00109-CV, 1999 WL 1018160, at *7 (Tex. App.—Houston [1st Dist.] 1999, no pet.); Langston v. Eagle Publ’g Co. 719 S.W.2d 612, 617 (Tex. App.—Waco 1986, writ ref’d n.r.e.).

336 Cates, 11 S.W. at 850 (emphasis added). 337 That was the law then and now. TEX. BUS. ORGS. CODE ANN. § 20.002(c)(1) (West 2006). 338 Fraud on a shareholder is always a direct action. In re Seven Seas Petroleum, Inc., 522 F.3d 575, 586 (5th

Cir. 2008). 339 Cates, 11 S.W. at 849. 340 Id. 341 Id. 342 Id.


depreciation of the value of his stock, and injury to the corporate property.”343

Finally, the Court turns to the plaintiff’s other individual claim, breach of contract: “Treating the case as one for damages for the breach of a contract by the defendants, and for the recovery of prospective profits which might have been realized if the contract to develop the mines and construct the railroad had been carried out . . . .”344 The problem with this claim is not want of a duty, but proof of damages. “[I]t is only necessary to say that what his stock would have been worth, and the probable enhanced value of the corporate property if the enterprise embarked in had been successful, are elements of damage too remote to form the basis for a recovery, even if they had been alleged with sufficient certainty.”345

3. Subsequent Treatment

The language used by the Cates court to describe the few types of situations in which a shareholder has an individual cause of action against the company has been grossly misconstrued in some subsequent cases. In Langston v. Eagle Publishing Co.,346 the court indicated that a shareholder had standing to bring a derivative action only in the extremely narrow instances where Cates had ruled the shareholder had an individual claim:

Before a shareholder can bring a derivative suit in the right of a corporation, . . . the shareholder must plead and prove that the board of directors’ refusal to [pursue the claim] was ‘characterized by ultra vires, fraudulent, and injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such interference, would leave the latter remediless.’347

On its face, the statement could not possibly mean that. A derivative suit is brought by the shareholder on behalf of the corporation against officers and directors who have violated duties to the corporation that resulted in harm to the corporation. Requiring the shareholder to plead and prove that “the company or its controlling agency [had] clearly subvert[ed] of the rights of the minority, or of a shareholder” would be wholly immaterial to the corporation’s cause of

343 Id. at 850. The Texas Supreme Court in Ritchie characterized the holding in Cates as “affirming dismissal of

shareholder’s claim against company’s controller for devaluation of shares brought by shareholder individually because right of action belonged to corporation.” Ritchie v. Rupe, 443 S.W.3d 856, 876 n.31 (Tex. 2014). This shocking misstatement of the case presumably reflects nothing more than a failure to read it. The one thing that the Cates opinion did not do was dismiss the claim because the claim belonged to the corporation. One might argue that Cates was a derivative claim that the Court dismissed as a result of applying the business judgment rule, as other cases have construed the opinion, see infra note 355, but as has been argued here, that construction of the opinion ignores the Court’s own statement of the facts and issues in the case and the wording of the Court’s holding.

344 Cates, 11 S.W. at 850. 345 Id. 346 719 S.W.2d 612 (Tex. App.—Waco 1986, writ ref’d n.r.e.). 347 Id. at 616–17. Accord Pace v. Jordan, 999 S.W.2d 615, 623 (Tex. App.—Houston [1st Dist.] 1999, pet.

denied) (“To show that the decision was governed by something other than sound business judgment, appellants had to prove that the board’s refusal to act was characterized by an ultra vires, fraudulent, and injurious practice, an abuse of power, and an oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such interference, would leave the latter remediless.”).


action. Construing the limited instances in which a shareholder has an individual claim as being the only instances in which a shareholder can bring a derivative action cannot be reconciled with Cates description of a shareholder derivative action just a few pages before in which the Court described a broad range of situations in which “corporation is the party to bring the suit in equity” against officers and directors who “cause a loss of corporate property by negligence or culpable lack of prudence,” fail to exercise their functions, misappropriate the corporate property “in any manner,” obtain “any undue advantage, benefit, or property for themselves,” or “in any manner commit a breach of their obligations.”348 In all of these situations, the corporation may sue the officers and directors, but a “shareholder suing representatively for all others similarly situated,” may not “unless the corporation, either actually or virtually, refuses to prosecute.”349 If a shareholder could bring a derivative suit only after pleading and proving “ultra vires, fraudulent, and injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such interference, would leave the latter remediless,” then a shareholder could not possibly “sue representatively,” when the corporation refuses to do so, in all the situations mentioned in the Cates opinion. This specious construction was recently argued to and rejected by the Texas Supreme Court in Sneed v. Weber.350 Without stating whether or not it had ever been the law that derivative claims were so limited, the Court held that the common-law standing requirements for derivative claims have now been superseded by statute.351

In another regard, the Court’s discussion of Cates in Sneed v. Weber is raises serious questions. The Supreme Court in Sneed made clear that, although the language in Cates had no application as to derivative standing, it may have application in the determination of the merits.

[T]he business judgment rule traditionally is implicated twice within the life cycle of a shareholder derivative proceeding brought on behalf of a corporation. First, the business judgment rule applies to the board of directors’ decision whether to pursue the corporation’s cause of action. Second, 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.352

The Sneed opinion states the principle in Cates that

an officer or director’s breach of duty that would authorize court interference ‘is that which is characterized by ultra vires, fraudulent, and injurious practices, abuse of

348 Cates, 11 S.W. at 848–49. 349 Id. 350 Sneed v. Webre, 465 S.W.3d 169, 180 (Tex. 2015) (“To obtain standing under the defendants’ theory,

Webre would have to plead and prove that the board of directors’ failure to pursue the corporate cause of action was ‘characterized by ultra vires, fraudulent, and injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such interference, would leave the latter remediless.’”).

351 Id. at 186. 352 Id. at 178–79.


power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such interference, would leave the latter remediless’

is still the law.353 “Accordingly, the pronouncement of the business judgment rule in Cates, with respect to breaches of duty, goes ‘in reality to the right of the plaintiff to relief rather than to the jurisdiction of the court to afford it.’”354 Therefore, the question remains as to whether the statement “ultra vires, fraudulent, and injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such interference, would leave the latter remediless” defines the very limited circumstances in which a shareholder may have a direct claim against the corporation or describes the application of the business judgment rule in a derivative claim brought for the benefit of the corporation. Several cases have incorrectly seized on this language as a description of the business judgment rule applied in a derivative action: “Texas courts to this day will not impose liability upon a noninterested corporate director unless the challenged action is ultra vires or is tainted by fraud.”355

In Texas, the business judgment rule protects corporate officers and directors from being held liable to the corporation for alleged breach of duties based on actions that are negligent, unwise, inexpedient, or imprudent if the actions were ‘within the exercise of their discretion and judgment in the development or prosecution of the enterprise in which their interests are involved.’356

The business judgment rule may be interposed as a defense in a suit instituted by the corporation as well as a derivative suit brought on behalf of a corporation.357 There is a huge gulf between not imposing liability on officers and directors when they are merely “negligent, unwise, inexpedient, or imprudent” and only imposing liability on officers and directors when their actions are “characterized by ultra vires, fraudulent, and injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive

353 Id. at 186 (quoting Cates, 11 S.W. at 849). 354 Id. at 187 (quoting Dubai Petroleum Co. v. Kazi, 12 S.W.3d 71, 76–77 (Tex. 2000)). 355 Gearhart Indus., Inc. v. Smith Int’l, Inc., 741 F.2d 707, 721 (5th Cir. 1984); Floyd v. Hefner, 556 F. Supp.

2d 617, 634 (S.D. Tex. 2008). See also In re Life Partners Holdings, Inc., No. DR-11-CV-43-AM, 2015 WL 8523103, at *7 (W.D. Tex. Nov. 9, 2015) (“In addition to being unbiased toward the other defendants, the Outside Directors can have no personal interest in seeing that the derivative claims are dismissed to avoid their own liability.”); Resol. Trust Corp. v. Holmes, No. H-92-0753, 1992 WL 533256, at *6 (S.D. Tex. Aug. 7, 1992) (“[T]he business judgment rule as adopted and applied by Texas courts is not merely a defense to a claim of negligence or breach of fiduciary duty against a corporate debtor.”); Langston v. Eagle Publ’g Co., 719 S.W.2d 612, 616–17 (Tex. App.—Waco 1986, writ ref’d n.r.e.) (explaining that shareholder in derivative suit must do more than show board’s actions were unwise); Zauber v. Murray Savings Ass’n, 591 S.W.2d 932, 936 (Tex. Civ. App.—Dallas 1979, writ ref’d) (“[I]f fraudulent, deceptive, or improper conduct underlies that action a court may declare it invalid.”).

356 Sneed, 465 S.W.3d at 178 (quoting Cates, 11 S.W. at 849). 357 E.g., Game Syss., Inc. v. Forbes Hutton Leasing, Inc., No. 02-09-00051-CV, 2011 WL 2119672, at *2 (Tex.

App.—Fort Worth May 26, 2011, no pet.) (Corporation sued directors for breach of fiduciary duty, fraud, conversion; directors asserting business judgment rule as defense); Pace v. Jordan, 999 S.W.2d 615, 624 (Tex. App.—Houston [1st Dist.] 1999, pet. denied) (Shareholders brought derivative suit against directors for breach of fiduciary duty due to poor investment strategies; directors successfully invoked protection of business judgment rule).


of the rights of the minority, or of a shareholder.” If Cates meant to limit officer and director liability to the corporation only to the latter, then the Court’s other statement that the corporation had a claim against officers or directors who “cause a loss of corporate property by negligence or culpable lack of prudence,” fail to exercise their functions, misappropriate the corporate property “in any manner,” obtain “any undue advantage, benefit, or property for themselves,” or “in any manner commit a breach of their obligations”358 is nonsense. The Texas Supreme Court in Ritchie was at pains to emphasize that officers and directors “owe a fiduciary duty to the corporation in their directorial actions, and this duty ‘includes the dedication of [their] uncorrupted business judgment for the sole benefit of the corporation.’”359 The majority opinion repeats that standard of liability no less than five times.360 The court states that “when a corporate director violates the duty to act solely for the benefit of the corporation . . . minority shareholders are entitled to relief, either directly to the corporation or through a derivative action.”361 The same standard is repeated in Sneed.362 Again the notion that directors are liable directly to the corporation or through a derivative suit whenever they fail to “act solely for the benefit of the corporation” cannot be reconciled with the notion that they are only liable for acts “characterized by ultra vires, fraudulent, and injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder.” Sneed leaves the matter somewhat ambiguous.

C. Re-examining Patton v. Nicholas

The courts of appeals’ opinions that developed the shareholder oppression doctrine363 relied heavily on the significant 1955 Texas Supreme Court opinion in Patton v. Nicholas.364 The Ritchie Court held this reliance was misplaced.365 Nevertheless, the Ritchie opinion made it abundantly clear that Patton is still good law.366

1. Facts

The Patton case involved a Dallas company called the Machinery Sales & Supply Company, which was initially a profitable sole proprietorship owned by the defendant in the case.367 The two plaintiffs were “young salaried employees,” who were each rewarded with a 10% interest in the profits of the company in 1940, which was increased to 20% each in

358 Cates, 11 S.W. at 848–49. 359 Ritchie v. Rupe, 443 S.W.3d 856, 868 (Tex. 2014) (quoting Int’l Bankers Life Ins. Co. v. Holloway, 368

S.W.2d 567, 577 (Tex. 1963)). 360 See id. at 868, 883, 884, 886. 361 Id. at 884. 362 Sneed, 465 S.W.3d at 178 (quoting Ritchie, 443 S.W.3d at 868). 363 See Boehringer v. Konkel, 404 S.W.3d 18 (Tex. App.—Houston [1st Dist.] 2013, no pet.); ARGO Data Res.

Corp. v. Shagrithaya, 380 S.W.3d 249 (Tex. App.—Dallas 2012, pet. denied); Ritchie v. Rupe, 339 S.W.3d 275 (Tex. App.—Dallas 2011), rev’d, 443 S.W.3d 856; Redmon v. Griffith, 202 S.W.3d 225, 234 (Tex. App.—Tyler 2006, pet. denied); Davis v. Sheerin, 754 S.W.2d 375 (Tex. App.—Houston [1st Dist.] 1988, writ denied).

364 279 S.W.2d 848 (Tex. 1955). 365 Ritchie, 443 S.W.3d at 876. 366 See id. at 876, 883–84. 367 Id. at 849.


1943.368 In 1944, the defendant’s attempt to revoke the arrangement was met with the plaintiffs’ insistence that they were partners. Ultimately, the parties entered into a written settlement agreement in August 1945, providing for the incorporation of the business, the issuance of the stock 60% to the defendant and 20% to each of the plaintiffs, and providing that all three would be directors and officers for the initial year and setting their salaries for that year.369 All of this was put into place by October 1945, and within days, “hostilities were resumed.”370 The defendant berated the plaintiffs in front of subordinate employees and circulated reports criticizing the plaintiffs among the employees that the Supreme Court characterized as “not only quite inappropriate and offensive . . . but also a threat that their tenure of office and employment would probably be short.”371 Both plaintiffs resigned in December 1945 and started a competing business as the settlement agreement expressly permitted them to do.372 No dividends were paid over the next six years; the defendant received a generous, but not excessive, salary, while the plaintiffs received nothing at all.373 During this time, “the net worth of the corporation steadily increased, the surplus coming up from zero to about $130,000.”374 In January 1946, the defendant wrote to a third party that “he intended to use his power as majority stockholder arbitrarily to the prejudice of the respondents. The letter also referred to the respondents in defamatory terms such as ‘crooked.’”375 Employees testified at trial that the defendant had made statements to the effect that he would see to it that no dividends would be paid so long as the plaintiffs were stockholders, that he bore strong personal ill will toward the plaintiffs, and that “he would not buy the stock of respondents for even a small fraction of its value or sell his own at any price.”376 The plaintiffs were not re-elected as directors, and were replaced with individuals who were “plainly little more than nominees and representatives” of the defendant.377

The plaintiffs filed suit in 1951 and went to trial on the primary theory that

they were [fraudulently] induced to effect a dissolution of their partnership and transfer money, property and assets of the partnership to the corporation and that the consideration for such had failed, and that the corporation was nothing more or less than a vehicle of fraud to effect and bring about malicious diversion, confiscation, etc., of [plaintiffs’] properties and assets, and that said corporation has been a continuing fraud, and that the corporate entity should be disregarded and set aside and an accounting of all properties, moneys and assets be immediately carried out through a receivership with power to liquidate and divide the business. . . . 378

368 Id. 369 Id. at 849–50. 370 Id. at 850. 371 Id. 372 Id. at 850–51. 373 Id. at 851. 374 Id. 375 Id. 376 Id. at 851–52. 377 Id. at 851. 378 Patton v. Nicholas, 269 S.W.2d 482, 483 (Tex. Civ. App.—El Paso 1954), aff’d in part, rev’d in part, 279

S.W.2d 848 (Tex. 1955). It is interesting to note that this was almost exactly the same theory of liability pleaded by the


The plaintiffs also made claims for damages caused to them by the defendant’s mismanagement and refusal to pay dividends.

The verdict included findings that the parties were partners just before the settlement was made; that [defendant] made the settlement ‘with the intention of wrongfully excluding’ the respondents ‘from the management, control, operation, and sharing of profits in the business’; . . . that he ‘wrongfully dominated and controlled the Board of Directors so as to prevent the declaration of dividends’; that he did this ‘for the sole purpose of preventing [plaintiffs] from sharing in the profits to be derived from the operation of the corporation’ as well as ‘for the sole purpose of depreciating the value of the shares of the stock in said corporation, owned by [plaintiffs], to a lower value than such shares of stock would otherwise have’; that he was ‘guilty of mismanagement of the corporation’ (mismanagement being defined in the charge as ‘bad, improper, or unskillful management, resulting in injury to the corporation’); . . . that [defendant] ‘was acting with malice toward [plaintiffs] in the acts of mismanagement and domination of the Board of Directors; but that he did not cause himself to be paid an excessive salary in the years 1949 and 1950.379

Damages issues were submitted on “the depreciation in value, if any, of the [plaintiff’s] stock” and “the loss of dividends, if any, that should have been paid during such period of time.”380 The jury awarded $110,610 in actual damages and $10,000 in exemplary damages.381 The trial court rendered a judgment on the fraud claim and entered an order that the corporate entity should be disregarded and dissolved and a receiver appointed to liquidate and divide accordingly.382 The trial court disregarded the damages award on the grounds that the plaintiffs were “forced into an election between standing on the agreement and asking for damages, or voiding the agreement and disregarding the corporate entity and asking a return of the property.”383 The court of appeals affirmed.384

2. Holdings

Supreme Court rejected out of hand the “rescission for fraud” claim on which the trial court’s judgment was based and affirmed by the court of appeals385 in part because the plaintiffs “expressly disclaim seeking rescission of that agreement.”386 The Court held that the plaintiff’s theory of the case did not state a fraud claim and that “their real complaint is less that the petitioner misrepresented his true state of mind, than that he later and wrongfully suppressed dividends or mismanaged the corporation or both.”387 Therefore, the Court recast

plaintiff in Cates v. Sparkman. See Cates, 11 S.W. at 847. 379 Patton, 279 S.W.2d at 852. 380 Id. 381 Id. at 849. 382 Patton, 269 S.W.2d at 484. 383 Id. at 485. 384 Id. at 487. 385 Patton, 279 S.W.2d at 852. 386 Id. at 853. 387 Id.


the judgment as one for mismanagement and suppression of dividends and the order of a liquidating receiver as based on those claims. The Court held that the mismanagement claims were not supported by the evidence.388 The Court held that the finding of general domination and control of the board of directors by the majority shareholder did not state a claim.389

“But the finding of his control of the board for the malicious purpose of, and with the actual result of, preventing dividends and otherwise lowering the value (if meaning current sale value in the market place) of the stock of the respondents, is something else.”390 The Court noted that the “evidence as to the wrongful state of mind” was “quite adequate” and that the connection between the malicious intent and the withholding of dividends was “enough.”391 The Court found the “statement of the petitioner about purchasing their stock could not unreasonably be interpreted as indicating a purpose to acquire it eventually for much less than its value.”392

We do believe that, coupling all the circumstances indicating the petitioner’s intent to eliminate the respondents from every connection with the business, and at an unfair sacrifice on their part, with the fact that no dividends were paid in the face of an accumulation of surplus . . . the findings of malicious suppression of dividends must be sustained,

along with the necessarily implied finding that, but for the “wrongful conduct of the [defendant] and the corporation under his dominance, dividends in some substantial amount would have been declared”—although there was no finding as to the amount.393

The Supreme Court stated that a “minority stock interest is far from ‘change left on the counter’” and held that wrongful conduct against that minority interest through “the malicious suppression of dividends is a wrong akin to breach of trust, for which the courts will afford a remedy.”394 However, the “character of the remedy is another question.”395 The trial court had ordered a receiver to liquidate the corporation and distribute its assets on the ground that the incorporation had been fraudulent and could be disregarded, which the court of appeals held was within the trial court’s power and authority to do.396 Approaching the liquidation as an equitable remedy for malicious suppression of dividends, the issue was more complex. The defendant contended that liquidation of a solvent corporation was either “wholly beyond the power of courts” or at least “wholly improper in cases like the present one.”397 After a lengthy

388 Id. 389 Id. 390 Id. 391 Id. 392 Id. 393 Id. at 854. 394 Id. 395 Id. 396 Patton v. Nicholas, 269 S.W.2d 482, 487 (Tex. Civ. App.—El Paso 1954) aff’d in part, rev’d in part, 279

S.W.2d 848 (Tex. 1955). 397 Patton, 279 S.W.2d at 854.


discussion of Texas statutory and case law and authorities from other jurisdictions,398 the Court concluded “that Texas courts, under their general equity powers, may, in the more extreme cases of the general type of the instant one, decree liquidation and accordingly appoint a receiver . . . for this purpose [liquidation] or the less drastic purpose of ‘rehabilitation.’”399 The Court noted the

experience of most lawyers having a substantial business practice will include instances, particularly in the case of small and closely held corporations . . . in which liquidation is about the only adequate remedy for the abused minority stockholder. On the other hand, we agree with the practically unanimous judicial opinion that liquidation of solvent going corporations should be the extreme or ultimate remedy, involving as it usually will, accentuation of the economic waste incident to many receiverships and most forced sales.400

“Wisdom would seem to counsel tailoring the remedy to fit the particular case.”401

Therefore, the Supreme Court vacated the liquidation and receiver and ordered the trial court to substitute a new decree “which will probably give adequate protection to the respondents and at the same time afford both parties a chance to normalize their relationships.”402 The new decree would include a mandatory injunction requiring the corporation and “its dominant officer and stockholder to declare and pay at the earliest practical date a reasonable” and “substantial” dividend, the amount of which would be determined by the court and to pay dividends in the future in amounts “not clearly inconsistent with good business practice.”403 The trial court was to retain continuing jurisdiction for up to five years “for the more adequate and convenient protection of the rights of the respondents”404 and to punish any “bad faith toward the decree or toward the respondents or either of them in their position of minority stockholders” both with the power of contempt and the option to order the liquidation of the corporation.405 “We regard this latter provision as fair and even necessary, considering the malicious character of the misconduct heretofore involved and the consequent possibility of its repetition.”406

The Supreme Court affirmed the denial of damages, but for a different reason than the trial court and the court of appeals. The Court held first that “there could be no even temporary devaluation of the stock in the ordinary sense, since it evidently never had a market,” and there was no evidence of any price for which the plaintiffs could have sold the stock.407 Furthermore, because the plaintiffs still owned their shares, the equitable relief fashioned by

398 Id. at 854–56. 399 Id. at 856–57. 400 Id. at 857. 401 Id. 402 Id. 403 Id. 404 Id. 405 Id. 406 Id. at 858. 407 Id.


the court would likely make the plaintiffs whole.408 The loss of dividends might have been a real loss had the plaintiffs sold their shares, but the order requiring payment of dividends would result in the plaintiffs receiving the withheld dividends, and any damage award would constitute a double recovery.409 There being no actual damages, the award of exemplary damages was also disregarded.410

Post script: On remand, the trial court entered an order consistent with the Supreme Court’s opinion and appointed a special master to determine the amount of the initial dividend.411 Based on the special master’s report, the trial court entered a judgment requiring the payment of $112,000 in dividends.412 The defendant immediately appealed again, and the court of appeals affirmed and ordered that the dividend accrue interest until paid.413 The Supreme Court refused the writ holding no reversible error.

3. Ritchie’s Treatment

The appellate opinions that developed the shareholder oppression doctrine in Texas looked chiefly to Patton as authority for the existence and flexibility of the courts’ inherent general equitable powers to fashion and order the buy-out remedy.414 The opinion was also very influential and widely cited in leading cases developing the shareholder oppression doctrine in other jurisdictions even prior to recognition of the doctrine in Texas.415 In Ritchie, the Texas Supreme Court was at pains to re-interpret Patton so as to deny that the opinion supported the development of a shareholder oppression cause of action and to demonstrate that the opinion was in fact consistent with the Ritchie holding. The Court stated: “But Patton involved neither a claim for oppression nor a court-ordered buyout of stock.”416 That statement is essentially accurate. The specific claim in Patton that the Supreme Court upheld was “malicious suppression of dividends,” which shareholder oppression cases have universally held to be a

408 Id. 409 Id. 410 Id. 411 Patton v. Nicholas, 302 S.W.2d 441, 442 (Tex. Civ. App.—Waco 1957, writ ref’d n.r.e.). 412 Id. 413 Id. at 443. 414 See, e.g., Kohannim v. Katoli, 440 S.W.3d 798, 816 (Tex. App.—El Paso 2013, pet. denied), disapproved

by, Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014) (“Wisdom to seem to counsel tailoring the remedy to fit the particular case.”); Ritchie v. Rupe, 339 S.W.3d 275, 286–87, 289 (Tex. App.—Dallas 2011), rev’d, 443 S.W.3d 856 (“Texas law authorizes the trial court, in an appropriate case, to order a buyout of an oppressed minority shareholder as an equitable remedy for shareholder oppression.”); Allchin v. Chemic, Inc., No. 14-01-00433-CV, 2002 WL 1608616, at *7 (Tex. App.—Houston [14th Dist.] July 18, 2002, no pet.); Davis v. Sheerin, 754 S.W.2d 375, 379–80, 383–84 (Tex. App.—Houston [1st Dist.] 1988, writ denied), disapproved by, Ritchie, 443 S.W.3d 856 (discussing Patton and concluding that Texas courts “may decree a buy-out in an appropriate case where less harsh remedies are inadequate to protect the rights of the parties.”).

415 See, e.g., Donahue v. Rodd Electrotype Co., 328 N.E.2d 505, 513, 514, 515 (Mass. 1975) (Patton cited for the proposition that “the power of the board of directors, controlled by the majority, to declare or withhold dividends and to deny the minority employment is easily converted to a device to disadvantage the stockholders.”); Baker v. Com. Body Builders, Inc., 507 P.2d 387, 395 n.24, 396 n.27 (Or. 1973) (protecting the minority shareholder without appointing receiver); Gimpel v. Bolstein, 477 N.Y.S.2d 1014, 1022 (N.Y. App. Div. 1984) (court ordered mandatory injunction, with “dissolution being one of the remedies for contempt”).

416 Ritchie, 443 S.W.3d at 876.


type of shareholder oppression,417 but which did not involve the reasonable expectations analysis at issue in the oppression cases. Also, Patton did not order a buy-out, nor was one requested. The legal proposition for which the shareholder oppression cases cited Patton as authority was that the court had broad, general equitable powers to fashion an appropriate remedy and that the scope of those powers included the buy-out remedy. If the court has general equitable powers to liquidate a corporation, or to appoint a receiver to rehabilitate the corporation, or to order the controlling shareholder to vote to declare dividends and retain jurisdiction for five years to make sure that he did so, then a court could certainly order a corporation or a majority shareholder to purchase the minority shareholder’s shares. Nothing in Ritchie questions that conclusion.

The difficulty for the Ritchie analysis was not Patton’s holding regarding the equitable powers to fashion a remedy, but the legal basis for imposing that remedy. Equitable remedies must be connected to a legal right and a cause of action for violation of that right.418 What was the legal right and the cause of action in Patton? If Patton recognized the existence in Texas common law of a minority shareholder’s legal right to dividends (under some circumstances) and the shareholder’s individual standing to bring a lawsuit for the violation of that right, then Texas law would have already recognized a common-law cause of action for oppression419 (of sorts), and the Ritchie court’s public policy discussion as to whether it should create such a new cause of action420 would have been superfluous. The majority in Ritchie solved that problem by assuming, with minimal analysis of the Patton opinion, that the plaintiff in Patton had brought a derivative claim for violation of the defendant’s fiduciary duties to the corporation.421 Does that conclusion follow from a fair reading of the Patton opinion?

417 See, e.g., Redmon v. Griffith, 202 S.W.3d 225, 235 (Tex. App.—Tyler 2006, pet. denied), disapproved by,

Ritchie, 443 S.W.3d 856 (malicious suppression of dividends constituted shareholder oppression); Davis, 754 S.W.2d at 382, disapproved by, Ritchie, 443 S.W.3d 856 (malicious suppression of dividends is a common squeeze-out technique); Morrison v. St. Anthony Hotel, 295 S.W.2d 246, 252 (Tex. Civ. App.—San Antonio 1956, writ ref’d n.r.e.).

418 See Gibbons Mfg. Co. v. Milan, 17 S.W.2d 844, 846 (Tex. Civ. App.—Texarkana 1929, no writ) (“Consequently it is a well-established rule that, in order to authorize the appointment of a receiver, it is essential that there shall be at the time of the appointment a suit pending in which relief other than the mere appointment of the receiver is sought.”).

419 The Ritchie opinion dismisses the notion that any such claim exists: “The Patton opinion uses the word ‘oppression’ only once, when describing the kind of future conduct that a rehabilitative receivership may be designed to prevent, in the context of a New Jersey case involving fraud claims by one corporate director against two other corporate directors.” Ritchie, 443 S.W.3d at 884 n.48. However, the Court ignores the fact that Cates uses the term “oppression” three times, all clearly referencing an existing cause of action. See Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889). The reference in Patton is not a quote of some New Jersey opinion, as the Ritchie opinion seems to imply, but a clear statement by the Patton Court of an appropriate basis for the use of the court’s equitable powers:

Wisdom would seem to counsel tailoring the remedy to fit the particular case. As suggested in Laurel Springs Land Co. v. Fougeray, equity may, by a combination of lesser remedies, including exercise of its practice of retaining jurisdiction for supervisory purposes and reserving the more severe measures as a final weapon against recalcitrance, accomplish much toward avoiding recurrent mismanagement or oppression on the part of a dominant and perverse majority stockholder or stockholder group.

Patton v. Nicholas, 279 S.W.2d 848, 857 (Tex. 1955). 420 Ritchie, 443 S.W.3d at 877–91. 421 Id. at 884 (“we treated that claim as being brought by the shareholders on behalf of the corporation”).


The Ritchie Court argues that “the cases on which we relied [in Patton]”—Cates v. Sparkman422 and Becker v. Directors of Gulf City Street Railway & Real–Estate Co.423—”indicate that we treated that claim as being brought by the shareholders on behalf of the corporation.”424 The Patton opinion refers to Cates and Becker twice: first, as authority for the proposition “Undoubtedly the malicious suppression of dividends is a wrong akin to breach of trust, for which the courts will afford a remedy. A minority stock interest is far from ‘change left on the counter’-to quote the petitioner’s own written comment about the settlement,”425 and, second, noting that the language in Cates and Becker “seems to recognize a minority right to receivership in cases of gross or fraudulent mismanagement, although without particular reference to whether liquidation or something else is to follow.”426 Neither reference gives the slightest hint that the action in Patton was brought derivatively or needed to be. Cates has already been dealt with at length. It was not a derivative action, although it discussed derivative actions. Its holding was not based on the failure to bring the claim derivatively but the failure to allege misconduct that violated a duty to the individual shareholder. Cates acknowledged that minority shareholders had the ability both to bring claims on behalf of the corporation in a representative capacity, when it refused to do so, and in certain instances to bring their own claims against the company to vindicate violation of their own rights when they otherwise would be left without a remedy. No language in Cates mentions suppression of dividends, breach of trust, or receivers, but the overall tenor of the case is clearly that minority shareholder rights are valuable and will be protected by the law.

Becker is a different kind of case and warrants close scrutiny given the importance that Ritchie placed on that opinion in interpreting Patton. Becker was brought by 33 shareholders of the Gulf City Street-Railway and Real-Estate Company, of Galveston, Texas.427 The lawsuit alleged that the directors of their company had illegally consolidated that corporation into the Galveston City Railroad Company, also of Galveston, and “by means of which they had fraudulently and unlawfully seized and taken possession of the rights, properties, and franchises of the Gulf City Street-Railway and Real-Estate Company [and had] appropriated and converted the same to their own use and benefit . . . contrary to law and the terms and conditions of the charter.”428 The plaintiffs sought to unwind the merger, to restore the property to their original corporation, and to have a receiver appointed to obtain and restore the corporation’s property. The original and amended petition sought only relief on behalf of the

422 Cates, 11 S.W. 846. 423 15 S.W. 1094 (Tex. 1891). 424 Ritchie, 443 S.W.3d at 884 (citing Patton, 279 S.W.2d at 854). 425 Patton, 279 S.W.2d at 859. The “change on the counter” quote does not come from either opinion but from

a letter written by the defendants which was quoted by the court of appeals:

You can also believe me that I paid them plenty good money. In fact, enough that as the business was incorporated they had better than $100,000.00 worth of stock due them, although a lot of my $75,000.00 bait money to save the business went into their stock. On the other hand, and what they could not figure in advance was that the $112,000.00 worth of stock they received could be change that they left on the counter.

Patton v. Nicholas, 269 S.W.2d 482, 484 (Tex. Civ. App.—El Paso 1954), rev’d in part on other grounds, 279 S.W.2d 848.

426 Patton, 279 S.W.2d at 854. 427 Becker, 15 S.W. at 1094. 428 Id. at 1094–95.


plaintiffs individually, but a second amended petition added claims on behalf of the original corporation.429 The Texas Supreme Court noted that “the petition was of a somewhat dual character. The plaintiffs asked for the receiver in their own rights as stockholders, and for a recovery for the benefit of the company. This latter ground was set up to obviate the objections made by the demurrers which were sustained in this particular to the first amended petition.”430 The claims for recovery on behalf of the corporation were clearly derivative claims, but the request for a receivership was at first an individual claim and appears to have remained so (in the alternative). The defendants argued that the derivative claims were time-barred because the second amended petition was filed more than two years after the merger. The Supreme Court held, in essence, that the second amended petition related back to the original petition because the relief sought by the plaintiffs always recognized the rights of the original corporation to its property and had sought a receiver to restore that property to the original corporation from the consolidated corporation.431 “Their avowed and manifest object was to restore the company to its original charter basis, and to the enjoyment and use of its property and franchises in accordance with the charter.”432 Therefore, the receivership sought in Becker was very different from that sought in Patton, which was for the purpose of liquidation and thus adverse to the corporation. In addition to the holding under the relation back doctrine, the Becker Court also noted that limitations would have been tolled, analogizing the corporation to a trustee for its shareholders: “It may also be noted that in cases of trusts and appropriation of trust property the statute of limitation will not begin to run until the repudiation of the trust is manifest, nor where the fraud of the trustees is concealed, so that it cannot be discovered by reasonable diligence.”433 Twenty-three years later, as will be discussed in much greater depth below, the Texas Supreme Court made this implicit comparison of corporation to trustee explicit in Yeaman v. Galveston City Co.,434 in which the Court held that the relationship between corporation and shareholders “has all the nature of a direct trust,”435 and that the corporation is held to many of the same duties as a trustee, including that “statutes of limitation have no application until there is a clear and unequivocal disavowal of the trust, and notice of it brought to the cestui que trust.”436 Therefore, Becker does mention the concept of trust duties and clarifies the context for Patton’s citation of that case in support of the proposition that “malicious suppression of dividends is a wrong akin to breach of trust.”437

Did the plaintiffs in Patton plead derivative claims? Absolutely nothing in either the reported court of appeals opinion or the Supreme Court opinion states that any claim was brought derivatively or on behalf of the corporation. Neither opinion states that any of the duties at issue were duties owed to only the corporation, as opposed to the minority shareholders. However, there is also no clear statement to the contrary. In the court of appeals,

429 Id. at 1096 (“second amended petition the plaintiffs seek to recover for the use of the company, but in their own names, and as share-owners, whereas in the first they asked the judgment in their own right as shareholders”).

430 Id. at 1097. 431 Id. at 1096–97. 432 Id. at 1097. 433 Id. (relying on two express trust cases, Turner v. Smith, 11 Tex. 620 (1854); Calhoun v. Burton, 64 Tex. 510

(1885)). 434 Yeaman v. Galveston City Co., 167 S.W. 710 (Tex. 1914). 435 Id. at 723. 436 Id. at 723–24. 437 Patton v. Nicholas, 279 S.W.2d 848, 854 (Tex. 1955).


the defendant challenged the “failure of the trial court to segregate the two causes of action, alleging that appellees sued individually and on behalf of the corporation,”438 but it is unclear whether this was merely the defendant’s characterization or was actually how the causes of action were actually pleaded. The court of appeals rejected any error as harmless because “the entire controversy is interwoven.”439 The Supreme Court’s opinion stated that the minority shareholders’ case “must be one for mismanagement of the corporation or misconduct in the handling of its affairs to [the minority shareholders’] prejudice or that of the corporation itself or both,”440 leaving open the possibility that the claims relating to mismanagement were either entirely direct or entirely derivative or a mixture, and never indicating that it made any difference one way or the other. Claims for mismanagement (assuming they survive the business judgment rule) do ordinarily belong to the company and may only be asserted by shareholders derivatively.441 So it is possible that the damages claim for mismanagement was presented derivatively. But what is clear beyond cavil, however, is that the plaintiffs in Patton did assert the individual claims, and what matters for this analysis is whether the Supreme Court imposed the mandatory injunction to pay dividends on the basis of those individual claims or solely on the basis of a derivative claim.

The Ritchie Court characterizes the plaintiff’s claims as “a suit in which a corporation’s two minority shareholders alleged that Patton—the corporation’s majority shareholder, president, and controlling board member—committed fraud and breached his duties to the corporation.”442 The fraud claim was clearly an individual claim.443 That claim was based on the defendant’s inducing the plaintiffs to incorporate their partnership, concerned only pre-incorporation events, and had nothing to do with duties to the corporation. The relief that the plaintiffs sought on their fraud claim was a receivership to liquidate the corporation. An action for liquidating receiver is an individual action brought by a shareholder, not a derivative action.444 A corporation may not seek a liquidating receivership for itself,445 nor may its directors seek one on its behalf,446 nor may a shareholder seek one derivatively.447 The Patton

438 Id. 439 Id. 440 Id. at 852. 441 Wingate v. Hajdik, 795 S.W.2d 717, 718 (Tex. 1990). 442 Patton v. Nicholas, 269 S.W.2d 482, 484 (Tex. Civ. App.—El Paso 1954), rev’d in part on other grounds,

279 S.W.2d 848. 443 Sherman v. Triton Energy Corp., 124 S.W.3d 272, 282 (Tex. App.—Dallas 2003, pet. denied). 444 See Hammond v. Hammond, 216 S.W.2d 630, 633 (Tex. Civ. App.—Fort Worth 1949, no writ) (“Our

conclusion, after considering many of the authorities referred to, is that a court of equity may properly take jurisdiction to wind up the affairs of a corporation and sell and distribute its assets at the suit of a minority stockholder on the ground of dissensions among the stockholders, but that it is only an extremely aggravated condition of affairs that will warrant such drastic action, and that the court will follow such a procedure only when it reasonably appears that the dissensions are of such nature as to imperil the business of the corporation to a serious extent and that there is no reasonable likelihood of protecting the rights of the minority stockholder by some method short of winding up the affairs of the corporation.”) (emphasis added).

445 A court “may appoint a receiver for a corporation on the petition of one or more stockholders of the corporation.” TEX. CIV. PRAC. & REM. CODE ANN. § 64.002(b) (West 1997). However, it “may not appoint a receiver for a corporation, partnership, or individual on the petition of the same corporation, partnership, or individual.” Id. at (a). See also Floore v. Morgan, 175 S.W. 737, 738, 740 (Tex. Civ. App.—Fort Worth 1915, no writ) (“[T]he company itself is prohibited from suing for the appointment of a receiver”).

446 Floore, 175 S.W. at 740 (The suit by the directors of the company was necessarily a suit in behalf of the


Court rejected the fraud claim as a basis for the receivership448 and undertook to determine whether a court had the equitable power to appoint a liquidating receiver on the basis of the remaining claims. The Texas authorities cited by the Court suggested the availability of a receiver in “extreme cases of mismanagement.”449 However, the Court ultimately held that there was no evidence to support the claim of mismanagement.450 Therefore, the specific claims that the Supreme Court noted may have been brought derivatively were emphatically not the basis of the equitable relief awarded.

Turning to the dividends claim, the Court found authority in other jurisdictions to appoint a receiver in egregious cases of withholding of dividends.451 The principal cases relied on in the Patton opinion were the Michigan Supreme Court case of Miner v. Belle Isle Ice Co.452 and the Fourth Circuit case of Tower Hill-Connellsville Coke Co. of W. Virginia v. Piedmont Coal Co.453 Neither of these cases were brought on behalf of the corporation. In Miner, a minority shareholder sued the corporation and the remaining shareholders seeking a receiver to wind up the affairs of the company following seven years of receiving no dividends, while the remaining shareholders received large salaries and rents from the corporation.454 The Court’s opinion makes absolutely clear that the party harmed was the minority shareholder, not the corporation, and the party for whom the relief was granted was the minority shareholder, not the corporation:

Who has any right to complain if ample and complete justice is awarded to Miner [the minority shareholder]? Who should be permitted to stand between him and an

company, and if the company itself is prohibited from suing for the appointment of a receiver, the same inhibition applies to the directors of the company acting in its behalf.).

447 See Johnson ex rel. MAII Holdings, Inc. v. Jackson Walker, L.L.P., 247 S.W.3d 765, 771 (Tex. App.—Dallas 2008, pet. denied). (“[B]ecause the court may not appoint a receiver for a corporation based on the corporation’s own request, the trial court did not err in denying the request for a receiver over MAII made by a shareholder seeking to act on MAII’s behalf.”).

448 Patton v. Nicholas, 279 S.W.2d 848, 852 (Tex. 1955). 449 Id. at 854 (citing Gibbons Mfg. Co. v. Milan, 17 S.W.2d 844, 847 (Tex. Civ. App.—Texarkana 1929, no

writ) (appointment of a receiver “only when necessary to protect the rights of creditors and the minority stockholders.”)); Prairie Lea Prod. Co. v. Tiller, 286 S.W. 638, 641 (Tex. Civ. App.—Austin 1926, no writ) (noting “trend of modern authority favors the inherent power of the court in a proper case to place the affairs of a corporation, at the suit of stockholders, in the hands of a receiver, when the officials are guilty of fraud or neglect”); Falfurrias Immigration Co. v. Spielhagen, 129 S.W. 164, 169 (Tex. Civ. App. 1909, no writ) (power to appoint a receiver to prevent majority from diverting “its entire business to the other concerns in which they are interested, and thus destroy the value of plaintiff’s stock”); Hammond, 216 S.W.2d at 632 (noting “the courts have been comparatively liberal in the appointment of a receiver of a corporation, even though it is a solvent and going concern, where there are such dissensions among the stockholders, directors, or officers that the corporation cannot successfully carry on its corporate functions, imminent danger of loss of assets is threatened, and no other remedy appears to be adequate”). None of these cases appear to have been brought derivatively, with the possible exception of Falfurrias Immigration Co. v. Spielhagen in which the plaintiff brought the suit both “as a shareholder in said corporation, and in its behalf, and for its benefit.” 129 S.W. at 168.

450 Patton, 279 S.W.2d at 853. 451 See id. at 855–56. 452 Miner v. Belle Isle Ice Co., 53 N.W. 218, 224 (Mich. 1892). 453 Tower Hill-Connellsville Coke Co. v. Piedmont Coal Co., 64 F.2d 817, 829 (4th Cir. 1933). 454 Miner, 53 N.W. at 223.


adequate remedy? This corporation has utterly failed of its purpose, not because of matters beyond its control, but because of fraudulent mismanagement and misappropriation of its funds. Complainant [the minority shareholder] has a right to insist that it [the corporation] shall not continue as a cloak for a fraud upon him, and shall no longer retain his capital to be used for the sole advantage of the owner of the majority of the stock, and a court of equity will not so far tolerate such a manifest violation of the rules of natural justice as to deny him the relief to which his situation entitles him. I think a court of equity, under the circumstances of this case, in the exercise of its general equity jurisdiction, has the power to grant to this complainant ample relief, even to the dissolution of the trust relations. Complainant is therefore entitled to the relief prayed. A receiver will be appointed, and the affairs of this corporation would up.455

This point was even more pronounced in Tower Hill, where the corporation was the only defendant in a case brought by individual shareholders seeking a liquidation.456 On appeal, the directors, whose withholding of dividends resulted in the receivership, argued that they were necessary and indispensable parties and should have been joined—which would have resulted in defeating the federal court’s diversity jurisdiction—and the Fourth Circuit held “the defendant corporation itself was the only indispensable party.”457 The court stated that the lawsuit was “an earnest effort by these plaintiffs to rescue at least some part of their investment from an arbitrary, unjust, and tyrannical domination by a ruthless majority—a majority that acts entirely without regard to that trust relationship that exists between a controlling majority and a minority in a stock company.”458 The claim asserted was clearly a claim by the individual shareholders against, not on behalf of, the corporation:

Against the corporate defendant, the plaintiff sought an annulment of its charter, with incidental injunctional relief pending a hearing and decision of that main issue. This was an attack upon the existence of the corporation in which it was vitally interested, which it had to defend, and to which the stockholders and directors were in no sense necessary parties. It was clearly separable from the claim of damages against the individual defendants for acts which they did as directors and stockholders of the old corporation, in which the new corporation was not interested, and to which it could not be required to respond.

. . . .

In this case, the action of which the plaintiffs have reason to complain is the action of the corporation. This action, while controlled by the majority of the stockholders, is

455 Id. at 224. 456 See Tower Hill-Connellsville Coke Co., 64 F.2d at 827 (“If a majority of the shareholders or the directors of

a corporation wrongfully refuse to declare a dividend and distribute profits earned by the company, any shareholder feeling aggrieved may obtain relief in a court of equity.”).

457 Id. at 823. 458 Id. at 824.


the act of the corporation, and not their action, and relief is asked against the corporation and not against them. No rights of theirs will be affected by the action of the court, but only the rights of the corporation. After dissolution is decreed, they can come in and receive the portion of the assets belonging to them and make themselves parties to the suit pro hac vice, but this does not defeat the jurisdiction, for this is what happens in every receivership case.459

Furthermore, under Texas law, the right to dividends is a right belonging to the individual shareholder, not the corporation. In Moroney v. Moroney,460 the court held:

Indeed, in every profitable corporate venture, the rights of the stockholder are of great importance, and at all times will be properly protected, whether in a court of law or equity, according to the exigencies of the situation. The chief value of corporate stock is its right to receive dividends. So important is this right that courts of equity will, in a proper case, compel a payment of dividends.461

Dividends once declared are a debt that the corporation owes to the individual shareholder.462 An action to compel the declaration of dividends is based on the shareholder’s fundamental right to share in the net profits of the corporation, a right incident to the ownership of his stock and belonging to the shareholder individually.463 When dividends are suppressed, the injured party is the shareholder, and that injury is separate and distinct from any injury that the corporation might suffer arising from the same conduct.464 Even if the corporation had its own claim for breach of the directors’ duties, that claim would not be the same claim and would not affect the existence of the shareholder’s claim for his own individual injury.465 Therefore, the action to compel declaration of dividends is an action brought by the individual shareholder, not by the corporation or on its behalf.466

459 Id. at 825. 460 Moroney v. Moroney, 286 S.W. 167 (Tex. Comm’n App. 1926, judgm’t affirmed). 461 Id. at 169; see also Farrington v. Tennessee, 95 U.S. 679, 687 (1877) (listing among the fundamental

aspects of share ownership the entitlement “to share in the dividends and profits.”). 462 Keller v. Keller, 141 S.W.2d 308, 311 (Tex. 1940) (“When dividends are declared the corporation becomes

indebted to the stockholders for the amounts of their respective shares, and are not subject to change merely at the choice of a stockholder.”).

463 See Knapp v. Bankers Sec. Corp., 230 F.2d 717, 721 (3d Cir. 1956) (“The right to dividends is an incident of the ownership of stock. The fact that the distribution of profits cannot ordinarily be enforced until after a dividend has been declared does not detract from the shareholders’ fundamental right to share in the net profits of the corporation. This right is the basis of his suit to compel the declaration of dividends.”).

464 See id. (“If the directors have wrongfully withheld the declaration of dividends the shareholder is the injured party. He shows an injury to himself which is quite apart from any which the corporation might be thought to suffer.”).

465 See id. (“Even if the corporation might under some circumstances have a right of action that fact would not affect the authority of its shareholders to enforce by suit their personal and individual rights to the declaration of a dividend.”).

466 See Morrison v. St. Anthony Hotel, 295 S.W.2d 246, 250 (Tex. Civ. App.—San Antonio 1956, writ ref’d n.r.e.) (“Generally, it is the corporation and not the stockholders which must redress wrongs which weaken corporate values. But in a proper case, where a majority stockholder has abused its discretion and has maliciously suppressed the payment of dividends, a stockholder may assert a cause of action for damages and may compel the declaration of dividends.”). See also Tankersley v. Albright, 80 F.R.D. 441, 445 (N.D. Ill. 1978) (“[T]he now prevailing view is that


The conclusion of the Patton Court was that the remedy of a liquidating receiver, a remedy that the corporation could not request and to which it would be the adverse party, could be awarded for the violation of the rights of the minority shareholder to receive dividends, a right that the corporation does not have. The order to pay dividends, an order no one in Patton requested and which would not in any event have benefitted the corporation, was made within the Court’s equitable power to fashion a less drastic remedy as a substitute for the liquidating receivership. The judgment rendered by the trial court, which the Supreme Court affirmed as modified, was against the majority shareholder and the corporation, not in favor of the corporation.467 The injunction that the Supreme Court ordered on remand was against the majority shareholder and the corporation, not in favor of the corporation.468 The relief granted in the new order did not benefit the corporation in any way, but provided specific and substantial benefits to the individual minority shareholders. The trial court was ordered to retain jurisdiction for up to five years and to liquidate the corporation if the majority shareholder “in any manner operated with bad faith toward the decree or toward the respondents or either of them in their position of minority stockholders.”469 The relief granted in Patton was not on the basis of a derivative claim, and the Ritchie dissent properly took the majority to task for attempting to rewrite the opinion.470

In its effort to support the proposition that the derivative claim is sufficient to address most of the evils that the shareholder oppression doctrine sought to remedy471 and to claim that Patton is consistent with its holding, the majority opinion in Ritchie goes so far as to misstate the liability holding in Patton, claiming that Patton held “majority shareholder liable when he used ‘his control of the board for the malicious purpose of . . . preventing dividends and otherwise lowering the value . . . of the stock of the [minority shareholders].’”472 The language quoted was not the holding of Patton; it was a determination that evidence was sufficient to support the finding that the defendant had used his “control of the board for the malicious purpose of, and with the actual result of, preventing dividends and otherwise lowering the value” of the stock of the plaintiffs.473 The legal remedy that this finding supported was not liability of the majority shareholder to the corporation for such malicious activity toward the corporation, but an injunction against both the majority shareholder and the corporation compelling the corporation to pay dividends to the shareholders—backed up by the penalty of

an action to compel a declaration of dividends is personal, not derivative, because dividends are an incident of stock ownership, the shareholder is the injured party when a dividend is wrongfully withheld and finally because only the shareholder will gain by a judgment for plaintiff.”); Doherty v. Mut. Warehouse Co., 245 F.2d 609, 612 (5th Cir. 1957) (“A stockholder suing to compel the corporation to declare a dividend is enforcing a right common to himself and the other stockholders against the corporation, rather than a derivative right.”); Knapp, 230 F.2d at 721 (“[A] shareholders’ suit to compel the declaration of a dividend must be regarded as brought to vindicate a primary and personal right of the shareholders and not to enforce a secondary right derived from the corporation as the real party in interest. We are compelled to reach this conclusion when we consider who is the injured party, the shareholder or the corporation, and who will be benefited if the action is brought to a successful conclusion.”).

467 Patton v. Nicholas, 279 S.W.2d 848, 857 (Tex. 1955). 468 Id. at 857–58. 469 Id. at 858. 470 See Ritchie v. Rupe, 443 S.W.3d 856, 898 (Tex. 2014) (Guzman, J., dissenting). 471 Id. at 887. 472 Id. at 884 (citing Patton, 279 S.W.2d at 853). It is also important to note that the Supreme Court held that

there was no evidence that the stock value was actually harmed. 279 S.W.2d at 858. 473 Patton, 279 S.W.2d at 853.


liquidating the corporation if the “corporation has been in any manner operated with bad faith toward the decree or toward the respondents or either of them in their position of minority stockholders.”474

In fairness to the majority in Ritchie, however, perhaps we should assume that description of Patton was not an intentional mischaracterization of the opinion but an explanation of how the principles laid down in Patton should be applied going forward—that Ritchie’s treatment of the Patton opinion was not descriptive but prescriptive. Perhaps the Ritchie majority meant that the claims in Patton should have been derivative claims, that the holding was otherwise correct but should have made clear that such a claim must be prosecuted derivatively (again, in fairness, a point apparently not raised by any party before the Supreme Court in Patton). If that is true, then one would have to conclude that it would have to have been a very weird derivative claim indeed. In arguing that the derivative action remedy is sufficient to protect shareholders from wrongful withholding of dividends, the Ritchie Court stated: “Patton demonstrates that when a corporate director violates the duty to act solely for the benefit of the corporation and refuses to declare dividends for some other, improper purpose, the director breaches fiduciary duties to the corporation, and the minority shareholders are entitled to relief, either directly to the corporation or through a derivative action.”475 Further, the Ritchie opinion argued: “As Patton itself demonstrates, the very conduct the dissent claims does not harm the corporation in fact can give rise (and has given rise in the past) to a breach-of-fiduciary-duty claim against the corporate controller who engaged in such conduct to benefit himself at the expense of the corporation,”476 because “refusal to pay dividends, paying majority shareholders outside the dividend process, and making fire-sale buyout offers certainly can harm the corporation, for instance, by lowering the value of its stock.”477 The difficulty in understanding that proposition is that the corporation, as such, does not have any claim or interest in the value of its shares because the corporation does not own its own stock. The shareholders own the stock, and the corporation owns what the stock represents. When a shareholder sells stock, the shareholder keeps the money, and the corporation is unaffected by any gain or loss that the shareholder realizes on the transaction as a result of changes in the value of the shares. When action is taken to reduce the value of shares as to the shareholder, the corporation does not have a claim. There is no corporate remedy for devaluation of its shares. The theory of cases like Commonwealth of Massachusetts v. Davis is that when corporate property is damaged or stolen, incidentally resulting in the loss of value to the shares, then the corporation has a remedy for the harm that caused the devaluation,478 but the measure of damages is for the actual harm inflicted on the corporation (lost profits, property damage, etc.), not the resulting depreciation in the value of the shares suffered by the shareholders.479 Moreover, from the corporation’s perspective, whether profits remain in the corporation or are distributed to the shareholders as dividends is immaterial—arguably, the corporation as an entity would always be far better off to stockpile its cash resources and never

474 Id. at 858. 475 Ritchie, 443 S.W.3d at 884. It is a complete mystery how a court would order such relief “directly to the

corporation” in a dividend case. Would the court order the corporation to pay dividends to itself? 476 Id. at 885 n.53. 477 Id. at 893. 478 Massachusetts v. Davis, 168 S.W.2d 216, 226 (Tex. 1942). 479 Id.


declare dividends.480 So far from holding that the injunction remedy was available because of harm done to the corporation from loss of value of the corporation’s stock, the Patton Court expressly held that the value of the shares never diminished, not even temporarily.481 The Patton Court held that there was no evidence of damage to the corporation in any regard.482 There is no question that the majority shareholder in Patton breached his duty to act solely for the benefit of the corporation by refusing to declare dividends for reasons having nothing to do with the corporation,483 but a breach of fiduciary duty claim requires resulting harm to the corporation or benefit to the defendant as well as a breach of duty to be actionable.484 Leaving corporate profits in the corporation might harm the minority shareholders, but it would neither harm the corporation nor necessarily benefit the majority shareholder. Moreover, if the suit is successful, the corporation does not benefit from the relief; rather, the minority shareholder benefits at the expense of the corporation when the corporation pays out its cash reserves.485

Taking the Ritchie opinion at face value, then the Court must have been holding that, going forward, Texas law works something like this: Party A (majority shareholder controlling the board) owes duties to Party B (corporation) but not to Party C (minority shareholder). If Party A commits an act that is a breach of duty to Party B that harms Party C but does not harm Party B, then Party B has a cause of action against Party A but no damages, and Party C has damages but no cause of action. Nevertheless, Party A may be sued by or on behalf Party B for the harm done to Party C, and the court may award an equitable remedy compensating Party C that does not benefit Party B. If so, then Ritchie has fundamentally changed the nature of derivative suits from a vehicle by which the shareholder may obtain relief for the corporation to one in which the shareholder may obtain relief for himself using the corporation as a proxy. Take a minority shareholder, who is frozen out of a company by the majority’s cutting off all economic benefit for a malicious reason and not for the good of the company. Under Ritchie’s reading of Patton, the aggrieved minority shareholder could bring a derivative action based on the breach of the duty to act solely for the benefit of the company, offer no

480

The corporation is not injured by the retention of profits among its assets which might be distributed, and thus become the private, separate property of the stockholders. On the contrary, the corporation is enriched. The object of this suit is not to compel directors to do or refrain from doing something for the benefit of the corporation, but to do something for the benefit of the complaining stockholder which may be disadvantageous to the corporation.

Knapp v. Bankers Sec. Corp., 230 F.2d 717, 722 (3d Cir. 1956) (quoting Stevens v. U.S. Steel Corp. 59 A. 905, 906 (N.J. Ch. 1904)).

481 Patton v. Nicholas, 279 S.W.2d 848, 858 (Tex. 1955). 482 Id. at 853 (“we find no evidence otherwise that it was damaged”). 483 See Ritchie v. Rupe, 443 S.W.3d 856, 884 (Tex. 2014). 484 Priddy v. Rawson, 282 S.W.3d 588, 599 (Tex. App.—Houston [14th Dist.] 2009, pet. denied). 485

It is equally clear that the successful outcome of a suit such as the one before us will benefit only the shareholders. The defendant corporation suggests that such an action is for the benefit of the corporation in the sense that it is in the interest of the corporation that it be well managed and have a good dividend policy. We do not think that this highly theoretical benefit can outweigh the obvious disadvantage to the corporation of losing the cash which if not distributed to the shareholders would remain available for use in the conduct of the corporate business. Certainly it cannot be a benefit to a corporation, as such, to lose assets, even to its shareholders.

Knapp, 230 F.2d at 722.


evidence of any harm to the company,486 and receive equitable relief which provides significant, specific benefits to the minority shareholder and no benefits to the company. Depending on the case, the shareholder might receive a mandatory injunction requiring the company to pay dividends in an amount set by the court and five years of court supervision to prevent any act of bad faith by the majority shareholder toward the minority shareholder. Or, again depending on the case, the court might use its general equitable power to fashion a different, more appropriate remedy—say, a compulsory buy-out of the minority shareholder’s stock at a fair value determined by the court. If that is really what the Ritchie opinion means, then the shareholder oppression doctrine did not go away after all. Almost every the shareholder oppression case decided over the last 30 years was correct, save for one relatively minor thing: For some reason, those claims needed to be brought procedurally as derivative actions, instead of direct claims—with the added benefit that attorney’s fees will now be recoverable from the corporation whenever the plaintiff is successful.487 If that is what the Ritchie decision really means,488 then the pronouncements of the death of the shareholder oppression doctrine were greatly exaggerated.

It would be far better to read Patton as it is actually written and recognize that in certain limited situations, minority shareholders have protectable legal interest arising from the fact that they are shareholders and independent of any officer/director duties to the corporation, and Texas common law already recognizes, and has for over a century, that equitable relief is available in an action brought directly by the shareholder in his individual capacity for his own benefit to protect those interests. The cause of action affirmed in Patton is precisely the kind of claim anticipated by Cates—a claim for “injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such [an individual, equitable remedy], would leave the latter remediless.”489

Finally, it is worth noting that the majority shareholder in Patton was something of an underachiever when it comes to shareholder oppression. Like the majority shareholder in Boehringer, he acted out of malicious motives specifically aimed at harming and squeezing out the minority shareholders. He made their lives hell and forced them to resign, cutting off all economic benefits of share ownership, and refused to declare dividends. However, the Patton majority shareholder left all the profits in the company where they were available for later distribution. In Boehringer, the majority shareholder made sure the profits went into his pocket by increasing his salary. But for the existence of some duty to the minority shareholder, the fact that the majority shareholder is acting for the purpose of harming the minority

486 Patton, 279 S.W.2d at 853 (“we find no evidence otherwise that it was damaged”). 487 TEX. BUS. ORGS. CODE ANN. § 21.561(b)(1) (West 2006). 488 The Supreme Court invited exactly this conclusion in its per curiam opinion remanding Cardiac Perfusion

Services, Inc. v. Hughes. See 436 S.W.3d 790, 792 (Tex. 2014) (per curiam) (“When we declined in Ritchie to follow the Texas courts of appeals’ decisions recognizing a common-law cause of action for shareholder oppression, we did so in part because of the adequacy of other existing legal protections. We noted that a minority shareholder in a closely held corporation may recover equitable relief, in some cases individually as well as on behalf of the corporation, through a derivative action for breach of fiduciary duties under section 21.563(c) of the Business Organizations Code.”).

489 Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889).


shareholder—the deciding factor in Patton490 —such evil intent could not be actionable. After all, the decision to declare or not to declare dividends is something that the majority “has the right to do”491 and is accorded heavy deference by the courts,492 and of what legal significance can it possibly be that the majority shareholder is acting out of desire to harm someone to whom he owes no legal duty? The minority shareholder in either case might be able to bring a derivative action to restore to the corporation property wrongfully taken, but that would ignore the need for prospective relief due to “the malicious character of the misconduct heretofore involved and the consequent possibility of its repetition” that the Patton Court found so compelling.493 The legal rights of minority shareholders, the legal duties owed to them, and the legal and equitable remedies available to them, that are already firmly established in Texas common law and are available for development and extension by our courts, may not be as flexible as the “reasonable expectations” approach under the shareholder oppression doctrine, but they are substantial and offer Texas courts the opportunity accept the invitation made by the Ritchie Court to develop meaningful protections that fill in the gaps left by the Ritchie opinion through development of traditional, established causes of action and remedies that “already exist.’494

D. Re-examining Morrison v. St. Anthony Hotel

Morrison v. St. Anthony Hotel, San Antonio,495 was a case decided one year after Patton, which relied on Patton and applied exactly the same cause of action recognized in Patton, and was a case on which the Supreme Court refused the writ for no reversible error.496

If the opinion in Patton was at all ambiguous as to whether there were any derivative claims in the pleadings, the Morrison opinion was not. The plaintiff was a former stockholder in The St. Anthony Hotel, and sued that corporation, together with its directors and the Pan American Hotel Company, which owned the majority of the stock of The St. Anthony, for malicious suppression of dividends.497 In 1948, the plaintiff and Pan American had been engaged in another suit, which they settled by executing a written settlement agreement.498 The settlement provided for the formation of The St. Anthony Hotel corporation to operate a hotel property owned by Pan American, which would hold 52% of the stock in the new corporation.499 The minority shareholders, including the plaintiff, were to receive dividends of all the net earnings of the new corporation up to $130,000.500 The stock certificates specifically required the directors to declare dividends of all net earnings to the shareholders each year.501 The settlement agreement also provided that Pan American would have a continuing option to

490 Patton, 279 S.W.2d at 858. 491 Cates, 11 S.W. at 850. 492 ARGO Data Res. Corp. v. Shagrithaya, 380 S.W.3d 249, 270 (Tex. App.—Dallas 2012, pet. denied). 493 Patton, 279 S.W.2d at 858. 494 Ritchie v. Rupe, 443 S.W.3d 856, 879 (Tex. 2014). 495 295 S.W.2d 246 (Tex. Civ. App.—San Antonio 1956, writ ref’d n.r.e.). 496 Id. at 250. 497 Id. at 247. 498 Id. at 248. 499 Id. 500 Id. 501 Id.


purchase the minority stock at a price to be determined by the company auditor.502

In 1952, Pan American exercised its option to buy the minority stock.503 Morrison then filed suit, claiming that the option was invalid and that he still owned the stock, and claiming breach of contract for failure to pay dividends and breach of trust for conduct by the majority stockholder causing “the malicious depression [] of his dividends and stock values.”504 The court of appeals specifically noted that the lawsuit included claims for “damages which he claims he individually suffered by reason of certain mismanagement practices and a breach of trust on the part of the majority stockholder, which conduct resulted in depressing his dividends and stock values.”505

The ownership issue was severed and tried first, with the trial court holding that the plaintiff no longer owned his stock and upholding the valuation set by the auditor on which the purchase option had been exercised.506 That holding was affirmed on appeal.507 The case then went forward on the dividend claims. The trial court sustained a plea of res judicata and a special exception which stated that plaintiff had failed to assert a cause of action.508 The court of appeals rejected the res judicata holding on the grounds that the dividend claims were not part of the severed proceeding.509 The court of appeals reversed the dismissal of the contract claim, holding that the minority shareholders were contractually entitled to dividends on all net earnings and that dividends had not been declared on all net earnings.510 The court then turned to consider the breach of trust claim that were based on the “rights of minority stockholders apart from the objectives intended by the 1948 settlement agreement.”511

The breach of trust claim was different in substance from the contract claim. The breach of trust claim was not based just on the failure to declare all dividends required but on the intentional and malicious conduct by the majority shareholder to reduce the amount of the net earnings available for dividends during the period of time that all earnings were to be paid out in dividends to the plaintiff’s class of stock and ultimately to drive down the valuation of the corporation in anticipate of the defendants’ exercise of its option to purchase. Plaintiff pleaded that “The St. Anthony’s controlled board of directors charged certain salaries and directors’ fees against The St. Anthony when they, by agreement, should have been charged to Pan American; that at one time when earnings amounted to $131,000, the board declared dividends of $50,000, conditioned upon [plaintiff’s] written approval, failing which they told him they would declare only $40,000 dividends. He pleaded further that Pan American paid itself $95,863 out of operating cash for a debt which was not due until December 1979. He alleged that the defendants maliciously mismanaged the corporation for the wrongful purpose of

502 Id. 503 Id. 504 Id. 505 Id. 506 Id. 507 Id. 508 Id. at 247. 509 Id. at 249. 510 Id. at 250. 511 Id.


reducing the minority’s earnings and to suppress their dividends.”512

The trial court had sustained special exceptions to the cause of action for dividends and damages, which the court of appeals stated raised the following questions: “Does a stockholder have any rights to dividends prior to the time they are declared? Does a stockholder have any rights incident to the stock after the exercise of an option to buy his stock? Does a former stockholder, independent of the corporation’s rights to redress damage, individually have an action against the majority stockholder for breach of its trust toward the minority stockholder for mismanagement and the malicious refusal to declare dividends and suppress stock values?”513 The court of appeals stated that the “answer to the first two questions is ordinarily in the negative but there are exceptions to the rule.”514 The court held: “Under certain circumstances, not only stockholders, but former stockholders, may assert an action for their own damages. The general rule does not prevent stockholders from suing to restrain, or recover damages for, wrongful acts which are not only wrongs against the corporation but also violations of duties arising from contracts or otherwise and owing directly to the injured stockholders.”515 The court stated, “Texas recognizes this exception to the general rule.”516

Unlike in Patton, the direct/derivative issue in Morrison was central and squarely before the court: Was there a legal duty owed individually to the shareholder that would support a direct cause of action for equitable relief or damages arising from the malicious suppression of dividends? The court’s answer was in the affirmative: “Generally, it is the corporation and not the stockholders which must redress wrongs which weaken corporate values. But in a proper case, where a majority stockholder has abused its discretion and has maliciously suppressed the payment of dividends, a stockholder may assert a cause of action for damages and may compel the declaration of dividends.”517 As authority for this proposition, the court of appeals cited Patton v. Nicholas.518 The court further stated that “the duty of corporations, such as Pan

512 Id. at 252. 513 Id. at 249. 514 Id. at 249–50. 515 Id. at 250. 516 Id. at 251 (citing Massachusetts v. Davis, 168 S.W.2d 216, 222 (Tex. 1942)); Stinnett v. Paramount-Famous

Lasky Corp., 37 S.W.2d 145, 150 (Tex. Comm’n App. 1931, holding approved, judgm’t affirmed). 517 Id. at 250. 518 The court also cited numerous out of state cases upholding individual claims for dividends. See Warburton

v. John Wanamaker Philadelphia, 196 A. 506, 510–11 (Pa. 1938) (suit by individual shareholder for breach of terms of preferred stock to pay dividends); Lydia E. Pinkham Med. Co. v. Gove, 20 N.E.2d 482, 486 (Mass. 1939) (suit by individual shareholder for violation of bylaw requiring payment of dividends); Crocker v. Waltham Watch Co., 53 N.E.2d 230, 233 (Mass. 1944) (suit by shareholder to compel dividends based on bylaw provision); New England Trust Co. v. Penobscot Chem. Fibre Co., 50 A.2d 188 (Me. 1946) (suit to compel dividends based on terms of preferred stock); W.Q. O’Neall Co. v. O’Neall, 25 N.E.2d 656, 660 (Ind. Ct. App. 1940) (suit to compel dividends to preferred shares based, not on express terms of preferred but “abuse [of] discretion by refusing so to do.”); Burk v. Ottawa Gas & Elec. Co., 123 P. 857 (Kan. 1912) (suit for breach of bylaws requiring dividends); Patterson v. Durham Hosiery Mills, 200 S.E. 906 (N.C. 1939) (suit to enjoin amendment to charter that would remove right to dividends). Two of these cases were particularly relevant. In Lydia E. Pinkham Med. Co. v. Gove, the court rejects the argument that “the shareholder’s right to have a dividend declared is wholly derivative, and that any suit that he may bring should be brought in behalf of the corporation as for a wrong to the corporation itself,” and holds:

We do not intend to intimate that a bill brought by a stockholder for the benefit of all stockholders would not lie. Such bills have succeeded for this purpose in other jurisdictions.


American in this case, which own controlling stock in a subsidiary corporation . . . is one of trust and strong presumptions come into force against the management which pays itself enormous management fees and refuses to pay dividends.”519

When a majority of the stock of one corporation is owned by another, which thereby acquires the right to control its management, the controlling corporation assumes a relation of trust towards the minority stockholders of the corporation controlled, and is under an obligation to manage its affairs for the benefit of all the stockholders and not for its own aggrandizement. This is merely an application of the principle that, while a majority of the stockholders may legally control the corporation’s business, they assume the correlative duty of good faith, and cannot manipulate such business in their own interest to the injury of minority stockholders.520

The court concludes that the plaintiff had asserted valid causes of action “against The St. Anthony Hotel and Pan American Hotel Company, both under the contract by which the minority would receive all net earnings of The St. Anthony Hotel and on the breach of trust theory for damages.”521 The court of appeals reversed the dismissal and remanded for trial.522

Morrison was clearly an example of an individual action brought by the minority shareholder for his own benefit based on duties owed to himself. The plaintiff was not a shareholder at the time of the litigation. The first sentence of the opinion identifies the plaintiff as “R. E. Morrison, a former stockholder in The St. Anthony Hotel.”523 As such, the plaintiff could not have brought the action as a derivative claim,524 a point made clearly in the dissent.525 The fact that the plaintiff was no longer a shareholder also raises an important distinction between the remedies granted in Morrison and Patton. In Patton, the plaintiffs were still shareholders and the funds were still in the corporation; therefore, a mandatory injunction

Probably in most instances practical considerations will make this course necessary, as it will seldom happen that a corporation whose directors refuse to declare dividends will itself bring suit. But in a case like this one a right to sue in the corporation and a right to sue in the stockholders are not necessarily mutually exclusive.

20 N.E.2d at 490 (citations omitted). In W.Q. O’Neall Co. v. O’Neall, the court rejects argument that directors were necessary parties and holds that the court may render “judgment against the corporation for the dividends.” 25 N.E.2d 656, 660 (Ind. Ct. App. 1940).

519 Morrison, 295 S.W.2d at 251 (citing Mayflower Hotel Stockholders Protective Comm. v. Mayflower Hotel Corp., 173 F.2d 416 (D.C. Cir. 1949)).

520 Id. (quoting Mayflower Hotel Stockholders Protective Comm., 173 F.2d at 422). 521 Id. at 252. 522 Id. at 252–53. 523 Id. at 247. 524 See Zauber v. Murray Sav. Ass’n, 591 S.W.2d 932, 937 (Tex. Civ. App.—Dallas 1979, writ ref’d) (“The

reasoning behind allowing a shareholder to maintain a suit in the name of the corporation when those in control wrongfully refuse to maintain it is that a shareholder has a proprietary interest in the corporation. Therefore, when a shareholder sues, he is protecting his own interests as well as those of the corporation. If a shareholder voluntarily disposes of his shares after instituting a derivative action, he necessarily destroys the technical foundation of his right to maintain the action.”). See also TEX. BUS. ORGS. CODE ANN. § 21.522 (West 2007).

525 Morrison, 295 S.W.2d at 253 (Murray, J., dissenting) (“Likewise, I am of the opinion that appellant’s suit for damages for alleged breaches of fiduciary duties and mismanagement cannot be maintained by appellant since he is not a stockholder, but an exstockholder of the corporation.”).


that the dividends be declared made the plaintiffs whole. In Morrison, the plaintiff was no longer a shareholder and could no longer receive dividends, and the claim in Morrison was not that the money was sitting there, but that the finances had been manipulated to reduce the funds available for dividends and that the money available for distribution had been taken out of the corporation. The plaintiff in Morrison was not in a position to benefit from an injunction to declare dividends and did not have standing to bring a derivative claim for misappropriation of assets. The only possible remedy was one for damages based on a breach of duty owed to the plaintiff individually.

As did Patton,526 Morrison characterized the breach of duty as a “breach of trust.”527 The malicious conduct in Morrison resulting in the loss of dividends to the minority shareholder was also clearly an example of a claim for what Cates v. Sparkman termed “injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder” for which no other remedy existed.528 In the intervening years, the Morrison opinion has been cited repeatedly as good authority.529 In Wingate v. Hajdik,530 the Texas Supreme Court held that the general rule that shareholders have no individual cause of action for harm done solely to the corporation “does not, of course, prohibit a stockholder from recovering damages for wrongs done to him individually where the wrongdoer violates a duty arising from contract or otherwise, and owing directly by him to the stockholder.”531 Wingate cited Morrison as a specific example of an individual claim by a shareholder “arising from contract or otherwise.”532 Both Ritchie and Sneed cited Wingate for that same proposition, although neither mention Morrison.533

E. Question of Duty

The gaps left by the demise of the shareholder oppression doctrine are basically two-fold: (1) the absence of individual rights and duties that belong to every shareholder (what used to be called “general reasonable expectations”) that protect individual shareholders from use of the corporation to specifically harm or eliminate their interests, and (2) the absence of individual equitable remedies, including a compulsory buy-out, that would protect “the legitimate interests of a minority shareholder” when the use of derivative claims to “protect[]

526 Patton v. Nicholas, 279 S.W.2d 848, 854 (Tex. 1955) (breach of trust). 527 Morrison, 295 S.W.2d 246. 528 Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889). 529 Schautteet v. Chester State Bank, 707 F. Supp. 885, 888 (E.D. Tex. 1988); Economy Gas, Inc. v. Burke, No.

14-93-01016-CV, 1996 WL 220903, at *9 n.2 (Tex. App.—Houston [14th Dist.] May 2, 1996, no pet.) (mem. op.) (not designated for publication); Horton v. Robinson, 776 S.W.2d 260, 263 (Tex. App.—El Paso 1989, no pet.); Bush v. Brunswick Corp., 783 S.W.2d 724, 727 (Tex. App.—Fort Worth 1989, pet. denied); Davis v. Sheerin, 754 S.W.2d 375, 384 (Tex. App.—Houston [1st Dist.] 1988, writ denied).

530 Wingate v. Hajdik, 795 S.W.2d 717 (Tex. 1990). 531 Id. at 719. 532 See id. See also Schoellkopf v. Pledger, 739 S.W.2d 914, 919 n.9 (Tex. App.—Dallas 1987) (citing

Morrison v. St. Anthony Hotel for the proposition that “a minority stockholder may sue majority stockholder for malicious suppression of dividends and mismanagement to suppress the value of the stock, as breach of duty of trust between majority and minority stockholders”), rev’d on other grounds, 762 S.W.2d 145 (Tex. 1988).

533 See Sneed v. Webre, 465 S.W.3d 169,188 (Tex. 2015); Ritchie v. Rupe, 443 S.W.3d 856, 888 n.55 (Tex. 2014).


the well-being of the corporation” would not do so.534 This section has reviewed several landmark cases that are not based on the shareholder oppression doctrine for the purpose of demonstrating that Texas common law does recognize that individual minority shareholders do have causes of action based on the violation of their individual rights and duties owed to them and that Texas courts have granted equitable relief to individual shareholders. Stinnett v. Paramount-Famous Lasky Corp. of N.Y. and the case it chiefly relies on, Ritchie v. McMullen, held that individual shareholders have a claim for conduct harmful to themselves, even if that same conduct harms the corporation, but only where the law recognizes an independent duty owed to the shareholder individually. Cates v. Sparkman describes the kind of situations in which such a cause of action might arise. Cates describes an individual cause of action that an individual shareholder would bring against the corporation (not the officers and directors) for corporate actions that constitute “injurious practices, abuse of power, and oppression.” 535 Cates does not describe what such conduct would be, other than to make clear that ordinary, operational decisions, such as shutting down the company when the money runs out, are not the kinds of conduct that constitutes “injurious practices, abuse of power, and oppression.” Patton v. Nicholas and Morrison v. St. Anthony Hotel are two examples of individual claims asserted by minority shareholders, as described in Cates, for violation of duties owed directly to themselves, as stated in Stinnett. The elements of a claim for breach of trust, for which both courts ruled that an equitable remedy would be available, were not clearly defined in either case.

None of the cases re-examined in this section, however, defines the cause of action with any precision. Cates basically lays out the three elements of an individual shareholder cause of action against the corporation: (1) An intentional breach of duty by the corporation (“injurious practices, abuse of power, and oppression on the part of the company or its controlling agency”); (2) Material violation of rights of the plaintiff shareholder (“clearly subversive of the rights of the minority, or of a shareholder”); and (3) No adequate remedy at law (“which, without such [an equitable remedy], would leave the latter remediless”).536 The elements described by Cates are clearly discernible in both Patton and Morrison: (1) Intentional breach of duty by the corporation (suppressing dividends for the malicious purpose of harming the minority shareholder); (2) Material violation of rights of the plaintiff shareholder (right to share in profits of the corporation); and (3) No adequate remedy at law. However, defining the breach of duty using the terms “injurious practices, abuse of power, and oppression” is less than satisfactory. As the Texas Supreme Court commented in Ritchie, the term “oppression” is extremely vague and “falls short of providing any clear standards” necessary to “deter the undesirable conduct without deterring desirable conduct or unduly restricting freedoms.”537 Basing a cause of action on terms “so vague and subject to so many different meanings in different circumstances . . . is simply bad jurisprudence.”538 In order to better define the elements of this breach of trust cause of action, it is necessary to determine precisely what substantive rights the law recognizes as belonging to every shareholder by virtue of being a shareholder and what duties the corporation owes to each shareholder so that we may

534 See Ritchie, 443 S.W.3d at 888. 535 Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889). 536 Id. 537 Ritchie, 443 S.W.3d at 889. 538 Id. at 890.


demonstrate that the “theory of liability [is] based on a standard that is far more concrete than the meaning of ‘oppressive.’”539

V. RECOGNIZING INDIVIDUAL RIGHTS OF MINORITY SHAREHOLDERS

A. Stock Ownership as Personal Property

In Texas, property rights are “sacred and fundamental”540 “a foundational liberty, not a contingent privilege,”541 “natural, inherent, inalienable, not derived from the legislature and as preexisting even constitutions.”542

The right to acquire and own property, and to deal with it and use it as the owner chooses, so long as the use harms nobody, is a natural right. It does not owe its origin to constitutions. It existed before them. It is a part of the citizen’s natural liberty—an expression of his freedom, guaranteed as inviolate by every American Bill of Rights.

The ancient and established maxims of Anglo-Saxon law which protect these fundamental rights in the use, enjoyment and disposal of private property, are but the outgrowth of the long and arduous experience of mankind. They embody a painful, tragic history—the record of the struggle against tyranny, the overseership of prefects and the overlordship of kings and nobles, when nothing so well bespoke the serfdom of the subject as his incapability to own property. They proclaim the freedom of men from those odious despotisms, their liberty to earn and possess their own, to deal with it, to use it and dispose of it, not at the behest of a master, but in the manner that befits free men.543

The Texas Supreme Court has stated that “freedom itself [] demand[s] strong protections for individual property rights.”544 Protection of those rights is “one of the most important purposes of government.”545

Stock is personal property, and the stockholder is a property owner.546 Texas law has long

539 Id. 540 State v. Texas City, 295 S.W.2d 697, 704 (Tex. Civ. App.—Galveston 1956), aff’d, 303 S.W.2d 780 (Tex.

1957); Ford v. Grand United Order of Odd Fellows, 50 S.W.2d 856, 859 (Tex. Civ. App.—Beaumont 1932, writ dism’d w.o.j.) (“right to own and have exclusive dominion over private property is a sacred one”).

541 Tex. Rice Land Partners, Ltd. v. Denbury Green Pipeline-Texas, L.L.C., 363 S.W.3d 192, 204 n.34 (Tex. 2012).

542 Eggemeyer v. Eggemeyer, 554 S.W.2d 137, 140 (Tex. 1977). 543 Spann v. City of Dallas, 235 S.W. 513, 515 (Tex. 1921). 544 Tex. Rice Land Partners, Ltd., 363 S.W.3d at 204. 545 Eggemeyer, 554 S.W.2d at 140. 546 TEX. BUS. ORGS. CODE ANN. § 21.801 (West 2006) (“Except as otherwise provided by this code, the shares

and other securities of a corporation are personal property.”); Engel v. Teleprompter Corp., 703 F.2d 127, 131 (5th Cir. 1983) (“Under Texas law, shares of corporate stock are personal property.”); Capital Parks, Inc. v. Se. Advert. & Sales Sys., Inc., 864 F. Supp. 14, 16 (W.D. Tex. 1993) (“The shares of corporate stock, on the other hand, are the personal


recognized “the property right which a share in such a company creates.”547

Shares of stock in a corporation are a species of personal property, belonging to the holder thereof, entirely separate and distinct from the property of the corporation itself. They are the subject of barter and sale the same as other personal property. Under our laws they are subject to taxation, may be impounded by garnishment proceedings, and may be sold under execution as other personal property. They are the intangible interests of the individual shareholders in the corporate business, while the tangible property belongs to the corporation.548

What does it mean to own a personal property interest in “stock”? First, it is important to note that “owning stock” does not mean possessing a stock certificate. Texas law has long held that the certificate is not the “stock.”549 The certificate is merely evidence of the ownership of the stock.550 A stockholder owns the stock whether or not he possesses the certificate and regardless of whether a certificate was ever even issued.551

property of the shareholders.”), aff’d, 30 F.3d 627 (5th Cir. 1994); Barnhill v. Automated Shrimp Corp., 222 S.W.3d 756, 764 (Tex. App.—Waco 2007, no pet.) (“By virtue of owning shares of stock in a Texas corporation, Barnhill maintains personal property in Texas.”); Brosseau v. Ranzau, 81 S.W.3d 381, 387 (Tex. App.—Beaumont 2002, pet. denied) (“In Texas, stock is considered personal property, even when the underlying corporation itself owns real property.”); Evans v. Prufrock Rests., Inc., 757 S.W.2d 804, 805–06 (Tex. App.—Dallas 1988, writ denied) (“[T]he transaction was the sale of a personalty rather than realty. . . . It is a well established fact that the sale of stock is personalty not real estate.”); Griffith v. Jones, 518 S.W.2d 435, 437 (Tex. Civ. App.—Tyler 1974, writ ref’d n.r.e.) (“Shares of corporate stock are personal property in the nature of choses in action.”); Benson v. Greenville Nat’l Exch. Bank, 253 S.W.2d 918, 928 (Tex. Civ. App.—Texarkana 1952, writ ref’d n.r.e.) (“Without any attempt at historical review, we think it is now well settled that shares of corporate stock are personal property in the nature of choses in action”). See also Dewing v. Perdicaries, 96 U.S. 193, 196 (1877) (“The shares are a distinct and separate property.”); Cummings v. People, 71 N.E. 1031, 1034 (Ill. 1904); Auto. Mortg. Co. v. Ayub, 266 S.W. 134, 135 (Tex. Comm’n App. 1924, judgm’t adopted) (“While not negotiable, shares are freely assignable, and in this respect resemble negotiable choses in action and tangible property rather than other nonnegotiable choses in action.”); Bergin v. Bergin, 312 S.W.2d 409, 412 (Tex. Civ. App.—Texarkana), rev’d on other grounds, 315 S.W.2d 943 (Tex. 1958) (“Corporate stock, which is personalty, is involved.”); Parker v. Mona-Marie Trust, 278 S.W. 321, 323 (Tex. Civ. App.—Fort Worth 1925, no writ) (“Shareholders are not tenants in common or co-owners of the property of the corporation in any sense; but the title thereto rests in the legal entity called the corporation.”).

547 Yeaman v. Galveston City Co., 167 S.W. 710, 719 (Tex. 1914). 548 Auto. Mortg. Co., 266 S.W. at 135. 549 Yeaman, 167 S.W. at 720 (“In a corporation the certificate of stock is not the stock itself”). 550 Id. (stating that the share certificate “is but a muniment of title, an evidence of the ownership of the stock.”);

Greenspun v. Greenspun, 194 S.W.2d 134, 137 (Tex. Civ. App.—Fort Worth), aff’d, 198 S.W.2d 82 (Tex. 1946) (“In this latter connection it is to be remembered that the certificates of stock are not in themselves property, but are only evidence of the interest of the stockholder in the corporation.”); A. B. Frank Co. v. Latham, 190 S.W.2d 739, 741 (Tex. Civ. App.—Austin 1945), aff’d, 193 S.W.2d 671 (Tex. 1946) (“Nor does mere cancellation of the stock certificates effect a reduction of the capital. They are but evidences in the hands of the holder of his aliquot part of the legal capital of the corporation.”). See also Dewing, 96 U.S. at 196 (“The stock of such corporations may be held by a valid title without a certificate. The certificate is only one of the indicia of title. The right to the stock is in the nature of a non-negotiable chose in action.”).

551 Yeaman, 167 S.W. at 720 (Possession of a stock certificate “is not necessary to a subscriber’s complete ownership of the stock.”); Greenspun, 194 S.W.2d at 137 (“It is possible under some circumstances for one to own stock in a corporation though no certificate has been issued to him or endorsed or delivered to him, and likewise it is possible under some circumstances for title to the stock to pass without delivery of the certificate of stock or without


Rather, “stock” constitutes an undivided partial ownership interest in the corporation. Courts analogize the corporation to a trust fund made up of the assets, opportunities, and business operations of the corporate enterprise.552 Each share of stock is an undivided, proportional ownership interest in the trust fund.553 However, ownership of the trust fund itself and ownership of the partial interest in that fund are completely different things.554 The corporation owns the trust fund555 but does so as trustee556 for the benefit of the shareholders.557

B. The Stockholder’s Bundle of Property Rights

In Moroney v. Moroney,558 the court wrote:

The corporation is a legal entity, and the title to its assets is vested in the corporation. The stockholder does own, however, his shares, stock, or interest whatsoever in the corporation, and this carries with it certain legal rights, but they are not the rights of a legal owner of the corporation assets in whole or in part. This distinction holds good even though all the stock may be held by a single individual. It does not follow from this, however, that the rights of a stockholder in a corporation are not of judicial

written assignment of it.”); Estate of Bridges v. Mosebrook, 662 S.W.2d 116, 121 (Tex. App.—Fort Worth 1983, writ denied); Estate of Crawford, 795 S.W.2d 835, 838 (Tex. App.—Amarillo 1990, no writ) (“Complete ownership of certificated stock may exist without the issuance of a certificate or its delivery.”).

552 Dewing, 96 U.S. at 196 (“The capital stock and all the other property and effects of a corporation are a trust fund.”).

553 Id. (shares represent “aliquot parts of the trust fund”); Farrington v. Tennessee, 95 U.S. 679, 687 (1877) (“Each share represents an aliquot part of the capital stock.”). See also Auto. Mortg. Co., 266 S.W. at 135 (“It is generally agreed that shares in an incorporated company are the aliquot parts of the capital stock, and merely give to the owner a right to his share of the profits of the corporation, while it is a going concern, and to a share of the proceeds of its assets, when sold for distribution in case of its dissolution and winding up.”) (quoting Presnall v. Stockyards Nat’l Bank, 151 S.W. 873, 876 (Tex. Civ. App.—Texarkana 1912), aff’d, 194 S. W. 384 (Tex. 1917)).

554 Auto. Mortg. Co., 266 S.W. at 135 (“Shares of stock in a corporation are a species of personal property, belonging to the holder thereof, entirely separate and distinct from the property of the corporation itself.”); Farrington, 95 U.S. at 686 (“The capital stock [i.e., the corpus of the trust fund] and the shares of the capital stock are distinct things.”).

555 Tenneco Inc. v. Enter. Prods. Co., 925 S.W.2d 640, 645 (Tex. 1996); see also McAlister v. Eclipse Oil Co., 98 S.W.2d 171, 176 (Tex. 1936) (“Under our authorities the corporation is a legal entity, distinct from its stockholders. In this regard, strictly speaking, the ownership of the corporate assets is vested in the corporation itself and not in its stockholders.”); Hicks v. State, 419 S.W.3d 555, 558 (Tex. App.—Amarillo 2013, no pet.) (“It has long been the law that a stockholder owns an interest in the company but not the assets of the company. Rather, the assets, including the cash residing in corporate bank accounts, are owned by the corporation, and the latter is a separate legal entity from its shareholders.”).

556 Dewing, 96 U.S. at 196 (“The corporation owns and holds [the trust fund] as a trustee.”); Farrington, 95 U.S. at 686 (“It is a trust fund, held by the corporation as a trustee.”).

557 Farrington, 95 U.S. at 687 (“Every [stock]holder is a cestui que trust to the extent of his ownership.”); McAlister, 98 S.W.2d at 176 (“Also, strictly speaking, the ownership of the stock does not carry with it the equitable title to the corporate property. This simply means, however, that the stockholders have no right to require the corporation to convey to them the legal title to the corporate property. In a larger or real sense the stockholders of a corporation are the beneficial owners of its corporate properties.”).

558 286 S.W. 167 (Tex. Comm’n App. 1926, judgm’t affirmed).


cognizance.559

So what does the shareholder actually own? The shares of stock that a shareholder owns consist of a set of intangible rights and interests with respect to the corporate enterprise.560 However, all property ownership ultimately constitutes an intangible “bundle of rights.”561 The concept of property does not refer to a thing but rather to the rights and legal relationship between a person and a thing.562 The common law and statutes define these rights.563 The Texas Supreme Court has listed among the “core rights in the bundle of property rights”:

(1) the right to exclusive possession; (2) the right to personal use and enjoyment; (3) the right to manage use by others; (4) the right to the income from use by others; (5) the right to the capital value, including alienation, consumption, waste, or destruction; (6) the right to security (that is, immunity from expropriation); (7) the power of transmissibility by gift, devise, or descent.564

In the context of stock ownership, Texas courts recognize that “[t]here are certain rights, powers, and privileges that accrue to a stockholder in a corporation.”565 This “array of rights” possessed the individual shareholders “spring from many sources: (1) the corporation’s organic documents, (2) agreements between shareholders or between the corporation and shareholders, (3) statutory corporation law, and (4) decisional law governing the operation of corporations.”566 The shareholder’s bundle of rights and interests that have been developed in the common law derive “from the nature of the organization, and the relation of the stockholders to the corporation and its property.”567

For purposes of protecting minority shareholders from oppressive and predatory conduct in closely-held corporations, we will focus on five basic components of the “bundle” or “array” of rights and interests that constitute stock ownership and are subject to legal protections. The Texas Constitution establishes a legal mandate that Texas law “provide fully

559 Id. at 169. 560 Turner v. Cattleman’s Trust Co., 215 S.W. 831, 832 (Tex. Comm’n App. 1919, judgm’t adopted) (“The

tangible property belongs to the corporation. The shares of stock are the intangible interests in the corporate business owned by the individual shareholders.”); Presnall v. Stockyards Nat’l Bank, 151 S.W. 873, 876 (Tex. Civ. App.—Texarkana 1912), aff’d, 194 S.W. 384 (Tex. 1917) (“by a ‘share of stock’ and ‘share’ in a corporation, as used in the statute, is meant an intangible interest or right, in legal contemplation, of the owner in the corporation property or fund”).

561 E.g., Evanston Ins. Co. v. Legacy of Life, Inc., 370 S.W.3d 377, 382 (Tex. 2012) (“We have referred to property as a ‘bundle of rights.’”); Canyon Reg’l Water Auth. v. Guadalupe-Blanco River Auth., 258 S.W.3d 613, 618 (Tex. 2008) (“Where an owner possesses a full ‘bundle’ of property rights, the destruction of a ‘strand’ of the bundle is not a taking.”).

562 Evanston Ins. Co., 370 S.W.3d at 382–83. 563 Id. at 383. 564 Id. 565 Turner, 215 S.W. at 833. 566 Schautteet v. Chester State Bank, 707 F. Supp. 885, 888 (E.D. Tex. 1988). 567 Moroney v. Moroney, 286 S.W. 167, 169 (Tex. Comm’n App. 1926, judgm’t affirmed). However, it should

be noted that because corporations are set up differently, these rights and interests “may well vary from one corporation to the next.” Schautteet, 707 F. Supp. at 888.


for the adequate protection . . . of the individual stockholders.”568 Texas courts have held that, in every profitable corporate venture, the rights of the stockholder are of great importance, and at all times will be properly protected, whether in a court of law or equity, according to the exigencies of the situation.569

I. Recognition of Ownership

Perhaps the most obvious and central right of ownership is the assurance that the law will protect the existence and continuation of that ownership—that the owner has “the right to exclusive possession” and “the right to security.”570 The stockholder is an owner. The stock is his property. It cannot be taken away without his consent.571

In the context of a shareholder’s ownership, this right means at a minimum that the corporation may not act to impair the shareholder’s ownership interest.572 The stockholder has the right to have his ownership recorded on the books of the corporation573 and to have issued and delivered a stock certificate as written evidence of that ownership.574

II. Voice.

Another fundamental right of property ownership is the right to manage the use of that property by others.575 The nature of the corporate organization involves control by the corporate entity over what the stock represents. Shareholders elect directors who “direct the management of the business and affairs of the corporation” without direct input by the shareholders.576 Yet the owner of the stock is entitled to a voice in owner-level decisions: who is to manage the property, what limitations or requirements are to be imposed on the managers, and whether to sell or make fundamental changes in the nature of the enterprise. Shareholders decide certain fundamental transactions577 and whether to remove directors578 Some owner-

568 TEX. CONST. art. XII, § 2. 569 Moroney, 286 S.W. at 169. 570 Evanston Ins. Co., 370 S.W.3d at 383. See also Dos Republicas Coal P’ship v. Saucedo, 477 S.W.3d 828,

836 (Tex. App.—Corpus Christi-Edinburg 2015, no pet.) (“Under Texas common law, property ownership comes with a ‘bundle of rights’ which includes, among other things, the rights of possession and use.”); Apr. Sound Mgmt. Corp. v. Concerned Prop. Owners for Apr. Sound, Inc., 153 S.W.3d 519, 525 (Tex. App.—Amarillo 2004, no pet.) (“The right to own and have exclusive dominion over private property is a sacred one, and it is a universal principle of law that the right to own property carries with it the right to control and dispose of it in such manner as not to contravene law or public policy.”).

571 Yeaman v. Galveston City Co., 167 S.W. 710, 723 (Tex. 1914) (“We are unwilling to affirm that, in the absence of some statutory or charter power, or express consent to that effect, a corporation has any authority to forfeit a stockholder’s shares upon such a ground.”).

572 Id. 573 TEX. BUS. ORGS. CODE ANN. § 3.151(a)(3) (West 2006). 574 Id. § 3.204. 575 Evanston Ins. Co., 370 S.W.3d at 383. 576 BUS. ORGS. § 21.401. See, e.g., Solum Eng’g, Inc. v. Preis & Roy, P.L.C., No. 14-10-01054-CV, 2011 WL

4490049, at *3 (Tex. App.—Houston [14th Dist.] Sept. 29, 2011, pet. denied) (“[A] shareholder cannot terminate a corporation’s contractual obligations . . . .”).

577 BUS. ORGS. § 21.058 (amending bylaws); id. §§ 21.055(b), 21.364(b) (amending certificates); id. § 1.002(32) (mergers); id. § 21.452(e) (sales of all or substantially all a corporation’s assets other than in the


level decisions require unanimity,579 some a majority,580 some a super-majority,581 and the stockholder is entitled to his proportional share of the vote on each such decision. Among the “rights, powers, and privileges that accrue to a stockholder in a corporation,” are “the right to attend stockholders’ meetings and vote on matters under consideration by shareholders; the right to hold official position of trust in the corporation.”582 The right to vote, in particular, has long been recognized as one of the “incidents” of stock ownership.583 But the broader principle, critical for the minority shareholder in a closely-held corporation who will likely always be out-voted, is that those in control of the corporation remain accountable to and ultimately subject to the will of the owners (collectively)—all the owners—and minority shareholders have a voice and a right to participate in that process. The shareholder’s right to voice is more than the mere right to vote on a limited number of matters; it is the right to hold the corporation’s management accountable to all of the shareholders and to confront management on matters about which the shareholder disagrees.584 Therefore, each stockholder has a fundamental right to meet periodically with the other shareholders, to require that corporate management report to and remain accountable to all shareholders, to have the opportunity to ask questions and express opinions, and to vote on the directors and other matters in a proceeding where the vote of every share of the same class will be counted the same.585

ordinary course of business); id. § 21.457(a); id. §§ 1.002(32), 21.455(f), 21.457(a) (voluntary winding ups); id. §§ 21.364(b), 21.503(b).

578 See id. §§ 21.405(a), 21.409(a). See, e.g., Adams v. Farmers Gin Co., 114 S.W.2d 583, 587 (Tex. Civ. App.—Eastland 1938, no writ) (right of management of business of corporation is vested in directors rather than shareholders; remedy of shareholders if they disapprove of management decisions is to elect new directors in prescribed manner at regular time); see also Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 959 (Del. 1985) (“If the stockholders are displeased with the action of their elected representatives, the powers of corporate democracy are at their disposal to turn the board out.”).

579 BUS. ORGS. § 21.502 (winding up or decision to revoke winding up); id. § 21.715 (shareholders’ agreement).

580 Id. § 21.409 (removal of director(s)); id. § 21.502(2) (winding up if business has not issued shares); see id. § 21.454 (approval of exchange of shares); id. § 21.455(a) (approval of sale of all or substantially all of assets).

581 Id. § 21.364 (amend certificate of formation, reinstatement, increase or decrease total number of authorized shares, change par value of shares, change rights of shares, create a new class of shares, change already declared dividend); id. § 21.457 (approval of fundamental business transaction).

582 Turner v. Cattleman’s Trust Co., 215 S.W. 831, 833 (Tex. Comm’n App. 1919, judgm’t adopted). 583 Farrington v. Tennessee, 95 U.S. 679, 687 (1877). (“The corporation, though holding and owning the capital

stock, cannot vote upon it. It is the right and duty of the shareholders to vote. They in this way give continuity to the life of the corporation, and may thus control and direct its management and operations.”); Morrison v. St. Anthony Hotel, 274 S.W.2d 556, 567 (Tex. Civ. App.—Austin 1955, writ ref’d n.r.e.) (“incidents of stock ownership” include “the rights, pro tanto, to share in its management”). See also Baker v. Raymond Int’l, Inc., 656 F.2d 173, 180 (5th Cir. 1981) (“Ownership of a controlling interest in a corporation entitles the controlling stockholder to exercise the normal incidents of stock ownership, such as the right to choose directors and set general policies, without forfeiting the protection of limited liability.”).

584 Grayburg Oil Co. v. Jarratt, 16 S.W.2d 319, 320 (Tex. Civ. App.—El Paso 1929, no writ) (“We can see no good reason why a stockholder in a corporation who is dissatisfied with the internal management of the corporate affairs should not have the right to call to the attention of his fellow stockholders conditions in the corporate management with which he is dissatisfied and in good faith regards as prejudicial to the best interest of the corporation and its stockholders. In our opinion, stockholders have such right.”).

585 See BUS. ORGS. §§ 21.351–.363.


III. Information.

A necessary corollary to the fundamental right to manage the use of one’s property by others is the right to information, so that the shareholder may “ascertain whether the affairs of the corporation are properly conducted and that he may vote intelligently on questions of corporate policy and management.”586 “A minority shareholder has very few rights. By definition, those shareholders who, along with their allies, are in the majority, have sufficient votes to nullify the minority’s right of franchise. In such instance, about the only thing left to a dissatisfied minority stockholder is his right to inspect, coupled with his right to denounce any matters disclosed by his inspection.”587 The right to information has been held to be “a privilege . . . incident to [the] ownership of stock,”588 and a “valuable right.”589 The owner is entitled to know what is going on in his own company, how his investment is doing, what it is worth, how his money is being spent, how his property is being managed.

Corporations are required by statute to keep records and accounts and to permit shareholders to inspect the records.590 The statutory right of inspection in Texas is limited to current shareholders who have held their shares for at least six months or who hold at least five percent of all the outstanding shares of the corporation.591 However, all shareholders have a common law right of inspection if the inspection is made in good faith for a proper purpose.592 “There can be no question that the decisive weight of American authority recognizes the common-law right of the shareholder, for proper purposes and under reasonable regulations as to place and time, to inspect the books of the corporation of which he is a member.”593 Texas courts have held that the passage of a legislative right of inspection does not negate the preexisting common-law right.594 Similarly, the inspection statute itself makes clear that it does not preempt common-law rights.595

IV. Right of Alienation

The rights of property ownership include “the right to the capital value, including alienation . . . [and] the power of transmissibility by gift, devise, or descent.”596

586 Johnson Ranch Royalty Co. v. Hickey, 31 S.W.2d 150, 153 (Tex. Civ. App.—Amarillo 1930, writ ref’d). 587 Perry v. Perry Bros., Inc., 753 S.W.2d 773, 777 (Tex. App.—Dallas 1988, no writ) (Howell, J., dissenting). 588 Johnson Ranch Royalty Co., 31 S.W.2d at 153 (shareholder’s right to examine the books and records of the

corporation “is a privilege . . . incident to his ownership of stock.”). 589 Chavco Inv. Co., Inc. v. Pybus, 613 S.W.2d 806, 809 (Tex. Civ. App.—Houston [14th Dist.] 1981, writ

ref’d n.r.e.) (“The right of a stockholder as conferred by statute to examine the corporate records, although not absolute, is a valuable right.”).

590 See BUS. ORGS. §§ 3.151–.153, 21.173, 21.218–.222. 591 Id. § 21.218(b). 592 Williams v. Freeport Sulphur Co., 40 S.W.2d 817, 825 (Tex. Civ. App.—Galveston 1930, no writ) (holding

that the right of inspection is provided “both by the common law and the statutes of this state”); see also Palacios v. Corbett, 172 S.W. 777, 782 (Tex. Civ. App.—San Antonio 1915, writ ref’d) (finding a common law right to inspect county records).

593 Guthrie v. Harkness, 199 U.S. 148, 153 (1905). 594 Tex. Infra-Red Radiant Co. v. Erwin, 397 S.W.2d 491, 493 (Tex. Civ. App.—Eastland 1965, writ ref’d

n.r.e.). 595 BUS. ORGS. § 21.218(c). 596 Evanston Ins. Co. v. Legacy of Life, Inc., 370 S.W.3d 377, 383 (Tex. 2012).


“Transferability is the primary value-imparting characteristic of most property interests,”597 including stock ownership.598 “Alienability is a legal incident of property, and restraints against it are generally contrary to public policy.”599 While restrictions on the transferability of stock are permitted, they must be reasonable, consented to by the stockholder, clearly disclosed, and not violative of public policy.600

V. Proportional Share in the Profits.

Another fundamental property right is the “right to the income from use by others.”601 As the Texas Supreme Court has stated, “a right to [property] essentially implies a right to profits accruing from it, since, without the latter, the former can be of no value.”602 The principal reason for stock ownership is the expectation of economic return, if the venture is successful. Texas cases have held that the right to share “pro tanto” in the corporation’s “profits and, upon dissolution, its assets” are among the “incidents of stock ownership.”603 Among the “rights, powers, and privileges that accrue to a stockholder in a corporation” is “the right to receive dividends from the profits and gains made by the common fund.”604 So important is the right of shareholders to participate in corporate profits, “that courts of equity will, in a proper case, compel a payment of dividends.”605 Because the shareholder beneficially owns a definite portion of the corporate enterprise, his property right is not only to receive a share in any economic return but to receive the full proportional share of what is his own. 606

597 Cooper v. United States, 322 F. Supp. 2d 733, 737 (E.D. Tex. 2004). 598 See Tenneco, Inc. v. Enter. Prod. Co., 925 S.W.2d 640, 646 (Tex. 1996) (“Sound corporate jurisprudence

requires that courts narrowly construe rights of first refusal and other provisions that effectively restrict the free transfer of stock.”); Sandor Petroleum Corp. v. Williams, 321 S.W.2d 614, 617 (Tex. Civ. App.—Eastland 1959, writ ref’d n.r.e.) (“Generally speaking, corporate shares of stock are property which may be freely sold and delivered.”).

599 Hicks v. Castille, 313 S.W.3d 874, 881 (Tex. App.—Amarillo 2010, pet. denied); see TEX. CONST. art. I, § 26 interp. commentary (West 2007) (“The framers of the Texas Constitutions, beginning with that of the Republic, have believed in an unrestrained power to convey or transfer property, and thus have written into the Bill of Rights this provision against perpetuities, primogeniture and the entailment of estates.”).

600 Dixie Pipe Sales, Inc. v. Perry, 834 S.W.2d 491, 493 (Tex. App.—Houston [14th Dist.] 1992, writ denied); see also BUS. ORGS. § 21.209 (“Except as otherwise provided by this code, the shares and other securities of a corporation are transferable in accordance with Chapter 8, Business & Commerce Code.”); id. §§ 21.210–.213 (stating manner of creating restrictions and listing examples of valid restrictions on transfer of shares); TEX. BUS. & COM. CODE ANN. § 8.204 & cmt. 1 (West 1995) (validity of restriction determined by other law, but any restriction on transfer must be noted conspicuously on certificate if certificated security to be enforceable).

601 Evanston Ins. Co., 370 S.W.3d at 383. 602 Sheffield v. Hogg, 77 S.W.2d 1021, 1028 (Tex. 1934); see also Exxon Corp. v. Breezevale Ltd., 82 S.W.3d

429, 436–37 (Tex. App.—Dallas 2002, pet. denied) (“[T]hus a devise of the profits of land, or even a grant of them, will pass a right to the land itself. Thus, a conveyance of an interest in the minerals that are produced from land, such as a working interest or a royalty interest, passes a right to the land itself.”); U.S. Pipeline Corp. v. Kinder, 609 S.W.2d 837, 839 (Tex. Civ. App.—Fort Worth 1980, writ ref’d n.r.e.).

603 Morrison v. St. Anthony Hotel, 274 S.W.2d 556, 567 (Tex. Civ. App.—Austin 1955, writ ref’d n.r.e.). 604 Turner v. Cattleman’s Trust Co., 215 S.W. 831, 833 (Tex. Comm’n App. 1919, judgm’t adopted). 605 Moroney v. Moroney, 286 S.W. 167, 169 (Tex. Comm’n App. 1926, judgm’t affirmed); see also Farrington

v. Tennessee, 95 U.S. 679, 687 (1877) (listing among the fundamental aspects of share ownership the entitlement “to share in the dividends and profits.”).

606 See Auto. Mortg. Co. v. Ayub, 266 S.W. 134, 135 (Tex. Comm’n App. 1924, judgm’t adopted) (“It is generally agreed that shares in an incorporated company are the aliquot parts of the capital stock, and merely give to the owner a right to his share of the profits of the corporation, while it is a going concern, and to a share of the


VI. RECOGNIZING DUTIES THAT CORPORATIONS OWE TO EVERY SHAREHOLDER

A. Beneficial Nature of Stock Ownership

1. Corporation Is a Trustee for the Stockholders

Unlike other forms of property ownership, stock ownership involves both a direct aspect—direct ownership of the shareholder’s undivided partial interest in the corporation, usually represented by the stock certificate—and an indirect aspect—what the “stock” represents, an undivided partial interest in the assets and business operations owned and controlled by the corporation. The Texas Supreme Court in Sneed v. Webre recently acknowledged that a shareholder’s ownership of “stock” is actually a beneficial or equitable ownership interest in the assets and business enterprise of the corporation.607 The Court noted that Texas law “recognized that ‘the stockholders are the beneficial owners of the assets of the corporation’ well over a century ago.”608 The “beneficial title to the assets of the corporation is

proceeds of its assets, when sold for distribution in case of its dissolution and winding up.”) (quoting Presnall v. Stockyards Nat’l Bank, 151 S. W. 873 (Tex. Civ. App.—Texarkana 1912), aff’d, 194 S.W. 384 (Tex. 1917); Olsen v. Homestead Land & Imp. Co., 28 S.W. 944 (Tex. 1894) (“The right which a shareholder in a corporation has by reason of his ownership of shares is a right to participate, according to the amount of his stock, in the surplus profits of the corporation on a division, and ultimately on its dissolution in the assets remaining after the payment of its debts.”); Byerly v. Camey, 161 S.W.2d 1105, 1110 (Tex. Civ. App.—Fort Worth 1942, writ ref’d w.o.m.) (“The stockholder has a right to his share of the profits while the corporation is a going concern, and to a share of the proceeds of its assets, when sold for distribution in case of its dissolution and winding up.”). See I-10 Colony, Inc. v. Chao Kuan Lee, 393 S.W.3d 467, 478 (Tex. App.—Houston [14th Dist.] 2012, pet. denied) (“The general rule for cotenants in Texas is that they are required to share any income or rents generated from the jointly-owned property according to their respective interests . . . .”). The analogy breaks down to some extent because shareholders do not hold direct title to the corporate assets and thus are not really tenants in common of those assets, at least not until dissolution. Eddings v. Black, 602 S.W.2d 353, 358 (Tex. Civ. App.—El Paso 1980, writ ref’d n.r.e.) (“[W]here the tenant in possession rents the property to a third person, he must account to his cotenant. Rents and profits received by one cotenant are held by him in trust for his cotenants.”); Auto. Mortgage Co., 266 S.W. at 135 (quoting U.S. Radiator Corp. v. State, 101 N.E. 783, 786 (N.Y. 1913)) (“The whole title to it is in the corporation, and the shareholders are neither tenants in common nor in any legal sense the owners of it.”); Montgomery v. Heath, 283 S.W. 324, 327 (Tex. Civ. App.—Amarillo 1926) (the shareholders of the defunct corporation become “owners as tenants in common of its property”), aff’d in part, rev’d in part on other grounds, 291 S.W. 855 (Tex. Comm’n App. 1927, holding approved). Shareholders do not have a right to an accounting from each other for disproportionate benefits; however, they do have the right to their proportional share of the earnings from the corporation. See also Burton v. Exxon Corp., 583 F. Supp. 405, 418 (S.D. N.Y. 1984) (“[S]tockholders are owners of the corporation and expect to share in its profits.”); Michaud v. Morris, 603 So. 2d 886, 888 (Ala. 1992) (“Certain basic expectations of investors are enforceable in the courts, and among those is a right to share proportionally in corporate gains.”); Burt v. Burt Boiler Works, Inc., 360 So. 2d 327, 332 (Ala. 1978) (“Should they, acting through the board and corporate officers, which they control, deprive the minority stockholders of their just share of the corporate gains, such would, of course, be actionable.”); Baur v. Baur Farms, Inc., 832 N.W.2d 663, 673 (Iowa 2013) (citing “the principle that every shareholder may reasonably expect to share proportionally in a corporation’s gains.”); Baker v. Com. Body Builders, Inc., 507 P.2d 387, 397 (Or. 1973) (explaining shareholders have “a legitimate interest in the participation in profits earned by the corporation”). Because share ownership involves multiple undivided interests, an analogy might be drawn to other situations involving multiple owners of a single property—or tenants in common—who have a duty to share profits proportionally and are accountable to the other co-owners.

607 See Sneed v. Webre, 465 S.W.3d 169, 191 (Tex. 2015). 608 Id. at 190–91 (citing Aransas Pass Harbor Co. v. Manning, 63 S.W. 627, 629 (Tex. 1901)).


in the stockholders.”609 There are certain legal consequences to this ownership structure610 in which beneficial ownership and legal title are held separately.611 One who holds the legal title to property for the benefit of the beneficial owner is a trustee,612 and trustees owe legal duties to the beneficiaries of their trust.613

The corporation holds the shareholders’ property pursuant to a “contractual relation whereby the corporation acquires and holds the stockholder’s investment under express recognition of his right and for a specific purpose.”614 Therefore, although the shareholder may be said to “possess” the stock,615 the stock is only an undivided interest in property, the actual possession of which is always with the corporation.616 Texas Courts have held that the corporation is the “custodian of the rights of the stockholders.”617 The “nature of the organization and the relation of the stockholders to the corporation and its property”618 impose legal duties on the corporation with respect to the stockholder’s ownership interest.619 The relationship, and its accompanying duties, have been characterized as “akin to one of trust,”620 with the corporation acting as a “quasi-trustee,” holding its stock for the benefit of and in trust for its stockholders.621

2. Rediscovering Corporate Trustee Duties

One must go back long before the advent of the shareholder oppression doctrine to find

609 Sneed, 465 S.W.3d at 190–91 (quoting Humble Oil & Ref. Co. v. Blankenburg, 235 S.W.2d 891, 894 (Tex. 1951)).

610 It is the shareholder’s beneficial ownership of the corporate assets that gives the shareholder standing as a plaintiff in a derivative suit, which as the Texas Supreme Court affirmed in Sneed extends to a derivative action brought by shareholder of a parent corporation on behalf of a wholly-owned subsidiary, one of the corporate assets in which the shareholder owns a beneficial interest. See id. at 192.

611 Id. at 191 (quoting Milner v. Milner, 361 S.W.3d 615, 620–21 (Tex. 2012)). 612 Burns v. Miller, Hiersche, Martens & Hayward, P.C., 948 S.W.2d 317, 322 (Tex. App.—Dallas 1997, writ

denied). 613 Herschbach v. City of Corpus Christi, 883 S.W.2d 720, 735 (Tex. App.—Corpus Christi 1994, writ denied). 614 Graham v. Turner, 472 S.W.2d 831, 836 (Tex. Civ. App.—Waco 1971, no writ). 615 Hooks v. Grayson, No. 05-91-00954-CV, 1992 WL 94670, at *3 (Tex. App.—Dallas May 7, 1992, writ

denied). 616 Turner v. Cattleman’s Trust Co., 215 S.W. 831, 833 (Tex. Comm’n App. 1919, judgm’t adopted) (stock at

all time remains “in the possession of the corporation”); see also Benson v. Greenville Nat’l Exch. Bank, 253 S.W.2d 918, 928–29 (Tex. Civ. App.—Texarkana 1952, writ ref’d n.r.e.) (“[T]he situs of the stock may be at the domicile of the corporation . . . .”).

617 Strange v. Houston & T.C.R. Co., 53 Tex. 162, 168 (1880) (“The company is to a certain extent the custodian of the rights of the stockholders, and is responsible for an illegal issuance of stock to their prejudice.”).

618 Moroney v. Moroney, 286 S.W. 167, 169 (Tex. Comm’n App. 1926, judgm’t affirmed). However, it should be noted that because corporations are set up differently, these rights and interests “may well vary from one corporation to the next.” Schautteet v. Chester State Bank, 707 F. Supp. 885, 888 (E.D. Tex. 1988).

619 See Graham, 472 S.W.2d at 836. 620 Disco Mach. of Liberal Co. v. Payton, 900 S.W.2d 124, 126 (Tex. App.—Amarillo 1995, writ denied) (The

relationship of corporation and shareholder is “akin to one of trust” because of “the contractual relation whereby the corporation acquired and held the stockholder’s investment for a specific purpose and under express recognition of his rights accruing in the investment.”).

621 Miller v. United States, 78 U.S. 268, 297 (1870) (“A corporation holds its stock, as a quasi trustee, for its stockholders.”).


opinions that took any care to define legal relationship between corporation and shareholder and the accompanying duties arising from that relationship. In light of the recent demise of the shareholder oppression doctrine in Texas, those cases are worth a fresh look.

Prior to the adoption of the Uniform Stock Transfer Act622 by the states, courts imposed “quasi-fiduciary duties” on corporate issuers and their transfer agents to insure that changes in stock registration were not wrongful as against the true owner.623 These duties arose from the courts’ analysis that “a corporation whose stock was transferable only on the books of the company was, to a certain extent at least, a trustee for its shareholders in respect to their stock.”624 Under this older line of case law, courts imposed on the corporation, as trustee, the “duty to exercise reasonable care and diligence to protect [the stockholder’s] interests by preventing [wrongful] transfers, and it had to respond in damages.”625 The big change that came with the adoption of the Uniform Stock Transfer Act was to render share certificates freely negotiable—the primary effect of which was to protect good faith purchasers and to ease the risks and burdens that the courts had imposed on corporations when they register a transfer.626 However, Article 8 of the Uniform Commercial Code does not preempt the common law,627 and one respected authority has noted that this “large body of case law . . . may still be useful today.”628 In light of the Texas Supreme Court’s recent extensive reliance in Ritchie629 and Sneed630 on pre-shareholder oppression cases from the late nineteenth and early twentieth centuries, this exploration seems particularly appropriate.

3. Yeaman v. Galveston City Corp.

One of the clearest statements of the relationship between shareholders and their corporation was given by the Texas Supreme Court in the case of Yeaman v. Galveston City Corp.,631 decided in 1914. That case had its genesis in a property dispute that occurred less than a year after the Battle of San Jacinto. In April of 1837, M. B. Menard, a signer of the Texas Declaration of Independence,632 who “claimed to own the whole of the league and labor

622 TEX. BUS. & COMM. CODE ANN. §§ 8.101–.307 (West 2015) “Chapter 8 of the Texas Business and

Commerce Code provides a single set of integrated rules applicable to the transfer of investment securities—shares of stock, bonds, debentures, warrants, and similar instruments.” 19 TEX. PRAC.: BUS. ORGS., supra note 7, at § 1:13.

623 12 FLETCHER CYC. CORP. § 5538 (2015). 624 Id. 625 Id. 626 Id. 627 Id.; see also Broadcort Capital Corp. v. Summa Med. Corp., 972 F.2d 1183, 1192 (10th Cir. 1992) (holding

that section 8-404 was not the exclusive remedy and that the plaintiff could sue issuer for common law conversion). 628 Id. 629 Calvert v. Capital Sw. Corp., 441 S.W.2d 247, 255 (Tex. Civ. App.—Austin 1969, writ ref’d n.r.e.);

Texarkana Coll. Bowl, Inc. v. Phillips, 408 S.W.2d 537, 539 (Tex. Civ. App.—Texarkana 1966, no writ); Cavitt v. Amsler, 242 S.W. 246, 247 (Tex. Civ. App.—Austin 1922, writ dism’d w.o.j.); Empire Mills v. Alston Grocery Co., 15 S.W. 505, 505–06 (Tex. Civ. App.—1891, no writ).

630 Blasband v. Rales, 971 F.2d 1034, 1043 (3d Cir. 1992); Hunt v. Bass, 664 S.W.2d 323, 324 (Tex. 1984); Cates v. Sparkman,11 S.W. 846, 848 (Tex. 1889).

631 Yeaman v. Galveston City Co., 167 S.W. 710 (Tex. 1914). 632 Margaret Swett Henson, Michel Branamour Menard, HANDBOOK OF TEXAS ONLINE,

https://tshaonline.org/handbook/online/articles/fme09.


of land633 granted to him by the republic of Texas, situated on the east end of Galveston Island,” got into a dispute with Robert Triplett and two other gentlemen who claimed ownership of the same land.634 A compromise was reached whereby the parties conveyed the land to Thomas Green, Levi Jones, and William R. Johnson in trust, to be subdivided and sold for the benefit of Triplett and his co-owners.635 The land was placed in a joint stock company and represented by 1,000 shares of stock, which were then offered to investors in June 1837.636 The first stockholders’ meeting was held in Galveston on April 13, 1838, where the stockholders organized the company, elected directors, and named the company the “Galveston City Company.”637 The company was incorporated in 1841 by an act of the Congress of the Republic of Texas, and “[a]ll stockholders in the joint-stock company were . . . made stockholders in the corporation.”638

Robert Triplett died in 1853 without having disposed of five of the original trust certificates, which he had never exchanged for share certificates in the corporation.639 The petition in the lawsuit alleged: “Robert Triplett was a careless man, and left his papers in great confusion. [S]earch among such of his papers as petitioners can find fails to disclose said certificates, and petitioners aver that said 5 certificates are lost or destroyed.”640 His descendants did not discover his ownership of the original five certificates until August 1909,641 at which time they sued the Galveston City Company and its president, individually, to establish their rights as stockholders, for an accounting and recovery of 72 years of dividends, and to enjoin the proposed dissolution of the corporation by the majority of its stockholders.642

The Texas Supreme Court first had to determine whether Triplett had been a shareholder in the corporation or had only had the right to become one—a right which would have been lost due to the statute of limitations—and to determine the legal effect of his never having received stock certificates in the corporation. The Court held that Triplett had become a stock holder by virtue of having fulfilled his subscription agreement643 and that his failure to obtain a stock certificate was irrelevant:

[I]n a corporation the certificate of stock is not the stock itself; it is but a muniment of title, an evidence of the ownership of the stock. It is not necessary to a subscriber’s complete ownership of the stock. He becomes a full stockholder, certainly where he has performed his obligation, and possession all of a stockholder’s rights, even if no

633 4,605 acres. Yeaman, 167 S.W. at 712. 634 Id. at 711. 635 Id. 636 Id. at 712. 637 Id. at 713. 638 Id. at 715. 639 Id. at 715. 640 Id. at 716. 641 Id. 642 Id. at 711. 643 “No principle of law is better settled than that which affirms that the payment of his subscription by an

original subscriber to the capital stock of a corporation constitutes him a stockholder, and that, as before stated, regardless of the issuance of any certificate.” Id. at 720.


certificate is issued to him at all.644

The Court then turned to the thornier issue of limitations and the plaintiffs’ 72-year delay in asserting their rights—particularly, whether the corporation could be forced to pay 72 years’ worth of dividends. The Court’s answer was based on the nature of the legal relationship between stockholder and corporation and the legal duties that the corporation owes to its stockholders arising from that relationship.

The Court held that a corporation “is a trustee for the interests of its shareholders in its property, and is under the obligation to observe its trust for their benefit.”645

[T]he trusteeship of a corporation for its stockholders is that of an acknowledged and continuing trust. It cannot be regarded of a different character. It arises out of the contractual relation whereby the corporation acquires and holds the stockholder’s investment under express recognition of his right and for a specific purpose. It has all the nature of a direct trust.646

Because the law imposes on the corporation the duties of a trustee, the Court held: “Its possession is friendly, and not adverse, and the shareholder is entitled to rely upon its not attempting to impair his interest.”647 Because the shareholder is the beneficiary of the trust, “[h]e is chargeable with no vigilance to preserve his stock or its fruits from appropriation by the corporation, but may confide in its protection for their security.”648 Therefore, the court rejected the corporation’s defense of limitations on the shareholder’s descendants’ 72-year-old claims for cancellation of their shares and for an accounting and for payment of dividends.649 “And when a corporate act is invoked as a repudiation of a shareholder’s stock or a conversion of its profits, before affecting his rights with limitation, it is only just to require that he or those standing in his stead have notice of it.”650 “Statutes of limitation have no application until there is a clear and unequivocal disavowal of the trust, and notice of it brought to the cestui que trust.”651

While Yeaman is a very old case,652 the legal relationship between a corporation and its shareholders as a particular type of trust has been often repeated, never denied or limited, and is very well established in Texas case law.653 More recent Texas cases continue to hold that the

644 Id. 645 Id. at 723. 646 Id. 647 Id. 648 Id. 649 Id. (“[T]heir suit is not barred, either to enforce their rights as stockholders, or for an accounting and the

recovery of profits, or such amount as these shares would be entitled to as dividends.”). 650 Id. 651 Id. at 723–24. 652 Although not nearly as old as Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889) on which both Ritchie and

Sneed relied heavily. Sneed v. Webre, 465 S.W.3d 169, 173 (Tex. 2015); Ritchie v. Rupe, 443 S.W.3d 856, 884 (Tex. 2014).

653 See Disco Mach. of Liberal Co. v. Payton, 900 S.W.2d 124, 126 n.2 (Tex. App.—Amarillo 1995, writ denied) (“Historically, the relationship between corporation and shareholder was akin to one of trust.”); Hinds v. Sw.


trust relationship “arises out of the contractual relation whereby the corporation acquires and holds the stockholder’s investment,”654 and that the corporation holds legal title to its assets and business,655 but that legal title is held for the benefit of the shareholders, who are the equitable and beneficial owners of the corporation’s assets.656 “In a larger or real sense the stockholders of a corporation are the beneficial owners of its corporate properties.”657

With respect to a shareholder’s right to participate in a corporation’s profits through dividends, the Yeaman Court wrote: “There can be no substantial difference between the trusteeship of a corporation as it relates to the stock of a shareholder and its duty to him in respect to the profits or dividends upon his stock.”658 And, as the Patton Court would hold

Sav. Ass’n of Houston, 562 S.W.2d 4, 5 (Tex. Civ. App.—Beaumont 1977, writ ref’d n.r.e.) (“[T]rusteeship of a corporation for its stockholders is that of an acknowledged and continuing trust . . . .”); Graham v. Turner, 472 S.W.2d 831, 836 (Tex. Civ. App.—Waco 1971, no writ) (“the relation of a corporation to its stockholders is that of a trustee of a direct trust.”); Rex Ref. Co. v. Morris, 72 S.W.2d 687, 691 (Tex. Civ. App.—Dallas 1934, no writ) (“A corporation stands in the relation of a trustee to its stockholders, so where it appears that a stockholder’s ownership is challenged by the company, he may maintain an action to establish his ownership.”); Green v. Galveston City Co., 191 S.W. 182, 185 (Tex. Civ. App.—Galveston 1916, writ ref’d) (“It is also true that a corporation stands in the relation of trustee to the owners of its stock.”).

654 Graham, 472 S.W.2d at 836. See also Disco Mach., 900 S.W.2d at 126 ([T]he relationship of corporation and shareholder is “akin to one of trust” because of “the contractual relation whereby the corporation acquired and held the stockholder’s investment for a specific purpose and under express recognition of his rights accruing in the investment.”).

655 Rapp v. Felsenthal, 628 S.W.2d 258, 260 (Tex. App.—Fort Worth 1982, writ ref’d n.r.e.). 656 See Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d 687, 697 (Tex. App.—Fort Worth 2006, pet.

denied); In re Estate of Trevino, 195 S.W.3d 223, 230 (Tex. App.—San Antonio 2006, no pet.); Martin v. Martin, Martin & Richards, Inc., 12 S.W.3d 120, 124 (Tex. App.—Fort Worth 1999, no pet.); Rapp, 628 S.W.2d at 260; Gossett v. State, 417 S.W.2d 730 (Tex. Civ. App.—Eastland 1967, writ ref’d n.r.e.). “[M]any other cases refer to a shareholder or stockholder as having a beneficial interest in a company.” Hahn v. R.R. Comm’n of Tex., No. 03-07-00183-CV, 2009 WL 2341859, at *3 (Tex. App.—Austin July 30, 2009, pet. denied) (mem. op.) (citing McAlister v. Eclipse Oil Co., 98 S.W.2d 171, 176 (Tex. 1936)) (“[S]trictly speaking, the ownership of the stock does not carry with it the equitable title to the corporate property. This simply means, however, that the stockholders have no right to require the corporation to convey to them the legal title to the corporate property. In a larger or real sense the stockholders of a corporation are the beneficial owners of its corporate properties.”); Auto. Mortg. Co. v. Ayub, 266 S.W. 134, 135–36 (Tex. 1924) (stating that stockholder is beneficial owner of corporate assets and does not have direct interest in corporate property; while company is operating, company has title of corporate property; stockholder has equitable right to corporate assets if company ceases to operate and assets remain after creditors are satisfied); McClory v. Schneider, 51 S.W.2d 738, 741–42 (Tex. Civ. App.—Amarillo 1932, writ dism’d w.o.j.) (stockholder “owns no part of the capital, and is not the owner nor entitled to the possession of any definite portion of its property or assets”; stock purchaser does not acquire title to corporate property but simply acquires “beneficial interest” in company). See also Berl v. Crutcher, 60 F.2d 440, 444 (5th Cir. 1932) (“Generally speaking, a corporation is a separate entity distinct from the stockholders, but as between itself and its stockholders this is a mere fiction, and the equitable ownership of all its property is in the stockholders, subject to the prior rights of creditors.”); In re Lawler, 50 B.R. 110, 118 (Bankr. N.D. Tex. 1985) (“as between the corporation and its shareholders, the latter have an equitable interest in assets held by the former.”); Humble Oil & Ref. Co. v. Blankenburg, 235 S.W.2d 891, 894 (Tex. 1951) (“As the owner of 90 shares of the stock petitioner is the beneficial owner of its proportionate part of the corporation’s assets and thus is the beneficial owner of an undivided interest in the property for which it sues.”).

657 McAlister, 98 S.W.2d at 176. “[W]hen this concern was chartered and the properties above described conveyed to it, it became the corporate owner thereof, but the real or beneficial owners of such property were the three stockholders in the proportion in which they held the stock of the corporation.” Id.

658 Yeaman v. Galveston City Co., 167 S.W. 710, 724 (Tex. 1914).


about forty years later, “the malicious suppression of dividends is a wrong akin to breach of trust, for which the courts will afford a remedy.”659 The Patton Court’s use of the phrase “breach of trust” to describe suppression of dividends was no accident, and it was not an archaic way of referring to the fiduciary duties that directors owe only to the corporation and not to the minority shareholders.660 The phrase “breach of trust” was first used in this context in the 1855 United States Supreme Court case of Dodge v. Woolsey,661 in which that Court wrote:

It is now no longer doubted, either in England or the United States, that courts of equity, in both, have a jurisdiction over corporations, at the instance of one or more of their members; to apply preventive remedies by injunction, to restrain those who administer them from doing acts which would amount to a violation of charters, or to prevent any misapplication of their capitals or profits, which might result in lessening the dividends of stockholders, or the value of their shares, as either may be protected by the franchises of a corporation, if the acts intended to be done create what is in the law denominated a breach of trust.662

The holding in Dodge v. Woolsey specifically related to ultra vires acts that “might result in lessening the dividends,” but the Texas Supreme Court, in later reviewing that landmark case, wrote:

After repeated efforts minority stockholders were successful in establishing their right to relief in courts of equity. It was first established in America in the case of Dodge v. Woosley, decided by the Supreme Court of the United States in 1855. . . . The doctrine announced [] has become thoroughly established as the law both in England and America. The rule in this regard is tersely stated by Mr. Cook in his splendid treatise on Stock and Stockholders, ‘that where corporate directors have permitted a breach of trust either by their fraud, ultra vires acts, or negligence.’663

Over the years, courts frequently listed “breach of trust” as one of the grounds on which a court of equity might disturb a decision by a board of directors regarding dividends.664 Both of the cases on which the Patton Court principally relied as authority for its substantive holding

659 Patton v. Nicholas, 279 S.W.2d 848, 854 (Tex. 1955). 660 See Ritchie v. Rupe, 443 S.W.3d 856, 884 n.49 (Tex. 2014). 661 Dodge v. Woolsey, 59 U.S. 331 (1855). 662 Id. at 341. 663 Pratt-Hewit Oil Corp. v. Hewit, 52 S.W.2d 64, 65–66 (Tex. 1932) (citations omitted). 664 See, e.g., Penn v. Pemberton & Penn, Inc., 53 S.E.2d 823, 828 (Va. 1949) (“The general rule is that in the

absence of a special contract or statute the board of directors, in its discretion, determines whether to declare dividends on the stock, or to apply the earnings and surplus to operating capital, or to some other corporate purpose. If the directors act in good faith, a court of equity usually will not interfere with the exercise of their discretion. However, if the action of the board in refusing to declare a dividend when there are sufficient earnings or surplus not necessarily needed in the business, is so arbitrary, or so unreasonable, as to amount to a breach of trust, such action is subject to judicial review.”); Gehrt v. Collins Plow Co., 156 Ill. App. 98, 102 (Ill. App. Ct. 1910) (“It requires a very strong case to induce a court of equity to order the directors to declare a dividend, inasmuch as equity has no jurisdiction unless fraud or a breach of trust is involved.”).


that a court may grant equitable relief for a suppression of dividends665 quote the “breach of trust” language from Dodge v. Woolsey.666 The Miner case, in particular, added this application of the “breach of trust” notion in the context of suppression of dividends:

The present case furnishes an instance of gross abuse of trust. Must the cestui que trust be committed to the domination of a trustee who has for seven years continued to violate the trust? The law requires of the majority the utmost good faith in the control and management of the corporation as to the minority. It is of the essence of this trust that it shall be so managed as to produce for each stockholder the best possible return for his investment. The trustee has so far absorbed all returns.667

B. Legal Duties Arising from the Trust Relationship

Stock is an abstract concept, an intangible set of rights and interests, not a physical thing. Ownership of stock may be evidenced by a written stock certificate and a written notation on the corporate books; however, the evidence of the thing is not the thing itself.668 Ultimately, stock ownership resides in the corporation’s acknowledgement of the existence of the ownership interest because the corporation has legal title and physical possession of its assets and enterprise. The stockholder has only an intangible right—a claim on the corporation—which involves the various property rights just discussed. That “claim” is meaningless unless the law recognizes enforceable legal duties to each shareholder.

1. Corporate Trustee Duties

Generally speaking, the duties that the law imposes on trustees are extremely strict. A trustee owes a trust beneficiary an unwavering duty of good faith, fair dealing, loyalty, and fidelity over the trust’s affairs and its corpus.669 The Texas Supreme Court has written:

When persons enter into fiduciary relations, each consents, as a matter of law, to have his conduct towards the other measured by the standards of the finer loyalties exacted by courts of equity. That is a sound rule and should not be whittled down by exceptions. The rule is general in its use and is fundamental. It is for the benefit of the cestui que trust and undertakes to enforce the duty of loyalty on the part of the trustee by prohibiting him from using the advantage of his position to gain any benefit for himself at the expense of his cestui que trust and from placing himself in any position where his self-interest will or may conflict with his obligations as trustee.670

However, the application of those duties in the corporate context must be a little different

665 See Patton v. Nicholas, 279 S.W.2d 848, 855 (Tex. 1955) (citing Tower Hill-Connellsville Coke Co. of W. Va. v. Piedmont Coal Co., 64 F.2d 817 (4th Cir. 1933)); Miner v. Belle Isle Ice Co., 53 N.W. 218 (Mich. 1892).

666 See Tower Hill-Connellsville, 64 F.2d at 826; Miner, 53 N.W. at 224. 667 Miner, 53 N.W. at 224. 668 Yeaman v. Galveston City Co., 167 S.W. 710 (Tex. 1914). 669 Herschbach v. City of Corpus Christi, 883 S.W.2d 720, 735 (Tex. App.—Corpus Christi 1994, writ denied);

Ames v. Ames, 757 S.W.2d 468, 476 (Tex. App.—Beaumont 1988), aff’d, 776 S.W.2d 154 (Tex. 1989). 670 Slay v. Burnett Trust, 187 S.W.2d 377, 377–78 (Tex. 1945).


from the application to a human trustee. In the corporate context, the strict duties of loyalty and care, which concern the management and control of the trust assets, are imposed on the directors and apply as to the corporation (the trust fund as a whole). Individual shareholders are not owed those duties apart from the corporation and have no ability to bring a claim on their own behalf for breach of those duties. The exception to this rule is that when the corporation is unable to enforce those duties, then the beneficial owners may bring a derivative claim on behalf of the corporation to do so. Nevertheless, as noted in the discussion above, shareholders have individual rights and interests of that are distinct from those of the corporation, and the corporation as trustee owes duties to the shareholder with respect to those rights and interests.

a. Duty to Acknowledge and Preserve Ownership Rights

As the Texas Supreme Court held in Yeaman, the corporation has a fiduciary duty to recognize, to respect, and not to attempt to interfere with a shareholder’s ownership: “[T]he shareholder is entitled to rely upon [the corporation’s] not attempting to impair his interest. He . . . may confide in its protection for their security.”671 The corporation “holds bare legal title”672 but it must recognize always that the shareholder is the “real owner.”673 Absent some statutory or charter power, or the express consent of the shareholder, a corporation has no authority to forfeit a shareholder’s stock.674

A trustee is also under a duty to the beneficiaries to administer the trust solely in the interest of the beneficiaries.675 A shareholder’s stock ownership includes a number of rights and interests, and the corporation has a duty not to “impair his interest.”676 Trust law recognizes that the profits belong to the beneficiaries, not to the trustee.677 Therefore, the corporation’s duty to its shareholders is to “to observe its trust for their benefit”678 and to preserve both the stock ownership and its “fruits.”679

b. Duty of Impartiality

Most significant of the trustee duties in the context of minority shareholders in a closely-

671 Yeaman, 167 S.W. at 723. 672 Sharma v. Routh, 302 S.W.3d 355, 366 (Tex. App.—Houston [14th Dist.] 2009, no pet.). 673 Burns v. Miller, Hiersche, Martens & Hayward, P.C., 948 S.W.2d 317, 322 (Tex. App.—Dallas 1997, writ

denied). 674 See Yeaman, 167 S.W. at 723 (“We are unwilling to affirm that, in the absence of some statutory or charter

power, or express consent to that effect, a corporation has any authority to forfeit a stockholder’s shares upon such a ground.”).

675 RESTATEMENT (SECOND) OF TRUSTS §170(1) (2016); Ditta v. Conte, 298 S.W.3d 187, 191 (Tex. 2009) (“High fiduciary standards are imposed upon trustees, who must handle trust property solely for the beneficiaries’ benefit.”).

676 Yeaman, 167 S.W. at 723. 677 Steves v. United Servs. Auto. Ass’n, 459 S.W.2d 930, 936 (Tex. Civ. App.—Beaumont 1970, writ ref’d

n.r.e.) (“profit from dealing with the property of the Trust is the property of the beneficiaries, not the trustee”); Hamman v. Ritchie, 547 S.W.2d 698, 710 (Tex. Civ. App.—Fort Worth 1977, writ ref’d n.r.e.) (“profits are the entitlement of the trust benefactor”).

678 Yeaman, 167 S.W. at 723. 679 Id.


held corporation is the corporate trustee’s duty of impartiality towards multiple beneficiaries. When there are two or more beneficiaries of a trust, the trustee is under a strict duty to deal impartially with them.680 Shares are fungible. Every share of the same class gets the same vote, the same dividend, and is entitled to the same treatment.681 In a dispute among shareholders over who will control the corporation, the corporation itself must remain strictly neutral.682

Nothing can be more unjustifiable and dishonorable than an attempt on the part of those holding a majority of the shares in a corporation to place their nominees in control of the company, and then to use their control for the purpose of obtaining advantage to themselves at the expense of the minority. It would be a conspiracy to commit a breach of trust. The directors of a corporation are bound to administer its affairs with strict impartiality, in the interest of all the shareholders alike; and the inability of the minority to protect themselves against unauthorized acts, performed

680 Brown v. Scherck, 393 S.W.2d 172, 181 (Tex. Civ. App.—Corpus Christi 1965, no writ) (“Where there are

several beneficiaries, the trustee owes the same fiduciary duty to all of them to protect their respective interests, without partiality or favor to some beneficiaries at the expense of the others.”); duPont v. S. Nat’l Bank of Hous., 771 F.2d 874, 887 n.12 (5th Cir. 1985) (“has a duty to deal impartially with the beneficiaries of the trust”); RESTATEMENT

(SECOND) OF TRUSTS § 183 (1959) (“When there are two or more beneficiaries of a trust, the trustee is under a duty to deal impartially with them.”); RESTATEMENT (THIRD) OF TRUSTS § 79(1)(a) (2007) (a “trustee has a duty to administer the trust in a manner that is impartial with respect to the various beneficiaries of the trust[;] . . . the trustee must act impartially and with due regard for the diverse beneficial interests created by the terms of the trust.”). This common-law principal is codified at TEX. PROP. CODE ANN. § 117.008 (West 2015) (“If a trust has two or more beneficiaries, the trustee shall act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries.”). See also Varity Corp. v. Howe, 516 U.S. 489, 514 (1996) (“The common law of trusts recognizes the need to preserve assets to satisfy future, as well as present, claims and requires a trustee to take impartial account of the interests of all beneficiaries.”); Chauffeurs, Teamsters & Helpers, Local No. 391 v. Terry, 494 U.S. 558, 586 (1990) (“Trust law, in a similar manner, long has required trustees to serve the interests of all beneficiaries with impartiality.”); Palmer v. Chamberlin, 191 F.2d 532, 545 (5th Cir. 1951) (“[T]he trustees’ duty was to act impartially between all beneficiaries . . . .”); Pierre v. Conn. Gen. Life Ins. Co., 932 F.2d 1552, 1562 (5th Cir. 1991) (“duty to deal impartially with the beneficiaries of the trust”); Miss. Valley Trust Co. v. Buder, 47 F.2d 507, 509 (8th Cir. 1931) (“The duty of a trustee to act with impartiality toward the several cestuis que trustent must be conceded, but the law permits a reasonable and practical course of conduct and does not set an impossible or extreme standard.”); In re Estate of Stuchlik, 857 N.W.2d 57, 70 (Neb. 2014) (“If a trust has two or more beneficiaries, a trustee has a duty of impartiality among beneficiaries. This includes a duty to ‘act impartially in investing, managing, and distributing the trust property, giving due regard to the beneficiaries’ respective interests.”); Harrison v. Marcus, 486 N.E.2d 710, 714 n.11 (Mass. 1985) (“Where there are successive beneficiaries, the trustees ‘owe[ ] a duty to them to administer the trust with impartial consideration for the interests of all the beneficiaries.’”); Estate of Sewell, 409 A.2d 401, 402 (Pa. 1979) (“It is axiomatic that ‘(w)hen there are two or more beneficiaries of a trust, the trustee is under a duty to deal impartially with them.’”); Johnson v. Johnson, 45 N.W.2d 573, 574 (Iowa 1951) (“A trustee must act at all times in good faith in administering the trust and impartially between the several beneficiaries thereof.”); Koretzky’s Estate v. Kislak, 86 A.2d 238, 250 (N.J. 1951) (“It is the duty of trustees to deal impartially with beneficiaries.”); Patterson v. Old Dominion Trust Co., 140 S.E. 810, 813 (Va. 1927) (“In the management of trust property, a trustee should always conduct himself with strict neutrality, favoring none of the parties to the suit, and endeavor to obtain an impartial direction in all cases of doubt or difficulty, and should also preserve and protect the trust fund for the benefit of all interested in the distribution thereof.”).

681 See TEX. BUS. ORGS. CODE ANN. § 21.152(c) (West 2015) (“Shares of the same class must be identical in all respects unless the shares have been divided into one or more series. If the shares of a class have been divided into one or more series, the shares may vary between series, but all shares of the same series must be identical in all respects.”).

682 See Alexander v. Sturkie, 909 S.W.2d 166, 170 (Tex. App.—Houston [14th Dist.] 1995, writ denied).


with the connivance of the majority, renders their right to the protection of the courts the clearer.683

The most common conduct challenged in oppression cases is manipulation of the control over the corporation to make the majority’s investment proportionally more valuable than the minority’s or otherwise to use the minority shareholder’s own corporation against him to disadvantage the minority relative to the majority.684 Actions taken by the corporation that result in the impairment of minority rights and interests to the benefit of the majority shareholder or result in the majority shareholder enjoying a disproportionate share of the profits or capital value to the detriment of the minority violate the duty of impartiality. Thus, a refusal to issue dividends in an effort to harm the minority shareholders is a “wrong akin to breach of trust.”685 This concept was accepted and reinforced in the Ritchie opinion by the majority’s argument that the corporation’s interests are not identical to the individual interests of its majority shareholders, and that officers and directors controlling a corporation have a duty “to the corporation and its shareholders collectively, not any individual shareholder or subgroup of shareholders, even if that subgroup represents a majority of the ownership.”686 “We do not determine the best interest of the corporation by examining only the interest of its majority shareholder(s).”687

c. Duty to Disclose and Account

The shareholders own the corporation and are the equitable or beneficial owners of all property possessed by the corporation, including all the information and all the records.688 Those in charge of the corporation are merely the agents ultimately of the stockholders who are the real owners, and the owners are entitled to information as to the manner in which the corporate business is conducted.689

While the corporation holds the legal title to its property, the stockholders are deemed the real and beneficial owners thereof and, as such, are entitled to information

683 Memphis & C. R. Co. v. Wood, 7 So. 108, 112 (Ala. 1889). 684 See Boehringer v. Konkel, 404 S.W.3d 18, 28 (Tex. App.—Houston [1st Dist.] 2013, no pet.) (oppression

by majority’s $20,000 per month salary increase, which resulted in a “de facto dividend to the exclusion of . . . the minority shareholder”); Davis v. Sheerin, 754 S.W.2d 375, 382 (Tex. App.—Houston [1st Dist.] 1988, writ denied) (oppression by payment of “informal dividends” only to the majority and use of corporate funds to pay the majority shareholder’s legal fees).

685 Patton v. Nicholas, 279 S.W.2d 848, 854 (Tex. 1955). 686 Ritchie v. Rupe, 443 S.W.3d 856, 885 n.5 (Tex. 2014). To support this argument, the Ritchie opinion cites

Redmon v. Griffith, 202 S.W.3d 225, 233 (Tex. App.—Tyler 2006, pet. denied); Somers ex rel. EGL v. Crane, 295 S.W.3d 5, 11 (Tex. App.—Houston [1st Dist.] 2009, no pet.); Lindley v. McKnight, 349 S.W.3d 113, 124 (Tex. App.—Fort Worth 2011, no pet.); Hoggett v. Brown, 971 S.W.2d 472, 488 (Tex. App.—Houston [14th Dist.] 1997, pet. denied).

687 Ritchie, 443 S.W.3d at 885 n.53 (citing Holloway v. Skinner, 898 S.W.2d 793, 797 (Tex. 1995) as “holding that corporate officer and majority shareholder could be held liable for acting ‘in a manner that served his interests at the expense of the other shareholders’ because his interests and the corporation’s were not necessarily aligned.”).

688 See Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d 687, 697 (Tex. App.—Fort Worth 2006, pet. denied).

689 Johnson Ranch Royalty Co. v. Hickey, 31 S.W.2d 150, 153 (Tex. Civ. App.—Amarillo 1930, writ ref’d).


concerning the management of the property and business they have confided to the officers and directors of the corporation as their agents. A stockholder’s assertion of right to inspect the corporation’s books and records is sometimes said to be one merely for the inspection of what is his own.690

A shareholder’s right to information about the corporation reflects the fundamental duties of disclosure owed by trustees.691 “In general, the common-law trustee of an irrevocable trust must produce trust-related information to the beneficiary on a reasonable basis, though this duty is sometimes limited and may be modified by the settlor.”692 Corporations are required by statute to keep records and accounts and to permit shareholders to inspect the records.693 However, the shareholder’s right to access corporate records is meaningless if those records are not kept, or are not accurate. The corporation as a trustee, has a broader duty to keep complete and accurate records to be able to meet its duty to account to its beneficiaries for the management of their property.694 The trustee’s duty regarding trust-related information is stated as follows:

A. Duty to keep accounts. The trustee is under a duty to keep accounts showing in detail the nature and amount of the trust property and the administration thereof.

B. Effect of failure to keep accounts. If the trustee fails to keep proper accounts, he is liable for any loss or expense resulting from his failure to keep proper accounts. The burden of proof is upon the trustee to show that he is entitled to the credits he claims, and his failure to keep proper accounts and vouchers may result in his failure to establish the credits he claims.695

“The trustee should have at least given an accurate and complete statement of the trust estate, free from any suggestion of fraud.”696

690 State ex rel. G.M. Gustafson Co. v. Crookston Trust Co., 22 N.W.2d 911, 915–16 (Minn. 1946); accord

Guthrie v. Harkness, 199 U.S. 148, 155 (1905). 691 See RESTATEMENT (SECOND) OF TRUSTS § 172 (2016) (duty to the beneficiary to keep and render clear and

accurate accounts with respect to the administration of the trust); id. § 173 (duty to the beneficiary to give him upon his request at reasonable times complete and accurate information as to the nature and amount of the trust property, and to permit him or a person duly authorized by him to inspect the subject matter of the trust and the accounts and vouchers and other documents relating to the trust).

692 United States v. Jicarilla Apache Nation, 564 U.S. 162, 183 (2011). 693 See TEX. BUS. ORGS. CODE ANN. §§ 3.151–.153, 21.173, 218–22 (West 2012). 694 See Huie v. DeShazo, 922 S.W.2d 920, 923 (Tex. 1996) (trustees and executors owe beneficiaries “a

fiduciary duty of full disclosure of all material facts known to them that might affect [the beneficiaries’] rights.”); Faulkner v. Bost, 137 S.W.3d 254, 259 (Tex. App.—Tyler 2004, no pet.) (“A trustee shall maintain a complete and accurate accounting of the administration of the trust.”); Shannon v. Frost Nat’l Bank, 533 S.W.2d 389, 393 (Tex. Civ. App.—San Antonio 1975, writ ref’d n.r.e.) (“[I]t is well settled that a trustee owes a duty to give to the beneficiary upon request complete and accurate information as to the administration of the trust” and “to make a frank and dull disclosure of all the information which it had.”).

695 RESTATEMENT (SECOND) OF TRUSTS § 172. See also Corpus Christi Bank & Trust v. Roberts, 587 S.W.2d 173, 182 (Tex. Civ. App.—Corpus Christi 1979), aff’d, 597 S.W.2d 752 (Tex. 1980); Harris Cty. v. Wilkinson, 507 S.W.2d 848, 851 (Tex. Civ. App.—Houston [14th Dist.] 1974, writ ref’d n.r.e.).

696 Roberts, 587 S.W.2d at 181–82. See Conrad v. Judson, 465 S.W.2d 819, 828 (Tex. Civ. App.—Dallas 1971, writ ref’d n.r.e.) cert. denied, 405 U.S. 1041 (1972); Cook v. Peacock, 154 S.W.2d 688, 691 (Tex. Civ. App.—


2. Objections to this Analysis

The concept of “fiduciary duties” owed by the corporation to its shareholders has drawn considerable hostility from some commentators and courts in other jurisdictions. In Ritchie, the Texas Supreme Court, in addressing a different legal issue, quoted one commentator who expressed extreme doubt as to fiduciary duties owed by the corporation:

The very idea that a corporation has a fiduciary duty to individual shareholders is troubling. The corporation can act only through its board of directors, officers, employees, and other agents. These actors are obligated to act in the best interests of the corporation, which may not coincide with the best interests of an individual shareholder transacting business with the corporation. There is no reason to impose a fiduciary obligation on these actors to act in the best interests of an individual shareholder when that shareholder proposes a course of conduct not in the best interests of the corporation.697

This concern, however, presents a false dilemma. First, the factual situation contemplated is a “shareholder transacting business with the corporation” where the “best interests of the individual shareholder” in that transaction do not coincide with the “best interests of the corporation.” For example, a corporation might need to rent a warehouse, and a minority shareholder might have a suitable property. In that situation, the minority shareholder is not dealing with the corporation as a shareholder but as a prospective landlord. The interests of the shareholder (receiving highest rent) and the interests of the corporation (paying lowest rent) are inherently in conflict. Nothing in Yeaman or in any case decided under the shareholder oppression doctrine suggests in the slightest that the corporation would be breaching a duty to the minority shareholder by renting a different warehouse that was better and cheaper. However, when a corporation seeks to redeem or repurchase shares from a minority shareholder—the one business transaction between corporation and shareholder where the shareholder is acting in his capacity as a shareholder—the corporation indisputably owes fiduciary duties to the individual shareholder.698

Eastland 1941, writ ref’d w.o.m.). 697 Ritchie v. Rupe, 443 S.W.3d 856, 890 n.62 (Tex. 2014) (quoting Mark J. Loewenstein & William K.S.

Wang, The Corporation as Insider Trader, 30 DEL. J. CORP. L. 45, 52 (2005)). The Supreme Court cites this commentator only on the issue of whether officers and directors owe fiduciary duties to individual shareholders:

Imposing on directors and officers a common-law duty not to act ‘oppressively’ against individual shareholders is the equivalent of, or at least closely akin to, imposing on directors and officers a fiduciary duty to individual shareholders. We have not previously recognized a formal fiduciary duty to individual shareholders, and we believe that better judgment counsels against doing so.

Id. at 890. The Supreme Court has most certainly recognized that corporations do owe the same types of duties—i.e., fiduciary duties—to shareholders as trustees owe to beneficiaries of the trust. See, e.g., Yeaman v. Galveston City Co., 167 S.W. 710, 724 (Tex. 1914). (“There can be no substantial difference between the trusteeship of a corporation as it relates to the stock of a shareholder and its duty to him in respect to the profits or dividends upon his stock.”).

698 Allen v. Devon Energy Holdings, L.L.C., 367 S.W.3d 355, 355 (Tex. App.—Houston [1st Dist.] 2012, pet. granted, judgm’t vacated w.r.m.); Miller v. Miller, 700 S.W.2d 941, 945 (Tex. App.—Dallas 1985, writ ref’d n.r.e.). The Ritchie opinion specifically cites this holding in Devon as an example of current remedies being adequate. See Ritchie, 442 S.W.3d at 888 n.56.


Second, what is at issue is not a potential conflict between the best interests of the corporation and the best interests of an individual shareholder, but what legal duties do corporations owe to each and every shareholder by virtue of the fact that they are shareholders of the corporation. If, for example, a corporation owed a duty to allow its shareholders to vote and to be bound by the result,699 then a corporation would be held to that legal duty regardless of whether the management of the corporation thought that it would be in the “best interest of the corporation” to disenfranchise certain shareholders. The corporation could not unilaterally cancel a troublesome minority shareholder’s stock because management sincerely (and even correctly) believed that the corporation would be better off without him. The corporation would not be permitted to pay dividends to all shareholders except one, based on the determination that the corporation needed the money, and that the best interests of the corporation trumped the best interests of an individual shareholder.

A number of courts have also resisted the idea that corporations owe “fiduciary duties” to shareholders based on the concern that this doctrine would result in vicarious liability to the corporation for wrongdoing initiated by and executed by its officers, directors or other shareholders.700 The Sixth Circuit has stated:

Liability for breach of the directors’ fiduciary obligation could not possibly run against the corporation itself, for this would create the absurdity of satisfying the shareholders’ claims against the directors from the corporation, which is owned by the shareholders. There is not, and could not conceptually be any authority that a corporation as an entity has a fiduciary duty to its shareholders.701

699 See TEX. BUS. ORGS. CODE ANN. § 21.401 (West 2006) (business affairs managed through board of

directors). 700 Many jurisdictions have held that there is no respondeat superior liability on a corporation for a breach of

fiduciary duty by its directors. See CCBN.Com, Inc. v. Thomson Fin., Inc., 270 F. Supp. 2d 146, 151–52 (D. Mass. 2003); U.S. Airways Grp., Inc. v. British Airways P.L.C., 989 F. Supp. 482, 494 (S.D.N.Y. 1997) (“[T]he imposition of respondeat superior liability on a corporation for breach of fiduciary duty by its directors on the board of another corporation would completely undermine Delaware corporate law, which limits such fiduciary duty to majority and controlling shareholders.”); cf. Med. Self Care, Inc. v. Nat’l Broad. Co., Inc., No. 01-CIV-4191, 2003 WL 1622181, at *7 (S.D.N.Y. Mar. 28, 2003) (citing U.S. Airways Group and rejecting theory under California law); see also RESTATEMENT (SECOND) OF AGENCY §§ 140, 212 (1958). But see In re Papercraft Corp., 165 B.R. 980, 991 (Bankr. W.D. Pa. 1994) (accepting theory in case applying Pennsylvania law), vacated on other grounds, 187 B.R. 486 (Bankr. W.D. Pa. 1995), rev’d on other grounds, 211 B.R. 813 (W.D. Pa. 1997).

701 Radol v. Thomas, 772 F.2d 244, 258 (6th Cir. 1985). See Jordan v. Global Natural Res., Inc., 564 F. Supp. 59, 68 (S.D. Ohio 1983) (“We conclude, however, that a corporation as an entity has no fiduciary duty to its shareholders as a matter of law. We have engaged in extensive research and have found nothing to indicate that a fiduciary relationship exists between a corporation and its shareholders. Rather, a corporation is a legal entity created and regulated by statute in derogation of the common law. The rights and obligations of a corporation and its shareholders are defined by statute and remedies are provided for breach of statutory duties. We can find no authority that would allow this Court to impose a common law fiduciary duty on the part of Global to its shareholders and we, therefore, decline to do so. . . . A corporation, because of its nature, may act only through its officers and agents. It may, therefore, be held vicariously liable for the acts of its officers and agents acting within the scope of their actual or apparent authority under the doctrine of respondeat superior.”) (citations omitted); see also Holloway v. Howerdd, 536 F.2d 690, 695 (6th Cir. 1976) (applying traditional agency principles to determine liability).


There is widespread agreement with this position.702 However, this objection is directed at a different set of duties than those recognized in Yeaman. The officers’ and directors’ duties run to the corporation. Liability for breach of those duties, say, stealing corporate funds, is to the corporation (and thus to all of the shareholders collectively). Of course, it is absurd to say that a corporation is liable to itself when the president steals its money. However, if the corporation owes a legal duty to a shareholder, then there is absolutely nothing “absurd” about a corporation being held liable to injured parties for the conduct of its agents that violate that legal duty. A corporation can only act through its human agents703 and make decisions through its human management.704 Every instance of corporate liability results from actions and decisions made by corporate agents. An injured driver may certainly seek compensation from the corporation when a corporate employee negligently causes an accident.705 The employee driver causing the accident certainly would have violated a duty to the corporate employer in driving negligently, as would directors seeking to entrench management by blocking the votes of certain shareholders. Likewise, when senior corporate management maliciously commits wrongdoing in the course and scope of their duties, that malicious intent is imputed to the corporation.706 If the law recognizes duties that corporations owe to shareholders arising from

702 Under New York law, a corporation does not owe fiduciary duties to its members or shareholders. Hyman v.

N.Y. Stock Exch., Inc., 848 N.Y.2d 51, 53 (N.Y. App. Div. 2007). Kansas law does not recognize a fiduciary duty between a corporation and its stockholders. See Litton v. Maverick Paper Co., 388 F. Supp. 2d 1261, 1296 (D. Kan. 2005). Litton relied on Burcham v. Unison Bancorp, Inc., which holds that it is the directors who owe fiduciary duties to the shareholders, and not the corporation, and that the corporation is not liable for the breach of the directors’ fiduciary duties to the shareholders because the directors control the corporation and are therefore not its agents and concludes that it would be unjust to shift responsibility from the directors to the corporation for the directors’ breach of duty to shareholders. 77 P.3d 130, 148 (Kan. 2003). Under Alaska law, officers, directors and controlling shareholders owe fiduciary duties to corporation and possibly to shareholders, but corporation does not owe fiduciary duties to its shareholders. See Meidinger v. Koniag, Inc., 31 P.3d 77, 87 (Alaska 2001). Under Illinois law, individuals who control corporations owe fiduciary duties to their corporations and their shareholders, but the corporation, as distinct from its officers and directors, does not owe fiduciary duties to shareholders. See Small v. Sussman, 713 N.E.2d 1216, 1221 (Ill. App. Ct. 1999); Doherty v. Kahn, 682 N.E.2d 163, 174 (Ill. App. Ct. 1997); Wencordic Enters., Inc. v. Berenson, 511 N.E.2d 907, 918 (Ill. App. Ct. 1987). However, Holmes v. Birtman Elec. Co., 159 N.E.2d 272 (Ill. App. Ct. 1959), rev’d on other grounds, 165 N.E.2d 261, 275 (Ill. 1960), held: “In Illinois a corporation and its agents are trustees with respect to the registration of transfers of its securities and are liable for injuries resulting from their failure to discharge such fiduciary responsibilities.” Allmon v. Salem Bldg. & Loan Ass’n held:

But a corporation is by law the custodian of the shares of its stock and clothed with power sufficient to protect the rights of everyone interested therein from unauthorized transfers, and, like every other trustee, it is bound to execute the trust with proper diligence and care, and is responsible for an injury sustained by its negligence or misconduct in making transfers or cancellations of such stock.

114 N.E. 170, 172 (Ill. 1916). Small v. Sussman distinguishes these cases as limited to situations of transfer of shares. See Small, 713 N.E.2d at 1221.

703 Bennett v. Reynolds, 315 S.W.3d 867, 883 (Tex. 2010) (Corporations, of course, “can act only through human agents.”).

704 Id. (“Corporate decisions, likewise, are ultimately made by human agents.”). 705 In re Merrill Lynch Trust Co. FSB, 235 S.W.3d 185, 188 (Tex. 2007) (“Corporations can act only through

human agents, and many business-related torts can be brought against either a corporation or its employees.”). 706 Bennett, 315 S.W.3d at 884 (“Generally, ‘[w]hen actions are taken by a vice-principal of a corporation,

those acts may be deemed to be the acts of the corporation itself,’ and ‘status as a vice-principal of the corporation is sufficient to impute liability to [the corporation] with regard to his actions taken in the workplace.’”); Hooper v. Pitney Bowes, Inc., 895 S.W.2d 773, 777–78 (Tex. App.—Texarkana 1995, writ denied) (“Generally, the willful and


the legal relationship between a corporation and each of its owners, then the liability falls on the corporation even though officers and directors make the decision to violate such a duty.707

Texas case law is abundantly clear that indirect harm suffered by shareholders caused by violations of duties by officers and directors owed solely to the corporation are actionable only by or on behalf of the corporation—that is, the law requires the trustee to recover for the damage done to the trust as a whole so that all the beneficiaries of the trust may be restored proportionately. If an individual shareholder could simply recast every misappropriation of assets by a director as a breach of fiduciary duty to the shareholder by the corporation, then the distinction between the interests of the corporation and the interests of the shareholder would be obliterated. Courts in other jurisdictions have universally condemned attempts to enforce corporate fiduciary duties in this way.708

These criticisms are not valid with respect to the corporate duties proposed here. The criticisms are largely a matter of nomenclature. Courts rejecting fiduciary duties imposed on corporations are chiefly concerned about the confusion between those duties that officers and directors owe to the corporation and those duties that a corporation may owe to its shareholders. Courts do not want shareholders to be able to assert a violation of legal duties owed only to the corporation through the back door by claiming that the corporation owes those same duties back to the shareholder. If a shareholder could bring a direct action against

malicious actions of an employee acting within the scope of his employment are imputed to the employer, and they subject the employer to liability under the principles of respondeat superior.”).

707 For example, one recent case reversed an award of attorneys’ fees against the individual officers and directors who refused to allow a shareholder to inspect corporation records—causing the corporation to violate the shareholder’s statutory inspection rights—holding “section 3.152 contemplates a suit and associated orders against an entity, not against individuals. The fact that the individual defendants may have caused the denial of access and [the corporation] may be affected by the award does not change the statutory language.” Tex. Ear Nose & Throat Consultants, P.L.L.C. v. Jones, 470 S.W.3d 67, 90 (Tex. App.—Houston [14th Dist.] 2015, no pet.).

708 Berkowitz v. 29 Woodmere Blvd. Owners’, Inc., 23 N.Y.S.3d 830, 834 (N.Y. App. Div. 2015) (“A corporation does not owe a fiduciary duty to its individual unit owners and shareholders.”); In re Stillwater Capital Partners Inc. Litig., 851 F. Supp. 2d 556, 569 (S.D.N.Y. 2012) (“Generally, a corporation does not owe fiduciary duties to its members or shareholders, because recognizing such a duty would lead to the confounding possibility that a shareholder of a corporation could bring a derivative action on behalf of the corporation against the corporation itself.”); Town of Smyrna v. Mun. Gas Auth., 129 F. Supp. 3d 589, 602 (M.D. Tenn. 2015) (“[C]ourts routinely hold that a corporation owes no fiduciary duty to its shareholders or members.”); Bateman v. JAB Wireless, No. 2:14-CV-147-RJS, 2015 WL 4077923, at *4 (D. Utah July 6, 2015) (plaintiffs “directed the court to no Utah or Colorado authority recognizing a fiduciary relationship between a corporation and its shareholders,” and other courts, including the Sixth Circuit in Rodol v. Thomas, 772 F.2d 244 (6th Cir. 1985), have considered and rejected the position urged by plaintiffs); In re Swisher Hygiene, Inc., No. 3:12-cv-2384, 2015 WL 4132157, at *13 n.4 (W.D.N.C. July 8, 2015) (“[T]he claim against Swisher itself should be dismissed because a corporation does not owe fiduciary duties to its shareholders.”); In re PHC, Inc. Shareholder Litig., No. Civ. A. 11-11049-GAO, 2012 WL 1195995, at *4 (D. Mass. Mar. 30, 2012) (“As a corporation, PHC itself owes no duty to its shareholders under Massachusetts law”); Onex Food Serv., Inc. v. Grieser, No. 93 Civ. 0278 (DC), 1996 WL 103975, at *7 (S.D.N.Y. Mar. 11, 1996) (“[A] corporation does not owe a fiduciary duty to its shareholders nor may it be held vicariously liable for breaches of fiduciary duty committed by its officers”); Johnston v. Wilbourn, 760 F. Supp. 578, 590 (S.D. Miss. 1991) (same); Burcham, 77 P.3d at 146 (“The plaintiffs have not cited any Kansas case in which the court found that a corporation owes a fiduciary duty to its stockholders; rather, it is the corporate management that owes the duty to both the corporation and its stockholders”). See also Schupp v. Jump! Info. Techs., 65 F. App’x. 450, 454 (4th Cir. 2003) (citing Rodol, 772 F.2d at 258–59) (“[Noting] doubts that a shareholder can maintain an action for breach of fiduciary duty directly against the corporation itself.”).


the corporation asserting exactly the same claim that the corporation would assert against its officers and directors, then the corporation’s ownership of those claims would be rendered meaningless and the public policy against multiplying litigation, potentially inconsistent results, and denying creditors and other shareholders of the benefits of the corporation’s recovery would be thwarted. The corporation would, in effect, have to sue itself. While there may be some overlaps in particular cases, the nature of the duties that the corporation owes to its individual shareholders is different from that of the duties that the officers and directors owe to the corporation. Holding that a corporation does not owe “fiduciary duties” to individual shareholders is not the same as holding that corporations owe no duties to shareholders. Delaware law, for example, does not recognize corporate “fiduciary duties” to shareholders709 and does not recognize the shareholder oppression cause of action,710 but Delaware law still holds that corporations have duties of full disclosure to shareholders711 and provides minority shareholders a direct remedy if they are treated inequitably.712

The Texas case law recognizing that the corporation as trustee owes enforceable duties directly to shareholders713 developed in the same time period as the cases holding that shareholders have no direct recovery for harm done only to the corporation.714 There is no inconsistency in these two doctrines as applied by Texas courts. The fiduciary duties owed to the corporation and the fiduciary duties owed by the corporation are simply different duties.

709 In re Wayport, Inc. Litig., 76 A.3d 296, 322–23 (Del. Ch. 2013) (“Wayport is not liable for breach of

fiduciary duty. As a corporate entity, Wayport did not owe fiduciary duties to its stockholders.”); Arnold v. Soc’y for Sav. Bancorp, Inc., 678 A.2d 533, 539 (Del. 1996) (“Plaintiff has not cited a single case in which Delaware courts have held a corporation directly liable for breach of the fiduciary duty of disclosure. Fiduciary duties are owed by the directors and officers to the corporation and its stockholders.”).

710 See Nixon v. Blackwell, 626 A.2d 1366 (Del. 1993). 711 See Malone v. Brincat, 722 A.2d 5, 11–12 n.21 (Del. 1998). 712 Under Delaware law, the fact that certain measures are lawful under the letter of Delaware’s corporate law

does not mean that those measures can be deployed for inequitable purposes. In re Gaylord Container Corp. Shareholder Litig., 753 A.2d 462, 473 (Del. Ch. 2000); Schnell v. Chris–Craft Indus., Inc., 285 A.2d 437, 439 (Del. 1971); Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983); Rabkin v. Philip A. Hunt Chem. Corp., 498 A.2d 1099, 1106–07 (Del. 1985). Compliance with the governing documents of the corporation does not established the fairness of the transaction. Boyer v. Wilmington Materials, Inc., 754 A.2d 881, 900 (Del. Ch. 1999). Directors have the duty not to time or structure an otherwise legal transaction “so as to permit or facilitate the forced elimination of the minority shareholders at an unfair price.” Id. at 899; Sealy Mattress Co. v. Sealy, Inc., 532 A.2d 1324, 1335 (Del. Ch. 1987). Directors must make the informed, deliberate judgment in good faith that the transaction is fair and not a “vehicle for economic oppression.” Boyer, 754 A.2d at 899; Sealy, 532 A.2d at 1335. Directors may not, “by way of excessive salaries and other devices, oust the minority of a fair return upon its investment.” Michelson v. Duncan, 407 A.2d 211, 217 (Del. 1979). See also Accipiter Life Scis. Fund, L.P. v. Helfer, 905 A.2d 115, 124 (Del. Ch. 2006) (“There is, of course, no dispute as to the plaintiff’s fundamental point. Delaware corporations may not take actions towards their stockholders which, though legally possible, are inequitable. The source of that standard is Schnell v. Chris-Craft, where the Supreme Court held that a board’s facially legal use of a bylaw to cut short the time available for stockholders to conduct a proxy contest was inequitable, and thus impermissible. That precedent is a cornerstone of Delaware law, and has repeatedly been reaffirmed by our courts.”); Juran v. Bron, No. Civ. A. 16464, 2000 WL 1521478, at *9 (Del. Ch. Oct. 6, 2000) (“Under Delaware law, a majority shareholder of a corporation clearly owes fiduciary duties to the minority shareholders.”).

713 E.g., Yeaman v. Galveston City Co., 167 S.W. 710, 721–22 (Tex. 1914). 714 E.g., Becker v. Dirs. of Gulf City St. Ry & Real Estate Co., 15 S.W. 1094, 1096 (Tex.1891).


3. Limited Scope of the Corporate Duties

Conceptualizing the corporation as trustee for its shareholders does have some limitations. None of the courts recognizing this legal relationship hold that there is a one-to-one correspondence to an express trust—rather the cases hold that the relationship is “akin to one of trust.”715 The principal economic feature of the corporation is the separation of ownership from control.716 A corporation is like a trust in that the corporation owns legal title to its assets and business operations, while the shareholders hold equitable ownership.717 In that sense, the corporation is like a trustee, and the shareholders are like the beneficiaries of the trust. 718 However, there is an additional aspect of the corporate structure that is unlike a trust. While the corporation holds legal title, it can do nothing apart from its agents.719 Control over the assets and operation of the corporation is vested in the directors and officers.720 A human trustee holds both legal title and exercises control.721 A corporation only holds legal title; its officers and directors exercise control. The management of the corporation owes fiduciary duties to the corporation or shareholders collectively, not to the shareholders individually.722 These are the duties that arise out of the exercise of control—duties that are based in the law of agency.723

Trustees are held to a strict duty not to misappropriate trust property for their own benefit.724 However, a corporation cannot possess property outside of itself; therefore, it would be impossible for a corporation to possess corporate property in which the shareholders would not still own a beneficial interest. Trustees are required to place the interests of the beneficiaries before their own interests.725 However, a corporation has no self-interest that is

715 Disco Mach. of Liberal Co. v. Payton, 900 S.W.2d 124, 126 (Tex. App.—Amarillo 1995, writ denied). 716 See PHC-Minden, LP v. Kimberly-Clark Corp., 235 S.W.3d 163, 174–75 (Tex. 2007). 717 Roadside Stations, Inc. v. 7HBF, Ltd., 904 S.W.2d 927, 931 (Tex. App.—Fort Worth 1995, no writ); Rapp

v. Felsenthal, 628 S.W.2d 258, 260 (Tex. App.—Fort Worth 1982, writ ref’d n.r.e.). 718 “[I]t is well established that the legal and equitable estates must be separated; the former being vested in the

trustee and the latter in the beneficiary. This separation of the legal and equitable estates in the trust property is the basic hallmark of the trust entity.” Perfect Union Lodge No. 10 v. Interfirst Bank of San Antonio, N.A., 748 S.W.2d 218, 220 (Tex. 1988) (citing Cutrer v. Cutrer, 334 S.W.2d 599, 605 (Tex. Civ. App.—San Antonio), aff’d, 345 S.W.2d 513 (Tex. 1961)); Miller v. Donald, 235 S.W.2d 201, 205 (Tex. Civ. App.—Fort Worth 1950, writ ref’d n.r.e.); George G. Bogert, TRUSTS & TRUSTEES § 141, at 4 (2d ed. 1979)). See also Burns v. Miller, Hiersche, Martens & Hayward, P.C., 948 S.W.2d 317, 322 (Tex. App.—Dallas 1997, writ denied) (“The trustee of a trust holds bare legal title and the right to possession of trust assets, while the beneficiary is considered the real owner of the property, holding equitable or beneficial title.”).

719 Rapp, 628 S.W.2d at 260. 720 TEX. BUS. ORGS. CODE ANN. §§ 3.101, 21.401, 21.402 (West 2011). 721 S. Pac. Co. v. Bogert, 250 U.S. 483, 487–88 (1919) (“The rule of corporation law and of equity invoked is

well settled and has been often applied. The majority has the right to control; but when it does so, it occupies a fiduciary relation toward the minority, as much so as the corporation itself or its officers and directors.”); Dierschke v. Ctr. Nat’l Branch of First Nat’l Bank at Lubbock, 876 S.W.2d 377, 381 (Tex. App.—Austin 1994, no writ).

722 Rapp, 628 S.W.2d at 260. 723 Evans v. Brandon, 53 Tex. 56, 60 (1880) (“On principle and authority, it is clear that the liability of

directors for a breach of duty that injures the corporate property as a whole, is primarily to the corporation whose agents they are.”). See also RESTATEMENT (SECOND) OF TRUSTS § 16A cmt. a (1959) (“The officers and directors of a corporation do not hold the title to the property of the corporation and therefore are not trustees.”).

724 Ames v. Ames, 757 S.W.2d 468, 476 (Tex. App.—Beaumont 1988), aff’d, 776 S.W.2d 154 (Tex. 1989). 725 Id.


not shared by all the shareholders.

The legal duties that the corporation as an entity owes directly to each of its shareholders, whether or not characterized as “fiduciary” duties, are “narrow.”726 Nevertheless, there are still distinct and important duties that the corporation owes to the shareholders. These duties arise out of legal ownership for the benefit of someone else—the same kinds of duties that the trustee owes to the beneficiary of the trust by virtue of the separation of legal and equitable title.727 The duties described in Yeaman deal only with the impairment of individual shareholders’ rights and interests as shareholders. The corporation breaches those duties if it denies that the shareholder is an owner or withholds the shareholder’s proportional share of profits or otherwise acts to impair the shareholder’s fundamental property rights. The corporation also breaches these duties when it fails to act impartially and neutrally among its shareholders. Impartiality is a matter of intent.728 A corporation is impartial when it is fair to all and does not act with the intent to favor one and disadvantage another.729 Absolute equality in results and effects is not required.730

Therefore, the duties that a corporation, as trustee, owes to its shareholders, as beneficiaries to the trust, are not far-reaching and vague obligations always to place the interests of each individual shareholder before its own,731 and certainly not the duty rejected in Ritchie to “act in the best interests of each individual shareholder at the expense of the corporation.”732 Rather, the corporation’s trust duties would be limited to the observance and preservation of each individual shareholder’s recognized property rights and to dealing with its multiple owners according to its duty of impartiality. Returning to the subject of “gaps” in the protection of minority shareholders, corporate actions would certainly violate duties owed directly to each minority shareholder—duties recognized by the Texas Supreme Court in the Yeaman opinion—if those actions impaired the rights and benefits of share ownership or were aimed at either driving the shareholder out of the company at an economic loss or rendering the shareholder effectively not a shareholder. Similarly, corporate action, such as not declaring

726 See Reibe v. Nat’l Loan Inv’rs, 828 F. Supp. 453, 456 (N.D. Tex. 1993). 727 Dierschke v. Ctr. Nat’l Branch of First Nat’l Bank, 876 S.W.2d 377, 381 (Tex. App.—Austin 1994, no writ)

(“A trustee holds legal title to trust property under a fiduciary duty to deal with it for the benefit of the beneficiaries, who hold equitable title.”); Jameson v. Bain, 693 S.W.2d 676, 680 (Tex. App.—San Antonio 1985, no writ) (“[T]he trustee is vested with the legal title and the right of possession of the trust property, but holds it for the benefit of the beneficiary.”).

728 See, e.g., N. Trust Co. v. Heuer, 560 N.E.2d 961, 964 (Ill. App. Ct. 1990) (“Unless terms of trust document provide otherwise, trustee’s fiduciary duty to each beneficiary precludes her from favoring one beneficiary over another.”).

729 RESTATEMENT (THIRD) OF TRUSTS § 79 at 129 (2007) (“Impartiality . . . means that a trustee’s treatment of beneficiaries or conduct in administering a trust is not to be influenced by the trustee’s personal favoritism or animosity toward individual beneficiaries.”).

730 “It would be overly simplistic, and therefore misleading, to equate impartiality with some concept of ‘equality’ of treatment or concern—that is, to assume that the interests of all beneficiaries have the same priority and are entitled to the same weight in the trustee’s balancing of those interests.” RESTATEMENT (THIRD) OF TRUSTS § 79 cmt. b. See also UNIF. TRUST CODE § 803 cmt. (“The duty to act impartially does not mean that the trustee must treat the beneficiaries equally. Rather, the trustee must treat the beneficiaries equitably in light of the purposes and terms of the trust.”).

731 E.g., Crim Truck & Tractor Co. v. Navistar Int’l Transp. Corp., 823 S.W.2d 591, 594 (Tex. 1992). 732 Ritchie v. Rupe, 443 S.W.3d 856, 888 (Tex. 2014).


dividends, taken with the specific intent to harm minority shareholders, would certainly constitute an actionable “breach of trust.”733 As developed below, the legal duties described here are enforced through a cause of action that we will call “breach of trust” to avoid confusion with “breach of fiduciary duties” that directors owe to the corporation.

VII. DEFINING THE BREACH OF TRUST CAUSE OF ACTION

As discussed above, individual shareholders have ownership rights and interests that are important, protected, and distinct from the rights and interests of the corporation or of the shareholders collectively. As the Texas Supreme Court held in Cates v. Sparkman, an individual shareholder’s claim for relief must be based on conduct that is “ultra vires, fraudulent, [or constitutes] injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such [an equitable remedy], would leave the latter remediless.”734 Therefore, individual shareholders may assert direct claims for their own benefit to vindicate and enforce these individual rights and interests against violations by the corporation in three instances: (1) ultra vires, (2) fraud, and (3) “injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such [an equitable remedy], would leave the latter remediless.” The first two categories are straight-forward and uncontroversial and will be explored later. The third category, however, specifically deals with the “gaps” left by the Ritchie Court’s holding.

A. Corporate Acts of Oppression

Cates v. Sparkman used the terms “injurious practices, abuse of power, and oppression” to describe the type of corporate acts that would give rise to a cause of action by an individual shareholder.735 The Fort Worth Court of Appeals, in a case decided the same year as Yeaman, described the plight of minority shareholders as follows:

It cannot be denied that minority stockholders are bound hand and foot to the majority in all matters of legitimate administration of the corporate affairs, and the courts are powerless to redress many forms of oppression practiced upon the minority under the guise of legal sanction, which fall short of actual fraud. This is a consequence of the implied contract of association, by which it is agreed, in advance, that a majority shall bind the whole body as to all transactions within the scope of the corporate powers. But it is also of the essence of the contract that the corporate powers shall only be exercised to accomplish the objects for which they were called into existence, and that the majority shall not control those powers to pervert or destroy the original purposes of the corporators.736

733 Patton v. Nicholas, 279 S.W.2d 848 (Tex. 1955); Morrison v. St. Anthony Hotel, 295 S.W.2d 246, 252

(Tex. Civ. App.—San Antonio 1956, writ ref’d n.r.e.). 734 Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889). 735 Id. 736 Tipton v. Ry. Postal Clerks’ Inv. Ass’n, 173 S.W. 562, 567 (Tex. Civ. App.—Fort Worth 1914, no writ).


The concept that minority shareholders may be subject to “oppression” is one that has been recognized in Texas law for a long time. However, defining what constitutes “oppression” with precision remains a challenge. Cates describes the first element of an individual shareholder cause of action as an intentional breach of duty by the corporations using the terms “injurious practices, abuse of power, and oppression on the part of the company or its controlling agency.”737 As the Ritchie Court noted in working through the statutory definition of “oppressive,” the “common meaning and usage” of the term oppression involves “an unjust exercise of power that harms the rights or interests of persons subject to the actor’s authority and disserves the purpose for which the power is authorized.”738 This definition of “oppression” is also very consistent with the other two descriptive phrases used by Cates, “injurious practices” and “abuse of power.” Therefore, the first element must involve an intentional use of the corporation’s powers over its shareholders in violation of the duties owed by the corporation to its shareholders. Intentional efforts to harm minority interests, such as the conduct in Patton and Morrison to deny the minority shareholders the economic benefits of share ownership by suppressing dividends, would violate the corporation’s duties to recognize and preserve the interests of the shareholders in their stock and its fruits and would also violate the duty of impartiality. Both Patton and Morrison involved dividend decisions that are ordinarily accorded maximum deference by the courts and would seem to fall within that range of activities that Cates held the directors of the corporation “have the right to do” and which cannot form the basis of a shareholder action. However, neither Patton nor Morrison even considered that issue, focusing instead on the “malicious” purpose of the conduct. Therefore, the only possible conclusion is that corporate action taken with the intent to specifically harm the interests of a minority shareholder constitutes a breach of duty that gives rise to a claim. Actions taken with such intent are categorically not something that corporations have the “right to do.”

B. Elements of Breach of Trust

As stated in Cates v. Sparkman, equitable relief is available in an action brought directly by the minority shareholder against the corporation to remedy a broad category of wrongful corporate conduct defined as follows: (1) “injurious practices, abuse of power, and oppression on the part of the company or its controlling agency,” (2) “clearly subversive of the rights of the minority, or of a shareholder,” and (3) “without such [an equitable remedy], would leave the latter remediless.”739

1. Intent to Harm the Minority

A plaintiff asserting a breach of trust claim would be required, first, to prove corporate action with the intent to harm or disadvantage the minority, conduct that Cates characterized as “injurious practices, abuse of power, and oppression on the part of the company or its controlling agency.”740 The controlling fact in the cause of action recognized in Patton was the “malicious purpose” or “wrongful state of mind” in connection with the corporate decision not

737 Cates, 11 S.W. at 849. 738 Ritchie, 443 S.W.3d at 870. 739 Cates, 11 S.W. at 849. 740 Id.


to declare dividends.741 It would not seem necessary to prove common law malice, defined as “ill-will, spite, or evil motive.”742 Rather, what is at issue is the violation of the corporation’s duty of impartiality, which would require proof of an intention to harm the interests of the minority or to favor the interests of the majority at the expense of the minority.743 However, proof that the decision was influenced by personal animosity against or hostile relations with the minority would certainly be relevant.744

In extreme cases, like Boehringer and Davis, where a majority shareholder causes a corporation to functionally cancel a minority shareholder’s ownership interest, there should be little question that the minority shareholder has an individual claim. Less extreme cases, however, such as the underlying dispute in Ritchie, are more difficult. In a lawsuit like Ritchie, the plaintiff would likely allege that the corporate policy not to meet with potential purchasers was a violation of the duty of impartiality because only the plaintiff was trying to sell her shares, and only she was disadvantaged by the effect of the policy. That allegation, however, would not state a claim for breach of the duty of impartiality. The policy did affect all shareholders the same. Under the particular circumstances, its negative effects were felt more by one shareholder than others, but none of the shareholders were benefitted at the expense of any other shareholder. The plaintiff might be able to establish entitlement to an equitable remedy, but only if the plaintiff could prove that the corporate “policy” was a pretext and that the true purpose and intent had been a desire to harm the single shareholder.

2. Impairment of Minority Ownership Rights

The plaintiff would also need to establish that the corporation’s failure to treat him impartially also impaired745 recognized ownership rights, such as the rights of recognition of ownership, voice, information, alienation, or proportional share in profits—in other words, that the oppressive conduct was “clearly subversive of the rights of the minority, or of a shareholder.”746

3. No Adequate Alternative Remedy

Finally, in order to invoke the remedial powers of a court in equity, the plaintiff must prove the absence of an adequate alternative remedy—that “without such [an equitable remedy], would leave the latter remediless.”747 “The existence of an adequate remedy at law” bars equitable relief.748 Therefore, if the plaintiff can be made whole through application of a

741 Patton v. Nicholas, 279 S.W.2d 848, 853 (Tex. 1955). 742 Huckabee v. Time Warner Enter. Co. L.P., 19 S.W.3d 413, 420 (Tex. 2000). 743 RESTATEMENT (THIRD) OF TRUSTS § 79 at 129 (2007) (“Impartiality means that a trustee’s treatment of

beneficiaries or conduct in administering a trust is not to be influenced by the trustee’s personal favoritism or animosity toward individual beneficiaries.”).

744 See In re Estate of Stuchlik, 857 N.W.2d 57, 70 (Neb. 2014); Reed v. Ringsby, 54 N.W.2d 318, 322 (Neb. 1952).

745 Yeaman, 167 S.W. at 723. 746 Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889). 747 Id. 748 Butnaru v. Ford Motor Co., 84 S.W.3d 198, 210 (Tex. 2002); Campbell v. Wilder, 487 S.W.3d 146, 152

(Tex. 2016).


statutory or legal remedy, such as recovery of damages through a derivative suit or the enforcement of statutory inspection rights, equity will not provide an additional remedy. The equitable remedies are available only in the absence of an adequate remedy at law.749 It is the plaintiff’s burden to plead and prove that there is no adequate remedy at law.750

“The fact that the “complainant may have a remedy at law,” however, “is not conclusive that such remedy is adequate and does not foreclose his right to equitable relief.”751 The legal remedy must be “complete and adequate.”752 Equitable relief will be available when “the legal remedy is not as complete as, less effective than, or less satisfactory than the equitable remedy.”753 In Davis v. Sheerin, the court recognized that damages awarded in a derivative suit would make the plaintiff whole for some of the wrongdoing, but would not remedy the total exclusion and disregard of the plaintiff’s ownership interest and would not remedy the pattern of oppression and likelihood of its continuation.754 In determining the completeness and adequacy of legal remedies, courts should determine whether those in control of the corporation are acting for the purpose of harming the minority shareholder and the likelihood that they will continue to do so, as the Supreme Court did in Patton.755

An important corollary is that “[e]quity looks with favor upon a complete disposition of controversies in one action rather than in multiple suits. Equity abhors a multiplicity of actions.”756 If the only prospect the minority shareholder has to protect his rights is a never-ending series of derivative damages claims and statutory enforcement actions, the court of equity would step in to provide a more permanent remedy.

If equity jurisdiction can interfere to prevent a multiplicity of suits, the condition of this record presents such facts or conditions as to call for the exercise thereof. It would be a paradox to say that equity jurisdiction can be exercised to prevent a multiplicity of suits and at the same time say that a legal remedy is complete and adequate, although it leads to such multiplicity. To our minds, if a remedy at law, though otherwise complete and adequate, leads to a multiplicity of suits, that very fact prevents it from being complete and adequate.757

In a typical shareholder oppression lawsuit involving firing the plaintiff, no dividends, and

749 Salgo v. Matthews, 497 S.W.2d 620, 625 (Tex. Civ. App.—Dallas 1973, writ ref’d n.r.e.); see also Callahan v. Giles, 155 S.W.2d 793, 795 (Tex. 1941) (mandamus governed by equitable principles); Poten v. Lockhart, 114 S.W.2d 219, 220 (Tex. 1938).

750 Davis v. Estridge, 85 S.W.3d 308, 310 n.2 (Tex. App.—Tyler 2001, pet. denied); Frost Nat’l Bank v. Burge, 29 S.W.3d 580, 596 (Tex. App.—Houston [14th Dist.] 2000, no pet.).

751 Repka v. Am. Nat’l Ins. Co., 186 S.W.2d 977, 980 (Tex. 1945). 752 Rogers v. Daniel Oil & Royalty Co., 110 S.W.2d 891, 894 (1937). 753 First Heights Bank, FSB v. Gutierrez, 852 S.W.2d 596, 605 (Tex. App.—Corpus Christi 1993, writ denied).

See Frost Nat’l Bank, 29 S.W.3d at 596. 754 Davis v. Sheerin, 754 S.W.2d 375, 384 (Tex. App.—Houston [1st Dist.] 1988, writ denied), disapproved by,

Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014). 755 Patton v. Nicholas, 279 S.W.2d 848, 857 (Tex. 1955) (“Wisdom would seem to counsel tailoring the

remedy to fit the particular case.”). 756 Barr v. Thompson, 350 S.W.2d 36, 42 (Tex. Civ. App.—Dallas 1961, no writ). 757 Repka v. Am. Nat’l Ins. Co., 186 S.W.2d 977, 980 (Tex. 1945) (quoting Rogers, 110 S.W.2d at 896).


excessive compensation to the majority shareholder, the plaintiff’s claim would involve conduct that potentially breached both officer/director duties to the corporation and corporate duties to the minority shareholder. Under Ritchie, the plaintiff could assert derivative claims to recover the overpayments to the majority shareholder as damages and for injunctive relief to compel payment of dividends. Depending on the case, those remedies might be adequate to make the plaintiff whole, in which case the plaintiff would have no equitable remedy for the violation of the corporation’s duties to himself. However, in most cases where a court would have granted a remedy under the shareholder oppression doctrine, the plaintiff would be able to argue that his legal remedies described by the Ritchie Court758 are inadequate because they provide no remedy that would fully compensate the minority shareholder for the harm caused by the impairment of his ownership rights, provide no protection against the majority shareholder’s malicious intent to harm the minority and the likelihood of future repetition, and will necessarily lead to a multiplicity of actions.

C. Remedies for Breach of Trust

1. Mandatory Injunctions

In Yeaman, the Texas Supreme Court held that the plaintiffs were entitled to bring a breach of trust claim to “to enforce their rights as stockholders”759—specifically to obtain a determination of how many shares the plaintiffs owned and, presumably, a mandatory injunction to have the certificates issued. Under Texas law, a shareholder is entitled to equitable relief compelling the corporation to acknowledge the shareholder’s ownership and to issue share certificates in his name.760 The plaintiff “may sue in equity for specific performance to enforce the issue and delivery of the stock certificate and the payment of any dividends that may be due thereon, or he may, as plaintiffs have here done here, sue to recover the consideration paid for the stock.”761 However, a shareholder’s rights entail more than just the right to hold a certificate, and the corporation’s duties extend to “not attempting to impair his interest.”762

A court of equity has extremely broad powers to remedy a breach of trust.763 Courts have the power to intervene in an “abuse of discretion” by trustees “and adjust the rights of the parties and to compel, if necessary, action on the part of the trustees.”764 Therefore, a court of

758 Ritchie, 443 S.W.3d at 882–89. 759 Yeaman v. Galveston City Co., 167 S.W. 710, 723 (Tex. 1914). 760 TEX. PRAC.: BUS. ORGS., supra note 7, at § 27:29; see Lilani v. Noorali, No. H-09-2617, 2011 WL 13667, at

*15 (S.D. Tex. Jan. 3, 2011) (Texas law). 761 Beaumont Hotel Co. v. Caswell, 14 S.W.2d 292, 294 (Tex. Civ. App.—Beaumont 1929, no writ); see also

Mathews v. First Citizens Bank, 374 S.W.2d 794, 796–97 (Tex. Civ. App.—Dallas 1963, writ ref’d n.r.e.) (“[H]e may seek equitable relief against the wrongdoer to compel it to replace the shares of stock on its books in his name.”).

762 Yeaman, 167 S.W. at 723. 763 See, e.g., TEX. PROP. CODE ANN. § 114.008 (West 2015) (providing that courts may compel the trustee to

perform the trustee’s duty or duties, enjoin the trustee from committing a breach of trust, compel the trustee to redress a breach of trust, including compelling the trustee to pay money or to restore property, order a trustee to account, appoint a receiver to take possession of the trust property and administer the trust, or order any other appropriate relief).

764 Kelly v. Womack, 268 S.W.2d 903, 907 (Tex. 1954). See also Citizens & S. Nat’l Bank v. Haskins, 327 S.E.2d 192, 202 (Ga. 1985) (“The court may also interpose its judgment when a trustee is acting from improper


equity would be empowered to fashion appropriate remedies to deal with specific violations of shareholder rights.765 “Certainly the rule allowing such equitable remedies to protect relationships of trust encompasses the ability to fashion such remedies against those who would conspire to abuse such relationships.”766 One example of such a remedy would be a mandatory injunction of the kind ordered by the Supreme Court in Patton v. Nicholas to remedy a wrong “akin to breach of trust.”767

“Equity will not suffer a right to be without a remedy.”768 The United States Supreme Court observed:

That the vast and increasing proportion of the active business of modern life which is done by corporations should call into exercise the beneficent powers and flexible methods of courts of equity, is neither to be wondered at nor regretted; and this is especially true of controversies growing out of the relations between the stockholder and the corporation of which he is a member. The exercise of this power in protecting the stockholder against the frauds of the governing body of directors or trustees, and in preventing their exercise, in the name of the corporation, of powers which are outside of their charters or articles of association, has been frequent, and is most beneficial, and is undisputed. These are real contests, however, between the stockholder and the corporation of which he is a member.769

motives in exercising discretion.”); Simpson v. Anderson, 137 S.E.2d 638 (Ga. 1964) (“the relief granted by a court of equity in dealing with trust estates will always be so moulded and framed as to render the trust effectual and secure the best interest of all parties.”).

765 See, e.g., Kelly, 268 S.W.2d at 907 (“Should the trustees be derelict in their duty and be guilty of abuse of discretion or of not moving with reasonable diligence, the beneficiaries would have resort to the court to determine and adjust the rights of the parties and to compel, if necessary, action on the part of the trustees.”); Powell v. Parks, 86 S.W.2d 725, 727 (Tex. 1935) (“Inasmuch as the existence of the trust here involved is cognizable by the trial court as a court of general equity jurisdiction, all matters pertaining to the execution of such trust is subject to that jurisdiction.”); Dernick Res., Inc. v. Wilstein, 471 S.W.3d 468, 482 (Tex. App.—Houston [1st Dist.] 2015, pet. filed) (“Courts may fashion equitable remedies such as profit disgorgement and fee forfeiture to remedy a breach of a fiduciary duty.”); Kauffman v. Parker, 99 S.W.2d 1074, 1079 (Tex. Civ. App.—Fort Worth 1936, no writ) (“[I]t is well settled that a court of equity has jurisdiction to accord relief to the beneficiary of a trust for misuse of trust funds and for betrayal of the trust in any other manner.”); Greater Fort Worth v. Mims, 574 S.W.2d 870, 872 (Tex. Civ. App.—Fort Worth 1978, writ dism’d w.o.j.) (“The essence of equity jurisdiction has been the power of the Chancellor to do equity and to mold each decree to the necessities of the particular case. Flexibility rather than rigidity has distinguished it.”).

766 ERI Consulting Eng’rs, Inc. v. Swinnea, 318 S.W.3d 867, 881 (Tex. 2010). 767 Patton v. Nicholas, 279 S.W.2d 848, 857–58 (Tex. 1955). 768 Chandler v. Welborn, 294 S.W.2d 801, 807 (Tex. 1956). See also Christus Health Se. Tex. v. Griffin, 175

S.W.3d 548, 552 (Tex. App.—Beaumont 2005, pet. denied) (“It is axiomatic that equity will not suffer a right to exist with a remedy.”).

769 Hawes v. City of Oakland, 104 U.S. 450, 453 (1881). This landmark United States Supreme Court case distinguished between suits brought individually by a shareholder against the corporation to enforce his own rights in a court of equity, which the Court characterizes as “frequent, and [] most beneficial,” from derivative suits in which the shareholder brings suit on behalf of the corporation “in which the rights involved are those of the corporation, and the controversy is one really between that corporation and the other party.” Id. at 454. This case has been repeatedly cited by Texas courts as controlling authority. E.g., Zauber v. Murray Sav. Ass’n, 591 S.W.2d 932, 937 (Tex. Civ. App.—Dallas 1979, writ ref’d); Rex Ref. Co. v. Morris, 72 S.W.2d 687, 691–92 (Tex. Civ. App.—Dallas 1934, no writ); Gibbons Mfg. Co. v. Milan, 17 S.W.2d 844, 846 (Tex. Civ. App.—Texarkana 1929, no writ).


Through the use of injunctive relief, courts may remedy specific instances of oppressive conduct. In fashioning the remedy, courts have the inherent power of “tailoring the remedy to fit the particular case,”770 taking due regard of “the malicious character of the misconduct heretofore involved and the consequent possibility of its repetition.”771

2. Damages

Actual damages are recoverable for breach of fiduciary duties.772 The court in Morrison v. St. Anthony Hotel held that the plaintiff, a former minority shareholder, could recover damages sustained while he was still a shareholder based on a “breach of trust theory.”773 Specifically, the plaintiff was entitled to recover the amounts which should have been declared as dividends based on the net earnings actually achieved and amount that would have been available for distribution but for the misconduct of the corporation and its majority shareholder who “maliciously mismanaged the corporation for the wrongful purpose of reducing the minority’s earnings and to suppress their dividends.”774

3. Rescission and Restitution

Injunctions and damages may remedy or curb particular abuses, but they leave the minority shareholder trapped in the closely-held corporation subject to continued abuse by the majority. Courts might order rescission of the plaintiff’s investment and restitution of the consideration paid as a way of freeing the minority shareholder and effectively remedying a pattern of oppression if it is possible to restore the status quo ante.775 The Fort Worth Court of Appeals affirmed this approach in Duncan v. Lichtenberger.776 That case was decided four years before Davis v. Sheerin and did not apply the shareholder oppression doctrine as the basis for its holding. The case was not brought as a derivative action but was characterized by the court as “a suit grounded in equity where [the minority shareholders] sought damages for a breach of fiduciary duty owed by [majority shareholder], Waldron W. Duncan, to them.”777 In Duncan, the parties were partners in a general partnership that ran a club. In June of 1978, the parties formed a corporation and transferred the assets of the original partnership and an additional $10,000 from each of them.778 Following the purchase of two of the other shareholder’s interests, Duncan became the 60% majority shareholder, with the two plaintiffs at 20% each. On October 31, 1978, both plaintiffs found themselves locked out of the club, and Duncan informed them that they were both fired.779 Duncan failed to give the plaintiffs notice

770 Patton, 279 S.W.2d at 857. 771 Id. at 858. 772 See Kahn v. Seely, 980 S.W.2d 794, 799 (Tex. App.—San Antonio 1998, pet. denied); Capital Title Co. v.

Donaldson, 739 S.W.2d 384, 391 (Tex. App.—Houston [1st Dist.] 1987, no writ). 773 295 S.W.2d 246, 252 (Tex. Civ. App.—San Antonio 1956, writ ref’d n.r.e.). 774 Id. 775 Neese v. Lyon, 479 S.W.3d 368, 381 (Tex. App.—Dallas 2015, no pet.) (“To summarize, then, rescission is

generally limited to cases in which counter-restitution by the claimant—that is, the return to the defendant of whatever the claimant received in the transaction—will restore the defendant to the status quo ante.”).

776 671 S.W.2d 948 (Tex. App.—Fort Worth 1984, writ ref’d n.r.e.). 777 Id. at 949. 778 Id. at 950. 779 Id. at 951.


of director and shareholder meetings, which he alone attended, paid himself management fees and officer compensation, and accumulated earnings in the corporation while withholding dividends (thereby imposing tax liability on the plaintiffs).780 There was also evidence that the defendant spoke openly about his admiration for two businessmen who were able to squeeze out their business partners.781 The jury found in favor of the plaintiffs on breach of fiduciary duty. The trial court rendered a judgment restoring to the plaintiffs the cash they paid and their share of the assets contributed at the time of incorporation.782 The court of appeals affirmed.

With respect to the liability issues, Duncan v. Lichtenberger was clearly wrong. The court based the judgment on the assumption that the majority shareholder owed fiduciary duties to the minority shareholders, while citing cases that clearly dealt with the duties that directors owe the corporation.783 In light of the Ritchie opinion, Duncan should have been brought as a derivative action, in which case it is questionable whether the equitable relief of rescission and restitution could have been granted in favor of the individual minority shareholders, although as noted above that result is a possibility in light of Ritchie’s interpretation of Patton. However, Duncan most certainly could have been brought as a claim for breach of trust. Every instance of wrongdoing was a corporate action taken with the intent of disadvantaging the minority and which certainly impaired their rights of voice and proportionate share in the profits. As a breach of trust case, rescission and restitution would most certainly have been an equitable remedy available.784 The Duncan court noted: “It has commonly been recognized by the courts that equitable relief is available for a breach of fiduciary duty.”785 The court also discussed the Patton case, noting that the Patton Court had held that a “wrong akin to breach of trust, for which the courts will afford a remedy”786 and noted that the only difference between Patton and “the present case is the form of relief prayed for.”787

4. Buy-Out

Rescission and restitution worked in Duncan because the oppressive conduct occurred very shortly after the investment. In most cases of oppression, however, that remedy not only would not work, but would be manifestly unjust. Most closely-held corporations are started with nominal consideration. Returning that consideration and allowing the majority shareholder to keep the full benefit of the years spent building the corporation ordinarily would not remedy oppression but would constitute a judicially-sanctioned squeeze-out of the minority.

In most cases of oppression, where the plaintiff is at the mercy of a majority that has and will continue to utilize the corporation to impair and destroy all benefit of share ownership to the minority, the only adequate remedy is to require the purchase of the plaintiff’s shares for

780 Id. 781 Id. at 951–52. 782 Id. at 952. 783 See id. (citing Canion v. Tex. Cycle Supply, Inc., 537 S.W.2d 510, 513 (Tex. Civ. App.—Austin 1976, writ

ref’d n.r.e.), and Int’l Bankers Life Ins. Co. v. Holloway, 368 S.W.2d 567 (Tex. 1963)). 784 Miller v. Miller, 700 S.W.2d 941, 948 (Tex. App.—Dallas 1985, writ ref’d n.r.e.). 785 671 S.W.2d at 952. 786 Id. at 953 (quoting Patton v. Nicholas, 279 S.W.2d 848, 854 (Tex. 1955)). 787 Id.


their fair value. As the court held in Davis v. Sheerin, “Texas courts, under their general equity power, may decree a ‘buy-out’ [] where less harsh remedies are inadequate to protect the rights of the parties.”788 While the Texas Supreme Court in Ritchie held that the buy-out remedy was not available under the receivership statute and that there was no stand-alone shareholder oppression cause of action in the common law, the Court did not hold that a buy-out order was not available as an equitable remedy for other causes of action. Nothing in the Ritchie opinion questions the equitable power to order a buy-out as stated in Davis. On the contrary, the Ritchie Court expressly suggested that the remedy might be available for breach of an informal fiduciary duty between shareholders arising from a relationship of trust and confidence,789 and did not foreclose a buy-out order as part of a receiver’s rehabilitation of a corporation.790

Nevertheless, a compulsory buy-out is an extreme remedy. The Ritchie Court questioned the dissent’s assumption that a court-ordered buy-out was always a “lesser remedy” than appointment of a rehabilitative receiver, noting that the remedy had been criticized by some commentators as sometimes threatening the financial security of closely-held corporations, even pushing them into bankruptcy or dissolution.791 The buy-out remedy should only be available in very serious cases where the remedy is truly justified and where lesser remedies are insufficient. Two types of situations would seem most appropriate for a compulsory buy-out. First, when the corporation, not only impairs the shareholder’s interests but actually attempts to extinguish them, a buy-out would seem the only appropriate remedy. A corporation’s refusal to acknowledge a shareholder’s ownership or denial that one is a shareholder is a violation of the shareholder’s property rights and of the corporation’s duties as trustee. As the Supreme Court in Yeaman noted, a corporation is absolutely prohibited from any attempt to forfeit the ownership interests of a stockholder.792 In Rio Grande Cattle Co. v. Burns793, the Texas Supreme Court held that a corporation’s refusal to recognize the ownership interest of a shareholder constituted the tort of conversion and entitled the shareholder to either compel the formal issuance of share certificates or to receive in assumpsit the value of what was taken, the fair market value of his shares.794 This is the functional equivalent of an equitable buy-out order.795 In Davis v. Sheerin, the majority shareholder denied that the plaintiff was a shareholder and was found by the jury to have conspired to deprive the plaintiff of his ownership in the corporation. This conduct, the court held, would “totally extinguish” all rights and expectations of share ownership and justified a court-ordered buy-out.796 Had the case been tried as a breach of trust case, the result should have been the same.

788 Davis v. Sheerin, 754 S.W.2d 375, 380 (Tex. App.—Houston [1st Dist.] 1988, writ denied). 789 Ritchie v. Rupe, 443 S.W.3d 856, 891–92 (Tex. 2014). 790 Id. at 874–76. 791 Id. at 875 n.26. 792 Yeaman v. Galveston City Co., 167 S.W. 710, 723 (Tex. 1914) (“We are unwilling to affirm that, in the

absence of some statutory or charter power, or express consent to that effect, a corporation has any authority to forfeit a stockholder’s shares upon such a ground. It is a trustee for the interests of its shareholders in its property, and is under the obligation to observe its trust for their benefit.”).

793 17 S.W. 1043 (Tex. 1891). 794 Id. at 1046. 795 We will explore the tort of stock conversion as an independent remedy that fills in some of the gaps left by

Ritchie in Part 2 of this article. 796 Davis v. Sheerin, 754 S.W.2d 375, 382 (Tex. App.—Houston [1st Dist.] 1988, writ denied), disapproved by,

Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014).


The other situation which should warrant the remedy of a buy-out is when the corporation admits that the plaintiff is a shareholder but conducts its activities so as to eliminate his share ownership as a practical matter by systematically ignoring his property rights and violating its duties to preserve them—no voice, no information, no share in corporate profits. These kinds of corporate actions fundamentally change the nature of the minority shareholder’s investment. In Texas common-law, the buy-out remedy was available in ultra vires cases in which the corporation caused such a fundamental change in the nature of the investment. In cases decided prior to the passage of statutes governing corporate mergers and providing rights of dissent and appraisal remedies,797 Texas courts held that a corporation could not consolidate into another corporation “and impose responsibilities and hazards upon the minority not contemplated by the original enterprise;”798 it could not “force a minority into such a scheme against their will, or compel them to accept an arbitrary value for their shares.”799 International & Great Northern Railroad Company v. Bremond800 was a suit by a shareholder in the Houston & Great Northern Railroad Company against that corporation, its former directors, and the corporation surviving the merger, International & Great Northern Railroad Company. The plaintiff subscribed for $100,000 in stock in 1870 and had paid $40,000 in installment payments at the time of the merger.801 At the time the plaintiff invested, the corporate charter did not provide for the ability to consolidate with another company. In 1874 though, the directors voted to merge the corporation with the International Railroad Company, under the name of the “International & Great Northern Railroad Company.”802 The legislature subsequently granted the surviving company a new charter and legalized the merger.803 The plaintiff objected to the merger and sued for the value of his interest, which he claimed was worth $50,000,804 and after a bench trial was awarded $43,182.30.805 The appeal was taken to the Texas Supreme Court.

In addition to defending the legality of the merger, the defendants attacked the plaintiffs’ lawsuit, claiming that it must be brought for the benefit of the corporation rather than as an individual action.806 The defendants asserted that the “only cause of action which dissenting stockholders have, upon an ultra vires act, is in equity, and to compel restitution to the corporation, and not to themselves,807 that the “plaintiff was not, in any case, entitled to recover damages payable to him personally,” and that, even if the consolidation was ultra vires, it did not allow the plaintiff to rescind his subscription.808 The plaintiff argued that the

797 Currently codified at TEX. BUS. ORGS. CODE ANN. §§ 10.351–.901, 21.410 (West 2007). 798 Tipton v. Ry. Postal Clerks’ Inv. Ass’n, 173 S.W. 562, 567 (Tex. Civ. App.—Fort Worth 1914, no writ). 799 Cattlemen’s Trust Co. v. Beck, 167 S.W. 753, 755–56 (Tex. Civ. App.—Austin 1914, writ ref’d). They also

could not dispose of all the assets of a solvent corporation without the unanimous consent of the stockholders. Aransas Pass Harbor Co. v. Manning, 63 S.W. 627, 628 (Tex. 1901).

800 53 Tex. 96 (1880). 801 Id. at 97. 802 Id. 803 Id. at 119–20 (“The consolidation, if illegal when attempted, has since been recognized by law, and for the

purposes of this case must be regarded as an accomplished fact.”). 804 Id. at 98. 805 Id. at 99. 806 Id. at 105–06. 807 Id. at 109. 808 Id. at 112.


merger “was ultra vires [under] the charter under which he became a stockholder,”809 that it was “a breach of trust towards a stockholder in a joint stock incorporated company, established for a certain definite purpose by its charter, if the funds or credit of the company are diverted from such purpose, although the misapplication be sanctioned by a vote of a majority of the stockholders”,810 and that for “this breach of trust” the “dissenting stockholders have a cause of action against [the directors] and the company participating with them in the conversion and breach of trust.”811

The Texas Supreme Court agreed with the plaintiff, holding first that the consolidation was “unauthorized and wrongful as to Bremond, an objecting stockholder of the former company, and having been consummated by a wrongful appropriation of his equitable interest by the consolidated company, that company became equitably liable to him therefor.”812 The plaintiff, however, was

not entitled to the personal judgment against the director recovered by him. The consolidation was the act of the stockholders, other than the plaintiff, and was therefore an act for which the directors, as such, should not be held responsible. As directors, they were answerable to the corporation for official delinquencies resulting in damage to the corporate property.813

But the plaintiff was entitled to an equitable award of monetary damages against the corporation for the value of his shares.814

The defendants argued that the plaintiff should be limited to the market value of his stock, but the Court rejected that argument because it appeared that

sales by subscribers were too rare to give the stock a market value. The inquiry should have extended to the actual value of stock, and as tending to show that value, the defendants were at liberty to show the true assets and liabilities of the Houston & Great Northern Railroad Company.815

The Court concluded that the trial court precluded the defendants from offering certain financial evidence about the corporation and reversed and remanded for a new trial.816

On another trial, the inquiry should be as to the real value of Bremond’s equitable interest in the Houston & G. N. Railroad Co., or the real value of his stock at the time the consolidation was practically effected; or at any period thereafter up to the institution of his suit. His

809 Id. at 113. 810 Id. at 114. 811 Id. at 114–15. 812 Id. at 117. 813 Id. at 118. 814 Id. 815 Id. at 120. 816 Id. at 121.


recovery should not exceed that value, with interest, from the institution of the suit.817

One commentator noted of Bremond: “This case is the only Texas decision prior to the adoption of the Business Corporation Act dealing with a party that can be analogized to a dissenting shareholder. It should be noted that the relief granted is identical to the recovery permitted under the appraisal procedure.”818 Effectively the same relief was developed in shareholder oppression cases by means of the buy-out remedy.

Therefore, in a case like Boehringer v. Konkel,819 the majority shareholder wrongfully interfered with the plaintiff’s rights to information,820 and wrongfully denied plaintiff’s right to “proportionate participation in the company’s earnings as a shareholder”821 through withholding dividends and granting himself “a de facto dividend”822 of excessive compensation to the exclusion of the minority shareholder. The majority shareholder caused the corporation to impair the shareholders’ interests, violate its duty of impartiality, and effectively deprived the plaintiff of his stock ownership rights. Such oppressive conduct effectively results in the “appropriation by the corporation” of the minority shareholder’s “his stock or its fruits.”823 Such oppressive conduct so fundamentally changes the nature and terms of the investment for the minority shareholder—so thoroughly “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,”824 if you will—that the oppressive conduct serves to “pervert or destroy the original purposes of the corporators,”825 “impose [] hazards upon the minority not contemplated by the original enterprise,”826 and to “force a minority into such a scheme against their will, [and attempt to] compel them to accept an arbitrary value for their shares.”827 In such cases, a buy-out should be ordered as an equitable remedy for the corporation’s breach of trust.

D. Other Issues

1. Joint and Several Liability of Controlling Shareholders

“It is settled as the law of this State that where a third party knowingly participates in the breach of duty of a fiduciary, such third party becomes a joint tortfeasor with the fiduciary and

817 Id. 818 Howard Wolf, Dissenting Shareholders: Is the Statutory Appraisal Remedy Exclusive?, 42 TEX. L. REV. 58,

63 (1963). 819 Boehringer v. Konkel, 404 S.W.3d 18 (Tex. App.—Houston [1st Dist.] 2013, no pet.). 820 Id. at 28. 821 Id. at 31. 822 Id. 823 Yeaman v. Galveston City Co., 167 S.W. 710, 723 (Tex. 1914). 824 Davis v. Sheerin, 754 S.W.2d 375, 381 (Tex. App.—Houston [1st Dist.] 1988, writ denied). 825 Tipton v. Ry. Postal Clerks’ Inv. Ass’n, 173 S.W. 562, 567 (Tex. Civ. App.—Fort Worth 1914, no writ). 826 Id. 827 Cattlemen’s Trust Co. v. Beck, 167 S.W. 753,755–56 (Tex. Civ. App.—Austin 1914, writ ref’d). They also

could not dispose of all the assets of a solvent corporation without the unanimous consent of the stockholders. See Aransas Pass Harbor Co. v. Manning, 94 Tex. 558, 562, 63 S.W. 627, 629 (1901).


is liable as such.”828 Therefore, the directors or the majority shareholder that cause or benefit from the corporate breach of trust will be individually liable.829 If monetary relief is granted, then the majority shareholder may be jointly and severally liable. If injunctive relief is granted, it may be directed against the majority shareholder.

2. Statute of Limitations

Because the corporation’s duties arise out of the corporation’s relationship as trustee to its shareholders, the four-year statute of limitations should apply to the breach of fiduciary duty claim.830 In cases involving a pattern of disregard and impairment of the plaintiff’s rights that may go on over a long period of time, limitations could become a significant issue. Oppressive conduct might seem like isolated disagreements or minor overreaching at first, but when the conduct escalates over time, the question of when the breach of trust actually happened could become difficult. However, the Texas Supreme Court in Yeaman ruled that a “shareholder is entitled to rely upon [the corporation] not attempting to impair his interest. He is chargeable with no vigilance to preserve his stock or its fruits from appropriation by the corporation, but may confide in its protection for their security.”831 Therefore, “statutes of limitation have no application until there is a clear and unequivocal disavowal of the trust, and notice of it brought to the cestui que trust.”832 The shareholder must have notice of overt conduct by the corporation denying or repudiating his interests.833 One court noted:

Given that repudiation triggered accrual, it was conceivable that situations could arise, when dealing with dividends or preemptive rights, where the corporation did nothing to repudiate them and the shareholder did nothing to secure them. Should that circumstance have occurred, then limitations would never have begun. . . . Had that occurred, limitations would never have begun, and the corporation would have been perpetually liable.834

828 City of Fort Worth v. Pippen, 439 S.W.2d 660, 665 (Tex. 1969); Kinzbach Tool Co. v. Corbett-Wallace

Corp., 160 S.W.2d 509, 514 (Tex. 1942). 829 Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d 687, 701 (Tex. App.—Fort Worth 2006, pet. denied)

(“A corporate officer may be held individually liable for a corporation’s tortious conduct if he knowingly participates in the conduct or has either actual or constructive knowledge of the tortious conduct.”) disapproved of on other grounds by, Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014).

830 TEX. CIV. PRAC. & REM. CODE ANN. § 16.004(5) (West 1999). 831 Yeaman v. Galveston City Co., 167 S.W. 710, 723 (Tex. 1914). 832 Id. at 723–24. Accord Bennett v. Hibernia Bank, 305 P.2d 20, 34 (Cal. 1956) (“Since a fiduciary has a duty

to make a full disclosure of facts which materially affect the rights of the parties, it seems obvious that any act by him amounting to a conversion of trust property is akin to a fraudulent concealment.”); Schneider v. Union Oil Co., 86 Cal. Rptr. 315, 319 (Cal. Ct. App. 1970) (emphasizing the “shareholder’s right to believe that the corporation would not assert a claim adverse to his rights until he had notice of some unequivocal act that his rights were being disputed. Similarly here, until plaintiff received such notice, she had the right to regard defendant as holding her interest in the corporation in trust for her.”).

833 Disco Mach. of Liberal Co. v. Payton, 900 S.W.2d 124, 126 n.2 (Tex. App.—Amarillo 1995, writ denied) (“Consequently, claims against the corporation involving his interest in the stock and its fruits did not accrue until the corporation undertook some overt conduct denying or repudiating the interest.”).

834 Id. That result was exactly the situation in Yeaman in which the corporate defendant failed to recognize the ownership interests of a shareholder and the claim brought 72 years later by his descendants was not time-barred.


3. Burden of Proof

Because the corporation is a trustee with fiduciary duties to the shareholder, the corporation should have the burden of proving that its conduct was consistent with its duties.835 Texas courts apply a presumption of unfairness to transactions between a fiduciary and a party to whom he owes a duty of disclosure.836 Thus, the profiting fiduciary bears the burden of showing the fairness of the transactions.837 Such fiduciaries must prove they acted in good faith and that the transactions were fair, honest, and equitable.838

4. Business Judgment Rule

When corporate action is utilized to impair fundamental shareholder rights and interests in breach of the corporation’s trust relationship with its shareholders, the business judgment rule should have no application. The business judgment rule exists to protect officers and directors from liability to the corporation as a consequence of poor, but honest, decisions.839 The duties that corporations owe to their shareholders are different from the duties that directors owe to the corporation, and there is no reason to assume that the business judgment rule would apply.840 There is no authority that the business judgment rule protects the corporation from liability to its shareholders. If a corporate president makes a poor decision that results in the corporation breaching a contract with a third party or negligently harming a third party, the

835 Tex. Bank & Trust Co. v. Moore, 595 S.W.2d 502, 509 (Tex. 1980) (“It should be emphasized that the

imposition by equity of a fiduciary relationship in such circumstances does no more than cast upon the profiting fiduciary the burden of showing the fairness of the transactions.”).

836 Fitz-Gerald v. Hull, 237 S.W.2d 256, 261 (Tex. 1951). 837 Collins v. Smith, 53 S.W.3d 832, 840 (Tex. App.—Houston [1st Dist.] 2001, no pet.). 838 Lee v. Hasson, 286 S.W.3d 1, 21 (Tex. App.—Houston [14th Dist.] 2007, pet. denied). See also Estate of

Miller, 446 S.W.3d 445, 453 (Tex. App.—Tyler 2014, no pet.) (“This places the burden on the fiduciary to rebut the presumption by establishing the fairness of the transaction with his principal.”); Vogt v. Warnock, 107 S.W.3d 778, 783 (Tex. App.—El Paso 2003, pet. denied) (“The court also observed that the fiduciary relationship did no more than cast upon the profiting fiduciary the burden of showing the fairness of the transactions.”); Procom Energy, L.L.A. v. Roach, 16 S.W.3d 377, 382 (Tex. App.—Tyler 2000, pet. denied) (“Additionally, where an issue is raised as to the fairness of a confidant or fiduciary in this type of transaction, the burden of proof is imposed upon that individual who refuses to convey the withheld interest to fully disclose the facts and circumstances that would demonstrate his good faith in his conduct.”); Zieba v. Martin, 928 S.W.2d 782, 789 (Tex. App.—Houston [14th Dist.] 1996, no writ) (“In that circumstance, the burden of proof to show fairness in disposing of community assets is upon the disposing spouse.”); Corpus Christi Bank & Trust v. Roberts, 587 S.W.2d 173, 181–82 (Tex. Civ. App.—Corpus Christi 1979), reformed in part and aff’d in part, 597 S.W.2d 752 (Tex. 1980) (“[T]he burden of proving the propriety of acts set forth in the account, if they are objected to, should rest on the trustee . . . .”); Graham v. Turner, 472 S.W.2d 831, 840 (Tex. Civ. App.—Waco 1971, no writ) (“Although the burden of proof is initially on the person seeking to impose the constructive trust to trace the funds into the specific property sought to be recovered, once this burden is satisfied, (as in the instant case), the burden of proof shifts to the constructive trustee to show that the part of the fund used to purchase the properties was his money only. Otherwise, the whole fund is treated as trust property.”).

839 Sneed v. Webre, 465 S.W.3d 169, 173 (Tex. 2015) (citing Cates v. Sparkman, 11 S.W. 846, 848–49 (Tex. 1889)).

840 In Ritchie, the majority refuted the assumption by the dissent that the business judgment rule would apply to breach of fiduciary duty claims brought by shareholder on the basis of relationships of trust and confidence. The majority wrote, “We see no basis for such an assumption and not that Texas law recognizes different kinds of fiduciary duties owed under different circumstances. . . . [W]e see no reason to assume the [business judgment] rule would apply [to different fiduciary duties].” Ritchie v. Rupe, 443 S.W.3d 856, 874 n.27 (Tex. 2014).


president would not be liable to the company, but the company will still be liable to the third party. The duties that corporations owe to their shareholders constrain corporate action. Acting to extinguish a shareholder’s ownership interest (either actually or constructively) is not one of those things that corporations have the right to do.841 The Texas Supreme Court in Yeaman was “unwilling to affirm that, in the absence of some statutory or charter power, or express consent to that effect, a corporation has any authority to forfeit a stockholder’s shares.”842 It must be noted that, although the Patton Court relied on the Cates decision843—a fact that the Ritchie Court found extremely significant in its analysis of Patton844—the Patton opinion never mentioned the business judgment rule or made the least inquiry into whether the majority shareholder in that case was accorded any discretion in the dividend decisions that he made.

2015 Amendments to the Business Organizations Code

A significant legislative development after the Ritchie opinion may also have an effect on the ability of individual shareholders to obtain equitable relief for oppressive conduct. Subchapter R to the Chapter 21 of the Code became effective on September 1, 2015.845 Among other changes, the new subchapter creates a new judicial proceeding to challenge the validity of corporate acts and transactions.846 An individual shareholder847 or a member of the board of directors848 may bring an action to have the court “determine the validity and effectiveness of” a “defective corporate act.”849 A “defective corporate act” is defined as including “any act or transaction purportedly taken by or on behalf of the corporation that is, and at the time the act or transaction was purportedly taken would have been, within the power of a corporation to take under the corporate statute, but is void or voidable due to a failure of authorization.”850 A “failure of authorization” means “the failure to authorize or effect an act or transaction in compliance with the provisions of the corporate statute, the governing documents of the corporation, or any plan or agreement to which the corporation is a party, if and to the extent the failure would render the act or transaction void or voidable.”851 Shareholders and directors may also bring an action to “determine the validity of any corporate act or transaction”852 This claim would obviously encompass a broader category of corporate acts and transactions, which might not be void or voidable, and which might be invalid for other reasons, such as a violation of fiduciary duties to the corporation, a violation of the shareholder’s common-law property rights, a violation of the corporation’s duties to the individual shareholder. In determining the validity of the challenged acts or transactions, the court is empowered to base its determination on any “factors or considerations the district court considers just and

841 Cates, 11 S.W. at 620. 842 Yeaman v. Galveston City Co., 167 S.W. 710, 723 (Tex. 1914). 843 Patton v. Nicholas, 279 S.W.2d 848, 854 (Tex. 1955). 844 Ritchie, 443 S.W.3d at 876. 845 TEX. BUS. ORGS. CODE ANN. §§ 21.901–.917 (West 2015). 846 See id. § 21.914. 847 Id. at (a)(4). 848 Id. at (a)(3). 849 Id. at (b)(3)(B). 850 Id. § 21.901(2)(c). 851 Id. at (4). 852 Id. § 21.914(b)(4).


equitable.”853 In addition to making a declaration as to the validity of the challenged act, the court is also empowered to “make any other order regarding such matters as the court considers appropriate under the circumstances”854—a grant of authority that would necessarily include the ability to award a compulsory buy-out. It is important to remember that the Ritchie opinion did not hold that courts do not have the equitable power to order a buy-out, but only that Section 11.404 of the Business Organizations Code did not provide such a remedy and that no common-law cause of action for shareholder oppression provided a vehicle for such an equitable remedy. Even aside from the common-law breach of trust cause of action developed here, it appears that the Texas legislature has furnished such a vehicle by statutory enactment.

VIII. OTHER SHAREHOLDER CAUSES OF ACTION ARISING FROM CORPORATE TRUST DUTIES

A. Ultra Vires

Cates v. Sparkman held that an individual shareholder is entitled to bring a claim against the corporation for actions that are “ultra vires.”855

1. Elements

Under Texas law, ultra vires acts are “acts beyond the scope of the powers of a corporation as defined by its charter or the laws of the state of incorporation.”856 Under modern law, a Texas corporation’s certificate of formation may state that it is created to pursue any lawful purpose.857 Therefore, truly “ultra vires” acts, in the sense that the corporation had no power to enter into the transaction or was affirmatively prohibited from doing so, are exceedingly rare.858 Nevertheless, the ultra vires doctrine potentially remains useful in shareholder oppression disputes. Corporate action must be taken for the benefit of the corporation and comply with state law,859 including “basic principles of fiduciary law.”860 Corporate actions “must be pursued for corporate benefit. If pursued for personal benefit, they are ultra vires.”861 While misappropriation and other self-dealing transactions by the controlling majority may be the basis of a derivative claim for damages, such transactions may

853 Id. at (d)(5). 854 Id. at (c)(10). 855 Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889). 856 F.D.I.C. v. Benson, 867 F. Supp. 512, 521 (S.D. Tex. 1994); see also Gearhart Indus., Inc. v. Smith Int’l,

Inc., 741 F.2d 707, 719 (5th Cir. 1984) (“The duty of obedience requires a director to avoid committing ultra vires acts, i.e., acts beyond the scope of the powers of a corporation as defined by its charter or the laws of the state of incorporation.”).

857 See TEX. BUS. ORGS. CODE ANN. § 3.005(a)(3) (West 2007). 858 “[M]ost ordinary business activities are now intra vires . . . .” TEX. PRAC.: BUS. ORGS., supra note 7, at §

27:9. 859 See Religious Films v. Potts, 197 S.W.2d 592, 594 (Tex. Civ. App.—Galveston 1946, no writ) (“The test

generally applied is that if the act is not one prohibited by law or by public policy, and it inures to the direct benefit of the corporation and is executed, it is not, strictly speaking, ultra vires.”).

860 Solomon v. Armstrong, 747 A.2d 1098, 1114 n.45 (Del. Ch. 1999), aff’d, 746 A.2d 277 (Del. 2000). 861 TEX. PRAC.: BUS. ORGS., supra note 7, at § 27:9. See, e.g., Inter-Cont’l Corp. v. Moody, 411 S.W.2d 578,

587 (Tex. Civ. App.—Houston 1966, writ ref’d n.r.e.) (“The payment of an officer’s debt is ultra vires.”).


be ratified by a majority of disinterested directors or shareholders.862 The definition of “disinterested” under the Code is quite broad and can include allies, friends, and stooges.863 However, ultra vires acts that do not benefit the corporation, such as those constituting waste864 or gift,865 may only be ratified by a unanimous shareholder vote.866 Furthermore, the business judgment rule does not insulate ultra vires acts.867

A second area in which the ultra vires doctrine comes into play is when the officers, directors, or other corporate agents take the corporate action without authority.868 These acts are not truly “ultra vires” in the sense that they may be ratified after the fact,869 nevertheless they are void unless and until ratification occurs, and may be the subject of an ultra vires claim. Such ultra vires acts of officers and directors very frequently occur in shareholder oppression litigation in the course of excluding the minority shareholder from participation, particularly if the minority shareholder is a director. Often the board will be in deadlock, or the controlling shareholder does not wish to meet with the minority shareholder, and the controlling shareholder proceeds to act outside the board process. Action by written consent by

862 BUS. ORGS. §21.418 (b). 863 See id. §1003. 864 See Harbor Fin. Partners v. Huizenga, 751 A.2d 879, 897 (Del. Ch. 1999) (recognized that waste is a

“vestige” of the ultra vires doctrine). 865 “Void acts include fraud, gift, waste, or ultra vires acts.” Solomon, 747 A.2d at 1114. 866 TEX. PRAC.: BUS. ORGS., supra note 7, at § 27:9 n.5. See Gantler v. Stephens, 965 A.2d 695, 713 n.54 (Del.

2009). The unanimity requirement derives from the theory that no one “should be forced against their will to make a gift of their property.” Lewis v. Vogelstein, 699 A.2d 327, 335–36 (Del. Ch. 1997). See also Rogers v. Hill, 289 U.S. 582, 591–92 (1933) (“If a bonus payment has no relation to the value of services for which it is given, it is in reality a gift in part, and the majority stockholders have no power to give away corporate property against the protest of the minority.”); Solomon, 747 A.2d at 1114 (“No amount of shareholder ratification validates acts repugnant to public policy (e.g., fraud), and which are therefore void ab initio. In other words, those acts may still be subject to this Court’s equitable powers (e.g., rescission). Other than void acts [gift, waste, or ultra vires acts] precluded by public policy concerns, fully informed shareholder ratification will insulate a board action from subsequent legal attack by shareholders. The restriction is that only a unanimous shareholder vote can ratify these remaining void acts.”); Michelson v. Duncan, 407 A.2d 211, 219 (Del. 1979) (“It is only where a claim of gift or waste of assets, fraud or Ultra vires is asserted that a less than unanimous shareholder ratification is not a full defense.”).

867 F.D.I.C. v. Benson, 867 F. Supp. 512, 521 (S.D. Tex. 1994) (“To avoid the protective shield of the business judgment rule, [the plaintiff] must show that the acts of the directors and officers were ultra vires, or tainted by fraud, or a complete abdication of duty . . . .”); see also Fisher v. Shipyard Vill. Council of Co-Owners, Inc., 760 S.E.2d 121, 130 (S.C. Ct. App. 2014), aff’d as modified, 781 S.E.2d 903 (S.C. 2016) (“The business judgment rule only applies to intra vires acts, not ultra vires ones.”).

868 Governing Bd. v. Pannill, 561 S.W.2d 517, 524 (Tex. Civ. App.—Texarkana 1977, writ ref’d n.r.e.) (“That a corporate act is invalid because it was beyond the authority of officers or directors may be asserted by a member in an action against the corporation to enjoin the activity.”). See also Ravenswood Inv. Co., L.P. v. Bishop Capital Corp., 374 F. Supp. 2d 1055, 1066–67 (D. Wyo. 2005) (issuing shares to the individual Defendants at a reduced price and failing to hold annual shareholder meetings stated a claim for ultra vires acts); Woods v. Wells Fargo Bank Wyoming, 90 P.3d 724, 733 (Wyo. 2004) (“Ultra vires acts of a corporate president or other agent are void”); Gooding v. Millet, 430 So.2d 742, 743–44 (La. Ct. App.1983) (noting that the lack of shareholder meetings contributed to finding that directors of corporation had committed ultra vires acts).

869 Shoen v. SAC Holding Corp., 137 P.3d 1171, 1186 (Nev. 2006) (“Thus, for example, ‘[i]f . . . the [corporation’s] act was within the corporate powers, but was performed without authority or in an unauthorized manner, the act is not ultra vires.’”); 7A FLETCHER CYC. CORP. § 3401 (“A result of this distinction is that while the shareholders cannot by ratification render valid an act that is beyond the powers of the corporation, they may ratify an act that is within its powers but beyond the powers of the directors.”).


the majority shareholder is not valid, unless the Certificate of Formation—not the bylaws—specifically provides for nonunanimous written consent.870 Often shareholder or board-level decisions will be made without notice to the minority shareholder. “The general rule is that a board of directors may exercise its power only as a body at a meeting duly assembled.”871 Board members have no authority to act individually, or without a properly noticed meeting. Board-level actions taken without proper notice to all board members are void.872 In many instances, the controlling shareholder will attempt to exercise control over the corporation as its president, bypassing board and shareholder votes. However, a president’s authority only extends to matters in the ordinary course of business.873 The president has no authority to fire an officer appointed by the board.874 Similarly, the president has no authority to cause the corporation to hire counsel to fight with the minority shareholder.875

2. Remedies

A shareholder may sue the corporation directly for injunctive relief to restrain or set aside

870 TEX. BUS. ORGS. CODE ANN. § 6.202 (West 2006). 871 Am. Bank & Trust Co. v. Freeman, 560 S.W.2d 444, 446 (Tex. Civ. App.—Beaumont 1977, writ ref’d

n.r.e.); see Whitaker v. Vastine, 601 S.W.2d 398, 403 (Tex. Civ. App.—Dallas 1980, writ ref’d n.r.e.); Dowdle v. Tex. Am. Oil Corp., 503 S.W.2d 647, 652 (Tex. Civ. App.—El Paso 1973, no writ); Curtis v. Pipelife Corp., 370 S.W.2d 764, 767 (Tex. Civ. App.—Eastland 1963, no writ); Holloway v. Int’l Bankers Life Ins. Co., 354 S.W.2d 198, 214 (Tex. Civ. App.—Fort Worth 1962), rev’d on other grounds, 368 S.W.2d 567 (Tex. 1963); Wichita Falls Electric Co. v. Huey, 246 S.W. 692 (Tex. Civ. App.—Amarillo 1922, no writ); Nicholstone City Co. v. Smalley, 51 S.W. 527, 529 (Tex. Civ. App. 1899, no writ).

872 See Greater Fort Worth & Tarrant Co. Cmty. Action Agency v. Mims, 627 S.W.2d 149, 151 (Tex. 1982) (“The Board was illegally constituted so it had no authority to terminate Mims. Until the Board was properly constituted, it could not ratify its earlier unauthorized acts.”). See also Rare Earth, Inc. v. Hoorelbeke, 401 F. Supp. 26, 32 (S.D.N.Y. 1975) (where a written notice of the meeting of the board of directors is not given although required by either a statute or the corporate bylaws, any action taken by the meeting at which all the directors are not present is void); Schroder v. Scotten, Dillon Co., 299 A.2d 431, 435 (Del. Ch. 1972) (decisions made at a Board of Directors meeting held without due notice to all directors as required by the by-laws is not lawful and all acts done at such meeting are void); Moore Bus. Forms, Inc. v. Cordant Holdings Corp. (Moore II), No. 13911, 1998 WL 71836, at *7 (Del. Ch. Feb. 4, 1998) (same); 2 FLETCHER CYC. CORP. § 428 (“However, proceedings by directors at a meeting that was illegal because it was not called by the authority or in the mode prescribed by the articles of incorporation or bylaws, or because notice was not given to absent members of the board, or because a quorum was not present, or for any other reason, as explained in the preceding sections, are absolutely void, unless they are afterwards ratified, or unless the corporation is estopped as against innocent third persons.”).

873 Templeton v. Nocona Hills Owners Ass’n, Inc., 555 S.W.2d 534, 538 (Tex. Civ. App.—Texarkana 1977, no writ) (“[T]he settled rule in Texas is that a corporation president, merely by virtue of his office, has no inherent power to bind the corporation except as to routine matters arising in the ordinary course of business.”).

874 See In re Walt Disney Co. Deriv. Litig., No. 15452, 2005 WL 2056651, at *49 n.571 (Del. Ch. Aug. 9, 2005), aff’d, 906 A.2d 27 (Del. 2006) (“[A]bsent express authority, the presiding officer of a corporation has no power to remove an officer appointed by the board of directors where the power of removal is in the board.”).

875 In re CorrLine Int’l, L.L.C., 516 B.R. 106, 138 (Bankr. S.D. Tex. 2014). Defending a lawsuit and hiring counsel to pursue or defend litigation is not within the “ordinary course of business.” See Kaspar v. Thorne, 755 S.W.2d 151, 154 (Tex. Civ. App.—Dallas 1988, no writ); St. Star Designs, L.L.C. v. Gregory, No. H–11–0915, 2011 WL 3925070, at *3 (S.D. Tex. Sept. 7, 2011); Square 67 Dev. Corp. v. Red Oak State Bank, 559 S.W.2d 136, 138 (Tex. Civ. App.–Waco 1977, writ ref’d). See also Robert Nanney Chevrolet Co. v. Evans & Moses, 601 S.W.2d 411, 413 (Tex. Civ. App.—Beaumont 1980, no writ) (“Hiring of counsel in an attempt to thwart the will of the majority of the Board of Directors and the holders of the stock of the corporation is not, as a matter of law, a routine matter arising in the ordinary course of business.”).


ultra vires acts. The Business Organizations Code provides that

an act or transfer [] beyond the scope of the expressed purpose or purposes of the corporation or [] inconsistent with an expressed limitation on the authority of an officer or director may be asserted in a proceeding . . . by a shareholder or member against the corporation to enjoin the performance of an act or the transfer of property by or to the corporation.876

Shareholders may also bring claims for ultra vires acts against officers and directors, but only derivatively.877 However, the remedy for an ultra vires claim brought by or on behalf of the corporation is not limited to injunctive relief.

B. Fraud in the Purchase of Minority Shares

Cates v. Sparkman held that an individual shareholder is entitled to bring a claim against the corporation for “fraud.”878 Corporations rarely enter into transactions with existing shareholders in their capacity as shareholders, as opposed to officer, director, employee, lender, lessor, vendor, etc., other than in the repurchase or redemption of the shareholder’s stock. Redemption or repurchase of the minority shareholder’s stock is very common in successful squeeze-outs, and the corporation’s duties as trustee permit the shareholder to sue for fraud or breach of fiduciary duties if information is withheld or the transaction is otherwise for less than fair value.

1. Duty Owed to Minority Shareholders

In In re Fawcett, the widow of a shareholder in a closely-held corporation entered into an agreement with the corporation providing for the corporation to repurchase her shares.879 She later sued the corporation for fraud and breach of fiduciary duties because the corporation and the other shareholders failed to disclose the existence of a significant business opportunity that the corporation commenced within days after signing the agreement, and which would have greatly increased the value of her shares. The court of appeals held that there was a fact issue as to the existence of fiduciary duties owed to the individual shareholder under the circumstances.880 “An officer or director of a closely held corporation, as well as the corporation itself, may become fiduciaries to a shareholder when the corporation, officer, or director repurchases the shareholder’s stock.”881 Subsequent cases have cited In re Fawcett for the proposition that fiduciary relationships may be created by contract, through the repurchase

876 TEX. BUS. ORGS. CODE ANN. § 20.002(c)(1) (West 2006). See Inter-Cont’l Corp. v. Moody, 411 S.W.2d

578, 587 (Tex. Civ. App.—Houston 1966, writ ref’d n.r.e.) (“Any shareholder has his remedy, if equitably entitled to relief, through a suit to enjoin performance of the particular act.”).

877 See BUS. ORGS. § 20.002(c)(2); Inter-Cont’l Corp., 411 S.W.2d at 587 (“The corporation or its representatives or a shareholder have their remedy by suing the officers and directors.”).

878 Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889). 879 Estate of Fawcett, 55 S.W.3d 214, 216 (Tex. App.—Eastland 2001, pet. denied). 880 Id. at 220. 881 Id. (citing Miller v. Miller, 700 S.W.2d 941, 945–46 (Tex. App.—Dallas 1985, writ ref’d n.r.e.)); WILLIAM

MEADE FLETCHER ET AL., 12B FLETCHER CYC. CORP. § 5811.05 (perm. ed., rev. vol. 2000).


of a shareholder’s stock in a closely held corporation.882 However, it is clear from the opinion that the contract itself did not create fiduciary duties; rather it was the occasion of entering into the contract that resulted in the application of fiduciary duties that already existed in the relationship between the corporation and its shareholder.

The same duties are imposed on controlling shareholders and directors by implication if they use their position of control over the corporation and insider information to take unfair advantage in purchasing minority shareholder interests. In Miller v. Miller,883 the court addressed duties of controlling shareholders in purchasing shares from minority shareholders. Certain aspects of the case are unusual, and the case probably could have been resolved without reference to the corporate law issues. The case arose out of a divorce between a husband and wife. The husband had started a corporation with three other engineers, each of whom were issued 25% of the shares.884 The husband was an officer and director. None of the shares were in the wife’s name; her interests were purely the result of community property. At the time that the corporation was organized, the husband and wife were already separated. The purpose of the corporation was to develop and market some extremely promising telephone switching technology. A subsidiary of Exxon had agreed to provide venture capital and to take a significant equity stake.

Exxon required, as a condition of its investment, that the shareholders enter into a shareholders’ agreement restricting the sale of their shares. One of the provisions required any divorcing spouse of the shareholders to sell any shares owned by them back to the shareholder spouse, to the corporation or to the other shareholders at a price determined by a formula that was guaranteed to result in a relatively low price.885 All of the spouses were required to sign. The husband presented the agreement to the wife, and explained that it was an agreement between Exxon and the founders and was necessary to get the company started. He did not explain the agreement and did not disclose the facts he knew about the prospects of the company, the size of Exxon’s investment or the price per share paid by Exxon, or the potential value of the enterprise. The wife read the agreement and signed it and later testified that she had believed that she was already bound by it.

The husband’s 700,000 shares apparently were not dealt with in the divorce, but were treated as his separate property, and he never demanded that she sell the shares or offered her the consideration under the agreement, which he contended was $2,500. Two years later, the wife later learned that the corporation was worth far more than she had believed. She sued to rescind the agreement and partition the shares.886 The case was tried to a jury, which found the affirmative representations made by the husband were false and material and that the husband had failed to disclose that Exxon had purchased 1.5 million shares at $1 per share, that the wife would be required to sell in the event of a divorce, that the stock had a fair market cash value,

882 See In re Rosenbaum, No. 08-43029, 2010 WL 1856344, at *7 (Bankr. E.D. Tex. May 7, 2010). See also

Redmon v. Griffith, 202 S.W.3d 225, 237 (Tex. App.—Tyler 2006, pet. denied) (“[F]iduciary relationship that may exist between majority and minority shareholders . . . by contract . . . .”); accord Willis v. Donnelly, 118 S.W.3d 10, 31, 33 (Tex. App.—Houston [14th Dist.] 2003) rev’d in part on other grounds, 199 S.W.3d 262 (Tex. 2006).

883 700 S.W.2d 941 (Tex. App.—Dallas 1985, writ ref’d n.r.e.). 884 Id. at 943. 885 Id. 886 Id. at 944.


and that the corporation was developing technology that would be in great demand. However, the jury also found that the husband did not act with the intent to deceive. With regard to breach of fiduciary duties, the jury found that the husband had acted in good faith, that the agreement had a reasonable business purpose, but that the agreement was unfair to the wife.887 On the basis of these findings, the trial court denied rescission of the shareholder’s agreement and ordered that the wife be paid the amount due under the shareholders’ agreement.

The wife appealed only the breach of fiduciary duties. The jury had found a confidential relationship, and certain fiduciary duties would have existed as a matter of law by virtue of the marriage relationship. However, the court of appeals’ analysis places primary emphasis on the husband’s power over the wife’s stock rights as a result of his controlling position in the corporation:

The record shows that as a founder, officer, and director of InteCom, Howard had an insider’s knowledge of the affairs and prospects of the corporation. . . . Recognition of a fiduciary duty in this case is based not only on the personal relationship between Howard and Judy but also on Howard’s position as a founder, officer, and director of InteCom.888

The court noted that no Texas case had addressed the issue of whether an officer and director of a corporation has a duty to disclose to a stockholder his knowledge of information affecting the value of the stock before purchasing it from the stockholder.889 The court noted that majority rule was that a director or officer does not stand in a fiduciary relation to a stockholder in respect to his stock and, therefore, has the same right as any other stockholder to trade freely in the corporation’s stock.890

However, some jurisdictions had held that officers and directors have a fiduciary duty to individual stockholders, as well as to the corporation itself and, thus, cannot properly purchase stock from a stockholder without giving him the benefit of any official knowledge they have of information that may increase the value of the stock.891 Still other courts had followed the majority rule, but recognized an exception when “special facts” impose on the officer or director a limited fiduciary duty to disclose any knowledge of special matters relating to the corporate business—e.g., merger, assured sale, etc.—that may affect the value of the stock.892

887 Id. 888 Id. at 945. 889 Id. at 946. 890 Id. at 945–46 (citing Seitz v. Frey, 188 N.W. 266, 268 (Minn. 1922)); Schuur v. Berry, 281 N.W. 393, 395

(Mich. 1938). 891 Id. at 946 (citing Dawson v. Nat’l Life Ins. Co., 157 N.W. 929, 934 (Iowa 1916)); see Jacobson v. Yaschik,

155 S.E.2d 601, 605 (S.C. 1967); cf. Harris v. Mack, No. SA:11-CV-00622-DAE, 2013 WL 416299, at *4 (W.D. Tex. Jan. 31, 2013) (affirming summary judgment for majority shareholder on minority shareholder’s fraud by nondisclosure claim because majority shareholder did not owe a fiduciary duty to disclose information to minority shareholder); Jones v. Sherman, 857 S.W.2d 468, 468 (Mo. Ct. App. 1993) (“Neither closely held corporation nor majority shareholder had duty to disclose financial information to minority shareholder while negotiating to buy out minority shareholder.”).

892 Miller v. Miller, 700 S.W.2d 941, 946 (Tex. App.—Dallas 1985, writ ref’d n.r.e.) (citing Strong v. Repide, 213 U.S. 419, 431 (1909)); Hobart v. Hobart Estate Co., 159 P.2d 958, 969–70 (Cal. 1945); 3A FLETCHER § 1171.


The court declined to rule whether Texas would follow the “majority” or “minority” rule, but held that even under the majority rule the “special facts” of this case were sufficient to bring it within the exception.893 The “special facts” critical to the court’s decision were that the husband knew that “Exxon was purchasing 1,500,000 shares at one dollar per share and that if IBX was developed, it would be in great demand” and that the husband therefore had a fiduciary duty to disclose those facts prior to contracting with the wife regarding the ownership of her shares.894

In Westwood v. Continental Can Co.,895 the Fifth Circuit decided a case involving a shareholder and managing director of a Texas corporation who negotiated a deal sell the stock of his corporation, and then negotiated option agreements with all the stockholders that would permit him to buy their stock and resell it at a premium. Ultimately, the buyer refused to consummate the transaction, and the shareholder sued for breach of contract. The buyer successfully defended the action on the grounds that the contract was unenforceable because it constituted a breach of the shareholder’s fiduciary duties to the corporation and its shareholders.

The Fifth Circuit held that the contract was unenforceable because

when directors or other officers step aside from the duty of managing the corporate business under the charter for the benefit of stockholders, and enter upon schemes among themselves or with others to dispose of the corporate business and to reap a personal profit at the expense of the stockholders by buying up their shares without full disclosure and at an inadequate price, there is a breach of duty.896

If a favorable opportunity arises to sell out, the stockholders and not the managing officers are entitled to have the benefit of it. If an agreement cannot be reached by the stockholders, no doubt one faction may buy out the other.897

Any shareholder, even though an officer and director, could legally buy up the stock of the other shareholders with the purpose of reselling at a profit, but only on full disclosure.898 The shareholder had disclosed to the other shareholders in a letter “the state of the business, the want of harmony among the stockholders, and the wisdom of acting promptly to save the investment.”899

“In making his offer for the stock, he stated that he proposed to resell it as an entirety, and if unable to do so, to dissolve the corporation and dispose of the assets, hoping to make a profit as the reward of his risk and efforts.”900 He had even disclosed that he was in the process of

893 Miller, 700 S.W.2d at 946. 894 Id. 895 80 F.2d 494, 498 (5th Cir. 1935). 896 Id. 897 Id. 898 Id. 899 Id. 900 Id.


carrying on negotiations for a possible sale.901 However, in the lawsuit, the shareholder contended that he in fact had a contract with the buyer; and the court held that, if so, “the plan as a whole was thus one for the managing officer to deceive the stockholders and acquire the corporate assets for his own and another’s profit.”902

Both Miller and Westwood involved shareholders who were also officers and directors, and both opinions emphasize their duties as officer and directors. Neither was a derivative action—in Miller, the plaintiff was suing individually, and in Westwood the corporation was not involved in the transaction. The duties of disclosure in these cases are best understood as flowing from the corporation’s duties to its shareholders, with the courts imposing those same duties on the officer/director defendants because of their control of the corporation. If a corporation could not enter into a transaction or purchase shares from a shareholder because the corporation was in possession of undisclosed, material information, then an officer or director who is in the same position of advantage over the shareholder as a result of his control over a corporation is subjected to the same duties of disclosure.

Allen v. Devon Energy Holdings, L.L.C. concerned the redemption of Allen’s minority interest in an LLC involved in natural gas exploration and development.903 The LLC redeemed Allen’s interest in 2004 based on a 2003 $138.5 million appraisal of the LLC.904 Approximately 18 months after the redemption, however, the LLC was sold for $2.6 billion—almost twenty times the value used to calculate the redemption price.905 Allen sued, claiming that the majority shareholder and the LLC made misrepresentations, failed to disclose facts regarding the LLC’s future prospects, and that Allen would not have sold his interest in 2004 if he had known these material facts.906 For instance, the majority shareholder withheld information concerning the LLC’s technological advances in horizontal drilling and significant lease acquisitions in an existing natural gas field, both of which occurred after the redemption offer but before the redemption.907

Although the transaction was a redemption in which the company was the purchaser, the court of appeals treated the transaction as though it were a purchase by the majority shareholder. “We note that the duty we recognize is owed by Rees-Jones, a majority owner and manager with virtually unmitigated control over an LLC, not [the LLC] itself—whether [the company] owed Allen any fiduciary duties is not before this Court.”908 The appellate court determined that a majority shareholder owed a fiduciary duty to a minority shareholder in the context of a redemption agreement. The court based its decision on majority shareholder’s operating control over the affairs of the company and intimate knowledge of the company’s daily affairs and future plans.909 Further, the purchase of a minority owner’s interest benefitted

901 Id. 902 Id. 903 Allen v. Devon Energy Holdings, L.L.C., 367 S.W.3d 355 (Tex. App.—Houston [1st Dist.] 2012, pet.

granted, judgm’t vacated w.r.m.). 904 Id. at 365–66. 905 Id. at 367. 906 Id. at 365. 907 Id. 908 Id. at 395. 909 Id. at 392.


the majority owner.910

Ritchie’s treatment of this line of authority is significant.911 The majority opinion cited Allen as authority for the ability of individual shareholders to sue directors and majority shareholders for “fraudulently [] manipulat[ing] the shares’ value” under existing causes of action. Fawcett, Miller, and Allen all clearly recognize that officers, directors, and controlling shareholders owe fiduciary duties to minority shareholders at least in the context of a transaction to purchase the minority’s shares when there is knowledge of material facts within the corporation not disclosed to the shareholder. At first glance, the holdings of this line of cases, which Ritchie cites with approval, seems grossly at odds with the holding in Ritchie. The duties that arise in the context of a share redemption or repurchase are better understood as the duties of fairness and disclosure imposed on the corporation as a result of the trustee relationship described in Yeaman. As noted above, officers, directors, and controlling shareholders may be held personally liable for participating in a breach of the corporation’s legal duties to its shareholders. This line of cases represents a clear application of the quasi-fiduciary duties and liability based on the common-law cause of action for breach of trust. Ritchie’s characterization of Allen as “addressing fraud claims relating to closely held company’s purchase of minority shareholder interests”912—a fraud claim that existed only because of the fiduciary duty to make full disclosure—is at least an implicit acknowledgment of the existence of such duties.

It is important to note that the legal duty and liability for breach of that duty in these fraud cases arising in the context of a shareholder selling his stock to the corporation or those in control must be based on the fiduciary relationship between corporation and not on general tort law or statutory duties in securities fraud claims. If the fiduciary duty is removed, the result is different. In Ward v. Succession of Freeman,913 the Fifth Circuit reversed a securities fraud judgment in favor of former minority shareholders of a Louisiana Coke-bottling corporation. A group of shareholders who together controlled twenty percent of the outstanding shares and who had control of the corporation’s management, caused the corporation to make a series of tender offers to repurchase minority shares after attending a 1979 convention at which they learned that the Coca-Cola Corporation intended to initiate a restructuring program whereby it would “actively participate” in changes to the ownership of the affiliated bottling companies. In 1980, 1982, and 1983, the corporation made nonbinding offers to redeem minority shares at prices ranging from $321 per share to $850 per share. The plaintiffs sold their shares in the 1982 tender offer. In the 1982 tender offer document, the defendants mentioned to the possibility of a future reverse stock split (which would cash out a minority shareholder positions) but also represented at the company had no current plans for such a reverse split. As a result of the various tender offers, the defendants increase their share position from 20% to 80%. In 1984, the defendants sold the bottling company to Big Coke for $148 million. Thereafter, the plaintiffs sued, claiming that the series of tender offers were fraudulent and

910 Id. at 395; see Transeo S.A.R.L. v. Bessemer Venture Partners VI L.P., No. 11-CV-5331, 2013 WL 1285453, at *14 (S.D.N.Y. Mar. 29, 2013) (internal citations omitted) (stating majority shareholders owe fiduciary duties to minority shareholders but the duty is narrow and breached when majority shareholders exploit the minority shareholders).

911 Ritchie v. Rupe, 443 S.W.3d 856, 888 n.56 (Tex. 2014). 912 Id. 913 854 F.2d 780 (5th Cir. 1988).


constituted part of the defendants’ plans to “squeeze out” and “freeze out” the minority shareholders. The case was tried to a jury, and the plaintiffs received a favorable judgment.914

With respect to the securities fraud claim, the Court held that there must be a misrepresentation or omission of a material fact.915 The Court held that the plaintiffs’ contention that the defendants had failed to disclose their “secret plan” or “true purpose” to “squeeze out or freeze out” the minority shareholders in order to sell to Big Coke did not state a claim for securities fraud. Federal securities laws do not provide a cause of action for breach of fiduciary duties unless there is an element of deception or fraudulent manipulation.916 Therefore, the defendants’ good faith or subjective motivation in entering into the transaction is not a “material fact.”917 The law governing securities fraud claims did not require disclosure of the mere possibility of a future sale to Big Coke because there was no offer, and negotiations did not begin until more than a year after the tender offer.918 The breach of fiduciary duties claim was brought under Louisiana law. The Court held that the jury charge had applied the incorrect standard because the tender offers were not self-dealing transactions under Louisiana law because the benefit to the defendant shareholders from those transactions was no different from the benefit that devolved upon the corporation or all shareholders generally.919 Therefore, the plaintiffs had no claim. However, had the case been decided under Texas law applying the duties recognized in Yeaman, it would seem that the result would have been different.

2. Constructive Fraud Cause of Action

As discussed above, the corporation’s duties to its shareholders include the duty to not to impair his ownership interests, to “to observe its trust for their benefit” and to preserve both the stock and its “fruits.”920 A transaction in which the corporation purchases an existing shareholder’s stock and renders him no longer an owner falls squarely within the scope of this legal duty. Liability for common law fraud by non-disclosure, where there is a duty to disclose, applies “even in an ordinary arms-length transaction in which no “fiduciary duties” exist and only the ethics of the marketplace apply.”921 However, the cause of action asserted in the context of a fiduciary relationship is for constructive fraud,922 which “is the breach of a legal

914 Id. at 782–83. 915 Id. at 790. 916 Id. at 791 (citing Santa Fe Indus. v. Green, 430 U.S. 462 (1977)). 917 Id. (citing Biesenbach v. Guenther, 588 F.2d 400 (3d Cir.1978)) (determining that directors’ failure to

disclose “the true purpose behind” their activities to gain control of a corporation failed to state a claim); Vaughn v. Teledyne, Inc., 628 F.2d 1214 (9th Cir. 1980) (stating that undisclosed plan to increase control over corporation not fraud); Coronet Ins. Co. v. Seyfarth, 665 F. Supp. 661 (N.D. Ill. 1987) (holding that failure to disclose plan to entrench management not fraud). In part, these opinions are influenced by the fact that any person with even an elementary knowledge of the corporate structure would realize that an offer to repurchase stock would increase the ownership of the remaining shareholders and that the offer was probably made for that purpose. See Ala. Farm Bureau Mut. Cas. Co., Inc. v. Am. Fid. Life Ins. Co., 606 F.2d 602, 611 (5th Cir. 1979).

918 Ward, 854 F.2d at 792. 919 Id. at 794 (citing Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)). 920 Yeaman v. Galveston City Co., 167 S.W. 710, 723 (Tex. 1914). 921 Chien v. Chen, 759 S.W.2d 484, 495 (Tex. App.—Austin 1988, no writ) (emphasis in original). 922 Miller v. Miller, 700 S.W.2d 941, 947 (Tex. App.—Dallas 1985, writ ref’d n.r.e.) (“Although breach of such

a fiduciary duty is referred to in the above authorities as ‘constructive fraud,’ it is to be distinguished from other types


or equitable duty that the law declares fraudulent because it violates a fiduciary relationship.”923 Common-law fraud includes both “actual” and “constructive fraud.”924 “Breach of a fiduciary relationship can constitute fraud because the fiduciary relationship imputes higher duties, such as duties of good faith, candor, and full disclosure.”925 The elements of a breach of a fiduciary duty claim are (1) a fiduciary relationship between the plaintiff and defendant, (2) a breach by the defendant of her fiduciary duty to the plaintiff, and (3) an injury to the plaintiff or benefit to the defendant as a result of the defendant’s breach.926 In a fiduciary relationship, constructive fraud “does not require an intent to defraud.”927 Nor is reliance an element. In Miller v. Miller, the purchase of a minority shareholder’s stock was held invalid, notwithstanding jury findings that the defendant had acted in good faith, that his failure to disclose was not done with the intent to induce reliance, and that the plaintiff had not relied on the nondisclosure.928

The Texas cases have not fully examined the fiduciary duties that the trustee relationship imposes on a corporation in a transaction whereby it purchases the stock of an existing shareholder. However, in the context of a partnership, those duties are well-settled. The “law imputes to the relationship additional and higher duties and their breach may constitute a fraud as well.”929 These heightened duties, include the duty of “full disclosure respecting matters affecting the principal’s interests and a general prohibition against the fiduciary’s using the relationship to benefit his personal interest, except with the full knowledge and consent of the principal.” 930 In Johnson v. Peckham, the Texas Supreme Court has held:

[I]n a sale by one partner to another of his interest in the partnership, an absolute duty of full disclosure of all material facts and information to the buying partner is imposed upon the selling partner; such a sale, when challenged, will be sustained only when it is made in good faith, for a fair consideration and on a full and complete disclosure of all information as to value.931

of ‘constructive fraud’ in which the entire burden rests on the party asserting it.”). 923 Hubbard v. Shankle, 138 S.W.3d 474, 483 (Tex. App.—Fort Worth 2004, pet. denied). See also Archer v.

Griffith, 390 S.W.2d 735, 740 (Tex. 1964) (“Actual fraud usually involves dishonesty of purpose or intent to deceive, whereas constructive fraud is the breach of some legal or equitable duty which, irrespective of moral guilt, the law declares fraudulent because of its tendency to deceive others, to violate confidence, or to injure public interests.”).

924 Chien, 759 S.W.2d at 494–95. 925 Flanary v. Mills, 150 S.W.3d 785, 795 (Tex. App.—Austin 2004, pet. denied). 926 Jordan v. Lyles, 455 S.W.3d 785, 792 (Tex. App.—Tyler 2015, no pet.). 927 Hubbard, 138 S.W.3d at 483. 928 700 S.W.2d 941, 948 (Tex. App.—Dallas 1985, writ ref’d n.r.e.). 929 Chien, 759 S.W.2d at 495. 930 Id. 931 See Johnson v. Peckham, 120 S.W.2d 786 (Tex. 1938). See also Johnson v. Buck, 540 S.W.2d 393, 399

(Tex. Civ. App.—Corpus Christi 1976, writ ref’d n.r.e.) (requiring “in good faith, for a fair consideration and on a full and complete disclosure of all information as to value” in the purchase of a partnership interest); Gum v. Schaefer, 683 S.W.2d 803, 805 (Tex. App.—Corpus Christi 1984, no writ) (“A sale by one partner to another of his interest in the partnership will be sustained only when it is made in good faith, for a fair consideration and on a full and complete disclosure of all important information regarding value.”) (emphasis in original).


Strained relations between the parties do not lessen the duty.932 While the fiduciary duties that partners owe each other are admittedly broader than the duties that the corporation owes each shareholder,933 there is no reasoned basis that the legal duties imposed on the corporation in the purchase of an ownership interest would be any different. In Miller v. Miller, the Dallas Court of Appeals cited Johnson v. Peckham as the “leading Texas case” on fiduciary duties in the context of the purchase of an ownership interest and applied the holding of that case to a purchase of minority shares.934

Furthermore, the burden of proving that the purchase of the minority shares was “made in good faith, for a fair consideration and on a full and complete disclosure of all information as to value” is squarely on the purchaser.935 “All transactions between the fiduciary and his principal are presumptively fraudulent and void, which is merely to say that the burden lies on the fiduciary to establish the validity of any particular transaction in which he is involved.”936 Although the purchasing corporation must prove that it acted in good faith to sustain the transaction, good faith itself does not satisfy the defendant’s burden of proof.937 The fiduciary must also show that the transaction was “fair, honest, and equitable.”938

3. Remedy

The defrauded shareholder may elect to rescind the sale.939 In Miller v. Miller, the court of appeals held that the existence of a fiduciary duty along with the defendant’s failure to prove that the transaction was fair to the minority shareholder entitled the plaintiff to rescission as a matter of law, and reversed the trial court’s judgment in favor of the defendant and rendered judgment for the plaintiff.940

Actual damages are recoverable for both actual fraud and constructive fraud.941 The

932 Johnson, 120 S.W.2d at 788 (“If the existence of strained relations should be suffered to work an exception,

then a designing fiduciary could easily bring about such relations to set the stage for a sharp bargain. There is no suggestion in this record that Peckham did that thing, but mischief would result more often from engrafting exceptions upon the general rule than from a strict adherence thereto.”).

933 See, e.g., Bohatch v. Butler & Binion, 977 S.W.2d 543, 545 (Tex. 1998) (partners owe duties of loyalty to the joint concern and duties of utmost good faith, fairness, and honesty in dealing with each other in all matters pertaining to the partnership).

934 700 S.W.2d 941, 946–47 (Tex. App.—Dallas 1985, writ ref’d n.r.e.). 935 Johnson, 120 S.W.2d at 787–88; Miller, 700 S.W.2d at 947. 936 Chien v. Chen, 759 S.W.2d 484, 495 (Tex. App.—Austin 1988, no writ) (emphasis in original). See also

Stephens Cty. Museum, Inc. v. Swenson, 517 S.W.2d 257, 260 (Tex. 1974); Archer v. Griffith, 390 S.W.2d 735, 740 (Tex. 1964); Estate of Townes v. Townes, 867 S.W.2d 414, 417 (Tex. App.—Houston [14th Dist.] 1993, writ denied). Unlike most presumptions, the presumption of unfairness shifts both the burden of producing evidence and the burden of persuasion to the defendant. See Sorrell v. Elsey, 748 S.W.2d 584, 585 (Tex. App—San Antonio 1988, writ denied); Moore v. Tex. Bank & Trust Co., 576 S.W.2d 691, 695 (Tex. App.—Eastland 1979), rev’d on other grounds, 595 S.W.2d 502 (Tex. 1980).

937 Miller, 700 S.W.2d at 947. Accord Archer, 390 S.W.2d at 740; Cartwright v. Minton, 318 S.W.2d 449, 452–53 (Tex. Civ. App.—Eastland 1958, writ ref’d n.r.e.) (quoting Murphy v. Cartwright, 202 F.2d 71, 73 (5th Cir.1953)).

938 Archer, 390 S.W.2d at 740. 939 Italian Cowboy Partners v. Prudential Ins., 341 S.W.3d 323, 344 (Tex. 2011). 940 700 S.W.2d at 952. 941 See Speed v. Eluma Intern., Inc., 757 S.W.2d 794, 798 (Tex. App.—Dallas 1988, writ denied).


plaintiff may recover his out-of-pocket damages—the difference between the value of what the defrauded party parted with and the value it actually received942—or benefit-of-the-bargain damages—the difference between the value as represented and the value as received.943 As most cases would involve the failure to disclose information indicating a higher value of the shares being sold or payment on unfairly low consideration, the out-of-pocket measure would be the usual theory of damages. A difficulty arises when the undisclosed information is an opportunity that does not materialize for a period of time. In Allen v. Devon Energy Holdings, L.L.C., the company redeemed the minority owner’s interest for an agreed price but failed to disclose recent technological advances that made the company potentially much more valuable. One and a half years after the redemption, the majority (now sole) owner sold the company for twenty times the valuation used in the redemption.944 The defendants argued on appeal that the plaintiff had no actual damages as a matter of law because the price eventually received for the stock could not constitute actual damages, as the amount was not knowable at the time of the fraudulent transaction and such an award would be based on speculation.945 The defendants relied on the Texas Supreme Court’s decision in Miga v. Jensen, in which the Court reversed an award of damages for breach of an option contract to sell shares based on the increased value of the shares at the time of trial: “But the rule in Texas has long been that contract damages are measured at the time of breach, and not by the bargained-for goods’ market gain as of the time of trial.”946 The court of appeals rejected this authority as inapplicable in a fraud case, noting that “[u]nlike a contract case, the law favors granting the benefit of the delay to the victim of the fraud.”947 Because Allen was an appeal of a summary judgment in favor of the defendants, the plaintiff had not yet made his damages record. The court of appeals conceded that there might very well be issues with speculative damages evidence, but concluded that the defendants had not established that there were no damages as a matter of law.948

Significantly, however, the Allen court held that, even if the full benefit received by the defendants as a result of the fraud could not be recovered as actual damages, that amount certainly could be recovered through the equitable remedy of disgorgement.949 Additionally,

942 Aquaplex, Inc. v. Rancho La Valencia, Inc., 297 S.W.3d 768, 775 (Tex. 2009). 943 Formosa Plastics Corp. U.S.A. v. Presidio Eng’rs & Contractors, Inc., 960 S.W.2d 41, 50 (Tex. 1998);

Baylor Univ. v. Sonnichsen, 221 S.W.3d 632, 636 (Tex. 2007). 944 367 S.W.3d 355, 367 (Tex. App.—Houston [1st Dist.] 2012, pet. granted). 945 Id. at 406. 946 96 S.W.3d 207, 214 (Tex. 2002). 947 367 S.W.3d at 409 n.77. The court relied on the holding in Janigan v. Taylor, 344 F.2d 781, 786 (1st Cir.

1965):

[I]f the property is not bought from, but sold to the fraudulent party, future accretions not foreseeable at the time of the transfer even on the true facts, and hence speculative, are subject to another factor, viz., that they accrued to the fraudulent party. It may, as in the case at bar, be entirely speculative whether, had plaintiffs not sold, the series of fortunate occurrences would have happened in the same way, and to their same profit. However, there can be no speculation but that the defendant actually made the profit and, once it is found that he acquired the property by fraud, that the profit was the proximate consequence of the fraud, whether foreseeable or not. It is more appropriate to give the defrauded party the benefit even of windfalls than to let the fraudulent party keep them.

948 367 S.W.3d at 409–10. 949 Id. at 406. See Robertson v. ADJ P’ship, Ltd., 204 S.W.3d 484, 494 (Tex. App.—Beaumont 2006, pet.

denied) (stating that “disgorgement of profits has long been recognized as an appropriate remedy for fraud”); see also


the equitable doctrines of unjust enrichment and quasi-contract “allow for recovery of damages to prevent a party from obtaining a benefit from another by fraud, duress, unjust enrichment, or because of an undue advantage.”950

C. Accounting

Among the various “squeeze-out” or “freeze-out” tactics that the Texas Supreme Court specifically noted that controlling shareholders commonly use “to deprive minority shareholders of benefits, to misappropriate those benefits for themselves, or to induce minority shareholders to relinquish their ownership for less than it is otherwise worth,” for which “Texas law should ensure that remedies exist to appropriately address such harm when the underlying actions are wrongful,” is the denial of access to corporate books and records.951

A common complaint of those alleging shareholder oppression is the denial of access to the corporation’s books and records. Our Legislature has expressly protected a corporate shareholder’s right to examine corporate records, provided penalties for a violation of those rights, and identified applicable defenses in an action to enforce those rights. . . . These statutory rights and remedies adequately protect a minority shareholder’s access to corporate records.952

Yet the statutory right of inspection is only a part of the duties imposed on the corporation relating to corporate information. The inspection statute only gives the shareholder the right to inspect existing records. It places no duties to create and report information or to create and maintain accurate and meaningful records accounting for its management of the shareholders’ property.

The Business Organizations Code requires that “[e]ach filing entity shall keep: (1) books and records of accounts.”953 These records are to be made available to shareholders954 and directors,955 and the corporation must provide annual statements for the last fiscal year “that contain in reasonable detail the corporation’s assets and liabilities and the results of the

ERI Consulting Eng’rs, Inc. v. Swinnea, 318 S.W.3d 867, 874 (Tex. 2010) (noting that disgorgement and fee forfeiture are equitable remedies intended to prevent abuses of trust, “regardless of proof of actual damages”); Bonanza Rests. v. Uncle Pete’s, Inc., 757 S.W.2d 445, 448 (Tex. App.—Dallas 1988, writ denied) (holding that jury’s answer of $0 in damages caused by fraud did not preclude claimant from recovering rescission of franchise agreement induced by defendant’s fraud); Burrow v. Arce, 997 S.W.2d 229, 237–45 (Tex. 1999) (holding that trial court erred in granting summary judgment against breach of fiduciary duty claimants on ground that there were no actual damages).

950 Hubbard v. Shankle, 138 S.W.3d 474, 487 (Tex. App.—Fort Worth 2004, pet. denied). See Fortune Prod. Co., v. Conoco, Inc., 52 S.W.3d 671, 684 (Tex. 2000); see also Heldenfels Bros., Inc. v. City of Corpus Christi, 832 S.W.2d 39, 41 (Tex. 1992).

951 Ritchie v. Rupe, 443 S.W.3d 856, 879 (Tex. 2014). 952 Id. at 882 (citing TEX. BUS. ORGS. CODE ANN. § 21.218 (West 2006) (examination of records); id. § 21.219

(annual and interim statements of corporation); id. § 21.220 (penalty for failure to prepare voting list); id. § 21.222 (penalty for refusal to permit examination); id. § 21.354 (inspection of voting list); id. § 21.372 (shareholder meeting list)).

953 BUS. ORGS. § 3.151. 954 Id. §§ 3.153, 21.218. 955 Id. § 3.152.


corporation’s operations” to a shareholder upon written request.956 Unlike the duty to allow shareholder inspection, there is no statutory remedy for the failure to keep records and no express requirement to keep complete and accurate records. While not addressed specifically by the Code or in any Texas case, logic would dictate that the duty to keep records of account and provide them to owners and directors necessarily implies a duty to maintain financial records that are accurate, complete, and meaningful.957 How else would the corporation be able to comply with its statutory duty to provide annual statements that contain in reasonable detail the corporation’s assets and liabilities and the results of the corporation’s operations?958 Although logically implied by the corporation’s statutory obligation, these duties are expressly imposed by trust law. A fundamental duty of a trustee is to “maintain a complete and accurate accounting of the administration of the trust.”959 One Texas court has noted that the president and general manager of a corporation, “in control of the business and books of the corporation,” acts as a “trustee for the corporation and for the other stockholders.”960 Courts in other jurisdictions have held that the accounting duties of a trustee, by analogy, impose a duty on corporate officers and directors to account for corporate finances.961 The Texas Supreme Court in Yeaman, expressly recognized the shareholder’s right to the remedy of an accounting based on the corporation’s trust duties.962

956 Id. § 21.219. 957 See Dunn v. Acme Auto & Garage Co., 169 N.W. 297, 301 (Wis. 1918) (“The statutory right of the

stockholder to examine the books of the corporation imposes upon the corporation not only the duty of keeping such books open for inspection at all reasonable times, but also the duty of keeping its stock subscriptions and accounts in such form that they may be examined and the condition of the corporate affairs ascertained therefrom; otherwise the right of inspection is a barren legal right and of no value.”).

958 See Saks v. Gamble, 154 A.2d 767, 769 (Del. Ch. 1958) (noting the “duty required of the corporate officers to keep complete and accurate books of account”); Griffin v. Cambridge Const. Co., 236 So.2d 539, 541 (La. Ct. App. 1970) (duty of “proper bookkeeping”); Dunn, 169 N.W. at 301 (“Those who claim the right and authority to manage and control the money and property of others ought to show themselves competent to keep an honest and fairly accurate account of their transactions.”); 5A FLETCHER CYC. CORP. § 2187 (“Most jurisdictions impose an obligation on the corporation to keep correct and complete books and records.”).

959 Faulkner v. Bost, 137 S.W.3d 254, 259 (Tex. App.—Tyler 2004, no pet.). See also Beaty v. Bales, 677 S.W.2d 750, 754 (Tex. App.—San Antonio 1984, writ ref’d n.r.e.) (“The trustee is required to keep full, accurate, and orderly records concerning the status of the trust estate and of all acts performed thereunder.”); Corpus Christi Bank & Trust v. Roberts, 587 S.W.2d 173, 181 (Tex. Civ. App.—Corpus Christi 1979) aff’d, 597 S.W.2d 752 (Tex. 1980) (“One of the primary duties of a trustee is to keep full, accurate and orderly records concerning the status of the trust estate and of all acts performed thereunder.”).

960 Conrads v. Kasch, 26 S.W.2d 732, 735 (Tex. Civ. App.—Austin) writ denied, 31 S.W.2d 630 (Tex. 1930). 961 See, e.g., Smith v. Moore, 199 F. 689, 697 (9th Cir. 1912) (Corporate president’s “position was that of

trustee, and it was incumbent upon him to see that proper books of account were kept.”); Grand Amusement Co. v. Palladium Amusement Co., 287 S.W. 438, 441 (Mo. 1926) (“It is unquestionably true that the officers and directors of a corporation are, in a sense, trustees, and that, as such, it is their duty to keep correct accounts and to be able to make a full and correct showing of the corporation’s receipts and expenditures.”); Lancaster v. Johnson, 167 So. 435, 437 (La. 1936) (Corporate officer has a “duty to keep and preserve” an “honest and accurate account of his transactions.”); Trieweiler v. Sears, 689 N.W.2d 807, 840 (Neb. 2004) (Corporate officer “in control of the books . . . in the position of a trustee and must make a proper accounting.”); Anderson v. Clemens Mobile Homes, Inc., 333 N.W.2d 900, 904 (Neb. 1983) (same).

962 Yeaman v. Galveston City Co., 167 S.W. 710, 724 (Tex. 1914) (“plaintiffs are entitled to an accounting from the corporation”). See also Trieweiler v. Sears, 689 N.W.2d 807, 840 (Neb. 2004) (“Although the burden of proof is ordinarily upon the party seeking an accounting to sustain the accounting, when another person is in control of the books and has managed the business, that other person is in the position of a trustee and must make a proper


“A suit for an accounting is generally founded in equity.”963 “The granting of an accounting is within the discretion of the trial court.”964 To be entitled to an accounting, the plaintiff must show a fiduciary relationship with the defendant965 and the need for the procedure—typically that the failure to keep accurate and complete records will render the task of uncovering the defendant’s wrongdoing so complex that adequate relief cannot be obtained at law.966 However, the remedy of an accounting may require the creation of accurate financial records where none exists, not merely grant the plaintiff access to existing records. If the minority shareholder can obtain the needed information through a statutory inspection demand or through ordinary discovery in a lawsuit, then the court will not order an accounting.967

The accounting remedy will be useful to minority shareholders in cases where the corporation has either failed to keep adequate accounting records or where the books have been “juggled”968 to hide theft. In situations where the controlling shareholder, through his control of the books, has prepared to defend his gross misappropriation of funds and disproportionate distributions by making the misconduct difficult to prove, an accounting remedy might be particularly helpful as a step preceding a derivative suit for damages. An order requiring the corporation and the controlling shareholder to prepare and present accurate financial records, properly accounting for all corporate receipts, expenditures, assets, and liabilities can shift some of the enormous burden of unscrambling the financial eggs onto the corporation and majority shareholder, rather than on the plaintiff minority shareholder. An accounting is a flexible remedy that may apply in a variety of scenarios.969 Also useful is the trial court’s ability to appoint an independent auditor to oversee or to perform the accounting.970 The audit procedure provides the court the power to appoint an auditor “[w]hen an investigation of accounts . . . appears necessary for the purpose of justice between the parties to any suit,” and requires the auditor to prepare a report, verified by affidavit “that he has carefully examined the state of the account between the parties, and that his report contains

accounting. Here, the evidence establishes that Campagna had control of the books of the corporation and managed the business and that Sears had a duty to examine Campagna’s conduct; it was the appellants’ burden to account for the corporation’s revenues and the disposition of its assets.”).

963 Palmetto Lumber Co. v. Gibbs, 80 S.W.2d 742, 748 (Tex. 1935); Garcia v. Garza, 311 S.W.3d 28, 40 (Tex. App.—San Antonio 2010, pet. denied); Sw. Livestock & Trucking Co. v. Dooley, 884 S.W.2d 805, 809 (Tex. App.—San Antonio 1994, writ denied).

964 Sw. Livestock, 884 S.W.2d at 809; Gifford v. Gabbard, 305 S.W.2d 668, 672 (Tex. Civ. App.—El Paso 1957, no writ).

965 See T.F.W. Mgmt., Inc. v. Westwood Shores Prop. Owners Ass’n, 79 S.W.3d 712, 717 (Tex. App.—Houston [14th Dist.] 2002, pet. denied); Hunt Oil Co. v. Moore, 656 S.W.2d 634, 642 (Tex. App.—Tyler 1984 writ ref’d n.r.e.); Hedley v. duPont, 580 S.W.2d 662, 666 (Tex. Civ. App.—Houston [14th Dist.] 1979, writ ref’d n.r.e.); O’Connor v. O’Connor, 320 S.W.2d 384 (Tex. Civ. App.—Dallas 1959, writ dism’d).

966 Richardson v. First Nat’l Life Ins. Co., 419 S.W.2d 836, 838 (Tex. 1967); Michael v. Dyke, 41 S.W.3d 746, 754 (Tex. App.—Corpus Christi 2001, no pet.); Hutchings v. Chevron U.S.A., Inc., 862 S.W.2d 752, 762 (Tex. App.—El Paso 1993, writ denied); T.F.W. Mgmt., Inc. v. Westwood Shores Prop. Owners Assoc., 79 S.W.3d 712, 717 (Tex. App.—Houston [14th Dist.] 2002, pet. denied).

967 T.F.W. Mgmt., Inc., 79 S.W.3d at 717–18 (“When a party can obtain adequate relief at law through the use of standard discovery procedures, such as requests for production and interrogatories, a trial court does not err in not ordering an accounting.”).

968 Patton v. Nicholas, 279 S.W.2d 848, 853 (Tex. 1955). 969 See, e.g., Gifford, 305 S.W.2d at 672; Sw. Livestock, 884 S.W.2d at 810. 970 TEX. R. CIV. P. 172 (West 1988).


a true statement thereof, so far as the same has come within his knowledge.”971 The parties are given a 30-day deadline to file exceptions to the report, and “the court shall award reasonable compensation to such auditor to be taxed as costs of suit.”972

The duty to account is a duty that the corporation, as trustee, owes to each shareholder and should be available as an individual remedy against the corporation, as was the case in Yeaman. However, similar to Ritchie’s treatment of the Patton claim for suppression of dividends, there may be policy reasons for requiring the claim be brought in a derivative action, because the benefit would be conferred on all shareholders equally and the responsibility for complying with the order to perform the accounting will fall on the corporation’s management.

D. Dividend Actions

Among the various “squeeze-out” or “freeze-out” tactics that the Texas Supreme Court specifically noted in Ritchie for which “Texas law should ensure that remedies exist to appropriately address such harm when the underlying actions are wrongful,” is withholding payment of, or declining to declare, dividends.973 The Supreme Court recognized that a common complaint by those alleging shareholder oppression relates to the corporation’s declaration of dividends, including the failure to declare dividends or the failure to declare higher dividends.974

The right to dividends is clearly a legal right that the individual shareholder has as against the corporation. The Texas Supreme Court pointed out in Ritchie that “that shareholders already have a right to receive payment of a declared dividend in accordance with the terms of the shares and the corporation’s certificate of formation, and they can enforce that right as a debt against the corporation.”975 The corporation’s fiduciary duties as trustee also encompass the shareholder’s right to dividends. As the Supreme Court held in Yeaman, the corporation, as trustee, has a fiduciary duty to preserve both the shareholder’s stock and “its fruits.”976 “Though considered a debt, as a shareholder’s dividends are payable by the corporation only on demand, its holding of them until the demand is in the nature of a trustee relation.”977

1. Suppression of Dividends Claim

“Texas law does not require a corporation to issue dividends. It is within the discretion of the board of directors whether a dividend will issue.”978 Courts tend to show extreme

971 Id. 972 Id. 973 Ritchie v. Rupe, 443 S.W.3d 856, 879 (Tex. 2014). 974 Id. at 882. 975 Id. at 882–83. See also Keller v. Keller, 141 S.W.2d 308, 311 (Tex. 1940) (“When dividends are declared,

the corporation becomes indebted to the stockholders for the amounts of their respective shares.”); Cavitt v. Amsler, 242 S.W. 246, 247 (Tex. Civ. App.—Austin 1922, writ dism’d w.o.j.) (“[W]hen a dividend is declared, it becomes a debt owing by the corporation to the stockholders”).

976 Yeaman v. Galveston City Co., 167 S.W. 710, 723 (Tex. 1914). 977 Id. at 724. 978 ARGO Data Res. Corp. v. Shagrithaya, 380 S.W.3d 249, 270 (Tex. App.—Dallas 2012, pet. denied). See


deference as to the decision to declare dividends or to retain earnings.979 Nevertheless, Texas law has long held that the “chief value of corporate stock is its right to receive dividends. So important is this right that courts of equity will, in a proper case, compel a payment of dividends.”980 The right of a shareholder to enforce the payment of dividends “does not arise from any actual contract between the corporation and its stockholders, but rather from the nature of the organization, and the relation of the stockholders to the corporation and its property.”981 That relation between stockholder and corporation is that of trustee to beneficiary.982 Therefore, the common law cause of action for suppression of dividends recognized and developed in Patton and Morrison was for “breach of trust.”983

Neither Patton nor Morrison state the elements for a breach of trust claim. Both characterize the wrong-doing as “malicious suppression of dividends.”984 In Patton, the key fact seems to have been the majority shareholder’s wrongful intent to withhold dividends for the express purpose of harming the minority and perhaps acquiring their shares for an unfairly low price.985 Morrison involved the manipulation of the corporation’s finances to reduce earnings available for distribution, as well as unfairly low distributions, but both with the wrongful intent of harming the minority.986 Such an intent would breach the corporation’s duties as trustee to the shareholders of acting impartially and of “not attempting to impair [their] interest.”987

(a) Stockpiling Cash

The fact situation giving rise to a claim as contemplated by Ritchie would be the

TEX. BUS. ORGS. CODE ANN. § 21.302 (West 2012). See also Ritchie, 443 S.W.3d at 883 (citing BUS. ORGS. §§ 21.302–.303; 21.310–.313).

979 See Cleaver v. Cleaver, 935 S.W.2d 491, 495 (Tex. App.—Tyler 1996, no writ) (“It is established that corporate management may invest company earnings in corporate assets rather than distributing those earnings to shareholders.”); Fain v. Fain, 93 S.W.2d 1226, 1228–29 (Tex. Civ. App.—Fort Worth 1936, writ dism’d) (“It is a settled rule that the legal title to stock in a corporation is not affected by the acquisition of additional assets by the corporation, and that, in the absence of fraud, the directors of a corporation may, in their discretion, invest its earnings in such assets instead of distributing them to the shareholders. Also that enhanced value of the assets inure to the shareholders.”); Bryan v. Sturgis Nat’l Bank, 90 S.W. 704, 705 (Tex. Civ. App. 1905, writ ref’d) (“It is also well settled that the declaration of dividends rests in the discretion of the directors or other governing body of the corporation, and that such discretion will not, in the absence of fraud, be controlled by the courts.”). See also Lich v. U.S. Rubber Co., 39 F. Supp. 675, 683 (D.N.J.), aff’d, 123 F.2d 145 (3d Cir. 1941) (“The directors are charged with the management of the corporate business, and, in the absence of fraud or bad faith, their authority must be regarded as absolute. Questions of management and policy must be left to their honest judgment and discretion.”).

980 Moroney v. Moroney, 286 S.W. 167, 169 (Tex. Comm’n App. 1926, judgm’t affirmed). 981 Id. 982 Yeaman, 167 S.W. at 724 (“There can be no substantial difference between the trusteeship of a corporation

as it relates to the stock of a shareholder and its duty to him in respect to the profits or dividends upon his stock.”). 983 Patton v. Nicholas, 279 S.W.2d 848, 854 (Tex. 1955). See Morrison v. St. Anthony Hotel, 295 S.W.2d 246,

252 (Tex. Civ. App.—San Antonio 1956, writ ref’d n.r.e.). 984 Morrison, 295 S.W.2d at 252. 985 Patton, 279 S.W.2d at 854. 986 Morrison, 295 S.W.2d at 252. 987 Yeaman, 167 S.W. at 723.


accumulation of retained earnings without declaration of dividends, or “stockpiling” cash.988 When the cash is in the company and available for distribution, minority shareholders would have three legal theories to compel a distribution. First, would be an action for a mandatory injunction compelling a distribution as was provided in Patton. The Ritchie Court seems to have accepted the cause of action articulated by Patton but redefined it as a derivative action.989 Although we have argued that Ritchie misconstrues the procedural posture of Patton, requiring the claim to be pursued derivatively in the fact situation presented in Patton makes practical sense. When the money is just sitting in the company, the suppression decision affects all shareholders the same, as does the benefit of the injunctive relief to pay out the stockpiled funds. Some other jurisdictions have taken the same approach.990 In order to obtain relief from stockpiling, the plaintiff would have to overcome the business judgment rule by showing that the decision to stockpile cash rather than declare dividends was made for an “improper purpose.”991 The Patton Court indicated that the plaintiff was required to prove a “malicious purpose.”992 The Ritchie opinion seems to have considerably lowered the plaintiff’s burden of proof, requiring proof only that the directors made their dividend decision without dedicating their “uncorrupted business judgment for the sole benefit of the corporation.”993 Proof that the purpose of the dividend decision was to personally benefit the controlling shareholder would certainly satisfy the plaintiff’s burden.994 However, even non-self-interested purposes that did not solely benefit the corporation would also seem to satisfy the burden as described in Ritchie. In fact, a plaintiff might be able to satisfy his burden by proof merely of non-feasance—that the board wasn’t doing its job, was refusing to make a decision that it was charged with making. Ritchie’s repeated description of the board’s duty certainly implies an affirmative duty to exercise business judgment for the benefit of the corporation.995 Many courts have held that the business judgment rule does not shield the failure to make decisions, when that failure involves an abdication of the director’s duties.996

988 See ARGO Data Res. Corp. v. Shagrithaya, 380 S.W.3d 249, 268 (Tex. App.—Dallas 2012, pet. denied). 989 See Ritchie v. Rupe, 443 S.W.3d 856, 883 (Tex. 2014). 990 See, e.g., Powell v. Bernstein, 262 A.D.2d 221, 222 (N.Y. App. Div. 1999) (“Plaintiffs’ claims to compel

the declaration of a dividend and restitution of allegedly excessive salaries are derivative nature.”). 991 Ritchie, 443 S.W.3d at 884 (“when a corporate director violates the duty to act solely for the benefit of the

corporation and refuses to declare dividends for some other, improper purpose, the director breaches fiduciary duties to the corporation, and the minority shareholders are entitled to relief, either directly to the corporation or through a derivative action”).

992 Patton v. Nicholas, 279 S.W.2d 848, 853 (Tex. 1955) (“malicious purpose of, and with the actual result of, preventing dividends”).

993 Ritchie, 443 S.W.3d at 883 (quoting Int’l Bankers Life Ins. Co. v. Holloway, 368 S.W.2d 567, 576–77 (Tex. 1963)).

994 Id. at 884 n.51 (“Patton is thus contrary to the dissent’s assertion that majority shareholders can simply refuse to declare dividends for their own personal benefit rather than in the best interest of the corporation.”).

995 Id. at 876 n.27 (“This Court has recognized a fiduciary duty owed by corporate officers and directors to the corporation [that] requires them to exercise their “uncorrupted business judgment for the sole benefit of the corporation,” quoting Holloway, 368 S.W.2d at 576–77 (Tex.1963) (emphasis added)).

996 See Resol. Trust Corp. v. Norris, 830 F. Supp. 351, 357 (S.D. Tex. 1993) (“The business judgment rule does not protect defendants who “abdicated their responsibilities as directors”). See also F.D.I.C. v. Benson, 867 F. Supp. 512 (S.D. Tex. 1994) (to avoid protective shield of Texas business judgment rule, plaintiff must show that acts of directors and officers were ultra vires or tainted by fraud, or a complete abdication of duty); RTC v. Acton, 844 F. Supp. 307 (N.D. Tex. 1994) (in general, Texas business judgment rule restricts liability of officers and directors for liability for acts of gross negligence, which may include complete abdication of their responsibilities); F.D.I.C. v.


A second alternative legal theory would be available where the stockpile of cash has been segregated, perhaps in a special investment fund separate from the corporation’s other working capital. In that case, a minority shareholder could claim that there had been a constructive declaration and demand payment. Texas courts have held that

it is not essential to the right to receive a dividend that there should have been a formal declaration of a dividend, but where the corporation sets apart a fund for distribution to its stockholders to such extent as to become segregated from the property of the corporation, such property henceforth becomes, equitably, the stockholders’ property. . . . In other words, where there has been such a segregation of the corporate funds, and such a dedication to the stockholders, the assets thus segregated cease to belong to the corporation, but do belong to the stockholders individually.997

The minority shareholder’s claim would be an individual claim against the corporation for the payment of debt. 998

Finally, individual minority shareholders would have a breach of trust claim as described above to recover unpaid dividends as damages.999 However, that remedy would be available only where the minority shareholder had no other adequate remedy, such as through a derivative action, which was the situation in Morrison.

(b) Manipulation

A more difficult situation arises when dividends are suppressed, not because the cash is being stockpiled, but because the corporation’s finances are being manipulated to eliminate the cash. That was the situation in Morrison. Where the money that would otherwise be available for distribution to the shareholders is being siphoned off to the majority through excessive salaries and bonuses, personal expenses, misappropriation, and other self-dealing transactions, then the manipulation constitutes a breach of fiduciary duties to the corporation,1000 and

Brown, 812 F. Supp. 722 (S.D. Tex. 1992) (Texas business judgment rule does not bar claims for gross negligence against disinterested corporate directors; Texas business judgment rule does not protect director if director abdicated his responsibility and failed to exercise any judgment, rule necessarily presumes that directors exercise their judgment); Rabkin v. Philip A. Hunt Chemical Corp., No. 164,1990, 1987 WL 28436 (Del. Ch. Dec. 17, 1987) (directors who “abdicate their managerial responsibilities” are not entitled to the business judgment rule’s protection from liability.).

997 Moroney v. Moroney, 286 S.W. 167, 169–70 (Tex. Comm’n App. 1926, judgm’t affirmed). 998 Ritchie, 443 S.W.3d at 882–83; Keller v. Keller, 141 S.W.2d 308, 311 (Tex. 1940); Cavitt v. Amsler, 242

S.W. 246, 247 (Tex. Civ. App.—Austin 1922, writ dism’d w.o.j.). 999 Morrison v. St. Anthony Hotel, 295 S.W.2d 246, 252 (Tex. Civ. App.—San Antonio 1956, writ ref’d n.r.e.). 1000 Ritchie, 443 S.W.3d at 887 (“the duty of loyalty that officers and directors owe to the corporation

specifically prohibits them from misapplying corporate assets for their personal gain or wrongfully diverting corporate opportunities to themselves”); Holloway, 368 S.W.2d at 576 (“A corporate fiduciary is under obligation not to usurp corporate opportunities for personal gain, and equity will hold him accountable to the corporation for his profits if he does so.”); Dunagan v. Bushey, 263 S.W.2d 148, 152 (Tex. 1953) (“The directors of a corporation stand in a fiduciary relationship to the corporation and its stockholders, and they are without authority to act as such in a matter in which a director’s interest is adverse to that of the corporation. The directors are not permitted to appropriate the property of


minority shareholders have the remedy of a derivative claim to recover the stolen funds.1001 In a closely-held corporation, the court has the power to treat such a derivative claim as a direct claim and award the minority shareholder his proportional share of the misappropriated funds directly,1002 which would place the plaintiff in the same position as he would have been in had the dividends been declared. In situations like Morrison, where the derivative claim remedy is not available, a shareholder should be able to bring an individual breach of trust claim for damages based on the corporation’s violation of its duty of impartiality and the impairment of the minority shareholder’s right to proportionately share in profits. If the misappropriations are part of a much larger scheme to effectively eliminate the minority shareholder’s ownership interest, such that damages for the misappropriation would not make the plaintiff whole, then the minority shareholder should have a breach of trust claim for a buy-out.

(c) Re-examining ARGO Data Res. Corp. v. Shagrithaya

At the time the Supreme Court decided Ritchie, two other cases out of the Dallas Court of Appeals were also pending review in the Supreme Court: Cardiac Perfusion Services, Inc. v. Hughes,1003 where the minority shareholder prevailed in the court of appeals and which the Supreme Court reversed and remanded with a per curiam opinion,1004 and ARGO Data Res. Corp. v. Shagrithaya,1005 where the minority shareholder lost in the court of appeals and which the Supreme Court denied the petition for review after the case was fully briefed. ARGO was a case tried under the shareholder oppression doctrine in which the central issue concerned suppression of dividends. The case was tried to a jury, which found in favor of the minority shareholder, and the trial court rendered judgment in favor of the plaintiff, including an injunction to pay out an $85 million dividend.1006 It is a pity that the Supreme Court disposed of ARGO as it did, because the reasoning of the court of appeals was clearly inconsistent with the holdings in Ritchie, and while the court of appeals’ reversal was no doubt correct in light of Ritchie, the court of appeals’ opinion plainly demonstrates that the record would have supported claims that the Ritchie opinion indicated were valid and would likely have been successful in a new trial based on the correct legal theories.

Max Martin and Balkrishna Shagrithaya met and became friends while working at Electronic Data Systems in Wisconsin. In 1980, Martin approached Shagrithaya about starting a software business together. Shagrithaya agreed to join the venture, and the men co-founded ARGO Data Resource Corporation, a business providing software and related services to the retail financial services industry.1007 Shagrithaya developed the technology, and Martin ran the business side. Martin received 53% of the stock, and Shagrithaya 47%; both were directors and had an equal vote, but agreed that Martin had the power to appoint a third director in the event

the corporation to their benefit, nor should they permit others to do so.”). 1001 Ritchie, 443 S.W.3d at 887 (“Like most of the actions we have already discussed, these types of actions

may be redressed through a derivative action, or through a direct action brought by the corporation, for breach of fiduciary duty.”).

1002 TEX. BUS. ORGS. CODE ANN. § 21.563 (c) (West 2013). 1003 380 S.W.3d 198 (Tex. App.—Dallas 2012), aff’d in part, rev’d in part, 436 S.W.3d 790 (Tex. 2014). 1004 Cardiac Perfusion Services, Inc., 436 S.W.3d 790. 1005 380 S.W.3d 249 (Tex. App.—Dallas 2012, pet. denied). 1006 Id. at 257. 1007 Id. at 257–58.


of a deadlock.1008 Both agreed to retain earnings while building the company, and no dividends were paid for more than twenty years.1009 The company’s capital grew from “$1000 in 1980 to $152 million in 2008.”1010 During this time, both men paid themselves equal salaries each year, which increased and topped out at $1 million each.1011

The relationship between the parties became strained, beginning in the early 2000s.1012 In 2005, the IRS audited ARGO and imposed a penalty for excessive retained earnings. ARGO filed an ultimately successful protest to the penalty claiming that it was not accumulating “earnings and profits beyond the reasonable needs of its business.”1013 Among the business needs for working capital specified in the protest, was that the anticipated redemption of Shagrithaya’s shares, which was anticipated in 2005. Additionally, the letter stated that

‘[ARGO’s] “executive management had concluded prior to June 30, 2005, that Mr. Shagrithaya’s minority stock position would likely have to be redeemed to protect the stability of [ARGO’s] business and to avoid impending management and shareholder conflicts that [ARGO’s] executive management believed were almost certain to occur.’1014

The letter further stated that, “[t]he implementation of the phase-out of Mr. Shagrithaya began in earnest in 2003 with a restructuring of [ARGO’s] operational structure.”1015 At the time of the protest letter, Martin and Shagrithaya had not yet discussed a buy-out, and Shagrithaya was completely unaware of the on-going “phase-out” of his ownership, including the need to stockpile cash to pay for it. Neither the tax penalty, nor the protest, nor the contents of the protest letter were disclosed to Shagrithaya.1016

In 2006, Martin unilaterally cut Shagrithaya’s salary from $1 million to $300,000, while keeping his own $1 million salary unchanged.1017 Thereafter, the two shareholders held discussions, off and on, over the next two years, regarding payment of dividends (which Shagrithaya now advocated), salary, having the company appraised, and buying out Shagrithaya’s interest.1018 Martin and Shagrithaya never came to an agreement on any of the matters, particularly the price to be paid for Shagrithaya’s shares. Ultimately, as negotiations went nowhere, Shagrithaya lost interest in a buy-out and began to push for a sizable dividend of $85 million from the company’s $152 million stockpile of cash.1019 Martin and the third

1008 Id. at 258. 1009 Id. 1010 Id. 1011 Id. 1012 Id. at 259. 1013 Id. at 260. 1014 Id. 1015 Id. 1016 Id. 1017 Id. at 259. 1018 Id. at 259–61. 1019 Id. at 262.


board member he had appointed ultimately approved a $25 million dividend.1020

The case was tried to a jury on theories of shareholder oppression, malicious suppression of dividends, fraud, and various derivative claims; the jury found for the plaintiff on every issue submitted.1021 The trial court entered a judgment for the plaintiff and awarded damages and attorney’s fees on a number of theories, but most significantly ordered an immediate dividend in the amount of $85 million—$20 million more than the jury had found should be issued.1022 The Dallas Court of Appeals reversed and rendered on all theories.1023 While several issues are raised by the court of appeals’ decision, of central interest to this discussion is its treatment of the dividend award and the factual findings supporting it.

The plaintiff had made the claim for dividends based on shareholder oppression and malicious suppression of dividends as separate causes of action, and had received findings in support of both. The court of appeals held that malicious suppression of dividends was not a separate cause of action, but was merely one form of shareholder oppression, and the court therefore reviewed the dividends claim findings solely in terms of the two definitions of shareholder oppression,1024 and without regard to the corporation’s fiduciary duties or the Patton and Morrison decisions.1025 In light of Supreme Court’s opinion in Ritchie v. Rupe, the ARGO court got that point exactly backwards. It is the shareholder oppression claim that does not exist, while the claim recognized in Patton remains the law.

The jury found that Martin engaged in a plan “to retain ARGO’s earnings to buy out Shagrithaya’s interest in ARGO without disclosing this plan to Shagrithaya,” and that Martin caused ARGO to “retain earnings rather than paying a greater amount of dividends to its shareholders than it actually paid.” 1026 The court of appeals held that there was sufficient evidence to support these findings and that the evidence and jury findings were consistent with the plaintiff’s theory that “beginning at latest in 2003 and possibly as early as 2001, Martin began retaining ARGO’s earnings for the purpose of buying out Shagrithaya’s shares without telling him.”1027 The jury also found that Martin

dominat[ed] and controll[ed] the Board of Directors of ARGO with the actual result of suppressing the issuance of dividends to Shagrithaya . . . for the purpose of preventing Shagrithaya from sharing in the profits to be derived from the operation of ARGO . . . [and] depreciating the value of the shares of stock in ARGO owned by

1020 Id. at 263. 1021 Id. 1022 Id. at 264. 1023 Id. at 276. 1024 Id. at 268 (“We first note that, although Shagrithaya asserted ‘malicious suppression of dividends’ as a

separate cause of action, this claim is merely a form of minority shareholder oppression and must be analyzed as such.”).

1025 The court of appeals did acknowledge the plaintiff’s reliance on Patton v. Nicholas, but held that the legal basis for that decision had been altered by the passage of the oppression provisions of the receivership statute and that cases like Davis v Sheerin subsequently made clear that the statutory shareholder oppression claim had subsumed the common-law malicious suppression of dividends claim. See id. at 268 n.5.

1026 Id. at 268. 1027 Id. at 269.


Shagrithaya to a lower value than his shares of stock would otherwise have.1028

The court of appeals rejected those findings.

The court of appeals’ reasoning was based on three propositions, none of which had anything to do with the adequacy of the evidence, and each of which was inconsistent with the Supreme Court’s reasoning in Ritchie: First, the court of appeals stated that, “to the extent dividends were ‘suppressed’ from being paid to Shagrithaya, they were also suppressed from being paid to Martin.”1029 This is a true, but utterly immaterial observation. In Patton v. Nicholas, exactly the same factual situation existed and yet the Supreme Court held that the plaintiffs were entitled to relief, and the Supreme Court in Ritchie reaffirmed as correct the holding in Patton. The implied conclusion of the court of appeals is that, so long as the money is still in the company, the minority shareholder has not been harmed, or at least the majority and minority share the same proportional benefits and disadvantages of that situation. That conclusion defies common sense. When the money is left in the company, both the minority and majority may retain their proportional equitable interests in the money in an abstract sense, but the majority shareholder has control and the ability to access the funds whenever he wants. The minority shareholder does not. The suppression of Shagrithaya’s dividends was involuntary; the suppression of Martin’s dividends was completely voluntary, subject to his control, and within his ability to manipulate for his own benefit. The court of appeals’ reasoning would hold that there is no difference in value of $1 million in a trust fund that could not be accessed for 25 years and $1 million in a checking account. The difference to the trust beneficiary vs. the checking account holder is immense. That difference is exacerbated when the minority shareholder has an immediate need for the funds and the majority shareholder does not, or when the minority shareholder is not deriving other economic benefits from the company that the majority shareholder enjoys, such less than one-third the salary (ARGO) or no salary at all (Patton).

Second, the court of appeals stated that “Shagrithaya was not entirely prevented from ‘sharing in the profits’ of ARGO, because he had proportionally participated in three dividend payments over a four-year period totaling $25 million.1030 Again, so what? The jury found that $65 million in dividends had been wrongfully withheld. The fact that $25 million had not been wrongfully withheld is immaterial. Moreover, a shareholder’s right is to a “proportionate share in profits.” The observation that the plaintiff was not “entirely” prevented from sharing in profits is irrelevant. Finally, the court of appeals stated: “Even assuming that the evidence supported the finding as to Martin’s motivation [to depreciate the value of Shagrithaya’s stock], there is no evidence to support a finding that Martin’s actions resulted in lowering the value of Shagrithaya’s stock.”1031 Exactly the same thing was true in Patton. In both Patton and ARGO, the courts noted that, because the companies were making money and because those profits were kept in the company, the value of the stock necessarily increased, not decreased.1032 The court of appeal’s observation is wrong on its face, first because it ignores

1028 Id. 1029 Id. 1030 Id. 1031 Id. 1032 Id. (“The evidence shows that the value of the company and Shagrithaya’s shares continued to grow

throughout the time period that Shagrithaya claims Martin was suppressing dividends. Shagrithaya directs us to no


the fact that the value of the stock to Shagrithaya may be diminished even though the value of the company as a whole is not. If the minority shareholder gets no economic benefit from stock ownership because no dividends are paid, particularly if the company is a subchapter S corporation so that the profits create tax liability to the minority owner or if the minority owner needs the money, then the value to that minority owner of his stock is vastly diminished by the intentional withholding of dividends. Every shareholder oppression scenario involves an effort by the majority to diminish the value of the stock to the minority by eliminating or impairing the benefits of ownership. As Patton clearly recognized, that is possible even though the cash stays in the company and the majority does not receive any disproportionate benefits from that cash. More importantly, the holding in Patton was that the suppression of dividends was wrongful based on the malicious intent, not on the success of diminishing the value of the shares. As the Ritchie court stated,

when a corporate director violates the duty to act solely for the benefit of the corporation and refuses to declare dividends for some other, improper purpose, the director breaches fiduciary duties to the corporation, and the minority shareholders are entitled to relief, either directly to the corporation or through a derivative action.1033

Therefore, it is Martin’s improper purpose, found by the jury, not the actual effect of his conduct, that establishes a valid cause of action.

The ARGO court concluded “that the evidence supports the jury’s findings that Martin caused ARGO to retain earnings rather than pay a greater amount of dividends” and that the “evidence also supports the jury’s finding that Martin retained earnings for the purpose of buying out Shagrithaya’s shares without making Shagrithaya aware of this purpose,” but that the evidence was legally insufficient to support a “finding that Shagrithaya was individually targeted for the purpose of preventing him from sharing in the profits of the company or that the value of his shares was depreciated by Martin’s actions.”1034 Again, the court’s reasoning is non-sense on its face. Obviously, the evidence supported a finding that Martin’s actions were “individually targeted” against Shagrithaya—the evidence was that Martin was stockpiling cash to buy Shagrithaya’s stock, not anybody else’s stock. As noted above, there was ample evidence to support the jury findings regarding Martin’s purpose; the court of appeals’ basis for rejecting the findings was only that Martin was not entirely successful.

The ARGO court then analyzed the dividends findings in terms of the former shareholder oppression doctrine’s two tests of defeating reasonable expectations and burdensome, harsh, or wrongful conduct. Within the confines of the pre-Ritchie law, its conclusions were perhaps not unreasonable. First, the court concluded that “Shagrithaya joined ARGO with no expectations of receiving dividends and Martin’s conduct did not defeat Shagrithaya’s specific

evidence that the value of his shares was affected by Martin’s actions.”). Probably, the only factual situation in which a shareholder could ever prove damage to the value of his shares from stockpiling cash would be if there were an actual attempt to sell a third party, and the evidence proved that the price was diminished by the absence of dividends and would have been greater if dividends had not been suppressed.

1033 Ritchie v. Rupe, 443 S.W.3d 856, 884 (Tex. 2014). 1034 ARGO, 380 S.W.3d at 269–70.


expectations.”1035 That conclusion stretches the evidence slightly. The court’s statement of the evidence was that Shagrithaya’s expectation was that dividends would not be paid during the time that the parties were building the company. By implication, there would have been some expectation that profits would be distributed after that was done, but the court of appeals must have concluded that Shagrithaya never testified that this eventual payment of dividends was “central to his decision to join the venture.” Next, the court held that “a shareholder may generally expect to share proportionately in the company’s earnings, but a shareholder has no general expectation of receiving a dividend.”1036 Therefore, the only general expectation that Shagrithaya could have would be “in receiving a proportional share of any dividend the board of directors may choose to issue.”1037 That statement is somewhat problematic. The court accepts that all shareholders have a right to share proportionately in the company’s earnings; however, there are only two ways that the earnings can be shared with the shareholders: salaries, bonuses, and other employment-related compensation, or dividends. However, if shareholders have no reasonable expectation in their continued employment, no reasonable expectation in their level of compensation, and no reasonable expectation in their receipt of dividends, then the reasonable expectation in a proportionate share of earnings is illusory because there is no reasonable expectation in any means of receiving those payments.

Finally, the court determines whether the facts found by the jury “constitute burdensome, harsh, or wrongful conduct.”1038 The court concludes in the negative: “Because Martin’s ‘suppression of dividends’ did not substantially defeat Shagrithaya’s expectations or prejudice his rights as a shareholder, we conclude this conduct did not amount to minority shareholder oppression.”1039 This conclusion is based on the court’s argument that

[b]uying out a minority shareholder’s interest is not an improper purpose for retaining a company’s earnings. Such a purpose becomes improper only if it negatively impacts the minority shareholder’s rights. As Shagrithaya notes in his brief, the two ways a minority shareholder’s rights may be impacted are if he is prevented from sharing in the profits of the company or the sale value of his shares in the marketplace is depreciated. But, as shown above, neither of these things occurred.1040

Under Ritchie, none of the ARGO court’s reasoning would have been relevant. The derivative claim recognized in Ritchie, based on its construction of Patton, did not inquire into the reasonable expectations of the shareholder or even the nature of the conduct. The sole issue is the purpose of the action, whether the director “violates the duty to act solely for the benefit of the corporation and refuses to declare dividends for some other, improper purpose.”1041 The only statement in ARGO that addresses this issue is the court’s bare assertion, without any citation of authority, that “[b]uying out a minority shareholder’s interest is not an improper

1035 Id. at 270. 1036 Id. 1037 Id. 1038 Id. at 271. 1039 Id. 1040 Id. at 270–71. 1041 443 S.W.3d 856, 884 (Tex. 2014).


purpose for retaining a company’s earnings.”1042 That statement is completely contrary to settled law. The buy-out of a minority shareholder does not benefit the corporation in any way. It only benefits the majority shareholder who acquires a greater percentage of the benefits of ownership, and, depending on the fairness of the price, the minority shareholder. Quite simply, a corporation’s use of its retained earnings to purchase the interests of any particular shareholder1043 is not a corporate purpose at all.1044 The jury’s finding that Martin’s purpose was (1) to prevent Shagrithaya from sharing in the company’s profits, (2) to reduce the value of Shagrithaya’s shares to Shagrithaya, and (3) ultimately to use Shagrithaya’s own money that has been retained in the company for the purpose of buying out his interests and enlarging Martin’s interests is quite clearly a purpose that was not “solely for the benefit of the corporation.” Martin clearly violated his fiduciary duties to ARGO, as defined by Ritchie, and would have been entitled to the equitable relief awarded in Patton, based on the jury’s findings.

2. Challenging “No Dividend” Policy

A related concern is where a corporation, with the consent of all shareholders, follows a policy of distributing profits by means other than dividends, typically salary and bonuses, and a change of circumstances occurs whereby some shareholders no longer benefit proportionately. In the oppression context, this often occurs as a result of the majority terminating the employment of the minority, but it can happen in many other ways: voluntary resignation, retirement, inability to work due to disability, or death of the employee resulting in the stock passing to heirs not involved in the business. In each of these situations, what was once a fair financial structure for the shareholders becomes an unfair one. The Ritchie Court specifically noted that when dividends are not paid, “a minority shareholder who is discharged from employment and removed from the board of directors is effectively denied any return on his or her investment.”1045 Often, the shareholders still employed or the directors will argue that the long-standing policy against payment of dividends, to which the plaintiff had previously agreed, is binding and cannot be changed. This argument is wrong unless the specific restrictions on the ability to declare dividends are written into the certificate of formation.1046 Nevertheless, directors may use their discretion to continue to abide by an

1042 ARGO, 380 S.W.3d at 270. 1043 A distinction is made between the repurchase of shares of a particular minority shareholder in a closely-

held corporation resulting from an agreement between the minority shareholder and the majority shareholder and a corporate redemption in a public corporation that is tendered to all shareholders. The latter situation is similar to a dividend in that it benefits all shareholders.

1044 “[O]rdinarily, a corporation has no special interest in the opportunity to purchase its own shares False” Alexander v. Sturke, 909 S.W.2d 166, 170 (Tex. App.—Houston [14th Dist.] 1995, writ denied). See also Equity Corp. v. Milton, 213 A.2d 439, 443 (Del. Ch. 1965) (“[T]he acquisition of its own capital stock is not ordinarily an essential corporate function”), aff’d, 221 A.2d 494 (Del. 1966); Brophy v. Cities Serv. Co., 70 A.2d 5, 8 (Del. Ch. 1949) (“The acquisition of its own capital stock is not ordinarily an essential corporate function”); Katz Corp. v. T.H. Canty & Co., Inc., 362 A.2d 975, 980 (Conn. 1975) (“Ordinarily, a corporation has no interest in its outstanding stock . . . .”); PJ Acquisition Corp. v. Skoglund, 453 N.W.2d 1, 10 (Minn. 1990) (“Ordinarily, a corporation has no interest in its outstanding stock . . . .”).

1045 443 S.W.3d at 879 n.39 (citing Douglas K. Moll, Reasonable Expectations v. Implied-in-Fact Contracts: Is the Shareholder Oppression Doctrine Needed?, 42 B.C. L. REV. 989, 1067 (2001)).

1046 See TEX. BUS. ORGS. CODE ANN. § 21.310 (West 2006). Also a restriction on the power of directors to make distributions must be stated in the certificate of formation. See id. § 21.303(a). A “distribution” includes


unwritten, informal policy, even though that policy is not binding and now works an injustice.

In these situations, the directors are causing the corporation to violate its fiduciary duties to treat all shareholders impartially and not to impair the rights as shareholders, which include a proportional share in profits. Either by a claim for breach of trust or a derivative claim for suppression of dividends, courts should be able to grant equitable relief to the disadvantaged shareholders. One Delaware case involved doctors in a professional corporation MRI clinic that had distributed profits through payment of above-market fees for reading MRIs to the shareholder doctors. That practice worked well to distribute corporate profits on a pro rata basis until some of the doctors withdrew from the arrangement. The Delaware Chancery Court stated that the board has a fiduciary duty to reassess the unfair situation.1047 In Gimpel v. Bolstein, the plaintiff was fired for good cause, which the New York court held could not constitute shareholder oppression.1048 However, the resulting unfairness of the corporation’s firmly established policy of not paying dividends prompted the court to “fashion a remedy” and order the majority to “make an election: they must either alter the corporate financial structure so as to commence payment of dividends, or else make a reasonable offer to buy out [the plaintiff’s] interest.”1049

Similarly, in Braswell v. Braswell, the wife of the majority shareholder in a closely held corporation was awarded shares in the company as a result of a divorce.1050 The wife argued that the division of the stock was not equitable because she was now a shareholder in a corporation that was subject to the control of her ex-husband. The Waco Court of Appeals noted that the corporation had never before paid dividends, but reasoned that both husband and wife had lived on the husband’s salary taken out of the corporation and that it would have been costly in taxes and unwise for the corporation to pay dividends prior to the divorce. “We do not believe these facts raise a presumption that the corporation acting through its dominant officer and stockholders will not now regularly declare and pay reasonable dividends. If they should improperly refuse to do so, then any minority stockholder has his or her legal remedy”1051—specifically citing Patton and Morrison v. St. Anthony Hotel.

3. Defacto Dividends

Allegations that directors or controlling shareholders are manipulating dividends to “oppress” minority shareholders typically arise when the majority shareholders not only withhold dividends but also use some alternative method to distribute the corporation’s profits exclusively to themselves—frequently, by inflating their own salaries.1052 The “[r]efusal to pay

dividends, share repurchases or redemptions, and liquidation payments. Id. § 21.002(6)(A). 1047 See Del. Open MRI Radiology Ass’n v. Kessler, 898 A.2d 290, 321 (Del. Ch. 2006). 1048 477 N.Y.S.2d 1014, 1020–21 (N.Y. Sup. Ct. 1984). 1049 Id. 1050 476 S.W.2d 444, 447 (Tex. Civ. App.—Waco 1972, writ dism’d). 1051 Id. (citing Patton v. Nicholas, 279 S.W.2d 848, 853 (Tex. 1955), and Morrison v. St. Anthony Hotel, 295

S.W.2d 246, 250 (Tex. Civ. App.—San Antonio 1956, writ ref’d n.r.e.)). 1052 Ritchie v. Rupe, 443 S.W.3d 856, 885 (Tex. 2014) (citing Boehringer v. Konkel, 404 S.W.3d 18, 31–32

(Tex. App.—Houston [1st Dist.] 2013) (addressing failure to pay dividends couples with increase in controlling shareholders-director’s salary)).


dividends [and] paying majority shareholders outside the dividend process,”1053 the Ritchie Court argued, “may be redressed through a derivative action, or through a direct action brought by the corporation, for breach of fiduciary duty.”1054 While that may be true in most instances, the same conduct also constitutes a corporate breach of trust in failing to deal with shareholders impartially and appropriating the minority’s proportionate share of the profits through what are actually de facto dividends being paid the majority. The differences between addressing this oppressive conduct derivatively as withholding dividends plus excessive compensation versus directly as a breach of trust in the disproportionate payment of defacto dividends are real and significant.

“A distribution by a corporation to its shareholders may constitute a dividend in law even though not formally designated as a dividend by the board of directors.”1055 In Moroney v. Moroney,1056 a guardian controlled a corporation with 500 shares, one he owned personally, and the other 499 he held in trust for the wards of the estate. The guardian caused the corporation to pay himself a large sum of money, and the wards of the estate later sued him for their 499/500 share. The defense was that the money was not a distribution but a misappropriation, and only the corporation could bring the suit. The Texas Commission of Appeals held:

Now, it is not essential to the right to receive a dividend that there should have been a formal declaration of a dividend, but where the corporation sets apart a fund for distribution to its stockholders to such extent as to become segregated from the property of the corporation, such property henceforth becomes, equitably, the stockholders’ property. There has been in legal effect a declaration of a dividend, and of course if such fund is actually delivered to the stockholders, there has been a payment, and the fund is legally that of the stockholder. In other words, where there has been such a segregation of the corporate funds, and such a dedication to the stockholders, the assets thus segregated cease to belong to the corporation, but do belong to the stockholders individually.1057

The court held that the payments were “in effect” dividends even though “there was never at any time a formal declaration of dividends”—it being “presumed that [the corporation] intended to do a lawful thing, and that the sums paid represented a legal liability of the corporation.”1058 “The evidence indicates the corporation was a prosperous concern, and by common consent it pursued this method of distributing its proceeds to the rightful owners of such profits. The transaction evidences an intention to distribute the proceeds of the business to

1053 Id. at 885 n.53 (Tex. 2014). 1054 Id. at 887. 1055 Legrand-Brock v. Brock, 246 S.W.3d 318, 322 (Tex. App.—Beaumont 2008, pet. denied). See also Ramo,

Inc. v. English, 500 S.W.2d 461, 465 (Tex. 1973) (“We are unwilling to permit the dividend limitation to be circumvented by so transparent a device as entering the withdrawals on the books as ‘accounts receivable’ and calling them loans.”).

1056 Moroney v. Moroney, 286 S.W. 167 (Tex. Comm’n App. 1926, judgm’t affirmed). 1057 Id. at 169–70. 1058 Id. at 170.


the rightful owners.”1059 Furthermore, it made “no difference whether the corporation, Moroney Hardware Company, does or does not have a cause of action against [the guardian]. The estate recovers in this case upon the merits of its own claim.”1060 As the Texas Supreme Court has held: “[W]hether or not a corporate distribution is a dividend or something else, such as a loan, gift, compensation for services, repayment of a loan, interest on a loan, or payment for property purchased, presents a question of fact to be determined in each case.”1061

Assume that a corporation is paying no dividends, that the 40% minority shareholder draws no salary, and that all corporate profits are consumed in payment of a large salary to the 60% majority shareholder—so that, in reality, part of the payment to the majority is compensation for services and part is a distribution of profits, a de facto dividend. Under the approach described in Ritchie, the plaintiff is required to address two very different questions. First, was the majority shareholder excessively compensated? This requires an inquiry into whether there was wrongdoing by the directors in setting the majority shareholder’s salary and will focus on whether the majority shareholder is being paid above-market.1062 Because of the wide range of executive salaries, the plaintiff’s burden is very difficult. Second, the plaintiff must prove that dividends should be declared. This requires proof that the decision not to pay dividends was based on a purpose other than benefiting the corporation; however, this is a difficult thing to prove in the face of a director’s claim of plausible corporate purposes and a judicial policy of extreme deference on dividend decisions. If the plaintiff is successful on both questions, the de facto dividend is cancelled and reissued properly—the defendant puts the money back into the corporation, and the plaintiff receives his portion of the de facto dividend.1063 If the amount of the de facto dividend was $120,000, then the plaintiff would recover his 40%, or $48,000.

If the plaintiff were to approach the problem not as a breach of fiduciary duties to the corporation, but as a breach by the corporation as a trustee, the analysis is very different. “When dividends are declared, the corporation becomes indebted to [each] stockholder[] for the amounts of [his] respective shares.”1064 Dividends cannot be rescinded.1065 The factual question would not involve an issue of wrongdoing or of business judgment but merely one of value. Recognizing that it is perfectly appropriate to distribute profits in a closely-held corporation by means of salary and bonuses,1066 the jury would only need to determine how much of the payment to the majority shareholder was for services and how much was

1059 Id. 1060 Id. 1061 Ramo, Inc., 500 S.W.2d at 467. 1062 Gibney v. Culver, No. 13-06-112-CV, 2008 WL 1822767, at *15 (Tex. App.—Corpus Christi Apr. 24,

2008, pet. denied) (mem. op.). 1063 As a practical matter in this particular hypothetical, dealing with the second question would probably not

be necessary because the court would treat the derivative action as a direct action for purposes of the remedy, and the plaintiff could receive his share of the overpayment directly as damages. TEX. BUS. ORGS. CODE ANN. § 21.563 (West 2007). However, in any situation involving prospective relief, both questions would need to be addressed.

1064 Keller v. Keller, 141 S.W.2d 308, 311 (Tex. 1940). 1065 See id. (dividends, once declared, “are not subject to change merely at the choice of a stockholder.”); C.I.R.

v. Cohen, 121 F.2d 348, 349 (5th Cir. 1941) (“Under the law of Texas, a declaration of dividends creates a debt owed by the corporation in favor of each stockholder which cannot be rescinded.”).

1066 See Moll, Shareholder Oppression in Texas, supra note 25, at 37.35.


distribution of profit? Because the “directors must make compensation decisions in compliance with the formal fiduciary duties that they, as officers or directors, owe to the corporation, and thus to the shareholders collectively,”1067 and because “equity regarding as done that which ought to be done,”1068 the jury would have to assume that the compensation for services would be valued at the lowest amount that comparable services could be procured on the market, and the rest is profit distribution. If the amount of the de facto dividend actually paid to the majority shareholder was $120,000, then the corporation would have a fiduciary duty to pay the minority shareholder $80,000, because the total dividend constructively declared would have been $200,000—60% to the majority ($120,000) and 40% to the minority ($80,000). This would clearly represent an instance where the legal remedy ($40,000) is not adequate when compared with the equitable remedy ($80,000).

Texas courts have frequently been willing and able to find a variety of financial benefits that majority shareholders confer on themselves to be de facto dividends. In Ramo, Inc. v. English,1069 the corporation distributed substantial sums of money to the controlling shareholder, which were recorded on the books as advances. Only the first advance was documented with a board resolution; none of the advances were evidenced by a promissory note; and apparently, the advances were without interest. The jury found that the controlling shareholder had no intention to repay the money.1070 A lender contended that these distributions were not loans,1071 but were actually dividends in violation of a covenant in the security agreement. The Texas Supreme Court held that whether the distributions were loans or dividends was a question for the jury, but that the evidence would have supported a finding that the distributions were really dividends if a jury question had been submitted.1072

In Rivas v. Cantu,1073 the plaintiff sued the controlling shareholder for breach of contract and fraud for having failed to transfer 50% of the shares in a corporation as promised prior to incorporation. The plaintiff claimed as special damages 50% of the amount of “constructive dividends” that the controlling shareholder had received. The court of appeals approved this

1067 Ritchie v. Rupe, 443 S.W.3d 856, 883 (Tex. 2014). 1068 Sanderson v. Sanderson, 109 S.W.2d 744, 748 (Tex. 1937); First Heights Bank, FSB v. Gutierrez, 852

S.W.2d 596, 605 (Tex. App.—Corpus Christi 1993, writ denied); Dixon v. Huggins, 495 S.W.2d 621, 625 (Tex. Civ. App.—Waco 1973, writ dism’d); King Land & Cattle Corp. v. Fikes, 414 S.W.2d 521, 524 (Tex. Civ. App.—Fort Worth 1967, writ ref’d n.r.e.). See also White v. Hancock, 238 S.W.2d 801, 803 (Tex. Civ. App.—Fort Worth 1951, no writ) (“Equity regards and treats as done that which in fairness and good conscience ought to be done.”).

1069 Ramo, Inc. v. English, 500 S.W.2d 461 (Tex. 1973). 1070 Id. at 464. 1071 The court noted:

A loan is an advance of money on an agreement, express or implied, to repay at some time in the future, while the term ‘dividend’ as ordinarily used means a corporate distribution that the shareholder is entitled to receive and retain without any obligation of repayment. A basic and essential difference between a loan and a dividend then is the presence or absence of a legal obligation to repay.

Id. at 465. 1072 Id. at 467 (“To weigh the evidence, draw inferences from the facts, and choose between conflicting

inferences is, of course, the function of the trier of fact. The evidence in the present case would support a finding that the advances were dividends, but it is not conclusive. The question is an issue of fact, but no issue fairly presenting that question was submitted or requested.”).

1073 37 S.W.3d 101 (Tex. App.—Corpus Christi 2000, pet. denied).


measure of damages.1074 The court noted that “a constructive dividend occurs when an expenditure is made by a corporation for the personal benefit of a stockholder, or corporate-owned facilities are used by a stockholder for his personal benefit” and that “the crucial concept is that the corporation conferred an economic benefit on the stockholder without expectation of repayment.”1075 The court held that constructive dividends could be established by evidence of excessive compensation paid by the corporation to family members of the controlling stockholders; however, a “constructive dividend does not occur automatically when a stockholder’s family member works for the corporation, but only when that relative is overcompensated.”1076 There must be evidence that compensation was paid for work that was not done, or work that was not needed by the corporation, or that the compensation for the services performed was unreasonably high.1077

In Davis v. Sheerin, the jury found that “appellants received informal dividends by making profit sharing contributions for their benefit and to the exclusion of appellee.”1078 The trial court awarded $20,893 to the plaintiff individually on a de facto dividends claim, separate and apart from his shareholder oppression and derivative claims.1079 In Redmon v. Griffith, the plaintiff’s pleading that defendants made improper loans to themselves, paid personal expenses from corporate funds, and paid excessive dividends to themselves was held to properly state a pattern of oppressive conduct.1080 In Boehringer v. Konkel, the majority shareholder withheld dividends for two years, claiming that the corporation did not have the funds to pay dividends in those years.1081 However, the defendant also increased his salary to $20,000 per month during this time. The court concluded that the defendant “withheld [payment] of a dividend and used his two-fold pay increase as a means of denying [the minority shareholder] his proportionate participation in the company’s earnings . . . .”1082 The court stated that the sizeable salary increase for the majority shareholder resulted in a “de facto dividend” to the exclusion of the minority shareholder.1083 In In re White, the court held payments of bonuses to the majority shareholders that tracked the profits of the company constituted “$4,900,000 in disguised dividends.”1084

The equitable remedy for de facto dividends described here may result in de facto dividend declarations that subject the majority shareholder to additional liability to the corporation. The premise of the plaintiff’s claim is that funds taken from the company by the majority shareholder were constructive dividends—meaning that a court of equity would presume that was “done that which ought to be done,”1085 and the corporation had declared a

1074 Id. at 118. 1075 Id. (citing Hillsboro Nat’l Bank v. Comm’r, 460 U.S. 370, 392, (1983). See Ireland v. United States, 621

F.2d 731, 735 (5th Cir.1980)). 1076 Rivas, 37 S.W.3d at 119. 1077 Id. 1078 754 S.W.2d 375, 382 (Tex. App.—Houston [1st Dist.] 1988, writ denied). 1079 Id. at 378. 1080 Redmon v. Griffith, 202 S.W.3d 225, 235 (Tex. App.—Tyler 2006, pet. denied). 1081 Boehringer v. Konkel, 404 S.W.3d 18, 28 (Tex. App.—Houston [1st Dist.] 2013, no pet.). 1082 Id. at 31. 1083 Id. 1084 In re White, 429 B.R. 201, 214 (Bankr. S.D. Tex. 2010). 1085 Sanderson v. Sanderson, 109 S.W.2d 744, 748 (Tex. 1937); First Heights Bank, FSB v. Gutierrez, 852


dividend in the amount reflected by what was paid to the majority. If the majority owns 60% of the stock and takes $600,000 in defacto dividends, then the actual amount of the constructive dividend declaration would be $1 million, and the corporation would owe the minority shareholder his 40% or $400,000 of the constructive dividend. What if the corporation doesn’t have $400,000? Directors are prohibited by statute from declaring dividends that would render the corporation insolvent or exceeds the distribution limit.1086 The distribution limit for dividends is the amount of the surplus of the corporation,1087 meaning the amount by which the net assets of the company exceed the stated capital of the company.1088 If the majority shareholder has been doing a thorough job of cleaning out the excess profits of a corporation through de facto distributions to himself, then the amount of the grossed-up total constructive dividend declaration would frequently exceed the corporation’s surplus, in which case directors who vote for or assent to such a de facto dividend will be jointly and severally liable to the corporation for the amount by which the distribution exceeds the limit.1089 The practical result is that the majority shareholder would be personally responsible for funding the plaintiff’s dividend if the corporation were unable to do so. However, the liability for an illegal dividend is solely to the corporation,1090 therefore, this claim would be required to be asserted by the minority shareholder as a derivative claim.

4. Statute of Limitations on Dividend Claims

Specifically, with respect to dividend and de facto dividend claims, a unique tolling doctrine developed. First, each dividend is a separate transaction, and each refusal to pay is also a separate cause of action.1091 Second, the corporation is deemed to hold all unpaid dividends in trust for the benefit of the shareholder and such dividends are payable upon demand.1092 The shareholder

is under no obligation to draw or demand his dividends within any prescribed period. He may leave them with the corporation, if he chooses, and be under no default. The debt which a declared dividend creates on the part of the corporation to the stockholder is one payable only on demand, as is the obligation of a bank to its depositors. It is not subject to limitation until there has been a demand upon the corporation and a refusal to pay.1093

However, the court held:

S.W.2d 596, 605 (Tex. App.—Corpus Christi 1993, writ denied); Dixon v. Huggins, 495 S.W.2d 621, 625 (Tex. Civ. App.—Waco 1973, writ dism’d); King Land & Cattle Corp. v. Fikes, 414 S.W.2d 521, 524 (Tex. Civ. App.—Fort Worth 1967, writ ref’d n.r.e.). See also White v. Hancock, 238 S.W.2d 801, 803 (Tex. Civ. App.—Fort Worth 1951, no writ) (“Equity regards and treats as done that which in fairness and good conscience ought to be done.”).

1086 TEX. BUS. ORGS. CODE ANN. § 21.303(b) (West 2015). 1087 Id. § 21.301(1)(B). 1088 Id. at (12). The “stated capital” is sum of the par value of the stock, plus the consideration received for non-

par-value stock, plus any stated capital allocated in a stock dividend or by resolution of the board. Id. at (11). 1089 See id. § 21.316(a). 1090 See Smith v. Chapman, 897 S.W.2d 399, 401 (Tex. App.—Eastland 1995, no writ). 1091 Cavitt v. Amsler, 242 S.W. 246, 247 (Tex. Civ. App.—Austin 1922, writ dism’d w.o.j.). 1092 Id. at 248. 1093 Yeaman v. Galveston City Co., 167 S.W. 710, 724. (Tex. 1914). See also Cavitt, 242 S.W. at 248 (“[U]ntil

a stockholder makes a demand for the payment of his dividends and the same is refused, the statute of limitation will not begin to run.”).


it is not necessary that a specific demand for dividends should be made, and the same should be refused, in order to put the statute of limitation in motion. If the acts or words or both, of the corporation, clearly and unequivocally indicate to a stockholder that the corporation will not pay a dividend to him, this would be equivalent to a demand and refusal for the payment of such dividend.1094

The shareholder must have clear notice of the refusal to pay,1095 and because of the fiduciary relationship, the diligence required of the shareholder is not “as prompt and as searching an inquiry into the conduct of the other party as where the parties were strangers or were dealing with strangers.”1096 The mere opportunity or power to investigate is not sufficient to start the running of the statute of limitations; actual notice, not constructive notice, is required.1097

IX. CONCLUSION

Courts may be “powerless to redress many forms of oppression practiced upon the minority under the guise of legal sanction,”1098 but not all. A court may grant relief for “oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder.”1099 Such cases of extreme oppressive conduct constitute a “breach of trust, for which the courts will afford a remedy.”1100 In fashioning such a remedy, “[w]isdom would seem to counsel tailoring the remedy to fit the particular case,”1101 taking due regard of “the malicious character of the misconduct heretofore involved and the consequent possibility of its repetition.”1102 In an appropriate case, under the existing common law, “Texas courts, under their general equity power, may decree a ‘buy-out’ . . .[] where less harsh remedies are inadequate to protect the rights of the parties.”1103

The purpose of this article has been to identify with a degree of specificity the “gaps” that the Ritchie Court acknowledged now exist in Texas law after the demise of the shareholder oppression doctrine. We have attempted to identify legal rights and remedies that “already exist”1104 and to some extent fill in the gaps left by the Ritchie decision. We have gone back to the pre-shareholder oppression case law, including the cases relied on by the Court in Ritchie

1094 Cavitt, 242 S.W. at 248. 1095 Yeaman, 167 S.W. at 724 (“And when a corporate act is invoked as a repudiation of a shareholder’s stock

or a conversion of its profits, before affecting his rights with limitation, it is only just to require that he or those standing in his stead have notice of it.”). See also id. (“Though considered a debt, as a shareholder’s dividends are payable by the corporation only on demand, its holding of them until the demand is in the nature of a trustee relation; and in our opinion the same rule which requires notice to a cestui que trust of the trustee’s repudiation of the trust, to set limitation in motion against him, should govern in the case of a conversion by a corporation of dividends belonging to one of its stockholders.”).

1096 Bush v. Stone, 500 S.W.2d 885, 890 (Tex. Civ. App.—Corpus Christi 1973, writ ref’d n.r.e.). 1097 Id. (finding that “actual notice of the fraud before the limitations statute is set into motion”). 1098 Tipton v. Ry. Postal Clerks’ Inv. Ass’n, 173 S.W. 562, 567 (Tex. Civ. App.—Fort Worth 1914, no writ). 1099 Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889). 1100 Patton v. Nicholas, 279 S.W.2d 848, 854 (Tex. 1955). 1101 Id. at 857. 1102 Id. at 858. 1103 Davis v. Sheerin, 754 S.W.2d 375, 380 (Tex. App.—Houston [1st Dist.] 1988, writ denied). 1104 Ritchie v. Rupe, 443 S.W.3d 856, 879 (Tex. 2014).


and Sneed, and other cases decided in the same time period, and have identified well-established shareholder rights and interests and duties owed by the corporation to individual shareholders. Finally, we have attempted to define the elements and remedies of the common-law cause of action for breach of trust as it currently exists in Texas common law and as it might logically be applied in factual situations previously remedied under the shareholder oppression doctrine. While we have brought together some concepts in new ways and have drawn some inferences from existing case law, nothing that is proposed in this article is new. Nothing is suggested that would require “directors to act in the best interest of individual shareholders at the expense of the corporation”1105—rather, the concepts discussed here are based on protected rights of shareholder and duties of the corporation. Discretion to determine what is in the best interest of either the corporation or the shareholder is beside the point. Finally, the common-law cause of action described here is certainly “far more concrete than” the term “oppressive”1106 as previously developed in the former shareholder oppression doctrine.

Although the Texas Supreme Court did not hesitate to overturn three decades of common law developed by the courts of appeals as “new”—a body of law that an entire generation of business attorneys and business persons accepted and utilized to guide and govern their actions—the Supreme Court took utmost care to remain consistent with even nineteenth century Texas Supreme Court opinions and lower court opinions that have stood the test of time. The majority opinion in Ritchie quoted Justice Hecht’s eloquent statement that the Texas Supreme Court

as steward of the common law, possesses the power to recognize new causes of action, but the mere existence of that power cannot justify its exercise. There must be well-considered, even compelling grounds for changing the law so significantly. Where, as here, no such grounds are given, the decision is more an exercise of will than of reason.1107

The rights, interests, causes of action, and remedies outlined in this article do not involve a change in the law, but are based on well-established law and are available to address oppressive conduct. As the “steward of the common law,” the Texas Supreme Court should find that the legal concepts described in this article are consistent with the precepts of the Ritchie opinion and serve in large measure to fill in the gaps acknowledged by the Court in the legal protection of minority shareholder interests.

1105 Id. at 888. 1106 Cf. id. at 890. 1107 Twyman v. Twyman, 855 S.W.2d 619, 630 (Tex. 1993) (Hecht, J., joined by Enoch, J., concurring in part

and dissenting in part), quoted by Ritchie, 443 S.W.3d at 891.

ARBITRATION CLAUSES: ARE ARBITRATION CLAUSES

IN ENGAGEMENT LETTERS BINDING WHEN THE

CLIENT DOESN’T SIGN AND THE PARTY SUING IS

DOING SO DERIVATIVELY?

By Ashley Tegeler*

Cedillo v. Immobiliere Jeuness Establissement, 476 S.W.3d 557 (Tex. App.—Houston

[14th Dist.] 2015, pet. denied).

On August 27, 2015, the 14th District Court of Appeals in Houston (“Court”) determined

that arbitration may be compelled based on the arbitration clause contained in a law firm’s

representation agreement with their client.1 The “Lichtenstein entity”

2 that brought suit in this

case was bound to the arbitration clause because it was suing derivatively on behalf of the

client; the claims at issue fell within the scope of the clause; and the client bound itself to the

representation agreement even though the client did not sign the agreement.3

The case at hand was a legal malpractice case against Davis, Cedillo, & Mendozo, Inc.

(“DCM”) and three of its attorneys, brought by IJE, the Liechtenstein entity, on behalf of two

partnerships (“Original Partnerships”) in which IJE was a partner.4 Beginning in March 2009

and continuing until June 2011, DCM represented the Original Partnerships in litigation

involving transactions relating to the development of an affordable housing complex, initiated

by IJE.5 The representation agreement between DCM and the Original Partnerships consisted

of the following arbitration clause:

Arbitration: Any disputes arising out of the relationship between Firm [DCM] and

Client [the Original Partnerships] shall be submitted to binding arbitration, and both

Firm and Client agree to be bound by the results of arbitration. The arbitration shall

be governed by the Commercial Arbitration Rules of the American Arbitration

Association. San Antonio, Bexar County, Texas shall be the exclusive venue, and any

disputes submitted to arbitration shall be governed by the laws of the State of Texas.6

In June 2011, DCM determined that a conflict had arisen in their representation of the

Original Partnerships and the trial court thereafter granted their motion to withdraw.7 The case

concerning the affordable housing units was ended around May 2013.8 The legal malpractice

case against DCM was brought in August 2012 by IJE on behalf of the Original Partnerships

alleging malpractice on the part of DCM through its legal work and representation of the

* Ashley Tegeler is a 2016 J.D. Graduate from South Texas College of Law Houston. 1

Cedillo v. Immobiliere Jeuness Establissement, 476 S.W.3d 557, 572 (Tex. App.—Houston [14th Dist.] 2015,

pet. denied). 2

Id. at 561, probably should read “Liechtenstein”. 3

Id. at 564–70. 4

Id. at 561. 5

Id. 6

Id. at 562. 7

Id. 8

Id.


Original Partnerships.9 After a seventeen (17) month abatement and the beginning of

discovery, DCM’s attorneys discovered the Arbitration Clause and subsequently filed a Motion

to Compel Arbitration.10

The trial court denied DCM’s motion on the basis that IJE was not a

party to the representation agreement and this interlocutory appeal followed.11

In beginning its analysis of whether DCM had the right to compel arbitration, the Court

first discussed the validity of the arbitration clause in light of the fact that the Original

Partnerships never signed the representation agreement.12

Since the Original Partnerships

never signed the agreement, the court had to determine if a non-signatory is bound by the

arbitration clause.13

The lack of signature does not by itself defeat the arbitration clause

because neither Federal nor Texas arbitration rules require that arbitration clauses be signed,

they must only be written and agreed to by the parties.14

The court found that because DCM

performed under the representation agreement by representing the Original Partnerships in the

housing issue and the Original Partnerships accepted DCM as their counsel until DCM

withdrew, the Original Partnerships accepted the representation agreement and the arbitration

clause contained within it.15

Therefore, the arbitration clause contained in the representation

agreement was valid.16

IJE argued and the trial court found that even if the arbitration clause was valid, IJE was

not bound by the clause because it was not a party to the representation agreement.17

IJE is

suing DCM in a derivative suit on behalf of the Original Partnerships.18

The Court noted that a

plaintiff who brings a derivative suit “steps into the shoes” of the party on whose behalf

plaintiff brings the suit.19

This means that a derivative plaintiff is also bound by any

agreements entered into by that party.20

The Court found that the trial court erred in

determining that the motion to compel arbitration should be denied solely because IJE was not

the original party to the arbitration agreement.21

The Court found no compelling reason to

depart from the principle discussed above, that a derivative plaintiff suing on behalf of another

party is bound to any agreements made by that party.22

The Court declined to follow IJE’s

argument that they were not bound by the representation agreement since the malpractice

action was brought derivatively.

9 Id.

10 Id. at 562–63.

11 Id. at 563.; see TEX. CIV. P. REM. CODE §51.016 (authorizing interlocutory appeal of denial of motion to

compel arbitration under the Federal Arbitration Act); and TEX. CIV. P. REM. CODE §171.098(a)(1) (permitting

interlocutory appeal of denial of motion to compel arbitration under the Texas General Arbitration Act). 12

Cedillo, 476 S.W.3d at 564. 13

Id. 14

Id. at 564–65. 15

Id. at 566. 16

Id. 17

Id. at 563. 18

Id. at 566. 19

Id. 20

Id. (citing In re Labatt Food Serv., L.P., 279 S.W.3d at 644–46). 21


Id.

2017] DERIVATIVE SUITS OF ARBITRATION CLAUSES IN ENGAGEMENT LETTERS 201

Finally, the Court determined the scope of the arbitration clause by analyzing the specific

language within the arbitration clause.23

The Court notes that doubts concerning the scope of

an arbitration clause are resolved in favor of arbitration, in line with the strong presumption

favoring arbitration agreements.24

Here, the burden was on IJE to show the issues in their legal

malpractice case fell outside of the scope of the arbitration clause.25

The Court focused on the

factual aspects of the issues in the legal malpractice case to determine if the claim fell within

the scope of the clause.26

The Court looked to the following specific language within the

arbitration clause to determine what the scope of the clause was: “any dispute arising out of the

relationship.”27

“Relationship” was never defined in the agreement, however, it was noted that

the term “representation” was defined as including only the legal representation of the Original

Partnerships.28

The Court found that “relationship” was a broader term than “representation”

and made the arbitration clause broader in scope.29

Based on the factual allegations alleged by

IJE and the broad scope of the arbitration clause, it is plausible that at least some of IJE’s

allegations would fall within the scope of the arbitration clause.30

Since, IJE was unable to

overcome its burden to establish that the issues of the legal malpractice claim fell outside of

the arbitration clause, the Court concluded that the claims brought by IJE fell within the

clause.31

IJE also alleged two defenses to the arbitration clause to overcome the motion to compel,

unconscionability of the arbitration clause and waiver of arbitration.32

The Court found that

neither defense overcame DCM’s motion to compel arbitration nor lent credence to the trial

court’s decision to deny the motion to compel arbitration.33

The party opposing arbitration

bears the burden of proving the clause was unconscionable.34

IJE, within its response to the

motion to compel, tried to move the burden of proof to DCM and failed to present any

evidence concerning unconscionability, thereby providing no basis to their defense against the

motion to compel arbitration.35

IJE also asserted waiver of the arbitration.36

For a party to

waive their right to arbitration, they must substantially invoke, to the opposing party’s

detriment, the judicial process.37

A strong presumption against waiver of arbitration exists,

making the burden of proof difficult to meet.38

The Court’s determination of the existence of

waiver of arbitration depended on the totality of the circumstances, including any reason for

23 Id. at 567–70.

24 Id. at 567.

25 Id. (citing Prudential sec. Inc. v. Marshall, 909 S.W.2d 896, 899-900 (Tex. 1995); Osronia v. AmeriMex

Motor & Controls, Inc., 367 S.W.3d 707, 712 (Tex. App.—Houston [14th Dist.] 2012, no pet.)). 26


Id. at 568. 28

Id. 29

Id. 30

Id. at 569. 31

Id. at 570. 32

Id. 33

Id. at 570–72. 34

Id. at 570. 35

Id. 36

Id. 37

Id. 38

Id.


delay in enforcing an arbitration clause, the amount of discovery conducted before

enforcement, and if the movant sought disposition on the case based upon the merits.39

Since,

DCM only took five (5) months from the end of the abatement to enforce the clause, minimal

discovery occurred after the abatement, and no motions for a ruling on the merits of the case

been filed by DCM, the Court concluded that waiver of the arbitration clause did not occur.40

After the Court established that a valid arbitration agreement existed, and determined that

IJE was bound by this clause through its derivative suit and the claims fell within the scope of

the clause, the Court reversed the trial court’s denial of DCM’s motion to compel arbitration

and remanded for proceedings consistent with their opinion.41

39 Id. at 571.

40 Id. at 571–72.

41 Id. at 572.

WHETHER UCC ARTICLE 4 IN TEXAS PREEMPTS COMMON LAW

FRAUD AND BREACH OF CONTRACT CLAIMS IN THE

RELATIONSHIP BETWEEN A BANK AND ITS CUSTOMER

By Brendan J. Fleming*

Am. Dream Team, Inc. v. Citizens State Bank, 481 S.W.3d 725 (Tex. App.—Tyler

2015, pet. denied).

INTRODUCTION

American Dream Team, Inc. (“ADT”) filed suit against Citizens State Bank (“Bank”)

alleging that Bank had improperly charged back $30,000.00 against its account for a

provisional credit extended on a counterfeit check.1 The trial court granted summary judgment

to Bank, and ADT appealed.2 There are two pertinent issues in this review: (1) whether

Uniform Commercial Code Article 4 (the “Code”) preempts a claim of common law fraud

when looking at a communication between a bank and its customer;3 and (2) whether the Code

preempts common law rules concerning breach of contract.4 The Tyler Court of Appeals (the

“Court”) held that: (1) if the Code is silent on an issue, common law may supplement the

Code;5 and (2) the Code preempts common law breach of contract claims.

6

BACKGROUND

ADT is a real estate brokerage firm specializing in selling properties in the Cedar Creek

Lake area of Henderson County, Texas.7 On January 23, 2010 ADT received an email from a

person named Mr. Yang Hua Lopez (“Lopez”), who alleged he was a Chinese business man

searching for a retirement home in Texas.8 ADT supplied Lopez with a list of properties and he

swiftly decided on a particular property in Lewisville, Texas.9 Through multiple email

communications, Lopez confirmed his down payment had been sent to ADT, when it, in fact,

had not.10

Lopez was also asked to sign ADT’s representation agreement but failed to do so.11

Via UPS, ADT eventually received a check from Lopez for $30,000.00 in order to secure the

down payment on the property.12

The check’s drawer was a Canadian insurance company with

the payer bank being the Bank of Montreal in Toronto, Ontario.13

ADT’s vice president was

told by Banks’s branch manager that because the check was drawn on a foreign bank, it could

* Brendan J. Fleming is a 2017 J.D. Candidate at South Texas College of Law Houston. 1

Am. Dream Team, Inc. v. Citizens State Bank, 481 S.W.3d 725, 728 (Tex. App.—Tyler 2015, pet. denied). 2

Id. at 728. 3

Id. at 734–36. 4

Id. at 732. 5

Id. at 736. 6

Id. at 732. 7

Id. at 728. 8

Id. 9

Id. at 729. 10

Id. 11

Id. 12

Id. 13

Id.


take between one and two months for the funds to be collected.14

As a result, ADT was offered

a provisional credit for the check, pending collection.15

ADT elected to accept this provisional

credit, and the funds were immediately available for use under its deposit agreement with

Bank.16

On March 1, ADT was told by a Bank employee, after she had looked on her computer,

that, “the funds were there” and “it looks like they’re good.”17

The following day, an ADT

employee told a Bank teller that he wanted to wire $30,000.00 to a bank in Japan.18

Before

sending the wire, the employee told the teller that he wanted to make sure that the check from

Lopez had cleared.19

He testified that the teller looked at her computer screen and responded

“yes.”20

The money was wired to Tokyo that day.21

On March 15, Bank and ADT were

notified that the check was counterfeit.22

Attempts were made to recover the $30,000.00 wired

to the Tokyo bank, but to no avail.23

Bank then made a chargeback against ADT’s escrow

account for $30,000.00.24

ADT later filed suit against Bank to recover the $30,000.00

chargeback. ADT brought actions for:

I. common law fraud;

II. breach of contract (the deposit agreement);

III. negligent misrepresentation and conversion;

IV. violations of the Deceptive Trade Practices Act (DTPA);

V. money had and received; and

VI. promissory estoppel.25

The trial court ruled in favor of Bank on all claims and ADT appealed.26

ANALYSIS

I. Does Code Article 4 Preempt Common Law Fraud Claims?

ADT asserts that its fraud claim, which was based on the statements made by Bank’s two

14 Id. at 729–30.

15 Id. at 730.

16 Id.

17 Id.

18 Id.

19 Id.

20 Id.

21 Id.

22 Id.

23 Id.

24 Id.

25 Id.

26 Id.

2017] UCC ARTICLE 4 PREEMPTION OF FRAUD & BREACH OF CONTRACT CLAIMS 205

employees during the check settlement process, was not preempted by the Code.27

The trial

court granted summary judgment on Bank’s affirmative defense reasoning that the Code

preempts common law fraud claims.28

Chapter 4 of the Code specifies duties and

responsibilities for a bank in the actual check processing procedure.29

However, the Code is

silent about the bank’s communications with the customer during this period. 30

The Court

looked to the Official Comments of the Texas Business and Commerce Code to provide

guidance on the issue:

The Uniform Commercial Code was drafted against the backdrop of existing bodies of

law, including the common law and equity, and relies on those bodies of law to supplement it

[sic] provisions. . . . Therefore, while principles of common law and equity may supplement

provisions of the Uniform Commercial Code, they may not be used to supplant its provisions,

or the purposes and policies those provisions reflect . . . .31

The Comment supports the contention that common law may supplement but not supplant

the Code.32

Moreover, the Code specifically describes fraud as a cause of action that can be

used to supplement its provisions.33

In this instance, the Code provisions did not address

alleged misrepresentations about the check settlement process.34

Accordingly, the Court

followed a Montana Supreme Court opinion, which held that common law principles apply

when a bank communicates with a depositor who has inquired about the check processing

procedure.35

This holding reversed the trial court’s grant of summary judgment on Bank’s

affirmative defense of Code preemption as asserted against ADT’s common law fraud claim.36

A. Unjustified Reliance

ADT argued that Bank made fraudulent statements when communicating whether the

fraudulent check had cleared. 37

A plaintiff seeking to prevail on a common law fraud claim

must prove, among other elements, that the plaintiff suffered an injury by actively and

justifiably relying on the fraudulent representation.38

The Texas Supreme Court has held that a

person may not justifiably rely upon a representation if there are “red flags” indicating reliance

27 Id. at 734–36.

28 Id. at 736.

29 Id. at 736.

30 Id.

31 Id. at 735 (quoting TEX. BUS. & COM. CODE ANN. § 1.103(b) (West 2009) (emphasis added)).

32 Am. Dream Team, 481 S.W.3d at 735.

33 Id. at 736.

34 Id.

35 Id. (citing Valley Bank of Ronan v. Hughes, 147 P.3d 185, 191 (Mont. 2006) (holding because bank

communications to the customer in the check processing procedure are not addressed with specificity by the Code,

common law and equitable principles supplement the Code and govern the legal rights and responsibilities that apply

to a Banks representations to its customer)). 36

Am. Dream Team, 481 S.W.3d at 736. 37

Id. at 737–38 (ADT was told by a Bank employee, after being asked if the check had cleared, that “the funds

were there” and “it looks like they’re good.” Another Bank employee also allegedly told ADT the check had cleared

when asked the next day). 38

Id. at 737 (citing Exxon Corp. v. Emerald Oil & Gas Co., L.C., 348 S.W.3d 194, 217 (Tex. 2011)).

https://a.next.westlaw.com/Link/Document/FullText?findType=L&pubNum=1000168&cite=TXBCS1.103&originatingDoc=I37653ff0b30c11e5b10893af99153f48&refType=SP&originationContext=document&transitionType=DocumentItem&contextData=(sc.History*oc.Search)#co_pp_a83b000018c76


is unwarranted.39

In the instant case, the Court reasoned that ADT disregarded numerous red

flags arising from the dealings with Lopez.40

ADT appeared to accept the implausible name,

conflicting messages, inconsistent numbers on the check, unusual circumstances, and absence

of key documents at face value—rather than probing further into these red flags to determine if

there was a legitimate transaction.41

Consequently, the Court found that there was no evidence

of justifiable reliance on Bank’s representations and concluded that ADT could not prevail on

the common law fraud claim.42

II. Does Code Article 4 Preempt Common Law Breach of Contract Claims?

On the second issue, ADT alleged that Bank’s withdrawal of funds from ADT’s account

was a breach of the deposit agreement and, as a result, Bank breached its common law duty to

perform.43

In Texas, the Code regulates a bank’s handling of deposits and collections for its

customers.44

The agreements between a bank and its customer will also, in part, govern the

relationship.45

However, when the Code applies to this bank-customer relationship, common

law rules regarding breach of contract will not be applicable.46

In rejecting ADT’s breach of contract argument, the Court reasoned that “[w]here the

UCC applies, common law rules regarding breach of contract do not apply”47

and “when the

UCC applies, common law claims that conflict with the UCC are precluded.”48

The Court

found that in the present case—where a chargeback has occurred—the applicable Code

provisions are implicated.49

Any cause of action ADT had for breach of contract was preempted by the Code and as a

result, when the fraudulent check was determined to be counterfeit, Bank was authorized by

the Code to effectuate a chargeback.50

III. Other Holdings

ADT also brought an action for promissory estoppel.51

ADT alleges that Bank consented

39 Am. Dream Team, 481 S.W.3d at 740 (citing Grant Thornton LLP v. Prospect High Income Fund, 314

S.W.3d 913, 923 (Tex. 2010)). 40

Am. Dream Team, 481 S.W.3d at 740–41. 41

Id. (A Chinese business man (CFO) named “Lopez” who purportedly could only communicate through

email due to his poor English, assertions that deposit money had been sent when it had not, the check that had

inconsistent numbers spelled out in words compared to the numerals, a check from an insurance company in Canada

without explanation, and failure to sign the requested representation agreement were red flags that should have put

ADT on alert). 42

Id. at 741. 43

Id. at 732. 44

Id. 45

Id. 46

Id. 47

Id. 48

Id. (emphasis added). 49

Id. (citing TEX. BUS. & COM. CODE ANN. § 4.214(a) (West 2009)). 50

Am. Dream Team, 481 S.W.3d at 732. 51

Id. at 733.

2017] UCC ARTICLE 4 PREEMPTION OF FRAUD & BREACH OF CONTRACT CLAIMS 207

to inform ADT if the check was not good and was damaged when it relied on Bank employees’

statements that the check was good.52

The Court promptly affirmed the trial court’s holding,

reasoning that “if an alleged promise is part of a valid contract [the deposit agreement], the

promisee cannot disregard the contract and sue for reliance damages under the doctrine of

promissory estoppel.”53

Additionally, the Court affirmed the trial court’s ruling that ADT’s

negligent misrepresentation and conversion, as well as their DTPA action, were barred by the

statute of limitations.54

Furthermore, the Court found that the trial court properly granted

summary judgment in favor of Bank on ADT’s claim for money had and received.55

The Court

reasoned that “this common law cause of action has been supplanted by Chapter 4 of the

UCC.”56

CONCLUSION

The Court ultimately affirmed the trial court’s judgment.57

The Court’s holding sustains

the established principle in Texas that the Code preempts common law causes of action that

attempt to supplant the provisions of the Code. However, common law may still play an

important role in supplementing the Code—when appropriate. As a practitioner, it is important

to keep in mind that the Code provisions may sometimes be difficult to apply to every factual

permutation—such as fraud in the check processing procedure—and in these particular

instances, the courts may supplement the Code with common law principles. Still, common

law principles inconsistent with the purposes and policies of the Code will not likely be

considered by the courts.

52 Id.

53 Id.

54 Id. at 733–34.

55 Id. at 733.

56 Id.

57 Id. at 742.


WHETHER AN AGREEMENT TO ARBITRATE DISPUTES IS ILLUSORY

AND THUS UNENFORCEABLE WHEN ONE PARTY HAS THE POWER

TO TERMINATE ITS OBLIGATION AT ANY TIME, EFFECTIVE

IMMEDIATELY WITHOUT ADVANCE NOTICE OF TERMINATION

By Amy Hedgecock*

Nelson v. Watch House Int’l, L.L.C., 815 F.3d 190 (5th Cir. 2016).

Michael Nelson (“Nelson”) filed a lawsuit in federal court alleging he was terminated by

his employer, Watch House International, L.L.C. (“Watch House”), in violation of Title VII of

the Civil Rights Act of 1964 and Chapter 21 of the Texas Labor Code.1 Watch House sought to

enforce an arbitration provision within the employee handbook. However, because the

“Arbitration Plan” provided Watch House could make unilateral changes to the plan without

advance notice to employees, the Fifth Circuit held the arbitration provision was illusory and

Nelson could not be forced to arbitrate his claims.2

Upon receiving an offer of employment, Nelson received a copy of the Employee

Handbook which contained an “Arbitration Plan” (the “Plan”),3 pursuant to which the

employer and employee agreed to arbitrate any and all claims.4 The parts of the Plan that are at

issue are as follows: “the procedures, practices, policies and benefits described here may be

modified or discontinued from time to time;” and “the Company reserves the right to . . .

revoke . . . at any time with or without notice.”5 Any alteration by the employer would be

“immediately effective upon notice to Applicant/Employee of its terms, regardless of whether

it is signed by either Agreeing Party.”6 After having worked for the company for four years,

Nelson claimed that he was terminated shortly after advising his supervisor of continued

religious and racial harassment by his coworkers.7 Nelson filed suit in the United States

District Court for the Northern District of Texas and Watch House moved to compel

arbitration.8 The District Court granted the motion to compel arbitration and dismissed

Nelson’s claims.9 Nelson appealed on the grounds that “the Arbitration Plan is illusory because

it fails to include a savings clause related to existing claims and disputes requiring advance

notice of termination; . . . [and] that Nelson does not fall within the Plan’s definition of

‘employee’ and so is not bound to arbitrate.”10

* Amy Hedgecock is a 2017 J.D. Candidate at South Texas College of Law Houston.

1

Nelson v. Watch House Int’l, L.L.C., 815 F.3d 190, 192 (5th Cir. 2016). 2

Id. at 195–96. 3

Id. at 191. 4

Id. 5

Id. at 192 n.2. 6

Id. at 191–92. 7

Id. at 192. 8

Id. 9

Id. 10

Id.


THE LAW

The parties agreed that Texas law governed,11

and in Texas an arbitration agreement, like

other contracts, “must be supported by consideration.”12

If one party can “avoid its promise to

arbitrate by amending the provision or terminating it all together,” an arbitration clause is

considered illusory in Texas.13

In other words, if one party has “unrestrained unilateral

authority” to alter or even terminate the obligation altogether, the agreement will be found to

be illusory.14

The Fifth Circuit has determined that there is a two-step analysis to determine

whether the parties agreed to arbitration: first, did the parties intend to arbitrate; and second,

whether this particular claim is contained within the arbitration agreement.15

The landmark Texas case regarding an arbitration clause being illusory is In re

Halliburton Co.16

In Halliburton, the Texas Supreme Court focused on two fundamental

provisions: (1) the agreement provided that “no amendment shall apply to a Dispute of

which . . . [employer] had actual notice on the date of amendment,” and (2) that the

“termination shall not be effective until 10 days after reasonable notice of termination is given

to Employees or as to Disputes which arose prior to the date of termination.”17

These two

provisions constituted a “savings clause” that prevented the employer from “avoid[ing] its

promise to arbitrate by amending or terminating [the arbitration agreement] altogether.”18

The

Supreme Court further explained in In re 24R, Inc., that when a “savings clause” forces an

employer to act upon its promise (rather than being able to avoid the promise), the arbitration

agreement is not illusory.19

THE TEST

The Court has created a “simple, three-prong test to determine whether a Halliburton-type

savings clause sufficiently restrains an employer’s unilateral right to terminate its obligation to

arbitrate.”20

An agreement will not be illusory so long as the retained termination power “(1)

extends only to prospective claims, (2) applies equally to both the employer’s and the

employee’s claims, and (3) so long as advance notice to the employee is required before the

termination is effective.”21

The key is that the provision must include both, prospective claims

and advance notice.22

11 Id. at 193.

12 Id. (quoting Lizalde v. Vista Quality Markets, 746 F.3d 222, 225 (5th Cir. 2014), which in turn quoted

Mendivil v. Zanios Foods, Inc., 357 S.W.3d 827, 831 (Tex. App.—El Paso 2012, no pet.)). 13

Nelson, 815 F.3d at 193 (citing Carey v. 24 Hour Fitness, USA, Inc., 669 F.3d 202, 205 (5th Cir.2012),

which in turn quoted In re 24R, Inc., 324 S.W.3d 564, 567 (Tex. 2010)). 14

Nelson, 815 F.3d at 193 (quoting Lizalde, 746 F.3d at 225). 15

Nelson, 815 F.3d at 192–93 (citing Carey, 669 F.3d at 205). 16

In re Halliburton Co., 80 S.W.3d 566 (Tex. 2002). 17

Id. at 569–70. 18

Nelson, 815 F.3d at 193 (citing Carey, 669 F.3d at 206, which in turn quoted Halliburton, 80 S.W.3d at

570)). 19

Nelson, 815 F.3d at 193 (citing In re 24R, Inc., 324 S.W.3d 564, 567 (Tex. 2010), which in turn cited

Halliburton, 80 S.W.3d at 570). 20

Nelson, 815 F.3d at 193–94. 21

Id. (citing Halliburton, 80 S.W.3d at 569–70). 22

Nelson, 815 F.3d at 194.

2017] UNILATERAL TERMINATION OF AGREEMENTS TO ARBITRATE DISPUTES 211

In this case, the Court found that the plan did apply equally to both parties.23

However,

because Watch House could unilaterally make changes to the plan, and there was no

Halliburton-type savings clause which required advance notice of termination, the arbitration

agreement failed the last prong of the Lizalde test and was deemed illusory.24

Because the plan

was illusory, the Court held that Nelson was not bound and could not be compelled to

arbitrate.25

23 Id. at 195.

24 Id.

25 Id. at 196.


COMPELLING ARBITRATION—WHETHER A COURT SHOULD MANDATE ARBITRATION PURSUANT TO AN AGREEMENT WHEN

THE MOVANT CHALLENGES THE FORMATION OF THAT AGREEMENT

By Bryan Aldair Ramirez*

S.C. Maxwell Family P’ship v. Kent, 472 S.W.3d 341 (Tex. App.—Houston [1st Dist.] 2015, no pet.).

Advice: Do not walk into a trap, especially one of your own making. The Maxwell Family Partnership walked into a trap when it sought to compel arbitration of a dispute involving an asserted partnership agreement with the Kents, while at the same time vigorously arguing that the asserted partnership agreement containing the arbitration clause was never formed because of lack of consideration.1 Accordingly, the appellate court affirmed the trial court’s decision in denying the attorney’s motion to compel arbitration.2

I. BACKGROUND

The issue in Maxwell Family Partnership arose from a dispute between the Maxwell Family Partnership and the Kents. Originally, the Kents had received a letter from the Maxwell Family Partnership, which stated that “the partnership agreement between them was invalid.”3 Thereafter, the Kents filed a declaratory-judgment action, claiming that the partnership agreement was valid.4 The Kents alleged that according to the partnership agreement’s terms, they were “50% owners of a self-storage facility in Brenham, Texas.”5 During the trial court proceedings, the Maxwell Family Partnership acknowledged that an agent of its general partner had executed the partnership agreement, but asserted a defense of lack of consideration.6 It also asserted several defenses, attacking the validity of the partnership agreement including fraud and fraud in the inducement, and failure of consideration.7 The Maxwell Family Partnership filed a motion asking the trial court to compel arbitration of the parties’ dispute.8 In the motion, the Maxwell Family Partnership stated that since failure of consideration and lack of consideration were present, the partnership agreement was never in existence.9 Furthermore, the Maxwell Family Partnership argued that “the validity of the partnership agreement with the Kents were issues for the arbitrator to decide.”10 The trial court disagreed with the Maxwell Family Partnership and denied its motion to compel arbitration.11

* Bryan Aldair Ramirez, 2017 J.D. Candidate at South Texas College of Law Houston. 1 S.C. Maxwell Family P’ship v. Kent, 472 S.W.3d 341, 342–43 (Tex. App.—Houston [1st Dist.] 2015, no

pet.). 2 Id. at 345. 3 Id. at 343. 4 Id. 5 Id. 6 Id. 7 Id. 8 Id. 9 Id. 10 Id. 11 Id.


An interlocutory appeal followed, in which the Maxwell Family Partnership alleged the trial court had erred in its decision.12

II. COURT OF APPEALS FOR THE FIRST DISTRICT OF TEXAS ANALYSIS

On appeal, this Court reviewed the trial court’s decision “for an abuse of discretion deferring to the trial court’s factual determinations if they [were] supported by the evidence and review[ed] legal determinations de novo.”13 The court of appeals began its review by stating that in the parties’ partnership agreement, the built-in arbitration clause specifically cited to the Texas Arbitration Act (“TAA”).14 Nevertheless, the court of appeals resorted to decisions in its review addressing both the Federal Arbitration Act (“FAA”) and the TAA, since neither the Maxwell Family Partnership nor the Kents argued the FAA preempted the TAA.15

Section 171.021(a) of the Texas Civil Practice and Remedies Code provides that if a movant wants to succeed on a motion to compel arbitration, the movant must establish at the outset “an agreement to arbitrate and the opposing party’s refusal to arbitrate.”16 If a movant is not able to prove that an agreement to arbitrate exists, then the movant will be unsuccessful in compelling arbitration, even when “Texas law strongly favors arbitration.”17 While the Maxwell Family Partnership alleged that the issue confronting the arbitration provision within the partnership agreement was to be left for the arbitrator to decide, the Prima Paint separability doctrine provides a different proposition.18 According to the Prima Paint separability doctrine, “an arbitration provision is separable from the rest of a contract, such that a challenge to the validity of the entire contract is a question for the arbitrator, while a challenge directed specifically to the arbitration provision may be resolved by a court.”19 The Texas appellate courts have applied this separability doctrine to those agreements governed by the TAA.20

In accordance with this doctrine, when a movant seeking to compel arbitration raises issues on the existence of a contract, the question then becomes, whether those issues impact the contract’s ‘formation’ or the contract’s ‘validity.’21 Under Texas law, the Texas Supreme Court “has held that ‘where the very existence of a contract containing the relevant arbitration agreement is called into question, the . . . courts have authority and responsibility to decide the

12 Id. 13 Id. 14 Id. 15 Id. 16 See TEX. CIV. PRAC. & REM. CODE ANN. § 171.021(a) (West 2011). 17 Maxwell Family Partnership, 472 S.W.3d at 343–44. 18 Id. at 344. 19 Id. (citing Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 404 (1967)). 20 See, e.g., id.; Women’s Reg’l Healthcare, P.A. v. FemPartners of N. Tex., Inc., 175 S.W.3d 365, 368 (Tex.

App.—Houston [1st Dist.] 2015, no pet.); Saxa Inc. v. DFD Architecture Inc., 312 S.W.3d 224, 229 n.4 (Tex. App.—Dallas 2010, pet denied).

21 Maxwell Family Partnership, 472 S.W.3d at 344.

2017] CHALLENGES TO THE FORMATION OF AN ARBITRATION AGREEMENT 215

matter.’”22 Therefore, if the movant’s claim solely attacks the contract’s very formation, such as a signor lacking the authority or capacity to execute the contract, then these issues are to be resolved by the court.23 However, if the movant’s claim deals solely with the contract’s validity, then the arbitrator could resolve those issues without the intervention of the court.24

As previously mentioned, the Maxwell Family Partnership was the movant who sought to compel arbitration in this case.25 To be successful, the Maxwell Family Partnership had to satisfy the burden as stated in section 171.021(a) of the Texas Civil Practice and Remedies Code, namely by proving the existence of “an agreement to arbitrate.”26 However, the Maxwell Family Partnership initially repudiated the contract’s formation by claiming that it lacked consideration.27 Also, the Maxwell Partnership repudiated the contract’s validity by asserting fraud and fraud in the inducement.28 This Court noted that if the Maxwell Family Partnership’s claims had solely been directed to the validity of the contract that was formed, the arbitrator could then have decided such issues on its own.29 That was not case here, however.

In his opinion, Justice Massengale placed emphasis on how persistent the Maxwell Family Partnership was in reiterating the lack of consideration claim.30 Not only did the Maxwell Family Partnership mention this lack of consideration claim in its pleadings, but also “reiterated that it was challenging the agreement on the basis of a lack of consideration” at the hearing on its motion to compel arbitration and on appeal.31 The evidence undoubtedly showed that the Maxwell Family Partnership had attacked the formation of a valid contract. This evidence presented the Maxwell Family Partnership with a roadblock, as its goal had been to compel arbitration from the beginning.32

This Court noted that when the central issue was to determine whether the parties in dispute had agreed to arbitrate, “courts generally . . . should apply ordinary state-law principles that govern the formation of contracts.”33 Moreover, under Texas contract law, consideration is required for the formation of a valid contract.34 The Maxwell Family Partnership presented this “lack of consideration” argument to the appellate court while hoping that it would enforce the arbitration clause in the partnership agreement that it had made with the Kents.35 However, the

22 Id. (citing In re Morgan Stanley & Co., 293 S.W.3d 182, 187 (Tex. 2009) (orig. proceeding)). 23 Id. 24 Maxwell Family Partnership, 472 S.W.3d at 344. 25 Id. 26 Id. (citing TEX. CIV. PRAC. & REM. CODE ANN. § 171.021(a) (West 2011)). 27 Id. 28 Id. 29 Id. 30 See id. 31 Id. (“On appeal, [the Maxwell Family Partnership] stated again that it ‘reserved the right to attack the

partnership agreement on the basis that . . . there was a failure of consideration or lack of consideration for the agreement.’”).

32 Id. 33 Id. at 344–45. 34 Id. at 345. 35 Id.


lack-of-consideration claim “undermine[d] the very existence of that contract, [and therefore] it was a matter for the court to resolve.”36 When the trial court denied the Maxwell Family Partnership’s motion to compel arbitration, it was within its discretion to decide on the matter.37

The Maxwell Family Partnership presented a second argument in its appellate brief, alleging the trial court should have allowed for arbitration because the Kents never denied the existence of the agreement.38 However, section 171.021(b) of the Texas Civil Practice and Remedies Code did not support the Maxwell Family Partnership’s assertion.39 As Judge Massengale highlighted, “the Kents [did] not deny the existence of the agreement, but instead affirmatively [sought] to confirm the agreement’s existence and validity.”40 Consequently, the Maxwell Family Partnership was unsuccessful with this second claim.41

Finally, the Maxwell Family Partnership asserted the Kents had admitted during the trial setting that arbitration was appropriate and therefore, this was enough to enforce the arbitration clause.42 The record showed the Kents’ counsel had in fact stated: “if there’s a valid Partnership Agreement, I fully agree.”43 This conditional statement, however, did not suggest conclusively that the Kents had admitted to allowing arbitration to occur.44 But even if the Kents’ counsel had provided a statement admitting that arbitration was appropriate, the focus on appellate review was on the issue pertaining to the formation of the contract.45 For these reasons, the Court of Appeals overruled the Maxwell Family Partnership’s sole issue.46

III. CONCLUSION

In Maxwell Family Partnership, the movant argued from the outset that it wanted to compel arbitration.47 But to do so, the Maxwell Family Partnership alleged that the contract was non-existent by attacking both its validity and its formation.48 Had the Maxwell Family Partnership solely brought forth claims attacking the validity of the contract, such as by alleging fraud and fraud in the inducement, these issues would have then been left for an

36 Id. 37 Id. 38 Id. 39

If a party opposing an application made under Subsection (a) denies the existence of the agreement, the court shall summarily determine that issue. The court shall order the arbitration if it finds for the party that made the application. If the court does not find for that party, the court shall deny the application.

TEX. CIV. PRAC. & REM. CODE ANN. § 171.021(b) (West 2011). 40 Maxwell Family Partnership, 472 S.W.3d at 345. 41 Id. 42 Id. 43 Id. 44 Id. 45 Id. 46 Id. 47 Id. at 342. 48 Id. at 344–45.

2017] CHALLENGES TO THE FORMATION OF AN ARBITRATION AGREEMENT 217

arbitrator to decide.49 However, the Maxwell Family Partnership also attacked the formation of the contract.50 Raising the issue that the contract lacked consideration gave the trial court the “authority and responsibility to decide the matter”.51 Therefore, the First Court of Appeals affirmed the trial court’s decision to deny the Maxwell Family Partnership’s motion to compel arbitration, as the “trial court correctly could have concluded that it failed to satisfy its initial burden to establish the existence of an enforceable arbitration agreement.”52

49 Id. at 344. 50 Id. 51 Id. 52 Id. at 345.

Documents

T E X A Sweb1.amchouston.com/flexshare/003/BusinessLaw/Journal/TJBL_Is… · t e x a s j o u r n a l o f b u s i n e s s l a w vol. 47, no. 1 winter 2017 does halliburton ii allow