This article explores the unique issues of applying the statute of limitations under Texas law to shareholder deriviative suits and shareholder oppression suits.
You may download the full article in pdf format and other resources by joining the Shareholder Oppression Discussion Group and clicking on Files.
A. Discovery Rule
Generally, a cause of action accrues, and the statute of limitations begins to run, when facts come into existence that authorize a claimant to seek a judicial remedy. Johnson & Higgins of Texas, Inc. v. Kenneco Energy, Inc., 962 S.W.2d 507, 514 (Tex.1998). The discovery rule is a limited exception which tolls the accrual of a cause of action which applies if, “the nature of the injury incurred is inherently undiscoverable and the evidence of injury is objectively verifiable.” Via Net v. TIG Ins. Co., 211 S.W.3d 310, 313 (Tex. 2006).
1. Applicability of Discovery Rule
The general statement of the discovery rule is that limitations begins to run when the cause of action is discovered or, by the exercise of reasonable diligence should have been discovered. Courseview, Inc. v Phillips Petroleum Co., 312 S.W.2d 197, 205 (Tex. 1957); In re Fawcett, 55 S.W.3d 214, 219 (Tex. App.—Eastland 2001, pet. denied) (“The issue in a breach of fiduciary duty case is, thus, when the plaintiff knew or should have known, with the exercise of reasonable diligence, of the legal injury giving rise to the right to sue.”). The existence of a fiduciary relationship does not change the rule that diligence in discovering the breach of fiduciary duty or fraud is required, but the existence of a fiduciary relationship affects the application of the rule. G. Property Mgt., Ltd. V. Multivest Financial Serv. Of Texas, Inc., 219 S.W.3d 37, 48-49 (Tex. App.—San Antonio 2006, no pet) (citing Courseview, Inc. v. Phillips Petroleum Co., 312 S.W.2d at 205).
2. Relaxed Diligence Standard
"The mere fact that the defrauded party has the opportunity or power to investigate the fraud, is not sufficient to charge him with notice of the fraud, so as to start the running of the statute of limitations." Bush v. Stone, 500 S.W.2d at 890. For example, while parties are ordinarily charged with knowledge of evidence in the public record, this is generally not the case in a fiduciary relationship. See Zimmerman v. First Am. Title Ins. Co., 790 S.W.2d 690, 699-700 (Tex. App.—Tyler 1990, writ ref’d n.r.e.).
3. Near Actual Knowledge Required
A cause of action for injury to the property of a corporation or for impairment or destruction of its business is vested in the corporation, as distinguished from its shareholders. Redmon v. Griffith, 202 S.W.3d 225, 236 (Tex. App.—Tyler 2006, pet. denied) (citing Davis v. Sheerin, 754 S.W.2d 375, 381 (Tex. App.—Houston [1st Dist.] 1988, writ denied)); see Murphy v. Campbell, 964 S.W.2d 265, 268 (Tex.1997); Hajdik v. Wingate, 753 S.W.2d 199, 201 (Tex. App.—Houston [1st Dist.] 1988), aff'd, 795 S.W.2d 717 (Tex.1990). To recover for wrongs done to the corporation, the shareholder must bring the suit derivatively in the name of the corporation so that each shareholder will be made whole if the corporation obtains compensation from the wrongdoer. Redmon, 202 S.W.3d at 236-37 (citing Faour v. Faour, 789 S.W.2d 620, 621-22 (Tex. App.—Texarkana 1990, writ denied)). In a derivative suit, the shareholder brings the claim in a representative capacity. The real party in interest is the corporation, not the plaintiff shareholder. Therefore, under the discovery rule, the cause of action would accrue when the corporation, not merely the plaintiff shareholder, discovers the claim.
B. Adverse Domination
When does the corporation (which presumably would be charged with knowledge of all the activities of its officers and directors) receive notice of a breach of fiduciary duty? See, e.g., FDIC v. Shrader & York, 991 F.2d 216, 222 (5th Cir. 1993); FDIC v. Ernst & Young, 967 F.2d 166, 170 (5th Cir. 1992). In International Bankers Life Ins. Co. v. Holloway, 368 S.W.2d 567, 580 (Tex. 1963), the Supreme Court held that notice to the corporation for purposes of the statute of limitations is notice to its disinterested officers and directors rather than notice to the wrongdoers of their own conduct. This holding was considered at length by the Austin Court of Appeals in Allen v. Wilkerson, 396 S.W.2d 493 (Tex. Civ. App.-Austin 1965, writ ref’d n.r.e.). In Allen, a creditor of a defunct corporation sought to enforce a cause of action belonging to the corporation against one of its former directors for misappropriation of corporate assets. The former director defended on the grounds that limitations had run on the cause of action. The Court held: "In order for limitations to run against a corporation’s right of action against one of its own directors, two things must concur: (1) notice (2) to a disinterested majority of its board of directors. " Id at 500. The Allen Court affirmed a judgment for the creditor because there was sufficient evidence that the corporation had never had a disinterested majority on its board of directors after its cause of action arose; therefore, limitations never ran. Thus, under the doctrine of adverse domination, if a disinterested majority of directors does not exist, then limitations never begins to run. This doctrine of adverse domination has been clearly recognized as controlling Texas law in recent federal decisions. E.g., Askanase v. Fatjo, 130 F.3d 657, 666 (5th Cir. 1997); FDIC v. Henderson, 61 F.3d 421, 426-27 (5th Cir. 1995); FDIC v. Dawson, 4 F.3 d 1303, 1309 (5th Cir. 1993), cert. denied, 114 S. Ct. 2673 (1994).
1. Notice Is to Disinterested Directors Only
The disinterestedness of officers and directors of a corporation is a fact issue. See International Bankers Life Ins. Co. v Holloway, 368 S.W.2d at 580. "In short, interestedness or disinterestedness does not turn on any technical form of legal status; it is a substantial fact question." Allen v. Wilkerson, 396 S.W.2d at 501. See also FDIC v. Dawson, 4 F.3d 1303, 1309 (5th Cir. 1993), cert. denied, 114 S. Ct. 2673 (1994). However, the plaintiff shareholder does have the burden of proof that a majority of the board are not disinterested. Askanase v. Fatjo, 130 F.3d at 666; FDIC v. Henderson 61 F.3d at 426.
2. Proving Absence of Disinterested Majority
3. Shareholder’s Knowledge Is Irrelevant
In a shareholders' derivative action, however, while the corporation might not legally have had notice of the wrong-doing, the shareholder initiating the suit might have had knowledge of the wrongdoing outside the limitations period. No Texas case has addressed the application of the tolling of limitations in the context of derivative actions, but the reasoning of the controlling authorities leads to the conclusion that prior notice of the claims to individual shareholders does not necessarily bar the derivative action. This conclusion is based, first, on the important principle that derivative claims belong exclusively to the corporation and not to the shareholders initiating the action. Eye Site, Inc. v. Blackburn, 796 S.W.2d 160, 161 (Tex. 1990); Wingate v. Hajdik, 795 S.W.2d 717, 718 (Tex. 1990); El T Mexican Rest., Inc. v. Bacon, 921 S.W.2d 247, 251 (Tex. App.-Houston [1st Dist.] 1995, writ filed); In re Thurmond, 888 S.W.2d 269, 280 (Tex. App.–Amarillo 1994, writ denied). The shareholders of a corporation are not agents of the company, and their knowledge is not imputed to the corporation. RTC v. Fleischer, 890 F. Supp. 972, 977-78 (D. Kan. 1995); Wathen v. Greencastle Skate Place, Inc., 606 N.E.2d 887, 891 (Ind. App. 1993). A shareholder has no power to act for or to bind the corporation. Accent Energy Corp. v. Gillman, 824 S.W.2d 274, 278 (Tex. App.-Amarillo 1992, writ denied); Liken v. Shaffer, 64 F. Supp. at 442. An individual shareholder cannot settle, release or ratify a wrong done to the corporation by a director. Allen v. Wilkerson, 396 S.W.2d at 501; RTC v. Fleischer, 890 F. Supp. at 978.
Under the Texas law of adverse domination, notice to the shareholders should be immaterial for purposes of limitations: “And where, as here, the management of a corporation's affairs are de facto under the domination and control of the adversary of such cause of action, or the corporation is de facto powerless to sue on such cause of action because of the lack of a disinterested majority of its board, mere notice to shareholders does not start running of limitations against the corporate cause of action.” Allen v. Wilkerson, 396 S.W.2d at 502 (emphasis added). This principle is accepted in other jurisdictions. RTC v. Fleischer, 890 F. Supp. 972, 977-78 (D. Kan. 1995) ("Generally, the knowledge of a particular shareholder or shareholders is not material in considering the statute of limitations as a bar to a claim of the corporation itself"); Liken v. Shaffer, 64 F. Supp. 432, 442 (N.D. Iowa 1946) ("The knowledge or lack of knowledge of an individual stockholder not connected with a corporation other than as a stockholder is not material in considering the statute of limitations as a bar to the claim of the corporation itself"); Whitten v. Dabney, 171 Cal. 621, 629, 154 P. 312, 315 (Cal. 1915) (Notwithstanding notice of fraud to shareholders, "[s]o long as the corporation itself remains ... in the hands of a board of directors accused of participation in the frauds, the statute of limitations does not run against it."); Golberg v. Berry, 231 A.D. 165, 247 N.Y.S. 69, 75 (N.Y. App. 1930) ("in a stockholder's [derivative] action of this kind, knowledge of the facts by one stockholder will not defeat the cause of action which belongs to the corporation.")
The argument that the doctrine of adverse domination should not apply when the shareholder could have earlier prosecuted the claim by a derivative action was made by the former director in Allen v. Wilkerson and was rejected by the Court: “Whatever right Chester Lankford [a shareholder and director] might have somehow perfected to bring a shareholders derivative suit for recovery on a corporate cause of action, he himself could neither have expressly released such cause of action, nor have sued directly on the cause of action, which belonged to the corporation and was under the control of its board of directors.” 396 S.W.2d at 501.
Some other jurisdictions have applied the adverse domination doctrine in a way that might preclude its application in derivative suits. See, e.g., RTC v. Grant, 901 P.2d 807 (Okla. 1995). Texas follows what has been termed the "majority test" theory of adverse domination in which adverse domination tolls the statute of limitations when a majority of the board of directors are adverse to the cause of action. FDIC v. Dawson, 4 F.3d at 1310. The competing theory, which has been adopted by some jurisdictions, is called the "complete domination test." Id. at 1309. The leading case on this theory is International Rys. v. United Fruit Co., 373 F.2d 408 (2nd Cir. 1967); cert. denied, 587 U.S. 921 (1967). This theory requires proof that the corporation is in the "full, complete and exclusive control" of the defendants and requires that the plaintiffs to "negate the possibility that an informed stockholder or director could have induced the corporation to sue." Id. at 414. Under the "complete domination test," adverse domination would generally not apply in a derivative case, but that test is simply not the law in Texas. FDIC v. Dawson, 4 F. 3d at 1310; FDIC v. Howse, 736 F. Supp. 1437, 1443 (S.D.Tex. 1990).
Furthermore, there is no policy reason for requiring shareholders to use the same diligence in enforcing corporate claims that the law imposes on officers and directors. A shareholder has no duty to protect the corporation or to institute a derivative action. RTC v. Fleischer, 890 F. Supp. at 978; Whitten v. Dabney, 171 Cal. at 629, 154 P. at 315. A shareholder is free to act in his own self interest. RTC v. Fleischer, 890 F. Supp. at 978; Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 958 (Del. 1985). Furthermore, the shareholder's right to bring a derivative suit is far from unfettered. The shareholder must first make demand on the corporation and be prepared to show that the corporation's refusal to act is the result of more than unsound business judgment. Zauber v. Murray Sav. Ass’n, 591 S.W.2d 932, 936 (Tex. Civ. App.-Dallas 1979), writ ref’d 601 S.W.2d 940 (Tex. 1980). The rules of procedure governing derivative actions are "designed to prevent shareholders from interfering with legitimate discretion in corporate governance.“ Eye Site, Inc. v. Blackburn, 796 S.W.2d at 161.
A corporation that is dominated by dishonest officers and directors is considered by the law to be under a "disability" similar to that of a minor or mentally incompetent party. See Whitten v. Dabney, 154 P. at 315. A shareholder who brings a derivative action to assert a cause of action for the corporation is the same representative capacity as a guardian or parent who brings an action as "next friend" on behalf of a minor or incompetent. “The cause of action which such a plaintiff brings before the court is not his own but the corporations. It is the real party in interest and he is allowed to act in protection of its interest somewhat as a "next friend" might do for an individual, because it is disabled from protecting itself.” Koster v. American Lumbermens Mut. Cas. Co., 330 U.S. 518, 522-23, 67 S. Ct. 828, 831 (1947); see also ZB Holdings, Inc. v. White, 144 F.R.D. 42, 47 (S.D.N.Y. 1992) (“The shareholder has no standing to assert the claim for the shareholder's personal benefit but is permitted to step into the corporation's shoes and assert that right on behalf of the corporation as a sort of next friend.”). Texas law is clear that the knowledge or lack of diligence by one who brings an action in a representative capacity does not affect tolling of limitations. In a suit brought by the next friend for a minor, the minor and not the next friend is the real plaintiff. Safeway Stores v. Rutherford, 111 S.W.2d 688, 689 (Tex. 1938); Hopkins v. Spring Ind Sch. Dist., 706 S.W.2d 325, 326 (Tex. App.-Houston 1986), aff’d 736 S.W.2d 617 (Tex. 1987). The Supreme Court has held that the capability of a parent to bring a suit within the two year limitations period does not affect the tolling of limitations on the claim of a minor. Weiner v. Wasson, 900 S.W.2d 316, 319-20 (Tex. 1995). In Hopkins v. Spring Ind. Sch. Dist., 706 S.W.2d at 326, the knowledge of the accident by the mother who brought suit as next friend for her daughter did not affect the tolling of limitations. In Simpson v. City of Abilene, 388 S.W.2d 760, 762 (Tex. Civ. App.-Eastland 1965, writ ref’d n.r.e.), claims brought by the father as next friend for his son were not barred by limitations even though the father's individual claims arising from the same accident were barred by limitations. Similarly, the corporation's rights in connection with a claim asserted in its behalf in a stockholders’ derivative suit are the same as if the corporation sued directly. Liken v. Shaffer, 64 F. Supp. at 441. “Where a claim is asserted in behalf of a corporation in a stockholders derivative action in order for matters to be a bar to the claim, they must be such matters as relate to the corporation itself, and the conduct of a particular stockholder is not material.” Id at 442.
The only reported Texas authority which reaches an inconsistent result is Alice Roofing & Sheet Metal Works, Inc. v. Halleman, 775 S.W.2d 869 (Tex App.–San Antonio 1989, no writ). In that case, a cause of action brought by the new owners of a corporation against the former owners was held to be time-barred. The court reasoned that a change in ownership did not re-start the limitations clock after it has run. Id. at 870. The court did not consider whether the running of the limitations clock had been tolled for any period of time. This case has been held not to be applicable to a claim of adverse domination. “Alice Roofing did not involve the adverse domination rule.... Although the adverse domination rule might have been relevant, nothing in the opinion indicates that appellants argued adverse domination before either the trial court or the court of appeals." FDIC v. Brown, 1992 WL 677891, at *3 (S.D. Tex. 1992). The recent unreported Texas case of Gibney v. Culver, 2008 WL 1822767 (Tex. App.—Corpus Christi 2008, no pet.), likewise reaches an inconsistent result on the facts, but without mention or consideration of the doctrine of adverse domination. [This case is analyzed on the 10/21/08 post on the Shareholder Oppression Blog. Click here to view.]
While delay on the part of a shareholder does not affect the corporation’s claim, unreasonable delay may be relevant on the issue of whether the individual shareholder may represent the corporation in the derivative action. 20 R. Hamilton, Texas Practice: Business Organizations § 839, at 360-61 (1973). One court has held: “Thus, a particular stockholder who institutes a stockholder's derivative suit, may have participated in the wrong complained of, or may have ratified the wrong complained of or acquiesced in it, or have had knowledge of the wrong complained of under circumstances which would make him guilty of laches. In such cases, a court of equity will not recognize him as a proper suitor in a court of equity and will abate the action without reference to the merits of the claim sought to be asserted in behalf of the corporation.” Liken v. Shaffer, 64 F. Supp. at 442. Limitations, however, is not the issue. The shareholder's right to represent the corporation is not a cause of action for which there is a limitations period. It is an equitable remedy to allow the bringing of a claim belonging to the corporation. See Meyer v. Fleming, 327 U.S. 161, 167, 66 S.Ct. 382, 386 (1946). A challenge to a shareholder's representative status must be pleaded under the doctrine of laches. Liken v. Shaffer, 64 F. Supp. at 442; R. Hamilton, supra at § 839, at 361. Moreover, laches requires proof of more than mere delay. The defendant directors must also prove that the delay was unreasonable, and that the defendants changed their position to their detriment in good faith because of that delay. Rogers v. Ricane Enterps., Inc., 772 S.W.2d 76, 80 (Tex. 1989); City of Fort Worth, 388 S.W.2d 400, 403 (Tex. 1964). The defense of laches and undue delay are factual, not legal questions. Sawyer v. Getz, 398 S.W.2d 376, 378 (Tex Civ. App.–Eastland 1965, writ ref'd n.r.e.). Furthermore, laches must be proved against every shareholder involved in the derivative action. "The fact that one stockholder has discovered fraud and is guilty of laches does not prevent another stockholder who is not guilty of laches from instituting a stockholder's derivative suit." Liken v. Shaffer, 64 F. Supp. at 442; see also Whitten v. Dabney, 171 Cal. at 629, 154 P. at 316 ("that the plaintiff stockholder has waited too long before commencing his action, . . . does not operate as a bar to the corporate rights when prosecuted by another stockholder."). Even if every plaintiff is guilty of laches, the remedy is not to bar the claim of the corporation but to abate this action to allow another shareholder to intervene. Liken v. Shaffer, 64 F. Supp. at 442.
4. Laches May Disqualify Shareholder as Representative