This article explores the legal theory of the shareholder oppression cause of action in Texas--what interests and duties are protected, when, and why.
The corporate structure allows the owners of a business to shield themselves from liability for debts incurred by the business, to document and 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 actively, 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.” Hoagland ex rel. Midwest Transit, Inc . Sandberg, Phoenix & von Gontard, P.C., 385 F.3d 737, 747 (7th Cir. 2004). Because ownership is split up into shares, it is also usually the case that certain shareholders will have minority ownership interests in the corporation.
A. Nature of the Corporation
Texas corporate law provides for centralized control of corporate affairs through directors elected by the shareholders and for majority rule on elections and most matters submitted to a shareholder vote. The business corporations statute states that “the business and affairs of a corporation shall be managed under the direct of the board of directors of the corporation.” TBCA art. 2.31; BOC §§ 3.101, 21.401. These 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. TBCA art. 2.32 (A), (C); BOC §§ 21.405, 21.409. Therefore, whoever controls the majority of the shares, controls who runs the company. In most smaller corporations, a shareholder may only own 51% of the shares, but because of the doctrine of majority rule, that shareholder can place himself in 100% control of 100% of the corporate assets.
B. Principle of Majority Rule
C. The Phenomenon of Shareholder Oppression
In publicly-held corporations, shareholders may buy and sell stock with essentially no interaction with the business of the corporation or its management and may participate in the financial success of the business both by receipt of dividends and enjoyment of the increasing 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. In public corporations, with a broad and diversified base of shareholders, the principles of centralized control and majority rule rarely present a significant opportunity for abuse of individual minority shareholders. Furthermore, shareholders of public companies are also protected by a web of regulations 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 publicly held. By far, most are so-called “close” or closely-held corporations, which are largely unregulated, and where the dynamics of the interaction between management and owners is much different.
1. Vulnerability of Minority Shareholders in Closely-Held Corporations
“Oppressive conduct” is conduct that destroys or substantially impairs or diminishes the value of a minority shareholder’s ownership interest in the corporation by reducing or eliminating any economic benefit of ownership, by systematically violating the rights and duties associated with share ownership, and by otherwise defeating the reasonable expectations of the shareholders as to ownership of the shares. This type of conduct can take many forms and appear 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 expense of the minority. 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. More often, the motivation for oppressive conduct is personal conflict among the majority and minority shareholders.
2. Oppressive Conduct by Controlling Shareholders
The concept in Texas law of oppressive conduct of majority shareholders comes from the statutes providing for the appointment of a receiver for rehabilitation or dissolution of corporations. TBCA art. 7.05(A)(1)(c) (now also BOC §11.404(a)(1)(c)) permits a district court to appoint a receiver in an action brought by a receiver upon a showing that “the acts of the directors or those in control of the corporation are illegal, oppressive or fraudulent.” Very little case law exists interpreting this statute. However, courts have held that it is an extreme remedy, only to be utilized when there is no other way to protect the rights of the minority shareholders.
“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.” Hammond v. Hammond, 216 S.W.2d 630, 633 (Tex. Civ. App.—Fort Worth 1949, no writ).
For the most part, Texas has always recognized that actions for wrongful conduct in the management or control of a corporation may not be asserted directly by the shareholders. See Commonwealth of Massachusetts v. Davis, 168 S.W.2d 216, 221 (Tex. 1943) (“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.”). However there has always been a recognized exception “where the wrongdoer violates a duty arising from contract or otherwise, and owing directly by him to the stockholder.” Id. at 222. In the landmark case of Cates v. Sparkman, 11 S.W. 846 (Tex. 1889), the Texas Supreme Court upheld the dismissal of a minority shareholder lawsuit against the directors and majority shareholders of the corporation. In that case, the plaintiff owned lands with coal deposits. The plaintiff entered into an agreement with the defendants to develop the coal deposits. The defendants formed a corporation, and the plaintiff exchanged his title to the land for stock in the corporation. The defendants began development of the mining project, but apparently ran out of money and shut it down—thus leaving the plaintiff with no land and near worthless stock in a company that was out of business. The plaintiff filed suit claiming that the defendants breached duties owed to him as a shareholder. The Texas Supreme Court upheld the dismissal of the action on the basis of the business judgment rule: “The breach of duty authorizing a suit by an individual stockholder for damage in the depreciation of his stock does not refer to mere mismanagement or neglect of the officers or directors in the control of the corporate affairs, or the abuse of discretion lodged in them in the conduct of the company's business. On this ground the courts do not interfere. … If the acts or things [challenged by a 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.” Id. at 849. This ruling continues to be cited as the classic statement of the business judgment rule in Texas jurisprudence. See Pace v. Jordan, 999 S.W.2d 615, 623 (Tex. App—Houston [1st Dist.] 1999, pet. denied); Langston v. Eagle Pub. Co., 719 S.W.2d 612, 617 (Tex. App.—Waco 1986, writ ref’d n.r.e.); Gearhart Indus., Inc. v. Smith Int’l, Inc., 741 F.2d 707, 721 (5th Cir. 1984); TTT Hope, Inc. v. Hill, 2008 WL 4155465 (S.D. Tex. 2008);FDIC v. Benson, 867 F.Supp. 512, 516 n.2 (S.D. Tex. 1994).
B. Duties Owed Directly to Shareholders
In the 1980s, Texas courts began drawing on this prior line of authority, together with case law and statutory developments in other states, to fashion a new cause of action for “shareholder oppression.” The shareholder oppression cause of action is unusual among traditional causes of action in the corporate context in a number of ways: First, the claim is based upon legal duties of loyalty that are found to exist among shareholders of a corporation. Much of the prior case law cast doubt on the existence of such duties. Second, unlike the traditional view of misconduct among corporate insiders, this cause of action belongs to the individual shareholder and does not need to be asserted through a derivative action. Individual shareholders may now seek a remedy for types of wrongdoing that were once shielded from a shareholder suit by problems of standing and other procedural hurdles. Third, the standard of conduct is not well-defined, is largely subjective, and may even involve a pattern of oppressive conduct made up of individual acts that are otherwise either not actionable or cause no real harm in and of themselves. Fourth, the usual remedy for oppression, a forced buy-out, allows the minority shareholder to receive a monetary award, not based on the amount of the plaintiff’s loss, but based on the “fair value” of the plaintiff’s stock. Thus, a plaintiff who has suffered no actual monetary damages may still be entitled to a substantial monetary award. Moreover, the judicially-determined “fair value” may have little relationship to an actual cash market value of the minority interest. Absent this judicial remedy, the minority shareholder typically could not sell the stock perhaps at any price, but certainly not for a price approaching the “fair value” available from the court. Finally, the shareholder oppression cause of action introduces apparent exceptions to or at least modifications of other well-established legal principles, including the doctrine of centralized control of corporations, majority rule, the business judgment rule, and at-will employment. See generally D. Moll, Majority Rule at 438.
C. Advent of New Legal Theory
The first case among the recent series of shareholder oppression cases was Duncan v. Lichtenberger, 671 S.W.2d 948 (Tex. App.—Fort Worth 1984, writ ref’d n.r.e.). This case is something of a mystery in its reasoning. It can only be understood as shareholder oppression case, but the court uses different (and probably incorrect) terminology. The court affirms a trial court judgment in favor of the two minority shareholders of a corporation (20% each) against the majority shareholder (60%) for breach fiduciary duties owed directly to them. Id. at 954. In affirming the holding that the majority shareholder owed a fiduciary duty to the minority shareholders, the court cited Canion v. Texas Cycle Supply, Inc., 537 S.W.2d 510, 513 (Tex. Civ. App.—Austin 1976, writ ref'd n.r.e.), for the proposition that corporate directors owe fiduciary duties to the corporation and its shareholders. The court clearly misapplied that authority to hold that there is a fiduciary running from a majority shareholder to the minority shareholders individually. See 671 S.W.2d at 952. However, the court also relied on Patton v. Nicholas, 279 S.W.2d 848 (Tex. 1955), which clearly does recognize individual duties from majority shareholders to minority shareholders. See 671 S.W.2d at 953.
1. Duncan v. Lichtenberger
The Houston case of Davis v. Sheerin, 754 S.W.2d 375, 377-78 (Tex. App.—Houston [1st Dist.] 1988, writ denied), was the first Texas case truly to define the shareholder oppression cause of action in Texas and remains the leading case in Texas jurisprudence. In that case, the Texas corporation, W.H. Davis Co., was formed in 1955 and was owned by two shareholders, William Davis, 55%, and James Sheerin, 45%. Both Davis and Sheerin 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. Davis’ wife, Catherine, was also employed by the corporation, and was apparently also a director. In 1985, Sheerin sued both William and Catherine Davis claiming shareholder oppression. Sheerin sued only in his individual capacity, and the corporation does not appear to have been made a party. 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. Id. at 377. The lawsuit also involved claims arising from a separate real estate partnership, but those claims are not relevant to this discussion.
2. Davis v. Sheerin
The next significant oppression case decided in Texas also came out of the First Court of Appeals: Willis v. Bydalek, 997 S.W.2d 798 (Tex. App.—Houston [1st Dist. 1999], pet. denied). In the Willis v. Bydalek case, Joseph Bydalek and Robert Fox formed RMF&JB Corporation to buy and run a bar in Huntsville, Texas. Id. at 799. Bydalek owned 49%, and Fox owned 51% of the stock. Bydalek invested $31,000. Id. Fox must also have invested initially, but this is not discussed in the appellate opinion. However, Fox’s estate later infused at least an additional $59,000 in the company. Id. at 800. Bydalek and his wife ran the day-to-day operations of the corporation, kept the books, and were the only shareholders to draw a salary. Id. About the same time the club opened, Fox was killed in a car accident, and his sister Jeannine Willis took over his stock ownership as Administratrix of his estate. Id. Over the next five months, relations soured; the club had difficulties with the renewal of its alcohol license, and the club lost money. Id. Willis called a special shareholders’ meeting, which Bydalek did not attend. It was disputed whether he was given notice. Willis elected two attorneys and herself to the board of directors. Sometime later, she took over management of the bar, changed the locks, and effectively barred Bydalek from the premises. Id. Bydalek sued, and the jury found (1) that Bydalek was “wrongfully locked out,” (2) that Willis acted “willfully and maliciously,” (3) that the fair value of Bydalek’s shares was $612.50, and (4) that Bydalek was entitled to $180,000 in punitive damages. Id. The jury found that Willis had not committed conversion. The trial court entered a judgment for shareholder oppression, ordered a buy-out for $612.50, and awarded punitive damages in the amount of $30,000. Id. at 800-01.
3. Willis v. Bydalek
Commentators and courts in other states have struggled for some time to agree on the logical and legal basis of the shareholder oppression cause of action. Two different approaches predominate regarding the legal basis for analyzing duties to individual minority shareholders. The conclusion of the Massachusetts courts is that a unique duty exists to protect minority shareholders in a closely-held corporation, based on the similarities between general partnerships and closely-held corporations, and that these duties are different from and higher than those duties that directors owe to corporations and are distinct from those duties imposed in large or public corporations. The analysis of the Delaware courts is that the fiduciary duties owed to shareholders are the same in large or public corporations as they are in closely-held corporations and that these duties are the same duties that directors owe to corporations. Neither of these approaches works in Texas corporate law.
D. Legal Basis of the Oppression Cause of Action
The Massachusetts Supreme Judicial Court essentially created the modern shareholder oppression cause of action in Donahue v. Rodd Electrotype Co., 328 N.E.2d 505 (Mass. 1975), and reasoned that closely-held corporations act and operate more like partnerships, id. at 511-12 (referring to closely-held corporations as “incorporated partnerships”), and stated that minority shareholders in a closely-held corporation, like members of a partnership, are at risk because of the illiquidity of their ownership interests, id. at 513-15. Therefore, the Massachusetts Court held: “Because of the fundamental resemblance of the close corporation to the partnership, the trust and confidence which are essential to this scale and manner of enterprise, and the inherent danger to minority interests in the close corporation, we hold that stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe each other.” Id. at 515; see also Wilkes v. Springside Nursing Home, Inc., 353 N.E.2d 657, 661-62 (Mass. 1976). Under Massachusetts law, partners owe each other a duty of “utmost good faith,” which is a higher duty than the duty of good faith and loyalty owed by directors to their corporations. The Massachusetts Court imposed this higher duty on majority shareholders in closely-held corporations as to their minority shareholders. The court clearly limited the imposition of these special duties to closely-held corporations, without providing any kind of bright-line definition as to what constituted a closely-held corporation. Donahue v. Rodd Electrotype, 328 N.E.2d at 511. This approach has found a great deal of acceptance among academic commentators. See D. Moll, Majority Rule Isn’t What It Used to Be: Shareholder Oppression in Texas Close Corporations, 63 Tex. B. J. 434, 436 (2000).
1. Texas Shareholder Oppression Cause of Action Is Not Based on an Analogy to Partnership Law.
Delaware, undoubtedly the most influential jurisdiction on questions of corporate law, has rejected the Massachusetts approach of creating unique duties for closely-held corporations based on a partnership analogy. See Riblet Products Corp. v. Nagy, 683 A.2d 37, 40 (Del. 1996); Nixon v. Blackwell, 626 A.2d 1366, 1380-81 (Del. 1993). Rather, the Delaware courts have held that minority shareholders’ claims for mistreatment or oppressive conduct fall under the general law of corporate fiduciary duties of loyalty, care and good faith. See Nixon v. Blackwell, 626 A.2d at 1380-81 (holding that claims of minority shareholder oppression in a closely-held corporation may be pursued through the “entire fairness test, correctly applied and articulated”). While the Delaware Supreme Court has not yet ruled on an oppression-type claim by a minority shareholder in a closely-held corporation, other courts have predicted that the Delaware law would recognize such a claim. See Clemmer v. Cullinane, 815 N.E.2d 651, 652-53 (Mass. App. 2004) (holding that the Nixon decision did not foreclose a shareholder oppression cause of action, but merely required that the claim be pursued through Delaware’s “entire fairness” test, and on that basis held that the plaintiff had stated a claim for shareholder oppression under Delaware law); see, e.g., Hollis v. Hill, 232 F.3d 460, 465, 469 n. 28, 470-71 (5th Cir. 2000); Mroz v. Hoaloho Na Eha, Inc., 410 F.Supp.2d 919, 934-35 (D. Hi. 2005); Minor v. Albright, 2001 WL 1516729 (N.D. Ill. 2001) Reserve Solutions, Inc. v. Vernaglia, 438 F.Supp.2d 280, 290 (S.D.N.Y. 2006); Sokol v. Education Sys. Corp., 809 N.Y.S.2d 484 (N.Y. Sup. 2005); see also Gagliardi v. TriFoods Int’l, Inc., 683 A.2d 1049, 1051 (Del. Ch. 1996) (“I need not address the general question whether Delaware fiduciary duty law recognizes a cause of action for oppression of minority shareholders; I assume for purposes of this motion, without deciding, that under some circumstances it may.”). Litle v. Waters, 1992 WL 25758 (Del. Ch. Feb. 11, 1992) (applying “reasonable expectations test” and holding that plaintiff had stated a claim for minority shareholder oppression).
2. Shareholder Oppression Is Not an Extension of Corporate Directors’ Fiduciary Duties.
3. What Is Going On in Texas Fiduciary Duty Law?
Texas law seems considerably unclear, even perhaps schizophrenic, on the issue of fiduciary duties owed to minority shareholders. On the one hand, the case law seems to be clear and consistent that generally officers, directors, and controlling shareholders do not owe fiduciary duties directly to individual shareholders by virtue of their status as shareholders. See, e.g., Massachusetts v. Davis, 168 S.W.2d 216, 221 (Tex. 1942), cert. denied, 320 U.S. 210 (1943); Cotten v. Weatherford, 187 S.W.3d at 698; Grinnell v. Munson, 137 S.W.3d 706, 718 (Tex. App.—San Antonio 2004, no pet.); In re Estate of Fawcett, 55 S.W.3d 214, 220 (Tex. App.—Eastland 2001, pet. denied); Hoggett v. Brown, 971 S.W.2d at 488; Bush v. Brunswick Corp., 783 S.W.2d 724, 727 (Tex. App.—Fort Worth 1990, writ denied). “A corporate officer owes a fiduciary duty to the shareholders collectively, i.e. the corporation, but he does not occupy a fiduciary relationship with an individual shareholder, unless some contract or special relationship exists between them in addition to the corporate relationship.” Faour v. Faour, 789 S.W.2d 620, 621-22 (Tex. App.—Texarkana 1990, writ denied) (emphasis in original).
a) Statement of the General Rule
However, the cases are equally emphatic that sometimes, “in certain limited circumstances, a majority shareholder who dominates control over the business may owe such a duty to the minority shareholder.” Hoggett v. Brown, 971 S.W.2d at 488 n. 13, citing Patton v. Nicholas, 279 S.W.2d 848 (Tex. 1955) (injunction issued against majority shareholder maliciously suppressed dividends); Davis v. Sheerin, 754 S.W.2d 375 (Tex. App.—Houston [1st Dist.] 1988, writ denied) (court-ordered buy-out of minority shareholder where majority shareholder engaged in oppressive conduct); Duncan v. Lichtenberger, 671 S.W.2d 948 (Tex. App.—Fort Worth 1984, writ ref'd n.r.e.) (minority shareholders entitled to reimbursement of monetary contribution to corporation where majority shareholder completely excluded minority shareholders from management of business); Thompson v. Hambrick, 508 S.W.2d 949 (Tex. Civ. App.—Dallas 1974, writ ref'd n.r.e.) (fact issue existed as to whether majority shareholders wrongfully obtained premium for selling control of the corporation) Morrison v. St. Anthony Hotel, 295 S.W.2d 246 (Tex. Civ. App.—San Antonio 1956, writ ref'd n.r.e.) (former minority shareholder entitled to sue majority shareholder for malicious suppression of dividends). All the cases agree that the duty owed to minority shareholders, and thus the instances when such shareholders may sue individually, are limited. Neither the older duty cases nor the newer shareholder oppression cases explain exactly when the duty arises and why.
b) The Exception
Under Texas law, a fiduciary relationship can be either “formal” or “informal.” A formal fiduciary relationship arises as a matter of law in certain relationships, such as attorney-client, partnership, and trustee-beneficiary relationships. Meyer v. Cathey, 167 S.W.3d 327, 330 (Tex. 2005); Insurance Co. of N. Am. v. Morris, 981 S.W.2d 667, 674 (Tex. 1998). Informal fiduciary relationships arise from confidential relationships "where one person trusts in and relies upon another, whether the relation is moral social, domestic or merely personal." Crim Truck & Tractor Co. v. Navistar Int'l Transp. Corp., 823 S.W.2d 591, 593-94 (Tex.1992). In other words, a “formal” fiduciary relationship involves the imposition of fiduciary duties as a matter of law based on the legal status of the parties to the transaction; whereas an “informal” fiduciary relationship grows out of the particular facts of the case showing that the plaintiff’s trust and confidence in the defendant has placed the defendant in a position of unfair advantage. See Pabich v. Kellar, 71 S.W.3d at 504-05. Informal relationships do not exist as a matter of law but are normally fact issues. Kaspar v. Thorne, 755 S.W.2d at 155. Not every relationship involving a high degree of trust and confidence rises to a fiduciary relationship. Meyer v. Cathey, 167 S.W.3d at 330. Such a relationship is an extraordinary one and will not be lightly created; the mere fact that one subjectively trusts another does not alone indicate that confidence is placed in another in the sense demanded by fiduciary relationships because something apart from the transaction between the parties is required. Kline v. O'Quinn, 874 S.W.2d 776, 786 (Tex. App.—Houston [14th Dist.] 1994, writ denied), cert. denied, 515 U.S. 1142 (1995). To impose an informal fiduciary duty in a business transaction, the special relationship of trust and confidence must exist prior to and apart from the agreement or transaction made the basis of the suit. Meyer, 167 S.W.3d at 331.
c) The Confidential Relationship
The way to bring clarity to this line of authority is to focus on the interests of the minority shareholder that the case law seeks to protect. I would propose that these interests grow out of the relationship of the minority shareholder to the corporation, not the relationship of the minority shareholder to the majority shareholder or corporate officers and directors. Historically in Texas law, the relationship between a corporation and its shareholders has been seen as a particular species of trust. See Yeaman v. Galveston City Co., 167 S.W. 710, 723 (Tex. 1914); Disco Machine of Liberal Co. v. Payton, 900 S.W.2d 124, 126 n. 2 (Tex. App.—Amarillo 1995, writ denied); Hinds v. Southwestern Savings Assn, 562 S.W.2d 4, 5 (Tex. Civ. App.—Beaumont 1977, writ ref’d n.r.e.); Graham v. Turner, 472 S.W.2d 831, 836 (Tex. Civ. App.—Waco 1971, no writ); Rex Refining Co. v. Morris, 72 S.W.2d 687, 691 (Tex. Civ. App.—Dallas 1934, no writ). The corporation holds legal title to its assets and business. Rapp v. Felsenthal, 628 S.W.2d 258, 260 (Tex. App.—Fort Worth, 1982, writ ref’d n.r.e.). But that legal title is held for the benefit of the shareholders, who are the equitable and beneficial owners of the corporation’s assets. McAlister v. Eclipse Oil Co., 98 S.W.2d 171, 176 (Tex. 1936); In re Estate of Tevino, 195 S.W.3d 223, 230 (Tex. App.—San Antonio 2006, no pet.); Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d 687, 697 (Tex. App.—Fort Worth 2006, pet. denied); Martin v. Martin, Martin & Richards, Inc., 12 S.W.3d 120, 124 (Tex. App.—Fort Worth 1999, no pet.); Rapp v. Felsenthal, 628 S.W.2d 258, 260 (Tex. App.—Fort Worth, 1982, writ ref’d n.r.e.); Gossett v. State, 417 S.W.2d 730 (Tex. Civ. App.—Eastland 1967, writ ref'd. n.r.e.). The Texas Supreme Court has held that a corporation “is a trustee for the interests of it shareholders in its property, and is under the obligation to observe its trust for their benefit. Its possession is friendly, and not adverse, and the shareholder is entitled to rely upon its not attempting to impair his interest.” Yeaman, 167 S.W. at 723. The court further characterized the “trusteeship of a corporation for its shareholders” as “an acknowledged and continuing trust.” Id. “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 ….” Id. at 723-24. In Patton v. Nicholas, 279 S.W.2d 848, 854 (Tex. 1955), the Texas Supreme Court termed the malicious suppression of dividends in a closely-held corporation to be a wrong “akin to breach of trust” and cited with approval authorities from other jurisdictions as describing directors and dominant shareholders occupying a “semi-trustee status.”
4. Proposed Synthesis—Minority Shareholders Are Analogous to Trust Beneficiaries
5. Implications of the Trust Analogy
The principal economic feature of the corporation is the separation of ownership from control. This notion speaks primarily to the ownership of the business as an entity or going concern. There is a second notion in which the corporation separates the legal ownership of its assets from the beneficial ownership. 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. In that sense, the corporation is like a trustee and the shareholders are like the beneficiaries of the trust. However, there is an additional aspect to corporations that is unlike a trust. While the corporation holds legal title, it can do nothing apart from its agents. Control over the assets and operations of the corporation is vested in its directors and officers. A trustee holds both legal title and exercises control. A corporation only holds legal title. Therefore, the analysis under Texas law places fiduciary duties on the directors and officers, and these duties are owed to the corporation. These are the duties that come out of the exercise of control--duties that are based in the law of agency. See Restatement (Second) of Trusts §16A, comment 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.”). The duties owed to the shareholders, however, are the duties that come out of ownership—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. Therefore, in distinguishing the duties owed to the shareholders as owners from the duties owed to the corporation by its managers, it is important to examine the interests that the law protects in equitable ownership. Admittedly, this is somewhat of an artificial distinction, growing out of the legal fiction of the corporation as a separate person. The Delaware scheme of looking to the directors as owing fiduciary duties directly to the shareholders probably makes more sense, but at present this analysis is necessitated by the choices made in Texas jurisprudence.
a) Distinguishing Director Fiduciary Duties from Duties Owed to Shareholders
The fiduciary duty owed directly to minority shareholders under Texas law is “narrow.” See Reibe v. National Loan Investors, L.P., 828 F.Supp. 453, 456 (N.D.Tex. 1993). The shareholders’ rights and interests derive “from the nature of the organization, and the relation of the stockholders to the corporation and its property.” Moroney v. Moroney, 286 S.W. 167, 169 (Tex. Comm. App. 1926, jmt adopted). Therefore, the duty of the corporation as trustee to its shareholders as beneficiaries concerns and is limited to those interests and expectations that flow from the nature of share ownership and the relationship between the corporation and its shareholders. Within that context, however, the corporation as trustee is held to a strict duty of loyalty. 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. Hersbach 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 and modified, 776 S.W.2d 154 (Tex.1989), cert. denied, 494 U.S. 1080 (1990). 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.” Slay v. Burnett Trust, 187 S.W.2d 377, 377-78 (Tex. 1945).
b) The Shareholder’s Interests Under the Trust Analogy
Under this reasoning, the relationship between shareholder and corporation is most definitely a “formal” fiduciary relationship. The rights and duties protecting the shareholder arise as a matter of law from the legal status of the shareholder and are not issues for the finder of fact. There was some hint of this in the recent Texas Supreme Court case of Willis v. Donnelly, 199 S.W.3d 262, 277 (Tex. 2006), which treated the claim that a majority shareholder owes a minority shareholder fiduciary duties as distinct from a fiduciary duty arising from a confidential relationship and held that no fiduciary duty could have arisen in that case because the plaintiff was never a shareholder.
c) The Duties Derive from Shareholder Status
In identifying the nature and source of the duties, it is useful to analyze the duties as being owed by the corporation. In practical terms of assigning liability for the breach of those duties, however, corporations “can act only through human agents.” In re Merrill Lynch Trust Co., 235 S.W.3d 185, 188 (Tex. 2007). Therefore, conduct that violates the duties that the corporation owes to shareholders will always be performed by corporate directors, officers or employees, and will be caused by those in control of the corporation whether directors or majority shareholders. Under Texas law, "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 is liable as such." Kinzbach Tool Co. v. Corbett-Wallace Corp., 160 S.W.2d 509, 514 (Tex. 1942); see also Baty v. ProTech Ins. Agency, 63 S.W.3d 841, 863 (Tex. App.—Houston [14th Dist.] 2001, pet. denied); Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d 687, 701 (Tex. App.—Fort Worth 2006, pet. denied); Cox Tex. Newspapers, L.P., v. Wootten, 59 S.W.3d 717, 721 (Tex. App.—Austin 2001, pet. denied); S.W. Tex. Pathology Assoc., L.L.P., v. Roosth, 27 S.W.3d 204, 208 (Tex. App.—San Antonio 2000, pet. dism'd w.o.j.); Thompson v. Vinson & Elkins, 859 S.W.2d 617, 624 n. 5 (Tex. App.—Houston [1st Dist.] 1993, writ denied); Kirby v. Cruce, 688 S.W.2d 161, 166 (Tex. App.—Dallas 1985, writ ref’d n.r.e.). Furthermore, instigating, aiding, or abetting the wrongdoing constitutes participation. Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d at 701; Pabich v. Kellar, 71 S.W.3d 500, 508 (Tex. App.—Fort Worth 2002, pet. denied); Portlock v. Perry, 852 S.W.2d 578, 582 (Tex. App.—Dallas 1993, writ 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.” Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d at 701. In Cotton v. Weatherford Bancshares, Inc., the court held that corporate directors could be held individually liable for oppression against preferred shareholders if they favored the interests of the common shareholders over the interests of the preferred shareholders. See id. at 700-01. See also TBCA art. 705 and BOC § 11.404 (receivership remedy for "oppressive conduct" by "directors and those in control of the corporation").
d) Liability of Officers, Directors, and Controlling Shareholders
e) Liability Flows From Control, Not Majority Ownership
Most of the opinions describe the duties as being owed by the majority shareholders to the minority shareholders. However, TBCA art. 705 and BOC § 11.404, the statutory basis for remedies to oppressive conduct does not apply to "majority shareholders" but to "directors and those in control of the corporation." Moreover, as noted above, it is more useful and accurate to recognized that the duties are owed by the corporation to its shareholders. This analysis preserves the general rule that co-shareholders, as such, do not owe duties to each other. Hoggett v. Brown, 971 S.W.2d at 488. A majority shareholder may be held liable if he uses his position of control to cause the corporation to violate the rights of one of the other shareholders, but the liability flows from control, not from majority ownership.See, e.g., Tigrett v. Pointer, 580 S.W.2d 375, 379 (Tex. App.—Dallas 1978, writ ref’d n.r.e.) (“the peculiar duty of a controlling stockholder to deal fairly with the corporation, its stockholders, and creditors is broader than the trust-fund doctrine. It rests on his inside knowledge of the corporation's affairs and his opportunity to manipulate them for his personal advantage.”).
There are many ways that a shareholder with less than majority ownership might obtain control over the corporation, such as banding together with other shareholders to act jointly as a majority or obtaining control over the board of directors. In Hoggett v. Brown, the Fourteenth Court of Appeals held that a 50% shareholder did not owe fiduciary duties to a minority shareholder because he did not have control. Id. at 488 n. 13. The court’s recitation of the facts, however, clearly indicates that this conclusion is wrong, that the 50% shareholder was in a position to oppress the minority shareholder without a majority ownership of the shares. In Hollis v. Hill, 232 F.3d 460 (5th Cir. 2000) (applying Nevada law), the corporation had two shareholders, both with 50%, and the two of whom were the only directors. This situation of deadlock left one shareholder, who was the president, in effective control over the other, who was the vice-president. The Fifth Circuit noted that fiduciary duties applied as a result of one shareholder’s control of the corporation, without regard to ownership. Id. at 467 n. 21.
According to Davis v. Sheerin, the purpose of oppression cause of action is to protect minority shareholder’s ownership “interest and his rights in the corporation.” 754 S.W.2d at 383. The Davis court and others have referred to these rights and interests as the “reasonable expectations” of the shareholders. See id. at 381. Oppression of minority shareholders is conduct that "substantially defeats" these “reasonable expectations.” Id.
E. Interests Protected—“Reasonable Expectations”
In Willis v. Bydalek, the court held: “Texas law does not recognize a minority shareholder's right to continued employment without an employment contract. … All are presumed to know the law. Expectations of continued employment that are contrary to well settled law cannot be considered objectively reasonable.” Willis v. Bydalek, 997 S.W.2d 798, 803 (Tex. App.–Houston [1st Dist.] 1999, no writ). However, the court’s reasoning must also be true in the converse: If all are presumed to know the law, then every shareholder must be deemed to have an objectively reasonable expectation in the corporation’s respect of the shareholder's rights and fulfillment of the corporation’s duties, where those rights and duties are recognized in statutory or common law.
1. Statutory and Common Law Rights of Shareholders
The most fundamental right of a shareholder as against the corporation is to be secure in his ownership. A trustee is under a duty to the beneficiary to administer the trust solely in the interest of the beneficiary. Restatement (Second) of Trusts §170(1). Similarly, the corporation and those who control it have a duty to recognize, to respect, and not to attempt to interfere with such ownership. “The shareholder is entitled to rely upon [the corporation’s] 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.” Yeaman v. Galveston City Co., 167 S.W. 710, 723 (Tex. 1914). In Davis v. Sheerin, the court held that an attempt by the majority shareholder to deprive the minority shareholder of his ownership interest in the corporation by refusing to acknowledge that he was a shareholder, even though the attempt was ultimately unsuccessful and resulted in no damages, violated the shareholder’s rights and interests in the extreme, because such conduct “not only would substantially defeat any reasonable expectations appellee may have had … but would totally extinguish any such expectations.” 754 S.W.2d at 382.
a) Right to Security in Ownership
Probably the next most fundamental right is the right to meet periodically, to have the opportunity to confront management, and 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. See TBCA arts. 2.24, 2.28, 2.29; BOC §§21.351-363. Efforts to disenfranchise a shareholder or otherwise eliminate his participation rights are oppressive. See Davis v. Sheerin, 754 S.W.2d at 383 (controlling shareholder’s refusal to allow minority shareholder “any interest or voice in the corporation”); Willis v. Bydalek, 997 S.W.2d at 802 (failure to notify a shareholder of meetings is oppressive, citing Baker v. Commercial Body Builders, Inc., 507 P.2d 387, 390-91, 398 (Or.1973)).
b) Right to Vote and Be Heard
A shareholder’s right to information about the corporation is also vital and reflects the fundamental duties of disclosure owed by trustees. See Restatement (Second) of Trusts §172 (duty to the beneficiary to keep and render clear and accurate accounts with respect to the administration of the trust); §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). Likewise, both under the common law and statutory law, corporations are required to keep records and accounts and to permit shareholders to inspect the records. See TBCA art. 2.44; BOC §§ 3.151-153, 21.173, 218-222. The shareholder’s right to examine the books and records of the corporation “is a privilege … incident to his ownership of stock.” Johnson Ranch Royalty Co. v. Hickey, 31 S.W.2d 150, 153 (Tex. App.—Amarillo 1930, writ ref’d). The right to inspect corporate books and records exists 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.” Id. Refusal to give minority shareholder access to corporate information is oppressive. See Redmon v. Griffith, 202 S.W.3d at 235-36.
c) Right to Information
When there are two or more beneficiaries of a trust, the trustee is under a duty to deal impartially with them. Restatement (Second) of Trusts at §183. Similarly, in a corporation, shares are theoretically fungible. Every share of the same class gets the same vote, the same dividend, and is entitled to the same treatment. In a dispute among shareholders over who will control the corporation, the corporation must remain strictly neutral. Alexander v. Sturkie, 909 S.W.2d 166, 170 (Tex. App.—Houston [14th Dist.] 1995, writ denied). The most common challenged conduct in oppression cases is manipulation of the control over the corporation to make the majority’s investment 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. See Davis v. Sheerin 754 S.W.2d at 382 (oppression by payment of “informal dividends” only to the majority and use of corporate funds to pay the majority shareholder’s legal fees).
d) Right to Equality and Neutrality
Inherent in the nature of the investment is a reasonable expectation of economic return, if the venture is successful. In Moroney v. Moroney, 286 S.W. 167, 169 (Tex. Comm. App. 1926, jmt adopted), 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.” See also 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.”).
e) Expectation of Economic Return
The shareholders are the equitable and beneficial owners of the corporation’s assets. McAlister v. Eclipse Oil Co., 98 S.W.2d 171, 176 (Tex. 1936). For this reason, many courts have recognized that conduct by those in control of the corporation that harms the corporation or diminishes its assets—claims which belong solely to the corporation—do, in some sense, violate the rights and interests of the minority shareholders and can constitute oppression, particularly when the majority does not suffer equally with the minority. See Redmon v. Griffith, 202 S.W.3d at 235, (defendants made improper loans to themselves, paid personal expenses from corporate funds, diverted corporate opportunities, and paid excessive dividends to themselves); Davis v. Sheerin, 754 S.W.2d at 382, (excessive salaries by controlling shareholders is a “typical ‘squeeze out’ technique”).
f) Equitable Interests in Corporation’s Assets
Shareholders are permitted broad latitude in ordering the affairs of the corporation. Therefore, shareholders may create or modify rights and interests in the corporation’s articles, by-laws and other organizational documents, by written shareholder agreements, or by resolutions passed unanimously at shareholder meetings. "The shareholders of a corporation are the equitable owners of its assets and may bind the corporation by a contract that all of the shareholders sign." 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.).
2. Organic Documents of the Corporation
As formulated in Davis v. Sheerin and followed by other courts of appeals, the shareholder oppresion cause of action protects minority shareholders’ reasonable expectations from being substantially defeated by the actions of controlling shareholders. Davis v. Sheerin, 754 S.W.2d 375, 381 (Tex. App–Houston [1st Dist.] 1988, writ denied). In order to be worthy of protection, a shareholder’s expectation must be (1) objectively reasonable under the circumstances and (2) central to the minority shareholder’s decision to join the venture. Id. This formulation permits minority shareholders to protect rights and interests that stem from even unspoken understandings and practices. For example, if all the shareholders understood from the outset of the enterprise that all the shareholders would participate and have a voice in management, that all would be employed by the corporation so long as they owned their stock, and that all profits would be fairly distributed by means of increases in salary and bonuses, then these mutual expectations would surely become rights and interests incident to stock ownership, just as if they were expressly provided in a written shareholder's agreement.
3. Quasi-Contractual Expectations
Under Texas law, contracts may be expressly stated orally or in writing or may be implied from the facts and circumstances indicating a mutual intent to form an agreement. See Haws & Garrett Gen. Contractors, Inc. v. Gorbett Bros. Welding Co., 480 S.W.2d 607, 609 (Tex. 1972). "Our courts have recognized that the real difference between express contracts and those implied in fact is in the character and manner of proof required to establish them." Id. The terms of an implied agreement are determined from all the surrounding circumstances, including the statements and conduct of the parties, industry customs and standards, course of dealing, etc. See id.; see also Runnells v. Firestone, 746 S.W.2d 845, 850-51 (Tex. App.--Houston [1st Dist.] 1988), writ denied, 760 S.W.2d 240 (Tex. 1988); City of Houston v. First City, 827 S.W.2d 462, 473 (Tex. App.--Houston [1st Dist.] 1992, writ denied); Adams v. Petrade Int'l, 754 S.W.2d 696, 717 (Tex. App.--Houston [1st Dist.] 1988, writ denied). A minority shareholder's reasonable expectations concerning the rights and interests that are incident to stock ownership are really nothing more than the agreements made by the shareholders that may be implied from the facts and circumstances. In assessing a shareholder's reasonable expectations, a court "must investigate what the majority shareholders knew, or should have known, to be the [shareholder]'s expectations in entering the particular enterprise." In re Kemp & Beatley, Inc., 473 N.E.2d 1173, 1179 (N.Y. 1984). Not every instance of an expectation frustrated will deemed oppressive, the expectations that will be protected by the shareholder oppression cause of action are only those that are both "objectively reasonable" under all the circumstances and "central" to the decision to become a shareholder. Davis v. Sheerin, 754 S.W.2d at 381. Likewise, conduct "should not be deemed oppressive simply because the [minority shareholder]'s subjective hopes and desires in joining the venture are not fulfilled. Disappointment alone should not necessarily be equated with oppression." In re Kemp & Beatley, Inc., 473 N.E.2d at 1179. Returning to Willis v. Bydalek, the court held that the plaintiff's "expectations of continued employment, without a contract, [were not] 'objectively reasonable.'" 997 S.W.2d at 803. This statement, however, begs the question. The opinion certainly reveals that the expectation that employment was a right and interest incident to stock ownership existed in that case. All parties understood that expectation. All parties acted in accordance with that expectation until the dispute arose. The plaintiff in that case certainly relied to his detriment on that expectation by relocating to Texas from Wisconsin and investing his life savings into the venture. Under these circumstances, the expectation that employment was a benefit of stock ownership was certainly objectively reasonable at least in the beginning and was undoubtedly central to the investment decision. Therefore, in Willis v. Bydalek, the same facts establishing the plaintiff's reasonable expectations also establish that the plaintiff did, in fact, have a contract. The court is simply wrong that the absence of a contract was determinative. However, the holding is no-doubt correct that, under the circumstances, the minority shareholder's disappointment did not constitute oppression because there was no loss of economic return, the venture was not successful, and the majority shareholder did not act in bad faith or evidence a pattern of oppressive behavior beyond the firing.
a) Reasonable Expectations and Implied Contracts
Courts have held that caution is necessary in determining what constitutes oppressive conduct. Willis v. Bydalek, 997 S.W.2d 798, 801 (Tex. App.—Houston [1st Dist.] 1999, pet. denied); McCauley v. Tom McCauley & Son, Inc., 104 N.M. 523, 724 P.2d 232, 237 (1986). In determining whether a shareholder's expectations are objectively reasonable under the circumstances, and whether the frustration of those expectation constitutes oppression, the court cannot ignore other relevant factors that may justify the conduct of the majority. There is a very real risk that the effort to protect the interests of minority shareholders could unduly restrict the ability of management to run corporations. Despite the existence of legal duties protecting minority shareholders, a corporation’s officers and directors are still afforded a rather broad latitude in conducting corporate affairs. Willis v. Bydalek, 997 S.W.2d at 801; Masinter v. WEBCO Co., 164 W.Va. 241, 262 S.E.2d 433, 438 (1980). In determining whether the shareholder's expectations are objectively reasonable, and thus whether specific conduct is oppressive, courts are required to balance the minority shareholder's reasonable expectations against the corporation’s need to exercise its business judgment and run its business efficiently. See Willis v. Bydalek, 997 S.W.2d at 801; Landstrom v. Shaver, 561 N.W.2d 1, 8 (S.D.1997).
b) Balancing Other Factors