LLC Member Oppression After Ritchie v. Rupe

Shareholder Oppression is as likely and frequent in limited liability companies as it is in closely-held corporations. Surprisingly, LLC members may have remedies under Texas law that shareholders of corporations do not. HCWD, PLLC recently published a law review article in the Houston Business and Tax Law Journal that explores LLC member oppression and its unusual remedies under Texas law. Download your copy of the article here.

LLC Member Oppression Article

How To Draft an Enforceable Shareholder Settlement

Agreements that settle shareholder disputes or that provide for shareholder buy-outs are extremely vulnerable to later attack on grounds of fraud and breach of fiduciary duty. Drafting such settlements to achieve true finality is extremely challenging. Here is a drafting checklist and sample language to use in settlements involving shareholder buy-outs.

Settlement Checklist

Wording of the Release

Release language must be clear and unequivocal and must “mention” the claims to be released. It must also clearly state that it applies to claims of fraud in the inducement of the settlement agreement itself. Both fraud and fiduciary duties claims should be listed. The best practice is to include a broad general release, followed by a more specific (but non-exclusive) listing of specific claims.

The following is an example:

[Selling shareholder], on behalf of him/herself, his/her spouse, his/her affiliates, subsidiaries, partners, and any and all parties that may be able to make a claim by, through, or on behalf of him/her, fully and completely releases, acquits, and discharges all claims, causes of action, debts, obligations, and disputes that he/she may have against or as to [the acquiring or remaining shareholders], [the company], or the spouses, parents, subsidiaries, partners, affiliate, officers, directors, members, managers, attorneys, employees, or agents of [the acquiring or remaining shareholders and the company], whether known or unknown, whether accrued or unaccrued, from the beginning of the world to the date of this Agreement, save and except for the obligations of this Agreement. This release includes but is not limited [to all claims and counterclaims that were or could have been asserted in the Litigation and] to all claims of breach of fiduciary duties (including in connection with the negotiation and execution of this Agreement), all claims of fraud in the inducement of this or any other agreement, all claims of common law and statutory fraud, nondisclosure, misrepresentation, violations of the Texas Securities Act, shareholder oppression, negligence, mismanagement, breach of contract, [and any other matters that may apply]. This release includes but is not limited to any derivative claims that [selling shareholder] could have asserted on behalf of [the company].

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Disclaimers of Reliance in Shareholder Settlements

Settlement agreements that disclaim reliance may provide a defense against a subsequent fraud claim.

But not always. When are disclaimers of reliance effective and enforceable? How do they effect claims of fraudulent non-disclosure. How do they affect claims of breach of fiduciary duties?

Disclaimer of Reliance

The Texas Supreme Court has developed the use of a disclaimer of reliance as a defense to fraud in the inducement beginning with Schlumberger Tech. Corp. v. Swanson,  and continuing with Italian Cowboy  and Forest Oil,  and most recently IBM v. Lufkin Indus.  “[A] clause that clearly and unequivocally expresses the party’s intent to disclaim reliance on the specific misrepresentations at issue can preclude a fraudulent-inducement claim.”

     Threshold Test

The threshold test is whether the disclaimer of reliance was “clear and unequivocal.”  The initial inquiry is whether reliance has been disclaimed and whether the language of the disclaimer is “clear and unequivocal.” For instance, some courts have held that a disclaimer of reliance does not pass the threshold test if it does not use the word “rely.”  Therefore, care must be taken in the wording of the disclaimer. Efforts to sneak in the disclaimer by using softer language, such as “the parties are using their own judgment” probably won’t pass the threshold test. The language should state straightforwardly that the selling shareholder “has not relied on any statements, representations, or promises not stated in the Agreement.” However, does even this language disclaim reliance on non-disclosures? It would be difficult to argue that it “clearly and unequivocally” does. Therefore, the disclaimer should also include language disclaiming reliance and/or waiving the right to rely on any information not disclosed. This disclaimer can be strengthened by a representation and warranty that each party has done an independent investigation, that each party is relying solely upon their own information and judgment, and that each party accepts the risk that other information may exist that was not discovered.

     Extrinsic Factors

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Fraud Damages: Wrong Date = No Evidence

The Danger of Guessing Wrong on the Valuation Date for Fraud Damages

The First Court of Appeals (Houston) issued a new opinion yesterday highlighting the danger of getting the date wrong on your fraud measure of damages. The court held that proving up damages for the wrong date is the same thing as introducing no evidence of damages at all and reversed a $650,000 jury verdict and rendered a take nothing judgment. Plaintiffs need to be aware of this exceptionally harsh trap.

TAN DUC CONSTRUCTION LIMITED COMPANY, INC. AND HOANGYEN THI DANG, Appellants V. JIMMY TRAN, Appellee, 01-14-00539-CV, 2017 WL 491289 (Tex. App.—Houston [1st Dist.] Feb. 7, 2017, no. pet. h.), involved a fraud claim arising out of a divorce. The husband sued the wife and a company controlled by her for fraudulently inducing his transfer of his 25% interest in their home. The jury found that the defendants committed fraud and that the value of the lost interest in the real estate was $650,000. The court of appeals reversed the judgment for $650,000 in actual damages and $50,000 in punitive damages, and rendered a take nothing judgment in favor of the defendants on the ground of no legally sufficient evidence of damages.

Measure of Damages For Fraud

The court held that there are two measures of direct damages in a fraud case: out-of-pocket and benefit-of-the-bargain. "Out-of-pocket damages" measure the difference between the value paid and the value received. "Benefit-of-the-bargain damages" measure the difference between the value as represented and the value received. Both measures are determined at the time of the transfer of the interest induced by the fraud. Any additional losses may be recovered as consequential damages, which must be explicitly premised on findings that the losses were foreseeable and directly traceable to the misrepresentation.

Citing Formosa Plastics Corp. USA v. Presidio Eng'rs & Contractors, Inc., 960 S.W.2d 41 (Tex. 1998); Arthur Andersen & Co. v. Perry Equip. Corp., 945 S.W.2d 812 (Tex. 1997); Leyendecker & Assocs., Inc. v. Wechter, 683 S.W.2d 369 (Tex. 1984); Fazio v. Cypress/GR Houston I, L.P., 403 S.W.3d 390 (Tex. App.—Houston [1st Dist.] 2013, pet. denied).

No Evidence of Fraud Damages

In Tan Duc Construction v. Tran, the transfer of the interest occurred in March 2010. Therefore, the plaintiff had the burden to prove the value of the house as of that date. The plaintiff claimed that the value of the house as a whole exceeded $1 million and introduced evidence of the value of the house when the parties first married in 2007 (presumably the purchase price), when the house was foreclosed on in October 2011, and an expert appraisal of the house as of 2013. The court of appeals' opinion does not state the what the values were that were put into evidence, but it is a fair assumption that the values both before and after the date of the fraudulent transaction were consistent with a finding of $650,000 in fraud damages. Nevertheless, the court held: "But in order to show that he was damaged by the fraud, Tran was required to put on damages evidence regarding the value of the home in March 2010, when he was purportedly fraudulently induced to transfer his interest. Tran put on no such evidence. Neither Tran nor Lehrer [the expert] testified about the value of the house in 2010. Thus, Tran did not adduce any evidence to permit the jury to calculate damages based on the allegedly fraudulently induced transfer."

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