Shareholder Oppression Doctrine in Texas
Oppressive conduct under the former Shareholder Oppression Doctrine in Texas.
Shareholder Oppression Doctrine: Oppressive Conduct
What constituted oppressive conduct under the former Shareholder Oppression Doctrine? The Supreme Court in Ritchie v. Rupe recognized that oppressive conduct happens frequently in closely-held corporations and that its consequences on individual stockholders are severe. The Court held that the law must provide protection when the underlying conduct is wrongful. That is exactly what the Shareholder Oppression Doctrine was designed to do. However, the Supreme Court held that traditional common law concepts are sufficient and must be developed to provide adequate protection. In order to innovate existing remedies to provide such protection, it is critical to understand the "oppressive conduct" that the Shareholder Oppression Doctrine sought to remedy.
Interests Protected—"Reasonable Expectations"
According to Davis v. Sheerin, the purpose of oppression cause of action is to protect minority shareholder's "interest and his rights in the corporation." The Davis court and others have referred to these rights and interests as the "reasonable expectations" of the shareholders. Oppression of minority shareholders is conduct that "substantially defeats" these "reasonable expectations."
What are the shareholder's reasonable expectations? Texas courts recognize that rights and interests of each shareholder arise "from the nature of the organization, and the relation of the stockholders to the corporation and its property." The Davis court articulated a generalized duty of good faith and fair dealing—the shareholder's interest in "fair play on which every shareholder who entrusts his money to a company is entitled to rely." The Davis opinion also contemplates other more fact-specific kinds of expectations that "that objectively viewed were both reasonable under the circumstances and were central to the minority shareholder's decision to join the venture. Furthermore, the ownership of stock in a corporation involves an "array of rights" possessed the individual shareholders that "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." Because corporations are set up differently, these rights and interests "may well vary from one corporation to the next."
Statutory and Common Law Rights of Shareholders
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." 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. Broadly stated, "oppressive conduct" violated of impaired those fundamental rights and interests.
Right to Security in Ownership
The most fundamental right of a shareholder as against the corporation is to be secure in his ownership. The corporation and those who control it have a duty to recognize, to respect, and not to attempt to interfere with stock 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." 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."
Right to Vote and Be Heard
Probably the next most fundamental right is the right to meet periodically and have the opportunity to confront management, and the right 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. Efforts to disenfranchise a shareholder or otherwise eliminate his participation rights constitute oppressive conduct.
Right to Information
A shareholder's right to information about the corporation is also vital and reflects the fundamental duties of disclosure owed by trustees. 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. The shareholder's right to examine the books and records of the corporation "is a privilege … incident to his ownership of stock." 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." Oppressive conduct in shareholder oppression doctrine cases routinely involved the refusal to give minority shareholder access to corporate information.
Right to Equality and Neutrality
In a corporation, shares are supposed to be 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, Texas courts have held that the corporation must remain strictly neutral. The most common challenged conduct 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.
Expectation of Economic Return
Inherent in the nature of the investment is a reasonable expectation of economic return, if the venture is successful. In Moroney v. Moroney, 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."
Withholding Dividends Could Be Oppressive Conduct
In many small corporations, dividends are not paid, and all shareholders obtain an economic return through salary and bonuses. This is the reason that loss of employment is so often at the center of shareholder oppression cases—not so much that the shareholder has an expectation of lifetime employment as that the termination of employment by those in control of the corporation eliminates the minority shareholder's ability to receive any economic return on his investment. In Willis v. Bydalek, the court held that a minority shareholder's loss of employment (without more) was not oppressive conduct because the employee was at will and could not have an objectively reasonable expectation of continual employment. However, the court repeatedly emphasized that the corporation lost money and that the other shareholder did not take a salary or any other money out of the corporation. Therefore, there was no economic return to lose. The court distinguished the withholding of dividends in cases like Davis v. Sheerin, and McCauley v. Tom McCauley & Son, Inc., and the firing of the minority shareholders in cases like Duncan v. Lichtenberger, In re Topper, and Baker v. Commercial Body Builders, Inc., by noting that in each of those cases the corporation was generating income, that money was available to share with the minority shareholder, and that the majority shareholder in each case was benefiting economically at the expense of the minority.
Equitable Interests in Corporation's Assets
The shareholders are the equitable and beneficial owners of the corporation's assets. 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 oppressive conduct, particularly when the majority does not suffer equally with the minority.
Organic Documents of the Corporation
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." Violation of such agreements can constitute oppressive conduct.
As formulated in Davis v. Sheerin and followed by other courts of appeals, the shareholder oppression cause of action protects minority shareholders' reasonable expectations from being substantially defeated by the actions of controlling shareholders. 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. 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 for in a written shareholder's agreement.
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. "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." 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. 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." 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. 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."
Balancing Other Factors to Determine Oppressive Conduct
Courts have held that caution is necessary in determining what constitutes oppressive conduct. 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. 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 for the benefit of all shareholders.