right to dividends

The Right to Dividends and Wrongful Suppression 

 “Texas law does not require a corporation to issue dividends. It is within the discretion of the board of directors whether a dividend will issue.”  Courts tend to show extreme deference as to the decision to declare dividends or to retain earnings.  Nevertheless, Texas law has long held that the “chief value of corporate stock is its right to receive dividends. So important is this right that courts of equity will, in a proper case, compel a payment of dividends.”  The shareholder's right to dividends “does not arise from any actual contract between the corporation and its stockholders, but rather from the nature of the organization, and the relation of the stockholders to the corporation and its property.”  That relation between stockholder and corporation is one of trustee to beneficiary.  Therefore, the common law cause of action for suppression of dividends recognized and developed in Patton v. Nicholas and Morrison v. St. Anthony Hotel was for “breach of trust.”

Neither Patton nor Morrison state the elements for a breach of trust claim. Both characterize the wrong-doing as “malicious suppression of dividends.” In Patton, the key fact seems to have been the majority shareholder’s wrongful intent to withhold dividends for the express purspose of harming the minority and perhaps acquiring their shares for an unfairly low price. Morrison involved the manipulation of the corporation’s finances to reduce earnings available for distribution, as well as unfairly low distributions, but both with the wrongful intent of harming the minority. Such an intent would breach the corporation’s duties as trustee to the shareholders of acting impartially and of “not attempting to impair [their] interest.”

Denying the Right to Dividends by Stockpiling Cash

The fact situation giving rise to a dividend claim as contemplated by Texas Supreme Court decision in Ritchie v. Rupe would be the accumulation of retained earnings without a declaration of dividends, or “stockpiling cash." When the cash is in the company and available for distribution, minority shareholders would have three legal theories to compel a distribution. First, would be an action for a mandatory injunction compelling a distribution as was provided in Patton. The Ritchie Court seems to have accepted the cause of action articulated by Patton but redefined it as a derivative action. Although we have argued that Ritchie misconstrues the procedural posture of Patton, requiring the claim to be pursued derivatively in the fact situation presented in Patton makes practical sense. When the money is just sitting in the company, the suppression decision affects all shareholders the same, as does the benefit of the injunctive relief to pay out the stockpiled funds. Some other jurisdictions have taken the same approach. In order to obtain relief from stockpiling, the plaintiff would have to overcome the business judgment rule by showing that the decision to stockpile cash rather than declare dividends was made for an “improper purpose.” The Patton Court indicated that the plaintiff was required to prove a “malicious purpose.” The Ritchie opinion seems to have considerably lowered the plaintiff’s burden of proof, requiring proof only that the directors made their dividend decision without dedicating their “uncorrupted business judgment for the sole benefit of the corporation.” Proof that the purpose of the dividend decision was to personally benefit the majority shareholder or to harm the minority shareholder would certainly satisfy the plaintiff’s burden. However, even non-self-interested purposes that did not solely benefit the corporation would also seem to satisfy the burden as described in Ritchie. In fact, a plaintiff might be able to satisfy his burden by proof merely of non-feasance—that the board wasn’t doing its job, was refusing to exercise its business judgment to make a decision that it was charged with making. Ritchie’s repeated description of the board’s duty certainly implies an affirmative duty to exercise business judgment for the benefit of the corporation. Many courts have held that the business judgment rule does not shield the failure to make decisions, when that failure involves an abdication of the director’s duties.

A second alternative legal theory would be available where the stockpile of cash has been segregated, perhaps in a special investment fund separate from the corporation’s other working capital. In that case, a minority shareholder would claim that there had been a constructive declaration of dividends and demand payment of his proportional share. Texas courts have held that “it is not essential to the right to receive a dividend that there should have been a formal declaration of a dividend, but where the corporation sets apart a fund for distribution to its stockholders to such extent as to become segregated from the property of the corporation, such property henceforth becomes, equitably, the stockholders’ property. … In other words, where there has been such a segregation of the corporate funds, and such a dedication to the stockholders, the assets thus segregated cease to belong to the corporation, but do belong to the stockholders individually.” The minority shareholder’s right to dividends in that situation would be based on an individual claim against the corporation for the payment of debt.

Finally, individual minority shareholders would have a breach of trust claim to recover unpaid dividends as damages or to seek an injuction or other equitable remedy, such as a buy-out. However, those remedies would be available only where the minority shareholder had no other adequate remedy, such as through a derivative action, which was the situation in Morrison.

Denying the Right to Dividends Through Financial Manipulation

A more difficult situation arises when the right to dividends is violated, not because the cash is being stockpiled, but because the corporation’s finances are being manipulated to eliminate the cash. That was the situation in Morrison. Where the money that would otherwise be available for distribution to the shareholders is being siphoned off to the majority through excessive salaries and bonuses, personal expenses, misappropriation, and other self-dealing transactions, then the manipulation constitutes a breach of fiduciary duties to the corporation, and minority shareholders have the remedy of a derivative claim to recover the stolen funds. In a closely-held corporation, the court has the power to treat such a derivative claim as a direct claim and award the minority shareholder his proportional share of the misappropriated funds, which would place the plaintiff in the same position as he would have been in had the dividends been declared. In situations like Morrison, where the derivative claim remedy is not available
because the plaintiff is no longer a shareholder, the plaintiff should be able to bring an individual breach of trust claim for damages based on the corporation’s violation of its duty of impartiality and the impairment of the minority shareholder’s right to proportionately share in profits. If the misappropriations are part of a much larger scheme to effectively eliminate the minority shareholder’s ownership interest, such that damages for the misappropriation would not make the plaintiff whole, then the minority shareholder should have a breach of trust claim for a buy-out.