Shareholder Oppression Doctrine in Texas
Texas Shareholder Oppression Claim: Liability
The Texas shareholder oppression cause of action was an individual claim belonging to the shareholder personally and asserted in his individual capacity. The duties were imposed on the controlling shareholder or directors not to oppress the minority shareholder. Oppressive conduct could be proven in one of two ways: either by proof that the minority’s “reasonable expectations” had been substantially defeated or that the conduct was so bad as to constitute “burdensome, harsh, or wrongful conduct.” Reasonable expections were “the minority’s expectations that, objectively viewed, were both reasonable under the circumstances and central to the minority shareholder’s decision to join the venture.” A plaintiff could prove “specific reasonable expectations,” which would be based on either an express agreement between minority shareholder and majority shareholder or one clearly implied by the facts and required “proof of specific facts giving rise to the expectations in a particular case and a showing that the expectation was reasonable under the circumstances of the case as well as central to the minority shareholder’s decision to join the venture.” “General reasonable expectations” were reasonable as a matter of law, and were recognized by the courts as expectations that arise from stock ownership; these expecations were common to all stockholders and required no proof. While every case paid lip service to “specific reasonable expectations,” all the shareholder oppression cases really based their holdings on “general reasonable expectionations.” Early cases placed particular emphasis on the defendant’s malicious state of mind and required proof of a “pattern” of conduct likely to continue into the future. Later cases seem to have dispensed with the pattern requirement, with court of appeals in Ritchie v. Rupe affirming based on one bad act and the Boehringer v. Konkel court stating that any one of the bad acts proven would have been sufficient. Finally, the determination of whether the defendant had committed oppression was made by the court, with the jury only asked whether the defendant committed the allegedly oppressive acts.
Texas Shareholder Oppression Claim: Buy-Out Remedy
What gave the Texas shareholder oppression claim its remedial teeth was the buy-out order. While the courts were free to fashion any appropriate remedy, almost all of them opted for a compulsory buy-out. The vulnerability of a minority shareholder to oppressive conduct (and the source of the temptation to the majority shareholder to engage in such conduct) was that the minority was “locked-in,” trapped with no ability to cut his losses, cash out, and walk away. The buy-out remedy fixed what was broken about the legal structure of closely-held corporations. The remedy was incredibly practical and logical. As the court in Davis v. Sheerin had written, “[a]ppellants’ oppressive conduct, along with their attempts to purchase appellee’s stock, are indications of their desire to gain total control of the corporation. That is exactly what a ‘buy-out’ will achieve.” In effect, the majority had wrongfully taken the value of the minority’s stock ownership. The shareholder oppression doctrine with its buy-out remedy merely made the majority pay a fair price for what had been wrongfully taken. In Davis v. Sheerin, the court held:
“An ordered ‘buy-out’ of stock at its fair value is an especially appropriate remedy in a closely-held corporation, where the oppressive acts of the majority are an attempt to ‘squeeze out’ the minority, who do not have a ready market for the corporation’s shares, but are at the mercy of the majority.”
The typical measure of damages for loss of property, such as stock, would be fair market value. The problem with the notion of “fair market value” in the case of a minority interest in a closely-held corporation is that there is no market for the shares—and thus no way to determine a “market value.” Courts have generally acknowledged that the “true value” of a closely-held corporation is, at best, a subjective guess. However, Texas shareholder oppression cases used the term “fair value” as opposed to “fair market value.”
In the court of appeals’ opinion in Ritchie v. Rupe, the Dallas Court of Appeals fully developed the law governing the buy-out remedy. After holding that “Texas law authorizes the trial court, in an appropriate case, to order a buyout of an oppressed minority shareholder as an equitable remedy for shareholder oppression,” and rejecting the argument that the buy-out order was “so harsh as to constitute an abuse of discretion,” the court dealt with mechanics of valuation. First, what is the valuation date? The court noted that the wrongful acts that were chiefly relevant to the claim occurred in February 2006, that the lawsuit was filed in July 2006, and that the plaintiff’s expert’s valuation was based on “last audited financial statements” dated as of June 30, 2006, and held that the trial court’s use of June 30, 2006 was not an abuse of discretion. Next the court of appeals addressed the more difficult issue of applying minority discounts for lack of control and lack of marketability. In most contexts, appraisers believe that a minority interest in a closely-held corporation is worth less than the minority percentage of the market value of the business as a whole. The reason for this disparity in value is that no market exists for the minority shares, so that any buyer would be entirely dependent upon the declaration of dividends for a return on investment; and the purchaser, as a minority shareholder, would have no power to compel the distribution of dividends. Therefore, any purchaser of a minority interest would be given an incentive in the form of a discount to take these additional risks.
The reason for the minority discount is the risk of shareholder oppression. Texas courts refused to reward majority shareholders with the benefit of that discount.
The Ritchie court of appeals held that there are two types of “fair value,” enterprise value and fair market value, with “enterprise value” being “determined by the value of the company as a whole and ascribing to each share its pro rata portion of that overall enterprise value, and “fair market value” being defined as “the price at which the stock would change hands between a willing seller, under no compulsion to sell, and a willing buyer, under no compulsion to buy, with both parties having reasonable knowledge of relevant facts.” “Enterprise value does not include a discount based on the stock’s minority status or lack of marketability” whereas “fair market value” of corporate stock does include those discounts. The court held that, in most shareholder oppression cases, enterprise value “has been seen as the appropriate valuation when a minority shareholder, with no desire to
leave the corporation, has been forced to relinquish his ownership position by the oppressive conduct of the majority.” However, in Ritchie v. Rupe, the oppressive conduct chiefly complained of was the interference with the plaintiff’s ability to sell her minority interests to a third party; therefore, “[i]n crafting an equitable remedy for appellants’ oppressive conduct in connection with [plaintiff’s] efforts to sell the Stock, the trial court should have provided the relief prevented by appellants’ conduct, i.e., a sale at fair market value.”