Tort Conversion of Stock
Remedies for the Tort Conversion of Stock
When a corporation commits the tort conversion by interfering with stock ownership rights, what remedies does the law provide to the shareholder?
Tort Conversion Remedies
A plaintiff who establishes the tort of conversion is entitled to either (1) damages for the value of the property, or (2) equitable relief providing for the return of the property and any special damages for its loss of use during the time of its detention. When property has been converted, the owner is generally under no obligation to take it back. “[H]e has two rights and remedies. He may recover one but not both.” The plaintiff must elect to recover the property itself or its fair market value in damages. The election must be made before submission of the case to the jury and may not be changed.
Damages for Tort Conversion
“The measure of damages was the value of the property at the time and place of the conversion.” The value is usually defined as the “fair market value.” In order to recover, the plaintiff must introduce sufficient evidence of fair market value. “Market value is the price property would bring if it were offered for a sale by a willing but not obligated seller and purchased by a willing but not obligated buyer.”
Imagine a case in which the majority shareholder, in an effort to squeeze out the minority shareholder, cancels the minority shares on the company’s books and falsely denies the ownership of the minority shareholder. This is essentially the fact pattern in Davis v. Sheerin. While the appellate opinion indicates that the corporate records did reflect the plaintiff’s share ownership, the majority shareholder denied that the plaintiff owned shares, and the court held that the conspiring to deprive plaintiff of his ownership of stock in a corporation was a particularly oppressive act.
Prior to Ritchie v. Rupe, the aggrieved plaintiff would most likely have sued the majority shareholder for minority shareholder oppression. If the trial court holds that the majority has acted oppressively,it would most likely order the company to buy out the minority shareholder’s stock. When the court’s order is enforced, then title to the stock would pass to the corporation, and the former minority shareholder would have a sum of money representing the value of his stock ownership interest.
AfterRitchie v. Rupe, the shareholder oppression cause of action and its equitable buy-out remedy are no longer available to the stockholder; however, under tort law, almost exactly the same result would be reached if the minority shareholder sued for the tort of conversion. In this hypothetical situation, the oppressive conduct involves cancellation of shares. The cancellation of the shares on the company’s books or refusal to recognize the minority shareholder as an owner would constitute tort of conversion of his stock by the corporation. By electing his damages remedy, the minority shareholder would “legalize the wrongful detention by vesting the defendant with title” to the stock, and the minority shareholder would receive a sum of money representing the value of his stock interest.
Proof of fair market value of stock in a closely-held corporation
“Generally, the fair market value of closed corporation stock, or stock having no public market, as here, is ‘what a willing purchaser would pay to a willing seller who was not acting under compulsion to sell.’” One of the defining characteristic of stock ownership in a small closely-held corporation is the absence of any market for minority shares. It is the absence of any ability to exit the venture that give the majority shareholder the power to oppress the minority. This situation creates a problem when the law defines the measure of damages for conversion of the stock as the “fair market value” of the stock. Because no market exists, there will be no evidence of the market price, and a defendant might argue with some degree of credibility that the actual “fair market value” is essentially zero.
There is very little Texas case law dealing with this issue. None of the reported tort conversion cases involving stock in closely-held corporations explained the basis of the damages calculations made by the jury or resolved any challenges on appeal based on measure of damages or methodology. One Texas opinion has noted that, based on authority in other jurisdictions, the rule would probably be “that when the plaintiff establishes that no market exists for the stock or that it has never been offered for sale, the measure of damages is the stock’s actual value, i.e. the price a buyer would pay taking into consideration the original capital, assets and liabilities, and similar factors.” “In arriving at the actual value of the stock, appellees were permitted to prove, and the court took into consideration, the value of appellant’s assets, the amount of its liabilities, and its earning power for a number of years prior to the conversion. As the stock admittedly had no market value, this was a proper method to pursue to determine the actual value of the stock.”
In other damages contexts, courts have utilized other methods of assessing fair market value such as the asset approach and the earnings, or income, approach. One court noted a variety of relevant factors:
When too few stock sales exist to establish a market price, other factors to assess fair market value include:
1. The nature of the business and the history of the enterprise from its inception.
2. The economic outlook in general and the condition and outlook of the specific industry in particular.
3. The book value of the stock and the financial condition of the business.
4. The earning capacity of the company.
5. The dividend paying capacity.
6. Whether or not the enterprise has good will or other intangible values.
7. Sales of stock and the size of the block of the stock to be valued.
8. The market price of stocks of corporations engaged in the same or similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter.
A combination of determining the value of the assets net of liability (asset approach) and a discounted cash flow analysis that measures the present value of the cashflow that the company generates for its owners (income approach), together with a comparison of any available market transactions for sales of similar companies (market approach) is widely acknowledged as the proper valuation methodology in academic literature for valuing closely-held companies. From this evidence, the finder of fact may derive the value of the entire enterprise and multiply that number by the plaintiff’s percentage ownership. However, this exercise yields the “enterprise value” of the plaintiff’s stock, which is not the same this as the “fair market value.” The difference being that no rational buyer would pay the full proportional price for a minority interest in a closely-held company due to the illiquidity or lack of marketability of the investment and due to the lack of an ability to control the investment inherent in minority status. Appraisers back into the “fair market value” of a minority interest by applying “discounts” for lack of marketability and lack of control to the enterprise value.
Application of Minority Discounts in the Tort of Stock Conversion
In the context of converted minority shares, the notion of discounts is extremely ironic. The market rationale for the discount is that a third party stepping into the shoes of an existing minority shareholder is taking a substantial risk—the risk that the majority will act to diminish the value or economic return of the minority. A majority shareholder is not subject to that risk, so majority shares are not discounted. Assume the facts of Davis v. Sheerin in which there are two shareholders, a 55% shareholder and a 45% shareholder. The value of the majority shares is exactly 55% of the value of the corporation as a whole, but the value of the 45% shareholder is something less that 45% of the value of the enterprise, due to the application of a minority discount.
If the majority shareholder causes the corporation to convert the minority shares, then the majority shareholder’s percentage of ownership effectively goes to 100%—the majority shareholder is now entitled to 100% of all dividends, rather than 55%; the majority shareholder is now entitled to 100% of the proceeds of a sale or 100% of the profits available for distribution. If the majority shareholder must compensate the minority for the conversion based on the price a third party might pay, then the majority shareholder receives a significant windfall from the discount because the majority shareholder is not a third party. The majority shareholder has control and is subject to none of the risks that would cause a third party to discount the price. Unlike a third party, the majority will actually receive the full economic benefit of the wrongfully acquired shares. It is for this reason that the Texas courts who ordered buy-outs under the shareholder oppression doctrine typically excluded consideration of discounts. The appellate opinion in Ritchie noted: “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. In that situation, '[t]he oppressed minority investor was not looking to sell, and the oppressive majority investor, absent the threat of dissolution or other judicial sanction, was not looking to buy.’"
Fortunately, Texas case law applying the fair market value measure of damages in conversion tort cases have developed equitable doctrines to deal with this sort of injustice. The purpose of damages in a conversion case is to “to compensate for the injury.” Where the measure of damages works an injustice, the court has “the discretion required to fashion an equitable remedy.” The rule of damages for the tort of conversion is that a “conversion should not unjustly enrich either the wrongdoer or the complaining party.” This rule has been applied to award the plaintiff the price actually received that the defendant on the sale of converted gas, where the defendant had been able to sell for greater than the market value. Therefore, in oppression-type conversion cases that may be brought in the future, we should expect that courts would apply this equitable doctrine to preclude discounts in cases where the corporation or the majority shareholder has effectively appropriated the value of the minority interest.
However, the “same rule should apply to the aggrieved party.” In cases where the plaintiff will receive a significant windfall, “damages are limited to the amount necessary to compensate the plaintiff for the actual losses or injuries sustained as a natural and proximate result of the defendant's conversion.” In a case where the conversion was based only on interference with the right of alienation, then the plaintiff should probably only receive damages based on the specific right taken away—the right to sell to a third party. The inequity of overcompensating a plaintiff was the reason for the court of appeals in Ritchie remanding the case for new trial requiring the application of discounts for purposes of a buy-out.
Stock conversion is a tort and the plaintiff may recover punitive damages if the plaintiff meets its burden of proof. Exemplary damages may be recovered for conversion provided that the plaintiff proves malice. The Earthman court specifically pointed out that “in an appropriate case and upon proper proleading and proof[,] exemplary damages may properly be awarded in a stock conversion case.” Such damages would depend “the degree of malice,” malice need not be shown if damages occurred because of “some willful or wanton act based upon improper motive.” Evidence of any mental suffering is also proper.
Recovery of attorneys’ fees
Because conversion is a tort, generally, attorney’s fees cannot be awarded for a conversion cause of action, as they would be in most contract cases in Texas. However, there is an exception when the conversion claim is so intertwined with the contract which underlies the cause of action such that the action is “intrinsically founded on the interpretation of the contract.” In several conversion cases, courts have allowed recovery of attorney’s fees under Section 38.001 of the Civil Practice and Remedies Code, notwithstanding the fact that the liability is based on a tort. The plaintiff must present the claim and otherwise comply with the statute. This doctrine is likely to be extremely valuable to plaintiffs asserting stock conversion claims because Texas courts have repeatedly characterized the property rights incident to stock ownership as fundamentally contractual.
Most cases involving interference with rights of stock ownership necessarily involve interpretation of the corporation’s bylaws or governing documents or other agreements among the shareholders. In Sandor Petroleum v. Williams, the court held that plaintiff’s stock had been converted as a result of the defendants’ amendment of the bylaws to impose transfer restrictions on the shares of the corporation, which the court of appeals characterized as an impairment of a “vested contractual right.” Conversion cases in which attorney’s fees are awarded involve a contract—either verbal or written, require—the court to interpret necessary contractual provisions to determine the outcome of the case.
For example, in High Plains Wire Line Services, Inc. v. Hysell Wire Line Service, Hysell brought no breach of contract claim, only a tort claim for conversion. The claim centered on High Plains’ conversion of shelving, sign letters, and related items. The contract at issue was the Sale and Purchase Agreement in which Plains would buy equipment from Hysell and whether the Agreement included the sign letters and other items Hysell claims High Plains converted. If Hysell would have complied with the presentment requirement of section 38.001, attorneys' fees likely would have been awarded on the conversion claim, “since the resolution for Hysell’s claims depended on the interpretation of the contract, his cause of action was sufficiently grounded on contract to support an award of attorney’s fees.”
Comparing proposed breach of trust and conversion remedies for oppression
We believe that the law in Texas will develop individual causes of action for oppressive conduct toward minority shareholders based on existing, recognized legal duties and remedies for breach of trust and stock conversion. Both remedies are logical extensions of existing, traditional, common-law causes of action. Both are suggested by existing case law and are completely consistent with the approach suggested by the Ritchie opinion to fill the “gaps” left by the demise of the shareholder oppression doctrine. The application and effect of both remedies would be very similar. Why two remedies, and how do they compare? A California appellate opinion explored this issue, recognizing that when a corporation wrongfully cancels or transfers a shareholder’s stock, “it commits an action which is both one of conversion and breach of trust.”
The plaintiff has an election of remedies. “If he sues for conversion, his damages are measured by the value of his stock as of the date of the wrongful transfer or refusal to transfer, with interest from that time.” If he elects his equitable remedy, then the Court may fashion appropriate relief, which might include “a new certificate as evidence of his stock ownership, together with all dividends declared thereon from and after the date of the wrongful transfer or refusal to transfer, with interest.” The court’s equitable powers also prevent the plaintiff from receiving more than just compensation. If allowing the plaintiff to elect to recover the converted property itself will over-compensate him for his injury, then the trial court may take the election away from the plaintiff and limit the recovery to the fair market value of the property at the time and place of the conversion.
There is nothing unusual about multiple causes of action that may apply to the same wrongful conduct. In the case of the two oppression remedies suggested here, they arise out of distinct, although overlapping, legal duties: fundamental property rights of stock ownership, and the corporation’s duties as trustee of
those rights. One is a legal remedy; one is equitable. The limitations periods and tolling doctrines would be different for the conversion cause of action and the breach of trust cause of action. The burden of proof would likely be different. The breach of trust claim requires proof of intent to harm the plaintiff; the conversion claim does not. The valuation date for a buy-out would also likely be different which value of converted property measured as of the date of the conversion tort, and equitable buy-outs presumptively measured as of the date the lawsuit was filed.