Right to Transfer Ownership of Shares

Protecting the Right to Transfer Ownership of Shares

The Ritchie v. Rupe court of appeals opinion was a significant examination of the former Shareholder Oppression Doctrine. It was reversed by the Supreme Court, but its recognition of the right to transfer ownership of shares of shares will be important as the lower courts develop other legal theories to protect these same expectations, rights, and interests and fill in the gaps left by the Supreme Court.

The Dallas Court of Appeals Ritchie v. Rupe decision held that, absent valid restrictions on alienability or
limitations imposed by contract, all shareholders have the fundamental right to sell their shares to whomever they please at any price they wish.  The court held that the transferability of shares is a "general reasonable expectation" and is presumed as a matter of law to belong to all shareholders and to be "both reasonable under the circumstances and central to the decision to invest in the corporation," absent evidence to the contrary. 

Transferability of Shares as a Property Right

The court reasoned that every property owner, including the owner of stock in a corporation, has the right of free alienation of property, citing TEX. CONST. art. I, § 26 interp. commentary: "The framers of the Texas Constitutions, beginning with that of the Republic, have believed in an unrestrained power to convey or transfer property, and thus have written into the Bill of Rights this provision against perpetuities, primogeniture and the entailment of estates." Unrestricted shares are freely transferable. 

Texas Business Organizations Code §20.209 provides that all shares are transferrable, "except as otherwise provided by this code." Section 20.210 permits restrictions on transfer to be imposed by a corporations certificate of formation (articles of incorporation), bylaws, written agreement among two or more shareholders, or written agreement between the corporation and one or more shareholders (subject to certain disclosure requirements). Section 20.211 provides for the validity of most types of restrictions on transferability of shares.  However, the code imposes two significant limitations.  The first is that restrictions on transfer must be reasonable.  BOC §§21.211(a); 21.213(a)(2). 

The Texas Supreme Court in Ling & Co., Inc. v. Trinity Sav. & Loan Ass'n, upheld the reasonableness of a requirement to notify all shareholders prior to any transfer of shares.  However, the Court noted that the reasonableness requirement does impose limits:  "Conceivably the number of stockholders might be so great as to make the burden too heavy upon the stockholder who wishes to sell and, at the same time, dispel any justification for contending that there exists a reasonable corporate purpose in restricting theownership. But there is no showing of that nature in this summary judgment record." 

The other major restriction is that any limit on the transferability of shares must be imposed before the shares are issued, unless the shareholder votes in favor of the restriction or is a party to an agreement imposing a restriction. BOC §21.210(b).

Sandor Petroleum Corp. v. Williams

Majority shareholders can act oppressively by attempting to impose new restrictions on minority shareholders by amending the articles or bylaws.  This was the situation in Sandor Petroleum Corp. v. Williams. In that case, a corporation had issued unrestricted stock to its four founding shareholders for valuable consideration. When a dispute over management arose, one of the shareholders offered his stock for sale. The other three shareholders (who were also directors) then adopted a new bylaw containing restrictions on the transfer of stock, canceled the unrestricted share certificates, and issuing new share certificates containing the newly adopted transfer restrictions.

The court in Sandor recognized the minority shareholder owned the stock free of any restriction on transfer: "His ownership of the stock and his right to sell or transfer it was a vested right and interest, subject only to the right of the corporation to manage and regulate its affairs under the laws of this state and under the provisions of its charter and bylaws." The court rejected the argument that newly adopted transfer restrictions could be imposed on existing unrestricted stock, explaining that "[s]uch a restriction on previously un- restricted stock would unreasonably restrain and prohibit its sale and transfer and could result in depriving the owner of the full value of his stock." The court concluded the corporation's right to manage its affairs did not include the right to adopt policies that impair the vested rights of holders of unrestricted stock to seek to transferability of their stock:

Williams had a vested property right in the value of his stock. The right of the corporation to regulate and to manage its affairs does not include the power to impair that vested contractual right and to take from holders of unrestricted stock the value of their stock. The amended bylaw of the Sandor Petroleum Corporation so restricting the sale of its previously unrestricted stock was, therefore, unauthorized and invalid in so far as it denied appellee's right to sell at a price which he could have secured on the open market.

The Sandor court affirmed an award of damages for conversion to the minority shareholder based on the cancellation of his original share certificates.

Right to Transfer Ownership of Shares Under the Shareholder Oppression Doctrine

The Dallas Court of Appeals in Ritchie v. Rupe, found the Sandor case instructive, except that the majority shareholders in Ritchie had not taken any action overtly to prohibit the minority shareholder from attempting to sell her stock. Rather, the majority shareholders and directors simply refused to communicate with prospective purchasers solicited by the minority shareholder and indirectly interfered with the transferability of the plaintiff's shares. The minority shareholder's broker testified that any prospective purchaser would expect to meet with management as part of normal due diligence and that the refusal by the majority shareholders to meet with prospective purchasers had made it impossible to market the shares.  The court of appeals held that this refusal on the part of the majority substantially defeated the minority shareholder's reasonable expectation of the free transferability of her shares.  In addition to the substantive legal right to sell her shares, the court also focused on the realities of attempting to sell a minority interest in a closely-held corporation: 

Despite the general reasonable expectation of being able to sell unrestricted shares at a mutually acceptable price, often no ready market exists for the stock in a closely held corporation, especially if it represents a non-controlling, minority interest. In that context, unless the minority shareholder reaches an agreement to sell her stock back to the closely held corporation or to someone already involved in its ownership or management, to sell her stock she must market it to third parties. Because often no ready market exists, to sell her stock to third parties she must market her stock by (1) identifying potential third-party buyers through means such as advertising, networking through brokers and others, and meeting with potential buyers, and then (2) providing to those potential buyers sufficient information about the corporation and its businesses, assets, and management as to allow them to conduct a reasonable investigation as to the proposed transaction.

The court held that the majority's refusal to cooperate with the minority shareholder's attempts to sell, "constructively prohibit[ed] the shareholder from performing these activities" and therefore "would substantially defeat the shareholder's general reasonable expectation of being able to market her unrestricted stock." This holding is somewhat striking in that the majority is not only prohibited from interfering with the right to sell, but the court imposes an affirmative obligation on the majority to cooperate.

Independently, the court held that the second prong of the shareholder oppression definition imposes affirmative obligations on the majority. In addition to protecting a shareholder's reasonable expectations, the shareholder oppression doctrine also prohibits "burdensome, harsh, or wrongful conduct; a lack of probity and fair dealing in the company's affairs to the prejudice of some members; or a visible departure from the standards of fair dealing and a violation of fair play on which each shareholder is entitled to rely."  The court noted: "The second definition of shareholder oppression will often overlap the reasonable expectations definition because the standards of fair dealing on which all shareholders are entitled to rely will often include conduct necessary to meet the reasonable expectations of shareholders." Therefore, the court held that the majority's duty of fair dealing necessarily encompassed an obligation to cooperate in the minority shareholder's attempts to realize her reasonable expectation of the right to sell her stock: "Because a holder of unrestricted stock in a closely held corporation has a general reasonable expectation of being able to market her stock to third parties, it is also reasonable to expect that the corporation and its management (as part of the standards of fair dealing on which all shareholders are entitled to rely) will consent to a shareholder's reasonable requests for cooperation with respect to her efforts to sell the stock."

The court was quick to point out, however, "the rights of the minority shareholder and the concomitant obligations of the directors or those in control of the corporation are not unlimited."  The affirmative duties imposed on the majority are only to act reasonably and fairly and to avoid conduct that substantially defeats reasonable expectations:

For example, and in the context of a minority shareholder's efforts to sell her stock, the majority shareholders, directors, or those in control of the corporation need not seek potential purchasers for the minority shareholder's stock or otherwise market the stock on her behalf. They need not agree to requests that would unduly disrupt or affect the operation of the business or intrude into issues reserved for corporation's officers and directors. And a shareholder cannot request the corporation's management to speak or act in a manner that would tend to inflate the value of the stock and the corporation, and the shareholder may not request that management mislead potential investors.

Furthermore, the court recognized the right to impose reasonable restrictions on the access to and use of business information and reasonable limitations on the corporation's cooperation, including limiting the time spent with potential investors and requiring them to sign confidentiality agreements.

With the demise of the shareholder oppression doctrine, a facts that supported the shareholder oppression judgment in Ritchie would need to be pursued under a conversion cause of action.