undeclared dividends

Undeclared Dividends Claim 

At the time the Supreme Court decided Ritchie v. Rupe, two other cases out of the Dallas Court of Appeals were also pending review in the Supreme Court: Cardiac Perfusion Services, Inc. v. Hughes,  where the minority shareholder prevailed in the court of appeals and which the Supreme Court reversed and remanded with a per curiam opinion,  and Argo Data Res. Corp. v. Shagrithaya,  where the minority shareholder lost in the court of appeals and which the Supreme Court denied the petition for review after the case was fully briefed. Argo was a case tried under the shareholder oppression doctrine in which the central issue concerned undeclared dividends. The case was tried to a jury, which found in favor of the minority shareholder, and the trial court rendered judgment in favor of the plaintiff, including an injunction to pay out an $85 million dividend.  It is a pity that the Supreme Court disposed of Argo as it did, because the reasoning of the court of appeals was clearly inconsistent with the holdings in Ritchie, and while the court of appeals’ reversal was no doubt correct in light of Ritchie, the court of appeals’ opinion plainly demonstrates that the record would have supported claims that the Ritchie opinion indicated were valid and would likely have been successful in a new trial based on the correct legal theories. The failure of the Supreme Court to grant the plaintiff to chance to do so was a real and regrettable injustice.


Max Martin and Balkrishna Shagrithaya met and became friends while working at Electronic Data Systems in Wisconsin. In 1980, Martin approached Shagrithaya about starting a software business together. Shagrithaya agreed to join the venture, and the men co-founded ARGO Data Resource Corporation, a business providing software and related services to the retail financial services industry. Shagrithaya developed the technology, and Martin ran the business side. Martin received 53% of the stock, and Shagrithaya 47%; both were directors and had an equal vote, but agreed that Martin had the power to appoint a third director in the event of a deadlock. Both agreed to retain earnings while building the company, and no dividends were paid for more than twenty years. The company’s capital grew from $1000 in 1980 to $152 million in 2008. During this time, both men paid themselves equal salaries each year, which increased and topped out at $1 million each.

The relationship between the parties became strained, beginning in the early 2000s. In 2005, the IRS audited Argo and imposed a penalty for excessive retained earnings. Argo filed an ultimately successful protest to the penalty claiming that it was not accumulating “earnings and profits beyond the reasonable needs of its business.” Among the business needs for working capital specified in the protest, was that the redemption of Shagrithaya’s shares was anticipated in 2005. The protest letter stated that ARGO’s “executive management had concluded prior to June 30, 2005, that Mr. Shagrithaya’s minority stock position would likely have to be redeemed to protect the stability of [ARGO’s] business and to avoid impending management and shareholder conflicts that [ARGO’s] executive management believed were almost certain to occur.” The letter further stated that “[t]he implementation of the phase-out of Mr. Shagrithaya began in earnest in 2003 with a restructuring of [ARGO’s] operational structure.” At the time of the protest letter, Martin and Shagrithaya had not yet discussed a buy-out, and Shagrithaya was completely unaware of the on-going “phase-out” of his ownership, including the need to stockpile cash to pay for it. Neither the tax penalty, nor the protest, nor the contents of the protest letter were disclosed to Shagrithaya.

In 2006, Martin unilaterally cut Shagrithaya’s salary from $1 million to $300,000, while keeping his own $1 million salary unchanged. Thereafter, the two shareholders held discussions, off and on, over the next two years, regarding payment of dividends (which Shagrithaya now advocated), salary, having the company appraised, and buying out Shagrithaya’s interest. Martin and Shagrithaya never came to an agreement on any of the matters, particularly the price to be paid for Shagrithaya’s shares. Ultimately, as negotiations went nowhere, Shagrithaya lost interest in a buy-out and began to push for a sizable dividend of $85 million from the company’s $152 million stockpile of cash. Martin and the third board member he had appointend ultimately approved a $25 million dividend. 


The case was tried to a jury on theories of shareholder oppression, malicious suppression of dividends, fraud, and various derivative claims; the jury found for the plaintiff on every issue submitted. The trial court entered a judgment for the plaintiff and awarded damages and attorneys fees on a number of theories, but most significantly ordered an immediate dividend in the amount of $85 million—$20 million more than the jury had found should be issued. The Dallas Court of Appeals reversed and rendered on all theories. While several issues are raised by the court of appeals’ decision, of central interest to this discussion is its treatment of the dividend award and the factual findings supporting it.

The Plaintiff's Theory of Liability for Undeclared Dividends

The plaintiff had made the claim for the undeclared dividends based on shareholder oppression and malicious suppression of dividends as separate causes of action, and had received findings in support of both. The court of appeals held that malicious suppression of dividends was not a separate cause of action, but was merely one form of shareholder oppression, and the court therefore reviewed the dividends claim findings solely in terms of the two definitions of shareholder oppression, and without regard to the corporation’s fiduciary duties or the Patton v. Nicholas and Morrison v. St. Anthony Hotel decisions. In light of Ritchie v. Rupe, the Argo court got that point of law exactly backwards. It is the shareholder oppression claim that does not exist, while the claim recognized in Patton remains the law.

The jury found that Martin engaged in a plan “to retain ARGO’s earnings to buy out Shagrithaya’s interest in ARGO without disclosing this plan to Shagrithaya,” and that Martin caused ARGO to “retain earnings rather than paying a greater amount of dividends to its shareholders than it actually paid.” The court of appeals held that there was sufficient evidence to support these findings and that the evidence and jury findings were consistent with the plaintiff’s theory that “beginning at latest in 2003 and possibly as early as 2001, Martin began retaining ARGO’s earnings for the purpose of buying out Shagrithaya’s shares without telling him.” The jury also found that Martin “dominat[ed] and controll[ed] the Board of Directors of ARGO with the actual result of suppressing the issuance of dividends to Shagrithaya ... for the purpose of preventing Shagrithaya from sharing in the profits to be derived from the operation of ARGO ... [and] depreciating the value of the shares of stock in ARGO owned by Shagrithaya to a lower value than his shares of stock would otherwise have.” The court of appeals rejected those findings.

Rejection of Liability Based on Undeclared Dividends

The court of appeals’ reasoning was based on three propositions, none of which had anything to do with the adequacy of the evidence, and each of which was inconsistent with the reasoning in the Ritchie: First, the court of appeals stated that, “to the extent dividends were ‘suppressed’ from being paid to Shagrithaya, they were also suppressed from being paid to Martin.” This is a true, but utterly immaterial observation. In Patton v. Nicholas, exactly the same factual situation existed and yet the Supreme Court held that the plaintiffs were entitled to relief, and the Supreme Court in Ritchie reaffirmed as correct the holding in Patton. The implied conclusion of the court of appeals is that, so long as the money is still in the company, the minority shareholder has not been harmed, or at least the majority and minority share the same proportional benefits and disadvantages of that situation. That conclusion defies common sense. When the money is left in the company, both the minority and majority may retain their proportional equitable interests in the money in an abstract sense, but the majority has control and the ability to access the funds whenever he wants. The minority does not. The suppression of Shagrathaya’s dividends was involuntary; the suppression of Martin’s dividends was completely voluntary, subject to his control, and within his ability to manipulate for his own benefit. The court of appeals’ reasoning would hold that there is no difference in value of $1 million in a trust fund that could not be accessed for 25 years and $1 million in a checking account. The difference to the trust beneficiary vs. the account holder is immense. That difference is exacerbated when the minority shareholder has an immediate need for the funds and the majority shareholder does not, or when the minority shareholder is not deriving other economic benefits from the company that the majority shareholder enjoys, such less than one-third the salary (Argo) or no salary at all (Patton).

Second, the court of appeals stated that “Shagrithaya was not entirely prevented from ‘sharing in the profits’ of ARGO, because he had proportionally participated in three dividend payments over a four-year period totaling $25 million. Again, so what? The jury found that $65 million in undeclared dividends had been wrongfully withheld. The fact that $25 million had not been wrongfully withheld is immaterial. Moreover, a shareholder’s right is to a “proportionate share in profits.” The court of appeals' observation that the plaintiff was not “entirely” prevented from sharing in profits is beside the point. Finally, the court of appeals stated: “Even assuming that the evidence supported the finding as to Martin’s motivation [to depreciate the value of Shagrithaya’s stock], there is no evidence to support a finding that Martin’s actions resulted in lowering the value of Shagrithaya’s stock.” Exactly the same thing was true in Patton. In both Patton and Argo, the courts noted that, because the companies were making money and because those profits were kept in the company, the value of the stock necessarily increased, not decreased.  However, the court of appeal’s conclusion is wrong on its face, first because it ignores the fact that the value of the stock to Shagrithaya may be diminished even though the value of the company is not. If the minority shareholder gets no economic benefit from stock ownership because of undeclared dividends, particularly where the company is a subchapter S corporation so that the profits create tax liability for the minority owner or where the minority owner needs the money, then the value to that minority owner of his stock is vastly diminished by the intentional withholding of dividends. Every shareholder oppression scenario involves an effort by the majority to diminish the value of the stock to the minority by eliminating or impairing the benefits of ownership. As Patton clearly recognized, that is possible even though the cash stays in the company and the majority does not receive any disproportionate benefits from that cash. More importantly, the holding in Patton was that the suppression of dividends was wrongful based on the malicious intent, not on the success of diminishing the value of the shares. As the Ritchie Court stated, “when a corporate director violates the duty to act solely for the benefit of the corporation and refuses to declare dividends for some other, improper purpose, the director breaches fiduciary duties to the corporation, and the minority shareholders are entitled to relief, either directly to the corporation or through a derivative action.” Therefore, it is Martin’s improper purpose, found by the jury, not the actual effect of his conduct, that establishes a valid cause of action.

The Argo court concluded “that the evidence supports the jury’s findings that Martin caused ARGO to retain earnings rather than pay a greater amount of dividends” and that the “evidence also supports the jury’s finding that Martin retained earnings for the purpose of buying out Shagrithaya’s shares without making Shagrithaya aware of this purpose,” but that the evidence was legally insufficient to support a “finding that Shagrithaya was individually targeted for the purpose of preventing him from sharing in the profits of the company or that the value of his shares was depreciated by Martin’s actions.” The court’s reasoning is non-sense on its face. Obviously, the evidence supported a finding that Martin’s actions were “individually targeted” against Shagrithaya—the evidence was that Martin was stockpiling cash to buy Shagrithaya’s stock, not anybody else’s stock. As noted above, there was ample evidence to support the jury findings regarding Martin’s purpose; the court of appeals’ basis for rejecting the findings was only that Martin was not entirely successful.

Analysis of Undeclared Dividends Under the Shareholder Oppression Doctrine

The Argo court then analyzed the dividends findings in terms of the former shareholder oppresson doctrine’s two tests of defeating reasonable expectations and burdensome, harsh, or wrongful conduct. Within the confines of the pre-Ritchie law, its conclusions were perhaps not unreasonable. First, the court concluded that “Shagrithaya joined ARGO with no expectations of receiving dividends and Martin’s conduct did not defeat Shagrithaya’s specific expectations.” That conclusion stretches the evidence slightly. The court’s statement of the evidence was that Shagrithaya’s expectation was that dividends would not be paid during the time that the parties were building the company. By implication, there would have been some expectation that profits would be distributed after that was done, but the court of appeals must have concluded that Shagrithaya never testified that this eventual payment of dividends was “central to his decision to join the venture.” Next, the court held that “a shareholder may generally expect to share proportionately in the company’s earnings, but a shareholder has no general expectation of receiving a dividend.” Therefore, the only general expectation that Shagrithaya could have would be “in receiving a proportional share of any dividend the board of directors may choose to issue.” That statement is somewhat problematic. The court accepts that all shareholders have a right to share proportionately in the company’s earnings; however, there are only two ways that the earnings can be shared with the shareholders: salaries, bonuses, and other employment-related compensation, or dividends. If shareholders can have no reasonable expectation in their continued employment, no reasonable expectation in their level of compensation, and no reasonable expectation in their receipt of dividends, then the reasonable expectation in a proportionate share of earnings is illusory because there is no reasonable expectation in any means of receiving those payments.

Finally, the court determined whether the facts found by the jury “constitute burdensome, harsh, or wrongful conduct.” The court concludes in the negative: “Because Martin’s ‘suppression of dividends’ did not substantially defeat Shagrithaya’s expectations or prejudice his rights as a shareholder, we conclude this conduct did not amount to minority shareholder oppression.” This conclusion is based on the court’s argument that “[b]uying out a minority shareholder’s interest is not an improper purpose for retaining a company’s earnings. Such a purpose becomes improper only if it negatively impacts the minority shareholder’s rights. As Shagrithaya notes in his brief, the two ways a minority shareholder’s rights may be impacted are if he is prevented from sharing in the profits of the company or the sale value of his shares in the marketplace is depreciated. But, as shown above, neither of these things occurred.”

The Undeclared Dividends Claim Under Ritchie v. Rupe

Under Ritchie, none of the Argo court’s reasoning would have been relevant. The derivative claim recognized in Ritchie, based on its (mis)construction of Patton, did not inquire into the reasonable expectations of the shareholder or even the nature of the conduct. The sole issue is the purpose of the action, whether the director “violates the duty to act solely for the benefit of the corporation and refuses to declare dividends for some other, improper purpose.” The only statement in Argo that addresses this issue is the court’s bare assertion, without any citation of authority, that “[b]uying out a minority shareholder’s interest is not an improper purpose for retaining a company’s earnings.” That statement is completely contrary to settled law. The buy-out of a minority shareholder does not benefit the corporation in any way. It can only benefit the majority shareholder who acquires a greater percentage of the benefits of ownership, and perhaps, depending on the fairness of the price, the minority shareholder. Quite simply, a corporation’s use of its retained earnings to purchase the interests of any particular shareholder is not a corporate
purpose at all. The jury’s finding that Martin’s purposes were (1) to prevent Shagrithaya from sharing in the company’s profits, (2) to reduce the value of Shagrithaya’s shares to Shagrithaya, and (3) ultimately to use Shagrithaya’s own money that has been retained in the company for the purpose of buying out his interests and enlarging Martin’s interests. These are quite clearly purposes that were not “solely for the benefit of the corporation.” Martin clearly violated his fiduciary duties to Argo, as defined by Ritchie, and would have been entitled to the equitable relief awarded in Patton, based on the jury’s findings.