Wrongful Termination of a Shareholder's Employment
Is there a Texas Claim for Wrongful Termination of a Shareholder's Employment?
Violation of shareholders' agreements of employment - wrongful termination in Texas.
In any discussion of oppressive conduct, the wrongful termination of the minority shareholder’s employment by the majority shareholder is the elephant in the room. In almost all closely-held corporations, the primary purpose of the investment is to provide employment for the shareholders—the parties form the corporation not so much in order to “own their own business” as to “work for themselves.” In almost every closely-held corporation, profits are shared exclusively through salaries and bonuses, and compensation received by the shareholder-employees is the only way in which they participate economically in the corporation. In almost every shareholder oppression situation, the majority shareholder fires the minority shareholder—thus cutting off all economic benefit of share ownership—but more importantly cutting off the minority shareholder from access to his only source of wealth and income. In many ways, the shareholder oppression doctrine is really a judicial remedy for wrongful termination when the terminated employee is a part-owner of the employer. Yet, no court (particularly not in Texas) has ever been willing to own up to that conclusion. Strong public policies, such as at-will employment and the statute of frauds, make it very difficult for Texas courts to remedy wrongful termination of employment in any situation, and in even the most ardent pro-minority-shareholder opinions dance around the at-will issue. With the demise of the shareholder oppression doctrine in Texas, any judicial protection of the minority shareholder's right to “work for himself” is simply off the table.
just like every other employee
Minority shareholders must get written employment contracts just like every other employee.
Here's the bottom line for wrongful termination in Texas: Wrongful termination is an employment issue, not a shareholder issue. Texas law treats a minority shareholder's right to employment with no more dignity than that of any other employee. Minority shareholders who work in their own corporation are at-will employees--period--just like every other employee. Minority shareholder who does not want to be vulnerable to loss of the benefits of share ownership at the whim of the majority have the same option as any other employee who does not want to be at-will: Get a written employment agreement that either specifies a term of years for employment or limits to ability of the employer to terminate the relationship, such as "for cause only." Common sense would seem to dictate that the right of an owner in a company (particularly one who founded the company for the express purpose of being employed there) would have more of a claim for wrongful termination in Texas than a non-owner employee; however, that common sense is not the law.
Nevertheless, termination of employment undeniably does impact vital shareholder interests that Texas law protects, most importantly the right to share in profits. What is needed is the judicial development of a more flexible contractual approach to the need for shareholders to be protected in their employment. In other sections of this website, we argue for the development of judicial protections of the benefits and purposes of shareholder employment (but not the right to employment per se) through actions for breach of trust, stock conversion, and dividend claims.
termination of Texas shareholders
No legal protection of against wrongful termination of Texas shareholders
In Ritchie v. Rupe, the Texas Supreme Court noted that termination of employment is a common squeeze-out tactic in shareholder oppression cases. “A minority shareholder's loss of employment with a closely held corporation can be particularly harmful because a job and its salary are often the sole means by which shareholders receive a return on their investment in the corporation.” Nevertheless, “Texas is steadfastly an at-will employment state.” “For well over a century, the general rule in this State, as in most American jurisdictions, has been that absent a specific agreement to the contrary, employment may be terminated by the employer or the employee at will, for good cause, bad cause, or no cause at all.” The Court noted that, although at-will employment is the default, employers and employees have the freedom to contract for a different employment relationship, and the Business Organizations Code expressly provides for statutory shareholders’ agreements that memorialize the terms of employment for a director, officer, or other employee. “In the absence of such a contract, however, we may not presume that the company and its shareholders elected to forgo their at-will employment rights, for to do so would violate this State's strong policy in favor of at-will employment.” Therefore, the Ritchie Court held that, absent an enforceable contract, a minority shareholder is without other legal protection against a termination of employment, even though the purpose and effect of the termination was to oppress the minority shareholder—Texas’ “commitment to the principles of at-will employment compels us to conclude that the opportunity to contract for any desired employment assurances is sufficient.”
shareholder oppression doctrine
Treatment under the former shareholder oppression doctrine
Even under the former shareholder oppression doctrine, wrongful termination of employment did not receive substantial judicial protection. Courts routinely held that shareholders had no general expectation of annual employment compensation or continued employment; and therefore, absent proof of an express agreement, neither was a “reasonable expectation” subject to legal protection. One shortcoming of the legal analysis of reasonable expectations under the former shareholder oppression doctrine was that so-called “specific reasonable expectations,” which required “proof of specific facts showing that the specific expectation was reasonable under the circumstances and central” to the decision to join the venture, were still treated as legal interests that were less than contractual. Even in the face of proof establishing the existence “specific reasonable expectations,” courts still balanced the shareholder’s expectation against the majority shareholder’s need to manage the company and the public policy in favor of at-will employment. In Willis v. Bydalek, the plaintiff’s employment in the corporation was central to the agreement to organize the corporation.
The plaintiff in that case relocated to Texas from Wisconsin and invested his life savings into the venture in reliance on his having a job and an income from the corporation. Under these circumstances, the expectation that employment was a benefit of stock ownership was certainly objectively reasonable, at least in the beginning, and was undoubtedly central to the investment decision. Nevertheless, the court “balanced” the expectation of employment against the public policy of at-will employment and held that the legal policy favoring at-will employment made the expectation of continued employment “unreasonable” as a matter of law, regardless of the facts to the contrary, and held that the plaintiff's "expectations of continued employment, without a contract, [were not] 'objectively reasonable.'" This statement, however, begs the question. The opinion certainly reveals that the expectation that employment would be a right and interest incident to stock ownership existed in that case. All parties understood that expectation. All parties acted in accordance with that expectation until the dispute arose. The question addressed by the Court is whether the parties had a contract that tied stock ownership to employment or not. If there was an agreement tying continued employment to stock ownership, then the plaintiff was not an at-will employee, and there was no public policy to consider in determining the reasonability of the expectation. The same facts establishing the plaintiff's reasonable expectations also establish that the plaintiff did, in fact, have a contract. The court was simply wrong in reasoning that the absence of a contract was determinative. However, the ultimate holding was no-doubt correct that, under the circumstances, the minority shareholder's disappointment did not constitute oppressive conduct because there was no loss of economic return, the venture was not successful, and the majority shareholder did not act in bad faith or evidence a pattern of oppressive behavior beyond the firing.
employment by contract
Difficulties of establishing the right to continued employment by contract
Although enforceable agreements among shareholders may be written, oral, or implied as to most matters, courts are extremely hostile to any agreement altering the at-will nature of employment. For the most part, courts will not imply such agreements, even from very strong evidence of promises made and relied upon. Courts have refused to hold that statements in employee handbooks indicating that employment could be terminated for cause impose any limitation on an employer’s ability to terminate without cause. Contracts, express or implied, must be sufficiently definite as to all material terms. Courts generally express extreme skepticism as to implied agreements regarding continued employment or future compensation. For example, in Argo Data Res. Corp. v. Shagrithaya, a shareholder oppression case, the court rejected an implied agreement that the two shareholders with roughly equal share ownership would be compensated equally:
At trial, Shagrithaya testified that he had no discussions with Martin about his compensation before they founded ARGO. He further testified that he had no written or oral agreement about his compensation. Neither Martin nor Shagrithaya received any compensation until after ARGO began to generate revenue. Each year after the founding of the company, Martin and Shagrithaya signed board resolutions setting their salary for the year.
To the extent that Shagrithaya specifically expected to be paid an equivalent salary to Martin as they built the company together, and this expectation was central to his decision to join ARGO as a shareholder, his expectation was met for the first twenty-five years that he worked at the company. To the extent Shagrithaya expected, however, to maintain a level of compensation equal to Martin's indefinitely regardless of circumstances or his position in the company, we conclude that, without an agreement pertaining to compensation, such an expectation was not reasonable.
A related problem is the parol evidence rule. Even where the terms of an oral or implied agreement regarding future employment and compensation is proven to be sufficiently definite to be enforceable, that proof will be precluded if there is an integrated written document. If there is a written subscription agreement state fully states the terms of the stock purchase, the consideration, and the nature of the stock interest, then the parol evidence rule will preclude any evidence of other, additional or different agreements before or simultaneous with the stock purchase agreement. If there is a written subscription or stock purchase agreement (there usually isn’t), then a claim that the parties also had an agreement that stock ownership entailed employment might very well be unenforceable.
Statute of Frauds
An even more difficult problem is presented by the statute of frauds. Tex. Bus. & Comm. Code § 26.01. The statute of frauds prohibits enforcement of any contract that cannot be performed within one year, unless in writing and signed. Therefore, most oral agreements with respect to employment will be unenforceable even if the plaintiff can prove beyond doubt that the oral agreement was made. An unenforceable agreement is termed one that is “within the statute of frauds.” The question of whether an agreement falls within the statute of frauds is one of law. Yet the question of whether an exception to the statute of frauds applies is generally a question of fact. If an oral contract can, from the terms of the agreement, be performed within one year, it is not within the statute of frauds. Where the term of performance is uncertain, such as a contract that merely provides for the performance of a particular act that could conceivably be performed within one year, the statute does not apply, however improbable performance within one year may be. Generally, indefinite-term employment contracts are considered performable within one year and therefore do not fall within the statute of frauds. For example, where an employee has an oral agreement that he may only be terminated for cause and will remain employed as long as his performance is satisfactory, the contract is not within the statute of frauds. However, the mere fact that a duration of performance is "implied" may place an indefinite term agreement back within the statute of frauds. In one Texas Supreme Court case, the employee was retained under an indefinite-term employment contract to develop a sales territory. The employee's petition alleged that his oral contract would last for a “reasonable time.” The trial court submitted special issues to the jury that determined that a “reasonable time” was three years. The Texas Supreme Court reversed the trial court's award of damages, holding that the jury's three-year duration was an implied term of the contract and therefore the contract was barred by the statute of frauds. The Supreme Court has defined the issue as one of determining the parties' intentions at the time of contracting. When the parties omit an express stipulation as to time, it is in accord “with human experience and accepted standards of law for us to assume that they meant whatever term of days or years might be reasonable in the light of the circumstances before them at the date of the contract.” The jury must carefully examine the subject matter and the circumstances surrounding the parties' situation present at the time of the contract, but must not depend on facts arising after the contract was entered.
The statute of frauds may also be defeated by proof of partial performance of the contract or complete performance as to the plaintiff. Partial performance is only an exception to the statute of frauds if the acts are “such as could have been done with no other design than to fulfill the particular agreement sought to be enforced.” In the employment context, providing services is rarely sufficient to constitute partial performance. Courts reason that salary compensates for services rendered; if a person receives payment for his services, those services will not act as an exception to the statute of frauds. “Rendition of services for which a person receives a monthly salary is insufficient to take the alleged agreement out of the statute of frauds because the services were fully explained by the salary without supposing any additional consideration.” In the minority shareholder context, however, there is always an additional factor, which is the issuance of stock. If the agreement was that the shareholder would receive a share of stock in exchange for his investment and one of the attributes of that stock was the continuing option to work for the company and receive a salary so long as the investor remained a shareholder, then the payment of the subscription, the receipt of the shares, and the commencement of employment might very well constitute partial performance.
Finally, the statute of frauds is not a defense to a claim of constructive fraud. “Constructive fraud” is the breach of a legal or equitable duty that the law declares fraudulent because it violates a fiduciary relationship. To establish constructive fraud, the plaintiff must prove (1) that the defendant owed a fiduciary duty to the plaintiff, (2) that the fiduciary duty arose before and separate from the contract with the plaintiff, and (3) the defendant would be unfairly or unjustly enriched if the contract were not enforced.
Proving the Shareholder Agreement
Possible Texas Wrongful Termination Claim Based on a Shareholder Agreement
Obviously, the best possible situation would be a written shareholder's agreement providing for continued employment. Any minority shareholder, who has access to competent counsel in the formation of the company, would insist on such protection as a condition of going foreward. Unfortunately, that is almost never the situation in actuality.
Assume a very typical factual situation: Two shareholders form a closely-held corporation for the purpose of providing themselves with employment and with the intention to distribute the profits to themselves by means of salary. The plaintiff will need to prove that part of the consideration in the stock issuance was an agreement that each shareholder would be remain employe so long as he was a shareholder, that the option to work in the company and be paid a salary was a contractual benefit of stock ownership. Therefore, the shareholder would not be an at-will employee. Public policy would imply a "for cause" exception, permitting termination notwithstanding the agreement for serious misconduct.
How would the minority shareholder prove such an agreement? In all likelihood, there was never a specific “employment agreement” conversation, because the purpose for starting a business was too obvious for words to the participants and because neither participant conceived of himself as an "employee" or as an "employer" but as a partner who both works in the business.
Years later when the parties are in a dispute, the plaintiff may very well testify, as did the plaintiff in Argo Data Res. Corp. v. Shagrithaya, that there was never a specific conversation and that there was never an “agreement” regarding employment or compensation. That testimony is correct from the layman’s point of view but not from the point of view of the law. Parties can have an “agreement” that is completely unspoken and implied entirely from their mutual intent, evidenced by their actions and the circumstances. Counsel for the plaintiff in such a case will need to explore carefully with the minority shareholder (and in the majority shareholder’s deposition) the reasons and purposes for forming the enterprise. What were the shared expectations, hopes, and dreams? How specifically did the parties intend that they would benefit from their hard work and investment? What discussions did they have? Was it the purpose that the parties would be able to “work for themselves?”—which would necessarily require that the corporation provide both with jobs, right? Even if it was never explicitly stated, the truth is probably that both parties went into the formation of the company with the intent and purpose that the company would provide them both with employment and that the right to employment was one of the rights conferred by share ownership. So long as each was a shareholder, each would be an employee and draw a salary. (Shareholder's do frequently agree to the converse: that if either shareholder ceases to be an employee, then they can no longer be a shareholder.)
Statute of Frauds
The oral/implied contract that so long as each party retained share ownership, each would have a job, is not within the statute of frauds because no definite term is stated or implied. Conceivably, the shareholder could cease to be a shareholder within one year. The plaintiff would need to maintain that neither party had any idea about whether the venture would succeed or whether the parties would work well together and so it was entirely possible that they would fail within a year, or split up and sell the stock back within a year. The plaintiff would need to contend that no definite terms was discussed, contemplated, or intended. This position would be all the more credible if the parties had set up a mechanism to buy out a departing shareholder or had actually discussed how it would be handled if one of them wanted to leave.
Damages Remedy for Lost Wages
Having escaped the statute of frauds by proving that the oral or implied contract of employment could have been performed within a year because the parties, at the time of contracting, had no express or implied agreed intention on the length of duration of stock ownership, how then does the plaintiff prove damages for breach of the contract? In Gerstacker v. Blum Consulting Engineers, Inc., the Dallas court of appeals reversed a summary judgments based on the statute of frauds, where the plaintiff had proven that the parties had not agreed to any definite duration, but sought damages for eighteen months lost employment. The court held that the two issues were independent. In order to escape the statute of frauds, the plaintiff must prove that there was no agreement as to duration at the time of contracting and that the contract could have been performed within a year. Evidence of anything that happened or any understandings reached after the agreement was made is irrelevant to determining that intent. However, to establish damages, the plaintiff will be required to introduce some evidence indicating a probable duration of stock ownership--e.g., the business succeeded and thrived; both shareholders worked well together (initially); the plaintiff determined that he wanted to remain a shareholder and "work for himself" as long as he could.
That evidence must be based solely on things that happened after the agreement was made. However, any evidence that the parties actually intended and contemplated an ownership period longer than a year, e.g., a business plan with five-year projections, would likely constitute evidence of an implied duration longer than a year. On the other hand, defendants often are so adamant that there was no agreement and no guaranty of employment, that they may fail to testify as to an original intent that the duration of ownership and employment would be longer than a year and thus box themselves out of the ability to rely on the statute of frauds.
The plaintiff in this hypothetical case could approach the damages remedy like an ordinary Texas wrongful termination cause of action, in which case the plaintiff would receive the present value of salary he would have received for the number of years he can prove he would have remained employed, minus the amount of salary he would make, having acted reasonably to mitigate his damages. This proof is obviously problematic, because any evidence showing that the parties intended a lengthy employment at the time of contracting put the plaintiff back into the statute of frauds. The amount of time the plaintiff would have been employed and his future salary are quite speculative, and the requirement to mitigate (by finding another job) can greatly diminish the recovery.
Diminution in Stock Value
Damages Remedy for Diminution in Stock Value
A better alternative is to conceptualize the legal issue not as a wrongful termination issue but as a share ownership issue. The contract that the plaintiff had was not a contract providing him with employment as an employee but was a contract for the investment in shares in a corporation in which the specific attributes of the stock were agreed. Texas courts have frequently held that stock ownership is at its essence a contractual arrangement—the articles of incorporation, the bylaws, the share certificate, even the provisions of the corporations act have all been held by courts to be part of a contract between the corporation and the shareholder or among the shareholders. Part of the investment agreement (whether express or implied) are the various attributes and rights that stock ownership entails. A share of stock may confer whatever rights and benefits on its holder that the parties agree to. Disney stockholders used to get free or discounted entry to theme parks as a right (or perk) of stock ownership. The plaintiff in our hypothetical case will prove that one attribute of his stock is that it comes with a job, and thus a guaranteed way to participate economically in the profits of the company—much like a provision for guaranteed dividends. A share of stock with a right to a job is worth much more than a share of the same stock without such a right. The damages could easily be based on the difference in the value of the stock caused by the failure to grant all of the rights and benefits that the shareholder purchased when he made his investment.
For example, if the profits of the corporation are distributed by salary to shareholder-employees (the norm), then a damages expert could calculate the likely present value of the salary as part of the return on the investment in the stock. The plaintiff would be entitled to recover that value minus the value of the stock without such a guaranteed return (essentially zero). Under this analysis, there should be no duty to mitigate by finding alternative employment; however, the damages might be reduced by an amount that the plaintiff would make from alternative employment that would otherwise have been precluded by employment with the corporation, to prevent unjust enrichment of the plaintiff.
Providing an Exit
Alternative Remedy Providing an Exit
Assume a similar fact pattern in which the plaintiff may prove that the promise of continued employment was part of the essence of the investment contract. However, the plaintiff concedes that the unwritten promise of continued employment is within the statute of frauds and unenforceable due to the at-will employment doctrine. Therefore, the plaintiff’s investment contract is an illusory contract—one without consideration or in which the consideration necessarily fails. The minority shareholder is entitled to rescission and restitution of the entire investment contract. Where the plaintiff invested substantial capital, that remedy may be preferable. However, in most cases, the monetary investment in closely-held corporations is minimal in terms and is based on the promise to work in the company and build “sweat equity.” Frequently, the plaintiff (and everybody else) works for well below the fair market value of their services—in effect investing the value of those services into building the corporation—only to lose what they believed was guaranteed employment just when the investment is beginning to pay off. In such a case, the plaintiff would be entitled to restitution of the value of his sweat equity investment through a quantum meruit claim and would prove a claim of damages for the difference between the fair market value of the services he contributed and what he was paid. Many times, this remedy would not make the plaintiff whole, but in some cases it would be sufficient. Ordinarily, a quantum meruit recovery is not permitted where there is an express contract—i.e., the at will employment in which the plaintiff provided services and was paid what he agreed to take. However, that rule would not apply where the services were provided pursuant to a contract with the company to invest in stock. The plaintiff gave as consideration his promise of future services. He received in exchange a share of stock, the critical attribute of which is the right to work in the company and be paid. If the critical attribute of the stock that the plaintiff purchased is unenforceable, then the investment contract is illusory, and there is no express contract to bar the equitable remedy.
Causes of Action
Tort Causes of Action
Finally, the termination of the shareholder’s employment might give rise to a tort claim independent of any enforceable contract right. As we have argued elsewhere, a shareholder has certain fundamental property rights, including the right to share proportionally in the corporations’s profits. Because the norm among closely-held corporations is that profits are shared almost exclusively through salary, the decision to terminate the employment of a minority shareholder necessarily appropriates the economic value of his share ownership. Therefore, even if an at-will employee has no right to continued employment as such, the intentional violation of the shareholder’s right to share in corporate profits may nevertheless be actionable under remedies to compel payment of dividends or in extreme cases as stock conversion. Furthermore, as we have argued, Texas law recognizes that corporations owe certain fiduciary duties to shareholders, including the duty not to attempt to impair their interests, appropriate their dividends, or violate the duty of impartiality among shareholders. Where all shareholders work in the company and share in profits exclusively by means of employment compensation, the sudden decision to fire one of those employees for the purpose of impairing the value of his ownership, almost certainly violates fiduciary duties owed by the corporation to the shareholder. In Ritchie v. Rupe, the Supreme Court specifically contemplated that termination of employment may give rise to tort causes of action:
There may be situations in which, despite the absence of an employment agreement, termination of a key employee is improper, for no legitimate business purpose, intended to benefit the directors or individual shareholders at the expense of the minority shareholder, and harmful to the corporation. Though the ultimate determination will depend on the facts of a given case, such a decision could violate the directors' fiduciary duties to exercise their “uncorrupted business judgment for the sole benefit of the corporation” and to refrain from “usurp[ing] corporate opportunities for personal gain.” As we have already discussed, a shareholder may enforce these duties through a derivative action, and the Legislature's special rules would apply if the matter involved a closely held corporation.
The Supreme Court specifically was focusing on termination of employment decisions that would violate an officer's or director’s duty to the corporation and give right to a breach of fiduciary duty claim on behalf of
the corporation (which the minority shareholder might be able to pursue through a derivative action), however, the principal is the same. The termination of employment decision might be shielded from any claim by the terminated employee based on an unenforceable promise, but the same conduct might also violate property rights of the individual shareholder or corporate quasi-fiduciary duties owed to the shareholder by the corporation and give rise to a separate cause of action.