© 2014 The Texas Lawbook.
By Mark Curriden, JD
Senior Writer for The Texas Lawbook
(June 23) – A deeply divided Texas Supreme Court issued a landmark decision Friday that legal experts say will likely slam shut the courthouse door to minority investors in hundreds of privately owned Texas companies who feel they have been financially damaged by the actions or inactions of majority ownership.
And some legal experts predict the ruling will cause venture capitalists to think twice before investing in Texas-based business start-ups in technology, healthcare and energy companies.
The state’s highest court, in a 6-3 opinion, ruled that minority shareholders in closely held Texas companies can no longer turn to the court system to help them receive “fair market value” for their ownership interests when corporate leaders take positions designed to cause the value of the minority’s interests to plummet.
The justices also declared that it is not “oppressive conduct” when majority shareholders refuse to meet with prospective purchasers of the minority’s stock to discuss future business strategies even if the refusal means the minority will be unable to sell their interests or will be forced to sell at a drastically reduced price.
The ruling, which stunned many in the corporate law community, overturns 25 years of legal precedents and is a major blow to legal protections that have long been afforded to minority shareholders who have invested in small, mid-sized and very large private companies in Texas, according to legal analysts.
“This is a hugely important decision for family businesses and other small companies,” says Richard Smith, an appellate law expert at Lynn Tillotson Pinker & Cox in Dallas. “This is a decision that puts minority shareholders in a much weakened position when their personal interests clash with the decisions of the majority.”
In a strongly worded dissent, three state Supreme Court justices denounced the ruling as “a radical departure from settled precedents and expectations.” Justice Eva Guzman, in her dissenting opinion, notes that the majority’s decision goes against the law and precedent in nearly every other state.
The Supreme Court decision could significantly impact future business decisions by majority and minority shareholders at hundreds of privately held companies ranging from San Antonio-based HEB and Austin-based Dell Inc., to Murchison Oil and Gas in Dallas, according to legal analysts.
“The Texas Supreme Court has elected to go in a very different direction from the courts in the rest of the country,” says Christopher Kratovil, an appellate lawyer at the Dykema law firm in Dallas.
“Even other states with a reputation for being business-friendly, such as Delaware and Nevada, have recognized the importance of protecting minority shareholders in closely held corporations against abuse by the majority shareholder,” says Kratovil. “In the wake of this decision, minority owners in Texas enjoy much less protection than in other states.”
Smith and Kratovil say the Supreme Court imposes significant restraints on shareholder oppression claims and refocuses legal claims on whether harm suffered by the company rather than harm to minority shareholders.
“For decades, Texas courts have been willing to step in when a minority shareholder is being mistreated by the majority,” says Smith. “Sometimes that has meant requiring the majority to buy out the minority’s shares at some kind of fair price.
“This decision takes that possibility off the table, forcing business owners to keep on living with each other even when they can’t get along and can’t agree on how to run the company,” he says.
Several legal experts say the high court’s decision in Rupe could have substantial negative consequences on new business start-ups in Texas.
“I fear this decision will adversely impact the flow of venture capital and investment dollars into Texas, as sophisticated investors will now have little interest in taking a minority stake in a closely-held Texas company,” says Kratovil. “Action from the Legislature may be necessary to restore the flow of investment capital to Texas companies, and to vindicate the State’s reputation as a good place to start a new business.”
The case in question arose when Ann Rupe decided she wanted to sell her 18 percent of Dallas-based Rupe Investment Corp., a family trust she inherited when her husband, Buddy Rupe, died. The other members of the family, including Lee Ritchie and Paula Dennard, owned 79 percent of the company and offered to pay Rupe $1.7 million.
Rupe hired an independent securities broker who told her outside investors would pay $3.4 million, but only if the proposed investors could meet with the majority shareholders and management to discuss long-term financial strategies.
When the other family members refused to meet with the outside investors, Rupe sued claiming shareholder oppression.
A Dallas jury ruled in Rupe’s favor and valued the 18 percent at $7.3 million, which a judge then ordered the other family members to pay Rupe for her ownership interests in RIC.
Justice Jeffrey Boyd, in a 54-page majority opinion, said that the Texas Business Organizations Code does not authorize courts to order a corporation to buy out a minority shareholder’s stock and that there is no common-law cause of action for minority shareholder oppression.
“The court’s decision in this case will dramatically curtail, if not virtually eliminate shareholder oppression claims in Texas,” says Dallas attorney Robert Gilbreath, a partner at Hawkins Parnell Thackston & Young.
“Closely-held corporations appear to be the biggest beneficiaries of this decision, which will free management and the controlling shareholders to make decisions based on their business judgment and the best interests of the corporation without fear of litigation from a dissenting minority shareholder,” says Gilbreath, who represents Ritchie and Dennard in the appeal.
Gilbreath says the Rupe decision will be crucial in dozens of shareholder disputes currently pending across Texas.
One of the biggest is a minority shareholder oppression case brought by Bala Shagrithaya against Richardson-based ARGO Data Resources, a software solutions business for financial and healthcare companies.
Shagrithaya and CEO Max Martin started ARGO in 1980. Martin owns 53 percent of the company and Shagrithaya owns the rest. Shagrithaya sued the company in 2007 after Martin substantially reduced his salary despite huge financial successes for the business.
Shagrithaya demanded that Martin or ARGO buy his shares with no minority discount or issue a $90 million dividend.
In 2009, a Dallas jury heard six weeks of testimony and ruled for Shagrithaya. The court held that Martin’s conduct had oppressed Shagrithaya and Martin and Argo was ordered to pay his long-time minority shareholder his share of an $85 million dividend or $40 million. The Dallas Court of Appeals reversed the trial court but that decision is now on appeal before the Texas Supreme Court.
Steve Aldous, a lawyer representing Ann Rupe, says the Supreme Court decision is “short-sighted” and “ignores many realities that minority shareholders face on a regular basis.”
“The argument the court makes is disingenuous in that regard because it continually cites to derivative causes of action which are absolutely no help to individual shareholders and are consistently thrown out of court for seeking a remedy for an individual shareholder rather than the corporation, which has nothing to do with oppressive conduct,” says Aldous, a partner at Forshey Prostok in Dallas.
“The whole opinion is a discussion of what should take place in the perfect world—directors should not oppress the minority interest, they should only act with business judgment for the corporation, the parties should have a buy/sell agreement, the corporation can elect to be declared a closely held entity,” he says. “Of course, the rest of us live in the real world where money sometimes motivates the majority interest to squeeze out the minority interest and thereby obtain a windfall by getting the minority’s ownership interest at a fraction of the value.
“Now the Supreme Court has basically said tough luck, all to ‘keep courts out of corporate governance’,” says Aldous. “Sometimes the law has to step in and protect the legitimate property interest of those who have no remedy for wrongful acts.”
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