By Brad Jackson and Mark Taylor

Reversing more than 25 years of appellate court decisions, the Texas Supreme Court recently held that minority shareholder oppression is not a recognized cause of action under common law, and that the remedy for appointment of a receiver when the majority engages in oppressive conduct is only available when the oppressive conduct cannot be justified under the business judgment rule. Ritchie v. Rupe, 2014 Tex. LEXIS 500 (Tex. June 20, 2014).

Since the 1987 decision by the Houston Court of Appeals in Davis v. Sheerin, 754 S.W.2d 375 (Tex. App.—Houston [1^st Dist.] 1988, writ denied), no less than seven Texas appellate court decisions had recognized and developed standards for minority shareholder oppression that permitted a shareholder to force a buy-out of his shares if the conduct of the majority substantially defeated the reasonable expectations of the minority shareholder, or demonstrated a lack of probity and fair dealing in the affairs of the company to the prejudice of the minority. The decision in Ritchie reverses this entire body of law, and leaves many wondering whether investors may think twice before taking minority positions in Texas-based business start-ups.

Rupe Investment Corporation was controlled by four individuals who had inherited their interests from the company’s founders and early owners. When Ann Rupe married one of these shareholders, she was treated as an outsider and told she would “never get any money in this family.” After her husband died in 2002, Rupe twice asked the family to purchase her shares, but received offers that she believed were far below fair value. She then engaged a broker to sell her shares to a third party, but the majority stockholders refused to meet with potential purchasers, which Rupe believed would make it impossible to sell her shares.

Rupe brought suit alleging oppressive conduct and breach of fiduciary duty, and a jury found in her favor ordering a buy-out of her shares for $7.3 million. The court of appeals found the majority’s conduct to be oppressive as a matter of law and upheld the forced buy-out.

In determining that this remedy was inappropriate, the Supreme Court relied heavily upon the language of Section 11.404 of the Business Organizations Code, which authorized the appointment of a receiver if the conduct of the majority was “oppressive,” provided that all other remedies available at law or in equity were inadequate. Where other courts had interpreted the “availability of equitable remedies” language as the implicit recognition of a court’s equitable powers to fashion other remedies such as a forced buy-out, the Supreme Court found this interpretation turned the statute’s “language on its head – treating it as expanding rather than restricting the relief the statute provides.”

The Supreme Court further applied a cost-benefit analysis to determine whether a common law cause of action should be recognized. The court concluded that while oppression of minority interests was foreseeable and could be expected to cause substantial harm to minority investors, existing remedies were sufficient to protect those interests. Minority investors could insist upon the corporation invoking “close corporation” status, bring derivative lawsuits, or enter into shareholders’ agreements to protect their interests.

Furthermore, in determining the extent of the limited protection provided by Section 11.404, the Supreme Court held that the majority’s abuse of their authority with the intent to harm a minority shareholder must be “in a manner that does not comport with the honest exercise of their business judgment,” that leads to “a serious risk of harm to the corporation.” In doing so, the court relied upon a 1966 opinion from the Texarkana court of appeals that invoked the business judgment rule in a receivership action, Texarkana College Bowl, Inc. v. Phillips, 408 S.W.2d 537 (Tex. Civ. App. – Texarkana 1966, no writ), and expressly overturned a holding to the contrary by the court of appeals in Ritchie.

The dissent noted that Texas is the first state to eliminate the possibility of a forced buyout as an available equitable remedy in cases of oppression, and criticized the majority for allowing the business judgment rule to be invoked in these cases because the act of oppression rarely harms the corporation as a whole. In doing so, the majority negates the very foundations of protection that courts have long afforded to minority shareholders in closely held corporations.

In the wake of Ritchie, aggrieved minority owners must focus their complaints on breaches of fiduciary duty. The decision also puts a premium on the negotiation of shareholder agreements and other means of protecting owners of minority interests.

Brad Jackson is a commercial litigator at The Law Offices of Brad Jackson. He can be reached at brad@bradjackson.com. Mark Taylor is a partner at Powers Taylor LLP. He can be reached at mark@powerstaylor.com.