VLF Video Educational Series – Changes to Corporate Governance

Charles Vethan: Hi, I’m Charles Vethan. Welcome to the Vethan Law Firm P.C.’s Video Educational Series. Today’s topic focuses on recent changes to corporate governance under Texas Law, specifically the issues we will discuss today focus on what obligations, if any, in majority shareholder or a member in an LLC owes other members or shareholders in that business entity. We will focus on changes in the law and how this affects claims that used to exist in Texas for shareholder oppression and freeze outs. If you have more questions please contact us at www.vethanlaw.com. Joe a lot of our clients, a lot of business clients out there are concerned about a new decision by the Texas Supreme Ritchie versus Rupe that issued in June 2014. That decision materially altered corporate law landscape in Texas, specifically as it applied to major shareholder rights and minority shareholder rights and shareholder oppression.

Joseph Lanza: Charles my problem with the Rupe opinion is that it boils down to a simple rule. As long as the majority shareholder does nothing to harm the corporation, he’s free to harm the minority shareholders at will. Freeze them out, cut them off, move from the board of directors, fire them, refuse access to confidential information, they can do all those things so long as they justify it by showing that it‘s either beneficial to or at least it does not harm the corporation. Although the court recognizes that minority shareholders are uniquely vulnerable to lowest types of abuses, rather than broadening them and is available to them under the law. It greatly restricts its and wipes out the common law cause of the action for shareholder oppression. As Justice Guzman so eloquently puts it in her descent, it reduces the value of minority shareholders’ shares to change on the chain.

Charles: The majority correctly held that corporate documents, company agreements, shareholder agreements are contracts. When you have people who are able to contract and are into an agreement that says, “Person A has 51% ownership in the company.” That person has a controlling interest and there is nothing wrong with that. Texas recognizes the freedom of contract. Many of our small business clients work very hard and diligently to ensure that they have contracts in place that mean what they say and say what they mean. That is what this decision is all about, it protects individuals who negotiate a contract position.

Joe: Charles as you also from our experience mitigating, many corporation, closely held corporation owners aren’t that foresighted, they draft bare bones agreement and sometimes no agreements at all. Then not really provide for the variety of situations that can arise in the future. Rupe case is a perfect example. Mrs. Rupe didn’t come to this corporation. Her ownership enters through a contract. She came through it through inheritance, through her husband. As a result, she was excluded from the business by the family. I agree with you that a problem does arise if shareholders or members in an LLC or Limited Partnership use formulaic documents to represent their interest in the company, no questions about it there. But under Texas Law, if you enter into a contract, whether or not you read it, you own it and that principle must be upheld. While I agree with your Joe that people should not download contracts off the internet or use plain manila rubber stamp document, especially when they are talking about their corporation, which is not only their business but probably their main source of income and livelihood. Once they signed that document, it has to be upheld. If not, we are setting up various standards for courts and attorneys and business people as to what governs? What controls the business relationship amongst these people?

Joe: I agree in principle that if you sign a contract you are presumed to have read it. Mrs. Rupe didn’t sign a contact, her husband did. She had not control over what he signed. When she came to the table as the widow who inherited that contract, the disputes arose not from the management of corporation but from family relations. As a result that affected her interest and her ability to profit or to enjoy the fruits of her deceased husband while he was in a corporation.

Charles: Joe I think we are going to agree with this point. We know that regardless of what your interest is, in a company or a limited liability corporation or LLC. If a shareholder takes certain actions to benefit him or herself at the expense of the company, that is still illegal under Texas law and we have addressed that in other video, under Fiduciary duty and that still exist. The only issue and I disagree, is this decision Rupe, which basically stes if you sign it you own it. Another issue that Rupe addressed was the damages that would be available to a minority shareholder if they were frozen out. Prior to Rupe, a minority shareholder who felt that he or she stopped was excluded from management, didn’t have any say on what dividends could be paid or profits distributed could file suit. If he or she won, could force a buyout. What Rupe focused on also, in a small company the majority shareholder typically is also the person who is driving business. The valuation method used prior to Rupe looked at the company as a whole did without really giving credence to who was driving the business. Why is that a bad decision?

Joe: First of all, the Rupe did away with a forced buyout. Minority shareholders are now hostage to whims of the majority shareholder if he’s a responsible majority shareholder, they will benefit. If he is a dictatorial or irresponsible shareholder, they don’t benefit.

Charles: Joe this applies, you were talking about shareholders but this applies to both corporations and Limited Liability Companies.