SCOTx: No “Informal” Fiduciary Duty from Corporate Director to Shareholder, Regardless of Pre-Existing Relationship of Trust and Confidence


In the Matter of the Estate of Richard C. Poe

Supreme Court of Texas, No. 20-0178 (June 17, 2022)
Opinion (linked here) by Justice Huddle 

In Ritchie v. Rupe, the Texas Supreme Court held that, “[a]bsent a contractual or other legal obligation, [an] officer or director [of even a closely held corporation] has no duty to conduct the corporation’s business in a manner that suits an individual shareholder’s interests.” Instead, officers and directors owe fiduciary duties only to the corporation, itself, including “the dedication of [their] uncorrupted business judgment for the sole benefit of the corporation.” But what if a director has a relationship of trust and confidence with a shareholder that arose prior to and independent of their relationship as director and shareholder? The Supreme Court has held previously that such a relationship can give rise to an “informal fiduciary duty.” Can a director simultaneously owe both (i) conventional fiduciary duties to the corporation and (ii) an “informal” fiduciary duty to an individual shareholder, based on their pre-existing relationship? Is the latter an “other legal obligation” that is the exception to the rule as announced in Ritchie? In Poe, the Supreme Court answered, no, “a director cannot simultaneously owe these two potentially conflicting duties.” 

Richard C. (“Dick”) Poe operated several car dealerships in El Paso. He consolidated control of them in PMI, a Texas corporation, which was the general partner of several limited partnerships that, in turn, owned and operated the dealerships. Poe’s son, Richard, was the sole shareholder of PMI. But Richard gave his father, Dick, an irrevocable proxy to vote those shares, and Dick was the sole director of PMI. In 2015, Dick caused PMI to issue additional shares of stock, which he bought from PMI for $3.2 million. These new shares made Dick the majority shareholder. Son Richard was not notified of these additional shares until after Dick died, shortly after the shares were issued. Richard sued Dick’s longtime accountant, his office manager, and his attorney for, among other things, conspiring with Dick to breach his fiduciary duties both to PMI and to Richard in issuing the new shares to himself. Richard contended his father’s “informal” fiduciary duty to him, arising from their longstanding relationship of trust and confidence, triggered the “other legal obligation” language of Ritchie, meaning that Dick owed fiduciary duties to Richard, individually, as well as to PMI. 

A unanimous Supreme Court of Texas disagreed, holding that 

[A]s a matter of law, a corporation’s director cannot owe an informal duty to operate or manage the corporation in the best interest of or for the benefit of an individual shareholder. A director’s fiduciary duty in the management of a corporation is solely for the benefit of the corporation. 

Because the trial court erred by allowing the jury to decide about the existence and breach of an alleged “informal” fiduciary duty from Dick to Richard, the Supreme Court reversed and (i) rendered judgment against Richard on his claims for breach of an “informal” fiduciary duty, and, (ii) because of other errors in the charge, remanded for a new trial on the remaining issues.

SCOTUS Cuts Burden for Showing Waiver of Arbitration

Morgan v. Sundance, Inc.
United States Supreme Court, No. 21-328 (May 23, 2022)
Unanimous opinion by Justice Kagan, linked here

Based on the widely acknowledged “strong federal policy favoring arbitration” under the FAA, the great majority of federal courts have for many years held that a party impliedly waives its right to compel arbitration by “substantially invok[ing] the judicial process” on matters ostensibly subject to arbitration only if in doing so it “thereby causes ‘detriment or prejudice’ to the other party.” Salas v. GE Oil & Gas, 857 F.3d 278, 281 (5th Cir. 2017) (relying on Miller Brewing Co. v. Fort Worth Distrib. Co., 781 F.2d 494, 497 (5th Cir. 1986)). That is no longer the law in federal court. After acknowledging that at least nine federal circuits—including the Fifth—were applying this rule, the Supreme Court in Sundance decreed that these courts were wrong to craft and impose an “arbitration-specific waiver rule demanding a showing of prejudice.” “The FAA’s ‘policy favoring arbitration,’” it said, “does not authorize federal courts to invent special, arbitration-preferring procedural rules.” Instead, “the federal policy is about treating arbitration contracts like all others, not about fostering arbitration.” Consequently, whether a party has waived its right to arbitrate by invoking or participating in the judicial process is to be judged by the same standard applied to all other contractual rights—i.e., whether that conduct amounts to “the intentional relinquishment or abandonment of a known right,” without reference to whether it has caused any prejudice to the other side.

The Supreme Court’s Sundance ruling was directed to federal courts applying the FAA. But its effect will be even more pervasive. Most state courts also now include a “prejudice” component in their tests for determining whether a party has impliedly waived arbitration. In Texas, for example, “[a] party asserting implied waiver as a defense to arbitration has the burden to prove that (1) the other party has ‘substantially invoked the judicial process,’ which is conduct inconsistent with a claimed right to compel arbitration, and (2) the inconsistent conduct has caused it to suffer detriment or prejudice.G.T. Leach Builders, LLC v. Sapphire V.P., LP, 458 S.W.3d 502, 511-12 (Tex. 2015).  These state-court precedents will have to be reexamined and many likely will fall, just like the scores of federal decisions directly overruled by Sundance. Because the Court’s rationale rested in part on the absence of any support in the FAA for courts to create this arbitration-specific test, it is reasonable to assume that state courts will follow Sundance when applying the FAA. But even where state arbitration statutes are concerned, Sundance likely will force a reassessment. Again using Texas as an example, the Texas Arbitration Act is based on the Uniform Arbitration Act, as are the arbitration statutes of most other states, and the Texas Supreme Court has stressed “the importance of keeping federal and state arbitration law consistent.” Perry Homes v. Cull, 258 S.W.3d 580, 594 (Tex. 2008). Texas appeals courts have flatly said,  “The standard for determining waiver of the right to arbitration is the same under both the Texas General Arbitration Act and the Federal Arbitration Act.” E.g., Sedillo v. Campbell, 5 S.W.3d 824, 826 (Tex. App.—Houston [14th Dist.] 1999, no pet.). The change wrought by Sundance, therefore, likely will be felt not only in the federal system, but throughout the fifty states.  

Mandamus Relief for Denial of Advancement of Defense Costs

In re DeMattia
Dallas Court of Appeals, No. 05-21-00460-CV (April 12, 2022)
Justices Schenck, Nowell (Opinion, linked here), and Garcia 

Mark DeMattia co-owned Restoration Specialists, LLC and served as its managing member. In 2018, he sold the company. But a few days before the closing, he allegedly copied or deleted certain files. Under its new owners, Restoration later sued DeMattia, alleging breach of fiduciary duty and misappropriation of trade secrets.

DeMattia, in turn, demanded that Restoration indemnify him and advance his defense costs, pursuant to Restoration’s corporate regulations. The Texas Business Organizations Code allows LLCs to indemnify and advance defense costs, through their organizing documents, to both current and former officials and governing persons. After Restoration denied his demand for advancement, DeMattia counterclaimed and moved for summary judgment. Restoration responded that the advancement provision in the company regulations, by its terms, did not apply to former managers like DeMattia. The trial court denied DeMattia’s motion.

DeMattia sought mandamus relief in the Dallas Court of Appeals. Applying contract interpretation principles, the Court held that the advancement provision in Restoration’s corporate regulations did cover former managers like DeMattia, so the trial court erred by denying DeMattia’s motion for summary judgment. The Court also rejected Restoration’s argument that DeMattia’s “unclean hands”—his alleged misappropriation and breach of fiduciary duty—barred advancement as a matter of public policy. The Court explained that every lawsuit involves allegations of wrongdoing, so denying advancement based mere allegations of unclean hands would render the right to advancement a nullity. Finally, the Court held DeMattia did not have an adequate remedy by appeal, a requirement for mandamus relief. The right to advancement can be satisfied only during proceedings in the trial court, so proceeding to trial without advancement, when a party is entitled to advancement, would defeat the right to advancement. Therefore, the Court ordered the trial court to vacate its denial of summary judgment and issue an order granting DeMattia’s motion.

SEC’s EPS Initiative: Duty to Report Litigation Expenses?

Earlier this week, the United States Securities & Exchange Commission (“SEC”) announced that Healthcare Services Group Inc. (“HCSG.o”) agreed to pay a $6 million dollar fine to settle claims the SEC brought against the company for failing to properly account for its legal expenses. Under this civil claim, the SEC accused the company of inaccurately reporting litigation expenses paid to settle its employees’ claims in an effort to inflate the company’s quarterly earnings.

According to the SEC, the company’s underreporting of costly litigation deliberately inflated the company’s earnings to ensure that they were consistent with Wall Street’s earnings forecasts. This intentional misrepresentation, the SEC alleged, allowed the company to avoid the SEC’s detection and disguised the company’s true financial position to investors. The SEC explained that HCSG failed to accurately capture in its quarterly financial statements loss contingencies for settlements the company knew were “probable and reasonably estimable” as a result of class and collection litigation the company underwent in 2014 and 2015. In support of its position, the SEC asserted that such a failure was inconsistent with generally accepted accounting principles.

Director of SEC Enforcement in a statement explained that “HCSG repeatedly failed to record loss contingencies related to litigation settlement despite mounting evidence that such liability was probable and reasonably estimable, while misleading investors by reporting inflated net income and consistent EPS growth.” The director further cautioned companies that “it is critical for public companies to ensure that accounting judgments, including those involving loss contingencies, are not being used to manage earnings and distort financial statements.”

This case is yet another example of the SEC pursuing actions against companies as part of its recently created earnings per share (“EPS”) initiative. Implemented by the SEC in September 2020, the EPS initiative utilizes risk-based data analytics to uncover potential accounting and disclosure violations of companies’ earnings and management practices. These analytics aim to track a company’s financial progression to identify sudden drops in EPS following consecutive positive quarterly reporting that meet or exceed that company’s estimated EPS. These sudden drops or dips alert the SEC’s enforcement branch of a company’s potential financial misreporting, which result from, among other things, failing to properly account for the company’s legal expenses. A company’s failure to accurately report its company’s financials violate Sections 17(a)(2) and (3) of the Securities Act of 1933 and may also violate the financial reporting, books and records, and internal control provisions of the Securities Exchange Act of 1934.

Litigation is costly. With the SEC’s EPS initiative, a failure to accurately capture a company’s earnings may cost the company even more money. Directors and officers alike, particularly those in a financial position, should be cognizant of the SEC’s continued watchful eye—particularly as it pertains to litigation expenses and settlements. While the SEC has not established a rule-of-thumb to determine when litigation expenses are “probable and reasonably estimable,” companies should consult financial experts and generally accepted accounting principles to determine how and when litigation expenses are disclosed on a company’s quarterly earnings.

SEC Increasing Oversight over SPAC Markets

What are SPACs?

SPACs (special purpose acquisition companies) are formed by sponsors—usually former industry executives, institutional investors or private equity firms—for the sole purpose of acquiring one or more private companies after going public. SPACs are not operating companies; instead, they are blank-check shell companies used to identify a merger target and facilitate access to public markets. Once the SPAC’s initial public offering is completed, the SPAC begins evaluating and approaching potential merger targets. When a suitable target company is identified, and an agreement is reached and approved by the SPAC’s shareholders, the transaction closes and the target company survives as the publicly listed entity. SPACs generally have two years to find a target. If unsuccessful, SPACs return the money raised to investors.

Recent SEC Enforcement Action

The Securities and Exchange Commission (SEC) recently charged Stable Road Acquisition Corp. and its merger target, Momentus, Inc., in connection with a planned merger. As a SPAC, Stable Road has no operations of its own and exists for the purpose of merging with a privately held company with the effect of taking that company public. It completed its IPO in November 2019. Momentus is a privately held spaceflight technology company, which aspires to provide satellite-positioning services with in-space propulsion systems.

The SEC alleged that Stable Road and Momentus falsely represented to investors that Momentus successfully tested its spaceflight technology. Although Momentus was the initial source of this misrepresentation, the SEC noted that Stable Road’s due diligence failures compounded Momentus’s misrepresentations and “resulted in the dissemination of materially false and misleading information to investors.” In short, Stable Road “unreasonably failed both to probe the basis of Momentus’s claims that its technology had been ‘successfully tested’ in space.”

Further, Stable Road’s S-1 registration statement omitted concerns raised by the Committee on Foreign Investment, and Stable Road’s amended registration statement omitted that the Department of Commerce denied Momentus’s CEO’s application for an export license. As a result, the SEC charged both Stable Road and Momentus with fraud, and it charged Stable Road with reporting violations under 13(a) of the Securities Exchange Act of 1934 and soliciting a proxy containing a materially false statement under Section 14(a). The parties resolved the SEC’s misrepresentation claims, agreeing to a fine in excess of $8 million.

Going Forward

This enforcement action signals that increased regulatory oversight of SPAC transactions may be on the horizon, especially given the exponential increase in SPAC transactions. In 2010, only two SPACs came to market. In 2020, 115 SPACs completed or announced mergers and netted record IPO proceeds of $83.4 billion. According to data from SPAC Research, SPACs have raised more than $115 billion so far this year.

An advantage for SPAC sponsors is that the IPO process is relatively simple. Because SPACs have a straightforward business purpose, they can typically complete their paperwork within three months with little comment from the SEC. Further, target companies benefit from the SPAC transaction insofar as it offers them an expedited path to public listing and greater price and timing certainty.

But as the above SEC enforcement action demonstrates, there are also risks associated with SPAC transactions. SPAC sponsors should be aware of due diligence requirements when evaluating target companies and the evolving SEC regulation of SPAC transactions. Relatedly, potential SPAC board members should understand the D&O insurance being carried by the SPAC sponsor and assess whether they are comfortable with the level of coverage under the policy.

SEC to Increase Scrutiny on Good Faith in Rule 10b5 1 Insider Stock Plans

This month, newly-appointed SEC Chair Gary Gensler delivered remarks regarding how the SEC might “freshen up” Rule 10b5-1, which permits corporate insiders and others to buy and sell stock pursuant to trading plans adopted in good faith prior to learning material non-public information. Gensler’s focus on Rule 10b5-1 continues in the footsteps of his predecessor, Jay Clayton, who was appointed by the previous administration. In September of last year, Clayton wrote a letter to U.S. Representative Brad Sherman (D Ca), Chairman of the House Financial Services Subcommittee on Investor Protection, expressing concerns about interest alignment and fairness of law compliant Rule 105b 1 plans under the current SEC regulations. Congress has acknowledged the SEC’s concerns. Just this week Senators Chris Van Hollen (D-Md) and Deb Fischer (R-Neb) reintroduced the latest version of the Promoting Transparent Standards for Corporate Insiders Act, which formally directs the SEC to explore amendments to Rule 105b 1 and, within three months, provide Congress with a report discussing possible abuses of the Rule.

Rule 10b5-1 plans provide a “safe harbor” for insiders, commonly directors and officers, in possession of a company’s material non-public information (MNPI), to purchase or sell stock of that company without running afoul of insider trading laws. The Rule relies on the premise that if an insider agrees to a trading plan in good faith before possessing MNPI, then the insider will not be making decisions based on subsequently acquired MNPI at the time the transaction occurs in the future.

The increasingly widespread use of Rule 10b5-1 plans has led to what Gensler characterized as “cracks in our insider trading regime.” Gensler noted: 1) there is no required “cooling off” period before the first trade can occur, 2) plans can be canceled at any time, 3) there are no disclosure requirements, and 4) insiders can adopt more than one Rule 10b5 1 plan. Gensler further noted the SEC would consider reforms related to share buybacks in connection with a Rule 10b5 1 plan. In early 2016, as the popularity of Rule 10b5 1 plans continued to grow, the Harvard Law School Forum on Corporate Governance republished an article first published in Insights, that forecasted many of Gensler’s remarks. The article highlights the benefits of Rule 10b5 1 plans and provides suggestions on best practices that should be implemented to comply with the intent of the Rule’s safe harbor, including, amongst other recommendations: establishing only one plan, adopting the plan during an issuer’s open trading window, public disclosure of the plan, establishing a waiting period before the first trade, and avoiding multiple modifications, suspensions, and terminations.

With increased scrutiny of Rule 10b5 1 plans on the horizon, companies and their insiders should review their Rule 10b5-1 plans in light of anticipated SEC scrutiny and regulatory changes. A report published in January this year offers recommendations on how the SEC should regulate Rule 10b5-1 plans that rely on the safe harbor of the Rule, including: requiring minimum cooling-off periods of four to six months before the first trade can occur, eliminating single trade plans that effectively act as an option, eliminating plans in which the first trade occurs before the next earnings announcement, and requiring public disclosure by electronic filing when a plan is adopted, modified, suspended, or terminated, rather than a non-public filing only after the sale of restricted stock. These recommendations are consistent with the Chairs’ comments over the past year and are a good starting point for insiders when reviewing their Rule 10b5 1 plans.

Please contact your Carrington Coleman securities counsel should you have any questions related to Rule 10b5 1 plans, or any other securities related questions.


Earlier this week, the Supreme Court handed down its ruling in Liu v. Securities and Exchange Commission, No. 18-1501. This ruling is significant for two reasons. First, it resolves the previously unsettled question as to whether the SEC is empowered to seek a disgorgement award. The SEC is. Second, it explains limits upon disgorgement awards necessary to ensure it is not an improper penalty. 

As you may know, disgorgement is an equitable remedy intended to deprive wrongdoers of the net profits of unlawful conduct. The SEC often seeks a disgorgement award in connection with securities fraud claims. In the 2017 case of Kokesh v. SEC, the Supreme Court found disgorgement to be a penalty for statute of limitations purposes, but did not go so far as to decide whether disgorgement could still be imposed as a form of equitable relief. Equitable relief has generally not permitted recovery that would be punitive. This left a big question for the SEC and defendants alike. Can the SEC keep seeking disgorgement in these cases?

In this case, appellants challenged a $27 million award of disgorgement stemming from a visa scheme as an improper penalty. While the Supreme Court vacated the disgorgement award and remanded for further proceedings, it reaffirmed that the SEC had authority to seek disgorgement and explained certain restrictions on that recovery to ensure it is correctly calculated and used to reimburse victims of the fraud found in the lawsuit. More specifically, the Supreme Court clarified that courts must consider factors including what the actual profits from the fraud net of “legitimate expenses” are as well as ensuring that the money awarded is actually returned to defrauded investors and not the SEC.

This is a partial win for both the SEC and defendants against whom the SEC seeks disgorgement. For the SEC, it can still seek disgorgement, which has been a vital tool in its tool belt for enforcement in recent years. For defendants, they are now armed with significant arguments to limit the amount of disgorgement awarded. It remains to be seen exactly how or to what extent this will impact securities litigation, but for now we expect the SEC to continue pursuing and receiving disgorgement awards, but the size of those awards to shrink under the Supreme Court’s new guidance of what is necessary to avoid constituting an improper penalty.