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.  

DELAWARE SUPREME COURT UPHOLDS FEDERAL-FORUM-SELECTION PROVISIONS FOR ’33 ACT CLAIMS

Salzberg v. Sciabacucchi (opinion linked here) presented the Delaware Supreme Court with a clash of policies regarding forum-selection provisions: Helping Delaware corporations avoid the inefficiencies in having to defend claims under the Securities Act of 1933 in multiple forums, state and federal, versus preventing those corporations from barring the state courts of Delaware (the Chancery Court in particular) from adjudicating cases involving the internal affairs of Delaware corporations. Carefully parsing pertinent language from statutes and case law—drawing distinctions among “internal affairs,” “internal corporate claims,” and “intra-corporate affairs”—the Court managed to preserve and promote the former policy while doing no harm to the latter, as it held Delaware corporate charter provisions that require ’33 Act claims to be brought in federal court, rather than the state courts of Delaware, to be facially valid.

WHEN THE CORPORATION’S SHOES ARE TOO SMALL…

Gonzalez v. Gonzalez

Dallas Court of Appeals, No. 05-16-00238-CV (August 22, 2017) Justices Bridges, Lang-Miers, and Evans (Opinion, linked here)

In stockholder derivative cases, (A) the “individual shareholder steps into the shoes of the corporation.” In re Crown Castle Int’l Corp., 247 S.W.3d 349, 355 (Tex. App.—Houston [14th Dist.] 2008, orig. proceeding). And therefore (B), the “stockholder has no greater right in a stockholder’s derivative suit” than the corporation in whose right he is suing. Henger v. Sale, 365 S.W.2d 335, 339 (Tex. 1963). Right? Well, not exactly, says the Dallas Court of Appeals.

In Gonzalez, two stockholders of a corporation brought suit derivatively against a manager. The trial court granted summary judgment for defendant, because the corporation itself was barred from asserting those claims, having forfeited its charter, and therefore plaintiffs lacked standing to pursue the claims derivatively. The Dallas Court of Appeals reversed. The Court agreed that the corporation itself “no longer has the legal right to assert its causes of action in court,” because of the forfeiture of its charter. See TEX. TAX CODE § 171.252(1). But, it said, “when a corporation forfeits its privileges, title to its assets, including its causes of action, is birfurcated; legal title remains with the corporation and the beneficial interest is vested in its shareholders.” In that situation, the Court continued, “the shareholders holding beneficial title to the claims may assert the corporation’s causes of action as the corporation’s representatives” to protect their (the shareholders’) beneficial rights—i.e., the shareholders can step out of the shoes of the corporation and pursue such claims even if the corporation cannot.

Not addressed in the Dallas Court’s opinion or the briefing was the recent decision of the Fort Worth Court of Appeals in Carter v. Harvey, 2017 WL 2813936 (Tex. App.—Ft. Worth June 29, 2017, no pet.). There, the Fort Worth Court affirmed summary judgment dismissing derivative claims with respect to a corporation that had been dissolved for more than three years. Section 11.356 of the Business Organizations Code provides that a corporation can prosecute or defend claims only until the third anniversary of the entity’s termination. Because the claims in Carter were lodged after that third anniversary, the Fort Worth Court held they were barred not only for the corporation, but also if asserted by someone purporting to sue derivatively. “Because [claimant] derivatively stands in the shoes of” the dissolved corporation, the Court said, “he cannot bring a … claim that [the corporation] could not bring.”

Perhaps we will see one or both of these cases at the next level.

TEXAS ENFORCEMENT OF DELAWARE FORUM-SELECTION CLAUSES IN STOCKHOLDER DISPUTES—THE FIRST SHOE DROPS

In Pinto Technology Ventures, L.P. v. Sheldon (opinion here), the Supreme Court of Texas enforced a forum-selection clause in an amended shareholder agreement, requiring much of the underlying equity-dilution dispute to be litigated in Delaware. The Court upheld the clause’s validity and explored its scope, in terms of the claims and issues covered, and its enforcement by and against nonsignatories. Because the forum-selection clause appeared in a shareholder agreement, the Court had no cause to address the looming issue in this area—the enforcement by courts outside Delaware of a clause in a corporation’s bylaws, unilaterally adopted by its board of directors, that mandates exclusive jurisdiction in Delaware courts for all internal corporate claims, including all derivative actions, pursuant to the recently enacted Section 115 of the Delaware General Corporation Law.

DOJ AND FTC ISSUE ANTITRUST GUIDANCE FOR HR PROFESSIONALS

Late last month the Department of Justice Antitrust Division and the Federal Trade Commission jointly issued ANTITRUST GUIDANCE FOR HUMAN RESOURCE PROFESSIONALS. The Guidance, written in plain English rather than antitrust jargon, “is intended to alert human resource (HR) professionals and others involved in hiring and compensation decisions to potential violations of antitrust laws.” The release doesn’t break new ground in terms of antitrust principles; instead, it serves as a reminder that those who hire employees and set compensation are subject to the same antitrust rules and potential penalties—including treble damages in civil actions and possible criminal liability—as those who compete in the sale of products. “From an antitrust perspective, firms that compete to hire or retain employees are competitors in the employment marketplace, regardless of whether the firms make the same products or compete to provide the same services."

The Guidance offers two broad admonitions:

1. “Agreements among employers not to recruit certain employees or not to compete on terms of compensation are illegal.”
2. “Avoid sharing sensitive information with competitors.”

As to the first, the agencies warn that, “Naked wage-fixing or no-poaching agreements among employers, whether entered into directly or through a third-party intermediary, are per se illegal under the antitrust laws.” As to the second, the agencies explain, “Even if an individual does not agree explicitly to fix compensation or other terms of employment, exchanging competitively sensitive information [such as current or planned wage decisions] could serve as evidence of an implicit illegal agreement.”

The Guidance includes several pages of questions and answers designed to put real-world “meat” on the bones of the antitrust principles discussed earlier in the pronouncement. These illustrate both how an HR professional might unwittingly violate the law and ways that violations can be avoided. The repeated warnings about potential criminal liability should be taken to heart, particularly in light of the DOJ’s recent focus on individual responsibility and accountability, crystallized in the “Yates Memo” last fall. The Guidance should be required reading for any HR professional.

DELAWARE SAYS CORPORATIONS’ REGISTRATION TO DO BUSINESS ≠ PERSONAL JURISDICTION IN NON-“HOME” STATE

To do business within their borders, every state in the union requires “foreign” entities—corporations and other entities formed under the laws of another state or country—to register and appoint an agent to accept service of process. And registration and appointment of an agent have been widely considered sufficient grounds for “general” personal jurisdiction over those entities. But in recent years, two United States Supreme Court decisions dramatically changed the landscape of states’ exercise of general jurisdiction over foreign corporations. In Daimler AG v. Bauman, 134 S. Ct. 746 (2014)—following on the heels of Goodyear Dunlop Tires Operations, S.A. v. Brown, 564 U.S. 915 (2011)—the Supreme Court held that general jurisdiction over a foreign corporation would exist only when its contacts with a forum state “are so continuous and systematic as to render [it] essentially at home in [that] State.” For this general jurisdictional analysis, apart from an “exceptional case,” a corporation will be considered “at home” only in its state of incorporation and its principal place of business, even if it has engaged in “a substantial, continuous, and systematic course of business” in other states.

In Genuine Parts Co. v. Cepec, the Delaware Supreme Court has now joined several other courts in concluding that subjecting foreign corporations to general jurisdiction based on their registration to do business and appointment of a registered agent “collides directly with the U.S. Supreme Court’s holding in Daimler.” It therefore overruled in part its prior decision in Sternberg v. O’Neil, 550 A.2d 1105 (Del. 1988). As was true in many other states, the Delaware court in Sternberg had held compliance with the registration statute to constitute consent by foreign corporations to general jurisdiction in Delaware. In light of Daimler, the court undertook a detailed reexamination of that statute and related provisions and, noting that those statutes made no mention of consent to jurisdiction, concluded a more “sensible reading” did not include an express or implied consent to jurisdiction by foreign corporations that complied with the registration statute. The court also noted that this more “sensible reading” made better sense in Delaware’s relations with its sister states (and in protecting its turf as guardian of the nation’s corporate laws). “As the home of a majority of the United States’ largest corporations,” the court observed, “Delaware has a strong interest in avoiding overreaching in this sensitive area.” If other states followed the more expansive pre-Daimler approach, “major Delaware corporations with national markets could be sued by … stockholders on an internal affairs claim in any state in the nation because the corporations have had to register to do business in every state”—giving rise to potentially divergent constructions of Delaware corporate law by other states, something the Delaware courts very much wish to avoid.

The Delaware Supreme Court’s decision in Genuine Parts appears correct in light of Daimler. But other courts have come to a different conclusion. Those in that camp have noted that Daimler did not address the issue of “consent” to jurisdiction—the rationale most courts relied on to find general jurisdiction over foreign entities based solely on their registration in the forum state—and therefore have persisted in exercising general jurisdiction based on such express or implied consent even after Daimler. The Genuine Parts opinion collects the cases on both sides of that issue. It notes Pennsylvania is the only state whose statutes expressly provide that registering to do business constitutes consent to or “a sufficient basis for” general jurisdiction. The Delaware court then muses that, after Daimler, the “unconstitutional conditions doctrine” may prohibit states from exacting or coercing consent to jurisdiction as the price for doing business there. The Genuine Parts Court avoided that constitutional issue by construing Delaware’s registration statute as not constituting or requiring consent, but the question may well make its way to the United States Supreme Court from a state that rejects the approach now taken by Delaware.

TEXAS SUPREME COURT TACKLES SHAREHOLDER DERIVATIVE CLAIMS IN CLOSELY HELD CORPORATIONS

Last summer in Ritchie v. Rupe, when the Supreme Court of Texas killed off the cause of action for “minority shareholder oppression,” it pointed to shareholder derivative claims as an alternative that shareholders in closely held corporations might pursue. Now, in Sneed v. Webre, the Court has articulated several important principles with respect to such derivative cases:

• The “business judgment rule” applies as a defense to derivative claims involving closely held corporations, just as it does in other cases;
• The courts cannot create by implication prerequisites or requirements for a derivative suit involving a closely held corporation that the Legislature has expressly removed by statute; and
• Texas “recognizes the availability of double-derivative standing for shareholders of a closely held parent corporation to assert a derivative action on behalf of a wholly-owned subsidiary. 

The statutory framework for shareholder derivative actions in Texas was for years found in § 5.14 of the Texas Business Corporation Act. In 2010, those principles were migrated to §§ 21.551–.563 of the Business Organizations Code. Because “a corporation should be run by its board of directors, not a disgruntled shareholder or the courts,” the TBCA (and now the TBOC) included a number of threshold requirements before a “disgruntled shareholder” could pursue a derivative claim on behalf of a corporation—e.g., a demand must first be made to the board that the corporation itself pursue the claim in question, and an opportunity must be provided for an independent and disinterested evaluation of the proposed claim that can lead to dismissal of the putative derivative suit if pursuing it is not in the corporation’s best interest. With respect to closely held corporations, however—those with fewer than 35 shareholders and not traded or quoted on a national exchange or market—the Legislature elected to remove most of those threshold requirements and procedures. “Remarkably,” the Court observed, “the Legislature even removed the requirement that a [derivative] shareholder … fairly and adequately represents the interests of the corporation in enforcing the right of the corporation.” And it is that statutory context that largely governed the outcome of this case.

At the outset, the parties wrangled over the applicability to closely held corporations of the “business judgment rule”—i.e., that corporate fiduciaries like directors and officers will not be liable and their decisions will not be second-guessed by the courts if made “within the exercise of their discretion and judgment in the development or prosecution of the enterprise in which their interests are involved.” The derivative plaintiff in Sneed contended the rule had no place at all in claims involving closely held corporations; the defendants and corporations countered that the rule applied not only to the merits of the claims, but also stood as a barrier to the case proceeding at all, unless the derivative plaintiff could prove the board’s refusal to pursue the claims at issue was, itself, outside their protected “business judgment.” The Supreme Court rejected both arguments. The Court first held that nothing in the statutory scheme altered the viability of the business judgment rule as a defense and, therefore, “The business judgment rule continues to apply to the merits of a derivative proceeding, whether brought on behalf of a closely held corporation or any other corporation ….” On the other hand, because the Legislature had by statute stripped the threshold requirements of demand and independent review from derivative cases involving closely held corporations, the Court held such constraints could not be re-imposed by the judiciary by way of requiring that the derivative plaintiff first prove the board’s refusal to bring the proposed claims went “beyond unsound business judgment.” “[B]y removing the demand requirement, the Legislature gave shareholders of closely held corporations the right to pursue corporate causes of action derivatively without interference from the board of directors,” and further, “the Legislature removed the ability for disinterested and independent directors or a special investigation committee to decide whether continuing the derivative proceeding is in the best interest of the corporation.”

In addition to its principal ruling, the Court also held that, because shareholders of a corporation are “beneficial” or “equitable” owners of its assets, a shareholder of a parent corporation has standing to pursue a “double-derivative” claim on behalf of its wholly owned subsidiary. Finally, the Court noted in passing the provision of former TBCA § 5.14(L) (now, TBOC §21.563(c)), which authorizes a court to treat a derivative proceeding involving a closely held corporation like a direct action and allow the plaintiff shareholder to recover directly, rather than having any award paid to the corporation. The Court then observed, as have certain courts of appeals, that even in that situation, “the proceeding still must be derivative.” Like the courts of appeals before it, however, the Supreme Court did not explain what that meant in practical effect, other than to say that the right to such treatment was not “absolute.”