May 29, 2015

May 29, 2015

This week, the Texas Supreme Court released one opinion dealing with the standing of a shareholder of a closely held corporation to bring a derivative lawsuit under Texas law.

Sneed v. Webre , Case No. 12-0045: http://www.txcourts.gov/media/989197/120045.pdf

In this case, the Court was asked whether a shareholder in a parent company of a Texas closely held corporation had standing to pursue a shareholder derivative suit and whether the business judgment rule served as jurisdictional bar. The case involved a series of closely held family companies that were owned by and operated by various family members. Although each of the entities comprising the family business was closely held, the Webre family operated them as if they were larger, publicly traded entities. The entities were managed in full observation of all corporate formalities, there were regular shareholder and board of director meetings, and the entities kept written records of the actions and resolutions taken at those meetings. The family business also employed other staff, employees, and officers to help run the various entities.

The case involved the acquisition of a facility by United Salt that was promised to be profitable and not include a gas storage facility. However, documents executed by the managers of the company indicated their undisclosed intention was to include a gas storage facility at the location. Ultimately, the acquisition proved unprofitable and a lone dissenting shareholder sued, alleging that the United Salt board of directors relied upon the individual defendants' material non-disclosures and other misrepresentations, which caused United Salt to enter into an unprofitable transaction that lost in excess of $7,000,000 due to the individual defendants' "miscalculations, negligence, errors, mismanagement and lack of proper expertise."

The trial court found that Webre lacked standing to sue, but it did not elaborate on whether Webre's lack of standing was based on the double-derivative nature of the lawsuit or because his pleadings failed to overcome the business judgment rule. The trial court granted the pleas to the jurisdiction and motions to dismiss the lawsuit, and it did not rule on the motions for summary judgment, pleas in abatement, or special exceptions. The court of appeals reversed.

The Texas Supreme Court affirmed the court of appeals. While the business judgment rule will provide a defense to the merits of a case, the Court determined the business judgment rule would not serve as a jurisdictional bar in a derivative suit brought by the shareholder of a closely held corporation. The Court held that the relevant version of Article 5.14 of the Texas Business Corporation Act's standing, demand, and mandatory dismissal requirements do not apply to shareholder derivative lawsuits brought on behalf of closely held corporations. See Tex. Bus. Corp. Act art. 5.14(L)(1) ("The provisions of Section B through H of this article are not applicable to a closely held corporation."). Thus, with respect to closely held corporations, all that remains is Article 5.14(A)(1)'s recognition that a derivative proceeding "means a civil suit in the right of a domestic corporation," and Article 5.14(L)'s recognition that a shareholder of a closely held corporation may bring a derivative proceeding, and, if justice requires, a court may treat the derivative action as a direct action brought by the shareholder for his own benefit and award recovery directly to the shareholder or derivatively to the corporation. See id., Art. 5.14(A), (L). Reading sections (A) and (L) of Article 5.14 together, the Court held they establish that a shareholder of a closely held corporation may bring a derivative proceeding in the right of the corporation.

Additionally, the Court held that Texas law 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 Court affirmed the court of appeals and remanded to the trial court for further proceedings on the merits.

Conclusion:

Next week, the Court is scheduled to meet in Conference on Tuesday, June 2, 2015. Check back with us next week to see what new opinions the Texas Supreme Court releases as a result of the Conference. In the meantime, we hope this analysis is useful to your practice.

Best Regards,

The Bassett Firm