In line with the strict contract construction in The Godfather, the Texas Supreme Court recently issued a ruling in Ritchie v. Rupe, 57 Tex. Sup. J. 771 (Tex. 2014), which eliminates an equitable cause of action against a controlling shareholder who freezes out minority interest shareholders in the company. In blindly relying on the notion that every contract is a result of an arms-length, bargained for negotiation, the Texas Supreme Court held that if a minority shareholder signs a shareholder agreement that vests one of the shareholders with majority interest – and thus controlling interest, the majority shareholder has considerable sway over the direction of the company. While a controlling shareholder does, and should, have control of business matters at the company, the Rupe ruling does not consider situations where the controlling shareholder takes steps to shut out minority shareholders from management and operational decisions, including decisions that differentially benefit the majority shareholder. Essentially, with the ruling, a majority shareholder is free to act with near impunity, and the minority shareholder may not complain about the dismissive and freeze-out actions of the majority shareholder, if those actions have an ostensible business justification.
The problem with Rupe is that it ignores the reality of a closely held Texas corporation. The shareholders of a close corporation are typically involved and not passive investors. They are employees or managers of the corporation, which also provides them with their livelihood. The decision of a majority shareholder affects both the growth of the company and the livelihood of the minority shareholders. Allowing the majority shareholder to make decisions that differentially benefit him or her, prevents timely distribution of profits to all shareholders, or implements a roughshod management strategy, effectively freezes out minority shareholders. Under Rupe, there is no longer any realistic remedy for a minority shareholder.
So the takeaway from this decision is that the initial structure of the corporation, including allocation of interests and decision making powers must be fully negotiated. Settle all matters at the time the shareholder agreement is crafted, and carefully delineate rights and responsibilities. Yes, this should be done even though the company is little more than a hope or aspiration at the time the shareholders agreement is first crafted. Unfortunately this forces a minority shareholder to presuppose that his or her business partner, and fellow shareholder, will not act in a manner consistent with the minority shareholder’s best interest. Or, as Michael Corleone would state “Today I settled all Family business, so don’t tell me you’re innocent, Carlo.”