Shareholder Oppression Cause of Action in Florida

Shareholder Cause of Action in Florida

I recently had occasion research the availability of the shareholder cause of action and the buy-out remedy in Florida. There are no reported cases recognizing the shareholder cause of action in Florida and one federal case which deals with the pleading of that cause of action under federal law calls the claim a "misnomer." Nevertheless, all of the components and public policies that underlie the cause of action and remedy in other jurisdictions are firmly established in Florida law. Read the entire research memo on shareholder oppression in Florida law at the Shareholder Oppression website. Here is a summary of what we found:

Florida courts have held that controlling shareholders owe fiduciary duties directly to minority shareholders. E.g., Orlinsk v. Patraka, 971 So. 2d 796, 801 (Fla. App. 3rd Dist. 2007). In Tillis v. United Parts, Inc., 395 So2d 618 (Fla. App. 5th Dist. 1981), the minority shareholders sued the majority shareholders for having caused the corporation to buy back stock from the majority owners at an inflated price, where the same offer was not made to minority shareholders. The court held that the transaction was essentially a preferential dividend to the majority shareholders and violated fiduciary duties to the minority shareholders. Id. at 620‐21. The court of appeals reversed the dismissal of the plaintiffs’ claims, holding that the plaintiffs had stated claims for both breach of fiduciary duties to the corporation and for breach of fiduciary duties “as majority stockholders to not utilize their control of the corporation to their advantage as against the minority stockholders.” Id.

In Acoustic Innovations, Inc. v. Schafer, 976 So.2d 1139 (Fla. App. 4th Dist. 2008), the court of appeals affirmed the imposition of a buy‐out remedy. In that case, there was an agreement between the two founders of a corporation that they would each receive 50% of the shares. One of the founders handled the incorporation and issued himself all of the shares. Thereafter, he refused to issue shares to the other founder and ultimately fired him. The ousted founder sued for a declaratory judgment that he was a shareholder and for involuntary dissolution and for breach of fiduciary duties. The trial court found that the plaintiff was a 50% shareholder. The trial court awarded the plaintiff 50% of the distributions that the other shareholder had taken out of the corporation since inception and awarded him almost $2 million for the value of his shares. Although the relief requested was dissolution, the court did not order the corporation dissolved; rather the court ordered the defendant to purchase the plaintiff’s shares for the value found by the court and imposed a constructive trust on all the shares of the corporation until the purchase was accomplished. The court of appeals affirmed in all respects. Although this case was not called an oppression case, that is clearly what it was.

Two recent cases involving the appraisal remedy also recognize that, in the corporate context, the court has the equitable power to fashion remedies that go beyond the statute. See Foreclosure Freesearch, Inc. v. Sullivan, 12 So.3d 771 (Fla. App. 4th Dist. 2009); Williams v. Stanford, 977 So.2d 722 (Fla. App. 1st Dist. 2008).

Eric Fryar, Fryar Law Firm, P.C.

Shareholder Oppression and Rule 408

The ultimate goal of every scheme of shareholder oppression is to eliminate the minority shareholder’s interest. Sometimes the majority shareholder attempts to so diminish the minority shareholder’s interest, income and participation that the minority shareholder simply “withers on the vine” and gives up. The problem with this strategy is that the minority shareholder is still a shareholder, and the majority shareholder will always face the possibility of a lawsuit. Furthermore, if the majority shareholder wants ever to sell the corporation, then he will have to deal with the minority interest sooner or later. Less patient oppressors will use the leverage that their oppressive pattern of conduct gives them to attempt to coerce the minority shareholder to sell at an unfairly low price. In my experience representing minority shareholders, these efforts usually commence immediately after I alert the majority shareholder to the fact that the minority shareholder is now represented by counsel and is asserting his rights as a shareholder—this usually occurs when I send a shareholder’s demand for inspection of corporate records.

Invariably, the communications and attempts to purchase the minority interest come from lawyers representing the majority shareholder and are couched as “settlement offers” seeking to take advantage of the strictures of Rule 408. Texas Rule of Evidence 408 provides as follows:

Evidence of (1) furnishing or offering or promising to furnish or (2) accepting or offering or promising to accept, a valuable consideration in compromising or attempting to compromise a claim which was disputed as to either validity or amount is not admissible to prove liability for or invalidity of the claim or its amount. Evidence of conduct or statements made in compromise negotiations is likewise not admissible. This rule does not require the exclusion of any evidence otherwise discoverable merely because it is presented in the course of compromise negotiations. This rule also does not require exclusion when the evidence is offered for another purpose, such as proving bias or prejudice or interest of a witness or a party, negativing a contention of undue delay, or proving an effort to obstruct a criminal investigation or prosecution.

Federal Rule of Evidence 408 is identical, and most states have essentially the same principle in their rules of evidence. Believing that settlement communications are “privileged” under this rule, counsel for majority shareholders often feel free to make all kinds of threats and to begin negotiations with extremely low-ball offers. I have always believed that this is an extremely fool-hardy approach and strongly counsel majority shareholders that I represent against it. We usually take the position that these threats and unfair offers are themselves acts of oppression dressed up as settlement offers and that the rule does not shield them. We very aggressively seek to inject these oppressive communications into the case.

There is a very strong public policy in favor of encouraging settlement, and this is the policy that underlies Rule 408. However, there is an equally strong public policy in favor of enforcing fiduciary duties. Therefore, when the defendant owes the plaintiff fiduciary duties, courts will set aside a settlement procured in breach of fiduciary duties, notwithstanding the public policy in favor of the finality of settlements. See Voskamp v. Arnoldy, 749 S.W.2d 113 (Tex. App.—Houston [1^st Dist.] 1987, writ denied); see also Johnson v. Peckham, 120 S.W.2d 786 (Tex. 1938). This situation is particularly acute in a minority shareholder oppression context. The classic oppression scenario is that “the majority first denies the minority shareholder any return and then proposes to buy the shares at a very low price.” Robert H. Thompson, The Shareholder’s Cause of Action for Oppression, 48 Bus. Law. 699, 703-04 (1993). The attempt to force the sale of shares for less than fair value is itself an act of oppression. See Nochlas v. Patton, 279 S.W.2d 848, 852 (Tex. 1955) (noting the majority shareholder’s suggestion that “he would not buy the stock of [the minority] for even a small fraction of its value”); Davis v. Sheerin, 754 S.W.2d 375, 383 (Tex. App.—Houston [1st Dist.] 1988, writ denied) (noting that prior attempts to purchase minority shareholder’s stock were evidence of majority shareholder’s “desire to gain total control of the corporation”). If such oppressive conduct were shielded from disclosure to the jury by the rules of evidence, then majority shareholders would have the ability to act oppressively with impunity. Fortunately, that is not the law.

Rule 408 provides an important exception: “This rule also does not require exclusion when the evidence is offered for another purpose, such as proving bias or prejudice or interest of a witness or a party, negativing a contention of undue delay, or proving an effort to obstruct a criminal investigation or prosecution.” Proof of oppressive conduct is such “another purpose.” As one court has noted: “Rule 408 is also inapplicable when the claim is based upon some wrong that was committed in the course of the settlement discussions; e.g. libel, assault, breach of contract, unfair labor practice, and the like.” Avary v. Bank of Am., N.A., 72 S.W.3d 779, 803 n.4 (Tex. App.--Dallas 2002, pet. denied) (quoting 23 Charles Alan Wright & Kenneth W. Graham, Jr., Federal Practice and Procedure § 5314 (1980)). In Avary v. Bank of America, the Dallas Court of Appeal held that neither Rule 408 nor the statute providing for the confidentiality of mediation communications would preclude a plaintiff from introducing evidence of settlement communications to prove that an executor had committed a breach of fiduciary duties during the course of settlement negotiations in a court-ordered mediation. Id. at 799. Similarly, Texas courts have long recognized that Rule 408 does not protect settlement communications by insurance companies that demonstrate their bad faith settlement practices. See State Farm Mut. Auto. Ins. Co. v. Wilborn, 835 S.W.2d 260, 261 (Tex. App.—Houston [14^th Dist.] 1992, orig. proceeding); Allstate Ins. Co. v. Evins, 894 S.W.2d 847, 849 (Tex. App.—Corpus Christi 1995, orig. proceeding); In re Foremost Ins. Co., 966 S.W.2d 770, 772 (Tex. App.—Corpus Christi 1998, orig. proceeding). Other jurisdictions have applied the rule in the same way. See C.J. Duffey Paper Co. v. Reger, 588 N.W.2d 519, 525 (Minn. Ct. App. 1999) (holding that Rule 408 did not preclude admission of a settlement letter used to prove that a corporate officer had acted in bad faith); Brademas v. Real Estate Dev. Co., 175 Ind. App. 239, 242, 370 N.E.2d 997, 999 (Ind. Ct. App. 1977) (holding that the rule “is not applicable to those situations where the offers of compromise are allegedly oppressive”).

Link v. LSI: South Dakota Supreme Court addresses Valuation and Payout Issues

Link v. L.S.I., Inc., 793 N.W.2d 44 (S.D. Dec. 29, 2010).

The South Dakota Supreme Court recently reviewed issues relevant to shareholder oppression cases: valuation of shares, payment for those shares, and security when the trial court orders a payment plan rather than a lump-sum payment.

The Link case addresses the issue of valuation of shares when the corporation elects a buy-out to avoid dissolution pursuant to SDCL 47-1A-1434. The Court held that the value of the shares need not reduced for lack of marketability as the corporation serves as a market for the shares. A court has the authority to order a payment plan if a one-time payment would be too burdensome and the corporation is unable to obtain a loan for the payment amount. However, when a payment plan is in place, the court can also order that the corporation secure the payments, which can protect the shareholder as well as keep the corporation motivated to fulfill its obligation under the payment plan.

[Read Complete Cases Analysis of Link v. LSI]

Christina Richardson, Fryar Law Firm, P.C.

Direct vs. Derivative: Significant Opinion on shareholder oppression as a direct claim

An issue that recurs with annoying frequency in our shareholder oppression cases is the argument that shareholder oppression claims are derivative claims and that our clients therefore have no standing to assert them. This argument shows a thorough misunderstanding of the nature of an oppression claim. A shareholder oppression claim is, by definition, a claim asserted by an individual shareholder in his capacity as a shareholder for injury done to his individual interests that arise out of his share ownership. It is entirely a direct and individual claim based on the breach of duties owed directly to the shareholder.

The Texas Court of Appeals put it this way:

[A] corporate shareholder has no individual cause of action for personal damages caused solely by a wrong done to the corporation. The cause of action for injury to the property of a corporation or for impairment or destruction of its business is vested in the corporation, as distinguished from its shareholders, even though the harm may result indirectly in the loss of earnings to the shareholders. The individual shareholders have no separate and independent right of action for wrongs to the corporation that merely result in depreciation in the value of their stock.
As a result, to recover for wrongs done to the corporation, the shareholder must bring the suit derivatively in the name of the corporation so that each shareholder will be made whole if the corporation obtains compensation from the wrongdoer. However, a corporate shareholder may have an individual action for wrongs done to him where the wrongdoer violates a duty arising from a contract or otherwise and owing directly by him to the shareholder. Such a principle is not so much an exception to the general rule as it is a recognition that a shareholder may sue for violation of his individual rights regardless of whether the corporation also has a cause of action. It is the nature of the wrong, whether directed against the corporation only or against the shareholder personally, not the existence of injury, which determines who may sue. Appellate courts have also recognized an individual cause of action for “shareholder oppression” or “oppressive conduct.”

Redmon v. Griffith, 202 S.W.3d 225, 233-34 (Tex. App.--Tyler 2006, pet. denied).

A claim for shareholder oppression is thus a direct claim—not a derivative claim. Therefore, an individual shareholder necessarily has standing to assert the claim on his own behalf, does not have to comply with the procedural peculiarities of a derivative action, does not lose the right to assert the claim if the corporation goes into bankruptcy, and gets to keep all the money that a court may award on the claim.

However, there is a significant complicating factor. Very frequently, the manner in which a majority shareholder goes about oppressing a minority shareholder involves conduct that also harms the corporation and also breaches fiduciary duties that are owed only to the corporation and not to the shareholder individually. University of Houston law professors Douglas Moll and Robert Ragazzo, in their excellent treatise The Law of Closely Held Corporations, describe the “classic oppression scenario” as follows:

(a) the majority uses its control over the board of directors to discharge the minority from employment and cut off access to dividends (which, as a practical matter, denies the minority any return on its investment); (b) the majority uses its shareholder voting power to remove the minority from the board of directors and otherwise cuts off all participation by the minority in the decision-making process (which may prevent the minority from being aware of misconduct by the majority); (c) the majority engages in acts of self-dealing (e.g., by paying excessive salaries or diverting business opportunities that belong to the corporation); and (d) the majority administers the coup de grace by offering to purchase the minority’s shares at a fraction of their true value. (2010 Supplement at 2-11).

Therefore, in order to prove shareholder oppression, the plaintiff must often allege conduct that sounds awfully like the pleading of a derivative claim. For example, a majority shareholder might use his power over the corporation to pay himself exorbitant bonuses, thereby leaving nothing for the minority shareholder. A majority shareholder might also take a corporate opportunity and place it in a company that he owns 100% thereby avoiding the sharing of the profits with the minority shareholder. In both instances, the majority shareholder did violate duties owed only to the corporation and thereby damaged the corporation. The corporation could certainly sue, and the minority shareholder can and should assert a derivative claim on behalf of the corporation seeking a monetary award of actual damages that were caused by the breach of fiduciary duties to the corporation. However, the minority shareholder can also point to those acts as evidencing a pattern of oppressive conduct whereby the majority shareholder has acted to enrich himself at the minority sharerholder’s expense, to diminish and violate the rights and interests that the minority shareholder has by virtue of share ownership, and otherwise to substantially frustrate the reasonable expectations of the minority shareholder. Nevertheless, a minority shareholder may not in his own capacity sue the majority shareholder seeking to recover the damages suffered by the corporation caused by the breach of fiduciary duties to the corporation. What the minority shareholder can do is to point to that same conduct as evidence of the majority shareholder’s pattern of oppressive conduct toward the minority.

Shareholder oppression is an equitable remedy. If the shareholder proves a pattern of oppressive conduct, the shareholder is not necessarily entitled to economic damages caused by that conduct. Rather, the court is required to fashion an equitable remedy designed to address the harm suffered by the minority shareholder’s rights and interests arising from share ownership. The most common remedy is a judicially-ordered buy out of the plaintiff’s shares at a fair price as determined by the court. There is absolutely nothing inconsistent about claiming, as a result of the majority shareholder’s misappropriation of corporate assets, that the corporation, on the one hand, is entitled to an award of actual damages for the amount of the misappropriated assets and that the minority shareholder, on the other hand, is entitled to have the majority shareholder buy the minority shares. The plaintiff could assert both claims in the same lawsuit, and we frequently do this. The only issue that must be addressed by the simultaneous assertion of the derivative claim and the oppression claim is whether the plaintiff should be awarded a pro rata share of the derivative claim damages or whether that amount should be reflected in the fair value of the shares.

Sometimes, the minority shareholder will not be able to assert the derivative claim. The corporation may be in bankruptcy, in which case the derivative claims are controlled by the bankruptcy estate. Or the derivative claims may have already been released or barred by res judicata. Or the defendants may be successful in blocking the derivative claims through various procedural maneuvers, such as appointment of a special committee. In those instances, the shareholder only has his direct claim for shareholder oppression, but the shareholder may still offer into evidence certain oppressive conduct of the defendant even though that same conduct would also give rise to a no-longer-assertable derivative claim—so long as the shareholder does not seek to recover the damages that would have been awarded under the derivative claim. The issue that faces the court in such an instance is not one of standing but one of evidence. So long as the plaintiff is only using conduct that breaches duties to the corporation as evidence of oppressive conduct toward the minority shareholder, he is not asserting a derivative claim. The issue is not whether the shareholder has standing to offer such evidence, but whether the specific conduct the shareholder seeks to prove is relevant to a claim of oppressing the minority shareholder.

A very significant decision was recently handed down in one of Fryar Law Firm’s cases that addressed these very issues. The United States Bankruptcy Court for the Southern District of Texas (Judge Bohm) issued a 108-page opinion on January 13, 2011, resolving exactly the direct vs. derivative issues described here. In re Skyport Global Communications, Inc., No. 08-36737, 2011 WL 111427 (Bankr. S.D. Tex. 2011). In that case, Fryar Law Firm filed a lengthy and complex oppression and fraud lawsuit in state court in Houston, Texas on behalf of four different groups of shareholders. The corporation had previously been through bankruptcy, and the majority shareholder had received releases of all derivative claims as part of the reorganization. Therefore, the plaintiffs could only assert whatever individual, direct claims survived the bankruptcy. The various defendants removed the case to federal bankruptcy court and asserted that all of plaintiff’s claims were derivative and moved to dismiss the lawsuit with prejudice in its entirety. The Court rejected that argument and acknowledged that many states have adopted the position stated here that oppression claims are inherently direct. However, Delaware law governed the claims in this case, and the Delaware courts had not ruled on that issue. Therefore, in an exhaustive and painstaking analysis, Judge Bohm’s opinion applies the Delaware test for derivative claims to each factual component of each of the plaintiffs’ claims. The Court did hold that certain allegations made would support only claims that were either derivative claims or were otherwise barred by the bankruptcy confirmation order. These claims were dismissed with prejudice. However, the Court found that the majority of plaintiffs’ claims for oppression and fraud were direct claims under Delaware law, and the Court ordered these claims to be remanded to the state court to proceed to trial.

Eric Fryar, Fryar Law Firm, P.C.