The Texas Supreme Court has finally put to rest the question of whether the implied warranty to repair or modify tangible goods or property in a good and workmanlike manner can only be brought by a consumer under the Texas Deceptive Trade Practices Act (DTPA) or whether it can be brought under the common law as well. The Court held it could in fact be brought under both, in Nghiem v. Sajib, 2019 WL 406123 (Tex.), 1 (Tex., 2019). This is significant because a consumer must bring an action under the DTPA for the breach of this implied warranty within two years or the action will be barred by the DTPA two-year statute of limitations. On the other hand, it appears that a consumer has up to four years to bring an action for breach of this implied warranty under the common law before being barred by the applicable statute of limitations. Further, there are additional criteria that must be met to bring a claim under the DTPA that do not have to be met under the common law.

In the Ngheiem case, the consumer’s airplane was damaged in a crash-landing when the airplane engine failed. The consumer made a claim against the company that had serviced the airplane for years and made repairs to it immediately before the crash. The consumer alleged that the defendant company breached the common law implied warranty to make repairs in a good and workmanlike manner. The defendant company alleged that the consumer’s claim could only be brought under the DTPA and not under common law.  Therefore, the claim was barred by the DTPA two-year statute of limitations because the consumer waited too long to file the lawsuit.  The trial court agreed and rendered judgment for the defendant and court of appeals affirmed.

The Texas Supreme Court granted the consumer’s petition for review and held that this implied warranty could be brought both under the common law and the DTPA. Since the consumer brought the action under the common law, the claims were not barred by the DTPA two-year statute of limitations.

The result of this opinion is that it will give consumers including large corporations who may not qualify for consumer status under the DTPA the right to bring an action for breach of this implied warranty. Further, it should also give consumers up to four years from the date of the breach to bring this action.

In 2011, the Texas Legislature passed the Texas Citizens Participation Act (TCPA) also characterized as an anti-SLAPP statute (Strategic Lawsuit Against Public Participation). “The purpose of this [Act] is to encourage and safeguard the constitutional rights of persons to petition, speak freely, associate freely, and otherwise participate in government to the maximum extent permitted by law and, at the same time, protect the rights of a person to file meritorious lawsuits for demonstrable injury.” Tex. Civ. Prac. & Rem. Code Ann. § 27.002 (West). However, as can be seen from one recent case, due to the broad language within the statute, the TCPA is now being applied  to lawsuits arising out of business disputes that appear to exceed the TCPA’s expressed purpose.

In the case of Grant v. Pivot Tech. Sols., Ltd., 556 S.W.3d 865, 865–71 (Tex. App.—Austin 2018, no pet. h.), the Plaintiff Purchaser Entities sued the Defendant Seller Entity and its principals  for breach of contract, tortious interference, breach of fiduciary duty, fraud, misappropriation of trade secrets, civil conspiracy and violations of non-compete agreements. The dispute arose out of an asset purchase agreement entered into between one of the Defendant Purchaser Entities and the Defendant Seller Entity.  The Defendant Seller Entity was a technology solutions provider certified by the State of Texas as a Historically Underutilized Business (HUB) allowing it to compete for government contracts that give preferential treatment to HUBs. There was a series of transfers and modifications made in connection with the asset purchase agreement in order to preserve the HUB status of the  Defendant Seller Entity.

In the years following the execution of the asset purchase agreeement, the business relationship between the Defendant Seller Entity and Plaintiff Purchaser Entities deteriorated and the underlying lawsuit ensued. The Defendants filed a motion to dismiss under the TCPA. The trial court denied the motion in its entirety and the appeal followed.

The Austin Court of Appeals found that the trial court erred in denying the motion in its entirety because the allegations in the Plaintiffs’ lawsuit fell within the purview of the TCPA. According to the appellate court, the statute applied to Plaintiffs’ lawsuit in that the underlying transactions between the buyer and seller companies and allegations against Defendants were related to the Defendant Seller Entity’s HUB status. The TCPA applies to the “exercise of the right of free speech.” The HUB issues relate to “government”and to “economic well-being.”  This is sufficient to make the best TCPA applicable. Grant v. Pivot Technology Solutions, supra, pp. 877–878.

Further, the appellate court found that the TCPA applied because the allegations in Plaintiffs’ lawsuit  involved the “exercise of the right of association.” The court stated that many of the Plaintiffs claims were based upon the Defendants’ acting together to share and use  Plaintiff’s confidential information.  “Consequently, these claims (which are almost identical to those brought by the plaintiffs in Elite Auto ) are “based on, relate[d] to, or [are] in response to” communications “between [the Defendants] who had joined together to pursue a common interest in employment with [the Defendant Seller Entities] and ensuring [Defendant Seller Entity] was able to operate as a HUB,” protected as an “exercise of the right of association.”” Grant v. Pivot Tech. Sols., Ltd., supra, p. 881.The court even seemed to place importance upon the allegations that the Defendants conspired to commit illegal acts.

The appellate court held that the trial court erred by denying the Defendants’ TCPA motion to dismiss “because the [Plaintiffs] failed to present clear and specific evidence of a prima facie case for every essential element of each and every claim for relief.” Grant v. Pivot Tech. Sols., Ltd., supra, p. 884. The only claims of the Plaintiffs that survived were those based upon improper solicitation and competition which are excluded from the TCPA under the commercial-speech exemption.

In conclusion, this opinion seems to be a far reaching opinion in applying the TCPA.  Moreover, there seems to be a growing body of Texas case law applying the Act in ways that one would never have imagined when it was first enacted. Thus, business plaintiffs and their attorneys in many types of corporate disputes will have to be prepared at the early stages of litigation to defend against a possible motion to dismiss under the TCPA. Otherwise, they may find their otherwise meritorious cases being dismissed under the Act. This will no doubt increase the costs of litigation in the early stages for business plaintiffs.

The constructive trust is a powerful weapon that plaintiffs can use against defendants who have breached their fiduciary duties or committed fraud. In one Texas case, the court of appeals actually affirmed the trial court’s award to the plaintiffs of all the assets in the business owned by the defendant who breached his fiduciary duties and committed fraud. Bright v. Addison, 171 S.W.3d 588, 595 (Tex. App.—Dallas 2005, pet. denied) .

In the Bright case, supra, Plaintiffs sued their attorney, Bright, and his law firm(s) for usurping a business opportunity to manage a casino in Aruba. Plaintiffs also sued the Aruban corporation set up by Bright to manage the casino.  The factual record of the case is limited, but apparently, Plaintiffs were in the casino business and hired Bright to perform legal work related to Plaintiffs’ business operations.  In connection with Bright’s representation of Plaintiffs, he allegedly learned of an opportunity to manage a casino in Aruba and did not disclose this opportunity to Plaintiffs   Instead, Bright took advantage of this opportunity for himself by setting up his own corporation to manage the Aruba casino.

Plaintiffs later learned about Bright’s alleged misdeeds and sued Bright and his law firms for usurping this business opportunity. Plaintiff’s alleged causes of action against Defendants including for breach of fiduciary duty, fraud and tortious interference with a prospective contract. Plaintiffs requested that the trial court impose a constructive trust upon the assets of Bright’s corporation used to manage the Aruba casino, and also requested that the trial court award Plaintiffs lost profits and punitive damages against Defendants.  Plaintiffs prevailed at trial and the Defendants appealed.

The court of appeals held that there was legally and factually sufficient evidence to show that Bright was Plaintiffs’ attorney so that Bright owed Plaintiffs a fiduciary duty of full disclosure.  Bright had a duty to disclose the opportunity to Plaintiffs to manage the Aruba casino and intentionally chose not to disclose this opportunity to them. There was sufficient evidence to uphold the trial court’s determination that Bright breached his fiduciary duty, committed fraud and committed tortious interference.

The court of appeals also affirmed the trial court’s ruling that a constructive trust should be imposed in favor of Plaintiffs upon all the assets of the Aruban corporation set up by Defendant Bright to manage the Aruba casino. The court of appeals held that breach of fiduciary duty and fraud are grounds for imposing a constructive trust and the trial court did not abuse its discretion in imposing the constructive trust.

Defendants also challenged the trial court’s award of lost profits. Defendants grounds for appeal on this issue included that Plaintiff’s expert CPA was not qualified to testify as to lost profits.  The Court found that the trial court did not abuse its discretion in finding that the CPA who had extensive experience in valuing casinos was qualified to testify.  The court also upheld the trial court’s award of punitive damages against the Defendants.

In conclusion, Texas courts have the authority to award both equitable relief and damages against parties committing breach of fiduciary duty or fraud.  One of the available equitable remedies is the imposition of a constructive trust upon assets that are obtained as a result a breach of fiduciary duty or fraud. As can be seen from the Bright case, this remedy can be harsh and extensive.  Typically, an expert will need to be hired to trace the assets upon which the plaintiff seeks the imposition of the constructive trust as well as to support an award of lost profits. If the expert is qualified, and the plaintiff proves his case, a defendant may lose everything tainted by the breach of fiduciary duty or fraud.

 

Texas Corporate directors and officers owe fiduciary duties of obedience, loyalty and due care to the corporation.  Gearhart Indus., Inc. v. Smith Intern., Inc., 741 F.2d 707, 719 (5th Cir. 1984); Loy v. Harter, 128 S.W.3d 397, 407 (Tex. App.—Texarkana 2004, pet. denied). In this context, directors and officers are probably most often found liable for violating the fiduciary duty of loyalty.

“The duty of loyalty dictates that a corporate officer or director must act in good faith and must not allow his or her personal interest to prevail over the interest of the corporation. The duty of loyalty is described as requiring an extreme measure of candor, unselfishness, and good faith on the part of the officer or director.” Loy v. Harter, supra, p. 407. “An officer or director is considered “interested” if he or she (1) makes a personal profit from a transaction by dealing with the corporation or usurps a corporate opportunity, (2) buys or sells assets of a corporation, (3) transacts business in his or her officer’s or director’s capacity with a second corporation of which he or she is also an officer or director or is significantly financially associated, or (4) transacts corporate business in his or her officer’s or director’s capacity with a family member.” Loy v. Harter, supra, pp. 407–08.

A Texas corporation can make these insider transactions valid by following proper corporate formalities. More specifically, Texas Business Organizations Code § 21.418 sets forth procedures that can be followed to authorize and make this type of transaction valid. In general, these procedures require full disclosure by the interested directors and officers as well as approval of the transaction by the disinterested directors or shareholders. Further, even if this approval is not obtained, the transaction will be deemed valid if it meets the fairness scrutiny of the statute. Additionally, shareholders of a privately held  corporation may  enter into a shareholder agreement governing these transactions (see Tex. Bus. & Org. Code § 21.101. In fact, the Texas Supreme Court in the recent case of Richie v. Rupe, 443 S.W.3d 856, 881 (Tex. 2014) seemed to encourage shareholder agreements.

In conclusion, Texas corporate officers and directors must strictly comply with their fiduciary duties including the duty of loyalty. These issues can be addressed in advance in a manner that will protect the officers and directors from liability and simultaneously benefit the corporation.  This may be done by following applicable  procedures set forth in the Texas Business Organizations Code or through a shareholder agreement. This is why it is important for corporations of all sizes to follow proper corporate formalities.

Introduction. In Texas, officers and directors of a corporation owe fiduciary duties to the corporation. “Three broad duties stem from the fiduciary status of corporate directors; namely, the duties of obedience, loyalty, and due care. Ubelaker at 781–82. The duty of obedience requires a director to avoid committing ultra vires acts, i.e., acts beyond the scope of the powers of a corporation as defined by its charter or the laws of the state of incorporation.” …”The duty of loyalty dictates that a director must act in good faith and must not allow his personal interests to prevail over the interests of the corporation.” …“Under the law of most jurisdictions, the duty of care requires a director to be diligent and prudent in managing the corporation’s affairs.” Gearhart Indus., Inc. v. Smith Intern., Inc., 741 F.2d 707, 720 (5th Cir. 1984). What happens when an officer or director breaches one of these fiduciary duties?

Texas Supreme Court opinion. In the recent Texas Supreme Court case of Longview Energy Co. v. Huff Energy Fund LP, 533 S.W.3d 866, 868 (Tex. 2017), reh’g denied (Dec. 8, 2017), reh’g denied (Jan. 26, 2018), the court addressed the evidence required to support the remedies allowed for breach of corporate fiduciary duties. These remedies include the imposition of a constructive trust upon assets wrongfully acquired and disgorgement of ill-gotten gains.

In this case, Longview Energy Corporation sued two of its directors and entities associated with them after discovering one of the associated entities, Riley-Huff, purchased mineral leases in an area where Longview had been investigating the possibility of buying leases.  The jury found that the directors breached their fiduciary duties owed to Longview by usurping a corporate opportunity and by competing with the corporation without disclosure. The trial court rendered judgment awarding Longview $95.5 million, imposing a constructive trust in Longview’s favor on substantially all Riley-Huff’s Eagle Ford acreage leases and associated properties, together with future production from the leases; and ordering Riley-Huff to transfer the leases and properties to Longview. Unfortunately, for Longview, the court of appeals reversed the judgment and the Texas Supreme Court affirmed the reversal.

Background. Longview, an oil and gas exploration company, was looking into investment opportunities in the Eagle Ford. In 2010, Longview held a board meeting to discuss the results of its investigation. The proposal before the board involved investing up to $40 million to lease 7,000 acres for drilling. The proposal did not identify or target specific acreage or leases in the large blobs of land considered. Longview decided against investing, at least in part, because of alleged misrepresentations and factual omissions by two of Longview’s board of directors.

These two directors had formed Riley-Huff in the preceding year to locate and fund oil and gas investments including in Eagle Ford. This had not been disclosed to Longview. Just 3 days before the 2010 Longview board meeting, Riley-Huff agreed to purchase Eagle Ford leases from Wyldfire which was one of the lease brokers Longview consulted in developing the proposal. Riley-Huff eventually acquired mineral leases to approximately 50,000 Eagle Ford acres, some of which were within the blobs on maps Longview’s board had considered.

The jury found that the two Defendant directors breached their fiduciary duties owed to Longview by taking a corporate opportunity and by engaging in competition with Longview without the approval of its board of directors. The trial court rendered judgment awarding Longview $95.5 million; imposing a constructive trust in Longview’s favor on substantially all Riley-Huff’s Eagle Ford acreage leases and associated properties, together with future production from the leases; and ordering Riley-Huff to transfer the leases and properties to Longview.

Court’s holding. The Texas Supreme Court affirmed the reversal of the trial court’s judgment because Longview failed to prove that the leases in issue were acquired by Riley-Huff as a result of the Defendants’ breach of fiduciary duties. There was no evidence that the leases in question were leases that Longview intended to acquire.  There was only evidence that these leases were encompassed within the large blobs of land considered by Longview as part of the investment proposal.  Thus, the evidence was not specific enough to support the court’s imposition of a constructive trust upon these leases, award of $95 million in lost profits or award of other remedies.

Conclusion. The lessons learned from this case are that corporate officers and directors owe strict fiduciary duties to the corporation and must be open and honest with the corporation about any competing ventures in which the directors and officers have invested or intend to invest.  Otherwise, they may have to account to the corporation for these investments.  Further, it is important for a plaintiff suing for breach of fiduciary duty to hire competent financial experts to trace the specific assets that a plaintiff alleges were wrongfully acquired as a result of a defendant’s breach.  Can you imagine investing large amounts of money and time into a lawsuit, being awarded a judgment for almost $100 million in damages and then later having the judgment reversed?

Modern technology is making it much more difficult for businesses to protect their trade secrets. Long gone are the days when an unscrupulous company officer or employee would have to spend hours late at night at the copy machine to copy and steal valuable trade secrets like customer lists, plans or specifications. In the digital age, this can be accomplished in a matter of minutes by downloading the data to a flash drive that fits on a key chain. Texas is doing its best to pass laws to protect businesses from trade secret theft. As discussed in one of my previous articles, the Texas Uniform Trade Secrets Act was passed in 2013, making it easier for businesses to protect their trade secrets.

This act has now been amended. On May 19, 2017, the Texas Governor signed the bill into law clarifying the meaning of the act and expanding the definition of trade secrets that are protected. The act as amended, effective as of Sept. 1, 2017, provides that “”trade secret” means all forms and types of information, including business, scientific, technical, economic, or engineering information, and any formula, design, prototype, pattern, plan, compilation, program device, program, code, device, method, technique, process, procedure, financial data, or list of actual or potential customers or suppliers, whether tangible or intangible and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing if…..”

The italicized language is the language that was added by the amendment. As you can see, the amendment expands the definition of a trade secret so that a wider net is cast to make additional types of company information protectable as a trade secret. So for example, if you own an engineering firm and engineering information or plans are stolen, the act includes this information as a protectable trade secret. Keep in mind, if your business has suffered a trade secret loss, time is of the essence and you should take immediate action.

One area in Texas commercial litigation that continues to evolve is the cause of action for theft of trade secrets. State and federal statutes have recently been enacted making it easier for businesses to protect their trade secrets. This is becoming increasingly important in the digital age when large amounts of information including protected trade secrets can be downloaded in seconds or minutes.

The Texas Supreme Court seems to be following the trend. In its recent June 2016 opinion of Southwestern Energy Production Co. v. Hefland, Opinion No. 13-0986, the court decides whether to uphold a verdict for trade secret theft of over $30 million. The underlying allegations involve the alleged misappropriation of data identifying highly productive oil and gas formations. Although, the court remands the case for a new trial on the grounds the plaintiff proved up some but not all of the damages, the court cites legal precedent stating, “A “flexible and imaginative” approach is applied to the calculation of damages in misappropriation-of-trade secrets.”

The court discusses multiple ways to measure damages for trade secret theft leaving the door open for Plaintiff’s to be creative in developing their damages models. However, in reading the opinion one gets the impression that the Plaintiff may have been a little too creative and would have been better off taking more of a rifle rather than a shotgun approach to proving up damages. For example, the court finds that the Plaintiff’s expert provided no basis for valuing certain elements of the damages claimed and overstated other damages calculations. The result is that at the end of the day the court remands the case to the trial court for a new trial.

Lessons learned from this case are that Texas courts may take a liberal view on damages in trade secret theft cases. Even so, plaintiffs must meet the technical requirements in offering probative expert testimony to support damages. Otherwise, plaintiffs may find themselves retrying their cases after years of hard work, or, even worse, being completely reversed on appeal.

Just when it looked like all was lost for minority shareholders of closely held Texas corporations after the Texas Supreme Court eliminated shareholder oppression as a cause of action, along came the Court’s decision of Sneed v. Webre, 465 S.W.3d 169 (Tex. 2015). In this fascinating decision, the Court found that shareholders of TX closely held corporations do not have to first make a formal written demand upon the board of directors as a prerequisite to filing a derivative lawsuit. (A closely held corporation is one with fewer than 35 shareholders).

A derivative lawsuit is a proceeding instituted by shareholders on behalf of the corporation when the board of directors fails to initiate the lawsuit. This typically arises when one or more interested directors or officers has allegedly breached fiduciary duties owed to the corporation. Naturally, in these situations, even those directors who have done nothing wrong may be reluctant to file a lawsuit on behalf of the corporation against one of their fellow board members or officers. Thus, if the directors fail to act, the law provides a mechanism for the shareholders to file a derivative action on behalf of the corporation.

Generally, before the shareholders of a corporation may file a derivative action, they must first make a formal written demand upon the board of directors to institute the lawsuit. Only after the directors refuse to do so or fail to timely respond to the demand may the shareholders institute the lawsuit. However, the Texas Supreme Court held that the shareholders of Texas closely held corporations do not have to meet this demand requirement. They may simply file the lawsuit. This saves time and money for the complaining shareholders.

One other interesting fact in this case was that the shareholders of the parent corporation were instituting the derivative action on behalf of the parent corporation’s wholly owned subsidiary. The court held that they were equitable shareholders of the subsidiary and therefore had standing to also bring the action on behalf of it.

The Texas Supreme Court has made it clear in a recent opinion that majority shareholders do not owe formal fiduciary duties to minority shareholders, even in closely held corporations. Cardiac Perfusion Services, Inc. v. Hughes, 436 S.W.3d 790 (Tex. 2014). However, a recent Texas appellate court held that managing members of a limited liability company (LLC) may owe a fiduciary duty to the non-managing member when the company agreement vests sole control of the company in the managing members.  Guevara v. Lackner, 447 S.W.3d 566 (Tex. App.—Corpus Christi 2014), reh’g overruled (Dec. 11, 2014).

The moral of the story is that in forming an LLC, careful attention should be paid to drafting the company agreement that governs the operation of the LLC.

 

The last post discussed the Texas Supreme Court’s recent decision in Ritchie v. Rupe eliminating shareholder oppression as a cause of action in Texas.  However, all is not lost for minority owners in small corporations or limited liability companies who are treated unfairly.  In fact, the same court made it clear that board of director members and officers continue to owe fiduciary duties to their corporations that can be enforced by shareholders through derivative actions.

Lessons that can be learned from this decision are:

1. The court favors that shareholders use shareholder agreements to govern their respective rights and obligations.  The court mentions the use of shareholder agreements multiple times throughout the opinion.  I anticipate corporate attorneys will utilize these agreements more frequently in forming corporations and representing minority investors.

2. Shareholders in closely held corporations (corporations with fewer than 35 shareholders) may file suit against directors or officers in control of a corporation who breach their fiduciary duties without jumping over all the procedural hurdles typically required in derivative actions.

3. A shareholder has statutory but not common law rights to inspect a corporation’s books and records.

4. The directors of a corporation cannot refuse to pay dividends for an improper purpose such as devaluing the shares of the other shareholders.

5. In limited instances, if the controlling officers or directors terminate a minority shareholders employment, they may be liable for breach of fiduciary duty.

6. Officers and directors will continue to be held accountable to a corporation for misapplying corporate funds or diverting corporate opportunities.

7. If controlling directors or officers take action to deflate the value of a corporation’s shares, “perhaps to allow the company or its shareholders to purchase a minority shareholder’s shares for less than their true market value,” the corporation may have a cause of action for breach of fiduciary duty.