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.

A recent court of appeals discussed the significance of the fiduciary relationship created when someone signs a power of attorney authorizing another to act as their agent.  (Jordan v. Lyles, 485 S.W.3d 785 (Tex. App. – Tyler 2015)).  In this case, Bud executed a durable power of attorney appointing his stepdaughter as his agent. Subsequently, Bud, with the help of his stepdaughter, completed some forms making his stepdaughter the sole beneficiary of Bud’s bank and annuity accounts.  As a result, when Bud died these accounts vested in the stepdaughter and did not become part of Bud’s probated estate.

After Bud’s death, the stepdaughter withdrew the money from the accounts and liquidated the annuities.  Bud’s heirs sued the stepdaughter for breach of fiduciary duty.  The court held that the power of attorney created a fiduciary relationship between Bud and his stepdaughter as a matter of law. Even in the case of a gift between parties with a fiduciary relationship, the law presumes the gift to be unfair and invalid.  The recipient of the gift must prove that the transaction was fair and reasonable.

The jury found that Bud’s stepdaughter breached her fiduciary duty, under the circumstances of this case, and awarded damages to the heirs. The court of appeals upheld the jury award.

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.

 

Owners often require general contractors they hire to perform construction services to agree to waive their rights to recover delay damages.  General contractors in turn require their subcontractors to agree to the same.  When a contractor’s work is significantly delayed by others, this can result in catastrophic financial losses to the contractor.

Fortunately, the Texas Supreme Court recently held that there are exceptions to the enforceability of these no delay damages clauses.  The court held that the exceptions to their enforceability include when the opposing party causes the delay or hindrance by engaging in arbitrary and capricious conduct, active interference, bad faith or fraud. (See Zachry Const. Corp. v. Port of Houston Auth. of Harris County, 449 S.W.3d 98, 104 (Tex. 2014), reh’g denied (Dec. 19, 2014)).

Lessons learned are that if you are a contractor, you should avoid signing a contract that contains a blanket waiver of the right to recover delay damages.  However, even if you have agreed to this type of clause, all may not be lost if you sustain delay damages.  You will just have to submit proof that one of the common law exceptions applies to the enforceability of the clause.

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.

This past summer the Texas Supreme Court in Richie v. Rupe,  2014 Tex. LEXIS 500 (Tex. 2014),  all but eliminated shareholder oppression as a cause of action available to minority shareholders in closely held corporations being treated unfairly by the majority.  The Court held that there is no common law cause of action for shareholder oppression.  Rather, it is simply one of several statutory grounds for a court to impose a receivership upon the operation of a corporation.

Unfortunately, by the time a corporation reaches the point of receivership it is usually a sinking ship. This is not much help to shareholders who are being taken advantage of by those in control of profitable corporations. Thus, for all practicable purposes this cause of action has been completely eliminated.

Up until the court’s decision in Richie v. Rupe, supra, Texas courts had generally recognized a cause of action for shareholder oppression when the ‘majority shareholders’ conduct substantially defeated the minority’s expectations that, objectively viewed, were both reasonable under the circumstances and central to the minority shareholder’s  decision to join the venture; or conduct by the majority that was: burdensome, harsh, or wrongful; constituted a lack of probity and fair dealing in the company’s affairs to the prejudice of some members; or a visible departure from the standards of fair dealing and a violation of fair play on which each shareholder was entitled to rely.’ (See Ritchie v. Rupe, 339 S.W.3d 275,  289 (Tex. App. – Dallas, 2011, pet. granted, reversed and remanded, 2014 Tex. LEXIS 500 (Tex., June 20, 2014)).

So, for example if the controlling shareholders fired the minority shareholder and reaped the benefits of the profits from the corporation by paying themselves higher salaries while paying the minority shareholder no dividends, the minority shareholder might have a cause of action for shareholder oppression.  If the minority shareholder prevailed, the court would in turn fashion an equitable remedy such as requiring the corporation to purchase the minority’s shares for their fair market value. This will no longer be a possibility under the courts ruling.

However, all is not lost.  Minority shareholder may still be able to bring a cause of derivative action on behalf of the corporation against the controlling members for breach of fiduciary duty.  It just tends to be more difficult to prove.  Some may say this is a good day for corporations.  I would say this is not necessarily so.  It may now be more difficult for closely held corporations to raise capital by selling minority interests to investors.  As they say, be careful what you ask for, you might get it.

 

It is no secret that a majority of Texas corporations are privately held companies controlled by a small number of shareholders.  The controlling shareholders in these corporations may have a duty not to oppress the economic interests of the shareholders holding a minority interest. There are currently three cases pending before the Texas Supreme Court that will address the cause of action known as shareholder oppression. 

“Texas courts have generally recognized two non-exclusive definitions for shareholder oppression:

1. Majority shareholders’ conduct that substantially defeats the minority’s expectations that, objectively viewed, were both reasonable under the circumstances and central to the minority shareholder’s decision to join the venture; or

2. Burdensome, harsh, or wrongful conduct; a lack of probity and fair dealing in the company’s affairs to the
prejudice of some members; or a visible departure from the standards of fair dealing and a violation of fair play on which each shareholder is entitled to rely.” Ritchie v. Rupe, 339 S.W.3d 275, 288 (Tex. App. – Dallas 2011, pet. granted).

 

Cardiac Perfusion Services, Inc. v. Hughes, 380 S.W.3d (Tex. App. – Dallas 2012, pet. filed)

 
In this case the majority shareholder and minority shareholder were cardiac perfusionists who operated heart-lung machines during open-heart surgery.  One year after the formation of the corporation under which these services were performed, a 10% stake in the company was sold to the minority shareholder.  The shareholders entered into a buy-sell agreement that required the shareholders of the corporation to purchase the stock of another shareholder, at book value, upon termination of that shareholder’s employment with the corporation. Six years later the minority shareholder’s employment was terminated.  The majority shareholder sued to exercise his contractual right to purchase the minority shareholder’s interest at book value. The minority shareholder counter-sued for shareholder oppression alleging that the majority shareholder utilized the corporation as his personal vehicle to pursue his own self interests and misused corporate funds.
 
The jury found that the majority shareholder suppressed payment of profit distributions to the minority shareholder; paid himself excessive compensation; improperly paid his family members; improperly paid his personal expenses using company funds; and used control of the company to lower the value of the minority shareholder’s stock.  The jury found that the fair value of the minority’s shares was $300,000.  The trial court found that the majority shareholder engaged in shareholder oppression and required him and the corporation to purchase the minority’s shares at what the jury found to be the fair value – $300,000.  The court of appeals upheld the trial court verdict and this case may be ultimately decided by the Texas Supreme Court.
 

Ritchie v Rupe, 339 S.W.3d 275 (Tex. App. – Dallas 2011, pet. granted)

 
In this case, the primary complaint of the minority shareholder was that the majority shareholders refused to meet with potential buyers of the stock of the minority shareholder, making the minority’s interest unmarketable.  The jury found in favor of the minority shareholder and the court ordered the corporation to buy the minority’s shares at their fair market value.  The court of appeals affirmed and remanded the case to the trial court to make further determinations on the fair market value of the minority’s shares, taking into account the discount of the value of the minority’s interest based upon lack of marketability.  This case is now pending before the Texas Supreme Court for final review.
 

Argo Data Resource Corporation v Sharithaya, 380 S.W.3d 249 (Tex. App. – Dallas 2012, pet. filed)

 
The court of appeals reversed the trial court’s judgment in favor of the minority shareholder on the minority’s shareholder oppression claim, which was based, at least in part, on the payment of excessive compensation to the majority shareholder.  The trial court ordered the majority shareholder to require the corporation to pay an $85 mil. dividend as equitable relief for the majority’s alleged oppressive conduct.  The court of appeals found there was insufficient evidence to support a finding of shareholder oppression and the case may ultimately be decided by the Texas Supreme Court.
 

Effective September 1, 2013 the Texas Uniform Trade Secrets Act becomes law.  In the past, trade secret law in Texas has been largely governed by a large and sometimes confusing body of case law.  Having a statute to rely upon should make it easier for companies to enforce their rights when their trade secrets are misappropriated and give clearer guidance as to what is considered a violation.

Highlights of the new bill are:

 

  • It may now be easier for Texas companies to recover damages for trade secret theft.
  • Customer data is included as the type of information that can be a protected trade secret, making it easier to obtain court relief against departing employees and unscrupulous competitors that misappropriate this data.
  • A Company must use reasonable efforts to keep the information secret for it to be a trade secret entitled to protection.
  • Injunctive relief, monetary damages, attorney fees and punitive damages may be awarded against the wrongdoers.