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From Securities Regulation Daily, May 29, 2015

Shareholders of closely held corporations need not show demand futility

By Lene Powell, J.D.

The Texas Supreme Court held that although the business judgment rule applies to the merits of all shareholder derivative suits, for the purposes of determining standing, a shareholder of a closely held corporation does not need to plead or prove that the board of directors acted outside of the protections of the business judgment rule in deciding not to pursue the corporation’s cause of action. Further, 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 (Sneed v. Webre, May 29, 2015, Green, P.).

Background. Members of the Webre family of Texas own multiple entities engaged in the production of salt and brine. Texas United Corporation and its wholly owned subsidiary, United Salt Corporation, manufactured salt products for sale to retail and business customers. Texas Brine Company, LLC and other related entities drilled wells into salt caverns to produce and recover brine. In 2006, United Salt began the process of acquiring a salt mining and storage facility in Saltville, Virginia (the Saltville Acquisition), which would extract salt from brine and use the underground caverns created by the brining process for gas storage. According to the plan, Texas Brine would create a new subsidiary, Texas Brine Company Saltville, LLC, immediately after the Saltville Acquisition, and the subsidiary would acquire the gas storage operations and associated liabilities from United Salt.

Over the next several years, the cost of the Saltville Acquisition exceeded initial projections.

After the acquisition was completed, a United Salt director, Lloyd P. Webre, who was also a Texas United director and shareholder, sued a United Salt director and several executives who executed the acquisition. Webre said the individual defendants did not tell the board that the company would operate a gas storage facility at the site, even though they executed corporate documents that expressly contemplated that the transaction would include gas storage operations. He said this lack of disclosure caused United Salt to enter into an unprofitable transaction that lost more than $7 million. He alleged that the defendants breached their fiduciary duties by recklessly entering into contracts that United Salt could not perform and fraudulently concealed key information relating to the Saltville Acquisition.

Texas United and United Salt intervened as indispensable defendants and moved to dismiss on the basis that, among other reasons, Webre did not have standing to assert a shareholder derivative lawsuit. The trial court found that Webre lacked standing to sue and dismissed the complaint. The court of appeals reversed and held that Webre had double-derivative standing to sue because, as a shareholder of Texas United, he held an equitable ownership interest in United Salt because it was Texas United’s wholly owned subsidiary. Further, he could pursue direct recovery against the individual defendants by virtue of a derivative lawsuit. The court also ruled that because the shareholder derivative suit was brought on behalf of a closely held corporation, demand requirements did not apply.

Business judgment rule. According to the court, the business judgment rule applies to the merits of a derivative proceeding when a corporation’s officers’ or directors’ actions are being challenged, whether the proceeding is brought on behalf of a closely held corporation or any other corporation. However, the standing, demand, and mandatory dismissal requirements of Article 5.14 of the Texas Business Corporations Act, which governs shareholder derivative suits, did not apply to shareholder derivative lawsuits brought on behalf of closely held corporations. In fact, the Legislature specifically removed the demand requirement in derivative proceedings brought on behalf of closely held corporations.

Consequently, the court held, the demand requirement is excused in all instances in which a shareholder asserts a derivative proceeding on behalf of a closely held corporation. The court of appeals properly concluded that the business judgment rule did not deprive Webre of standing to assert a derivative proceeding on behalf of a closely held corporation.

Double-derivative standing. As the court explained, in a “double derivative” action, the shareholder effectively maintains the derivative action on behalf of the subsidiary, based on the fact that the parent or holding company has derivative rights to the cause of action possessed by the subsidiary. Texas United is the sole shareholder of United Salt, and the defendants argued that only the actual shareholder of a corporation can bring a derivative suit in that corporation’s name. However, Webre argued that as a shareholder of United Salt’s only shareholder, he had a beneficial or equitable ownership interest in United Salt.

The court agreed with Webre. The stockholders are the beneficial owners of the assets of the corporation. Further, the Legislature made the statutory standing provisions of Article 5.14(B) inapplicable to closely held corporations. Therefore, in the context of the closely held corporation, the derivative plaintiff does not need to be a shareholder of the corporation he is bringing suit on behalf of, and the definition of a shareholder does not exclude those with a beneficial or equitable interest in a subsidiary, said the court.

Decision affirmed. Because Webre had standing to bring the action, the court affirmed the decision of the court of appeals, and remanded to the trial court for further proceedings.

The case is No. 12-0045.

Attorneys: Neal S. Manne (Susman Godfrey LLP.) for James F. O’Donnell. Sydney Gibbs Ballesteros (Gibbs & Bruns LLP) for Robert Wayne Sneed. Kevin D. Jewell (Chamberlain, Hrdlicka, White, Williams & Aughtry) for Texas United Corp. Ben A. Baring Jr. (De Lange, Hudspeth, McConnell & Tibbets, LLP) for James H. Tichenor. Michael Gary Orlando (Orlando & Orlando, LLP) for Lloyd P. Webre, Jr.

Companies: Texas United Corp., Texas Brine Company, LLC, United Salt Corporation, Texas Brine Company Saltville, LLC

MainStory: TopStory CorporateGovernance DirectorsOfficers BeneficialOwnership TexasNews

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