WHEN THE CORPORATION’S SHOES ARE TOO SMALL…

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Gonzalez v. Gonzalez
Dallas Court of Appeals, No. 05-16-00238-CV (August 22, 2017) Justices Bridges, Lang-Miers, and Evans (Opinion, linked here)
In stockholder derivative cases, (A) the “individual shareholder steps into the shoes of the corporation.” In re Crown Castle Int’l Corp., 247 S.W.3d 349, 355 (Tex. App.—Houston [14th Dist.] 2008, orig. proceeding). And therefore (B), the “stockholder has no greater right in a stockholder’s derivative suit” than the corporation in whose right he is suing. Henger v. Sale, 365 S.W.2d 335, 339 (Tex. 1963). Right? Well, not exactly, says the Dallas Court of Appeals.
In Gonzalez, two stockholders of a corporation brought suit derivatively against a manager. The trial court granted summary judgment for defendant, because the corporation itself was barred from asserting those claims, having forfeited its charter, and therefore plaintiffs lacked standing to pursue the claims derivatively. The Dallas Court of Appeals reversed. The Court agreed that the corporation itself “no longer has the legal right to assert its causes of action in court,” because of the forfeiture of its charter. See TEX. TAX CODE § 171.252(1). But, it said, “when a corporation forfeits its privileges, title to its assets, including its causes of action, is birfurcated; legal title remains with the corporation and the beneficial interest is vested in its shareholders.” In that situation, the Court continued, “the shareholders holding beneficial title to the claims may assert the corporation’s causes of action as the corporation’s representatives” to protect their (the shareholders’) beneficial rights—i.e., the shareholders can step out of the shoes of the corporation and pursue such claims even if the corporation cannot.
Not addressed in the Dallas Court’s opinion or the briefing was the recent decision of the Fort Worth Court of Appeals in Carter v. Harvey, 2017 WL 2813936 (Tex. App.—Ft. Worth June 29, 2017, no pet.). There, the Fort Worth Court affirmed summary judgment dismissing derivative claims with respect to a corporation that had been dissolved for more than three years. Section 11.356 of the Business Organizations Code provides that a corporation can prosecute or defend claims only until the third anniversary of the entity’s termination. Because the claims in Carter were lodged after that third anniversary, the Fort Worth Court held they were barred not only for the corporation, but also if asserted by someone purporting to sue derivatively. “Because [claimant] derivatively stands in the shoes of” the dissolved corporation, the Court said, “he cannot bring a … claim that [the corporation] could not bring.”
Perhaps we will see one or both of these cases at the next level.

BEST LAWYERS© NAMES COLLINS 2018 “LAWYER OF THE YEAR” FOR SECURITIES LITIGATION IN DALLAS

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Bruce Collins received the honor of being named by Best Lawyers© 2018 as the Litigation – Securities “Lawyer of the Year” for Dallas. Based on peer-review surveys, the legal guide designates a single lawyer per practice specialty in each geographic region. Honorees received high praise for legal prowess, integrity, and professionalism. Along with being recognized for his Securities Litigation practice, Bruce was also named in the 24th Edition of The Best Lawyers in America© 2018 for his work in Commercial Litigation and Litigation – Regulatory Enforcement (SEC, Telecom, Energy). Fifteen additional Carrington Coleman attorneys were selected by their peers for their excellence in 22 different practice areas. Click to view the complete list.

SECURITIES ACT OF 1933 STATUTE OF REPOSE NOT SUBJECT TO TOLLING BY FILING OF CLASS ACTION COMPLAINT

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Section 11 of the Securities Act of 1933 gives purchasers of securities a cause of action when there are misrepresentations in a registration statement. Section 13 states, in part, that: “In no event shall any such action be brought to enforce a liability created under section [11] of this title more than three years after the security was bona fide offered to the public . . . .” In California Public Employees’ Retirement System v. ANZ Securities, Inc., the Supreme Court held that this portion of Section 13 is a statute of repose that is not subject to tolling by the filing of a class action complaint.

CalPERS purchased Lehman Brothers Holdings, Inc.’s securities through public offerings in 2007 and 2008. Shortly after Lehman Brothers filed for bankruptcy in September 2008, a putative class action was filed alleging securities violations based on the sale of Lehman Brothers stock in the 2007 and 2008 public offerings. The putative class action was consolidated with other securities suits brought against Lehman Brothers in a single multidistrict litigation. In February 2011, which was more than three years after the relevant CalPERS’s purchases, CalPERS filed a separate complaint alleging identical securities law violations as the class action complaint. CalPERS’s individual suit was consolidated with the multidistrict litigation. When the putative class action settled, CalPERS opted out of the class, choosing instead to pursue its individual suit. The defendants then moved to dismiss CalPERS’s individual suit, arguing that the Section 11 violations were untimely under the three-year exclusion period in Section 13. CalPERS responded that that the three-year exclusion period was tolled during the pendency of the class action lawsuit and relied on the tolling of a different statute of limitations established in American Pipe & Construction Co. v. Utah. The district court disagreed and dismissed CalPERS’s lawsuit. The Second Circuit affirmed and the Supreme Court granted certiorari.

Justice Kennedy authored the Court’s opinion and affirmed the Second Circuit. The Court began by analyzing whether the language in Section 13 is a statute of repose or a statute of limitations. A statute of limitations is designed to encourage a plaintiff to diligently pursue claims and begins to run when the claim accrues. In contrast, a statute of repose is designed to provide a defendant with certainty that it is free of liability after a certain time and begins to run on the date of the defendant’s last culpable act or omission. The three-year period in Section 13 is a statute of repose because it runs from the date of the defendant’s last culpable act, and because its explicit language, “[i]n no event,” creates a set bar against any future liability.

The Court then explained that a statute of repose is not subject to equitable tolling. Instead, a statute of repose can only be tolled when there is “a particular indication that the legislature did not intend the statute to provide complete repose but instead anticipated the extension of the statutory period under certain circumstances.” Examples of this legislative indication can be found in certain statutes of repose (e.g., 29 U.S.C. § 1113). But there is no such legislative indication in Section 13. The Court then easily rejected CalPERS principal argument that the three-year period in Section 13 was tolled during the pendency of the class action lawsuit because the American Pipe tolling CalPERS sought to apply to the statute of repose was equitable tolling. And in contrast to Section 13’s statute of repose, the statute that was tolled in American Pipe was a statute of limitations, which can be tolled through equitable tolling. Accordingly, the Court affirmed the dismissal of CalPERS’s Section 11 claims as untimely.

The Court’s decision provides securities litigation defendants with certainty about the exact time when potential liability for Section 11 claims will be extinguished. Plaintiffs, on the other hand, now know that they must timely file separate protective actions during the pendency of a class action if they wish to preserve the choice of opting-out of the class action.

FINANCIAL CHOICE ACT: CHANGES IN GOVERNMENTAL SECURITIES REGULATION MAY BE COMING

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While you might have heard that the House has passed a bill that would repeal portions of the Dodd-Frank Act (a bill enacted in July 2010 in the wake of the Great Recession to provide additional government regulation of the financial industry), you might not have heard that the nearly 600 page “Financial CHOICE Act of 2017” (H.R. 10) has provisions covering a broad range of topics that could have a significant impact on government regulatory agencies as well as require a number of specific changes to the Securities and Exchange Commission. While these changes will only take effect if or when the Senate passes the Financial Choice Act, the Financial Choice Act is a bill worth monitoring to see what changes may come. A few of the more notable changes proposed in the bill include:

  • Enhancement of SEC civil penalties for violations of securities laws including tripling the amount of monetary fines when the penalty is tied to illegal profits and permitting penalties equal to investor loss in cases involving “fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement.”
  • Requiring all financial regulators to complete a cost-benefit analysis of any new regulation.
  • Creating a process to permit a recipient of a Wells notice to appear before the Commission in-person.
  • Publication of an updated enforcement manual outlining the SEC’s policies and procedures.
  • Repealing the authority of the SEC to prohibit persons from serving as officers or directors. Amending the Investment Company Act of 1940 to heighten the pleading standard and require a security holder of a registered investment company to state with particularity all facts forming the basis of their breach of fiduciary claim under Section 36(b) and raising the burden from a “preponderance of the evidence” standard to a “clear and convincing evidence” standard.

Looking forward, it is clear that changes could be coming. Those changes could greatly impact how federal securities regulations are created, enforced, and even litigated. We’ll be keeping an eye on this bill to see what come to fruition and so should you.

SUPREME COURT UNANIMOUSLY RULES THAT SEC SOUGHT DISGORGEMENT IS A “PENALTY” SUBJECT TO A FIVE-YEAR STATUTE OF LIMITATIONS

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In Kokesh v. SEC, the Supreme Court determined that the five-year statute of limitations for any “action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise” in 28 U.S.C. § 2462 applies to claims for disgorgement sought by the SEC as a sanction for violations of the federal securities laws. On October 4, 2009, the SEC brought an enforcement action against Kokesh based on his alleged violations of the securities laws between 1995 and 2009. After a jury found Kokesh liable, the district court imposed a civil penalty based solely on Kokesh’s conduct after October 4, 2004, concluding that the five-year statute of limitations in 28 U.S.C. § 2462 precluded any civil penalty based on Kokesh’s conduct five years before the SEC brought suit. The district court, however, ordered Kokesh to disgorge $34.4 million based on violations going all the way back to 1995—with $29.9 million of that amount resulting from violations before October 4, 2004—because the district court reasoned that disgorgement is not a penalty to which 28 U.S.C. § 2462 applied. The Tenth Circuit affirmed, and the Supreme Court granted certiorari.

Justice Sotomayor, writing for a unanimous court, concluded otherwise. She relied on a 1892 Supreme Court case that defined “penalty” as “punishment, whether corporal or pecuniary, imposed and enforced by the State, for a crime or offen[s]e against its laws.” Huntington v. Attrill, 146 U.S. 657, 667 (1892). From this definition, Justice Sotomayor distilled two principles. First, a penalty redresses a wrong to the public. Second, a penalty is intended to punish and to deter others from committing similar offenses, as opposed to compensating the victim. The Supreme Court reasoned that the disgorgement sought by the SEC is a remedy for violations of public laws against the United States, as opposed to violations against the aggrieved individual. Furthermore, disgorgement is punitive because it is primarily intended to deter violations of the federal securities laws “by depriving violators of their ill-gotten gains.” The Supreme Court noted that in many instances the disgorged funds do not compensate the victims, such as instances when it is not feasible to identify them. Based on the two principles distilled from the definition of penalty, the Supreme Court concluded that SEC sought disgorgement falls within the five-year statute of limitations in 28 U.S.C. § 2462 because disgorgement goes beyond compensation and is intended to punish wrongdoers for violating public laws. Kokesh v. SEC, No. 16-529, 2017 WL 2407471 (2017).

TEXAS ENFORCEMENT OF DELAWARE FORUM-SELECTION CLAUSES IN STOCKHOLDER DISPUTES—THE FIRST SHOE DROPS

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In Pinto Technology Ventures, L.P. v. Sheldon (opinion here), the Supreme Court of Texas enforced a forum-selection clause in an amended shareholder agreement, requiring much of the underlying equity-dilution dispute to be litigated in Delaware. The Court upheld the clause’s validity and explored its scope, in terms of the claims and issues covered, and its enforcement by and against nonsignatories. Because the forum-selection clause appeared in a shareholder agreement, the Court had no cause to address the looming issue in this area—the enforcement by courts outside Delaware of a clause in a corporation’s bylaws, unilaterally adopted by its board of directors, that mandates exclusive jurisdiction in Delaware courts for all internal corporate claims, including all derivative actions, pursuant to the recently enacted Section 115 of the Delaware General Corporation Law.

Sheldon and Konya asserted a variety of claims against the majority shareholders and the officers and directors of their company, IDev, arising from what they contended to be the wrongful dilution of their equity interests. Both had signed iterations of the IDev shareholder agreement. The first two versions of that agreement designated Harris County, Texas, as the forum for any disputes “arising out of” the agreement, but the last three versions prescribed Delaware as the exclusive forum. 

Sheldon and Konya had not asserted claims for breach of the shareholder agreement itself, urging statutory and common-law tort claims instead. Nevertheless, the Supreme Court held their dispute fell within the “arising out of” language of the forum-selection clause. It rejected the strict “but for” reasoning of the court of appeals majority that, because their claims derived from statute and common law, they could not “aris[e] out of” the amended shareholder agreement. The Supreme Court stated a desire to avoid “slavish aderence to a contract/tort distinction” and to prevent litigants from evading an agreed forum-selection clause through “artful pleading.” Focusing on “the factual allegations undergirding the [parties’] claims rather than the legal causes of action asserted,” the Court found “the existence or terms of the shareholder agreement are operative facts in the litigation,” and “but for” their status as shareholders and as parties to the shareholder agreement, Sheldon and Konya would not be aggrieved. The Court did note that, if the provision had been tied to “claims arising out of” the shareholder agreement, rather than the broader “disputes arising out of” the agreement, the result might have been different—a decision it reserved, however, for another day.
Next, the Court examined the extent to which the forum-selection clause should be enforced with respect to those who were not parties to the amended shareholder agreement. Sheldon had signed all but the most recent amended agreement. Konya, however, had signed only the first two versions of the agreement—the versions that specified Harris County, Texas as the exclusive forum—and therefore argued he was not bound by the amended versions that prescribed Delaware as the forum. Not so, said the Supreme Court. Every version of the agreement, including those signed by Konya, provided that it could be amended by agreement of the corporation and the holders of a majority of the voting stock. That protocol was followed in the subsequent amendments that adopted the Delaware-forum provision. And so, the Court said, Konya and Sheldon were bound whether they signed the later amendments or not.
Two of the IDev officer-defendants, however, had not signed any version of the shareholder agreement in their individual capacities. Based upon a strict reading of the agreement—which said it conferred no rights on anyone other than the parties—the Court found neither of them could enforce the forum-selection clause against Sheldon and Konya (even if other parties to the case could). In so doing, the Court avoided deciding whether Texas would adopt the “transaction-participant doctrine,” whereby an employee of a party to a contract that contains a forum-selection clause can enforce that clause against another party, like Sheldon and Konya. That question will wait for another day.
So, too, must we await some future decision to learn Texas’s response to a Delaware-only forum-selection clause unilaterally adopted by a company’s board of directors and incorporated into that company’s charter or bylaws, all pursuant to Section 115 of the Delaware General Corporation Law. The Delaware Chancery Court approved such a board-adopted forum-selection clause in Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), and two years later, that result was codified in 8 Del. C. § 115. That statute not only allows the boards of Delaware corporations to unilaterally insert Delaware-only forum clauses in bylaws, it also prohibits bylaw or charter provisions that establish exclusive jurisdiction in any forum other than the courts of Delaware. So, a company incorporated in Delaware, whose headquarters and operations are in Dallas, cannot adopt a bylaw that makes courts in Texas the exclusive fora for resolving intracorporate disputes. Neither can it adopt a bylaw that requires such disputes to be resolved only by arbitration, because that, too, would deprive shareholders of access to Delaware courts. Other states’ reactions to this Delaware-centric provision are still developing. Oregon’s Supreme Court, for example, has approved and accepted it, in Roberts v. TriQuint Semiconductor, Inc., 364 P.3d 328 (Ore. 2015). Texas has yet to weigh in.
In any event, legislative history seems to make clear that § 115 has no effect on shareholder agreements, and so provisions there that require disputes to be resolved in arbitration or in the courts of a state other than Delaware will survive. See Bonanno v. VTB Holdings, Inc., C.A. No. 10681-VCN, 2016 Del. Ch. LEXIS 24 (Del. Ch. Feb. 8, 2016). In Texas, the Supreme Court’s guidance and reasoning in Pinto will continue to control such cases.

The Mother of all Holidays!

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The Texas Family Code standard possession order (SPO) sets forth a schedule of weekend possession (first, third, and fifth weekends) each month both as to parents who live within 100 miles of each other, or who live more than 100 miles apart. But there is an approaching holiday that supersedes any conflicting weekend possession regardless of the distance the parents reside apart.

That holiday is Mother’s Day. The SPO provides that a mother who is a conservator of a child under the order shall have possession of the child beginning at 6 p.m. on the Friday before Mother’s Day, and ending at 6 p.m. on Mother’s Day. If that weekend is not one under the SPO that would have been her weekend, then she will pick the child up from the residence of the other conservator who would have had possession that weekend and must return the child to the same place at the end of the Mother’s Day possession.

But wait—there’s more, the same precedence is given to a conservator who is a father for Father’s Day weekend which falls in June of each year.

It is the declared public policy of this state to assure children have frequent and continuing contact with parents who have shown the ability to act in their children’s best interest, and a strong statement about the importance of each parent’s role is made by giving precedence to these special days.

Wishing everyone a Happy Mother’s Day (and an early Happy Father’s Day next month)!

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