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Published On: February 25, 2015Categories: Securities and Investor

Will Texas shareholder derivative actions go to a new Chancery Court?

Texas H.B. No. 1603 Proposed to Create “Texas Chancery Courts”

Representative Villalba (R-Dallas) recently proposed H.B. 1603 which is “An Act relating to the creation of the chancery court and the court of chancery appeals to hear certain cases.” Essentially, this bill would create a new, specialized court to handle Texas shareholder derivative actions and potentially other business suits or disputes among management and shareholders.

Texas shareholder derivative actions generally include lawsuits brought by shareholders on behalf of the company against management for management’s wrong-doing. We often see these suits brought during major corporate changes like a merger, acquisition, or divestiture of a major asset. Generally, the law does not allow suits merely for negligence, bad decisions, or even decisions that are unpopular–even broadly so–among shareholders. These are protected under the business judgment rule and the proper remedy for shareholders is to vote out the board of directors and replace management through normal governance channels.

The law would create specialized Chancery Courts to hear Texas shareholder derivative actions, and also create a specialized court of Chancery Appeals. These would govern all Texas shareholder derivative actions, whether the company was incorporated in Texas or not.

A practical rationale for the bill

The law is plainly a practical solution to the glutting of the district and county civil courts, especially in Dallas. In Texas shareholder derivative actions are brought by in-state shareholders against out-of-state businesses, or brought by shareholders against Texas businesses. A great majority of these have been filed by shareholders to challenge proposed mergers to protect smaller shareholders’ rights. They are taking up more and more of the local dockets’ space and time.

Another group of cases that would go to these courts are so-called “shareholder oppression” actions (which the Texas Supreme Court just gutted here). Those cases are brought by minority shareholders against majority or controlling shareholders (typically) in small businesses to challenge mismanagement or wrongful “ousting” of the minority shareholder, or depriving him or her of their investment. In Delaware, these are brought as breaches of fiduciary duties–in Texas, they were brought under the oppression statute which the Supreme Court ruled doesn’t really mean what it actually says.

In any event, Texas shareholder derivative actions require specialized knowledge and understanding, and many of our local judges have become veritable experts. They could probably use some help though. Why not just create more judge-ships in the Dallas County District Courts?

Is streamlining Texas shareholder derivative actions the real purpose?

There is another possible reason lurking here. Delaware is host to the most well-known chancery court system. More companies are incorporated in Delaware than anywhere else in the United States. The state is home to more lawsuits about corporate governance than anywhere else. Texas may see itself as a competitor and be trying to gain marketshare.

In fact, some have said the bill is a way to court businesses who wish to incorporate in Texas. Ostensibly, to lure managers to reincorporate in Texas on the promise that this will be a more “management friendly” venue than even the Delaware Chancery court. I wonder if someone has done the math to see whether the fees paid for incorporating in Texas (and maybe paying Texas franchise taxes, which are pretty high) will offset the costs of the new chancery courts.

Texas shareholders could benefit in theory by having somewhere that is more streamlined and fast for fast determinations of lawsuits. One should note that the chancery judges–“chancellors”, actually–will be selected by the governor rather than elected like all of the rest of Texas’s judges. This has not gotten enough analysis from the academics and wonks who have been evaluating the bill.

Ultimately, however, I doubt shareholders will do very well (at least in the short run). You see, there has been a trend towards favoring management in the substantive law. And, currently, Texas shareholder derivative actions are jury trial matters (at least presumptively so–certain equitable remedies ultimately get decided by the court). This bill would effectively remove the threat of a jury by placing everything in the hands of an “expert” jurist. That jurist will not be elected. He may even have a mandate.

Will The Texas Chancery Court Bill Get Passed?

I have no idea. Not being a politician I am not privvy to the backroom talks. I am a little surprised that a Republican would submit a bill that invites more litigation and requires more state spending. Granted, the Texas GOP has generally been on an anti-lawsuit tear for the past decade. Then again, this could be one of those bills that is simply a nominal submission for the proposing legislator. But, I have heard from friends that there is support for the bill among GOP operatives and certain pro-business lobby groups. Have they suddenly taken up for the every-day shareholder? We will wait and see.