Texas Supreme Court Issues Opinion on Business Judgment Rule and Double-Derivative Standing That Could Affect Closely Held Texas Energy Companies

The Texas Supreme Court has recently issued an opinion that could impact closely held energy companies organized under Texas law. In Sneed v. Webre, 2015 WL 3451653 (Tex. 2015), the Court concluded that the business judgment rule did not affect the plaintiffs standing in a derivative suit brought by the shareholder of a closely held Texas corporation. The Court also held that a shareholder of a closely held Texas corporation has so-called double-derivative standing to bring suit on behalf of the corporations wholly-owned subsidiary. In Sneed, the shareholder of a closely held parent corporation asserted a derivative lawsuit on behalf of the parent corporations wholly-owned subsidiary against several of the subsidiarys directors, officers, and employees. The shareholder alleged that the defendants committed fraud and breached their fiduciary duties concerning the acquisition of a facility in Saltville, Virginia. The Court first considered the role of the business judgment rule in shareholder derivative actions brought on behalf of closely held Texas corporations. A closely held corporation is defined in Texas as a corporation whose stock is not publicly traded (on an exchange or over the counter) and has fewer than 35 shareholders. The Court noted that the business judgment rule normally applies to both the board of directors decision whether to pursue the corporations cause of action and as a defense to the merits of a shareholders derivative lawsuit. The Court then made clear that closely held corporations may assert the business judgment rule as a defense to the merits of such a suit. The Court went on to hold, however, that a shareholder in a closely held corporation does not need to establish derivative standing by pleading and proving that the corporations directors failed to exercise business judgment. Specifically, the Court explained that Articles 5.14(A) and 5.14(L) of the Texas Business Corporation Act (TBCA), when read together, established that a shareholder of a closely held corporation may bring a derivative action on behalf of the corporation, and that the Legislature did not require shareholders of a closely held corporation to establish derivative standing by pleading or proving that directors failed to exercise their honest business judgment in not pursuing the corporate cause of action. The Court next addressed double-derivative standing. In a double-derivative action, the shareholder maintains the derivative action on behalf of the subsidiary, based upon the parent corporations derivative rights to the cause of action possessed by the subsidiary. The defendants argued that only the actual shareholder of a subsidiary corporation could bring a derivative suit in the corporations name. The Court, however, concluded that the plaintiff, as a stockholder in the parent corporation, was also an equitable owner of stock in the wholly-owned subsidiary. Thus, in the context of a closely held Texas corporation, the Court held that the derivative plaintiff can proceed based on his or her beneficial or equitable interest in a subsidiary. In a footnote the Court attempted to limit its holding concerning double-derivative standing to the instant facts, although future litigants may attempt to expand this holding. Sneed thus clarifies thatin the context of a closely held Texas corporationwhile the business judgment rule will provide a defense on the merits in a derivative action, it will not serve as a jurisdictional bar. Derivative plaintiffs who are shareholders in a parent corporation will also have double-derivative standing to sue on behalf of subsidiaries in closely held Texas corporations. It is important to note these holdings are based on Texas statutory law and only apply to closely held Texas corporations, not to corporations that are publicly traded or have 35 or more shareholders, or to corporations organized under the law of another state (such as Delaware). The Court further explained in a footnote that its analysis would not have materially differed under the current Texas Business Organizations Code (TBOC), which replaced the TBCA. Thus, Sneed will have ongoing application to closely held Texas energy companies and may make it easier for shareholders to pursue future derivative actions.