RECENT CASE LAW DEVELOPMENTS FOR TEXAS PRACTITIONERS

Transcription

1 RECENT CASE LAW DEVELOPMENTS FOR TEXAS PRACTITIONERS ELIZABETH S. MILLER Professor of Law Baylor University School of Law State Bar of Texas ADVANCED BUSINESS LAW STRATEGIES October 21-22, 2010 San Antonio CHAPTER Elizabeth S. Miller, All Rights Reserved

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3 Elizabeth S. Miller is a Professor of Law at Baylor University School of Law where she teaches Business Organizations, Business Planning, and related courses. Professor Miller speaks and writes extensively on business organizations topics, particularly partnerships and limited liability companies. She frequently appears on continuing legal education programs and is co-author of a three-volume treatise on Business Organizations published by Thomson/West as part of its Texas Practice Series. Professor Miller has served as Chair of the LLCs, Partnerships and Unincorporated Entities Committee of the Business Law Section of the American Bar Association as well as the Partnership and Limited Liability Company Law Committee of the Business Law Section of the State Bar of Texas. She has also served as Chair of the Council of the Business Law Section of the State Bar of Texas. Professor Miller has been involved in the drafting of legislation affecting Texas business organizations for many years and has served in an advisory or membership capacity on the drafting committees for numerous prototype, model, and uniform statutes and agreements relating to unincorporated business organizations. She is an elected member of the American Law Institute and a Fellow of the American Bar Foundation and the Texas Bar Foundation.

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5 TABLE OF CONTENTS I. INTRODUCTION... 1 II. NEGLIGENT MISREPRESENTATION; HOLDER FRAUD CLAIM... 1 III. SHAREHOLDER DERIVATIVE LITIGATION DEMAND REQUIREMENT... 1 IV. CORPORATE LIABILITY FOR EXEMPLARY DAMAGES (BASED ON VICE-PRINCIPAL S CRIMINAL ACT)... 2 V. SHAREHOLDER OPPRESSION... 2 VI. CORPORATE VEIL PIERCING: CONFLICT OF LAWS; SCOPE OF AFFILIATE... 3 VII. CORPORATE VEIL PIERCING: AFTERLIFE OF SINGLE BUSINESS ENTERPRISE?... 4 VIII. EFFECT OF CONVERSION... 4 IX. CREATION OF GENERAL PARTNERSHIP... 5 X. LIABILITY OF PARTNER IN LIMITED LIABILITY PARTNERSHIP (LLP)... 7 XI. LIABILITY OF PARTNER IN SUBSEQUENT SUIT AFTER JUDGMENT AGAINST PARTNERSHIP; STATUTE OF LIMITATIONS... 8 XII. FIDUCIARY DUTIES OF PARTNERS AND AFFILIATES... 9 XIII. REMEDIES OF JUDGMENT CREDITOR OF LIMITED PARTNER OR LLC MEMBER: CHARGING ORDER, TURNOVER ORDER, EXEMPT WAGES V. DISTRIBUTIONS XIV. PIERCING LIMITED LIABILITY COMPANY (LLC) VEIL XV. FIDUCIARY DUTIES OF LLC MEMBERS, MANAGERS, OFFICERS XVI. DISTRIBUTIONS; FRAUDULENT TRANSFER; CONFLICT OF LAWS i

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7 RECENT CASE LAW DEVELOPMENTS FOR TEXAS PRACTITIONERS I. INTRODUCTION Summarized below are selected recent cases of interest to the business law practitioner. This survey only covers opinions issued within the last year and a half and concentrates on Texas Supreme Court opinions and opinions dealing with issues that are not well-developed or well-settled. II. NEGLIGENT MISREPRESENTATION; HOLDER FRAUD CLAIM Grant Thornton LLP v. Prospect High Income Fund, 314 S.W.3d 913 (Tex. 2010). Bond and hedge fund investors asserted various claims against the outside auditor of a bond issuer after the bond issuer filed bankruptcy. The investors allegedly relied on the auditor s audit reports, which were publicly available, in connection with investment decisions made regarding the publicly traded bonds. Among other issues, the Texas Supreme Court addressed the contours of a negligent misrepresentation claim under Texas law and the viability of a holder claim for fraud. With respect to the negligent misrepresentation claim, the Supreme Court reaffirmed its holding in McCamish, Martin, Brown & Loeffler v. F.E. Appling Interests, 991 S.W.2d 787 (Tex. 1999), that non-clients may sue professionals for negligent misrepresentation under limited circumstances set forth in Section 552 of the Restatement (Second) of Torts. In McCamish, the Court explained that a section 552 cause of action is available only when information is transferred by an attorney to a known party for a known purpose. A known party under Section 552 is one who falls in a limited class of potential claimant, for whose benefit and guidance [one] intends to supply the information or knows that the recipient intends to supply it. This formulation limits liability to situations in which the professional providing the information is aware of the non-client and intends that the non-client rely on the information. A defendant cannot be found liable for negligent misrepresentation to a plaintiff who falls outside this scope of liability. The Court held that a claimant in this case who purchased bonds on the open market and did not have any prior connection to the issuer or the auditor did not fall within the auditor s scope of liability. The Court also addressed a claim by investors that the auditor s misrepresentations induced them to refrain from selling the bonds. The investors alleged that they would have sold their bonds sooner, when it would have been more profitable, or that they would have forced the issuer into bankruptcy sooner, when it 1 had more assets to liquidate, but for the auditor s misrepresentations. Whether to recognize a so-called holder claim was a matter of first impression for the Court. The Court noted that state law holder class actions are now preempted by the Securities Litigation Uniform Standards Act of 1998, while individual holder claims remain state law actions. The Court discussed cases in other states, some of which have recognized holder claims and some of which have not, as well as the scant case law in Texas addressing holder claims. The Court agreed with those courts that have concluded a viable holder claim must involve a direct communication between the plaintiff and defendant. Because the alleged misrepresentations were made in publicly available documents and it was undisputed that the investors had no direct communications with the auditor, the Court held that the auditor was entitled to judgment as a matter of law. The Court stated that it need not decide whether a holder claim involving more specific and direct communications would be actionable under Texas law. III. SHAREHOLDER DERIVATIVE LITIGATION DEMAND REQUIREMENT In re Schmitz, 285 S.W.3d 451 (Tex. 2009). The Texas Supreme Court considered the adequacy of a shareholder demand under Article 5.14 of the Texas Business Corporation Act (which has been recodified in Sections of the Business Organizations Code) and concluded that the demand in question failed to satisfy the statute because it did not identify the shareholder making demand and did not state the claim with particularity. The corporate derivative suit provisions do not permit a shareholder to commence a derivative suit until the shareholder has filed with the corporation a written demand setting forth with particularity the act, omission, or other matter that is the subject of the claim or challenge and requesting that the corporation take action. There is no longer any futility exception under Texas law (although there is a provision that states that various requirements, including the demand requirement, do not apply in the case of a closely held corporation, defined for these purposes as a corporation that has fewer than 35 shareholders and no shares listed on a national securities exchange or regularly quoted in an over-the-counter market). In this case, the demand was sent by a lawyer, and the letter did not name the shareholder. For a number of reasons, the Court concluded that the statute requires the demand to identify the shareholder on whose behalf the demand is made. The Court also concluded that the demand in this case failed to satisfy the statute because it lacked the particularity required by the statute. The only complaint and demand for action set forth in the two-sentence demand was that the Board should stop a proposed merger for $22 per share in light of a

8 superior offer for $23 per share. The Court stated that a large number of competing variables may affect the inherent value of competing offers and that a board cannot analyze a shareholder s complaint about a higher competing offer without knowing the basis of that complaint. The remaining sentence of the demand stated that the Board should fully and fairly consider all competing offers and disclose to shareholders its analysis for recommending the merger. According to the Court, This bland statement of a corporate board s duties could be sent to any board at any time on any issue. Acknowledging that the requisite specificity of a demand will depend on the circumstances of the corporation, the board, and the size of the transaction (which in this case involved several hundred million dollars), but declining to explore all the ways in which a demand may or may not meet the particularity requirement, the Court held that the demand in this case was clearly inadequate. IV. CORPORATE LIABILITY FOR EXEMPLARY DAMAGES (BASED ON VICE-PRINCIPAL S CRIMINAL ACT) Bennett v. Reynolds, 315 S.W.3d 869 (Tex. 2010). Reynolds sued Bennet and a corporate landowner of which Bennett served as president for conversion of thirteen head of Reynolds s cattle that strayed onto land owned by the corporation. The jury found that the cattle were converted and awarded actual and exemplary damages against Bennett and the corporation. On appeal, the Texas Supreme Court analyzed whether the exemplary damages award was warranted under the Texas Civil Practice and Remedies Code and whether the award was unconstitutionally excessive in light of applicable due process constraints under the United States Constitution. The Court also analyzed whether there was a basis for exemplary damages against the corporation for the acts of its president. Although the Court concluded that the statutory predicate of malice was present, the Court held (after setting forth a lengthy and detailed analysis of the constitutional considerations) that the exemplary damage award was unconstitutionally excessive, and the Court thus remanded to the court of appeals for reconsideration in accordance with the Court s opinion and prevailing ratio analysis. The Court rejected the corporation s argument that it could not be assessed exemplary damages for the conduct of Bennett, its president. The jury imposed exemplary damages based on a jury charge that tracked Section of the Civil Practice and Remedies Code as follows: In an action arising out of a criminal act committed by an employee, the employer may be liable for punitive damages but only if: (1) the principal authorized the doing and the manner of the act; (2) the agent was unfit and the principal acted with 2 malice in employing or retaining him; (3) the agent was employed in a managerial capacity and was acting in the scope of employment; or (4) the employer or a manager of the employer ratified or approved the act. The Court held that the evidence was legally sufficient to uphold exemplary damages under subpart (1), which imposes liability if the principal authorized the doing and the manner of the act, because Bennett was a vice-principal, and the acts of a vice-principal are deemed to be the acts of the corporation. The Court relied upon prior case law for the proposition that a vice-principal includes the following four classes of agents: (a) corporate officers; (b) those who have authority to employ, direct, and discharge servants of the master; (c) those engaged in the performance of nondelegable or absolute duties of the master; and (d) those to whom a master has confided the management of the whole or a department or division of his business. Bennett was the highest corporate officer and exercised complete de facto control over the corporation s ranch operations. Additionally, the corporate charter, bylaws, and a resolution of the shareholders gave him broad authority. Not only did he direct ranch operations generally, but he used his authority to direct corporate employees, on corporation time, using the corporation s trucks, to take Reynolds s cattle and sell them at auction. Though Bennett personally received the funds from the cattle sale, the receipt of the funds was made possible by Bennett s cattle lease on the corporation s land, which was Bennett s compensation for serving as president. Bennett argued that there must be some nexus between the agent s act and the scope of duties or authorization, and the Court agreed that the corporation would not be liable for exemplary damages if the vice-principal s conduct occurred while he was acting in a personal capacity unrelated to his authority as a corporate viceprincipal. Here, however, the Court found ample evidence that Bennett was acting in a corporate capacity because he used corporate authority over corporate employees, on corporate land, to convert cattle using corporate equipment. Thus, the corporation authorized the doing and manner of the act based on the authorization and approval by Bennett, a vice-principal, of his own act of conversion. V. SHAREHOLDER OPPRESSION In re White, 429 B.R. 201 (Bankr. S.D. Tex. 2010). White, an 8% shareholder and employee of a corporation, was terminated by the corporation, and White and the corporation asserted various claims against each other. White s claims included claims for wrongful termination and shareholder oppression. The

9 bankruptcy court rejected White s wrongful termination claim because White was an at-will employee who was terminated for making disparaging remarks about the corporation, its owners, and management, rather than to cover up improper loans or to rid the corporation of a minority shareholder as alleged by White. The oppression claim related to the payment of bonuses to shareholder-employees after the termination of White s employment. The court concluded that the payments were disguised dividends that were characterized by the corporation as bonuses for tax avoidance purposes (i.e., in order to provide the corporation a deduction for the payments and avoid double taxation that would result if the payments were dividends paid out of the corporation s earnings) and that White was entitled to damages equal to the amount he would have received from the dividend pool. Additionally, the court concluded that the disguised dividends were a form of shareholder oppression justifying an award of equitable relief to White. In concluding that the disguised dividends constituted shareholder oppression, the court noted that the dividends were in derogation of federal tax law and, in that sense, were illegal. Further, the court characterized the payment of $4.9 million in disguised dividends to other shareholders as denying White his reasonable expectation as a shareholder. The court stated that the conduct would only entitle White to past damages if it were unlikely to continue in the future, but the court concluded White was entitled to a form of equitable relief to protect his future expectations. The court considered whether to award a buy-out or a permanent injunction fashioned after the Texas Supreme Court s relief in Patton v. Nicholas, 154 Tex. 385, 279 S.W.2d 848 (1955) (a malicious suppression of dividends case), and the court concluded that it should require the corporation to elect between the two alternative forms of relief because it was unclear which was least burdensome to the corporation. The court based the terms of the buy-out alternative on a formula agreed to in a shareholders agreement. The permanent injunction alternative specified the manner and basis on which payments could be paid to shareholders and their family members and affiliates and required the corporation to provide White monthly reports showing all payments made to shareholders and their family members and affiliates. VI. CORPORATE VEIL PIERCING: CONFLICT OF LAWS; SCOPE OF AFFILIATE Phillips v. United Heritage Corp., S.W.3d, 2010 WL (Tex. App. Waco 2010, no pet. h.). Officers and directors of a foreign corporation appealed a judgment holding them liable for the corporation s breach of contract on veil piercing theories. On appeal, the court considered the scope of Articles 8.02 and 2.21 of the Texas Business 3 Corporation Act (TBCA). (Although the TBCA expired January 1, 2010, with respect to a corporation formed before January 1, 2006, the TBCA governs a matter involving an act, transaction, or contract of the corporation or the corporation s directors, officers, or shareholders occurring prior to January 1, 2010, unless the corporation elected early adoption of the Business Organizations Code. The provisions discussed in this case have been recodified in the Business Organizations Code, and the court actually considered certain provisions of the Business Organizations Code in interpreting the predecessor provisions.) The court first addressed the argument that Article 8.02 of the TBCA (providing that the laws of a foreign corporation s jurisdiction of incorporation govern the internal affairs of the corporation and the liability of the shareholders for debts, obligations, and liabilities of the corporation for which they are not otherwise liable) excluded from its scope the liability of non-shareholder officers and directors for liabilities of the corporation. The court concluded that the law of the state of incorporation should govern the liability of nonshareholder officers and directors in a veil piercing case, even though the statute did not specifically mention officers and directors in this regard. The court commented that it was not surprising that the statute referred only to shareholders in this context since veil piercing claims are primarily asserted against shareholders and it is unclear to what extent veil piercing claims can be utilized to impose liability on a non-shareholder. The court further noted that the governing law provisions of the Business Organizations Code that recodified Article 8.02A expressly include the liability of a managerial official for a debt, obligation, or liability of the entity and that the revisor s note indicates no substantive change to the source law was intended. Finally, the court stated that it would be an unreasonable, illogical, and absurd result and contrary to the spirit and intent of Article 8.02A for the laws of the jurisdiction of incorporation to determine the liability of shareholders, including shareholders who are directors and officers, in a veil piercing case, while requiring the laws of Texas to determine the fate of non-shareholder officers and directors of the same foreign entity. The court discussed the veil piercing standards under the law of the corporation s jurisdiction of incorporation (Turks and Caicos Islands) and concluded that the plaintiff presented no evidence to permit piercing the veil under that law. The court also discussed the scope of Article 2.21 of the TBCA, specifically whether the term affiliates as used in the statute encompasses non-shareholder officers and directors. The plaintiff argued that the statutory actual fraud standard required for piercing the corporate veil did not apply to the non-shareholder officers and directors in this case because the term

10 affiliate did not include individuals affiliated with the corporation unless they were also affiliates of a shareholder, beneficial owner, or subscriber for shares. The court held that the plain and intended meaning of affiliate as used in Article 2.21A encompasses any individual who is affiliated with (1) a shareholder, (2) a beneficial owner or subscriber, or (3) the corporation itself, including individuals who are officers and directors. The court looked to certain provisions in the Business Organizations Code as well as the language of Article 2.21 before and after the amendment in 1997 that added the affiliate clause to the statute. The plaintiff did not obtain findings or produce any evidence of actual fraud; therefore, the veil piercing claims against the non-shareholder officers and directors failed under Texas law. Because the plaintiff s veil piercing claim failed regardless of whether Texas law or the law of the Turks and Caicos Islands applied, the court concluded that it was not necessary to determine which law applied. VII. CORPORATE VEIL PIERCING: AFTERLIFE OF SINGLE BUSINESS ENTERPRISE? Big Easy Cajun Corp. v. Dallas Galleria Ltd., 293 S.W.3d 345 (Tex. App. Dallas 2009, pet. filed). A lessor obtained a judgment against a lessee for breach of the lease after the lessee defaulted on the lease and abandoned the premises. The lessor then brought suit against various corporations seeking to hold the corporations liable under the single business enterprise theory for the judgment obtained against the lessee. The jury found for the plaintiff on the single business enterprise claim, and the trial court entered judgment in favor of the plaintiff on the claim. During the pendency of the appeal, the Texas Supreme Court issued its opinion in SSP Partners v. Gladstrong Investments (USA) Corporation, 275 S.W.3d 444 (Tex. 2008), in which the Supreme Court rejected the single business enterprise theory. The plaintiff argued that it proved more than the single business enterprise theory discussed in SSP Partners, i.e., that it obtained an implicit finding of actual fraud. The court of appeals concluded that the trial court s judgment in favor of the plaintiff must be reversed, however, because the Supreme Court rejected the fundamental theory of liability the plaintiff submitted to the jury. (The court of appeals also rejected the plaintiff s claim that there was enough evidence of an implied partnership between the lessee and the various related corporations to submit the implied partnership claim to the jury.) In re HRM Holdings, LLC, 421 B.R. 244 (Bankr. N.D. Tex. 2009). The bankruptcy trustee sought to pierce the veil of the debtor limited liability company and hold several 4 affiliated LLCs liable as a single business enterprise based on actual fraud consisting of the debtor LLC s failure to notify creditors that it was terminating its business operations. The bankruptcy court applied corporate veil piercing principles in the LLC context, noting that Texas courts and other jurisdictions have applied the same state law principles for veil-piercing that they have applied to corporations. The trustee s original complaint had simply asserted the single business enterprise theory as a basis of liability without specifying fraud, and the court found the complaint deficient based on SSP Partners v. Gladstrong Investments (USA) Corporation, 275 S.W.3d 444 (Tex. 2008). The court gave the trustee the opportunity to specify actual fraud as a basis to hold the affiliated defendants liable to the debtor s creditors. According to the second amended complaint, the management of the debtor LLC engineered the transfer of all the debtor LLC s assets to the defendant LLCs without notifying the creditors of the debtor LLC. The court concluded that the failure to give the statutorily required notice of winding up could constitute actual fraud under the Texas veil piercing statutes, but the court found that the second amended complaint failed to specify who the perpetrators of the fraud were and how the fraud benefitted the defendants. The court gave the trustee a final opportunity to further amend its complaint and admonished the trustee to examine the Texas veil piercing statutes and the SSP Partners case when and if deciding to draft a third amended complaint. VIII. EFFECT OF CONVERSION Grohman v. Kahlig, S.W.3d, 2010 WL (Tex. 2010) (per curiam). The Texas Supreme Court disagreed with the conclusion of the court of appeals in this case and held that the conversion of two corporations into limited partnerships did not violate the terms of a security agreement covering shares of stock in the corporations. As part of a divorce settlement in 2001, Kahlig executed a promissory note payable to Grohman secured by 70% of Kahlig s stock in two corporations. In 2003, the corporations were converted to limited partnerships to save franchise taxes. Pursuant to the plan of reorganization, as described by the Court, Kahlig formed a holding company for each of the two corporations and contributed his stock in each corporation to the corresponding holding company. Kahlig then converted the corporations to limited partnerships, and each holding company received limited partnership units in exchange for the stock in the converted corporations, which was canceled once it was replaced with the limited partnership units. In 2007, when the limited partnership form no longer provided a franchise tax advantage, the entities were converted back to corporations. Grohman sued Kahlig in 2005 and asserted that the conversions resulted in a

11 breach of the terms of the security agreement under which Kahlig agreed not to sell, transfer, lease or otherwise dispose of the Collateral or any interest therein without Grohman s consent and further agreed not to allow the Collateral to become wasted or destroyed. The court of appeals agreed with Grohman and held that Kahlig breached the security agreement because he disposed of the Collateral in violation of the security agreement. According to the court of appeals, Kahlig destroyed the shares of stock when the shares were converted to limited partnership units because the shares were canceled and ceased to exist. The Supreme Court, however, focused on the definition of Collateral in the security agreement, which encompassed all replacements, additions, and substitutions, and concluded that the conversion did not destroy the Collateral. The Court pointed out that the shares of stock that were canceled in the conversion were first replaced with limited partnership units that represented the same interest in the businesses. Kahlig remained the owner of his interest in the businesses, and the change in form of the Collateral did not destroy it according to the Supreme Court. Grohman did not dispute that the value of the Collateral actually increased (due to the more beneficial franchise tax treatment). Grohman also argued that Kahlig transferred the Collateral in the conversion because the plan of reorganization involved movement of interest in the companies between Kahlig and the holding companies. The Court stated that Kahlig retained ownership of his entire interest in the companies throughout the conversion despite the technical movement of business interests between him and his holding companies. Thus, the Collateral was not transferred, and Grohman s security interest was not impaired. The Court noted that the security agreement lacked any specific mention of the consequences of a business entity conversion, and the Court stated that the most reasonable interpretation of the agreement, read as a whole, was that it did not prohibit Kahlig from converting the business entities and that Kahlig did not breach the agreement at any point in the conversion. VRV Dev., L.P. v. Mid-Continent Cas. Co., Civil Action No. 3:09-CV-1382, 2010 WL (N.D. Tex. Feb. 3, 2010). The district court in this case held that an insurance policy covering a corporation did not cover the entity after it converted into a limited partnership. The corporation purchased a liability insurance policy in 2004 that was renewed in 2005 and expired in The corporation converted into a limited partnership on January 1, The insurer was never informed of the conversion of the corporation into a limited partnership, nor was coverage for the limited partnership ever requested. The limited partnership, general partner, and sole limited partner (the 5 plaintiffs ) demanded a defense and indemnification under the policy with respect to claims asserted against them, and the insurer denied the plaintiffs demands. The plaintiffs filed this suit against the insurer, and both sides sought summary judgment. The insurer argued as a threshold matter that none of the plaintiffs were insured under the policy because none of them were expressly named as a Named Insured in the policy declaration. The only Named Insured was the corporation. The court agreed with the plaintiffs, however, that an exception to the eight corners rule of insurance contract construction allowed consideration of extrinsic evidence to determine whether the plaintiffs were insured under the policy. The extrinsic evidence showed that the corporation was converted to a limited partnership effective January 1, The plaintiffs argued that the partnership is the legal equal of the corporation under Texas law. The plaintiffs cited the conversion provisions of the Texas Business Corporation Act regarding the effect of a conversion and relied upon a case in which a guarantor could not escape his guarantee obligation to a business entity solely by virtue of the entity s change in name or organizational form. The court distinguished that case, however, and stated that the insurer had not contracted to pay a simple debt, but to bear a risk that it evaluated and voluntarily accepted. The court concluded that allowing the plaintiffs to substitute a new party to an insurance contract, without the insurer s knowledge or approval and without giving the insurer the opportunity to evaluate the entity or person it is purportedly insuring, materially rewrites the insurance contract in a way that appears to contravene existing authority. The court also relied upon a provision in the policy that stated that no person or organization is an insured with respect to the conduct of any current or past partnership, joint venture or limited liability company that is not shown as a named insured in the Declarations. Because the corporation was the only named insured, it never notified the insurer or requested coverage for the converted entity, and the insurer never had the opportunity to evaluate the general partner or any other change in the business structure, the plaintiffs were not insured under the policy. IX. CREATION OF GENERAL PARTNERSHIP Ingram v. Deere, 288 S.W.3d 886 (Tex. 2009). For the first time since the passage of the Texas Revised Partnership Act, the Texas Supreme Court addressed what is required to form a general partnership under Texas law. Though the Court stated that the factors making up the common law and statutory test for creation of a partnership are similar, the Court concluded that the determination under TRPA (or the Business Organizations Code, as the case may be) is made with reference to the five factors set

12 forth in the statute using a totality-of-the-circumstances approach as opposed to the common law approach, which the Court stated required the presence of all the factors making up the common law test. Unlike the common law, TRPA does not require proof of all the listed factors for a partnership to exist. After discussing and applying each factor to the evidence in the case at bar, the Court found that there was no evidence of any of the TRPA factors. In 1997, Ingram, a psychologist, and Deere, a psychiatrist, entered into an oral agreement which provided that Deere would serve as the medical director for a pain clinic. Deere asserted that they agreed Deere would receive one-third of the clinic s revenue, Ingram would receive one-third, and the remaining one-third would be used to pay expenses. Deere also claimed that Ingram told him their work was a joint venture, or [they] were partners, or [they] were doing this together. Ingram asserted that they agreed only that Deere would receive one-third of the revenue and that there was no agreement as to the remaining two-thirds. Deere admitted that he never contributed money to the clinic, did not participate in hiring employees, did not know the clinic staff s names, never purchased any of the clinic s equipment, was not a signatory on the clinic s bank account, and was not named on the lease agreement for the clinic space. Fourteen months after Deere began working at the clinic, Ingram prepared for Deere s signature a Physician Contractual Employment Agreement that stated Ingram was the sole owner of the clinic. Deere refused to sign the agreement, claiming it contradicted their agreement, and ceased working at the clinic. Deere sued Ingram, and the jury found that Deere and Ingram entered into a partnership agreement and that Ingram breached his fiduciary duty to Deere. Ultimately, however, the trial court granted a motion by Ingram for a judgment n.o.v. and rendered a take nothing judgment. The court of appeals reversed and reinstated an earlier judgment of the trial court. Ingram appealed to the Texas Supreme Court, and the Court determined that there was no evidence of a partnership between Deere and Ingram and reinstated the trial court s take-nothing judgment. The Court reviewed the development of Texas partnership law with respect to determining the existence of a partnership, first discussing the approach that developed under common law and then analyzing the statutory treatment. The Court stated that the following five-factor test for partnership formation developed under the common law: (1) intent to form a partnership, (2) a community of interest, (3) an agreement to share profits, (4) an agreement to share losses, and (5) a mutual right of control or management of the enterprise. The Court then traced the history of Texas partnership statutes from the passage of the Texas Uniform Partnership Act to the adoption of the 6 Texas Revised Partnership Act ( TRPA ) and the Texas Business Organizations Code ( TBOC ), explaining that it was uncontested that TRPA governed the dispute in this case because the partnership in issue was allegedly formed in (The Court noted that the TRPA and TBOC rules for determining partnership formation are substantially the same.) The Court quoted Section 2.02(a) of TRPA ( an association of two or more persons to carry on a business for profit as owners creates a partnership ), and listed the five factors specified in Section 2.03(a) as indicating creation of a partnership: (1) receipt or right to receive a share of profits of the business; (2) expression of an intent to be partners in the business; (3) participation or right to participate in control of the business; (4) sharing or agreeing to share losses of the business or liability for claims by third parties against the business; and (5) contributing or agreeing to contribute money or property to the business. The Court characterized these factors as similar to the common law factors but distinguished the common law test and the TRPA approach on the basis that the common law test required proof of all five factors to establish the existence of a partnership, whereas TRPA contemplates a less formalistic and more practical approach to recognizing the formation of a partnership. Unlike the common law, TRPA does not require proof of all the listed factors for a partnership to exist. The Court stated that TRPA does not require direct proof of the parties intent to form a partnership but instead lists the expression of intent to form a partnership as a factor to consider. In the past, intent to be partners was a prime, though not controlling, element in the creation of a partnership. The court also distinguished the treatment of profit-sharing at common law and under TRPA by stating that sharing of profits is not required under TRPA whereas it was essential for establishing a partnership under the common law. The Court noted that the comments to TRPA recognize that sharing profits and control over the business will likely continue to be the most important factors in the analysis. Finally, the Court pointed out that TRPA recognizes that sharing of losses may be indicative of a partnership but that such an arrangement is not necessary to create a partnership. The Court next discussed the question of how many of the TRPA factors are required to form a partnership. The Court stated that the TRPA factors seem to serve as a proxy for the common law requirements of intent to form a partnership by identifying conduct that logically suggests a collaboration of a business s purpose and resources to make a profit as partners. The Court concluded that the issue of whether a partnership exists should be decided considering all of the evidence bearing on the TRPA partnership factors, i.e., a totality-of-thecircumstances test, an approach the Court noted would

13 be difficult to uniformly apply. The Court counseled that evidence of none of the factors will preclude recognition of a partnership, and conclusive evidence of all the TRPA factors will establish the existence of a partnership as a matter of law. The challenge, the Court acknowledged, will be application of the totalityof-the-circumstances test between these two points on the continuum. The Court offered the additional guidance that conclusive evidence of only one factor normally will be insufficient to establish the existence of a partnership. The Legislature does not indicate that it intended to spring surprise or accidental partnerships on independent business persons, if, for example, an employee is paid out of business profits with no other indicia of a de facto partnership under TRPA. Turning to the application of the TRPA factors to the case at bar, the Court found that there was no evidence of any of the TRPA factors. With respect to the first factor, the evidence did not show that Deere received a share of the profits because Deere received a percentage of gross revenue rather than profits. There was no evidence that the amount Deere received would have changed if expenses grew or shrank. Also, the checks written to Deere referred to him as medical consultant or contract labor, and Deere cashed the checks without challenging the characterizations. Under TRPA, receipt of profits as compensation as an employee or independent contractor is not evidence of a partnership. With respect to the second factor, expression of an intent to be partners, the Court stated that courts should only consider evidence not specifically probative of the other factors, i.e., evidence of profit or loss sharing, control, or contribution of money or property should not be considered evidence of an expression of intent to be partners. The Court characterized the TRPA factor of expression of an intent to be partners as differing from the common law issue of intent to be partners, which was a primary concern and involved consideration of other factors. The Court gave the following examples of possible evidence of an expression of an intent to be partners under TRPA: parties statements that they are partners, one party holding the other party out as a partner on the business s letterhead or name plate, or a signed partnership agreement. The Court cautioned that the terms used by the parties do not control, and merely referring to another person as partner where the recipient of the message would not expect the statement to have legal significance is not enough. The Court pointed out that the term partner is regularly used in common vernacular with a variety of meanings; therefore, courts should look to the context in which the statements were made and consider the identity of the speaker and the listener. Here, Deere s testimony was unclear and gave the alleged arrangement three different characterizations that 7 they were joint venturers, partners, or were doing this together. Deere s testimony revealed that he did not understand the legal definition of a partner, and the evidence did not show content, context, or circumstances that would give any of the alleged expressions of intent legal significance as evidence of a partnership. With respect to the third statutory factor, control, the evidence showed at most that Ingram talked with Deere about the business. Deere offered no evidence that he made executive decisions or had the right to make executive decisions. With respect to loss sharing, the evidence showed that the parties never discussed losses, only expenses. Deere alleged that the parties agreed that each would receive one-third of the clinic s revenue and that the expenses would be paid by the remainder, but there was no evidence of any discussion of how expenses in excess of one-third of the revenue would be divided. Finally, there was no evidence that Deere agreed to contribute or actually contributed any money or property. Deere argued that he contributed his reputation, which the Court acknowledged could be property contributed to a partnership, but the evidence did not show that Deere s reputation added value to the clinic, and, even if it did, there was no evidence that distinguished any value contributed from that of an employee. In sum, the Court found no evidence of any of the factors specified in TRPA as indicating a partnership. X. LIABILITY OF PARTNER IN LIMITED LIABILITY PARTNERSHIP (LLP) Evanston Ins. Co. v. Dillard Dep t Stores, Inc., 602 F.3d 610 (5th Cir. 2010). The Fifth Circuit Court of Appeals concluded that partners of a law firm that was registered as an LLP when the law firm engaged in trademark infringement and other business torts were personally liable for the judgment against the firm because the firm s registration had expired at the time the judgment was entered. Dillard Department Stores, Inc. ( Dillard s ) sued a law firm, Chargois & Ernster, L.L.P., in 2003 for federal and state trademark infringement, cyberpiracy, and various business torts based on the law firm s use of the Dillard s name and logo on a website developed by the law firm to solicit clients with claims against Dillard s. The law firm was registered as a Texas limited liability partnership. Early in 2004, while the litigation with Dillard s was ongoing, the partners executed a separation agreement providing for dissolution of the partnership, and they did not renew the firm s LLP registration when it expired in July, In November, 2004, the court entered a final judgment against Chargois & Ernster, L.L.P. Dillard s was unable to collect the judgment, and Dillard s filed a complaint against the two partners of the law firm in Each partner was served, and

14 Dillard s sought summary judgment declaring that the partners were personally liable on the judgment against the law firm. The district court granted summary judgment, and the partners appealed. The partners argued that they were protected from liability under the provisions of the Texas Revised Partnership Act ( TRPA ). The court rejected the partners argument that they were protected from liability under the LLP provision of TRPA that provided a partner is not liable for a debt or obligation of the partnership incurred while the partnership is an LLP. (This provision is now found in Section of the Business Organizations Code.) The partners argued that the law firm s debt was incurred when the infringing website was created in 2003, at which time the firm was registered as an LLP. Noting that the terms debt and incurred are not defined in the statute, the court found, however, that a plain reading of the statute supported the argument of Dillard s that the debt was incurred when the judgment was entered in 2004, at which time the LLP registration had expired. The court stated that the underlying conduct gave rise to the possibility of a future debt, but that a debt was not incurred at that time because the conduct might have gone undetected, might have been adjudged innocent, or Dillard s might have opted not to sue. The parties did not rely on another provision of the LLP statute that states a partner is not personally liable for another person s errors, omissions, negligence, incompetence, or malfeasance committed while the partnership is a registered limited liability partnership, but the court considered it significant that liability of a partner is limited for malfeasance committed while the partnership is an LLP. The court stated that the legislature s use of different language created a regime in which partners could be held liable for debts and obligations incurred when the partnership is not a registered LLP but would not bear liability for one another s independent malfeasance committed while it is an LLP. Thus, the court concluded that the partners in this case were not protected from personal liability because the law firm was not registered as an LLP at the time its debt was incurred. [Note: The parties apparently did not raise, and the court did not address, commentary to the LLP provision of the Revised Uniform Partnership Act stating that [p]artnership obligations under or relating to a tort are generally incurred when the tort conduct occurs so as to prevent a culpable partnership from engaging in wrongful conduct and then filing an LLP registration to sever vicarious liability of the partners for future injury or harm caused by conduct prior to the filing. Uniform Partnership Act (1997) (U.L.A.) 306, cmt. 3. The court also did not discuss how its interpretation squares with the provisions addressing the liability of an incoming partner or a withdrawing partner. See Tex. Bus. Orgs. Code (b), (a).] 8 XI. LIABILITY OF PARTNER IN SUBSEQUENT SUIT AFTER JUDGMENT AGAINST PARTNERSHIP; STATUTE OF LIMITATIONS Evanston Ins. Co. v. Dillard Dep t Stores, Inc., 602 F.3d 610 (5th Cir. 2010). The Fifth Circuit Court of Appeals held that a judgment creditor who obtained a judgment against a partnership based on trademark infringement and other business torts was not required to sue the partners in the initial suit brought against the partnership, and the suit to enforce the judgment against the partners, which was brought approximately four and a half years after the trademark infringement and other torts occurred, was timely because it was brought within four years of the entry of the judgment. Dillard Department Stores, Inc. ( Dillard s ) sued a law firm, Chargois & Ernster, L.L.P., in 2003 for federal and state trademark infringement, cyberpiracy, and various business torts based on the law firm s use of the Dillard s name and logo on a website developed by the law firm to solicit clients with claims against Dillard s. The law firm was registered as a Texas limited liability partnership. Early in 2004, while the litigation with Dillard s was ongoing, the partners executed a separation agreement providing for dissolution of the partnership, and they did not renew the firm s LLP registration when it expired in July, In November, 2004, the court entered a final judgment against Chargois & Ernster, L.L.P. Dillard s was unable to collect the judgment, and Dillard s filed a complaint against the two partners of the law firm in Each partner was served, and Dillard s sought summary judgment declaring that the partners were personally liable on the judgment against the law firm. The district court granted summary judgment, and the partners appealed. After rejecting the partners argument that they were protected from liability under the LLP provisions of the Texas Revised Partnership Act (see discussion of this issue above), the court addressed the partners argument that Dillard s was required to sue the partners in the suit against the partnership in order to hold them liable for the trademark infringement and tort claims. The partners relied upon Section 3.05 of the Texas Revised Partnership Act (recodified in Section of the Business Organizations Code), which provides that a judgment against a partnership is not itself a judgment against the partners, but a judgment may be entered against a partner who has been served in a suit against the partnership. The court did not find this provision to be helpful to the partners because Dillard s did not rely on the judgment against the partnership by itself. Dillard s relied upon a judgment obtained against the partners in a separate suit against them to enforce a pre-existing judgment by holding the partners

15 individually liable for the partnership s debt. The court also distinguished Kao Holdings L.P. v. Young, in which the Texas Supreme Court interpreted Section 3.05 of the Texas Revised Partnership Act and held that its purpose was to make clear that a judgment against a partnership is not automatically a judgment against a partner and that a judgment cannot be entered against a partner who has not been served merely because judgment has been rendered against the partnership. Here, the court pointed out, the partners were defendants in a separate action, which they lost after mounting a vigorous defense, and a judgment was not automatically entered against them. Finally, the partners argued that the action against them was barred by the statute of limitations because the claims against them were the same as the claims against the partnership, i.e., claims based on tort and trademark infringement. Dillard s argued, however, that its action was one for debt, i.e., to enforce the judgment against the partners based on their statutory joint and several liability. The court agreed with Dillard s, relying on In re Jones, 161 B.R. 180 (Bankr. N.D. Tex. 1993). The court quoted In re Jones for the proposition that a party can either sue partners along with the partnership so that a judgment can be entered against the partners when liability against the partnership is established, or a party can sue the partnership and bring a subsequent suit against the partners on their liability for the partnership s obligation after liability of the partnership is established. Dillard s chose the latter course of action, and the court stated that Dillard s was thus seeking to impose liability on the partners for partnership debt by operation of law. The court concluded that the applicable statute of limitations was the four-year statute of limitations for suit on a debt and that it began to accrue, at the earliest, upon entry of the judgment against the partnership on November 2, The suit against the partners was brought January 10, 2008, and the action thus was not time-barred. XII. FIDUCIARY DUTIES OF PARTNERS AND AFFILIATES ERI Consulting Eng rs, Inc. v. Swinnea, S.W.3d, 2010 WL (Tex. 2010). The Texas Supreme Court held in this case that when a partner in a business breached his fiduciary duty by fraudulently inducing another partner to buy out his interest, the consideration received by the breaching party for his interest in the business is subject to forfeiture as a remedy for breach, in addition to other damages that result from the tortious conduct. [Note: The term partner here appears to be used in a somewhat generic sense. Although part of the transaction in issue involved the buy-out by Swinnea of Snodgrass s partnership interest in what appeared to be a limited partnership, the principal focus of the 9 opinion is the buy-out of Swinnea s stock in a corporation.] Swinnea and Snodgrass owned equal interests in ERI Consulting Engineers, Inc. ( ERI ), and Malmeba Company, Ltd. ( Malmeba ), a partnership that owned a building and leased office space to ERI. The case arose out of the redemption of Swinnea s stock in ERI and the purchase by Swinnea of Snodgrass s halfinterest in Malmeba. In connection with the buy-out, ERI agreed to employ Swinnea for six years, and Swinnea agreed not to compete with ERI. Also, ERI agreed to continue leasing office space from Malmeba for six years. The business of ERI suffered after the buy-out due to various activities of Swinnea, and Snodgrass eventually sued Swinnea and prevailed on claims for fraud, breach of a non-compete agreement, and breach of fiduciary duty. The damage award included actual damages, equitable forfeiture, and exemplary damages. On appeal, Swinnea did not dispute his liability for fraud, breach of contract, or breach of fiduciary duty. He only disputed the damages awarded. He asserted that the forfeiture award was unsupported by law, but the court disagreed. The Court stated that courts may fashion equitable remedies such as profit disgorgement and fee forfeiture to remedy a breach of fiduciary duty, and the Court pointed out that the trial court found Swinnea liable for fraudulent inducement as to the buy-out agreement as well as finding Swinnea owed fiduciary duties to both ERI and Snodgrass. It followed, said the court, that Swinnea s actions in fraudulently inducing the buy-out agreements were willful breaches of fiduciary duty. The Court held that where willful actions constituting breach of fiduciary duty also amount to fraudulent inducement, the contractual consideration received by the fiduciary is recoverable in equity regardless of whether actual damages are proven subject to certain limiting principles discussed by the court in its opinion. The Court likened this case in many respects to the fee forfeiture scenario between a principal and agent discussed in Burrow v. Arce, 997 S.W.2d 229 (Tex. 1999), and the Court discussed the application of the Burrow principles and factors to this case. The Court remanded the case to the trial court for consideration of these factors. The Court discussed the evidence relating to the contractual consideration subject to potential forfeiture and concluded that the lease payments from ERI to Malmeba were part of the contractual consideration for the buy-out, and the trial court should thus consider whether to include them in fashioning an appropriate equitable forfeiture. In re Harwood, 427 B.R. 392 (E.D. Tex. 2010). The district court affirmed the bankruptcy court s determination that an individual who was president and a 50% shareholder of the corporate general partner of a limited partnership owed a fiduciary duty to the