Texas’s new ‘Delaware-inspired’ business laws aim to make the state more attractive for incorporation, particularly for public companies.
Governor Abbott recently signed Senate Bill 29 (S.B. 29) implementing corporation-friendly changes to the Texas Business Organizations Code (“TBOC”). Effective immediately, these new laws codify business judgment rule, provide protections against derivative suits, and limit shareholder inspection rights:
Codifying the Business Judgment Rule
S.B. 29 codifies the business judgment rule, a doctrine that originated under Delaware law and has long been recognized in Texas courts under ‘common law’ but not in TBOC.
The business judgment rule is a rebuttable presumption that corporate directors and officers act in good faith, with due care, and in the company’s best interests when making decisions. To overcome such presumption, plaintiffs must prove a breach of fiduciary duty involving intentional misconduct, fraud, a knowing violation of law, or ultra vires acts. The rule aims to prevent courts from substituting their judgment for that of business professionals, recognizing that business decisions often involve uncertainty and risk.
S.B. 29 codifies the business judgment rule into TBOC, applying it automatically to Texas-formed publicly traded corporations, LLCs, and limited partnerships. The rule will also apply to any other entities that ‘opt in’ via their governing documents.
Shareholder’s Rights to Initiate Derivative Suits
A derivative proceeding is a suit brought by a shareholder on behalf of the corporation against the corporation’s directors or officers. Such suits are often brought to address alleged fraud, misconduct, or breach of fiduciary duties. Under TBOC § 21.552(a), to have standing to bring a derivative suit in Texas, a shareholder must:
- be a shareholder of the corporation at the time of the act or omission complained of; and
- fairly and adequately represent the interest of the corporation.
After S.B. 29, (i) public corporations or (ii) corporations that have elected to be governed by the codified business judgment rule and have 500 may now also set a minimum ownership threshold of up to 3% to initiate a derivative suit.
Who should be concerned about this new derivative suit requirement? Importantly, this threshold can only be applied to certain types of shareholders.
Does not apply to most small, closely-held corporations.
As stated above, the derivative limit can only apply to shareholders of (i) public corporations, or (ii) corporations that have elected to be governed by the codified business judgment rule and have 500 or more shareholders. If a corporation does not have common shares listed on a national securities exchange, or has less than 500 shareholders, it cannot have an ownership threshold requirement even if it opts into the new business judgment rule. Thus, the rights of shareholders of closely-held corporations to initiate derivative proceedings remain mostly unchanged.
A threshold only applies if it is in the corporation’s governing documents.
If the corporation with more than 500 shareholders has elected to use the new business judgment rule, the derivative threshold still only applies if stated in the corporation’s articles or bylaws.
If a shareholder is subject to a ownership threshold, they may collaborate with other shareholders to meet it.
Even if the threshold applies, shareholders may ‘band together’ to meet it. S.B. 29 amends TBOC § 21.551(2)(C) to state that a “shareholder” may include two or more shareholders acting in concert under an informal or formal agreement or understanding with respect to a derivative proceeding. This means if a shareholder is subject to an ownership threshold, they can work with other shareholders to overcome the ownership requirement in order to initiate a derivative proceeding.
Overall, the rights of shareholders of smaller, closely-held corporations remain virtually unchanged pertaining to the requirements to initiate a derivative proceeding.
Inspection Rights
S.B. 29 also drastically changes shareholders’ rights to inspect a corporation’s books and records. TBOC § 21.218 governs shareholder inspection rights. Shareholders who (i) have owned shares for at least six months or (ii) own at least 5% of outstanding shares may request to review the books and records of a corporation if it is for a proper purpose. Previously, such books and records could broadly include anything “reasonably related” to the proper purpose and “appropriate to examine.”
S.B. 29 now explicitly excludes the following from inspection unless such records “effectuate an action by the corporation”:
- e-mails;
- text messages or similar electronic communications; and
- information from social media accounts.
S.B. 29 further limits shareholder inspection rights if there is a pending derivative suit. A demand to inspect records will be deemed not for a proper purpose if the demand is in connection with:
- an active or pending derivative proceeding that is or is expected to be instituted or maintained by the shareholder or the shareholder’s affiliate; or
- an active or pending civil lawsuit to which the corporation, or its affiliate, and the holder, or the holder’s affiliate, are or are expected to be adversarial named parties.
Thus, a shareholder of a Texas corporation cannot exercise their inspection rights if they are a party in a derivative or civil suit against the corporation. They must instead obtain the records through discovery.
Are you starting a new business and want to implement S.B. 29 protections in your governing documents? Or are you a shareholder concerned about your rights under S.B. 29? Please reach out to our firm to discuss these new changes and how we can assist.
