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By Shain A. Khoshbin - - October 12, 2010
Question: If an irresistible force meets an immovable object, what is the result?
Answer: Mandamus. (Actually, there arguably is no such thing as an irresistible force or immovable object.)
The “irresistible force”: A minority shareholder is suing a majority shareholder for allegedly purloining company funds for his personal benefit. The minority shareholder seeks to discover the majority shareholder’s tax returns, and adduce evidence of the alleged mischief.
The “immovable object”: The majority shareholder refuses to produce his tax returns, despite the Texas trial court’s order to do so.
In In re Croft, 2010 Tex. App. LEXIS 7778 (Tex. App. - - Houston [14th Dist.] Sept. 22, 2010, no writ as of 10/12/10) (orig. proceeding) (per curiam) (memo op.), the Houston 14th District Court of Appeals addressed just such a situation.
THE RECENT CROFT CASE
The Croft case involved Preston Croft, Craig Corbell and Croft Production Systems, Inc. ("CPS"). CPS designs, installs, and leases dehydration and dew-point reducing equipment in the oil and gas industry. Although both were owners in CPS, apparently Mr. Corbell was a minority shareholder - - and Mr. Croft was a majority shareholder.
Mr. Corbell, individually and on behalf of CPS, sued Mr. Croft for breach of fiduciary duty, breach of contract, fraud, and minority shareholder oppression. Mr. Corbell alleged that Mr. Croft was improperly using CPS for his personal benefit, and was allocating his personal debt to CPS. In addition, Mr. Corbell alleged CPS's debt increased as a result of Mr. Croft's personal expenditures.
During discovery in the lawsuit, Mr. Corbell sought Mr. Croft's tax returns and other financial documents. Mr. Croft refused to produce the documents, objecting to the discovery requests as overly broad and irrelevant. The trial court ordered Mr. Croft to produce tax returns for certain years and certain financial documents based on Mr. Corbell's allegations of fraud, misapplication of corporate money and misuse of corporate assets (including conversion of corporate assets and money to personal use).
Mr. Croft sought mandamus relief from the trial court’s order, which was considered by the Houston 14th District Court of Appeals. The Court of Appeals concluded that the trial court abused its discretion by ordering Mr. Croft to produce his tax returns, and conditionally granted the petition for writ of mandamus (in part) to direct the trial court to set aside those portions of its discovery orders that compelled Mr. Croft to produce his tax returns.
SHAREHOLDER OPPRESSION IN TEXAS GENERALLY
In Texas, “there is no set standard for determining whether shareholder oppression has occurred.” Gage v. Rosenbaum (In re Rosenbaum), 2010 Bankr. LEXIS 1509 *19 (Bankr. E.D. Tex. May 7, 2010) (memo op.) and Four Seasons Equip., Inc. v. White (In re White), 429 B.R. 201, 213 (Bankr. S.D. Tex. 2010) (both citing Davis v. Sheerin, 754 S.W.2d 375, 382 (Tex. App. - - Houston [1st Dist.] 1988, writ denied)). A court considering a Texas minority shareholder oppression claim must examine the facts as a whole, and determine whether the alleged wrongful conduct has deprived the minority shareholder of the shareholder’s reasonable expectations as an equity holder of the corporation. See, e.g., Davis v. Sheerin, 754 S.W.2d 375, 382-83 (Tex. App. - - Houston [1st Dist.] 1988, writ denied).
For example, Texas courts have found "oppressive conduct" to include:
1. A majority shareholders' conduct which substantially defeats the minority shareholder's expectations that, when objectively viewed, were both reasonable under the circumstances and central to the minority shareholder's decision to join the venture; or
2. “Burdensome, harsh, or wrongful conduct; a lack of probity and fair dealing in the company's affairs to the prejudice of some members; or a visible departure from the standards of fair dealing and a violation of fair play on which each shareholder is entitled to rely.”
Bulacher v. Enowa, L.L.C., 2010 U.S. Dist. LEXIS 27784 *4 (N.D. Tex. Mar. 23, 2010) (memo op.) (citing Willis v. Bydalek, 997 S.W.2d 798, 801 (Tex. App. - - Houston [1st Dist.] 1999, pet. denied) (citing Davis v. Sheerin, 754 S.W.2d 375, 381-82 (Tex. App. - - Houston [1st Dist.] 1988, writ denied)).
DISCOVERY OF TAX RETURNS IN TEXAS GENERALLY
"Income tax returns are discoverable to the extent they are relevant and material to the issues presented in the lawsuit." Hall v. Lawlis, 907 S.W.2d 493, 494 (Tex. 1995) (orig. proceeding) (per curiam). Nonetheless, the Texas Supreme Court has expressed a "'reluctance to allow uncontrolled and unnecessary discovery of federal income tax returns.'" Hall, 907 S.W.2d at 494 (quoting Sears, Roebuck & Co. v. Ramirez, 824 S.W.2d 558, 559 (Tex. 1992) (orig. proceeding) (per curiam)). The Texas Supreme Court has explained:
Subjecting federal income tax returns of our citizens to discovery is sustainable only because the pursuit of justice between the litigants outweighs protection of their privacy. But sacrifices of the latter should be kept to the minimum, and this requires scrupulous limitation of discovery to information furthering justice between the parties which, in turn, can only be information of relevancy and materiality to the matters in controversy.
In re Croft, 2010 Tex. App. LEXIS 7778 *4 (quoting Maresca v. Marks, 362 S.W.2d 299, 301 (Tex. 1962) (orig. proceeding)). Therefore, a trial court abuses its discretion by ordering production of tax returns without a showing of relevance in the case. Id. at *6 (citing Hall, 907 S.W.2d at 494).
ANALYSIS IN THE CROFT CASE
The Court of Appeals in Croft recognized that Mandamus is an extraordinary remedy, where the moving party (or “relator”) must show: (1) the trial court clearly abused its discretion, and (2) he has no adequate remedy by appeal. In re Croft, 2010 Tex. App. LEXIS 7778 *3 (citing In re Laibe Corp., 307 S.W.3d 314, 316 (Tex. 2010) (orig. proceeding) (per curiam)). It also delineated Texas law regarding the need for relevancy in discovery:
Discovery is limited to matters relevant to the case. Texaco, Inc. v. Sanderson, 898 S.W.2d 813, 814 (Tex. 1995) (orig. proceeding) (per curiam). A party's requests must show a reasonable expectation of obtaining information that will aid in the resolution of the dispute. In re CSX Corp., 124 S.W.3d 149, 152 (Tex. 2003) (orig. proceeding) (per curiam). Therefore, discovery requests must be reasonably tailored to include only matters relevant to the case. In re Am. Optical Corp., 988 S.W.2d 711, 713 (Tex. 1998) (orig. proceeding) (per curiam). The Texas Supreme Court has repeatedly admonished that discovery may not be used as a fishing expedition. K Mart Corp. v. Sanderson, 937 S.W.2d 429, 431 (Tex. 1996) (orig. proceeding) (per curiam); Dillard Dep't Stores, Inc. v. Hall, 909 S.W.2d 491, 492 (Tex. 1995) (orig. proceeding) (per curiam); Texaco, Inc., 898 S.W.2d at 815. The scope of discovery is generally a matter of trial court discretion. In re CSX Corp., 124 S.W.3d at 152.
Id. at *3-4.
Then, the Croft Court discussed Texas law regarding both discovery of tax returns, as well as other financial records. In cases concerning the production of financial records generally, the Croft Court stated that the burden rests on the party seeking to prevent production. In re Croft, 2010 Tex. App. LEXIS 7778 *5 (citing In re Jacobs, 300 S.W.3d 35, 40 (Tex. App.--Houston [14th Dist.] 2009, orig. proceeding [mand. dism'd]). Once an objection is asserted, however, the Croft Court found that “the party seeking the discovery of income tax returns bears the burden of showing that the returns are relevant and material to the issues in the case.” Id. (citations omitted). It further found that a trial court abuses its discretion by ordering the production of tax returns without such a showing of relevance, and if the relevant information sought can be obtained from a source other than the tax returns. Id. at *5-6 (citations omitted).
According to the Croft opinion, Mr. Corbell was arguing the tax returns were necessary to determine the allocation of assets and liabilities of Mr. Croft and CPS, and the parties' respective ownership interests in CPS. Without explanation, the Croft Court held Mr. Corbell “has not met his burden show that the tax returns are relevant.” Id. at *6. Moreover, rather than establish he could not obtain the information sought from other sources, Mr. Corbell apparently admitted he could obtain the information he wanted in the tax returns from other financial documents. Id. With regard to the other types of financial documents, however, the Croft Court concluded that Mr. Croft had “not met his burden of showing that the remaining financial documents are not relevant to this case.” Id. at *7.
Therefore, although the Court of Appeals granted the mandamus such that Mr. Croft did not have to produce his tax returns, it denied the mandamus to the extent it concerned the other types of financial documents at issue. Id. at *7-8.
CONCLUSION
Sometimes when an irresistible force meets an unmovable object, they need an appellate court’s attention to pave the way for them. This happened in the Croft case involving a minority shareholder oppression claim. With regard to Mr. Croft’s tax returns, the Court of Appeals found that Mr. Corbell did not prove relevancy. However, “reading in between the lines,” it seems the Court really found Mr. Corbell did not need the tax returns to obtain the information he sought - - perhaps especially since he was obtaining the other financial documents being sought.
Nonetheless, it is important to note that shareholder oppression disputes are often fact-intensive cases; and such facts and allegations will bear on the nature and scope of discovery allowed by a Texas court. For example, in the Croft opinion, the Court noted that Mr. Corbell did not base his request for tax returns on his need to establish “net worth” for the purposes of perhaps punitive damages. In re Croft, 2010 Tex. App. LEXIS 7778 *5 n.1. Further, Mr. Corbell apparently did not specifically argue that such tax returns were necessary to establish his damages, or specifically urge to the Court of Appeals why they were relevant to his improper “personal use,” self-dealing or fraud claims against Mr. Croft. When considering such issues, forensic accountants may be able to provide assistance on the need for such tax returns, as well as why the relevant information sought cannot be found in other financial documents.
If you would like a copy of any of the legal opinions discussed in this article, or to discuss the issues raised in further detail, please do not hesitate to Shain Khoshbin at Clouse Dunn Khoshbin LLP.
Shain A. Khoshbin
CLOUSE DUNN KHOSHBIN LLP
1201 Elm Street, Suite 5200, Dallas, Texas 75270-2142
Main: (214) 220-3888 Direct Dial: (214) 239-2749 Mobile: (214) 893-6308 Fax: (214) 220-3833
Direct Email: skhoshbin@cdklawyers.com Website: www.cdklawyers.com/shain.php
THIS ARTICLE IS FOR INFORMATIONAL PURPOSES ONLY. IT DOES NOT, AND IS NOT INTENDED TO, CONSTITUTE LEGAL ADVICE. EACH CASE DEPENDS ON ITS FACTS, AND LAWS SOMETIMES CHANGE OVER TIME. FOR LEGAL ADVICE, CONTACT LEGAL COUNSEL LICENSED IN YOUR STATE.
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