Texas Seeks to “Seize the Moment” by Enacting Major Changes to Business Organizations Code
On May 14, Texas Governor Greg Abbott signed Senate Bill 29 (“S.B. 29”), which amends the Texas Business Organizations Code (“TBOC”) as part of the Texas legislature’s broader initiative to modernize the state’s corporate laws and attract businesses to the state. This follows, and in many ways complements, legislation in 2023 establishing the Texas Business Court to focus on, and accelerate the development of, Texas business law. S.B. 29 codifies the business judgment rule; provides a framework for navigating transactions involving a controlling shareholder; allows corporations to prospectively waive jury trials for internal entity claims and set ownership thresholds for shareholder actions; and allows alternative entities to eliminate fiduciary duties in their governing documents. While the amendments impact both public and private entities, the legislature was particularly focused on publicly traded corporations organized under Texas law (and those that are considering reincorporating in the state). The following provides a brief overview of noteworthy changes.
Entities can designate the Texas Business Court as the exclusive forum for internal-entity disputes. S.B. 29 adds a new provision to TBOC § 2.115, which previously allowed an entity to include a provision in its governing documents requiring a Texas forum for “internal entity claims” (defined as claims of any nature based on, arising from, or related to the internal affairs of the entity). Entities are now expressly permitted to designate a specific Texas court as the exclusive forum and venue for such claims, subject to state and federal jurisdictional requirements. (TBOC § 2.115(b)(2).) Although this could apply to any court, the legislature was clearly focused on the Texas Business Court, which some companies have already designated as the exclusive forum for internal claims.
Entities may waive jury trials in governing documents. The bill creates TBOC § 2.116, which allows an entity to include a provision in its governing documents that prospectively waives jury trials for internal entity claims. Any person that asserts an internal entity claim is deemed to have knowledge of the waiver by acquiring or holding an equity security after the time the waiver was incorporated (or by voting for or affirmatively ratifying the governing document including the waiver). This addresses one of the perceived disadvantages of the Texas Business Court vis-à-vis the Delaware Court of Chancery, which does not hold jury trials. We anticipate there will be constitutional challenges to this amendment, and it also raises legal questions regarding the intersection of contract law and corporate governance. These issues are beyond the scope of this update, but we expect the courts will have an opportunity to weigh-in before long.
Corporate books and records do not include emails. S.B. 29 narrows the types of records that a shareholder can obtain in a demand for books and records under TBOC § 21.218(b). It now states that “records of the corporation shall not include e-mails, text messages or similar electronic communications, or information from social media accounts” unless such information “effectuates an action by the corporation.” Similar language was added to provisions governing default access rights for members of a limited liability company (TBOC § 101.502(a)) and partners in a limited partnership (TBOC § 153.552(a)). In March, Delaware amended its General Corporation Law to specify the types of documents that can be demanded under 8 Del. C. § 220.
No proper purpose for books and records demand related to litigation. The amendments also provide a mechanism to object to a books and records demand made in connection with litigation. Newly added TBOC § 21.218(b-2) applies to corporations with securities listed on a national exchange or those that opt into the framework. It states that a shareholder demand “shall not be for a proper purpose if the corporation reasonably determines that the demand is in connection with” either (1) an active or pending derivative proceeding “that is or is expected to be instituted or maintained” or (2) an active or pending civil lawsuit to which the corporation and the shareholder “are or are expected to be adversarial named parties.”
Codification of the business judgment rule. For publicly traded corporations and corporations that voluntarily opt into the statutory framework, S.B. 29 provides a statutory version of the business judgment rule at TBOC § 21.419(c) — i.e., that in carrying out the business of the corporation, directors and officers are presumed to act (1) in good faith; (2) on an informed basis; (3) in furtherance of the interests of the corporation; and (4) in obedience to the law and the corporation’s governing documents. When applicable, the statute shields directors and officers from liability to the corporation and shareholders unless a claimant can rebut one of the four business-judgment presumptions, and prove a breach of duty, and prove (with particularized allegations) that the breach involved fraud, intentional misconduct, an ultra vires act, or a knowing violation of law. Although largely consistent with Texas common law, the codification of business judgment presumptions reinforces the significant deference afforded to directors and officers under Texas law.
S.B. 29 also adopts provisions extending similar statutory business judgment protections for managerial officials in limited liability companies (TBOC § 101.256) and limited partnerships (TBOC § 153.163).
Ownership thresholds for shareholder actions. One of the most consequential amendments pertains to shareholder derivative proceedings. Under the new TBOC § 21.552(a)(3), publicly traded corporations (and opt-ins with at least 500 shareholders) can include a provision in their governing documents imposing an ownership threshold for shareholders to institute derivative proceedings. The threshold cannot exceed 3% of outstanding shares.
S.B. 29 also adds new procedures corporations may invoke after receiving a derivative demand. The nuts and bolts of the process under TBOC § 21.554 remain the same. Upon receiving a derivative demand, the corporation’s path forward must be determined by majority vote of one of the following groups: (1) all independent and disinterested directors; (2) a committee of one or more independent and disinterested directors; or (3) a panel of independent and disinterested individuals appointed by the court. This group may request that a derivative action be stayed pending investigation and dismissed if the group determines in good faith that proceeding with litigation would not be in the best interests of the corporation. If the group was properly constituted, that decision is accorded significant deference. Consequently, shareholders seeking to sue derivatively often challenge the independence and disinterestedness of the individuals designated as decision-makers.
The amendments allow a corporation to preemptively obtain a determination on the independence and disinterestedness of directors tasked with evaluating a shareholder demand. A corporation invokes the process by filing a petition, which triggers a 45-day deadline for the court to hold an evidentiary hearing and a 75-day deadline for the court to make a determination. The court’s finding is dispositive in the absence of facts that were not presented to the court.
No attorneys’ fees for supplemental disclosures, regardless of materiality. The amendments limit the ability of shareholders to recover attorneys’ fees under the corporate-benefits doctrine. TBOC § 21.561 provides that a derivative plaintiff can seek attorneys’ fees if the court finds that initiating a legal proceeding conferred a substantial benefit on the corporation, even if the lawsuit was mooted by corporate action. This circumstance often arises in merger litigation. Shareholders may file a lawsuit alleging that the company’s proxy disclosures were inadequate and potentially seek an injunction to prevent the transaction from moving forward. Rather than spend money litigating, companies will often supplement their disclosures to moot the claims and pay a modest settlement to the objecting shareholder. This has become so common that merger “mootness fees” are sometimes referred to as a deal tax.
In recent years, the Delaware Court of Chancery has tightened standards on “disclosure only settlements,” and in such cases will only award fees where supplemental disclosures are “plainly material” to investors. S.B. 29 goes a step further. Newly added TBOC § 21.561(c) states that “a substantial benefit to the corporation does not include additional or amended disclosures made to the shareholders, regardless of materiality,” thereby eliminating the ability of shareholders to recover attorneys’ fees for disclosure-only settlements.
Option to eliminate fiduciary duties in alternative entity governing documents. Under Texas common law, partners owe default fiduciary duties to other partners and the partnership. Historically, Texas law allowed partners to modify the scope of those default fiduciary duties in the partnership agreement but prohibited eliminating these duties entirely. The amendments do away with this prohibition. Under TBOC § 152.002(e), a limited partnership agreement may now entirely eliminate the partners’ duties of loyalty and care, and the obligation of good faith. S.B. 29 also clarifies that under TBOC § 101.401, a limited liability company agreement may eliminate any duties, including fiduciary duties, that a member, manager, or officer owes to the company or a member or manager of the company.
Special committee procedures for transactions involving controlling shareholders, directors, and officers. Several of the amendments address interested-party transactions, adding protections additional to those in the safe-harbor for interested director and officer transactions under TBOC § 21.418. Under that section, transactions between a corporation and an interested director or officer are deemed valid if certain conditions are satisfied, including (1) approval by a majority of disinterested directors on the board or a board committee; (2) approval by shareholders; or (3) fairness to the corporation. For publicly traded corporations, the amendments add subsection (f), which provides that even if those conditions are not satisfied, interested directors and officers are still entitled to the protections described in TBOC § 21.419 (the statutory business judgment rule, described above).
The amendments also address the hot-button issue of controlling-shareholder transactions. TBOC § 21.416 now endorses the use of a special committee to review and approve transactions involving the corporation or any of its subsidiaries and a controlling shareholder, director, or officer. Further, newly added TBOC § 21.4161 provides a four-step process for a corporation to obtain a court ruling that special committee members are sufficiently independent and disinterested to consider a particular transaction:
- First, the corporation must file a petition designating legal counsel to act on behalf of the corporation and its shareholders. The petition must be filed in the Texas Business Court unless the corporation’s principal place of business is outside one of the court’s operating divisions.
- Second, the corporation must provide notice to shareholders that they have a right to participate in the proceedings (which can be accomplished through an SEC filing).
- Third, at least 10 days after this notice, the court must hold a preliminary hearing to appoint legal counsel to represent the corporation. Counsel for other shareholders may appear at this hearing and object to the corporation’s proposed counsel.
- Fourth, once counsel is appointed, the court must “promptly” hold an evidentiary hearing to determine whether committee members are independent and disinterested with respect to the transactions. The court’s determination is dispositive absent additional facts that were not presented to the court.
At this point, there is no way to know how effective this process will be in practice. For example, transacting entities under tight timing constraints may be reluctant to expose themselves to the possibility of judicial delay. Will the Texas Business Court adopt procedures to expedite a determination when necessary? If corporations move forward with a transaction without invoking this process, will it have an impact on a subsequent shareholder challenge to a committee’s independence and disinterestedness? Will concerns about confidentiality limit the use of this process? Special committees are often formed to assess a potential transaction before the transaction is publicly disclosed, and companies may be reluctant to use a pre-approval process that requires disclosure of sensitive non-public information before they are ready to go public with a deal. Once we see the process in action, we’ll have a better sense as to how effective it is likely to be.
Conclusion
When introducing S.B. 29, the bill’s sponsor described it as an effort to “seize this moment” by taking “a bold step toward making Texas the corporate law capital of America.” This is unlikely to be the last measure Texas takes in furtherance of that goal, and it may not even be the last such measure during this legislative session. Earlier this month, the House passed H.B. 40, which seeks to expand the Texas Business Court, both geographically and jurisdictionally. We will likely see additional developments as the Texas Business Court grows and continues to build a body of caselaw interpreting Texas law on key issues of corporate governance. We will be watching closely as the state’s business-law evolution continues.
This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.
