Last week, Texas Governor Greg Abbott signed into law Texas Senate Bill 29, which includes a comprehensive package of amendments to the Texas Business Organizations Code aimed at reinforcing and revitalizing the governance laws for entities incorporated in Texas. This marks the second consecutive session in which the Texas Legislature has passed significant corporate governance reforms, following last session's enactment of legislation creating the specialized Texas Business Court to handle corporate governance and shareholder claims and other high-stakes business disputes in the state. It is a further attempt by Texas to attract corporations considering incorporating or reincorporating in a state with greater predictability of outcome in their corporate law.
SB 29 modernizes the Texas Business Organizations Code by, among other things, codifying fiduciary protections, enabling jury-waiver provisions, and discouraging nuisance litigation. As the new law takes effect, Baker Botts's multidisciplinary board governance and fiduciary duty team stands ready to help Texas-based and Texas-bound companies navigate and seize the advantages of doing business in the Lone Star State.
1. Codification of the Business Judgment Rule
SB 29 codifies the long-standing common law business judgment rule, and increases a plaintiff's burden in bringing and proving a claim where the business judgment rule applies. The rule requires courts to presume officers and directors act in good faith, on an informed basis, in furtherance of a corporation's best interests, and in obedience to the law and the governing documents. Under the new law, a plaintiff asserting that a fiduciary breached its duty must not only rebut one of these presumptions, but importantly must also plead with particularity—and ultimately prove—that the alleged breach "involved fraud, intentional misconduct, an ultra vires act, or a knowing violation of law."
Moreover, while the new law makes clear that fiduciaries may consider other states' laws, judicial decisions, and practices when executing their duties, courts applying Texas law are barred from finding a breach of a duty based on a failure to conform to any other state's laws, decisions, or practices.
In codifying the business judgment rule and clarifying the burden to overcome the rule's presumptions, Texas provides clear statutory guidance to courts, directors, officers, and shareholders, that will foster greater predictability for all. Notably, the new law largely tracks Nevada's NRS 78.138 in this regard.
2. Predetermination of Independent and Disinterested
Directors
In what is perhaps the statute's most novel addition, corporations can receive advanced judicial blessing for the special committees that will review and consider approval of transactions involving controlling shareholders, directors, or officers, before the committee undertakes that review. A common challenge to board action is that the directors had an interest in the transaction or were not independent of another interested party, such as management or a controlling shareholder. The amendment provides a statutory process for courts to preapprove the disinterested and independent nature of a committee, providing increased assurance that the directors' decisions will be respected (particularly when paired with the new statutory business judgment rule).
The committees can be standing board committees formed before any transaction is even contemplated, or committees formed to review individual transactions. Once the committee is formed, the corporation would file a petition asking the Texas Business Court to determine that committee's independence and disinterestedness, and provide notice to its shareholders. After selecting counsel to represent shareholder interests, the court will promptly hold an evidentiary hearing and issue a ruling. This finding is dispositive absent new evidence. Absent good cause, the court must provide its decision within 75 days of the corporation's petition—ensuring an expedited review process to avoid delays. Thus the corporation can begin the process of considering a transaction with a controlling shareholder, officer, and director with assurance that the Texas Business Court agrees with the reviewing committee's composition, leading to much greater predictability of the corporation's ability to close that transaction, and reducing the risk of lengthy and costly litigation.
3. Targeted Limitations on Derivative Actions
SB 29 limits costly and distracting opportunistic shareholder derivative suits through a multipronged approach.
First, corporations may adopt a minimum ownership threshold—up to 3 percent of outstanding common shares—as a prerequisite to bringing a derivative action. The statute permits groups of shareholders to band together to meet this threshold. But for any corporation that adopts this requirement, no derivative action may even be asserted unless that threshold interest in the corporation's equity deems it appropriate to do so. This prevents opportunistic plaintiffs holding de minimis shares in a company from bringing suit over corporate governance matters.
Second, the bill bars fee awards in "disclosure only" settlements of derivative litigation. Supplemental proxy language is not a sufficient "substantial benefit" to justify an award of fees, "regardless of materiality." This removes what has historically been a significant motivation for lawyer-driven derivative litigation, and will likely result in fewer such claims asserted if the corporation is incorporated in Texas.
Third, a common tactic of the plaintiff's bar is to make books-and-records demands as a pretext for pre-petition fishing expedition to support a potential lawsuit. SB 29 now codifies that such demands are improper if the demand is in connection with a derivative proceeding (whether active or pending or expected to be instituted by the shareholder) or a civil lawsuit in which the shareholder and the company are on opposite sides. This may close off the ability for litigants to use books-and-records demands as a back-door discovery tool during or in anticipation of litigation.
4. Jury-Trial Waivers and Venue Selection in Governing
Documents
Directly addressing a common refrain by Delaware proponents that Texas derivative and other internal corporate claims carry the risk of jury trials (whereas Delaware does not), the new law authorizes Texas corporations to add to their governing documents a waiver of jury trials for these corporate claims. It also explicitly allows those governing documents to include venue-selection provisions that designate a Texas court—such as the Texas Business Court—as the exclusive venue for such claims. Corporations that choose to include both provisions can require that such disputes be heard in bench trials before Texas Business Court judges with considerable knowledge of and experience in the state's corporate law.
5. Narrowing of Books-and-Records Demands
SB 29 clarifies that emails, text messages, and similar electronic communications are outside the scope of a shareholder books-and-records request unless the particular communication effectuated a corporate act. This is in response to concerns over shareholders in other states previously using the statutory books-and-records demand process to access wide swaths of communications, resulting in intrusive and burdensome discovery outside the scope of any litigation. Moreover, as discussed above, SB 29 narrows the risk that demands will be used as a back-door discovery tool during or in anticipation of litigation. The requirement that a shareholder making a books-and-records demand must hold five percent of all outstanding shares in a corporation or have held shares for at least six months before a request remains in effect.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
