[Shareholder Oppression Blog] Shareholder Oppression and Rule 408

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Eric Fryar

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Feb 22, 2011, 10:49:26 PM2/22/11

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The ultimate goal of every scheme of shareholder oppression is to eliminate the minority shareholder’s interest. Sometimes the majority shareholder attempts to so diminish the minority shareholder’s interest, income and participation that the minority shareholder simply “withers on the vine” and gives up. The problem with this strategy is that the minority shareholder is still a shareholder, and the majority shareholder will always face the possibility of a lawsuit. Furthermore, if the majority shareholder wants ever to sell the corporation, then he will have to deal with the minority interest sooner or later. Less patient oppressors will use the leverage that their oppressive pattern of conduct gives them to attempt to coerce the minority shareholder to sell at an unfairly low price. In my experience representing minority shareholders, these efforts usually commence immediately after I alert the majority shareholder to the fact that the minority shareholder is now represented by counsel and is asserting his rights as a shareholder—this usually occurs when I send a shareholder’s demand for inspection of corporate records.

Invariably, the communications and attempts to purchase the minority interest come from lawyers representing the majority shareholder and are couched as “settlement offers” seeking to take advantage of the strictures of Rule 408. Texas Rule of Evidence 408 provides as follows:

Evidence of (1) furnishing or offering or promising to furnish or (2) accepting or offering or promising to accept, a valuable consideration in compromising or attempting to compromise a claim which was disputed as to either validity or amount is not admissible to prove liability for or invalidity of the claim or its amount. Evidence of conduct or statements made in compromise negotiations is likewise not admissible. This rule does not require the exclusion of any evidence otherwise discoverable merely because it is presented in the course of compromise negotiations. This rule also does not require exclusion when the evidence is offered for another purpose, such as proving bias or prejudice or interest of a witness or a party, negativing a contention of undue delay, or proving an effort to obstruct a criminal investigation or prosecution.

Federal Rule of Evidence 408 is identical, and most states have essentially the same principle in their rules of evidence. Believing that settlement communications are “privileged” under this rule, counsel for majority shareholders often feel free to make all kinds of threats and to begin negotiations with extremely low-ball offers. I have always believed that this is an extremely fool-hardy approach and strongly counsel majority shareholders that I represent against it. We usually take the position that these threats and unfair offers are themselves acts of oppression dressed up as settlement offers and that the rule does not shield them. We very aggressively seek to inject these oppressive communications into the case.

There is a very strong public policy in favor of encouraging settlement, and this is the policy that underlies Rule 408. However, there is an equally strong public policy in favor of enforcing fiduciary duties. Therefore, when the defendant owes the plaintiff fiduciary duties, courts will set aside a settlement procured in breach of fiduciary duties, notwithstanding the public policy in favor of the finality of settlements. See Voskamp v. Arnoldy, 749 S.W.2d 113 (Tex. App.—Houston [1^st Dist.] 1987, writ denied); see also Johnson v. Peckham, 120 S.W.2d 786 (Tex. 1938). This situation is particularly acute in a minority shareholder oppression context. The classic oppression scenario is that “the majority first denies the minority shareholder any return and then proposes to buy the shares at a very low price.” Robert H. Thompson, The Shareholder’s Cause of Action for Oppression, 48 Bus. Law. 699, 703-04 (1993). The attempt to force the sale of shares for less than fair value is itself an act of oppression. See Nochlas v. Patton, 279 S.W.2d 848, 852 (Tex. 1955) (noting the majority shareholder’s suggestion that “he would not buy the stock of [the minority] for even a small fraction of its value”); Davis v. Sheerin, 754 S.W.2d 375, 383 (Tex. App.—Houston [1st Dist.] 1988, writ denied) (noting that prior attempts to purchase minority shareholder’s stock were evidence of majority shareholder’s “desire to gain total control of the corporation”). If such oppressive conduct were shielded from disclosure to the jury by the rules of evidence, then majority shareholders would have the ability to act oppressively with impunity. Fortunately, that is not the law.

Rule 408 provides an important exception: “This rule also does not require exclusion when the evidence is offered for another purpose, such as proving bias or prejudice or interest of a witness or a party, negativing a contention of undue delay, or proving an effort to obstruct a criminal investigation or prosecution.” Proof of oppressive conduct is such “another purpose.” As one court has noted: “Rule 408 is also inapplicable when the claim is based upon some wrong that was committed in the course of the settlement discussions; e.g. libel, assault, breach of contract, unfair labor practice, and the like.” Avary v. Bank of Am., N.A., 72 S.W.3d 779, 803 n.4 (Tex. App.--Dallas 2002, pet. denied) (quoting 23 Charles Alan Wright & Kenneth W. Graham, Jr., Federal Practice and Procedure § 5314 (1980)). In Avary v. Bank of America, the Dallas Court of Appeal held that neither Rule 408 nor the statute providing for the confidentiality of mediation communications would preclude a plaintiff from introducing evidence of settlement communications to prove that an executor had committed a breach of fiduciary duties during the course of settlement negotiations in a court-ordered mediation. Id. at 799. Similarly, Texas courts have long recognized that Rule 408 does not protect settlement communications by insurance companies that demonstrate their bad faith settlement practices. See State Farm Mut. Auto. Ins. Co. v. Wilborn, 835 S.W.2d 260, 261 (Tex. App.—Houston [14^th Dist.] 1992, orig. proceeding); Allstate Ins. Co. v. Evins, 894 S.W.2d 847, 849 (Tex. App.—Corpus Christi 1995, orig. proceeding); In re Foremost Ins. Co., 966 S.W.2d 770, 772 (Tex. App.—Corpus Christi 1998, orig. proceeding). Other jurisdictions have applied the rule in the same way. See C.J. Duffey Paper Co. v. Reger, 588 N.W.2d 519, 525 (Minn. Ct. App. 1999) (holding that Rule 408 did not preclude admission of a settlement letter used to prove that a corporate officer had acted in bad faith); Brademas v. Real Estate Dev. Co., 175 Ind. App. 239, 242, 370 N.E.2d 997, 999 (Ind. Ct. App. 1977) (holding that the rule “is not applicable to those situations where the offers of compromise are allegedly oppressive”).