Commercial Litigation Note: The Derivative Lawsuit Demand in Texas

Stock CertificatesWhether you are playing offense or defense in a commercial dispute, it is always wise to take note of any pre-suit demand requirement. Plaintiffs will want to know if they need to send a written demand before suit, and if so, how long they will have to wait before filing suit. Defendants, on the other hand, will want to scrutinize the demand (both the timing and the content) to see if the plaintiffs have complied with their requirements. The pre-suit demand becomes especially important in the case of a derivative shareholder action, when a plaintiff, suing in a representative capacity, asserts rights belonging to the company because the officers and directors refuse to act.

Currently, Chapter 21 of the Texas Business Organizations Code (“TBOC”) governs for-profit corporations, and Sections 21.551 – 21.563 address derivative proceedings. Generally speaking, “a shareholder may not institute a derivative proceeding until the 91st day after the date a written demand is filed with the corporation stating with particularity the act, omission, or other matter that is the subject of the claim or challenge and requesting that the corporation take suitable action.” See TBOC § 21.553. This waiting period is not required if:

  1. the shareholder has been previously notified that the demand has been rejected by the corporation;
  2. the corporation is suffering irreparable injury; or
  3. irreparable injury to the corporation would result by waiting for the expiration of the 90-day period.

See TBOC §21.553(b).

Much could be written about the default demand rule set forth in TBOC §21.553, but the primary purpose of this note is to highlight a major exception the 90-day waiting period: The “closely held corporation” exception. For the purposes of a derivative action, a closely held company means a corporation that has:

  1. fewer than 35 shareholders; and
  2. no shares listed on a national securities exchange or regularly quoted in an over-the-counter market by one or more members of a national securities association.

See TBOC §21.563(a). Under the current statutory scheme, corporations that meet this definition do not need to comply with the demand requirement contained in TBOC §21.553. Basically, the Texas legislature has decided that shareholders in smaller corporations won’t have to make such a formal demand to management before taking their derivative action to the courthouse. Whether this is good news or bad news will certainly depend on your perspective, but this exception to the 90-day waiting period is worth noting by practitioners and parties alike.

 

George B. Ward and the attorneys at De Leon & Washburn, P.C. are available to assist clients with business disputes and complex commercial litigation. For more information regarding the firm’s practice areas, please visit our Commercial Litigation page, and feel free to contact the attorneys at any time.

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