1. law, govt and politics

HOW TO COACH YOUR CLIENT
TO BE LITIGATION SAVVY
University of Houston Law Foundation
May 3-4, 2007 (Dallas) and May 10-11, 2007 (Houston)
By: Ladd A. Hirsch
D I A M O N D M C C A R T H Y , LLP
1201 Elm Street, 34 t h Floor
Dallas, Texas 75270
Ph: (214) 389-5323
E-Mail: [email protected]
Website: www.diamondmccarthy.com
Table of Contents
I.
Page(s)
INTRODUCTION – SCOPE OF ARTICLE ................................................................. 1
II.
RETENTION LETTERS ................................................................................................. 1
A.
Who Is the Client .................................................................................................... 1
B.
Scope of Engagement ............................................................................................. 2
C.
No Guaranty of Success.......................................................................................... 2
D.
Waiver of Conflicts In Multiple Representation..................................................... 2
E.
Fee Retainers........................................................................................................... 3
F.
Resolution of Fee Disputes ..................................................................................... 3
G.
Lawyers Creed ........................................................................................................ 4
III.
INSURANCE AND PERSONAL LIABILITY ISSUES ............................................... 4
A.
Secure Adequate Insurance Coverage .................................................................... 4
B.
The Additional Duty Created By The Stowers Doctrine ........................................ 6
C.
Notice...................................................................................................................... 7
D.
Duty to Defend........................................................................................................ 8
E.
Directors & Officers Liability Policy ..................................................................... 8
IV.
PROTECTING CORPORATE ASSETS/EMPLOYMENT AGREEMENTS ........... 9
A.
Non-disclosure Agreements.................................................................................... 9
B.
Non-solicitation Agreements ................................................................................ 10
C.
Non-compete Agreements .................................................................................... 10
V.
ANTI-FRAUD PROVISION TO INCLUDE IN CONTRACT .................................. 12
A.
Merger and Integration Clauses are not “Anti-Fraud” Provisions........................ 12
1. Sample Merger/Integration Clauses.............................................................. 12
B.
Review of “Anti-Fraud” Provisions...................................................................... 13
1. Supreme Court Decision in Schlumberger and its Progeny.......................... 13
2. Sample Anti-Fraud Provision ....................................................................... 14
VI.
LIMITATIONS ON DAMAGES/REMEDIES ............................................................ 14
A.
Generally............................................................................................................... 14
B.
Allowable Limitations Under the Uniform Commercial Code (“UCC”) ............. 14
1. Applicable UCC Provisions.......................................................................... 14
C.
Liquidated Damages Provisions ........................................................................... 15
1. Liquidated Damages are Enforceable under Texas Law .............................. 15
2. Legal Requirements of Liquidated Damages Provisions.............................. 15
3. Sample Liquidated Damages Provision ........................................................ 15
D.
Other Limitations on Remedies ............................................................................ 16
1. Sample Contract Remedies Limitation Provision......................................... 16
i
VII.
ARBITRATION/MEDIATION..................................................................................... 16
A.
Mediation - Contractual Requirement (or Not) .................................................... 16
1. Mediation Issues ........................................................................................... 17
2. Key Point: Maintain Confidentiality of the Mediation Process.................... 17
B.
Arbitration - Contractual Requirement (or Not) ................................................... 17
1. Litigation v. Arbitration ................................................................................ 17
2. Reasons to Recommend Arbitration ............................................................. 17
3. Reasons to Resist/Avoid Arbitration ............................................................ 18
4. The Arbitration Provision - Points to Consider ............................................ 18
VIII. CORPORATE GOVERNANCE ISSUES –
MINORITY SHAREHOLDER OPPRESSION........................................................... 19
A.
Doctrine of Minority Shareholder Oppression ..................................................... 19
1. Typical Freeze-Out Techniques by Majority Shareholder(s) ....................... 19
B.
Statutory Action .................................................................................................... 19
C.
Breach of Fiduciary Duty...................................................................................... 20
D.
Practical Tips To Avoid A Minority Shareholder Oppression Lawsuit ............... 20
IX.
DOCUMENT RETENTION.......................................................................................... 21
A.
Sarbanes-Oxley Act .............................................................................................. 21
B.
Developing A Document Retention Policy........................................................... 22
C.
Implementation of the Policy................................................................................ 23
D.
Practical Tips ........................................................................................................ 23
APPENDIX A SAMPLE CLAUSES.......................................................................................... i
APPENDIX B TEXAS LAWYERS’ CREED .......................................................................... v
ii
I.
INTRODUCTION – SCOPE OF ARTICLE
Corporate clients want to minimize risk and limit their exposure to claims and litigation
in operating their businesses. Fortunately, there are a number of practical steps that businesses
can take at the time of formation or after they are already operating that will help to avoid or to
reduce their exposure to claims, litigation and/or arbitration proceedings.
Risk arises in many different contexts for business clients. As a result, this article is not
confined to one topic or subject and, instead, provides guidance related to the various types of
risks that businesses are likely to confront. The approach is from a trial lawyer’s perspective, but
with an emphasis on a practical, real world approach to business risks. The objective is to offer
useful tips for outside corporate counsel to consider and address with their clients who must deal
with a wide array of business issues and concerns.
As a starting point, because outside counsel cannot (or should not) provide legal advice to
clients until the attorney has actually been retained, the article begins with a review of issues that
relate to client retention, including: (i) defining the client, (ii) handling multiple representation
situations, (iii) confirming the scope of the engagement and (iv) issues regarding retainers and
fee disputes.
II.
RETENTION LETTERS
A.
Who Is the Client
The first step in the retention process is to promptly determine, and then confirm in
writing, the specific identity of the client (or clients) and the precise scope of the legal services
that counsel has agreed to provide to or for the client.
1.
Confirming the specific identity of the client is essential, e.g., is the client
a corporation or partnership, and if the latter, is it a limited partnership?
Does the scope of the representation include or exclude, subsidiaries,
affiliates, officers, directors, shareholders, general partners and/or limited
partners.
2.
Dual Representation of the Corporate Entity and its Officers is permitted,
but should be confirmed in the engagement letter and the potential for a
future conflict should be addressed
3.
Applicable rules: Tex. Disciplinary R. Prof. Conduct 1.05, 1.06, 1.12
4.
Generally, a lawyer representing an entity owes his fiduciary duties solely
to the entity, not its officers. Rule 1.12(a); See also David J. Beck, The
Legal Profession at the Crossroads: Who Will Write the Future Rules
Governing the Conduct of Lawyers Representing Public Corporations, 34
St. Mary’s L.J. 873, 878 (2003) (attorneys representing corporations
1
should always be aware they represent the entity itself, and not any of the
individuals through which the corporation acts).
5.
B.
The Conflict Rule 1.06(b): a lawyer may not represent a person if the
representation of the person: (1) involves a substantially related matter in
which the person’s interests are materially and directly adverse to the
interests of another client of the lawyer or of the lawyer’s firm; or
(2) reasonably appears to be or become adversely limited by the lawyer’s
or law firm’s responsibilities to another client or to a third person or by the
lawyer’s or law firm’s own interests.
Scope of Engagement
The nature and scope of the lawyer’s engagement should be set forth in the retention
letter to avoid any misunderstanding during the representation, as well as after the representation
concludes. For example, representation a client in a business acquisition does not necessarily
including advising the client regarding the tax implications of the acquisition. Similarly, the
representation of a client at trial does not necessarily include the representation of the client in
any appellate proceedings.
C.
No Guaranty of Success
Attorneys should never guarantee the expected results of the legal representation. On the
contrary, attorneys should advise the client that there is no guaranty of success. Attorneys may
want to advise clients that they will offer opinions based on the facts available and based on their
understanding of the applicable law, but acknowledge that these are only opinions, and should
not be taken as guarantees of any particular outcome or recovery.
D.
Waiver of Conflicts In Multiple Representation
1.
A client can waive a conflict described in Rule 1.06(b)
2.
Rule 1.06(c) allows counsel to provide dual representation of multiple
clients if: (1) the lawyer reasonably believes that the representation of
each client will not be materially affected; and (2) each affected or
potentially affected client consents to the dual representation after full
disclosure of the existence, nature, implications, and possible adverse
consequences of the common representation and the advantages that are
involved, if any.
3.
All waivers (consents) must be in writing and signed by all parties.
2
E.
F.
Fee Retainers
1.
Fee Retainers v. Advances - Non-refundable fee retainers are distinct from
client advances that are remitted to pay for future legal services. A true
fee retainer “is not a payment for services. It is an advance fee to secure a
lawyer’s services, and remunerate him for loss of the opportunity to accept
other employment.” Tex. Comm. On Prof’l Ethics. Op. 431, Tex. B.J.
1084 (1986). If a fee is not paid to secure the lawyer’s availability and to
compensate him/her for lost opportunities, then it is a prepayment for
services and not a true retainer. “A fee is not earned simply because it is
designated as non-refundable.” Id.
2.
Trust Account Deposits - Money that constitutes the prepayment of a fee
belongs to the client until the services are rendered and must be held in a
trust account. Tex. Disciplinary R. Prof’l Conduct. 1.14 cmt. 2.
3.
Practice Points: (a) A retainer that is not excessive, which clearly states it
is to secure the lawyer’s availability and compensate for lost opportunities
is earned by the lawyer upon receipt and may be immediately deposited in
the lawyer’s operating account, (b) if the fee is paid as an advance, it is
refundable and must be placed in a trust account, (c) upon termination of
representation, the lawyer shall take steps to extent reasonably practicable
to protect a client’s interests, including promptly refunding any advance
payments not earned. See Cluck v. Commission for Lawyer Discipline,
No. 03-05-00033-CV, (Tex. App. – Austin, February 19, 2007)
Resolution of Fee Disputes
1.
Some retention letters require any disputes related to the legal services that
counsel provided under the contract be subject to arbitration. Arbitration
agreements in attorney-client contracts have been upheld by Texas courts.
See Porter & Clemens v. Stone, 935 S.W.2d 217, 220-22 (Tex.App. –
Houston [1st Dist.] 1996, no writ).
2.
Mandatory arbitration provisions are generally valid, but attorneys should
advise their clients to seek independent legal counsel before entering into
this type of agreement. See In re Godt, 28 S.W.3d 732 (Tex.App. – Corpus
Christi 2000, orig. proceeding)(citing Tex.R.Prof.Cond. 1.08(g): “A
lawyer shall not make an agreement prospectively limiting the lawyer’s
liability to a client for malpractice unless permitted by law and the client is
independently represented in making the agreement...”). Id. at 739, n. 7.
3
3.
Sample Arbitration Clause
All disputes and controversies between the Client and the Attorney which
arise out of this fee agreement or the Attorney’s representation of the
Client shall be submitted to binding arbitration under the following
procedure: (a) any party may demand arbitration of a claim in writing in
which the party lists the name of its designated party-arbitrator and
describes the claim or issue in controversy; (b) within 15 days of receiving
such a demand, the other party shall name its own arbitrator; or upon the
party’s default or failure to designate an arbitrator, the American
Arbitration Association (“AAA”) shall appoint a second party arbitrator;
(c) the two arbitrators shall name a third arbitrator, or if they fail to agree
or do so within 15 days, a 3rd arbitrator shall be appointed by the AAA;
(d) each party shall bear its own arbitration fees and costs; (e) the
arbitration shall be conducted at a place and in the manner designated by
the arbitrators and according to the rules of the AAA and the Texas Rules
of Evidence; (f) the arbitration hearing shall be held within sixty (60) days
after the demand is filed and an award rendered with fifteen (15) days
after close of evidence submission, unless the arbitrators order otherwise;
(g) an award made by the majority of the arbitrators shall be final and
binding on the parties and judgment on such award may be entered in a
court of competent jurisdiction; (h) the parties stipulate that these
provisions shall be a defense to any suit or proceeding instituted in any
court or before any administrative tribunal with respect to any controversy
or dispute relating to this agreement.
G.
Lawyers Creed
It is required that the attorney either enclose a copy of or transcribe the entire Texas
Lawyers Creed as part of the Retention Letter. The Creed sets forth the duty of an attorney to act
in a professional manner in all of his/her dealings with the legal system, his clients, other lawyers
and judges. It mandates that an attorney’s conduct must go above and beyond compliance with
all laws and rules, in order to preserve and improve our legal system. A copy of the Creed is
attached to these materials.
III.
INSURANCE AND PERSONAL LIABILITY ISSUES
A.
Secure Adequate Insurance Coverage
The existence of adequate insurance coverage in an important consideration for the
corporate client to provide funds that will pay for the defense of lawsuits and indemnity against
any judgments. In addition, the company needs to consider securing insurance that will protect
its directors and officers against personal liability for their conduct within the scope of their
duties. There are a variety of different insurance policies available to companies that provide a
4
defense to and indemnity from claims and judgments. CGL – comprehensive general liability
insurance policies and errors and omissions policies for officers and directors are two common
forms of insurance that a corporation should consider securing to protect its assets, and to attract
and maintain qualified managers and directors.
1.
Liability Insurance
Under standard general liability insurance policies, an insurer has the duty to defend the
insured for losses that are covered by the policy. In addition, the insurance carrier also agrees to
indemnify the insured against losses suffered by the insured up to the specified limits of the
policy. Typically, the insurer’s duty to defend is triggered when the insured provides notice of a
claim made against the insured. The insurer then decides whether it owes a duty to defend.
“An insurer’s duty to defend is determined by the allegations in the pleadings and the
language of the insurance policy.” National Union Fire Ins. Co. v. Merchants Fast Motor Lines,
Inc., 939 S.W.2d 139, 141 (Tex. 1997). Texas follows this “eight corners” rule to determine
whether allegations in a petition or complaint state a cause of action against the insured which
falls within the coverage of a liability insurance policy. See id. “If a petition does not allege
facts within the scope of coverage, an insurer is not legally required to defend a suit against the
insured.” Id. “It is not the cause of action alleged that determines coverage but the facts giving
rise to the alleged actionable conduct.” Id. (quoting Adamo v. State Farm Lloyds Co., 853
S.W.2d 673, 676 (Tex. App.–Houston [14th Dist.], writ denied)) (emphasis in original).
“In addition, so long as the complaint alleges at least one cause of action within the
policy coverage, the insurer must defend.” Brooks, Tarlton, Gilbert, Douglas & Kressler v.
United States Fire Ins. Co., 832 F.2d 1358, 1367 (5th Cir. 1987). “[T]he responsibility for
defending is an ongoing one; therefore ‘[a] complaint which does not initially state a cause of
action under the policy, and so does not create a duty to defend, may be amended so as to give
rise to such a duty.’” Id. (quoting Rhodes v. Chicago Ins. Co., 719 F.2d 116, 119 (5th Cir.
1983)). Therefore, it is generally advisable to give notice to one’s insurer at the earliest time that
allegations made against the insured “potentially state a cause of action within the terms of the
policy . . .” Id. (emphasis in original).
2.
Director and Officer Insurance
Director and officer (“D&O”) insurance policies protect directors and officers from
financial exposure to claims against them personally, which allows a corporation to attract highlevel personnel for these positions. Many D&O policies also provide coverage for the company
based on the actions of the directors and officers. See Christopher W. Martin, Director and
Officer Insurance, 41-APR Hous. Law. 38, 39 March/April, 2004. Unlike general commercial
liability policies, D&O policies typically do not obligate the insurer to defend a lawsuit that is
brought against the corporation. See id. at 41. Instead, it is the insured’s responsibility to retain
counsel to defend the insured. See id. Most D&O policies provide for reimbursement of the
insured’s defense costs, so long as the insured obtains the insurer’s consent before hiring defense
counsel. See id.
5
B.
The Additional Duty Created By The Stowers Doctrine
Companies need to keep the Stowers doctrine in mind after the insurer assumes the
defense of a covered claim against the company. The Stowers doctrine provides the company
with a potential claim for negligence against an insurer that fails to settle a claim within policy
limits, and thereby exposes the company to an excess judgment. Under the Stowers Doctrine, an
insurer “is held to that degree of care and which a man of ordinary care and prudence would
exercise in the management of his own business.” G. A. Stowers Furniture Co. v. American
Indemnity Co., 15 S.W.2d 544, 548 (Tex. Comm’n App. 1929, holding approved). This duty
arises from an insurer’s obligations to defend and indemnify its insured pursuant to the insurance
contract, which grants the insurer control over the insured’s defense. See American Physicians
Ins. Exch. V. Garcia, 876 S.W.2d 842, 846 (Tex. 1994).
Policyholders may secure coverage that exceeds the limits of the policy if the insurer
unreasonably refuses to settle a claim for an amount within policy limits. See G.A. Stowers
Furniture Co. v. Am. Indem. Co., 15 S.W.2d 544, 544-46 (Comm’n App. 1929, holding
approved). Under the Stowers doctrine, the insurer has a common law duty to exercise
reasonable care in responding to a settlement demand within policy limits.
The controlling issue in a lawsuit against the insurer under Stowers Doctrine is whether
there was “negligence on the part of the [insurer] in failing or refusing to make settlement” at the
insured’s request. Id. If the insurer is held to be negligent, then the primary carrier must pay the
amount of the judgment regardless of whether it exceeds policy limits.
The Texas Supreme Court in Am. Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842 (Tex.
1994) clarified that the Stowers duty is activated when a third party seeking to impose liability
on an insured makes a demand to settle the claims and the following circumstances exist: (1) the
claim against the insured is within the scope of the policy’s coverage; (2) the settlement demand
is within the policy limits or a stated sum of money within the policy’s limits; (3) the proposed
settlement is one that will result in a full release of the insured; and (4) the terms of the
settlement demand are such that an ordinarily prudent insurer would accept it, considering the
likelihood and degree of the insured’s potential exposure to an excess judgment. Id. at 848-849.
The Stowers duty is not activated unless three conditions are met: (1) the claim against
the insured is within the scope of coverage of the policy, (2) the amount of the demand made by
the claimant falls within the limits of the policy, and (3) the terms of the demand are such that an
ordinarily prudent insurer would accept it, considering the likelihood and degree of the insured’s
potential exposure to an excess judgment.
“Generally, a Stowers settlement demand must propose to release the insured fully in
exchange for a stated sum of money, but may substitute ‘the policy limits’ for a sum certain.” Id.
“A demand above policy limits, even though reasonable, does not trigger the Stowers duty to
settle. Id.
6
C.
Notice
Insurance policies have different notice requirements depending on the term of the
policy. In a “claims-made” policy, the insured’s issuance of notice to the carrier triggers the
coverage afforded by the policy, while in an “occurrence” policy, an event or occurrence that
takes place during the policy triggers coverage. See Singleentry.com Inc. v. St. Paul Fire &
Marine Ins. Co., 117 Fed. Appx. 933, 936 (5th Cir. 2004). Most general liability policies are
written on an “occurrence” basis, while most professional liability polices (e.g. lawyer,
accountant, D&O, etc.) are written on a “claims-based” policy.
In an “occurrence” policy, the notice issued by the insured provides the insurer with an
awareness of the claim or lawsuit that has been filed, and the carrier is then expected to tender a
defense of the claim or lawsuit. See Harwell v. State Farm Mut. Auto. Ins. Co., 896 S.W.2d 170,
173 (Tex. 1993). Until notice is given, the insurer’s duty to defend the claim and indemnify the
insured against any loss is not triggered. By contrast, in a “claims-based” policy, the very act
triggers coverage. Singleentry.com, Inc., 117 Fed. Appx. at 936. “Claims-based” policies may
allow for “notice of circumstances” that later give rise to a claim.
As a general rule, notice is one area of insurance law where the policy’s requirements are
strictly construed in favor of the insurance carrier. Id. In 1973, however, the Texas State Board
of Insurance issued an amendatory endorsement applicable to all general liability policies. This
endorsement requires that insurers must demonstrate prejudice based on late notice when the
coverage is for bodily injury and property damage. See Coastal Refining & Marketing, Inc. v.
U.S. Fidelity and Guar. Co., --- S.W.3d ----, 2007 WL 707465, *3-4 (Tex. App.—Houston [14
Dist.] 2007, no pet.). Thus, even if the notice is untimely, if the insurer cannot show that it was
prejudiced by the delay, it cannot refuse to cover (pay) the claim. Id.; Travelers Indem. Co. of
Conn. v. Presbyterian Healthcare Resources, 2004 WL 389090 (N.D. Tex. 2004), and St. Paul
Guardian Ins. v. Centrum G.S. Ltd.,383 F.Supp.2d 891 (N.D. Tex., 2003).
In 2005, however, Dallas Court of Appeals declared that the prejudice standard applies
only to insurance policies that provide coverage for bodily injury and property damages, and the
Court refused to extend the prejudice standard to other types of claims against insurance carriers.
See PAJ v. The Hanover Ins. Co., 170 S.W.3d 258, 263 (Tex. App.—Dallas 2005, pet. granted).
In reaching its decision in PAJ, the Dallas Court of Appeals distinguished the Texas Supreme
Court decision in Hernandez v Gulf Group Lloyds, 875 S.W.2d 691 (Tex. 1994).
In Hernandez, the Supreme Court declared that an insurer cannot refuse coverage under
the policy’s “settlement-without-consent” exclusion only when the insurer could establish that it
was actually prejudiced by the insured’s settlement, notwithstanding the type of claim involved
in the lawsuit. The PAJ Court reasoned that Hernandez was irrelevant because it dealt with
application of prejudice standard to the exclusion in the policy, and not to a condition precedent.
The Dallas Court’s decision in PAJ is on appeal to the Texas Supreme Court, which will
decide whether an insurer is required to show that it was prejudiced by the late notice in all cases
and not just in cases seeking recovery for bodily injury and property damages.
7
D.
Duty to Defend
Texas courts apply the “eight corners rule” to determine whether an insurer has a duty to
defend its insured. Nat’l Union Fire Ins. Co. v. Merchants Fast Motor Lines, Inc., 939 S.W.2d
139, 141 (Tex. 1997). Under this rule, courts must compare plaintiff’s claims to the insurance
policy to determine whether the claim is covered under the policy. Cullen/Frost bank of Dallas,
N.A. v. Commonwealth Lloyd’s Ins. Co., 852 S.W.2d 252, 255 (Tex. App.—Dallas 1993, writ
denied). Courts must assume that allegations are true in making this determination and,
generally, extrinsic evidence cannot be considered. See Heyden Newport Chem Co. v. S. Gen.
Ins. Co., 387 S.W.2d 22, 24 (Tex. 1965); Nat’l Union Fire Ins. Co. of Pittsburgh, PA v.
Merchants Fast Motor Lines, Inc., 939 S.W.2d 139, 141 (Tex. 1997). Any doubt as to whether
the petition sets forth a covered cause of action must be resolved in the insured’s favor. See
Harken Exploration Co. v. Sphere Drake Ins., 261 F.3d 466, 471 (5th Cir. 2001).
If an insurer has a duty to defend against any of the claims that are alleged in a petition, it
is required to defend against all of the claims in the petition. See Huffines v. State Farm Lloyds,
167 S.W.3d 493, 497 (Tex. App.—Houston [14th Dist.] 2005, n.p.h.). After receiving notice of a
lawsuit, the insurer will either provide an “unqualified” defense or it will issue a reservation of
rights letter. If the insurer assumes an unqualified defense, it agrees to defend the lawsuit and
forego any defenses or exceptions to coverage. In contrast, when the insurer issues a letter by
which it reserves its rights, it is notifying the insured that a defense will be provided while the
insurer investigates whether the claim is covered. See J.E.M. v. Fidelity & Cas. Co., 928 S.W.2d
668, 673 (Tex. App.—Houston [1st Dist.] 1996, no writ).
The cost of defending lawsuits typically deplete the limits of coverage in a “claims-made
policy.” Where the defense costs are subtracted from the total policy limit, this type of a policy is
referred to as a “wasting policy.”
E.
Directors & Officers Liability Policy
A typical D&O policy indemnifies (1) directors and officers – for the wrongful acts for
which they have not been indemnified by their company – “Side A” coverage; (2) the
corporation – for its indemnification of directors and officers – “Side B” coverage; and (3) the
corporation – for direct liability of the entity itself – “Side C” coverage.
As a general rule, D&O policies do not provide coverage for fraudulent actions, ill-gotten
personal benefits, damages covered under general liability policies, ERISA and pollution
liability.
Virtually all of D&O policies are written on a “claims made” basis where the claim is
defined as any demand for money. Under these policies, coverage exists only for claims made
during the policy period or arising after the end of the policy period from “circumstances” of
which the insurer was properly notified during the period. Often, D&O policies will require not
only the assertion of a claim but also notice to be provided of the claim during the policy period.
8
Most D&O policies require the insured to provide the carrier with notice of claims or of
circumstances of claims to the insurer as soon as practicable – within a reasonable time – during
the policy period. The insured’s failure to provide notice of a claim “as soon as practicable” to
insurer may constitute a failure to comply with an explicit condition precedent and bar the
insured from recovery under the D&O policy. To be adequate, a “circumstances” notice under
D&O policy, must specify the alleged wrongful acts of officers and directors rather than make
generalized allegations of wrongdoing or adverse information. See FDIC v. Booth, 82 F.3d 670,
677-78 (5th Cir. 1996).
D&O policies are usually written as indemnity or reimbursement policies and they do no
impose a “duty to defend” on the insurer. Thus, the insured selects its own defense counsel,
subject to insurer’s consent. Reimbursement of costs is included, rather than in addition to, the
policy’s limits of liability and, usually, “defense expenses” include the reasonable costs of
attorneys’ fees incurred in defending a claim. To minimize any conflicts between the insured
and the insurer, the insurer should consider entering into a defense agreement establishing the
basis upon which the claim will be defended.
IV.
PROTECTING CORPORATE ASSETS/EMPLOYMENT AGREEMENTS
Businesses should take proactive measures to protect their confidential and proprietary
information. These steps include labeling the information as confidential and educating
employees regarding the need to protect against disclosure of such information to third parties
outside the company. Companies should also take reasonable steps to maintain the
confidentiality of their trade secrets, including preventing general access to trade secrets and
disclosing trade secrets only to those employees who need to know the information to perform
their job functions.
In addition, companies should consider entering into employment agreements with senior
level employees and those employees who are given access to company trade secrets and other
confidential information. Though there is no one size fits all solution or contract provision to
prevent former employees from harming the company, the following contractual provisions may
help curtail some post-employment competitive activities: (1) non-disclosure agreements; (2)
non-solicitation agreements; and (3) non-competition agreements.
A.
Non-disclosure Agreements
In a non-disclosure agreement, an employee promises not to disclose or use company
trade secrets and confidential information except as allowed by the employer. Non- disclosure
agreements can bolster protection of company information because they protect confidential
information that, unlike trade secrets, may not be otherwise protected by the common law. In
addition, non-disclosure agreements are widely enforced and may give the company an argument
for recovery of attorneys’ fees for disclosure of company trade secrets. See M. Scott McDonald,
Noncompete Contracts: Understanding the Cost of Unpredictability, 10 Tex. Wesleyan L. Rev.
137, 149 (2003).
9
B.
Non-solicitation Agreements
A non-solicitation agreement provides that a former employee will not solicit the
company’s customers for a limited period of time. As with non-compete contracts, Texas courts
tend to view non-solicitation clauses as restraints on trade. See, e.g, Peat Marwick Main & Co.
v. Haass, 818 S.W.2d 381, 385-388 (Tex. 1991); Stone v. Griffin Communications and Sec. Sys.,
Inc., 53 S.W.3d 687, 694 (Tex. App.–Tyler 2001, no pet.). Courts will, however, generally
enforce these provisions if they are narrowly tailored to protect existing customer relationships.
C.
Non-compete Agreements
Non-compete agreements are governed by the Texas Business and Commerce Code. See
TEX. BUS. & COMM. CODE ANN. §§ 15.50-15.52 (Vernon 2002). “[A] covenant not to compete is
enforceable if it is ancillary to or part of an otherwise enforceable agreement at the time the
agreement is made to the extent that it contains limitations as to time, geographical area, and
scope of activity to be restrained that are reasonable and do not impose a greater restraint than is
necessary to protect the goodwill or other business interest of the promisee.” Id. at § 15.50(a).
The Texas Supreme Court’s recent decision in Sheshunoff v. Johnson, 209 S.W.3d 644
(Tex. 2006) may alter the business practices of employers who include non-compete covenants
in their employment agreements. Previously, the Court had held in 1994 that a covenant not to
compete was unenforceable unless it was ancillary to an otherwise enforceable agreement
between the employer and the employee. See Light v. Centel Cellular Co. of Texas, 883 S.W.2d
642, 647 (Tex. 1994). In Light, the Court held that the consideration provided by the employer
had to have some nexus to the employee’s promise not to compete.
(1) the consideration given by the employer in the otherwise enforceable
agreement must give rise to the employer’s interest in restraining the employee
from competing; and
(2) the covenant must be designed to enforce the employee’s consideration or
return promise in the otherwise enforceable agreement.
The Court explained in a footnote that if an employer provided trade secrets and/or confidential
or proprietary information to the employee in exchange for his/her promise not to disclose them,
the employee’s agreement not to compete after his employment ended would be ancillary to an
otherwise enforceable agreement. To sustain a non-compete covenant, therefore, the employer
had to show that the employee was actually given access to the confidential information and/or
training or education regarding the use of the trade secrets or confidential information. In Light,
the employer’s promise to provide the employee with specialized future training was deemed
illusory because the employer could fire the employee and thus escape the obligation to perform.
The situation that the Supreme Court then considered in Sheshunoff was one in which the
employer had actually provided the specialized training it had promised to give the employee in
10
the employment agreement. In this circumstance, a unilateral contract is created under which the
employee becomes bound to honor the agreement that he/she had made to the employer not to
compete. In essence, the Court held that the employer’s promise may have been illusory and
unenforceable when it was made, but it became enforceable by the employer’s later actions.
Therefore, under Sheshunoff, an employer who actually provides its employees with
specialized training is entitled to enforce a non-compete covenant after the employee stops
working provided that the non-compete covenant is not unreasonable (over broad). The Court
returned the focus in these cases to the reasonableness of the restrictive covenant, and stated:
For these reasons, we hold that a covenant not to compete
is not unenforceable under the Covenants Not to Compete Act
solely because the employer’s promise is executory when made. If
the agreement becomes enforceable after the agreement is made
because the employer performs his promise under the agreement
and a unilateral contract is formed, the covenant is enforceable if
all other requirements under the Act are met.
...
We also take this opportunity to observe that section
15.50(a) does not ground the enforceability of a covenant not to
compete on the overly technical disputes that our opinion in Light
seems to have engendered over whether a covenant is ancillary to
an otherwise enforceable agreement. Rather, the statute’s core
inquiry is whether the covenant “contains limitations as to
time, geographical area, and scope of activity to be restrained
that are reasonable and do not impose a greater restraint than is
necessary to protect the goodwill or other business interest of the
promise.” TEX. BUS. & COM. CODE. § 15.50(a). Concerns that
have driven disputes over whether a covenant is ancillary to an
otherwise enforceable agreement – such as the amount of
information an employee has received, its importance, its true
degree of confidentiality, and the time period over which it is
received – are better addressed in determining whether and to what
extent a restraint on competition is justified. (fn8) We did not
intend in Light to divert attention from the central focus of section
15.50(a). To the extent our opinion caused such a diversion, we
correct it today.
Id. at 655-56 (emphasis added).
11
V.
ANTI-FRAUD PROVISION TO INCLUDE IN CONTRACT
A.
Merger and Integration Clauses are not “Anti-Fraud” Provisions
A merger clause in a contract confirms that all prior written or oral discussions or
negotiations related to terms of the contract are superseded by (and/or merged into) the final
written contract, which is controlling. A merger clause should preclude a party from relying on
any earlier agreements that were entered into before the final form of the contract at issue. The
merger doctrine is closely related to the parole evidence rule, because the rule excludes evidence
at trial of prior agreements. See, e.g., Hubacek v. Ennis State Bank, 317 S.W.2d 30, 32
(Tex.1958); Weinacht v. Phillips Coal Co., 673 S.W.2d 677, 679 (Tex.App.--Dallas 1984, no
writ). There are exceptions to the exclusion of evidence by the parol evidence rule, of course,
most specifically in fraud cases. See, e.g., Dallas Farm Mach. Co. v. Reaves, 307 S.W.2d 233 at
239 (Tex. 1957)(embracing the majority position that parol evidence is admissible to establish
fraud in the inducement even in the face of a “merger” clause in a written contract); Edward
Thompson Co. v. Sawyers, 111 Tex. 374, 234 S.W. 873, 874-75 (1921) (one who is entitled to
avoid a written contract because it was induced by fraud is no longer bound by any of its
stipulations, including those relating to representations or guaranties which induced its
execution); Schlumberger Tech. Corp. v. Swanson, 959 S.W.2d 171, 181 (Tex.1997)
(emphasizing that “a disclaimer of reliance or merger clause will not always bar a fraudulent
inducement claim”).
1.
Sample Merger/Integration Clauses
a.
Sample Clause No. 1
Full Agreement. This Agreement constitutes the entire agreement that exists between
the parties with respect to the subject matter set forth in the Agreement, and it supersedes any
and all previous agreements, understandings, conditions, writings, representations and
statements, whether oral or written, if any, with respect to the subject matter of this Agreement.
The parties further agree that they will not to seek to introduce other writings or parol evidence
to contradict or vary any of the terms of this Agreement.
b.
Sample Clause No. 2
Entire Agreement. This Agreement constitutes the entire agreement between the parties
with respect to the subject matter hereof and supersede all prior and contemporaneous
representations, understandings or agreements, whether oral or written, relating to the subject
matter thereof. All prior or contemporaneous representations, understandings or agreements,
whether oral or written, that are not expressly set forth in this Agreement are hereby deemed
waived, superseded and abandoned.
12
B.
Review of “Anti-Fraud” Provisions
A merger/integration clause does not bar claims for fraud. Specifically, a merger clause
is not a valid defense where one party to the contract alleges that it was fraudulently induced to
enter into the contract based on false statements or promises that were not set forth in the parties’
agreement. In comparison, an anti-fraud provision is designed to bar claims of a party who
claims to have relied on and been defrauded by inducements, promises or other consideration
that are not set forth in the written contract.
1.
Supreme Court Decision in Schlumberger and its Progeny
In 1997, the Texas Supreme Court held that “A release that clearly expresses the parties
intent to waive fraudulent inducement claims, or one that disclaims reliance on representations
about specific matters in dispute, can preclude a claim of fraudulent inducement.” Schlumberger
Technology Corp. v. Swanson, 959 S.W.2d 171, 181 (Tex. 1997). More simply stated, in
Schlumberger, the Court held as a matter of law that a party’s express disclaimer of reliance in
the contract conclusively negated the party’s later claim that it had relied on a promise that was
not contained in the contract.
Since the Schlumberger decision, appellate courts in and outside Texas have emphasized
the Supreme Court’s requirement that there must be a “clear and unequivocal expression of
intent necessary to disclaim reliance on the [ ] specific representations.” See Dunbar Medical
Systems Inc. v. Gammex Inc., 216 F.3d 441 (5th Cir.) Jun 21, 2000) (NO. 99-20274), rehearing
denied (Jun 26, 2000).
Any intent by a party to a contract to disclaim reliance on promises outside the contract
must clearly and unquestionably apply to the alleged promise or inducement. Further, an antifraud provision is not an absolute guaranty against a successful fraud claim. In holding that an
anti-fraud provision did preclude a particular fraud claim, the Schlumberger court noted the
following facts: 1) the parties were attempting to end their relationship, 2) the parties had
become “embroiled in a dispute,” 3) they were dealing at arm’s length, 4) both parties were
represented by highly competent and able legal counsel during the negotiations for the terms of
the release itself, 5) both parties were knowledgeable and sophisticated business players, and 6)
the terms of the release clearly and unequivocally disclaim reliance on the specific
representations at issue.
In the absence of these critical facts, several courts have held that fraud claims did
survive anti-fraud provisions. For instance, in holding that an anti-fraud provision did not bar a
fraud claim, two courts found it significant that the parties were not attempting to end their
relationship by the agreement. See Dunbar at 450 and Woodlands Land Development Co., L.P.
v. Jenkins, 48 S.W.3d 415, 422 (Tex. App.-Beaumont, no pet.). In view of these recent holdings,
an agreement containing an anti-fraud provision should recite compliance with as many of the
Schlumberger factors as possible.
13
2.
Sample Anti-Fraud Provision
No Reliance on Undocumented Statements. Each party to this Agreement expressly
warrants and represents that, in entering into this Agreement, it is not relying on any statements,
representations, promises, consideration, agreements or inducements, whether oral or written,
that are not fully set forth in this Agreement. In this regard, Buyer and Seller acknowledge that
in entering into this Agreement, they are each relying solely and exclusively on the statements
and the provisions that are expressly set forth in this Agreement, and they are not relying on any
statements, representations, promises, consideration, agreements or inducements of any kind,
written or oral, that were made by [include names of parties], by any of their agents or
representatives or by any third parties, which are not fully set forth in this Agreement.
VI.
LIMITATIONS ON DAMAGES/REMEDIES
A.
Generally
Under Texas law, parties are generally permitted to limit or exclude remedies (and
damages) in their contractual agreements. “If parties agree to a contractual remedy, such
agreement will be enforced unless illegal or against public policy.” Great Am. Ins. Co. v. North
Austin Mun. Util. Dist. No. 1, 902 S.W.2d 488, 499 (Tex. App.–Austin 1993) (the proper
measure of damages was the repair or replacement cost as provided in the contract, instead of the
common law measure), aff’d in part, rev’d in part on other grounds, 908 S.W.2d 415 (Tex.
1995); see Global Octanes Texas, L.P. v. BP Exploration & Oil Inc., 154 F.3d 518 (5th Cir. 1998)
(under Texas law, contracting parties can limit liability to a specific amount).
B.
Allowable Limitations Under the Uniform Commercial Code (“UCC”)
1.
Applicable UCC Provisions
Sections 2.718 and 2.719, of the Tex. Bus. & Com. Code (“Liquidation or Limitation of
Damages; Deposits” and “Contractual Modification or Limitation of Remedy”) - 2.719,
Subsection (c) (“Consequential damages may be limited or excluded unless the limitation or
exclusion is unconscionable”)
In contracts that are subject to the UCC, the Code authorizes parties to exclude remedies
and damages that would otherwise be recoverable. See Tex. Bus. & Com. Code § 2.719.
Section 2.719 provides that, subject to the terms of Section 2.718, which deals with the
liquidation and limitation of damages, a contract may provide remedies in addition to or in
substitution of those provided by the UCC and may limit or alter the measure of damages
allowed by the UCC. In addition, Section 2.719 provides that where a remedy is expressly
agreed to be exclusive, it is the sole remedy. See § 2.719(a)(2).
14
C.
Liquidated Damages Provisions
1.
Liquidated Damages are Enforceable under Texas Law
Liquidated damages provisions are not illegal or against Texas public policy. See, e.g.,
Arthur’ Garage, Inc. v. Racal-Chubb Security Sys., Inc., 997 S.W.2d 803, 810 (Tex. App.–Dallas
1999, no pet.) (“[A]n agreement to limit liability will not violate public policy if there is no
disparity of bargaining power between the parties.”).
2.
Legal Requirements of Liquidated Damages Provisions
Liquidated damage clauses are enforceable when: (1) the harm caused by the breach is
either incapable of estimation or difficult to estimate, and (2) the amount of the liquidated
damages is a reasonable forecast of just compensation. See Baker v. Int’l Record Syndicate, Inc.,
812 S.W.2d 53, 55 (Tex. App.—Dallas 1991, no writ); see also Tex. Bus. & Com. Code § 2.718
(liquidated damages clauses allowed where the amount is reasonable under the circumstances).
3.
Sample Liquidated Damages Provision
Liquidated Damages. If Manufacturer fails to meet a scheduled delivery date set forth on
the Delivery Schedule for the Products, then because damages to Customer arising from such
delay would be difficult to ascertain, Manufacturer shall pay to Customer, as liquidated damages
and not as a penalty, a sum equal to one percent (1%) per calendar day of the aggregate price of
the delayed Products continuing until the date such Product(s) are actually delivered to the
Customer (the “Liquidated Damages”). The assessment of liquidated damages shall not begin
until the expiration of a grace period of seven (7) days from the scheduled delivery date on the
Delivery Schedule for any Product. The Manufacturer’s liability under this Section with respect
to any delayed Product shall not exceed fifteen percent (15%) of the price of such delayed
Product.
Liquidated Damages Not a Penalty. The Parties each acknowledge and agree that
because the Products are unique and substitute equipment is not readily available, it is difficult or
impossible to determine with precision the amount of damages that would or might be incurred
by Customer if Manufacturer fails to deliver the Products in accordance with the Delivery
Schedule. It is understood and agreed by the Parties that (i) Customer shall be damaged if
Manufacturer fails to meet such obligations, (ii) it would be impracticable or extremely difficult
to determine the actual damages resulting therefrom, (iii) any sums payable under the previous
Section are in the nature of liquidated damages and not a penalty, and are fair and reasonable,
and (iv) these payments each represent a reasonable estimate by the parties of the fair
compensation to the Customer for the losses that may reasonably be anticipated from such failure
by the Manufacturer and shall without duplication, be the sole and exclusive measure of damages
with respect to any such failure by Manufacturer, without limiting Manufacturer’s obligation to
achieve all such scheduled delivery dates. Once the payment of these liquidated damages has
been made or the limits set forth in this Article 3 have been reached, the Manufacturer shall be
15
relieved of any and all further liability or any damages of any kind resulting from the failure to
meet the Delivery Schedule.
D.
Other Limitations on Remedies
As noted above, Texas courts will uphold and enforce the parties’ negotiated decision to
impose express contractual limitations on the damages or other relief that may be recoverable by
either of them in the event of a material breach. This is especially true when the parties are of
roughly equal bargaining strength and are both represented by legal counsel.
It should be noted that efforts to disclaim or waive liability under certain statutes, such as
the Texas Deceptive Trade Practices Act, which protects consumers, requires strict compliance
with the stringent requirements of that Act. See Tex. Bus. & Com. Code § 17.42 (“DTPA”).
Under the DTPA, for example, any purported waiver by the consumer is void and unenforceable
as against public policy unless the consumer is represented by legal counsel.
1.
Sample Contract Remedies Limitation Provision
Limitation of Recoverable Damages. EXCEPT AS EXPRESSLY SET FORTH IN
THIS AGREEMENT, IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE OTHER
PARTY FOR SPECIAL, EXEMPLARY, INDIRECT, COVER, INCIDENTAL OR
CONSEQUENTIAL DAMAGES, OR THE LOSS OF ANY PROFITS OR REVENUES, AND
EACH PARTY HEREBY RELEASES THE OTHER FROM ANY AND ALL SUCH
LIABILITY BASED ON ANY CLAIMS THAT ARE BASED ON, RELATE TO, OR ARE IN
ANY WAY CONNECTED WITH THIS AGREEMENT OR ANY OF THE PARTIES’
DUTIES OR OBLIGATIONS ARISING UNDER OR RELATED TO THIS AGREEMENT.
The foregoing limitations shall not (i) preclude recovery, where applicable, of liquidated
damages in the amounts provided for in Section ___ or of the cancellation fee or (ii) be construed
to limit any recovery that would otherwise be available under any indemnity that is provided for
in Article __ of this Agreement.
VII.
ARBITRATION/MEDIATION
A.
Mediation - Contractual Requirement (or Not)
Mediation is a non-binding settlement process that maintains confidentiality, which can
take place before and/or after formal legal proceedings have been filed. Most Texas courts, both
state and federal, require the parties to participate in mediation at some point before trial.
This decision as to whether to include a mediation requirement in a contract depends on
factors that will include: (a) the anticipated nature of the dispute, (b) the desire to avoid litigation
in a public forum, and (c) the business relationship of the parties.
16
1.
2.
B.
Mediation Issues
a.
Issue No. 1:
How quickly should mediation take place
b.
Issue No. 2:
How is the mediator selected
Key Point: Maintain Confidentiality of the Mediation Process
Arbitration - Contractual Requirement (or Not)
Arbitration results in a binding, final decision, i.e., the result is not appealable and may be
enforced by any court in the jurisdiction. In most cases, an arbitration proceeding is quicker, less
costly and far less burdensome than litigation, because discovery is far more limited. In addition,
the process is conducted in private by a third party company,1 and it therefore permits the parties
to maintain the confidentiality of the issues in dispute and, potentially, the final result, as well.
1.
Litigation v. Arbitration
OPINION: Arbitration tends to favor the Defendant/Respondent
2.
a.
Arbitrators are usually lawyers who are more conservative than
juries, follow the literal contract, and are not equitably motivated.
b.
Lack of discovery is often harmful to the Claimant, who cannot
obtain documents and secure the witness testimony necessary to
make its case effectively to the arbitrators.
c.
Arbitration reduces the risk of punitive damage awards; lawyers
are not as willing to punish and are uncomfortable in that role.
Reasons to Recommend Arbitration
a.
Client cannot afford to conduct litigation - client’s time and other
resources are strictly limited.
b.
Client needs confidentiality or privacy of business affairs - public
battle would be harmful to company image or business concerns
warrant the need for privacy.
1
Th e mo s t pro min en t arb itr a tion f irms tod a y are th e A me r ic an Arb itr ation A sso c iation
( “AAA ”) and th e Jud icial Med iation and Arb itration Serv ice ( “JA MS”), bu t th ere ar e o th er
emer g ing f ir ms av ailab le, as well, th at prov id e arb itr ation and me d iat ion serv ices. Th e AAA
and JAMS each ma intain web sites, e.g., adr.org and j a ms adr.co m, wh ich con tain their
a pp lic ab le pro cedu re s and o th er u s efu l in for ma tion and fo rms .
17
c.
3.
4.
Client is concerned about personal injuries and/or the potential for
an award for punitive damages.
Reasons to Resist/Avoid Arbitration
a.
Client is likely to be the claimant and will be attempting to prove a
claim for fraud or a business tort such as tortious interference.
b.
The other party is concerned about potential for adverse publicity
associated with a lawsuit and related discovery; the more public
courthouse forum provides leverage to the client.
c.
The other party to the contract has limited funds and cannot afford
to commit the time and expense associated with a lawsuit.
The Arbitration Provision - Points to Consider
a.
b.
Scope of the matters to be arbitrated
i.
Not all matters must be subject to arbitration; for example,
intellectual property disputes may be excluded
ii.
Preserve right to obtain injunctive relief in court (or not)
Consider specific discovery to be authorized
i.
ii.
Documents, depositions and expert reports - tailored
provision
Default provision - include a reference to procedures for
large, complex disputes
c.
Specialized rules exist for construction, patent, and securities
cases; specific reference to these may be appropriate
d.
Punitive damages may be excluded by contract
e.
Location of arbitration hearing - insist on home court for hearing
f.
Choice of law - require home cooking
g.
Number of arbitrators
i.
ii.
iii.
Each side picking one arbitrator is wasteful
Panel of at least three is generally recommended
Manner of selection of arbitrators
18
(1)
(2)
(3)
Arbitrators should all be neutral, no party arbitrators
Parties should be permitted to select their own, and
AAA panel members are included by default
Arbitrators do not have to be lawyers, and there are
certain characteristics that may be advisable
h.
Specify legal fees - prevailing party as defined
i.
Include entry of judgment language
VIII. CORPORATE GOVERNANCE ISSUES –
MINORITY SHAREHOLDER OPPRESSION
A.
Doctrine of Minority Shareholder Oppression
The doctrine of minority shareholder oppression protects minority shareholders in a
closely held company from the improper exercise of control by the majority shareholder(s). The
majority shareholders control the company’s board of directors, and they therefore have the
ability to act in ways that are harmful to the minority shareholder’s economic interests. These
techniques are commonly referred to as a “freeze-out” or “squeeze-out” that causes “oppression”
of the minority shareholder in the closely held company.
1.
Typical Freeze-Out Techniques by Majority Shareholder(s)
a.
b.
c.
d.
B.
Terminating the minority shareholder’s employment;
Refusing to declare any dividends;
Removing minority shareholder from management; and
Funneling corporate earnings through high compensation to the
majority shareholder(s) that are not received by the minority
shareholder.
Statutory Action
The Texas Business Corporation Act provides for the appointment of a receiver and the
possibility of liquidation when aggrieved minority shareholders are able to establish particular
grounds, including “illegal, oppressive, or fraudulent” conduct by “directors or those in control.”
Tex. Bus. Corp. Act Articles 7.05 and 7.06.
The Texas Supreme Court has not applied the minority shareholder oppression doctrine
in recent decisions, but the appellate courts have remained active in this area. In Davis v.
Sheerin, the court of appeals in Houston attempted to give some meaning to the definition of
“oppressive conduct” by citing the following definitions:
1.
[O]ppression should be deemed to arise only when the majority’s conduct
substantially defeats the expectations that objectively viewed were both
19
reasonable under the circumstances and were central to the minority
shareholder’s decision to join the venture.
2.
[Oppressive conduct refers to] burdensome, harsh and wrongful conduct, a
lack of probity and fair dealing in the affairs of a company to the prejudice
of some of its members, or a visible departure from the standards of fair
dealing and a violation of fair play on which every shareholder who
entrusts his money to a company is entitled to rely.
See 754 S.W.2d 375, 380 (Tex. App.-- Houston [1st Dist.] 1988, writ denied).
C.
Breach of Fiduciary Duty
Texas case law has also upheld challenges by minority shareholders who claim
oppressive conduct that is in breach of the majority shareholders’ fiduciary duties. The Supreme
Court did hold almost 50 years ago that a majority shareholder’s failure to declare dividends
constituted fraud and abuse of his controlling position. See Patton v. Nicholas, 279 S.W.2d
849 (Tex. 1955). The Court affirmed the jury’s verdict and noted that “the malicious
suppression of dividends is a wrong akin to breach of trust, for which the courts will afford a
remedy.” In Patton, the court issued an injunction requiring the corporation to pay a reasonable
dividend “at the earliest practical date,” as well as in future years. Id. at 849.
More recently, the court of appeals in Fort Worth in Duncan v. Lichtenberger, 671
S.W.2d 948, 950 (Tex. App.--Fort Worth 1984, writ ref’d n.r.e.) held that two minority
shareholders who never received compensation as officers or dividends as shareholder were
entitled to recover damages. In so doing the Court observed that “[t]he breach of a fiduciary duty
is the type of wrong for which the courts of this State will afford a remedy.”
D.
Practical Tips To Avoid A Minority Shareholder Oppression Lawsuit
1.
Financial reporting - issuing regular financial reports will put shareholders
on notice of the financial situation of the corporate entity. Should
oppression liability become an issue, the reports are a very effective means
to demonstrate how corporate funds were expended during particular
periods of time.
2.
Corporate Governance Meetings - in a similar way as the financial reports
serve as an explanation of how funds are being spent, regular formal
shareholder meetings serve as a forum to explain what decisions
management is taking and the reasoning behind such actions.
3.
Notices upon taking in investment funds
a.
Buy-sell agreements - A comprehensive buy-sell agreement will
provide shareholders the opportunity to have their stock bought
20
back by the corporation under specific circumstances. Most
important of which is the requirement that the corporation have
cash on hand to purchase the stock. In addition to this, a formula
must be included in the agreement to determine the value of the
stock, whether the shares will be purchased at a discount and the
manner in which payment will be made. Also, if a party wishes to
sell its stock to a third party (non-member) of the company, the
company should have a right of first refusal to purchase those
shares at a discount.
IX.
b.
Dividend Policy- if the company will not be declaring dividends,
management should explain the use of net revenues (if any) so as
to avoid allegations that management is withholding distribution of
profits, thereby oppressing the minority shareholders.
c.
Employment Agreements - Because employment is often a way to
distribute the profits of a close corporation, a majority
shareholder’s decision to terminate the employment of a minority
shareholder may be considered oppressive, even if the minority
shareholder can also be characterized as an at-will employee. Thus,
it may be wise to consider entering into employment contracts with
top corporate executives for a particular term, such that at the end
of the term, the contract may simply not be renewed, avoiding the
threat of minority oppression liability. However, an employment
contract would alter the at-will employment relationship, such that,
in the event of termination there may be breach of contract
allegations unless the reason for termination was one of the clearly
specified circumstances in the contract.
DOCUMENT RETENTION
A.
Sarbanes-Oxley Act
In the wake of the recent corporate scandals that rocked the financial markets, President
Bush signed the Sarbanes-Oxley Act of 2002 (“the Act”)2 on July 30, 2002. In broad terms, the
Act attempts to eliminate accounting fraud and restore investor confidence in the stock market.
In particular, the Act imposes higher penalties on conduct that amounts to obstruction of justice
and mandates new document retention requirements for corporate audit work papers. Although
the Act does not apply to non-public corporations, there is a trend both in public opinion and in
the courts to demand ample disclosure of corporate activities, and maintaining a document
retention policy in the spirit of Sarbanes-Oxley is strongly advised.
2
PL 107-204, Ju ly 30 , 2002, 116 Stat 745, Un ited States Pub lic Law s 107 t h Congress
– Second Session Conv en ing Janu ary 2002 (H.R. 3763)(S. 2673).
21
B.
Developing A Document Retention Policy
1.
The term document retention (or document management) policy refers to
the guidelines that are devised to control the amount of time documents
are retained before they are destroyed or disposed of. In developing a
document retention policy, a company must address a number of issues
before the policy is drafted and implemented. There is no “model policy”
that fits the needs of all businesses, because there are different variables
related to the type of business, the state in which it does business and
differing state and federal laws and regulations applicable to the business.
There are general principles, however, that are useful for a company to
consider in drafting the policy, regardless of the nature of the specific
business.
2.
The premise that must underlie the implementation of a valid document
retention policy is that it will serve reasonable, legitimate business
purposes. In other words, a document retention policy should not be
implemented by a company for the sole purpose of destroying damaging
documents. Instead, the retention policy must have reasonable business
bases such as promoting efficiency, reducing costs and assisting the
business in its day to day operations.
3.
If the policy covers the following elements, and the company monitors and
enforces the policy, the twin goals of retaining all documents essential to
conduct business, and disposing of unnecessary records will be achieved.
a.
b.
c.
d.
e.
Define the types of documents covered, including electronic data
Set the retention period for each document type in compliance with
applicable laws and regulations, including statutes of limitations.3
Design procedures that will require documents to be retained if a
duty arises, e.g., once a lawsuit or government investigation is
threatened.
Establish central registry and depository for retained files.
Develop procedures for document storage and disposition.
4.
Establish guidelines for implementation and enforcement of policy.
5.
Establish audit procedures.
3
For ex a mp le , th e Tex as H e a lth and S af e ty Cod e r equ ir es hos pita ls to ma in ta in
p a tien ts’ me d ica l re cords for a c er tain p er iod o f time . S ee T E X . H E A L T H & S A F E T Y C O D E
§241.103 . Feder a l regu la tions requ ir e cer tain ho spitals to retain med ical r eco rds for at least
f iv e yea rs. S ee 42 C.F.R.§482.24 (1998)
22
6.
Secure regular updates to reflect changes in the law.
C.
Implementation of the Policy
1.
Uniform and Consistent. The company must make someone
specifically responsible for enforcing its document retention policy.
Typically, this is the general counsel, who will, in turn, delegate this
responsibility to others while maintaining the ultimate authority to enforce
the policy. The number of people involved in the enforcement of the
retention policy depends on the company’s size. The main objective,
however, is to ensure that the policy is not ignored in the press of business.
A policy that is not regularly enforced may as well be non-existent.
2.
Training. All employees should be provided a copy of the
document retention policy and periodically receive training on how it
should be applied. A copy of the policy should not be given to an
employee without guidelines on its application. The company should be
alert to any requests for a copy of the policy, because it likely indicates a
problem or issue with the application of the policy.
3.
Audits. If funds permit, a company is well-advised to hire an
outside party to conduct an audit on compliance with its document
retention policy, that results in an audit report. If the company ever
becomes involved in litigation, and its document retention policy is
questioned, these audit reports will help establish that it was a reasonable
policy and consistently enforced for legitimate business purposes. In this
regard, the report should indicate the cost-savings the company achieved
from disposing of unnecessary documents and electronic data.
4.
Threatened Litigation or Foreseeable Investigations. Once a
lawsuit (or any type of government investigation) is filed or threatened
against a company, or becomes reasonably foreseeable, the company
cannot destroy its documents, even if the destruction would otherwise be
called for by an existing document retention policy. Although the
argument can be made that the destruction was inadvertent, the retention
policy must have an established procedure that is designed to preserve
documents once the company is placed on notice that the documents will
be relevant to a threatened lawsuit or investigation.
D.
Practical Tips
Timing is critical as it relates to document retention policies. Therefore, even strict
adherence to a valid retention policy is unlikely to justify a company’s destruction of relevant
records if the destruction took place just before a lawsuit or government investigation was
threatened or filed. In fact, the document destruction may well lead to criminal charges being
23
filed against the company and its officers. The existence of a reasonable document retention
policy that has been consistently followed by the company, however, will substantially bolster
the defense to any claim of improper document destruction. Compliance with the following
steps will go a long way in preventing potential liability for document destruction:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Develop the policy and tailor it to the needs of the business.
Maintain and regularly enforce the policy.
Communicate the policy and train all employees to follow it.
Arrange for regular audits of the policy, with reports.
Designate a specific person in charge of enforcement.
Apply the policy consistently.
Do not remind employees to comply with retention policy, especially on the eve
of an investigation or litigation.
Policy needs to have procedure to stop destruction when claim is threatened,
lawsuit is filed or investigation is announced.
The purpose of the policy should never be to destroy incriminating material.
Update policy to comply with recent changes in the law.
24
APPENDIX A
SAMPLE CLAUSES
APPENDIX A - SAMPLE CLAUSES
i
1.
Sample Merger/Integration Clauses
a.
Sample Clause No. 1
Full Agreement. This Agreement constitutes the entire agreement that exists between
the parties with respect to the subject matter set forth in the Agreement, and it supersedes any
and all previous agreements, understandings, conditions, writings, representations and
statements, whether oral or written, if any, with respect to the subject matter of this Agreement.
The parties further agree that they will not to seek to introduce other writings or parol evidence
to contradict or vary any of the terms of this Agreement.
b.
Sample Clause No. 2
Entire Agreement. This Agreement constitutes the entire agreement between the
parties with respect to the subject matter hereof and supersede all prior and contemporaneous
representations, understandings or agreements, whether oral or written, relating to the subject
matter thereof. All prior or contemporaneous representations, understandings or agreements,
whether oral or written, that are not expressly set forth in this Agreement are hereby deemed
waived, superseded and abandoned.
2.
Sample Anti-Fraud Provision
No Reliance on Undocumented Statements. Each party to this Agreement
expressly warrants and represents that, in entering into this Agreement, it is not relying on any
statements, representations, promises, consideration, agreements or inducements, whether oral or
written, that are not fully set forth in this Agreement. In this regard, Buyer and Seller
acknowledge that in entering into this Agreement, they are each relying solely and exclusively
on the statements and the provisions that are expressly set forth in this Agreement, and they are
not relying on any statements, representations, promises, consideration, agreements or
inducements of any kind, written or oral, that were made by [include names of parties], by any of
their agents or representatives or by any third parties, which are not fully set forth in this
Agreement.
3.
Sample Liquidated Damages Provision
Liquidated Damages. If Manufacturer fails to meet a scheduled delivery date set
forth on the Delivery Schedule for the Products, then because damages to Customer arising from
such delay would be difficult to ascertain, Manufacturer shall pay to Customer, as liquidated
damages and not as a penalty, a sum equal to one percent (1%) per calendar day of the aggregate
price of the delayed Products continuing until the date such Product(s) are actually delivered to
the Customer (the “Liquidated Damages”). The assessment of liquidated damages shall not
begin until the expiration of a grace period of seven (7) days from the scheduled delivery date on
the Delivery Schedule for any Product. The Manufacturer’s liability under this Section with
respect to any delayed Product shall not exceed fifteen percent (15%) of the price of such
delayed Product.
APPENDIX A - SAMPLE CLAUSES
ii
Liquidated Damages Not a Penalty. The Parties each acknowledge and agree
that because the Products are unique and substitute equipment is not readily available, it is
difficult or impossible to determine with precision the amount of damages that would or might
be incurred by Customer if Manufacturer fails to deliver the Products in accordance with the
Delivery Schedule. It is understood and agreed by the Parties that (i) Customer shall be damaged
if Manufacturer fails to meet such obligations, (ii) it would be impracticable or extremely
difficult to determine the actual damages resulting therefrom, (iii) any sums payable under the
previous Section are in the nature of liquidated damages and not a penalty, and are fair and
reasonable, and (iv) these payments each represent a reasonable estimate by the parties of the fair
compensation to the Customer for the losses that may reasonably be anticipated from such failure
by the Manufacturer and shall without duplication, be the sole and exclusive measure of damages
with respect to any such failure by Manufacturer, without limiting Manufacturer’s obligation to
achieve all such scheduled delivery dates. Once the payment of these liquidated damages has
been made or the limits set forth in this Article 3 have been reached, the Manufacturer shall be
relieved of any and all further liability or any damages of any kind resulting from the failure to
meet the Delivery Schedule.
4.
Sample Contract Remedies Limitation Provision
Limitation of Recoverable Damages. EXCEPT AS EXPRESSLY SET FORTH
IN THIS AGREEMENT, IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE
OTHER PARTY FOR SPECIAL, EXEMPLARY, INDIRECT, COVER, INCIDENTAL OR
CONSEQUENTIAL DAMAGES, OR THE LOSS OF ANY PROFITS OR REVENUES, AND
EACH PARTY HEREBY RELEASES THE OTHER FROM ANY AND ALL SUCH
LIABILITY BASED ON ANY CLAIMS THAT ARE BASED ON, RELATE TO, OR ARE IN
ANY WAY CONNECTED WITH THIS AGREEMENT OR ANY OF THE PARTIES’
DUTIES OR OBLIGATIONS ARISING UNDER OR RELATED TO THIS AGREEMENT.
The foregoing limitations shall not (i) preclude recovery, where applicable, of liquidated
damages in the amounts provided for in Section ___ or of the cancellation fee or (ii) be construed
to limit any recovery that would otherwise be available under any indemnity that is provided for
in Article __ of this Agreement.
5.
Sample Arbitration Clause
All disputes and controversies between the Client and Attorney which arise out of this
agreement and Attorney’s representation of Client hereunder shall be submitted to arbitration
pursuant to the following procedure: (a) any party may demand arbitration in writing and
designate the name of their arbitrator and the matter in controversy; (b) the other party shall
within 15 days after such demand, name its arbitrator; or upon default or failure to designate an
arbitrator, the Senior U.S. District Judge of the Northern District of Texas shall appoint a second
arbitrator; (c) the two arbitrators shall name a third arbitrator, or in the failure to agree or do so
within 15 days, a 3rd arbitrator shall be appointed by the Senior U.S. District Judge of the
Northern District of Texas; (d) each party shall bear its own arbitration expenses and costs;
(e) the arbitration shall be held and conducted at a place and in the manner designated by the
APPENDIX A - SAMPLE CLAUSES
iii
arbitrators and according to the rules of the American Arbitration Association and the
evidentiary laws of the State of Texas; (f) the arbitration shall be concluded within 20 days and
an award rendered with 15 days after close of evidence submission, unless the arbitrators order
otherwise; (g) an award by the majority of the arbitrators shall be final and binding on the parties
and judgment on such award may be entered by either party in a court of competent jurisdiction;
(h) the parties stipulate that the provisions hereof shall be a defense to any suit or proceeding
instituted in any court or before any administrative tribunal with respect to any controversy or
dispute arising out of this agreement.
APPENDIX A - SAMPLE CLAUSES
iv
APPENDIX B
TEXAS LAWYERS’ CREED
APPENDIX A - SAMPLE CLAUSES
v
THE TEXAS LAWYER’S CREED — A Mandate for Professionalism
The Texas Supreme Court and the Texas Court of Criminal Appeals adopted this Creed,
with the requirement that lawyers advise their clients of its contents when undertaking
representation.
I am a lawyer; I am entrusted by the People of Texas to preserve and improve our legal system. I am
licensed by the Supreme Court of Texas. I must therefore abide by the Texas Disciplinary Rules of
Professional Conduct, but I know that Professionalism requires more than merely avoiding the violation
of laws and rules. I am committed to this Creed for no other reason that it is right.
I.
OUR LEGAL SYSTEM. A lawyer owes to the administration of justice personal dignity,
integrity, and independence. A lawyer should always adhere to the highest principles of professionalism.
I am passionately proud of my profession. Therefore, “My word is my bond.” I am responsible to assure
that all persons have access to competent representation regardless of wealth or position in life. I commit
myself to an adequate and effective pro bono program. I am obligated to educate my clients, the public,
and other lawyers regarding the spirit and letter of this Creed. I will always be conscious of my duty to
the judicial system.
II.
LAWYER TO CLIENT. A lawyer owes to a client allegiance, learning, skill, and industry. A
lawyer shall employ all appropriate means to protect and advance the Partnership’s legitimate rights,
claims, and objectives. A lawyer shall not be deterred by any real or imagined fear of judicial disfavor or
public unpopularity, nor be influenced by mere self-interest. I will advise my client of the contents of this
Creed when undertaking representation. I will endeavor to achieve my client’s lawful objectives in legal
transactions and in litigation as quickly and economically as possible. I will be loyal and committed to
my client’s lawful objectives, but I will not permit that loyalty and commitment to interfere with my duty
to provide objective and independent advice. I will advise my client that civility and courtesy are
expected and are not a sign of weakness. I will advise my client of proper and expected behavior. I will
treat adverse parties and witnesses with fairness and due consideration. A client has no right to demand
that I abuse anyone or indulge in any offensive conduct. I will advise my client that we will not pursue
conduct which is intended primarily to harass or drain the financial resources of the opposing party. I will
advise my client that we will not pursue tactics which are intended primarily for delay. I will advise my
client that we will not pursue any course of action which is without merit. I will advise my client that I
reserve the right to determine whether to grant accommodations to opposing counsel in all matters that do
not adversely affect my client’s lawful objectives. A client has no right to instruct me to refuse
reasonable requests made by other counsel. I will advise my client regarding the availability of
mediation, arbitration, and other alternative methods of resolving and settling disputes.
III.
LAWYER TO LAWYER. A lawyer owes to opposing counsel, in the conduct of legal
transactions and the pursuit of litigation, courtesy, candor, cooperation, and scrupulous observance of all
agreements and mutual understandings. Ill feelings between clients shall not influence a lawyer’s
conduct, attitude, or demeanor toward opposing counsel. A lawyer shall not engage in unprofessional
conduct in retaliation against other unprofessional conduct. I will be courteous, civil, and prompt in oral
and written communications. I will not quarrel over matters of form or style, but I will concentrate on
matters of substance. I will identify for other counsel or parties all changes I have made in documents
submitted for review. I will attempt to prepare documents which correctly reflect the agreement of the
parties. I will not include provisions which have not been agreed upon or omit provisions which are
necessary to reflect the agreement of the parties. I will notify opposing counsel, and, if appropriate, the
Court or other persons, as soon as practicable, when hearings, depositions, meetings, conferences or
closings are canceled. I will agree to reasonable requests for extensions of time and for waiver of
procedural formalities, provided legitimate objectives of my client will not be adversely affected. I will
APPENDIX A - SAMPLE CLAUSES
vi
not serve motions or pleadings in any manner that unfairly limits another party’s opportunity to respond.
I will attempt to resolve by agreement my objections to matters contained in pleadings and discovery
requests and responses. I can disagree without being disagreeable. I recognize that effective
representation does not require antagonistic or obnoxious behavior. I will neither encourage nor
knowingly permit my client or anyone under my control to do anything which would be unethical or
improper if done by me. I will not, without good cause, attribute bad motives or unethical conduct to
opposing counsel nor bring the profession into disrepute by unfounded accusations of impropriety. I will
avoid disparaging personal remarks or acrimony towards opposing counsel, parties and witnesses. I will
not be influenced by any ill feeling between clients. I will abstain from any allusion to personal
peculiarities or idiosyncrasies of opposing counsel. I will not take advantage, by causing any default or
dismissal to be rendered, when I know the identity of an opposing counsel, without first inquiring about
that counsel’s intention to proceed. I will promptly submit orders to the Court. I will deliver copies to
opposing counsel before or contemporaneously with submission to the court. I will promptly approve the
form of orders which accurately reflect the substance of the rulings of the Court. I will not attempt to
gain an unfair advantage by sending the Court or its staff correspondence or copies of correspondence. I
will not arbitrarily schedule a deposition, Court appearance, or hearing until a good faith effort has been
made to schedule it by agreement. I will readily stipulate to undisputed facts in order to avoid needless
costs or inconvenience for any party. I will refrain from excessive and abusive discovery. I will comply
with all reasonable discovery requests. I will not resist discovery requests which are not objectionable. I
will not make objections nor give instructions to a witness for the purpose of delaying or obstructing the
discovery process. I will encourage witnesses to respond to all deposition questions which are reasonably
understandable. I will neither encourage nor permit my witness to quibble about words where their
meaning is reasonably clear. I will not seek Court intervention to obtain discovery which is clearly
improper and not discoverable. I will not seek sanctions or disqualification unless it is necessary for
protection of my client’s lawful objectives or is fully justified by the circumstances.
IV.
LAWYER AND JUDGE. Lawyers and judges owe each other respect, diligence, candor,
punctuality, and protection against unjust and improper criticism and attack. Lawyers and judges are
equally responsible to protect the dignity and independence of the Court and the profession. I will always
recognize that the position of judge is the symbol of both the judicial system and administration of justice.
I will refrain from conduct that degrades this symbol. I will conduct myself in court in a professional
manner and demonstrate my respect for the Court and the law. I will treat counsel, opposing parties, the
Court, and members of the Court staff with courtesy and civility. I will be punctual. I will not engage in
any conduct which offends the dignity and decorum of proceedings. I will not knowingly misrepresent,
mischaracterize, misquote or miscite facts or authorities to gain an advantage. I will respect the rulings of
the Court. I will give the issues in controversy deliberate, impartial and studied analysis and
consideration. I will be considerate of the time constraints and pressures imposed upon the Court, Court
staff and counsel in efforts to administer justice and resolve disputes.
APPENDIX A - SAMPLE CLAUSES
vii