California Appellate Court Holds Persons Who Associate With Persons With Disabilities Can Have Batson Challenges Exercised on Their Behalf

Previously, such as here, I have written about how Batson/Edmonson challenges could be used with respect to people with disabilities not being allowed to serve on juries. The interesting thing about Batson and its civil equivalents is that whenever I have asked litigators if they have encountered the situation of using Batson to prevent exclusion of persons with disabilities from serving on juries, they tell me they have not. On November 7, 2022. The Court of Appeals of the State of California, Second Appellate District, in Unzueta v. Akopyan, a published decision, here, holds that under California law people who associate with persons with disabilities have a right to be free from discrimination in jury selection. As usual, the blog entry is divided into categories and they are: facts; court’s reasoning that trial court erred in denying the Batson/Wheeler challenges; and thoughts/takeaways. Of course, the reader is free to focus on any or all of the categories.

 

I

Facts

 

Plaintiff alleged in her complaint that the defendant, the anesthesiologist during the birth of her child, negligently administered an epidural injection resulting in the paralysis of plaintiff’s right leg below the knee. Plaintiff lost at trial and appealed. On appeal, the appellate court held that the trial court erred in denying Batson/Wheeler (Wheeler is the California equivalent of Batson), challenges and said that the trial court had to revisit each of the challenged jurors to see if impermissible discrimination had occurred. If such impermissible discrimination occurred, the trial court was to reinstate the judgment. On remand, defendant’s attorney asserted that two of the prospective jurors were excluded because they had a family member who was disabled and the attorney feared the family member’s disability would cause the particular juror to be biased in favor of the plaintiff. One of the prospective jurors had a child with a disability. The other prospective juror had a husband who was disabled, unable to work, and had an outstanding Worker’s Compensation matter. The trial court found those justifications to be race neutral and plaintiff appealed saying that excluding the two prospective jurors based upon the disabilities of their family members was by itself discrimination based upon protected characteristics and therefore impermissible.

 

II

Court’s Reasoning That Trial Court Erred in Denying the Batson Challenges

 

  1. While peremptory challenges are a long-standing feature of both the civil and criminal systems in America, the exercise of even a single peremptory challenge solely on the basis of race or ethnicity offends the guarantee of equal protection of the laws under the 14th amendment to the U.S. Constitution. It also violates a defendant’s right to trial by a jury drawn from a representative cross-section of the community under the California Constitution.
  2. The prohibition against the exercise of peremptory challenges to include prospective jurors on the basis of group bias applies to both civil and criminal cases.
  3. Excluding evening a single prospective juror for reasons impermissible under Batson/Wheeler requires reversal.
  4. The three-step process for evaluating a Batson/Wheeler motion works like this: 1) the party objecting to the strike must establish a prima facie case by showing facts sufficient to support an inference of discriminatory purpose; 2) if the objector succeeds in establishing a prima facie case, the burden shifts to the proponent of the strike to offer a permissible nonbiased justification for the strike; and 3) if the proponent does offer a nonbiased justification, the trial court must decide whether that justification was genuine or instead whether impermissible discrimination impact motivated the strike.
  5. At the second step of the Batson/Wheeler analysis, the party exercising the peremptory challenge cannot justify an allegedly impermissible challenge with a different impermissible justification (i.e. that two of the six jurors had family members with disabilities). In other words, getting past the second step is not going to happen if what is happening is the substitution of an impermissible justification for another.
  6. When the trial court makes a sincere and reasoned effort to evaluate the proffered reasons for the strike, the reviewing court defers to its conclusions on appeal and examines only whether substantial evidence supports them.
  7. Batson/Wheeler challenges are subject to independent review on appeal.
  8. The United States Supreme Court has extended Batson/Wheeler motions to prevent the exercise of peremptory challenges to those based upon gender.
  9. The California Constitution prohibits the use of peremptory challenges on account of bias against an identifiable group distinguished on racial, religious, ethnic, or similar grounds.
  10. In 2000, California legislature expanded the list of groups subject to a Batson/Wheeler motion to race, color, religion, sex, national origin, sexual orientation, or similar grounds.
  11. In 2015, the California legislature expanded the list further by referencing §11135 of the Government Code, which specifically references mental disability, physical disability, genetic information, and medical condition among other things. §11135(d) also applies to people who associate with a person who is perceived or has any of the characteristics listed in the Government Code.
  12. Taking the 2000 and 2015 amendments together, means using peremptory challenges to exclude prospective jurors on the basis a person with whom the juror is associated with has a disability is impermissible.
  13. In a footnote, the court noted that it was clear from the legislative history that the intent of the 2000 and 2015 amendments was to align the limitations on peremptory challenges with California law prohibiting other forms of discrimination by the state, a state agency, or entities funded by the state.
  14. No dispute exists that the justification for excluding two of the jurors was their association with family members with disabilities. In fact, the attorney on remand focused specifically on the disability of the family members. The trial court in ruling on the motion likewise relied on the disability of the family members.

 

III

Thoughts/Takeaways

 

  1. While I received my J.D. degree from the University of San Diego (I also have an LL.M. in health law from Depaul), I never took the California bar. So, I am not licensed in California. Much of this decision turns on California law. When it comes to the rights of people with disabilities in California, it is important to get a California licensed attorney involved, particularly with California’s Unruh Act often being in play.
  2. As the court points out in a footnote, the United States Supreme Court and federal courts have yet to expand Batson/Wheeler to peremptory challenges based on a prospective juror’s disability. In fact, the two cases cited in the footnote by the court are cases that I have mentioned in blog entries previously here and here. The court also notes that the California Supreme Court has not addressed the application of Batson/Wheeler to jurors based upon their disability or the disability of a family member.
  3. The Second Court of Appeals talks about sole cause and it also talks about permissible reasons motivating a strike. The use of both terms in its opinion raises the question of whether Batson/Wheeler challenges in California turn on sole cause or motivating factor (I am not a licensed attorney in California). At the federal level, it would seem after Bostock v. Clayton County, Georgia, that sole cause would not be the standard.
  4. While the United States Supreme Court has not specifically weighed in on whether Batson and its civil progeny, Edmondson, applies to persons with disabilities, a plain reading of Tennessee v. Lane, which we have discussed many times, such as here, would suggest that the only logical conclusion is that Batson does apply.
  5. A plain reading of Bostock v. Clayton County, Georgia, which we discussed here, also suggests that Batson challenges would be in play for the LGBTQ community as well.
  6. The case serves as an important reminder that state laws can go further than federal laws.
  7. The disadvantage of Batson is that it relies on attorneys to make the challenge. The prospective juror has no ability to do it themselves.

Read More –>

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WASHINGTON — Supreme Court justices sounded sharply split Wednesday on whether to strike down a federal child custody law that seeks to keep Native American children with tribal families. Three of the court’s liberals, joined by Justice Neil M. Gorsuch, strongly defended the law. They said the Constitution gave Congress broad authority to protect Native […]

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Interactive Process Obligation Continues Through Litigation

Today’s blog entry deals with the question of whether the interactive process continues through any litigation and whether evidence of that interactive process taking place or not taking place when the case is being litigated can be brought into evidence. The case is Kovachich v. Department of Mental Health and Addiction Services, here, decided by the Supreme Court of Connecticut on September 27, 2022. As usual, the blog entry is divided into categories and they are: facts; majority reasoning that exhibits were properly admitted; Chief Justice Robinson’s dissenting opinion; and thoughts/takeaways. Of course, the reader is free to focus on any or all of the categories.

 

I

Facts

 

The facts can be distilled quite a bit. What you have here is a plaintiff requesting from her employer a scent free work environment. While the employer granted accommodations, some employees failed to comply with the scent free working environment designation. As a result, plaintiff was exposed to scents at the jobsite that exacerbated her rhinitis and asthma and on multiple occasions triggered the need for emergency medical treatment. She then sought out legal counsel to ensure that she was protected in the workplace. The plaintiff, her counsel, and the human resources director did meet with the result being a notice was placed on the overtime sign-up sheet informing employees that the Brief Care Unit was scent free. However, with limited exceptions, no additional measures were taken to educate the workforce or to enforce the scent free designation by means of workforce discipline. This led to a filing with the Connecticut version of the equal employment opportunity commission.

 

At trial, plaintiff’s counsel sought to introduce into evidence an April 29, 2013, email from plaintiff’s counsel to a Connecticut Assistant Attorney General with a subject line, “request for demand.” the content of that email asked for a discussion to find a solution to ensure that plaintiff could be given a scent free environment. No such meeting took place in response to the email. Plaintiff’s counsel also offered into evidence in the email of May 30, 2013, stating that one of the plaintiff’s coworkers was also affected by scents in mandatory training situations and suggesting that online training as a possible accommodation. It also said her employer’s approach was the wrong one and that plaintiff intended to move forward with her case. It specifically inquired about what solutions the employer might propose. Plaintiff’s counsel also sought to introduce into evidence a July 22, 2013 letter containing a set of demands and ending with, “we would be happy to meet with representatives of the defendant who has authority to discuss and recommend these requests.” All of these exhibits were offered for purposes of illustrating plaintiff’s attempts at the interactive process. The trial court admitted the exhibits and wound up finding in favor of the plaintiff awarding $3800 of additional pension income. It also awarded the plaintiff $125,000 for the emotional distress caused by the actions of the employer and $415,389.50 in attorney fees.

 

The defendant appealed to the appellate court and the appellate court wound up agreeing with the defendant on that the various exhibits should not have been admitted and for other reasons as well. Plaintiff appealed to the Connecticut Supreme Court.

 

II

Court’s Reasoning That the Exhibits Were Properly Admitted

 

  1. It is true that the Connecticut Code of Evidence provides that evidence of an offer to compromise or settle a disputed claim is inadmissible on the issue of liability and the amount of the claim. Good policy reasons exist for that rule.
  2. It is also true that the Connecticut Code of Evidence allows an offer to compromise or settle a disputed claim into evidence if it is offered for another purpose. The list of purposes that appear in that statute are illustrated rather than exhaustive.
  3. Whether the exhibits should have been admitted is an evidentiary area issue reviewed for an abuse of discretion.
  4. The Connecticut Fair Employment Practices Act borrows from the ADA and requires an interactive process to figure out what accommodation can be put in place in order to overcome a person with a disability’s limitations.
  5. The need for the interactive process arises because both parties hold information that the other does not have or cannot easily obtain.
  6. The employee has the burden of initiating the interactive process must come forward with some suggestion of accommodation, and the employer then must make a good-faith effort to participate in that discussion.
  7. A plaintiff who fails to initiate or participate in the interactive process in good faith loses.
  8. An employer’s refusal to give an employee his or her specific requested accommodation does not necessarily amount to bad faith, so long at the employer makes an earnest attempt to discuss other potential reasonable accommodations.
  9. An employer’s failure to participate in the interactive process in good faith does not give rise to per se liability. However, it may be sufficient grounds for denying a defendant’s motion for summary judgment because it is at least some evidence of discrimination. In other words, in Connecticut a failure to engage in a good faith interactive process, is not a separate cause of action but can be introduced as evidence tending to show disability discrimination.
  10. The interactive process required by law is ongoing and is not exhausted by one effort. The ongoing interactive process continues during the course of plaintiff’s employment even after the plaintiff has filed a complaint alleging disability discrimination.
  11. The Connecticut Supreme Court found persuasive the reasoning of numerous federal courts that have been admitted evidence of compromise offers and negotiations for purposes of showing that the parties engaged in the interactive process.
  12. Nothing in the record establishes that the communications contained in the exhibits occurred within the context of the commission’s mandatory mediation program. In fact, plaintiff’s complaint had been pending with the commission for approximately one year and had been referred to in commission investigator at the time the document was generated, which means that the mandatory mediation had at least concluded.
  13. Although the communication contained in the exhibits occurred while the plaintiff’s complaint was pending before the commission, no evidence exists to indicate that the exhibits were part of the commission’s conciliation efforts, as opposed to their investigative efforts, or independent of the commission’s efforts altogether.
  14. The purpose of the evidentiary admissions was not to show liability but to show that a party was engaging in the interactive process.
  15. The trial court did not rely on the exhibits to find that the defendant engaged in discrimination. Instead, the trial court found that the defendant had failed to effectuate the plaintiff’s accommodations by an abject failure to make any reasonable effort to educate the staff about what a scent free environment meant and a supervisor’s refusal to do anything whatsoever about the scent free workplace environment provided by the ADA committee.
  16. While the trial court did rely on the defendant’s failure to respond to one of the exhibits to find that the good faith interactive process had broken down, that finding was based on defendant’s failure to present any evidence that it responded to the plaintiff’s communication, rather than the content of the communication itself.
  17. There was no error in the trial court’s determination that the exhibits were highly relevant to the defendant’s ability to react intelligently and legally to the plaintiff’s request for accommodations.
  18. The content of the communications demonstrate that the plaintiff wanted to continue with the interactive process but was getting nowhere.

 

III

Chief Justice Robinson Dissenting Opinion

 

  1. Failure to engage in interactive process is not entirely distinct from the liability inquiry as a matter of law.
  2. Most circuits find a failure to engage in the interactive process results in liability when a reasonable accommodation would otherwise have been possible.
  3. Connecticut Code of Evidence prohibits admissibility of a variety of things when it goes to liability in general.
  4. Majority view is too narrow as to what is part of the mediation process.

 

IV

Thoughts/Takeaways

 

  1. My thanks to Daniel Schwartz, who has a blog called the Connecticut Employer Law Blog (the link will take you to his discussion of the case), for first bringing my attention to this case.
  2. Six justices were in the majority with the Chief Justice being the lone dissenter.
  3. The interactive process is a continuing duty that continues through any litigation.
  4. I am not a Connecticut licensed attorney. Mileage may also vary depending upon jurisdiction.
  5. Federal case law exists holding that request to engage in the interactive process made during ongoing litigation can be admitted for the purpose of demonstrating the continuing obligation of engaging in the interactive process.
  6. As a preventive law matter, an employer would do well to respond to any accommodation offers while litigation is ongoing. Of course, as we have discussed numerous times in our blog, such as here, once an employer is put on notice that a need for accommodation exists (magic words are not required), the employer should engage in the interactive process.
  7. In most circuits, failure to engage in the interactive process is a separate cause of action. In those circuits, the dissenting opinion here may hold quite a bit of sway because of the failure to engage in interactive process being a liability issue.

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Texas Tax Round Up (September 2022)

Texas Tax Round Up | September 2022

Hiya, folks! Nice for y’all to come visit again at the Texas Tax Round Up! We got another installment chock-full of Texas tax action, so let’s get started!

Court Cases

Sales and Use Tax

Manufacturing Exemption

Hegar v. Tex. Westmoreland Coal Co., Case 21-1007 (Tex. Sept. 30, 2022)—In this case, the Texas Supreme Court denied the Comptroller’s petition for review, leaving the decision of the Third Court of Appeals in favor of the taxpayer in place.  The Court of Appeals had held that equipment used to break apart lignite coal from a coal formation qualified for the manufacturing exemption from sales and use tax.[1] The Court of Appeals disregarded the Comptroller’s argument that the manufacturing exemption didn’t apply because the equipment was used on real property to create tangible personal property, holding that there was no basis in the statute for any requirement that an input to the manufacturing process had to be tangible personal property.

Franchise Tax

Apportionment

Citgo Petroleum Corporation v. Hegar, 21-0997 (Tex. Sept. 30, 2022)—The Texas Supreme Court denied the taxpayer’s petition for review in this case, so the decision of the Third Court of Appeals in favor of the Comptroller remains the law of the land. The Court of Appeals had held that only the net proceeds of sales of commodity futures contracts and options on commodity futures contracts could be included in the calculation of the taxpayer’s apportionment factor for purpose of calculating Texas franchise tax.

Rules

Adopted Rules

Collections

34 Tex. Admin. Code § 3.16 (Delinquent Taxpayer Financial Records; Information Exchange) (published at 47 Tex. Reg. 5339 (Sept. 2, 2022))—This rule implements House Bill (H.B.) 1258, 87th Leg., R.S. (2021), which requires financial institutions to provide data to the Comptroller quarterly to facilitate the matching of names of delinquent taxpayers with the names of account holders.

Proposed Rules

Sales and Use Tax

34 Tex. Admin. Code § 3.334 (Local Sales and Use Taxes) (published at 47 Tex. Reg. 6158 (Sept. 23, 2022))—Here we have the latest development in the ongoing saga regarding the sourcing of Texas local sales and use taxes, particularly with regard to orders placed over the internet.

In its 2018 decision in South Dakota v. Wayfair, the U.S. Supreme Court decided that states could impose tax collection requirements on out-of-state sellers lacking physical presence in the state as long as the requirements didn’t impose an undue burden on interstate commerce. In light of this decision, The Comptroller determined that the then-existing Rule 3.334 was inadequate to explain Texas’ local sales and use tax consummation statutes.[2]

However, the Comptroller’s proposed amendments to the rule in January 2020 met with backlash from cities and businesses. A public hearing was held on February 4, 2020, and the Ways and Means Committee of the Texas House of Representatives held an interim hearing to discuss the proposed amendments on February 5, 2020.[3]

Nevertheless, the Comptroller pressed ahead and finalized the amendments in May 2020. Shortly thereafter, the Comptroller amended the rule in 2020, the Cities of Round Rock, Coppell, DeSoto, Humble, and Carrolton sued, challenging the amendments’ validity.[4] Ultimately, a district court in Travis Count at least partially agreed with the cities, finding that the Comptroller failed to substantially comply with procedural requirements for notice of proposed rule.[5] The court remanded the rule to give the comptroller the opportunity to either revise or readopt it through established procedure.[6]

Thus, the Comptroller is now reissuing proposed Rule 3.334 with fuller explanation of the proposed rulemaking.[7]

At the heart of the debate over proposed Rule 3.334 is the sourcing of internet sales. The proposed rule would define the term “place of business of the seller” as “an established outlet, office, or location operated by a seller for the purpose of receiving orders for taxable items from persons other than employees, independent contractors, and natural persons affiliated with the seller.”[8] The location would have to be staffed by one or more sales personnel and these sales personnel would have to accept at least three orders of taxable items at the facility during the calendar year.[9]  The term “place of business of the seller” wouldn’t include “a computer server, Internet protocol address, domain name, website, or software application.”[10]

This change in the definition of “place of business of the seller” places out in proposed Rule 3.334(b)(5), which would provide that “[a]n order that is not received by a salesperson is received at a location that is not a place of business of the seller. Examples are orders received by a computer server through a shopping cart software program and orders received by an automated telephone ordering system.”[11]  This would cause orders that were placed on the internet that were not fulfilled at a place of business of the seller in Texas to be sourced to the location of the purchaser.[12] Currently, some taxpayers have taken the position such orders are received at a place of business of seller, which would mean that these sales would be sourced to that place of business.

Notable Additions to the State Tax Automated Research (“STAR”) System

Sales and Use Tax

Enterprise Zones

Comptroller Decision No. 117,512 (2022)—The ALJ found that a taxpayer that operated a petrochemical production facility that was designated as a Project as part of the Texas Enterprise Zone Program (the “Program”) was not entitled to a refund of sales and use taxes because not enough employees of the Project were residents of an Enterprise Zone.

The Program requires at least 35% of the new permanent jobs of the Project be held by residents of an Enterprise Zone or by economically disadvantaged individuals.[13] An area automatically qualifies for designation as an Enterprise Zone if the area is “designated by the federal government as a Federal Renewal Community, a Federal Empowerment Zone, or a Federal Enterprise Community, including any developable area approved by the federal agency responsible for making that designation.”[14]

The taxpayer identified several of the Project’s employees as residents of the Gulf Opportunity Zone (“GO Zone”). The GO Zone was created pursuant to the Gulf Opportunity Zone Act (Act), signed into law by President George W. Bush in 2005 in the wake of Hurricanes Katrina and Rita. The Act designated certain areas as “disaster areas” affected by the hurricanes, created the boundaries of the GO Zone, and established tax benefits for businesses and individuals in the GO Zone. The GO Zone was not designated by the federal government as a Renewal Community, Empowerment Zone, or Enterprise Community. Congress did not designate the GO Zone as a Renewal Community, Empowerment Zone, or Enterprise Community, and no federal agency designated or approved the GO Zone as such.

Thus, the ALJ found that the GO Zone wasn’t an Enterprise Zone and that the Project failed to meet the employee residency requirement.

Medical Devices

STAR Accession No. 202208009L (Aug. 15, 2022)—In this private letter ruling, the Comptroller determined that a device used by medical providers in the diagnostic evaluation and monitoring of patients experiencing unexplained symptoms such as dizziness, palpitations, chest pain, and shortness of breath was a therapeutic device and not a prosthetic device or orthopedic appliance.[15] Therefore, the device was exempt from sales and use tax when sold to a patient with a prescription, but was taxable when sold to a medical provider for use in a nontaxable medical service unless and exemption applied.[16] According to the Comptroller, the device:

  • was not a prosthetic device, because it didn’t replace a missing part of the body or perform the function of a vital organ, could be removed as soon as the medical provider obtained a diagnosis from the device, and only had a battery life of 3 years;[17]
  • was not an orthopedic appliance, because it wasn’t used to treat a deformity or disease of the skeleton, joint, or spine;[18] and
  • was a therapeutic device, because it is used as a diagnostic medical tool designed for use in patients with heart conditions.[19]

The Comptroller also ruled that the person selling the device couldn’t accept resale certificates from medical providers because the medical providers were using the devices to perform a nontaxable service.[20]  However, an exemption certificate could be accepted from a medical provider that qualified as an exempt organization under Tex. Tax Code §§ 151.309 (Governmental Entities) or 151.310 (Religious, Educational, and Public Service Organizations).

Credit Reporting Services

STAR Accession No. 202208011L (Aug. 22, 2022)—In this memo to Audit, Tax Policy states that it’s Comptroller policy that credit ratings of legal entities are subject to sales and use tax as a credit reporting service, while credit ratings of debt obligations aren’t taxable.[21]

The analysis hinges on the definition of a “credit reporting service” as “the assembly and furnishing of credit history or information relating to any person.”[22] According to the Code Construction Act, which specifically applies to Title 2 of the Texas Tax Code (which is where the state sales and use tax is found), a “person” includes a “corporation, organization, government or governmental subdivision or agency, business trust, estate, trust, partnership, association, and any other legal entity.”[23]

Thus, the Comptroller takes the position that while the credit rating of legal entity involves the assembly of credit information of a person within the meaning of the definition of a credit reporting service, the credit rating of a debt obligation doesn’t because a debt obligation is not a “person.”

Motor Vehicle Sales, Rental and Use Tax

Apportioned Registration

Comptroller’s Decision No. 117,430, 117,431 (2022)—The ALJ found that a taxpayer who purchased two trucks, registered them with non-apportioned plates, but then later obtained apportioned registration for the vehicles wasn’t entitled to a refund of the motor vehicle sales tax that he had paid on those vehicles.[24]

The ALJ noted Comptroller policy that the registration of a vehicle with non-apportioned plates creates a presumption of intrastate use that must be rebutted to prove the exemption. For instance, this presumption could be rebutted with evidence demonstrating that a vehicle was not operated prior to obtaining apportioned registration. The taxpayer did not produce any such evidence.

The ALJ also rejected the taxpayer’s claims of detrimental reliance on advice from Comptroller personnel, finding that the taxpayer didn’t show that any such advice was provided in writing in a private letter ruling or that any specific advice was incorrect.[25]

Gross Receipts Rental Tax

STAR Accession No. 202207023L (July 15, 2022)—In this private letter ruling, the Comptroller determined that a car-sharing app that enabled vehicle owners to list their personal vehicles as available for sharing to others was not responsible for collecting and remitting gross receipts rental taxes.[26]

For purposes of the motor vehicle sales, rental and use tax, a “rental” means in relevant part “an agreement by the owner of a motor vehicle to give for not longer than 180 days the exclusive use of that vehicle to another for consideration . . . .”[27]  The “owner of a motor vehicle” means “a person named in the certificate of title as the owner of the vehicle . . . or . . . a person who has the exclusive use of a motor vehicle by reason of a rental and holds the vehicle for re-rental.”[28]

Under the facts presented in this ruling, car-sharing app was not the owner of the vehicles being rented, because it was not on the certificate of title of the vehicles. Nevertheless, the people who used the app to rent their motor vehicles to others would have to collect and remit gross receipts rental tax as required under Tex. Tax Code § 152.045 (Collection of Tax on Gross Rental Receipts).

Franchise Tax

Forfeiture of Corporate Privileges / Officer Liability

Comptroller’s Decision No. 117,522 (2022)—The ALJ found that an officer of a corporation was liable for an International Fuel Tax Agreement assessment that the Comptroller had made against the corporation for the periods when the corporation’s corporate privileges were been forfeited due failure to file a franchise tax report.[29]

The officer didn’t argue, and therefore didn’t establish, that the debt was created or incurred over his objection or without his knowledge and that the exercise of reasonable diligence to become acquainted with the affairs of the corporation wouldn’t have revealed the intention to create the debt—which would constitute an exception to officer and director liability.[30]

The ALJ dismissed the officer’s argument that the corporation’s liability for the assessment was in error by noting that a person who is assessed personally as the officer or director of a corporation may not challenge the underlying corporate liability that is administratively final.

Mixed Beverage Taxes

Depletion Analysis

Comptroller’s Decision Nos. 117,651, 117,652 (2022)—The ALJ determined that there was no error in auditors presuming that all alcohol purchased by a bar during an audit period was sold during that period when the bar didn’t provide any documentation establishing opening and closing inventory.[31] The ALJ further found that allegations “that the auditors consumed alcohol during the pour observation, that the pour test observation sheet was forged, and that the lead auditor attempted to bully and intimidate [one of the bar’s owners] do not present justiciable issues for the ALJ to consider in the contested case hearing.”

 

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Freeman Law International Tax Symposium

Readers may be interested in the Freeman Law International Tax Symposium scheduled to take place virtually on October 20 and 21, 2022.  Attendees will qualify for CLE, CPE, and CE and the slate of presenters includes well-recognized speakers and panelists, such as the IRS Commissioner, a prior Chief Counsel of the IRS, a former Acting Assistant Attorney General of the U.S. Department of Justice Tax Division, and many others in government and private practice.

To Register for the Freeman Law International Tax Symposium, please visit www.its2022.freemanlaw.com.

 

********

 

[1] Tangible personal property directly used or consumed in or during the actual manufacturing, processing, or fabrication of tangible personal property for ultimate sale qualifies for the manufacturing exemption if the use or consumption of the property is necessary or essential to the manufacturing, processing, or fabrication operation and directly makes or causes a physical change to the product being manufactured, processed, or fabricated for ultimate sale.  Tex. Tax Code § 151.318(a)(2).

 

[2] 47 Tex. Reg. 6158.

 

[3] See id. at 6158-6159; Hearing on Interim Charges, Ways & Means, Tex. House of Representatives (Feb 5, 2020).

 

[4] Id. at 6159.

 

[5] Id.

 

[6] Id.

 

[7] Id.

 

[8] Id. at 6159.

 

[9] Id.

 

[10] Id.

 

[11] Id. at 6161.

 

[12] Id.

 

[13] Tex. Gov’t Code §§ 2303.003(6), 2303.402.

 

[14] Tex. Gov’t Code § 2303.101(2).

 

[15] A therapeutic device is a “device that is designed to alleviate pain or for use during the treatment or cure of human sickness, disease, suffering, or deformity.”  34 Tex. Admin. Code § 3.284(a)(14) (Drugs, Medicines, Medical Equipment, and Devices (Tax Code §151.313)).

 

[16] Tex. Tax Code § 151.313(a)(6) (Health Care Supplies); 34 Tex. Admin. Code § 3.284(d)(11)(C).

 

[17] See id. § 3.284(a)(13) (defining a “prosthetic device” as “an item that is artificial and replaces a missing part of the body, performs the function of a vital organ or appendage of the human body, or is permanently implanted in the body.”).

 

[18] See id. § 3.284(a)(12) (defining an “orthopedic appliance” as an “appliance or device designed specifically for use in the correction or prevention of human deformities, defects, or chronic diseases of the skeleton, joints, or spine.”).

 

[19] See id. § 3.284(a)(14).

 

[20] See Tex. Tax Code § 151.006(c) (“Sale for Resale”) (“A sale for resale does not include the sale of tangible personal property or a taxable service to a purchaser who acquires the property or service for the purpose of performing a service not listed as a taxable service . . . .”).

 

[21] A credit reporting service are a taxable service. See Tex. Tax Code 151.0101(a)(7) (“Taxable Services”).

 

[22] Tex. Tax Code § 151.0034 (Credit Reporting Service) (emphasis added).

 

[23] See Tex. Gov’t Code §§ 311.002 (Application), 311.005(2) (General Definitions); Tex. Tax Code § 101.002 (Construction of Code).

 

[24] A tax is 6.25% is imposed on the retail sale of a motor vehicle in the state. Tex. Tax Code § 152.021(a) (Retail Sales Tax). However, certain interstate motor vehicles are exempt from this tax. Id. § 152.089 (Exempt Vehicles). An “interstate motor vehicle” is “a motor vehicle that is operated in this state and another state or country and for which registration fees could be apportioned if the motor vehicle were registered in a state or province of a country that is a member of the International Registration Plan.” Id.

 

[25] See 34 Tex. Admin. Code § 3.10(c) (Taxpayer Bill of Rights):

Detrimental Reliance Policy. The comptroller will give relief to a taxpayer who follows erroneous advice given to the taxpayer by an agency employee. The taxpayer, however, must have provided complete and accurate information to the agency employee. . . .

(1) Unless otherwise provided by this section, a taxpayer must affirmatively prove and provide records as requested by the comptroller to show that it meets all four parts of the following test:

(A) the substance of the information or advice and its direct communication to the taxpayer must be in writing in accordance with §3.1 of this title;

(B) the taxpayer followed the information or advice;

(C) the taxpayer gave sufficient information to have resulted in correct advice and did not misrepresent information or withhold or conceal information that would affect the advice; and

(D) the taxpayer has suffered, or will suffer, harm based on the erroneous advice unless the comptroller provides relief to the taxpayer.

 

[26] Gross rental receipts from the rental of a motor vehicle are taxed at a rate of 10% if the rental is for 30 days or less or at a rate of 6.25% if the rental is for longer than 30 days. Tex. Tax Code § 152.026(a), (b) (Tax on Gross Rental Receipts).

 

[27] Tex. Tax Code § 152.001(5)(A) (Definitions).

 

[28] Id. § 152.001(9).

 

[29] A corporation’s failure to file a franchise tax report can result in the forfeiture of corporation’s corporate privileges.  Tex. Tax Code § 171.251 (Forfeiture of Corporate Privileges).  One consequence of the forfeiture of a corporation’s corporate privileges is that each of the corporation’s directors and officers becomes liable for each debt of the corporation created after the date on which the report is due and before corporate privileges are revived. Id. § 171.255 (Liability of Director and Officers).

 

[30] See id. § 171.255(c).

 

[31] Although not cited by the ALJ, see 34 Tex. Admin. Code §§ 3.1001(o)(3)             (Mixed Beverage Gross Receipts Tax) (“In the event records are not made available, the comptroller will presume all alcohol purchased was sold.”), 3.1002(c)(3) (Mixed Beverage Sales Tax) (potentially making the presumption in 34 Tex. Admin. Code § 3.1001(o)(3) applicable to the mixed beverage sales tax).

The post Texas Tax Round Up | September 2022 appeared first on Freeman Law.

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Examining the Fallout from a U.S. Supreme Court Bankruptcy Ruling a Year Later: City of Chicago v. Fulton

In City of Chicago v. Fulton, the U.S. Supreme Court held that creditors do not violate the automatic bankruptcy stay when they merely retain property they took before the bankruptcy petition was filed. Now, as this decision has been legal precedent for over a year, stakeholders are beginning to learn how courts are interpreting and applying the Supreme Court’s decision.

The Supreme Court’s Holding in City of Chicago v. Fulton

In Fulton, the city of Chicago seized vehicles of various persons, for unpaid parking tickets. Several of those persons (unrelated) later filed for bankruptcy protection. When each debtor filed for bankruptcy, an automatic stay went into effect. In those cases, the debtors requested the city return their car. The city refused, and each of the debtors filed a contested motion claiming Chicago violated the automatic stay by refusing to return the car. In bankruptcy cases, the automatic stay requires that creditors refrain from taking any further actions to collect on their debts once a bankruptcy petition is filed, among other things.

Several similar cases were consolidated on appeal. In overturning the bankruptcy courts and the Court of Appeals, the Supreme Court ruled in favor of the city of Chicago relying upon a literal reading of federal bankruptcy laws to hold that retaining property that was seized prior to a bankruptcy filing does not constitute an “act” that would violate an automatic stay. As such, the city of Chicago was not immediately obligated to return the debtor’s car. Writing in a separate concurrence, Justice Sonia Sotomayor noted the grave impacts the decision could have on debtors and called on policymakers to institute rules that could alleviate the situation.

Courts have now been left to apply the Supreme Court’s holding in Fulton under various factual scenarios. Debtors continue to file motions alleging violations of automatic stays. In considering the Fulton precedent, courts have had to determine whether the case applies to different factual situations. Even if courts are uncomfortable with what seemed like a harsh ruling (without a car, debtors may not be able to get to work to improve their financial situation), federal bankruptcy courts are obligated to follow Supreme Court precedent.

Courts Have Largely Applied Fulton Without Distinguishing It

Fulton has been applied by courts in numerous instances beyond those involving impounded cars. For example, the Ninth Circuit applied Fulton in allowing a creditor to maintain garnishments of the debtor’s bank accounts that were made prior to the bankruptcy filing. The appeals court used the same logic that the creditor was not required to reverse the status quo that existed right before the automatic stay took effect.

In most Bankruptcy Court cases since the Supreme Court’s holding in Fulton, judges have applied the holding with little question. After all, the Supreme Court’s unanimous decision announced practically a bright-line rule and left little to be doubted.

The Outer Limits of Fulton

However, there have been some outer limits on how far courts have been willing to take the holding in Fulton. For example, one bankruptcy court specifically noted that the Supreme Court in Fulton did not disturb another line of cases that may require someone to take an affirmative action to prevent something from happening. An omission after the automatic stay has gone into effect could be the same as an overt act when it comes to violating the automatic stay.

In that case, a debtor had filed an adversary proceeding (lawsuit within a bankruptcy case) against an attorney who represented a trust that bought the debtor’s property in a foreclosure auction. The debtor filed for bankruptcy protection six days before a previously scheduled eviction proceeding. Between the time of the bankruptcy petition date and the eviction, the debtor’s counsel contacted the attorney for the trust to attempt to repurchase the property. Although the attorney for the trust made one phone call, he did not delay the eviction before it happened post petition. The debtor asserted in the adversary proceeding that the attorney violated the automatic stay by failing to stop the eviction. The attorney argued that the Supreme Court’s holding in Fulton meant that he did not need to do anything to halt the eviction since it was already scheduled.

The bankruptcy court granted a motion for summary judgment in favor of the trust’s attorney, but it disagreed with attorney’s argument that he did not have to do anything based on Fulton. The court distinguished between the failure to take an affirmative action that would maintain the status quo and the failure to take an action that would change the status quo. According to the court, there are still instances in which someone would have an affirmative duty to act in order to avoid violating the automatic stay. Here, the attorney for the trust was not the person with that affirmative duty. Nonetheless, the court cautioned about reading Fulton too broadly to disturb another long line of cases that remains valid law.

The Practical Implications of Fulton

Fulton is one of the Supreme Court’s most consequential bankruptcy decisions in recent years. Applying the “most natural reading” of the federal bankruptcy code, the Supreme Court’s decision makes a debtors’ timing for filing for bankruptcy protection even more important. Debtors may be quicker to file for bankruptcy in situations where they might lose property, while creditors may be less willing to continue to work with debtors, knowing that the debtors may be on the verge of bankruptcy.

If anything, the Supreme Court’s decision in Fulton would encourage a creditor to become more aggressive in repossessing or seizing property when it appears the debtor may be nearing bankruptcy proceedings. Creditors would seemingly have an easier time maintaining the status quo than having to defend an action they took after the bankruptcy petition was filed. Given an expected surge in bankruptcy filings as a potential fresh recession nears, creditors should proactively evaluate accounts to determine whether they should take action. Nonetheless, given the consequences of violating the automatic stay, creditors should consult with an attorney in any close cases.

The post Examining the Fallout from a U.S. Supreme Court Bankruptcy Ruling a Year Later: City of Chicago v. Fulton appeared first on MehaffyWeber.

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North Dakota Supreme Court Invalidates Pore-Space Statute

North Dakota Supreme Court Invalidates Pore-Space Statute

This seems to be the season for oil patch courts to return property to its rightful owners. Last week it was a regulatory taking by the City of Dallas. This week it is Northwest Landowners Association v. State of North Dakota, in which the North Dakota Supreme Court deemed unconstitutional on its face a statute that stripped landowners of their rights in subsurface pore space.

SB 2344

In 2019 the North Dakota Legislature passed SB 2344, which allowed an oil and gas operator to use subsurface pore space in its operations and denied the surface owner the right to exclude others or demand compensation for subsurface use. The Bill granted the North Dakota Industrial Commission rulemaking authority to effectuate the purposes of the Bill and revised the definition of land to exclude pore space. The purpose was to overcome North Dakota’s Damage Compensation Act, which requires mineral developers to compensate landowners for lost land value and use. Finally, the Bill barred tort claims for injection or migration of substances into pore space.

The suit

The Association alleged that 2344 constituted an impermissible taking because it stripped landowners of their right to possess and use pore space and allowed the State to redistribute that right to others without the consent of or compensation to the landowners. The Fifth Amendment of the US Constitution guarantees that private property shall not be taken for public use without just compensation. The North Dakota Constitution prohibits taking or damage to private property for public use without just compensation having been first made to or paid into court for the owner.

The result

In its analysis the Court found a number of existing laws establishing the surface owner’s right to subsurface pore space, providing a statutory definition of pore space, and confirming that title to pore space is vested in the surface owner. The Court concluded that the surface owners demonstrated a constitutionally protected property interest in pore space that is recognized under state law.

The Court concluded that 2344 constituted a per se taking by allowing third-party oil and gas operators to physically invade a landowner’s property by injecting substances (such as CO2 or produced water) into the pore space.

An oil and gas operator does have an implied easement to dispose of wastewater into pore space produced within the same unit or pool, but the operator must compensate the surface owner for such disposal.

The Court relied on the plain meaning of ths statute to reject the State’s argument that the dominant mineral estate principle saved 2344 from constitutional infirmity. The statute applied to a broader set of circumstances.

The Court noted that although the use of pore space does not seriously interfere with a landowner’s use of the rest of his land because the pore space is beneath the surface, compensation is required for physical invasions even if the owner suffers only a minimal economic impact. This refuted intervenor Continental Resources’ assertion that pore spaces have no inherent value.

The Court denied the State’s argument that 2344 is not an unconstitutional taking because it is a proper exercise of its police power. The State may use police power only within constitutional limitations.

The Court determined that the constitutional and unconstitutional portions of the statute are independent and that the valid portions could be given effect without the invalid portion. Thus, the entire statute was not unconstitutional.

Your musical interlude

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If a Federal Courthouse is not Accessible to a Person With a Disability, What Remedies do They Have?

Today’s blog entry is a case sent to me by Prof. Leonard Sandler, a clinical law professor at the University of Iowa. The case of the day is Wilds v. Akhi LLC decided on July 29, 2022 by Magistrate Judge Jones of the Northern District of Florida. It deals with the question of what happens when a person with a service animal shows up at the federal courthouse with his service animal not on a leash. Plaintiff alleged that the animal was under his control and could not be on a leash in order to best compensate for his disability as he has blackouts. The security agency refused to let him in the federal courthouse. So, he sues alleging violation of the ADA and state law claims. As usual, the blog entry is divided into categories and they are: Federal Buildings Are Exempt from the ADA and a Federal Courthouse Is Not a Place of Public Accommodation; While Plaintiff Has a Constitutional Right of Access to the Courts, He Cannot Enforce That Right against the Defendants under §1983 or under Bivens; While No Private Cause of Action Exists under Florida Statute §1413.08(3), Plaintiff Does Have the Ability to Sue for Damages for Violations of the Florida Civil Rights Act; and Thoughts/Takeaways. Of course, the reader is free to focus on any or all of the categories.

 

 

I

Federal Buildings Are Exempt from the ADA and a Federal Courthouse Is Not a Place of Public Accommodation

 

  1. Only one Federal District Ct. has addressed the question of whether a federal courthouse constitutes a place of public accommodation under title III of the ADA. That court held that a federal courthouse was not a public accommodation.
  2. The lack of case law on whether a federal courthouse constitutes a public accommodation under title III of the ADA is likely because federal governmental buildings are generally exempt from the ADA.
  3. Federal buildings are governed by the Architectural Barriers Act of 1968.
  4. The Architectural Barriers Act does not provide a private right of action and courts have refused to imply one.
  5. An aggrieved person under the Architectural Barriers Act may file a complaint with the U.S. Access Board regarding any alleged Architectural Barriers Act violation.
  6. Courts allowing a private cause of action under the Architectural Barriers Act, have insisted that a litigant must first exhaust his administrative remedies with the Architectural Barriers Board before filing suit in federal court. Accordingly, a remedy the plaintiff has is to file a complaint with the Access Board.

 

II

While Plaintiff Has a Constitutional Right of Access to the Courts, He Cannot Enforce That Right against the Defendants under §1983 or under Bivens

 

  1. The defendants, the security companies providing security services to this particular federal court, are not state actors.
  2. The United States Supreme Court has refused to extend Bivens to private entities.
  3. Defendants are federal contractors and §1983 does not provide a cause of action against a federal official or contractor.
  4. By its own terms, §1983 only applies to state actors acting under color of state law and not to federal actors acting under color of federal law.
  5. A Bivens claim is available when a federal actor violates a plaintiff’s federal rights while acting under color of federal law. However, the United States Supreme Court has refused to extend Bivens liability to private entities that contract with the federal government.
  6. Since the purpose of Bivens is to deter individual federal officers from committing constitutional violations, inferring a constitutional tort remedy against a private entity is not possible.
  7. The defendants are private security companies providing security services for U.S. District Court for the Northern District of Florida in the Gainesville division under a federal contract.
  8. The Supreme Court has said that merely private conduct, no matter how discriminatory or wrongful, does not constitute state or federal action and is excluded from §1983 or Bivens.

 

III

While No Private Cause of Action Exists under Florida Statute §413.08(3), Plaintiff Does Have the Ability to Sue for Damages for Violations of the Florida Civil Rights Act

 

  1. Florida courts have refused to recognize a private right of action under §413.08 of the Florida statutes.
  2. Plaintiff may seek relief under Florida statute §760.01.
  3. The Florida Civil Rights Act provides a mechanism to obtain private relief and damages under §413.08 because §760.07 states that any violation of any Florida statute making discrimination unlawful gives rise to a cause of action for damages.
  4. Since plaintiff is proceeding pro se, the court construes a state law claims for violations of §413.08(3) to arise under the Florida Civil Rights Act.
  5. Whether plaintiff can bring a Florida Civil Rights Act claim against defendants denying him access to a federal building is a question that should be decided by Florida courts and not the federal court because plaintiff has no federal claim.
  6. A court should decline to exercise supplemental jurisdiction over state law claim when the court is dismissing all federal causes of action.
  7. In a footnote, the court noted that even if a federal courthouse was somehow considered to be a place of public accommodation under title III, the particular defendants sued in this case do not own, lease, or operate it. Instead, federal courthouses are owned and operated by the Gen. Services Administration of the United States government. Also, very few courts have considered whether security officers can be characterized as owners, lessors, or operators under title III of the ADA and those that did decided in the negative.
  8. In another footnote, the court noted that the Supreme Court recognize a constitutional right of access to the courts arising under the 14th amendment in the case of Tennessee v. Lane. Florida courts have recognized a number of affirmative obligation flowing from that principle, including: the duty to waive filing fees and in certain family law and criminal cases; the duty to provide transcript to criminal defendants seeking review of their conviction; and the duty to provide counsel to certain criminal defendants. Each of those cases make clear that ordinary considerations of cost and convenience alone cannot justify a State’s failure to provide individuals with meaningful right of access to the courts.
  9. In another footnote, the court notes that the Florida Civil Rights Act has exhaustion requirements.

IV

Thoughts/Takeaways

 

  1. I cannot see how federal courthouses can be a place of public accommodation.
  2. Courts are split on whether the Architectural Barriers Act allows for a private cause of action. At a minimum, a person would need to exhaust administrative remedies first before filing such a suit, assuming such a suit flies in the first place.
  3. Bivens and §1983 are of no help to a plaintiff faced with a similar situation.
  4. State law is something plaintiffs lawyers should look to when dealing with disability discrimination matters. They sometimes go further than federal law or are applied more broadly.
  5. About a month after this decision, the U.S. District Court accepted the magistrate’s report without objections from the parties.
  6. The General Services Administration is an executive agency. So, one wonders why a plaintiff when faced with this situation would not pursue a claim under §504 of the Rehabilitation Act. See for example, Bartell v. Grifols Shared Servs. NA, 1:21CV953 (M.D.N.C. Aug. 15, 2022)-holding that the Rehabilitation Act and the ADA get interpreted the same way when it comes to service animals.
  7. The court did direct the clerk to conduct a reasonable investigation, whatever that means, to see whether plaintiff’s request that he be permitted to enter the courthouse building with his service dog unleashed could be accommodated.

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Changes to Corporate Capital in Equity Financing Transactions, Part II.

How Are Fiduciary Duties Applicable to Decisions Authorizing Changes to Corporate Capital?

The first post in this series analyzed whether shareholders may seek remedies in the context of charter amendments to facilitate changes to corporate capital in equity financings. The conclusion was that if an amendment to a corporate charter is properly adopted (and doesn’t violate an independent contractual obligation), shareholders can obtain a remedy only if the corporate action can substantiate a claim for breach of fiduciary duty against enough directors or control persons.

In situations where corporations are needy for additional capital, existing and potential stockholders often seek to maximize their potential benefits upon providing investments. They may control the company or control board seats. Some of the actions they take can adversely affect other shareholders’ interests. For instance, they may create a senior class of stock with superior right and preferences. Consequently, it is worthwhile to consider when shareholders can claim a breach of fiduciary duty in connection with equity financings or recapitalizations. This part of the series addresses how fiduciary duties of corporate directors and control persons apply in these circumstances in Texas and Delaware.

Directorial Fiduciary Duties in General

Directors owe fiduciary duties to the corporations they serve. In both Delaware and Texas, the two core fiduciary duties are the duty of care and the duty of loyalty. See Mill Acq. Co v. Macmillan, Inc. 559 A.2d 12611, 1280 (Del. 1989) and In re Estate of Poe, 591 S.W.3d 607, 639 (Tex.—El Paso, 2019), rev’d in part on other grounds, 443 S.W.3d 856 (Tex. 2014), (citing Gearheart Industries, Inc. v. Smith Intern., Inc. 741 F.2d 707, 719 (5th Cir. 1984). In Texas, the duty of loyalty has been described as requiring a director to “act in good faith and not to allow his or her personal interests to prevail over the interests of the corporation (also referred to as self-dealing).” In re Estate of Poe, at 63 (citing Gearheart Industries, 741 F.2d at 719). Similarly, Delaware courts have stated the duty of loyalty mandates that directors and in good faith and that “the best interest of the corporation and its shareholders takes precedence over any interest possessed by a director, officer or controlling shareholder not shared by the stockholders generally.” Cede & Co. v. Technicolor, Inc. 634 A.2d 345, 361 (Del. 1993). The duty of care generally “requires a director to be diligent and prudent in managing the corporation’s affairs.” In re Estate of Poe, at 63 (citing Gearheart Industries, 741 F.2d at 719); accord Cede & Co., 634 A.2d 345, 367-369 (Del. 1993).

Directorial Fiduciary Duties as Applied to Stockholders

In both Texas and Delaware, even if elected by a majority owner, directors owe duties to the shareholders as a collective through the corporation—and not to any specific shareholder. See Ritchie v. Rupe, 443 S.W.3d 856, 883 (Tex. 2014); also see Klaassen v. Allegro Dev. Corp., 2013 WL 5967028, at *11 (Del. Ch. Nov. 7, 2013) (citing Unocal Corp. v. Mesa Petroleum Co, 493 A.2d 946, 955 (Del. 1985). Texas courts emphasize the running of fiduciary duties to the corporation itself, as opposed to the stockholders. See In re Estate of Poe, — S.W.3d —, 2022 WL — (Tex. June 17, 2022) [20-0178]. In contrast, Delaware courts hold that directors owe duties directly to stockholders, including minority shareholders. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 176 (Del. 1986); Odyssey Partners, L.P. v. Fleming Companies, Inc., 735 A.2d 386 (Del. Ch. 1999).

Fairness to Whom? That is the Question.

In many cases (but certainly not all), this may be a distinction without a difference. Texas courts do not determine the best interest of the corporation only through the perspective of majority shareholders. Ritchie, 883 n. 53 (Tex. 2014) (citing Holloway v. Skinner, 898 S.W.2d 793, 797 (Tex. 1995)). Generally, Texas courts will provide a remedy when controlling majority stockholders act to serve their own interest at the expense other shareholders. Id. However, in reviewing corporate actions for breach of fiduciary duty, Delaware courts extend fairness evaluations further in favor of stockholders. Compare In re Estate of Poe, — S.W.3d — (Tex. 2022) (holding that the trial court improperly instructed the jury to evaluate a transaction’s fairness to the plaintiff shareholder, instead of to the corporation) with Emerald Partners v. Berlin, 787 A.2d 85 (Del. 2001) (holding that in a fairness review, the question is whether the challenged transaction was entirely fair to the shareholder plaintiff). The Delaware Supreme Court has construed the fiduciary duty relationship as shouldering directors with a “basic duty of fairness” and a “requirement to treat shareholders and their equity interest in the corporation fairly.” Solomon v. Armstrong, 747 A.2d 1098, 1111 (Del. Ch. 1999).

Duties as Applied to Preferred Shareholders

Duties to preferred stockholders are “primarily . . . contractual in nature as they involve the rights and obligations created by a certificate of incorporation or a designation. See WatchMARK Corp. v. Argo Global Capital, Civil Action No. 711-N, at *1 (Del. Ch. Nov. 4, 2004); Rothschild Intern. Corp. v. Liggett Group, 474 A.2d 133 (Del. 1984); see also Wineinger v. Farmers’ Stockmen’s Loan, 278 S.W. 932, 935 (Tex.Civ.App. 1926); Cotten v. Weatherford Bancshare, Inc., 187 S.W.3d 687 (Tex.App. 2006), disapproved on other ground by Ritche, 443 S.W.3d 856, 866 (Tex. 2014). Their preferences must be clearly expressed and “will not be presumed.” Rothschild, 474 A.2d 133 (Del. 1984). Additionally, Delaware courts have held that preferred stockholders are owed fiduciary duties only when the right allegedly harmed “is shared equally with the common stock.” In re Trados Inc. S’holder Litig., 73 A.3d 17, 39-40 (Del. Ch. 2013). Texas courts do not appear to have addressed the scope of general corporate fiduciary duties as applied to claims of preferred stockholders. But given their focus on duties owed to the corporation and the shareholders collectively, it seems likely Texas Courts would agree that there are circumstances in which control persons can breach fiduciary duties to corporations through changes to corporate capital that result in harm to preferred shareholders.

Controlling Stockholders and Fiduciary Duties  

In addition to directors, controlling stockholders can owe fiduciary duties to the corporation in certain situations because they can act selfishly “to the detriment of the corporation’s minority stockholders. In re Nine Sys. Corp. S’holders Litig., 2014 WL 4383127, at *61 (Del. Ch. Sep. 4, 2014). This includes when they “stand on both sides of [a] transaction” with the corporation. Id. Both Delaware and Texas courts recognize this principal, but Texas case law is not as developed regarding the situations in which controlling stockholders have such duties. Nonetheless, Texas courts will apply fiduciary duties to controlling stockholders or groups when they act “as directors.” See Ritchie v. Rupe, 443 S.W.3d 856, 883 (Tex. 2014) (citing Int’l Bankers Life Ins. Co. v. Holloway, 368 S.W.2d 567, 577 (Tex. 1963); Gearheart Industries, inc. v. Smith Intern., Inc. 741 F.2d 707, 719 (5th Cir. 1984)). Practically, this means that in both Texas and Delaware minority stockholders can, on behalf of the corporation, seek relief against controlling stockholders when they act in manner that favors their own interests and harms the corporation or other shareholders.

Conclusion – Insider Financings Create the Most Risk

Consistent with the “twice-testing” principle, a stockholder can challenge actions taken in furtherance of an equity financing on the grounds they were in breach of the duty of care or the duty of loyalty. For example, if the price at which newly issued shares are offered to an outside party is unreasonably low given the value of the company, board members may be sued for having failed to exercise due care in informing themselves of the value of the company or in failing to seek an investor willing to pay a higher price. But most saliently, directors and controlling stockholders who approve actions in furtherance of dilutive equity financings and recapitalizations are subject to claims of breach of fiduciary duty when they are interested in the transaction.

When insiders seek to benefit themselves or associated persons by leveraging board or other control positions, they become exposed to claims for breach of the duty of loyalty and the evaluation of actions under fairness reviews. In these circumstances, in both Texas and Delaware, the affected shareholders may bring derivative fiduciary duty actions for any injury sustained by the corporation through a charter amendment and recapitalization. In some cases, they may bring direct claims. The likelihood that a finder of fact determines a director or controlling shareholder breached a duty in approving or taking a corporate action will depend on the standard of review applied in analyzing the challenged corporate actions. The next post in this series will focus on the standards of review applied by Texas and Delaware courts in evaluating compliance with fiduciary duties in corporate transactions resulting in equity dilution.

 

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The post Changes to Corporate Capital in Equity Financing Transactions, Part II. appeared first on Freeman Law.

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