“[A]s a general rule, it is only the private parties to contracts – as opposed to third parties or public authorities – who have the legal standing to sue for breach of contract.” See, generally, “Contract as Empowerment,” 83 U. Chi. L. Rev. 759, at note 120 (Spring 2016). But, “[e]very year, more than 100 reported court opinions consider the question whether an outsider can sue for damages under a contract made by others – in part because the law is so ambiguous.” See, discussion in “An ‘App’ for Third Party Beneficiaries,” 91 Wash. L. Rev. 1663 (Dec. 2016).

Both Kansas and Missouri follow the general rule that one must be a party or intended beneficiary of a contract to have standing to sue for breach of that contract. See, Verni v. Cleveland Chiropractic College, 212 S.W.3d 150, 153 (Mo. en banc 2007); compare, Cornwell v. Jesperson, 238 Kan. 110 at 115, 118, 708 P.2d 515 (1985), and Noller v. GMC Truck & Coach Div., General Motors Corp., 244 Kan. 612 at 617, 772 P.2d 271 (1989).

Neither Kansas nor Missouri treats the issue as one of capacity. The cases in both jurisdictions find that a plaintiff not a party to a contract lacks standing, not capacity. See, Midwestern Health Mgmt. v. Walker, 208 S.W.3d 295, 297 (Mo. App. 2006) (denial of assignment of account raised issue of standing, not capacity); Byers v. Snyder, 44 Kan. App.2d 380 at 385, 237 P.3d 1258 (Kan. App. 2010) (defense that plaintiffs not intended beneficiaries of contract raised issue of standing, implicating court’s jurisdiction).

This distinction has a difference. The rules of civil procedure lead to different methods of addressing lack of capacity vs. lack of standing.

Under the Federal and Kansas rules a plaintiff need not allege capacity to sue (except to establish jurisdiction in the federal court). F.R.Civ.P. 9(a)(1)(A), K.S.A. 60-209(a)(A). Under Missouri’s fact pleading rules a plaintiff need only plead the “ultimate fact” of capacity. Mo.R.Civ.P. 55.13. But, all of these rules require a party raising an issue of capacity to do so by specific denial supported by facts. F.R.Civ.P. 9(a)(2), K.S.A. 60-209(a)(2), Mo.R.Civ.P. 55.13.

On the other hand, the waiver provision of the rules does not apply to the defense of lack of subject matter. See, F.R.Civ.P. 12(h)(1), K.S.A. 60-212(h)(1), and Mo.R.Civ.P. 55.27(g).

In other words, the defense of lack of jurisdiction due to lack of standing cannot be waived. But, lack of capacity is waivable if not presented by specific denial. See, City of Wellston v. SBC Communs., Inc., 203 S.W.3d 189, 192 (Mo. en banc 2006); Douglas Landscape & Design, L.L.C. v. Miles, 51 Kan. App.2d 779 at Syl. ¶2, 355 P.3d 700 (Kan. App. 2015).

Since the cases in Missouri and Kansas treat the right to sue on a contract as providing standing for purposes of subject matter jurisdiction, a party can raise the issue at any time, even on appeal. See, Verni, supra, at 153; Byers, supra, at 385.

Texas courts handle this issue differently. In Texas, the right to sue as a party, intended beneficiary, or assignee of a contract provides capacity to sue.[1] If a defendant establishes that a plaintiff has no right to sue on a contract, the court must dismiss the plaintiff’s case on the merits, not for lack of subject matter jurisdiction. See, e.g., John C. Flood of DC, Inc. v. Supermedia, L.L.C., 408 S.W.3d 645, 650 (Tex.App.-Dallas 2013, pet. denied).

This difference means that in Texas a party must address the plaintiff’s right to sue on a contract immediately by a verified denial or waive the defense. Tex. R.Civ.P.93. But, in Kansas, Missouri, or federal courts not applying Texas law, a party can theoretically wait.

[1] Under Texas law a plaintiff must have standing and capacity. Coastal Liquids Transportation, L.P. v. Harris County Appraisal District, 46 S.W.3d 880,884 (Tex. 2001).

The normal rule is that a non-client may state a claim for legal malpractice against a lawyer only if the client intended the lawyer’s services to benefit the non-client. Donahue v. Shughart, Thomson & Kilroy, 900 S.W.2d 624, 628-629 (Mo. 1995) (establishing a balancing test for determining whether a lawyer owes a duty to a non-client). This is consistent with hornbook third party beneficiary law.

What if the client retained a lawyer to prepare or modify a trust or will naming beneficiaries but died without expressly stating (or including in the instrument) that he intended the lawyer’s services to benefit those beneficiaries?  The Missouri Court of Appeals has applied Donahue to imply such an intent from the settlor’s designation of the beneficiaries in the trust. Johnson v. Sandler, Balkin, Hellman, & Weinstein, P.C., 958 S.W.2d 42, 50 (Mo. App. 1997).

In Johnson, the beneficiaries under a trust established by their deceased father with the assistance of the father’s first lawyer sued the father’s second law firm for negligence in modifying the trusts to allow the father’s second wife to elect against the trust and deprive them of some of the proceeds. The Court of Appeals addressed the law firm’s contention that it had not performed services to benefit the plaintiffs, claiming that the decedent had not even instructed them to consider the plaintiffs:

“To satisfy Donahue, it is not necessary that the client advise the attorney drafting a will or a trust that he ‘intends to benefit’ the beneficiaries. The main purpose of retaining an attorney to prepare a testamentary trust is to ensure the future transfer of the settlor’s estate to the beneficiaries designated by the settlor…Therefore, an intent to benefit is inherent in designating persons as beneficiaries of a trust or will.” 958 S.W.2d at 50.

A few jurisdictions continue to hold that, absent fraud or collusion or malice, an attorney is not liable to a non-client for harm caused by the attorney’s negligence in drafting a will or trust. But, the majority of jurisdictions, like Missouri, recognize that intended beneficiaries harmed by a lawyer’s malpractice may maintain a cause of action against the lawyer even absent an attorney client relationship. See, Leak-Gilbert v. Fahle, 55 P.3d 1054, 1060 (Ok. 2002) (collecting cases at footnotes 15 and 16 and citing Johnson v. Sandler).

This post discusses the management of dissenters’ rights cases involving privately held corporations. These may be S corps, C corps, or LLC’s. They may be family owned or simply closely held. The common characteristic is a dispute between the majority in management and the minority.

Typically, the dispute arises because the minority shareholders consider that the majority in control of management of the company has in some way acted to prejudice the minority. The minority shareholders may claim breach of fiduciary duty, self-dealing, or fraud by the directors and sue for remedies under the common law. Or, the majority may use statutory procedures that enable them to “squeeze-out” the minority but obligate the company to pay “fair value” for the minority’s shares. The ensuing litigation may therefore involve both common law and statutory claims.

The term, “dissenters’ rights,” actually derives from the minority’s right to dissent from the majority’s statutory proceeding (typically a merger of the original corporation into a new corporation owned by the majority shareholders only). This right includes the entitlement to “fair value” for the dissenter.

1. Principal legal and factual issues

Some dissenters’ rights statutes expressly state that their fair value remedy is exclusive, typically with exceptions for fraud in the process. Most states, following either the Model Business Corporation Code or Delaware law, have incorporated some degree of exclusivity with exceptions into their case law. So, the first principal issue is whether the minority shareholder’s lawsuit is limited to a statutory fair value claim. Usually, a plaintiff can assert both common law claims and the statutory remedy if fraud or some form of self-dealing by the directors is present.

The legal and factual issues associated with common law claims are routine in the sense that they are similar to such claims outside of the dissenters’ rights context. They obviously may overlap with the issues in the statutory claims.

The issues in a statutory proceeding are different because (a) the judge is usually the trier of fact and (b) the statute, case law, or standards usually provide that “fair value” is measured at a date just before the statutory transaction, generally independent of the effects of the transaction. These two characteristics of a dissenters’ rights case lead to significant evidentiary issues, such as what facts are relevant to a valuation just before the transaction date.

The accepted standard is what was “known or knowable” at the valuation date, but that standard can provoke controversy as the judge decides what he may consider in valuing the plaintiff’s shares. So, there is considerable motivation by the party controlling the information (usually the majority in management) to limit or somehow modify the disclosure of information that might tend to increase the value of the dissenter’s shares. This motivation obviously leads to discovery issues and subsequently credibility issues.

2. What is the real source of the dispute?

On the surface, the answer to this question is easy. The dispute is about the value of the dissenting shareholder’s shares. The majority in management wants the amount to be low, and the dissenter wants the value to be high.

But, a disagreement about value usually has its roots in something more fundamental. Identifying that fundamental problem can assist not only in managing the case but also in resolving it. At worst, the fundamental problem may be that the shareholders have simply had a personal falling out (always potential in a closely held, even family, corporations), now have personal animosity, and cannot act rationally with respect to each other. At best, they have simply disagreed about the value. Understanding real source of the dispute is necessary to dealing with discovery issues and managing expectations.

3. How to maximize (or minimize) the “fair value?”

Developing the best strategy in a dissenters’ rights case means addressing several factors:

a. The party in control of the information (usually the majority in management) probably has a motivation and the ability to control and modify the information.

b. The dissenting shareholder may have had no involvement in management and may have little or no understanding of the business, its operation, or its records.

c. The judge as trier of fact may have insufficient time or inclination to understand the sometimes complex accounting issues required to value a business.

Each of these factors leads to challenges in discovery and proof of facts. The managing majority may resist any discovery, even alter records, and misstate the facts to suit its position on value. This potential increases when the plaintiff has no experience and so limited ability to recognize what is wrong. The plaintiff may have difficulty finding and presenting a “fact” witness, forcing reliance on expert testimony and cross-examination. Finally, a trial to the court may take an exceedingly long time, during which the presentation of evidence can become repetitive, the process expensive, and the judge can lose the ability to make difficult factual determinations. All of these factors can combine to make the whole experience emotionally difficult for the parties.

4. What are the challenges to the strategy?

Put differently, what are the unexpected pitfalls that can disrupt any well-planned strategy with mistakes? There are many, but they fall into a few categories:

a. Given the risk that a court may find the dissenters’ rights statutory remedy exclusive, the initial pleadings – even those premised on “notice” – are important. If the dissenting minority shareholder has a common law right of action, he must plead it carefully to come within the statutory or case law exceptions to exclusivity for fraud, breach of fiduciary duty etc knowing that the defendant will argue that the claim is simply about the price of the shares.

b. Given the control over the facts that the majority in management has, discovery must assume and counter efforts to limit and modify the truth. While good practice may assume this in any case, it is paramount in representing the minority, non-management shareholder. So, discovery can become more time consuming and expensive to achieve the necessary level of information.

c. If, as the plaintiff, the minority shareholder lacks personal information about the business and its operation, then the plaintiff needs to substitute another credible source of facts to preempt and counter the “story” from the defendant. The documents can help; cross-examination can help, and an expert can help. Whatever the approach, it is best to get the facts pinned down in deposition testimony ahead of trial to avoid time consuming, costly adjustments during trial. While trial lawyers often like to opt against detailed depositions before trial (for good reasons of cost, disclosure of approach etc), preemption of factual surprises may argue against that option in the dissenters’ rights case.

d. More than most cases, dissenters’ rights cases probably should be settled to save costs, avoid delays, and minimize the risk that the parties’ dislike for each other will color the proceeding. This means more attention to planning a settlement and working with counsel for the other side to carry it out.

Do shareholders have a fiduciary duty to one another? That is, in the context of being shareholders of the same corporation, can they act entirely for their own benefit or do they have a duty to act for the benefit of one another?

The default answer to this question is ‘no’. Shareholders are owners of the corporation and not the managers. Shareholders typically do not act in a management capacity and generally are free to vote or act in ways that benefit themselves, even if to the detriment of other shareholders.

This default can break apart in the context of a close or closely held corporation. A closely held corporation has few shareholders and usually those shareholders also serve as the directors and officers of the company. In that role, those shareholders also act in a management capacity. This relationship can be even more blurred when a shareholder holding the majority of the shares serves as a director or officer.

In these circumstances, it can be difficult to determine when shareholder should be acting for the benefit all the shareholders rather than for only themselves .

Think of a “corporation,” and you probably think of a large company with hundreds or thousands of shareholders with a separate board of directors. But a second kind of corporation exists alongside the large, public corporation. Known as the closely held corporation, close corporation, or even family corporation, this business structure differs in many ways.

The closely held corporation shares many of the characteristics of a public corporation in that it is formed by the filing of articles of incorporation, has shareholders, has bylaws (sometimes), and has a board of directors (sometimes).  An important difference exists in how the organization is managed. The entity has few shareholders and some or all of those shareholders also serve as the directors and officers of the corporation.

Business entities are primarily created by statute, but courts have long recognized the existence of the closely held corporation at common law. That is, courts have been willing to recognize that a corporation is “closely held” if it had certain characteristics.  For example, Missouri courts sometimes consider a corporation to be “closely held” if it has a small number of shareholders, does not have a public market for its stock, and its shareholders substantially participate in the business operations.

The purely common law existence of closely held corporations is now (mostly) an artifact of the past. Both Kansas and Missouri have enacted statutes creating the “close corporation.” In both states, a corporation must elect in its articles of incorporation to be a close corporation, and there is a limit to the number of shareholders of the corporation. Election to close corporation status means that the company falls under a different subset of statutory rules than the traditional corporation.

Nevertheless, the enactment of the statutory “close corporation” has not driven the common law “closely held corporation” extinct. Courts in both Kansas and Missouri continue to recognize its existence when the entity has not made the statutory election in its articles of incorporation but displays the characteristics of a closely held corporation.

Why does it matter? Because the duties owed to shareholders in a close (or closely held) corporation often are higher than in the typical public corporation. Meaning that directors (and sometimes shareholders) may owe a higher duty to the shareholder of a corporation displaying the qualities of a close corporation, even if it has not expressly elected such a status. Therefore, a shareholder in the “close corporation” or “closely held” corporation may be entitled to a higher duty of care than in a large, public company.

MISSOURI SUPREME COURT FINDS CONSUMER LOAN ARBITRATION CLAUSE UNCONSCIONABLE DESPITE U.S. SUPREME COURT DECISION

The Missouri Supreme Court previously held in 2010’s Brewer v. Missouri Title Loans, Inc. (“Brewer I”) that the inclusion of a class arbitration waiver in consumer title loan agreements was per se unconscionable. A year later, in AT&T Mobility, LLC v. Concepcion (“Concepcion”), the United States Supreme Court interpreted §2 of the Federal Arbitration Act (“FAA”) to prohibit that result. The Brewer I decision was subsequently vacated and remanded back to Missouri for further consideration in light of Concepcion.

In a duo of decisions issued on March 6, 2012, the Missouri Court rebuffed renewed efforts by payday and title loan companies to enforce such clauses in light of Concepcion. In Brewer v. Missouri Title Loans (“Brewer II”), the Court found that the arbitration agreement was unconscionable and unenforceable despite Concepcion, due to disparities in bargaining position of the parties and the one-sidedness of the agreement. Likewise, in Robinson v. Title Lenders, Inc. d/b/a Missouri Payday Loans (“Robinson”), they reversed the trial court’s order dismissing the case in reliance on Brewer I, and remanded it to the trial court for consideration of whether the arbitration clause, taken as a whole, was unconscionable and unenforceable.

In both cases, the Missouri Court revealed serious concerns about the fairness of class arbitration waivers, and threw the future enforceability of such agreements into question. More broadly, these decisions may signal an increasing willingness of the Missouri courts to disregard boilerplate arbitration agreements — which have become standard practice in American business — where the terms of the agreement may be regarded as unfair or excessively favorable to the draftsman.