The Texas Supreme Court held that individual shareholders cannot sue third parties based on agreements those parties made with the shareholders' corporate entity, even when the shareholders claim the agreement creates separate duties to individual shareholders. The court ruled that shareholders must pursue such claims through derivative actions on behalf of the corporation.
In *In re UMTH General Services, L.P.*, the court addressed whether shareholders of United Development Fund IV, a Maryland real estate investment trust with more than 12,000 shareholders, could bring direct claims against the fund's advisor based on an advisory agreement. Justice Bland delivered the opinion for the court, with Justice Hawkins not participating in the decision.
The case involved United Development Fund IV, which appointed UMTH General Services, L.P., as an advisor in 2014 to manage the trust's investments and day-to-day operations under the supervision and control of the board of trustees. The shareholders argued that the advisory agreement created duties to them individually, separate from obligations to the corporate entity as a whole.
The Texas Supreme Court rejected this argument, holding that "the agreement does not create a duty to individual shareholders distinct from obligations to the entity." The court emphasized that shareholders "must pursue claims for an injury to the entity via a derivative action." Without both a personal cause of action and an individual injury, the court ruled, shareholders lack the capacity to bring claims that the corporate entity owns.
The decision reinforces the fundamental principle of corporate law that distinguishes between the rights of a corporate entity and the rights of its individual shareholders. Under this doctrine, agreements made with a corporation generally create duties to the corporation itself, not to individual shareholders, unless the agreement explicitly creates separate individual duties.
The trust's governing documents supported this interpretation. The declaration of trust explicitly limited shareholders' rights, providing that shareholders are entitled "only to those rights provided in the Declaration." The shareholders "have no interest in the assets of the Trust" and "have no right to compel any partition, division, dividend or Distribution of the Trust or of its assets."
Additionally, the trust's bylaws designated Maryland as the exclusive forum for derivative actions brought on the trust's behalf, indicating that the organizational structure contemplated derivative rather than direct shareholder litigation for entity-related claims.
The court's ruling has significant implications for corporate governance and shareholder litigation. By requiring shareholders to pursue derivative actions rather than direct suits against third parties who contract with their corporation, the decision maintains clear boundaries between corporate and individual rights. This protects the integrity of the corporate form while ensuring that claims belonging to the entity are pursued through appropriate procedural channels.
Derivative actions require shareholders to meet specific procedural requirements and often face additional hurdles, including demand requirements and the business judgment rule. However, they ensure that any recovery benefits the corporation and all shareholders proportionally, rather than allowing individual shareholders to pursue claims that properly belong to the entity.
The decision also clarifies the analysis courts must undertake when determining whether shareholders have standing to sue third parties. Courts must examine whether the agreement at issue creates duties specifically to individual shareholders, distinct from duties owed to the corporate entity. Absent such individual duties and corresponding individual injuries, shareholders cannot bypass the corporate form to pursue direct litigation.
This ruling follows established precedent that protects the corporate entity doctrine, which serves important policy purposes including encouraging investment, limiting liability, and providing clear rules for corporate governance. By maintaining these boundaries, the court preserves the benefits of the corporate form while ensuring that corporate claims are pursued through proper channels.
The court conditionally granted mandamus relief and directed the trial court to dismiss the case with prejudice, indicating that the shareholders cannot cure the defects in their claims through amendment. This final disposition suggests that the court viewed the lack of individual duties and standing as fundamental rather than procedural.
For practitioners, the decision emphasizes the importance of carefully analyzing the source of claimed duties and injuries when advising shareholders considering litigation against third parties who contract with their corporation. Shareholders seeking to challenge third-party conduct must demonstrate either individual duties owed specifically to them or pursue derivative actions on behalf of the entity.
The case also highlights the significance of corporate governing documents in defining shareholder rights. The trust's declaration and bylaws clearly limited shareholder rights and specified procedures for entity litigation, which the court found determinative in its analysis.
This ruling reinforces Texas law's protection of corporate entity principles and provides guidance for courts addressing similar shareholder standing issues in future cases involving third-party agreements with corporate entities.