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In re Lonestar Logo & Signs, LLC

Court of Appeals of Texas, Third District, Austin

May 31, 2018

In re LoneStar Logo & Signs, LLC; Media Choice, LLC; and Vincent Hazen

          ORIGINAL PROCEEDING FROM TRAVIS COUNTY

          Before Justices Pemberton, Field, and Bourland

          OPINION

          Bob Pemberton, Justice

         The pivotal issue presented in this mandamus proceeding is whether a former-but not current-member of a Texas limited liability company has standing to assert derivative claims on that entity's behalf. At least in the posture of this proceeding, the former member does not.

         BACKGROUND

         The underlying litigation concerns two successive Texas Department of Transportation contracts to operate TxDOT's "Informational Logo Sign and Tourist-Oriented Directional Sign Program, " the program involving the now-familiar blue signs on Texas highways that advise motorists of participating businesses accessible from upcoming exits. In 2006, TxDOT awarded this "logo-sign contract" jointly to Media Choice, LLC (one of the relators here), and Quorum Media, LLC, for an initial five-year term beginning on January 1, 2007, with optional extension (ultimately exercised) for another five-year term (i.e., through December 31, 2016).[1] In advance of the effective date, Media Choice and Quorum Media formed, under Texas law, a third LLC-LoneStar Logos & Signs, LLC (LoneStar 1), also a relator here-for the express purpose of performing "all of the[ir] day-to-day operational responsibilities" under the 2006 logo-sign contract. To that end, the three executed a "Management Agreement" assigning those duties to LoneStar 1 during the 2006 logo-sign contract's term.[2]

         As the December 31, 2016, termination of the 2006 logo-sign contract approached, TxDOT solicited bids for a new ten-year logo-sign contract to commence on January 1, 2017. Media Choice bid on this contract, and a new LLC was formed-LoneStar Logos Management Company, LLC (LoneStar 2)-to assist Media Choice with the proposal and to perform its day-to-day operational responsibilities under the contract, similar to LoneStar 1 under the prior logo-sign contract, in the event Media Choice was successful. Media Choice ultimately won the contract, and it and LoneStar 2 have operated the logo-sign program since January 1, 2017. Meanwhile, upon the December 31, 2016, termination of the 2006 logo-sign contract and the Management Agreement, LoneStar 1 ceased business operations, although the entity remains in existence.

         At relevant times, the ownership of LoneStar 1 has consisted of six members: Media Choice, which holds approximately 52.26 percent; Dunster Live, LLC, which holds thirty percent; and four members that hold interests of less than ten percent each, which include relator Vincent Hazen, who owns a 5.5 percent interest.[3] Five of these six members-excluding only Dunster-also own the entirety of LoneStar 2. This distinction is a key focus of the underlying litigation, in which Dunster seeks damages based on allegations that the five LoneStar 1 majority owners acted wrongfully in pursuing and securing the 2017 logo-sign contract with their new LoneStar 2 entity as operator, as opposed to a continued or repurposed iteration of LoneStar 1, and thereby excluding Dunster from the benefits they enjoy under that contract.[4] The defendants include LoneStar 2, relator Media Choice, and relator Hazen. Dunster purports to assert claims both in its individual behalf (complaining, e.g., of a "covert scheme" by defendants to enrich themselves at Dunster's expense) and derivatively on behalf of relator LoneStar 1 (alleging, e.g., that defendants wrongfully utilized LoneStar 1 assets to benefit LoneStar 2). In the latter regard, Dunster has included LoneStar 1 as a nominal defendant.

         Relators acknowledge that the five LoneStar 1 majority owners sought deliberately to exclude Dunster from their dealings relating to the 2017 logo-sign contract-and maintain that they possessed both the legal right and good reason to do so.[5] But the immediate focus of the present proceeding is the threshold question of Dunster's standing to pursue its derivative claims. Relators and other defendants challenged Dunster's standing below through a motion for partial summary judgment seeking dismissal of all claims of LoneStar 1 that Dunster was purporting to assert on that entity's behalf.[6] The motion asserted two related grounds.

          First, the movants sought to establish as a matter of law that Dunster had ceased to be a member of LoneStar 1 in October 2016-before Dunster filed the present lawsuit[7]-when LoneStar 1 through its managers had redeemed Dunster's interest after Dunster failed to pay a capital call timely. In support, the movants presented summary-judgment evidence regarding the circumstances of this capital call and the redemption in an effort to establish that these actions had been within LoneStar 1's rights under the company agreement and effective legally. In response, Dunster disputed the legal effectiveness of the redemption under the company agreement. Dunster also argued, as further grounds for avoiding summary judgment, that the "purported redemption" was void or ineffective "due to the breach of fiduciary duties by the other members and managers of LoneStar [1]" and because it lacked "a valid business purpose." The movants countered that Dunster had failed to raise a fact issue as to any of these grounds, and that their summary-judgment proof had established a valid business purpose conclusively.

         The second ground on which the movants relied was purely one of law-the October 2016 cessation of Dunster's member interest, they asserted, had also terminated Dunster's standing to assert derivative claims on that entity's behalf. In response to that assertion, Dunster insisted that the movants had not invoked any standing requirement that was properly applicable to LoneStar 1 and that Texas law at most would have required merely that Dunster had been a member of LoneStar 1 at the time the derivative claims had accrued. Because Dunster had been a member of LoneStar 1 during this time period, it reasoned, it satisfied any standing requirement that Texas law could have imposed on it.

         The district court granted the motion as to the movants' first ground but denied it as to the second. The court ruled that "Plaintiff Dunster Live, LLC's membership interest in LoneStar Logo & Signs, LLC was redeemed and Plaintiff Dunster Live, LLC ceased being a member of LoneStar Logo & Signs, LLC as of October 13, 2016." But this cessation of membership did not negate Dunster's standing, the court further held, because "Plaintiff Dunster Live, LLC was a member at the time its derivative claims accrued and, therefore, it has standing to bring its derivative claims."

         Relators now seek mandamus relief from the portion of the district court's order that denied its second summary-judgment ground. They urge us to direct the district court to vacate that portion of its order and instead grant their motion in full and dismiss all of the claims that Dunster asserts on LoneStar 1's behalf.

         ANALYSIS

         We may issue a writ of mandamus to correct a trial court's "clear abuse of discretion" where no "adequate" remedy by appeal exists.[8] Relators argue that the district court misinterpreted or misapplied governing Texas law-a type of abuse of discretion[9]-in denying them summary judgment after having determined as a matter of law that Dunster's membership interest had ceased in October 2016, before it filed suit. Relators rely on what they view as a "straightforward principle of Texas law"-"a non-member of [an LLC] does not have standing to assert derivative claims on behalf of the company." Relators further profess to lack an "adequate" appellate remedy for the harm done by allowing Dunster's derivative claims to go forward despite, as they see it, its lack of standing to assert those claims. We agree with both of relators' assertions and that mandamus is appropriate.

         As both sides appear to acknowledge, the legal principles governing derivative claims brought on behalf of LLCs are, at least with respect to this case, materially identical extensions or analogues of those that have developed in regard to shareholder-derivative actions on behalf of corporations. The shareholder-derivative action is rooted historically in equity and evolved for the "purpose of . . . afford[ing] a means by which a stockholder, powerless to bring a direct civil action at law against faithless directors and managers, may seek to vindicate corporate rights that the corporation itself has refused to enforce."[10] This remedy for shareholders was deemed "justified only by [the] proprietary interest created by the stockholder relationship and the possible indirect benefits the nominal plaintiff may acquire qua stockholder of the corporation which is the real party in interest."[11] From these rationales has followed the rule, recognized in Texas as elsewhere, that a corporate shareholder (and, by logical extension, an LLC member) must have and maintain that ownership status in order to have standing to prosecute derivative claims on the entity's behalf.[12]And while Texas courts have recognized an equitable exception to this ownership requirement where a shareholder's interest is "destroyed" involuntarily without a valid business purpose, [13] the district court has determined that this exception is not applicable here by granting partial summary judgment recognizing that the redemption had been effective in causing Dunster to "cease[] being a member of LoneStar Logo & Signs, LLC as of October 13, 2016."[14]

          In insisting that it possesses standing to bring derivative claims despite this pre-suit loss of member status, Dunster relies principally on provisions within Subchapter J of Chapter 101 of the Business Organizations Code. Chapter 101 is Texas's primary statutory framework governing LLCs, and Subchapter J, consisting of Sections 101.451 through 101.463, addresses "derivative proceedings."[15] Subchapter J parallels the statutes governing "derivative proceedings" involving for-profit corporations, currently found in Subchapter L of Business Organizations Code Chapter 21.[16] Consequently, as both sides recognize, Subchapter L and its analogous predecessors inform the meaning and application of Subchapter J, as well.

         Section 101.451 defines a "derivative proceeding" within Subchapter J, in relevant part, as "a civil suit in the right of a domestic limited liability company."[17] Sections 101.452 through 101.459 then prescribe a series of limitations and procedural requirements that generally apply in "derivative proceedings." Among these are provisions aimed at affording the managers the power to exercise their business judgment in deciding whether the LLC should pursue the purported claims, including the requirement of a demand[18] and provisions for mandatory dismissal based upon the good-faith determination by disinterested and independent managers or a special investigative committee that pursuit of the claims is not in the LLC's best interest.[19] Additionally, Section 101.452, titled "Standing to Bring Proceeding, " prescribes the following additional requirements:

         A member may not institute or maintain a derivative proceeding unless:

(1) the member:
(A) was a member of the limited liability company at the time of the act or omission complained of; or
(B) became a member by operation of law from a person that was a member at the time of the act or omission complained of; and
(2) the member fairly and adequately represents the interests of the limited liability company in enforcing the right of the limited liability company.[20]

         The Texas Supreme Court has described the analogous provision governing shareholder-derivative suits as "statutory standing."[21] Subsection (1) of the provision codifies or incorporates the so-called "contemporaneous ownership" requirement, [22] which seeks to prevent subsequent purchasers of interests in an entity from speculating in litigation and purchasing grievances in order to sue the entity's governing body or officers.[23]

         However, Section 101.463 prescribes different requirements with respect to "closely held" LLCs, [24] a category that undisputedly encompasses LoneStar 1.[25] It provides, "Sections 101.452-101.459 do not apply to a closely held limited liability company."[26] The import and effect of this exemption, as the Texas Supreme Court has observed in regard to the parallel provisions that govern shareholder-derivative suits, are that "the Legislature has enacted special rules to allow its shareholders to more easily bring a derivative suit on behalf of the corporation, " including "without having to prove that they 'fairly and adequately represent[] the interests of' the corporation, without having to make a 'demand' upon the corporation, as in other derivative actions, and without fear of a stay or dismissal based on actions of other corporate actors in response to a demand."[27] Section 101.463 also affords trial courts discretion, "[i]f justice requires, " to treat "a derivative proceeding brought by a member of a closely held limited liability company . . . as a direct action brought by the member for the member's own benefit" and to order "a recovery in a direct or derivative proceeding by a member [to be] paid directly to the plaintiff or to the limited liability company if necessary to protect the interests of creditors or other members of the limited liability company."[28]

         The Texas Supreme Court has determined that the statutory standing, demand, and mandatory-dismissal provisions applicable to shareholder-derivative actions represent "a statutory equivalent" enacted by the Legislature to supplant the iteration of the action that had evolved in equity or common law.[29] It follows, in that court's view, that the exemption for closely held corporations, coupled with the analog to Section 101.451's definition of a "derivative proceeding" as "a civil suit in the right of a domestic corporation, " had the effect of codifying a version of the shareholder-derivative action authorizing "a shareholder of a closely held corporation [to] bring a derivative proceeding in the right of the corporation" free of the statutory standing, demand, and mandatory-dismissal requirements that would otherwise apply, and that these additional requirements did not survive in equitable or common-law form as a default.[30]

         The gravamen of Dunster's standing theory is that Sections 101.463 and 101.451, as the Texas Supreme Court has construed this same language in regard to shareholder-derivative suits, codifies a version of the derivative action that also eliminates any requirement that a claimant presently possess member status in order to assert derivative claims on behalf of a closely held LLC. In the alternative, Dunster asserts that it satisfies the contemporaneous-ownership requirement in Section 101.452 because it still had member status when the derivative claims accrued; this is the rationale on which the district court expressly relied when ultimately denying summary judgment on the standing issue. Both rationales rest upon the premise that the Legislature in Subchapter J intended to eliminate any requirement of present member status from the "derivative proceeding" it codifies. The statutory language does not go that far, nor has the Texas Supreme Court so held.

         As an initial observation, the implications of Dunster's standing theory should give some pause-Dunster's reasoning seemingly would imply that a litigant need not meet standing requirements of any kind in order to bring a derivative suit on a closely held LLC's behalf. Suggesting otherwise, Dunster insists that Section 101.463's provision allowing trial courts to treat "a derivative proceeding brought by a member of a closely held limited liability company . . . as a direct action brought by the member for the member's own benefit" has the effect of making a plaintiff's standing to assert derivative claims contingent on its standing to assert direct claims, in essence collapsing the two requirements into one. Not so. As the Texas Supreme Court has explained regarding parallel statutory language governing closely held corporations, "the proceeding still must be derivative."[31] And as relators urge, a "fundamental" and "definitional" attribute of a "derivative action, " as long known to Texas law (and more generally), is that the claimant possesses a present ownership interest in the entity on whose behalf it purports to sue, such that it has a stake in the outcome of those claims.[32] We are ...


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