With today’s order list, The Texas Supreme Court issued opinions in three new cases and granted rehearing to issue a substituted opinion in another. No new petitions were chosen for the fall argument calendar.

Today’s opinions involve a significant question about how to bring shareholder derivative suits in Texas (including a procedural holding relevant to many other mandamus cases), state liability for loose gravel on the roadways, and tort liability for jailhouse suicides.

My case summaries follow the break.

Prerequisites for shareholder derivative suits against Texas corporations

In re Harold R. Schmitz, No. 07‑0581 (DB).

This mandamus action asked what prerequisites are required for a shareholder derivative suit under Texas law. In a shareholder derivative suit, the plaintiff-shareholders sue on behalf of the corporation’s interests. Under the Model Business Corporation Act that was adopted in Texas, these shareholder-plaintiffs must, as a prerequisite to suit, demand to the board of directors that the corporation file the suit in its own name. Only if the corporation fails or refuses to file suit can the shareholders step into the corporation’s shoes to do so.

Justice Brister wrote the opinion. Chief Justice Jefferson did not sit. (( His brother was counsel for the Relators. ))

The demand letter read:

We write to insist that you confirm to us, in writing, no later than noon on Wednesday, December 21, 2005, that, in light of a superior offer having been received for the Lancer Corporation (“Lancer” or the “Company”) at $23 per share, you are taking no further steps to consummate or in any way facilitate the previously announced sale to Hoshizaki America, Inc. (“Hoshizaki”) at $22 per share. Your fiduciary obligations require that you fully and fairly consider all potential offers and that you disclose to shareholders all of your analysis that leads to your recommendation regarding the pending sale to Hoshizaki or any other offers made.

The Court held that this demand was inadequate, for two reasons. First, it did not name a shareholder. Second, it did not state its claim with sufficient particularity.

1. The demand must specify a shareholder by name.

Easy to say; easy to do. In most (future) cases, this should not matter at all.

The Court explains that a corporate board might want to know the shareholder’s identity in order to assess the seriousness or veracity of the claims. In the Court’s cute formulation, “a demand from Warren Buffett may have different implications than one from Jimmy Buffett.” (( Perhaps the board would be more likely to assume control of a meritorious claim brought to its attention by Jimmy Buffett rather than one suggested by Warren Buffett, who could be presumed to be a more sophisticated shareholder litigant on the corporation’s behalf. The incentive problem comes when the defendants would be the board members themselves — they might rather see Jimmy Buffett trying to sue them.

Here’s where the old futility rule made some sense. You want board members focused on who should be the plaintiff representing the corporation, not who they’d rather see suing them for violating their duties as board members. ))

Of course, if a big-name shareholder wants to get the board’s attention, that can be done in forms other than a demand letter. And if a big-name shareholder wants to file a derivative suit without sparking the board’s defensive radar, he need merely join forces with some smaller shareholders who can lead that charge. (( If getting the board to refuse the demand is the goal, it might be easy enough for a letter to name just small shareholders while not mentioning any big-name shareholders, in order to avoid triggering the board’s defensive actions.

The Court’s decision doesn’t suggest that the letter name all the shareholders who will be named as part of the derivative action. That sort of rule could entangle lots of actions down the road, as named shareholders are often substituted, dropped, or added later to satisfy other legal requirements. A rule requiring all shareholders to be named would accelerate some of the concerns about class representation into the demand letter phase, when the corporate board’s focus is supposed to be on the merits of filing suit not on how individual board members might defend themselves against one.

That’s how the demand requirement differs from most presentment-type statutes requiring notice be given before suit is filed. Those statutes usually involve notice to the potential defendant to raise the possibility of settlement. But, here, the demand gives a chance for the corporation to become the plaintiff in the suit. It’s only happenstance that the letter is sent to potential defendants, the board members. ))

The Court’s real concern comes near the end: “[W]e are concerned with the potential for abuse if demands can be sent without identifying any shareholder. The letter here was on the letterhead of a California law firm whose principal prosecuted hundreds of stockholder derivative actions, and later pleaded guilty to paying kickbacks to shareholders recruited for that purpose. His actions have been described by one federal court as the cause of much of the criticism about derivative suits…”

The Court’s holding that the law requires a shareholder be named seems motivated as much by distrust of lawyers as by having a more meaningful demand letter. That reflects badly on all of us.

2. The demand must state the claim with particularity.

This is the fuzzier area.

The demand letter said, in essence, “You’re selling the company for $22 per share when we know you have an offer for $23. We don’t understand why.”

This is where the futility rule made sense. The board is being asked to decide whether the corporation should sue… the board of directors. (I’d love to know how often that happens.) But the futility rule was rejected by the 1997 amendments to the statute. (( The Court explains:

Included [in 1997] were changes to article 5.14 to conform Texas derivative actions to the Model Business Corporation Act. Article 5.14(C) now provides that “[n]o shareholder may commence a derivative proceeding until … a written demand is filed with the corporation setting forth with particularity the act, omission, or other matter that is the subject of the claim or challenge and requesting that the corporation take suitable action.” Unlike Texas law for a century before, the new provision requires presuit demand in all cases; a shareholder can no longer avoid a demand by proving it would have been futile.

)) So, the board must be asked.

And the Court held that this demand letter was insufficiently particular to alert the board to a possible lawsuit. The Court explained that sometimes an offer of $23/share is less valuable than one for $22/share, such as if one of the amounts is priced as shares of acquirer stock (rather than cash) or if there are other conditions attached to the merger. So, the Court concluded, more details were necessary to explain to the board why there might be a claim here.

In a non-merger context, I would tend to agree. But, in a merger context, I’m more skeptical. It’s not clear what the demand letter could possibly have added to the board’s deep knowledge of those two proposals — one imagines that there were deal rooms full of material and that the board had carefully reviewed both deals.

Keep in mind what the board is being asked to decide about the demand letter: (A) the corporation should file the lawsuit in its own name, or (B) the corporation does not want to file the suit itself, letting the shareholders’ suit go forward. There is no option (C) to kill the suit.

In this context, one suspects the board had enough information to decide between (A) and (B). The Court’s holding today might suggest that the demand letter itself has to include enough information to make an initial assessment, regardless of what other information can be presumed to be at the board’s fingertips.

This demand letter could certainly have gone into more details about why the shareholders believed one offer to be superior to the other. If the shareholders did have information not available to the board, they could have offered some of it. (Curiously, because the board members would be the defendants, this would perhaps weaken the corporation’s eventual hand in any litigation that is filed. But that was perhaps the Legislature’s choice in getting rid of the futility rule.)

The Court does not provide guidance on how much particularity would have been enough, given this context, or what it would take in future cases. But future shareholder-plaintiffs are cautioned to err on the side of overinclusion.

Now that the board has dissolved, a future suit is foreclosed

The Court’s concern seems to be that, once the merger has gone through, there is no meaningful way to ever fix the defects in this demand letter.

Allowing this case to proceed to trial would effectively allow a shareholder to sue for damages connected with a merger without giving the corporation’s board an opportunity to make such a decision for itself.

Under the old statute, this might be a perfect example “futility,” and shareholders might be able to proceed without filing a demand letter at all.

But under the new statute, as explained by the Court today, the board must consider all demands. Because it is no longer possible for the board to consider whether it should file such a lawsuit in the interest of all shareholders, individual shareholders can no longer step into the (former) corporation’s shoes.

In counties with a centralized docket, which judge is the proper Respondent to a mandamus petition?

The Court also addressed a procedural question relevant to counties that have a centralized docket system for pretrial motions, such as Bexar County (San Antonio). In Bexar County’s system, “pretrial motions are generally heard by a presiding judge — one of the county’s 13 civil district judges who rotate monthly in that position.”

Here, the suit was filed in the court of Judge Lori Massey, but that judge did not hear this pretrial motion. Instead, it was decided by the presiding judge assigned at the time to hear such motions, Judge Gloria Saldaña.

This mandamus action should be directed at one of these judges, but not both.

And, here, that choice takes on great significance because Judge Massey has subsequently left office, but judge Saldaña remains. (( Mandamus law has a principle that — if the judge leaves office — any then-pending mandamus action should be abated to permit the new holder of that judicial office to first consider the motion. ))

The Court held that, for judicial orders, the proper respondent “should generally be the judge who made the ruling.” Here, that would be Judge Saldaña.

The Court explained why the rule looks back to the judge who made the decision rather than forward at the judge who may hear the next step of the case:

[I]t is never entirely predictable who will preside over a case when it returns to a trial court, as Texas law allows judges to sit for one another whenever they choose. This is especially true in counties with a central docket like Bexar County, as the presiding judge hearing pretrial matters changes monthly.

The Court’s holding means that this particular mandamus petition can avoid abatement. In future cases, applying this same rule may lead to more abatement, such as if the presiding judge chosen in a county like Bexar leaves office shortly after holding that post. But some judge had to be specified, and the Court’s choice seems consistent with the abatement rule’s concern that a new judge be given the chance to make the right ruling before a writ issues against them.

Loose gravel caused by repaving is not a “special defect” creating state liability for an automobile accident

Texas Department of Transportation v. York, No. 07‑0743 (per curiam) (DB).

The Court granted rehearing in this case and substituted a new opinion and judgment.

Back in December, the Court held that loose gravel was not a special defect and so the plaintiff could not prevail on a negligence theory. But the Court originally held the plaintiff could go back to the trial court on its fall-back theory that the state had actual knowledge of the dangerous condition.

With today’s grant of rehearing, the Court dismisses that secondary theory on procedural grounds. (Justice O’Neill noted her dissent to the grant of rehearing in York.)

Both opinions rejected the idea that loose gravel on the roadway could be a “special defect” for which the state might be subject to tort liability as if the motorist under a mere negligence — that is, if “the governmental unit should have known of a condition that created an unreasonable risk of harm.”

By contrast, for the state to be liable for a mere “premises defect,” the plaintiff would have to establish both the state’s actual knowledge and the plaintiff’s lack of knowledge of the same condition, not merely the state’s negligence.

The Court noted that the statute, while not defining “special defects,” likens them to excavations or obstructions. The Court concluded that loose gravel was not like an excavation or obstruction because it would not be a complete barrier. “Loose gravel does not form a hole in the road or physically block the road like an obstruction or excavation.” The Court noted the a large pile of gravel might indeed be an obstruction, but that a thin layer of loose gravel was in a different category and should be treated under the looser liability standard for mere premises defects.

The Court’s new opinion also disposes of the plaintiff’s premises defect theory without a remand. The state objected to that jury charge and suggested that the premises defect standard be submitted. Because the plaintiff did not ask the jury about actual knowledge questions, he had failed to get essential findings on that theory of liability the first time around.

The obvious lesson is that plaintiffs using a “special defect” theory might do well to also offer these additional questions (and offer additional proof) a a fallback to their principal theory if the appellate court views the condition differently than did the trial court.

A related petition

Texas Department of Transportation v. Gutierrez, No. 07‑1013 (per curiam)

The Court disposed of this related opinion, explaining how the case is controlled by today’s decision in York:

This appeal poses the same question we answer in another case decided today, Texas Department of Transportation v. York …: whether loose gravel on a road is a “special defect” under Texas Civil Practice and Remedies Code section 101.022(b). Because the court of appeals’ decision is incompatible with York’s holding that loose gravel is not a special defect as a matter of law, we reverse and dismiss the case for lack of subject-matter jurisdiction.

How the Tort Claims Act applies to jailhouse suicides

Dallas County v. Posey, No. 08‑0094 (per curiam) (DB)

The facts:

Bryan Posey was arrested for assaulting his mother. During the intake procedure, he denied ever having attempted suicide or having suicidal thoughts or tendencies. The standard intake procedure included completion of a Mental Disability/Suicide Screening Form, but the intake officer left blank a question that inquired whether the officer believed Posey to be a medical, mental health, or suicide risk. Posey was then seen by a nurse for a cut on his hand, and the nurse referred him to a psychiatrist for an anger management evaluation. Posey was placed in a holding cell with a cordless telephone. He made repeated, harassing calls to his mother, who requested that he be stopped from calling her. The officers moved Posey to a holding cell with an inoperative telephone. This telephone, however, had a cord. Shortly thereafter, the officers discovered Posey had committed suicide by hanging himself with the telephone cord.

The lawsuit alleged that the broken, corded telephone was a “condition or use” of state property that would perhaps fit within the Texas Tort Claims Act.

That framework is the Legislature has chosen. Accordingly, instead of focusing on the psychiatric screening, the Court must focus its decision on the telephone. (( The Court ended by directly addressing the argument that the county should be held liable for not properly screening Posey:

Finally, Posey’s parents argue that the county failed to properly assess Posey as a suicide risk, pointing to Posey’s incomplete suicide prevention screening form as evidence that the county’s immunity is waived under the Act. However, the quality of Posey’s assessment has no bearing on the county’s immunity.
))

The Court concludes that Posey’s use of the telephone was not a “use” of property within the meaning of the Tort Claims Act, because the statute was meant to regulate whether the government uses property negligently. Because Posey was the one handling the property, the statute did not apply.

So, too, the Court rejected the argument that the government should have removed the telephone prior to putting Posey in the cell — that, the Court is forced to explain, would have been a “mis-use” or a “non-use” of property, which are also not covered by the statute.

Nor did the Court believe that the broken “condition” of the phone contributed to this injury. “For a defective condition to be the basis for complaint, the defect must pose a hazard in the intended and ordinary use of the property.” Here, that might have meant electrical shock from exposed wiring when using the phone to attempt a call. But the use Posey made of the property was not the ordinary one.

Accordingly, the Court reversed the court of appeals and dismissed the action as barred by immunity.