Hotze v. In Mgmt., LLC

651 S.W.3d 19

David HOTZE; Donna Hotze, as Trustee; Bruce R. Hotze, Sr.; Elizabeth Hotze Sanchez; Bruce R. Hotze, Jr.; Christian Hotze Drake; Michele Hotze Supple; Ernest George Hotze, III; and Beth Hotze, as Trustee for the Bruce R. Hotze 2012 Family Trust, Appellants

v.IN MANAGEMENT, LLC; Inter Nos Barker Cypress, Ltd.; Inter Nos Odessa, Ltd.; Inter Nos Wichita, Ltd.; New Orleans in, Ltd.; Inter Nos Space Plus, Ltd.; Inter Nos Springville, Ltd. ; Inter Nos Pipeline, Ltd. ; Inter Nos Walker, Ltd.; Inter Nos TP Investments, Ltd. ; Richard Hotze, Individually and as Trustee of the Spy Glass Trust; Steven F. Hotze, Individually and as Trustee of the David Bradley SFH 2005 Family Trust; Mark Hotze, Individually and as Trustee of the Hotze Five Trust; Troika Partners; Peter Schwab; Edward Mattingly ; and Thomas Blackburn, Appellees

NO. 14-18-00995-CV

Court of Appeals of Texas, Houston (14th Dist.).

Opinion filed July 22, 2021

Jeff Joyce, Houston, William A. Taylor, Adrian V. Villacorta, Craig Trively Enoch, Melissa A. Lorber, Austin, for Appellant.

Paul Harty Doyle, Jesse R. Pierce, John Zavitsanos, Kent M. Adams, Don Jackson, Houston, Collin Dean Kennedy, Frisco, John C. Schwambach Jr., David E. Keltner, Jody Sanders, Fort Worth, Paul Smith, Kaitlyn Dawson, Eileen F. O'Neill, Houston, for Appellee In Management, LLC, Inter Nos Barker Cypress, Ltd., Inter Nos Odessa, Ltd., et al.

Michelle Meriam, Eileen F. O'Neill, Houston, for Appellee Peter Schwab, Edward Mattingly, and Tommy Blackburn ("Outside Director Appellees").

Panel consists of Justices Bourliot, Hassan, and Poissant.

Frances Bourliot, Justice

This case concerns a dispute among five brothers regarding control of a family-owned business, Compressor Engineering Corporation or "CECO." Two of the brothers, appellants David and Bruce Hotze, allege that the other three brothers, appellees Richard, Mark, and Steven Hotze, manipulated CECO's financial status to gain control of the company. Meanwhile, Richard, Mark, and Steven maintain that they merely undertook actions required to save CECO from impending bankruptcy and dissolution. Other parties to the lawsuit include trusts related to each of the brothers, family members, certain partnerships also owned by the brothers, and members of CECO's board of directors who had no ownership interest. Ultimately, CECO rebounded strongly from its financial troubles but Richard, Mark, and Steven ended up with greatly increased control of the company after debt CECO owed to Troika Partners, a partnership formed by the three brothers, was partially converted into CECO stock.

David, Bruce, and associated parties filed two lawsuits, bringing both individual and derivative claims. The lawsuits were consolidated for trial. A key issue in the case was whether the promissory note between Troika and CECO authorized a partial conversion of debt for stock. The trial court concluded that it did, and, so instructed, the jury found against David, Bruce, and the other plaintiffs on all claims. The trial court thereafter awarded certain defendants attorney's fees for successfully defending against claims under the Texas Theft Liability Act (TTLA).

Appellants raise five issues, asserting the trial court erred in (1) awarding attorney's fees to certain defendants for successfully defending against the TTLA claims; (2) refusing to invalidate the partial conversion of debt to CECO stock and instead instructing the jury that the promissory note authorized partial conversion; (3) allowing appellees to introduce evidence suggesting that the CECO board of directors relied on advice of counsel in approving the partial conversion but not permitting appellants to discover or introduce the substance of that advice; (4) rejecting appellants' claims relating to the indemnification and advancement of appellees' attorney's fees from certain jointly held business entities; and (5) construing appellants' trial pleadings as not raising a claim for breach of informal fiduciary duties.¹

We hold that the trial court erred in concluding the promissory note authorized a partial conversion of CECO stock and in instructing the jury in accordance with that conclusion. We also hold the trial court erred in awarding attorney's fees to appellees under the TTLA. Accordingly, we reverse and remand the trial court's judgment in part, modify the remainder of the judgment to remove the award of TTLA attorney's fees, and affirm the remainder of the judgment as so modified.

Background

CECO manufactures and sells parts for compressors and other oilfield equipment. It was founded in 1964 by the Hotze brothers' father, but by 2012, the five brothers combined owned almost 85 percent of the Class A voting shares. The remainder was owned by other family members or by a family member's trust. CECO began issuing Class B, nonvoting shares in 2012, with the shares being distributed among the Class A shareholders. Until 2014, all the brothers served as directors of CECO, and all except Steven were CECO employees.

The brothers also co-owned several limited partnerships, referred to as the Inter Nos entities, which existed primarily to lease assets to CECO. The brothers were also managers and members of IN Management, LLC, which served as the general partner for each of the Inter Nos entities.

In 2014, CECO experienced a financial crisis that started when a $6.3 million receivable owed to its wholly-owned subsidiary CECO Pipeline Services, Inc. was discovered to be worthless. At that time, CECO's and Pipeline's assets, including accounts receivable, were pledged as collateral on loans from Comerica Bank. When the worthless account was discovered, CECO's loans went into default because they were then under secured. This gave Comerica the right to foreclose, but it deferred this right under a forbearance agreement that required, among other things, an additional investment of $2.5 million into CECO. An investigation into the worthless receivable further revealed that Pipeline had suffered millions in losses and still owed a number of vendors. The situation purportedly put CECO close to bankruptcy.

Meanwhile, relationships among the brothers began to deteriorate. David was removed from the CECO board of directors in January 2015, and Bruce's roles as CEO and chairman of the board were terminated later that same year. At that point, the CECO board consisted of the remaining three brothers (Richard, Mark, and Steven) as well as four outside directors, three of whom are parties in this case and appellees in this appeal, Peter Schwab, Edward Mattingly, and Thomas Blackburn.

Richard, Mark, and Steven formed a partnership, Troika Partners, that borrowed $2.5 million from CECO outside director Schwab and then loaned it to CECO to satisfy Comerica's requirement of additional investment. Troika requested the loan agreement provide it with a right to convert the debt to CECO stock. The CECO board approved the loan, with Schwab and the remaining Hotze brothers abstaining.² Whether the Troika promissory note, executed on February 25, 2015, authorized a partial conversion of debt for CECO stock or only a full conversion was a hotly contested issue in the trial court and remains one in this appeal.

Three months later, on May 25, 2015, Troika notified CECO that it was going to convert a portion of the debt to CECO stock. As required under the note, an appraiser chosen by CECO's board appraised the value of CECO stock; the appraiser concluded the stock was worthless as of April 30, 2015. On September 22, the CECO board voted on whether to approve the partial conversion. Before the vote, Richard informed the directors that he had communicated with outside counsel regarding whether a partial conversion was authorized under the note, but he supposedly did not reveal what counsel advised. None of the brothers participated in the vote, two outside directors voted in person to approve the conversion, one outside director abstained, and one outside director gave his proxy to the one who abstained, who then voted the proxy to approve the conversion.

As a result of the conversion, Troika received 240,348 Class A shares at par value of $1.00 per share and 135,000 Class B shares at par value of $0.01 per share in exchange for waiver of $38,503.56 in principal and all interest accrued up to that point, totaling $203,194.44. After conversion, CECO still owed Troika $2,461,496.44 and the note was still in place. As a result of the new stock issuance, the ownership interest of all other parties was severely diminished and Troika owned over 96% of the voting shares. Several months after the conversion, Troika transferred its CECO shares to Richard, Mark, and Steven, who then transferred the shares to trusts. On February 7, 2018, the CECO board voted to ratify the actions taken on September 22, 2015, including approval of the conversion.

In 2016, David sued Richard, Mark, Steven, Bruce, IN Management, and the Inter Nos entities in what is referred to as the "Partnership Case." Bruce subsequently realigned as a plaintiff in this case, and David's wife was added in her capacity as trustee of a family trust. Of note among the allegations in this case, David and Bruce alleged that the Inter Nos entities improperly advanced funds to the CECO directors to pay their legal expenses.

In 2017, David, Bruce, and several related parties sued Richard, Mark, Steven, and three of CECO's outside directors. The 2017 lawsuit asserted numerous individual and derivative claims, including requests for statutory remedies relating to the allegedly improper partial conversion, breaches of fiduciary duty, common law fraud, statutory fraud, Blue Sky fraud, and violations of the TTLA. This so-called "Conversion Case" is the basis of most of the issues in this appeal.

The two cases were consolidated for trial. Before trial, the judge granted a directed verdict against appellants on their TTLA claims. The court also ruled pretrial that as a matter of law, the...