Small business owners who form a corporation often create shareholders’ agreements to govern their relationships, protect minority investors, and establish protocols for share transfers. These agreements are particularly common in family businesses or closely-held corporations with just a few shareholders. But what happens when these agreements don’t specify how long they remain in effect?
In Texas, a little-known statutory provision can cause shareholders’ agreements to automatically expire after a decade. This “10-year rule” can create significant complications when shareholders attempt to enforce what they believe are still-valid agreements. This typically only applies to agreements entered into prior to September of 2015. This can come as a surprise to those with pre-2016 agreements and is why it is important to engage business consultants on an ongoing basis to keep up with changes like this.
To help explain the importance of this rule, we can look to the recent Texas Court of Appeals case, Adams v. Atkinson, 2024 WL 4638652 (Tex. App.—Corpus Christi-Edinburg 2024). The case provides an opportunity to examine how courts interpret this provision and its implications for Texas business owners with older pre-2016 agreements.
Facts & Procedural History
In October 2004, three individuals—Adams, JMassey, and Klement—formed a business (“VDSI”). The business was in the business of processing sewer and grease trap waste.
In January 2005, each founder received 1,000 shares of VDSI stock and signed an undated stock purchase agreement. This agreement governed how shareholders could sell their VDSI stock—a classic example of a buy-sell agreement that many business formation professionals recommend as part of corporate governance documents.
The trouble began in 2015, when Klement attempted to sell his shares to Massey. Adams objected to the sale, claiming it violated their shareholders’ agreement. Due to Adams’ objection, Klement’s sale to Massey was initially rescinded. Klement then filed a lawsuit seeking a declaratory judgment that the agreement was no longer enforceable. He cited Section 21.102 of the Texas Business Organizations Code in support of his position.
After the court ruled in Klement’s favor, declaring the agreement unenforceable, Massey purchased Klement’s shares. Massey later passed away in November 2020, and his estate representative, Michelle Atkinson, became involved in further litigation when Adams attempted to enforce the same shareholders’ agreement to purchase Massey’s shares. This led to a second lawsuit that ultimately reached the Court of Appeals.
The Texas Business Organizations Code on Shareholders’ Agreements
The Texas Business Organizations Code provides a comprehensive framework for how corporations and other business entities operate in Texas. Section 21.101 outlines what shareholders’ agreements can govern, including restrictions on share transfers, management structure, dividend policies, and protocols for resolving disputes.
These agreements serve essential functions in closely-held corporations, allowing shareholders to customize their relationships beyond default statutory provisions. A well-drafted shareholders’ agreement can prevent deadlocks, protect minority owners, and create orderly processes for transitions that might otherwise lead to litigation.
For businesses operating with multiple owners, creating these agreements during business formation is an important step in preventing future disputes. This can be seen by reviewing the Common provisions included in these agreements. Common provisions include rights of first refusal for share sales, mechanisms for valuing shares, and processes for resolving disagreements. These are often the central terms at the heart of most types of business disputes.
The 10-Year Rule Under Section 21.102
At the heart of the Adams case is Section 21.102 of the Texas Business Organizations Code. This law states: “Any limit on the term or duration of a shareholders’ agreement under this subchapter must be set forth in the agreement. A shareholders’ agreement under this subchapter that was in effect before September 1, 2015, remains in effect for 10 years, unless the agreement provides otherwise.”
This provision creates a default expiration date for these pre-2016 shareholders’ agreements that don’t specify their duration. For agreements entered into before September 1, 2015, without a stated duration, the statute establishes a 10-year term. This automatic expiration can come as an unwelcome surprise to business owners who drafted agreements years ago and assumed they would remain effective indefinitely.
The provision represents a balancing of interests: on one hand, allowing perpetual agreements could bind future shareholders to outdated terms; on the other hand, forcing premature termination could disrupt carefully constructed corporate governance structures.
So why have this provision? The legislature appears to have determined that a decade provides reasonable longevity while encouraging periodic review of these important agreements.
What Makes a Shareholders’ Agreement Valid in Texas?
Before examining the court’s analysis in Adams, it’s helpful to understand the formal requirements for creating valid shareholders’ agreements in Texas.
Section 21.101(b) provides that a shareholders’ agreement must be either:
- Contained in the corporation’s certificate of formation or bylaws if approved by all shareholders; or
- A written agreement that is signed by all shareholders and made known to the corporation.
Additionally, amendments to these agreements generally require unanimous shareholder approval unless the agreement specifies otherwise. This unanimity requirement reflects the contractual nature of these agreements and protects minority shareholders from having their rights altered without consent.
For Texas registered agent clients and other businesses operating as corporations, maintaining proper documentation of these agreements is essential for their enforceability. This includes retaining evidence of shareholder approval and ensuring the corporation has official notice of the agreement.
How to Avoid the 10-Year Trap
Based on the Adams case, businesses operating as corporations in Texas should take several precautions regarding their shareholders’ agreements.
For existing agreements created before September 1, 2015, without a specified duration, determine whether they have potentially expired under the 10-year rule. If so, consider executing new agreements that clearly state their intended duration.
For businesses considering conversion to the corporate structure from other entity types like an LLC or partnership, be aware that shareholders’ agreements will be subject to this durational limitation unless explicitly addressed.
Regular reviews of corporate governance documents, including shareholders’ agreements, can help identify potential issues before they lead to disputes. This review should be part of regular annual compliance procedures.
The Takeaway
This case serves warning for Texas corporations relying on shareholders’ agreements that don’t specify their duration. The court’s application of the 10-year rule under Section 21.102 demonstrates that these agreements won’t last indefinitely without explicit terms to the contrary. Business owners should review their existing agreements to determine whether they’ve potentially expired and consider executing new agreements with clearly defined durations. This case also underscores the importance of understanding how entity-specific statutory provisions can impact long-term business planning and governance—a consideration that might influence entity selection decisions for new businesses or those contemplating conversion between entity types.
