In prior posts, I have noted the growing phenomenon of companies adopting various types of bylaws as a self-help version of litigation reform. Delaware’s courts have already approved the facially validity of both forum-selection bylaws and of fee-shifting bylaws, although measures pending in Delaware legislature in 2015 could address the fee-shifting bylaw. Other courts have considered mandatory arbitration bylaws as well (as discussed here). Now, add another type of bylaw to this list – the minimum-stake-to-sue bylaw.
As Alison Frankel noted in a January 21, 2015 post on her On the Case blog (here), life insurance settlement company Imperial Holdings has adopted an “apparently unique tactic to rein in suits by shareholders.” The company has amended its bylaws to require shareholders to deliver written consents representing at least three percent of the company’s outstanding shares in order to bring a class action or derivative suit.
Imperial Holdings has itself previously been the target of a derivative lawsuit. The case ultimately settled for $13.6 million (although as Frankel notes most of the settlement amount was paid to resolve a parallel securities class action lawsuit). After the earlier case settled, the company adopted the minimum-stake-to-sue bylaw, which a company representative told Frankel was “intended to stop shareholders without a real financial interest in the outcome of their own case from hijacking deals and forcing the company to defend meritless litigation.” Frankel quotes the company’s chairman as saying that “the bylaws are like a cooling-off period. We’re saying ‘Slow down, get support from other shareholders.’” Frankel’s article also notes that a similar minimum-stake to sue bylaw has been adopted by two other companies on whose boards Imperial’s Chairman also serves.
At least one Imperial Holdings shareholder has a problem with the new bylaw. On January 16, 2015, the named plaintiff from the earlier lawsuit filed a new action against the company and its directors in the Palm Beach County (Florida) Circuit Court, seeking a judicial declaration that the minimum-stake-to-sue bylaw was adopted illegally under Florida law, as well as an injunction against the provision’s enforcement.
The complaint in the new lawsuit (which can be found here) alleges that the bylaw was adopted in breach of the directors’ fiduciary duties because their “sole intent was to reduce their risk of being held accountable to the Company or its shareholders for any violation of law, including criminal law, breaches of fiduciary duties or other misconduct.” The complaint asserts that the pre-filing requirement is “so onerous” that it “effectively guarantees that, notwithstanding the provisions of state and federal law, no class or derivative action can be filed against Defendants, no matter how egregious their conduct may be.” The complaint alleges that the directors “acted disloyally and in bad faith and placed their own interests in avoiding liability to shareholders over the interests of both the Company and the public shareholders to who they owe fiduciary duties.”
In her article, Frankel quotes a statement from the company’s Chairman as saying that the new lawsuit is “exactly what the bylaw is supposed to prevent.” He also noted that the bylaw had been adopted with the advice of counsel and that the company’s shareholders will have a chance to vote on the measure at the company’s shareholder meeting in the spring. The plaintiffs counsel, in turn argues that the bylaw should have been put to shareholder vote before it was adopted. He also argues that even if a majority of shareholders approve the bylaw, it is still impermissible, arguing that “the federal and state securities laws do not permit the tyranny of the majority when it comes to shareholder rights.”
The complaint in the lawsuit has only just been filed; indeed, at the time Frankel spoke to the company’s Chairman, the company still had not yet even been served with the complaint. It remains to be seen how the lawsuit challenging the bylaw will fare. The case will of course be decided primarily on the basis of Florida law, so the outcome of the case will not necessarily be determinative of the question whether or not companies organized under the laws of other states could adopt a minimum-right-to-sue bylaw. Many publicly traded companies in the U.S. are organized under the laws of Delaware and at least at this point there is not way of knowing whether a bylaw of this type would survive scrutiny under Delaware law.
While it remains to be seen how the new lawsuit will fare and whether or not the validity of this type of bylaw will be upheld as a matter of Florida law, it is in any event clear that companies are continuing to experiment with the possibilities of litigation reform through bylaw revision. The fact that this case involves a Florida corporation and Florida law underscores the fact that these issues involve more than just considerations of Delaware law, and even the pending developments in the Delaware legislature regarding fee-shifting bylaws will not necessarily be determinative of the issue, as developments in other states could overtake the developments on these questions.
At a minimum, this company’s adoption of these new types of litigation reform bylaws shows that the phenomenon of the adoption of litigation reform bylaw has significant momentum. It is clear that companies will continue to experiment and new types of litigation reform bylaws are likely to continue to appear. Whether the various types of bylaws ultimately will survive judicial scrutiny remains to be seen, but if the courts confirm the validity of any of the various litigation reform bylaws under discussion, there could be some various significant changes in the shareholder litigation environment. Stay tuned, because depending on how all of this plays out, the D&O litigation arena could be entirely transformed.
Federal Preemption and Fee-Shifting Bylaws: While as noted above the various kinds of litigation reform bylaws under discussion could transform the litigation environment, there are a number of important considerations that could militate against this transformation. As discussed in a January 26, 2015 post on the CLS Blue Sky Blog (here), Columbia Law School Professor John Coffee believes that few companies will attempt to use board-only approved fee-shifting bylaws, because the major proxy advisory firms have made it clear that they will oppose the re-election of any board that approves the adopting of such a bylaw. Accordingly, Coffee suggests that the likelier future scenario is that IPO companies will insert fee-shifting bylaw provisions in the corporate charters.
Coffee contends that the attempt to adopt these kinds of bylaws through corporate charter provisions raises a number of concerns, including the possibility that this issue may be preempted by federal law, at least with respect to the application of such a provision in federal court. Coffee notes that the federal preemption issues will inevitably have to be litigated regardless of what the Delaware legislature ultimately does on the pending fee-shifting bylaw issues, because even if the Delaware legislature votes to curb the use of fee-shifting bylaws by Delaware corporations, issuers organized under the laws of other jurisdictions have already adopted these kinds of provisions.
As the type of bylaw discussed above, this issue is not just a question of the laws of one particular jurisdiction and is not just a question of one type of bylaw. The whole topic of litigation reform bylaws is likely to continue to percolate for some time to come. As Professor Coffee’s article demonstrates, there are a number of questions surrounding the enforceability of these types of bylaws that will have to be sorted out. But at this point, the smart money is betting that these issues will become increasingly common and that courts will increasingly be called on to address these kinds of issues.
I will say that the developments involving litigation reform bylaws may be among the most interesting developments in the corporate and securities litigation arena in many years.