One of the more interesting recent developments in the world of corporate and securities litigation has been the litigation reform bylaw movement. Among the types of bylaws with which various companies have experimented are the forum selection bylaws (now permitted by statute in Delaware) and fee-shifting bylaws (now prohibited in Delaware for stock corporations, as discussed here). Yet another type of litigation reform bylaw that has attracted attention is the minimum stake to sue bylaw, which requires shareholder claimants to show that the represent a specified interest of the company’s ownership interest in order to be able to pursue a class or derivative claim.
As I discussed in a prior post, a shareholder of Imperial Holdings filed a legal action challenging the minimum stake to sue bylaw that the company had adopted. As discussed below, the company has secured the dismissal of the action, though the court’s entry of the dismissal order did not address the merits or validity of the bylaw itself. An October 19, 2015 memo from the Foley & Lardner discussing the dismissal can be found here. The court’s September 9, 2015 dismissal order can be found here.
On January 16, 2015, a plaintiff shareholder filed an action against Imperial Holdings and its directors in the Palm Beach County (Florida) Circuit Court, seeking a judicial declaration that the company’s minimum-stake-to-sue bylaw was adopted illegally under Florida law, as well as an injunction against the provision’s enforcement. (In Spring 2015, Imperial Holdings changed its name to Emergent Capital, as discussed here.) According to the Foley & Lardner memo, the plaintiff filed suit in both state and federal court.
The challenged bylaw requires a shareholder to obtain the consent of holders of at least three percent of the company’s outstanding shares before suing the company or its officers or directors in a class action or derivative action. The bylaw provides as follows:
Except where a private right of action at a lower threshold than that required by this bylaw is expressly authorized by applicable statute, a current or prior shareholder or group of shareholders (collectively, a “Claiming Shareholder”) may not initiate a claim in a court of law on behalf of (1) the corporation and/or (2) any class of current and/or prior shareholders against the corporation and/or against any director and/or officer of the corporation in his or her official capacity, unless the Claiming Shareholder, no later than the date the claim is asserted, delivers to the Secretary written consents by beneficial shareholders owning at least 3% of the outstanding shares of the corporation as of (i) the date the claim was discovered (or should have been discovered) by the Claiming Shareholder or (ii), if on behalf of a class consisting only of prior shareholders, the last date on which a shareholder must have held shares to be included in the class.
The plaintiff’s complaint (which can be found here) allege 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.”
The company filed a motion to dismiss, arguing that the bylaw had not harmed the plaintiff and that, in approving the bylaw, both the company’s board and its shareholders were fully informed.
As reflected in the court’s September 9, 2015 order, the plaintiff filed an unopposed motion to dismiss his lawsuit with prejudice. According to the law firm memo, the case was dismissed without compensation to the plaintiff or his counsel, and also according to the memo, the plaintiff issued a statement that the defendants “acted in good faith and did not engage in any improper behavior in adopting the bylaw at issue or otherwise.”
As the law firm memo notes, the plaintiff’s dismissal of this action leaves the bylaw in force and also “leaves the door open for other companies to follow” this company’s lead in “taking action to protect shareholder value” against what the company’s chairman described as “lawyer-driven knee-jerk strike suits.”
While the dismissal of the case unquestionably does “leave the door open” for other companies to adopt the type of minimum stake to sue bylaw involved here, the resolution of this case did not involve either a judicial determination of the merits or validity either of the lawsuit or of the process the company uses in adopting the bylaw. The question of whether or not this type of bylaw would withstand judicial scrutiny will have to await another day.
However, in the litigation reform bylaw laboratory where the ideas for these various kinds of bylaws are developed, the minimum stake to sue bylaw experiment clearly will continue. It remains to be seen whether and to what extent other companies will seek to try to adopt this kind of bylaw and whether or not this type of bylaw ultimately will withstand judicial scrutiny. It is clear that companies will continue to experiment and new types of litigation reform bylaws are likely to continue to appear. 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.
More About the SEC and Director Liability: In a post earlier this week, I took a look at recent trends relating to SEC enforcement action against outside directors. As I noted in the post, SEC enforcement actions against outside directors are “rare.” In an October 14, 2015 speech (here), outgoing SEC Commissioner Luis Aguillar touched on this issue and reiterated just how rare SEC enforcement actions against directors are:
From my own experience, and based on discussions with our staff, it appears that the SEC has rarely brought cases against directors—particularly outside directors—for failing to fulfill their responsibilities as corporate fiduciaries. Indeed, these matters are so infrequent that the agency does not currently maintain statistics on cases that are brought against directors. On those occasions when the SEC has brought actions against directors, the matters typically involve directors who either have taken affirmative steps to participate in fraudulent misconduct or have otherwise enabled fraudulent misconduct to occur by unreasonably turning a blind eye to obvious “red flags” of misconduct.