The latest in restrictive corporate bylaws: Small shareholders can’t sue

November 13, 2014

One of the biggest reasons for the seismic shift in shareholder litigation over the past decade from securities fraud class actions to M&A challenges is that it’s easier for plaintiffs’ firms to bring M&A cases and derivative suits. After Congress amended securities laws in 1995 to rein in shareholder suits, federal-court fraud class actions became the near-exclusive province of institutional investors, not individual shareholders with small holdings. But those small-timers could still bring derivative suits and shareholder class actions challenging M&A deals. So a lot of shareholder firms without ties to big pension funds stopped bringing fraud cases and started filing these instead.

It has not been lost on judges, especially in Delaware Chancery Court, that shareholders with hardly any stake in the outcome are behind some deal cases and derivative suits. Look, for example, at comments by Vice Chancellor Travis Laster at a hearing in May 2013. Laster pointed out to plaintiffs’ lawyers that their client owned a grand total of two shares in a medical products company called Gen-Probe Inc. The client’s entire interest in the deal he was challenging, Laster said, was $160. “What was his rationale for wanting to litigate the transaction while holding two shares?” Laster asked. “If he was that frustrated about it, you could probably, you know, throw in some lunch money for him and take care of his concerns.”

I’m providing this quick overview as the context for an extraordinary new bylaw adopted by the board of a Florida corporation called Imperial Holdings, which buys and sells life insurance policies for the secondary market. As first reported by University of Denver law professor J. Robert Brown at The Race to the Bottom blog, Imperial’s new bylaw restricts small shareholders from bringing class actions or derivative suits. Investors can sue only if they deliver to the company written consents from the owners of at least 3 percent of the outstanding shares.

Imperial’s float is about 21 million shares. Under this bylaw, an investor would have to submit written consent from holders of about 630,000 shares. That’s a lot of shares to get consent from, especially because Imperial’s two largest shareholders – one of whom is also the company’s chairman, activist investor Phillip Goldstein of Bulldog Investors – each own about a 10 percent stake. Assuming the new bylaw is legal under Florida corporate law, it pretty much guarantees that Imperial won’t face shareholder suits from small investors.

The company said that’s exactly the point. “The board has noticed a disturbing trend of lawsuits brought by shareholders with very small stakes in publicly traded companies against the companies, their directors and their officers, purportedly on behalf of a class of shareholders or on behalf of the company,” Goldstein said in a press release announcing the bylaw. “These lawsuits often result in other shareholders receiving no meaningful benefit and indirectly incurring the cost of the plaintiff’s lawyer and the company’s lawyer. The board believes it is in the best interest of the company to require a shareholder claiming to represent a class of shareholders or the company to demonstrate a minimum level of shareholder support.” It’s worth noting here that Imperial speaks from experience. The company agreed to pay $12 million in late 2012 to settle shareholder fraud and derivative class actions.

As best I can tell, Imperial is the first public company to adopt a bylaw requiring a minimum stake to bring a shareholder suit. As you know, bylaw amendments and charter provisions to restrict litigation have swept boardrooms in the year or so since Delaware courts OKed forum selection clauses and signaled that corporations may be able to adopt bylaws that shift the cost of defending shareholder suits onto investors. I checked with Institutional Shareholder Services, which closely tracks forum selection and fee-shifting bylaws, about Imperial’s minimum stake provision. An ISS representative told me that the group is going to start monitoring Securities and Exchange Commission filings for bylaws similar to those enacted by Imperial but can’t confirm that this is the first or only such provision.

I reached out to Imperial chairman Goldstein and outside counsel Michael Kirwan of Foley & Lardner. Goldstein was not available and Kirwan didn’t get back to me. An Imperial representative declined to comment beyond the press release.

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