by Cydney Posner
In this article, Reuters discusses yet another creative permutation on restrictive bylaw provisions — requiring that plaintiffs in certain shareholder litigation provide consents to the litigation from shareholders holding shares in excess of a minimum threshold. The problem the bylaw seeks to address is that shareholder litigation is frequently launched by counsel representing shareholders with only nominal stakes in the company. The author was of the view, but could not confirm definitively, that the bylaw is the first of its type adopted by a public company.
The bylaw at issue prohibits a shareholder or shareholder group from initiating a derivative suit or class action against the company, its directors or officers unless the shareholder delivers to the company the consent of at least 3% of the beneficial owners of outstanding shares.* The company that has adopted the bylaw is a publicly held (accelerated filer) Florida corporation. According to the company’s press release, the new bylaw “is designed to ensure that any shareholder filing a lawsuit on behalf of the company or a class of shareholders has a minimum degree of shareholder support and adequately represents shareholders’ interests.” The chairman of the board (and a principal of the company’s largest shareholder) commented as follows in the press release: “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. 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.”
In this case, the company’s press release indicated that, while the bylaw became effective upon adoption by the board, the company intends to submit it for ratification by the shareholders at the next annual meeting. Based on the company’s last proxy statement, its 5% holders accounted for over 60% of the outstanding, so it’s certainly conceivable that the bylaw provision could win approval. That could certainly complicate matters for a plaintiff that might try to upend the bylaw.
This particular bylaw was adopted under Florida law, and it is not currently known whether a bylaw of this type would be considered valid under Delaware law. (And it may well be challenged under Florida law also.) The Delaware Supreme Court’s analysis of the facial validity of a fee-shifting bylaw in ATP Tour, Inc. v. Deutscher Tennis Bund appeared, at least on the surface, to be quite flexible in terms of the types of bylaws that might be permitted. However, as noted in this post, a former Justice has indicated his surprise that many counsel assumed that the holding in ATP, a private, non-stock corporation, would be equally applicable in the larger public company context. And the Court may look less favorably on restrictions that could preclude bringing a case at all, as opposed to intrusions into where cases are brought or who pays for them (although it has certainly been argued that fee-shifting bylaws are effectively preclusive. See this post).
However, the author observes, 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.” To support that point, she looks to comments by Vice Chancellor Travis Laster directed to plaintiffs’ counsel, at a hearing in May 2013, noting that “their client owned a grand total of two shares” in the defendant: “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.’” His comments seem to tacitly recognize that, in most of these cases, plaintiffs’ counsel stands to benefit more than the actual plaintiffs.
Whether any Delaware corporations take up the challenge of adopting a bylaw imposing a minimum support threshold remains to be seen. Exclusive forum bylaw provisions have been upheld in recent cases, but there has yet to be a Delaware case upholding a fee-shifting bylaw on an as-applied basis. (See this post.) As a result, some companies have adopted a wait-and-see attitude, and may be reluctant to become a Delaware test case for this new variant of restrictive bylaw. In addition, ISS will certainly be watching these developments. The new ISS QuickScore 3.0 has added as a factor whether the board has recently taken action, absent shareholder approval, that materially reduces shareholder rights, and ISS would likely view a bylaw of this type to fit into that category, especially with regard to small holders. In addition, an ISS representative advised Reuters that ISS intends to start monitoring SEC filings for bylaws similar to those discussed here. Watch this space.
*The precise language of the bylaw is: “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.”