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Shareholder lawsuit's dismissal leaves stock share bylaws unsettled

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A lawsuit objecting to a bylaw provision that shareholder plaintiffs must hold a minimum percentage of the company's stock has been dismissed, but the tool's ultimate success as a means of reducing litigation remains in question.

Shareholder Harry Rothenberg objected to a bylaw approved by the board of directors of Boca Raton, Florida-based Imperial Holdings Inc., a premium finance business, that said to pursue class or derivative actions, shareholders must first obtain consent from other shareholders that own at least 3% of the company's outstanding shares.

He filed a putative class action lawsuit in U.S. District Court in West Palm Beach, Florida in April in Harry Rothenberg vs. Phillip F. Goldstein et al. v. Imperial Holdings Inc.

According to the lawsuit, Imperial, which has since changed its name to Emergent Capital Inc., was under investigation by the Securities and Exchange Commission in connection with its legacy premium finance business and corresponding financial exporting, and by the Internal Revenue Service in connection with its structured settlement business.

“The sole purpose of the bylaw is to insulate defendants from shareholder redress for violation of state and federal statutory law and breaches of fiduciary duty,” says the lawsuit.

Emergent Capital said in a statement issued Sept. 21, which was not widely publicized until last week, that the lawsuit was dismissed with prejudice.

The statement quoted Mr. Rothenberg as stating that after meeting with representatives of the board of directors, “I now believe that they acted in good faith and did not engage in any improper behavior in adopting the bylaw or otherwise.”

Emergent attorney Michael P. Matthews, a partner with Foley & Lardner L.L.P. in Tampa, Florida, said among the reasons Mr. Rothenberg agreed to drop the lawsuit was, “The case was not ripe. The plaintiffs did not actually have a suit that they wanted to bring, nor tried and failed to get the required 3%.”

At least two other companies have similar by-laws, New York-based Special Opportunities Fund Inc. and the Milwaukee -based The Mexico Equity and Income Fund Inc. Phillip Goldstein is chairman of both Emergent and Special Opportunities, and is on Mexico Equity's board of directors.

Kevin LaCroix, executive vice president of RT ProExec, a division of R-T Specialty L.L.C. in Beachwood, Ohio, said there is no data available regarding how many other firms may have adopted similar bylaws. He said it remains unclear whether such bylaws will stand up to judicial review, which did not occur in the Emergent case.

Regarding the merits of such an approach, “It does disadvantage smaller shareholders or shareholders who can't aggregate the 3% and in some sense is discrimination” against them. Theoretically, such a bylaw could cut off meritorious lawsuits, said Mr. LaCroix.

The counterargument would be “by having that level of stake required, you're requiring validity that the issue relates to the welfare of the corporation” and not just the small shareholder.

Meanwhile, because the Rothenberg lawsuit was withdrawn, any firm considering adopting such a bylaw at this point “does not have the comfort of a judicial decision,” and risks having it rejected if it is challenged, said Mr. LaCroix.

Another possible tactic to minimize the number of lawsuits is requiring losing plaintiffs to pay attorneys' fees. However, earlier this year, the Delaware legislature approved legislation that prohibits publicly-traded corporations from adopting bylaws that force shareholders to pay legal fees if they do not win their lawsuits against the corporation.

Observers say the legislature approved the measure despite the state's business-friendly reputation because of a general agreement that permitting the fee-shifting bylaws went too far in favoring businesses.