Greater Protection for Shareholders in the New Year?

Posted on January 11, 2010 by Tom Patterson

The Supreme Court’s begins hearing January arguments today. Of interest to shareholders, however, is not a case argued today but rather a case heard in November 2009. Before the end of the current term, the Court will issue an opinion in Merck v. Richard Reynolds. Merck focuses on whether the statute of limitations on a federal securities fraud action begins to run when an investor obtains evidence of scienter of fraud or when any evidence of fraud is uncovered.

The distinction is real and would impact many securities fraud cases. Federal law requires securities fraud cases to be brought within the earlier of two years of knowledge or five years of the violation. Generally speaking, the two year period relating to knowledge does not run until all elements of a violation are discovered. The issue is important in security fraud cases because there is often evidence of fraud before there is evidence of the requisite intent. The evidence of fraud, however, is only recognizable in hindsight based on newer evidence demonstrating the intent to defraud. For example, in Merck, an internal study reached a suspicious but supportable conclusion. It was not until an independent study was published two years later that Merck’s original position demonstrated its intent to defraud.

If the statute of limitations is applied to the first instance of possible fraud, shareholders are put in a position whereby they need to take aggressive action to protect their rights. Such action is expensive, such as instituting preliminary injunction and temporary restraining order actions to preserve possible evidence of intent, and may not uncover any fraud on the part of the corporation. Corporations would also incur an added expense as they are forced to defend preliminary litigation. Waiting until all of the evidence necessary to bring a case is available will not harm corporations that are engaged in ethical practices. 

Merck will be an important case to watch not only for its impact on the discovery rule in securities fraud cases. As the Wall Street Journal Law Blog points out today, it may also demonstrate whether the Obama Administration can affect a change in the Court’s pro-business stance under President Bush.

Tags: , , , ,

When Do You Need A Preliminary Injunction In An Illinois Corporate Shareholder Dispute?

Posted on November 19, 2009 by Tom Patterson

Illinois is supposed to be more shareholder friendly than Delaware. Its Business Corporation Act provides minority shareholders protections if the majority shareholders are

  1. committing waste;
  2. practicing fraud;
  3. acting illegally; or
  4. oppressing minority shareholders. 

There was an article in Business Law Today a while ago that contended that minority shares of stock are worthless apart from whatever rights were provided in a shareholders’ agreement, but I disagree: minority shareholders in Illinois--without any shareholders’ agreement-- have the rights given them by the Illinois Business Corporation Act (and this Act influenced the drafting of the Model Business Corporation Act). If they sue to vindicate these rights, the majority shareholders can elect to buy them out, and their buy out price is the fair value (not the fair market value) of their shares. 

Listing the rights given by statute begins to answer the question posed. If you are a minority shareholder, you need a preliminary injunction if the majority shareholders are doing one or more of the above acts and you or the corporation is going to be immediately irreparably harmed as a result. Waste of corporate assets might not be recoverable absent immediate action; an illegal act may cause the corporation to be sanctioned by law enforcement officials. Oppression is an elastic concept, but the standard is the reasonable expectation of the shareholders.   Most of these defalcations will diminish the goodwill of the corporation, a harm that is difficult to quantify, justifying a preliminary injunction.

In the midst of the ill-will that accompanies actions that necessitate shareholder actions, actual or threatened improper withdrawals from the corporation may require a preliminary injunction or temporary restraining order. Minority shareholders need to be vigilant in guarding the corporate purse. A preliminary injunction can be justified on a constructive trust theory (corporate money is a res that is the subject of dispute over whether the payment is proper). The Illinois Business Corporation Act codifies the court’s power to issue injunctions as well. And the Act provides panoply of remedies available to the court: appointment of a receiver or director, for example, and, more broadly, any order necessary.

Tags: , , , , , , , , , ,