Litigation: Examining preliminary injunctions in disputes between shareholders

The MBCA or Delaware state statutes can often hold the key when examining these disputes

One of the most common types of commercial litigation has to deal with disputes between shareholders. In cases such as these, when the future of a corporation may be at stake, it is essential to know if and when a preliminary injunction or TRO becomes necessary.

There are a variety of statutes and common law rules that govern shareholder relations. The most important of these are the federal statutes, the Model Business Corporation Act (MBCA) and Delaware state statutes, and the common law. Each of these has a unique set of regulations that determines when injunctive relief might be granted.

There are a number of federal statutes that regulate when and how shareholders can act, and violations of those statutes may create a basis for injunctive relief. SEC Rule 10(b)-5, for example, prohibits the use of the “mails or any other device” to defraud in connection with the sale or purchase of securities. Another law that can lead to the granting of a preliminary injunction or TRO is section 14(a), which prohibits proxy solicitations that are false, misleading or leave out a material fact that is necessary to make a statement not false or misleading. It can be of the utmost importance to get an injunction to prevent illegal solicitations from damaging the company during the time litigation takes to run its course. Federal law also requires certain disclosures to be made both by those issuing takeover bids as well as shareholders who make a tender offer that would increase their stake to over 5 percent of a class of securities. Without emergency litigation, untold damage can be done to a corporation taken over by interests who have not been adequately transparent, and an eventual victory on a claim will prove entirely hollow if, for example, the takeover of the board was prelude to a cash-out merger.

When it comes to state statutes, there are different sources that might be referred to, depending on the jurisdiction. 31 states have adopted the MBCA to lay out the guidelines and regulation for the formation and operation of corporations. The state with the largest number of corporations, Delaware, has not adopted the MBCA, however, and instead uses its own statute on corporations. While broadly similar, there are many important, and often subtle, distinctions between the statutes of different states. The MBCA, for example, expressly allows equitable relief, and thus the granting of injunctions, for violation of one its provisions; Delaware does not, and, except for a narrow range of situations involving close corporations, only allows for equitable relief on traditional grounds, which can make it more difficult to receive an injunction.

The common law is the final body of law that regulates shareholder behavior. There are a number of situations where a shareholder can appeal to the common law in moving for an injunction. For example, there might be a need to enforce the provisions of a transactional document. Voting rights are another area where an injunction might be necessary to preserve the status quo until the matter can be litigated. Similarly, the issuance of new stock, which can dilute the power of existing shareholders, is also a matter where simply allowing the litigation to run its course without an injunction might allow irreversible damage.

The common thread running through all of these potential issues that might necessitate emergency litigation is that there will be an injury done that cannot be remedied. An irreparable injury without adequate remedy at law, of course, is one of the four elements that need to be shown in order for a TRO or preliminary injunction to be granted, and those elements apply to cases involving shareholder disputes as well. The first element, the probability of success, is not much changed in the context of shareholder disputes, asking whether there exists a probability that the non-moving party did violate some rule, regulation, statute or contract regarding shareholder conduct. The irreparable harm element is essentially the same as for other cases as well, although, because it can be impossible to quantify the damage done, for example, by a shareholder’s stock being diluted, or having his voting right denied, this element may be more easily shown than in other types of commercial litigation. Similarly, the balance of harm element can favor the moving party more than it might in other situations, as courts are loathe to find that not acting within federal and state laws, or even its own corporate bylaws, will cause any serious harm to a corporation. It is possible, however, for moving parties to overreach, as it is still necessary to connect the harms they allege to the specific acts of the non-moving party, or else a court is apt to give these injuries less weight in balancing harms. The final element, that of public interest, is unlikely to decide whether or not an injunction is granted, as there is a public interest both in shareholders being able to assert their rights, and corporations being able to act without needless interference from shareholders.

Shareholder disputes can be complex and difficult to unweave. Compounding matters, without quick action, serious, and often irreparable damage can be done to a corporation, and, therefore, the shareholders who own stock in that corporation. As there are a myriad of different jurisdictions, statutes and other rules to navigate, an experienced commercial litigator can often be one’s best asset when dealing with this type of problem.

Contributing Author

author image

Thomas Patterson

Thomas E. Patterson started the Patterson Law Firm in 2000. He has 32 years of experience preparing and trying lawsuits for businesses, professionals and entrepreneurs—often...

Bio and more articles

Join the Conversation

Advertisement. Closing in 15 seconds.