Attorney: Samuel J. Adams
Pomerantz Monitor July/August 2015
In a victory for shareholder rights, Delaware’s Governor recently signed into law a bill that prohibits fee-shifting bylaws for Delaware-incorporated publicly traded corporations. The bill was passed in response to a growing number of Delaware stock corporations that had recently begun adopting fee-shifting provisions that sought to pass defense costs on to unsuccessful shareholder plaintiffs or, in some cases, even plaintiffs that were only partly successful in a lawsuit for breach-es of fiduciary duty or other similar claims. Because shareholder plaintiffs – like plaintiffs in all other kinds of actions – almost never prevail on all counts asserted in a complaint, the specter of crushing financial liability from such bylaws threatened to choke off almost all shareholder litigation, regardless of the merits.
The increasing number of fee-shifting bylaws adopted by Delaware corporations stemmed from the Delaware Supreme Court’s decision last year in ATP Tour v. Deutscher Tennis Bund, which upheld a fee-shifting bylaw enacted by a private company. In that decision, the court held that a private Delaware corporation may adopt a bylaw which shifts all litigation expenses to a member plaintiff who does not obtain “a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.” While the ATP court did not weigh in on whether such a bylaw would be permissible in the context of a public company, some public corporate boards of directors sensed an opening. With dozens of public companies adopting such fee-shifting provisions, action was needed by either the legislature or the judiciary in order to clarify the enforceability of these bylaws.
Earlier this year, prior to Delaware’s enactment of the fee-shifting bylaw prohibition, Pomerantz was on the vanguard of the fight against fee-shifting provisions in a case of first impression in Strougo v. Hollander. In that opinion, the first to address fee-shifting provisions following ATP, the Delaware Court of Chancery found that a fee-shifting bylaw was inapplicable to a share-holder plaintiff and the class where the bylaw was adopted after a plaintiff had been forcibly cashed out through a reverse stock split. While not explicitly ruling on the broader issue of the applicability of fee-shifting bylaws generally to public corporations, Chancellor Bouchard found that the bylaw in that instance did not apply to the shareholder plaintiff both because the bylaw was adopted after the plaintiff had been forcibly cashed out as a shareholder, and also because Delaware law does not authorize bylaws that regulate the rights or powers of a stockholder whose equity interest in a corporation had been eliminated before the bylaw was adopted.
In enacting the bill, the Delaware legislature recognized the chilling effect that fee-shifting bylaws would likely have on the ability of shareholders to voice certain challenges to corporations in court. Because many public companies chose to incorporate in Delaware, the Delaware courts and judiciary have a substantial influence on corporate governance. The synopsis of the bill itself states that the prohibition on fee-shifting provisions was enacted “in order to preserve the efficacy of the enforcement of fiduciary duties in stock corporations.” While many believed that the Delaware courts would have ultimately invalidated fee-shifting bylaws for public companies, the bill obviated the need for the courts to weigh in on the issue. As a consequence, shareholder plaintiffs can seek to hold corporate fiduciaries accountable without the risk of liability to corporate defendants for potentially millions of dollars in attorneys’ fees.
In a compromise, the recently-enacted bill also affirmed the enforceability of forum selection bylaws which seek to dictate the exclusive court in which plaintiffs may file certain types of shareholder litigation, such as those asserting claims for breaches of fiduciary duty. In many cases, shareholder plaintiff can elect to file such litigation in either a public company’s state of incorporation or the state of a corporation’s head- quarters. For Delaware public companies that wish to limit such litigation to a particular venue, the Delaware legislature clarified that such forum selection clauses are enforceable, so long as Delaware is selected as the exclusive forum for such litigation.