“Fee-Shifting” Bylaws–A New Tool to Stem the Tide of Shareholder Litigation?

On May 8, 2014, the Delaware Supreme Court issued an en banc response to certified questions of law from the U.S. District Court for the District of Delaware, in which the Supreme Court held that a “fee shifting” bylaw provision in a non-stock corporation’s bylaws “can be valid and enforceable under Delaware law.” ATP Tour, Inc. v. Deutscher Tennis Bund (German Tennis Federation), et al., No. 534, 2013 (Del. May 8, 2014). The bylaw at issue would shift the company’s defense fees and costs to a member who had sued the company (or any other member) and was unsuccessful in “substantially achiev[ing], in substance and amount, the full remedy sought” in the litigation.

This decision comes closely on the heels of then-Chancellor, now-Chief Justice Strine’s June 2013 opinion, in which the Court of Chancery found that “forum selection bylaws” adopted by Delaware corporations specifying Delaware as the forum of choice for any litigation over the internal affairs of that company were valid and enforceable. Practitioners have witnessed a fairly wide-spread adoption of forum selection bylaws. Will fee-shifting bylaws see a similar rate of adoption? As we discuss below, while the Supreme Court may have given a “green-light” to fee-shifting bylaws conceptually, there may still be significant barriers to their wide-spread adoption.

In the ATP decision, the Supreme Court responded to four questions that had been certified to it by the District Court.

The first question asked whether fee-shifting bylaws would be permissible under Delaware law. The Supreme Court answered the question in the affirmative by holding that “neither the DGCL nor any other Delaware statute forbids the enactment of fee-shifting bylaws,” and that the bylaw at issue was facially valid. The court reasoned that a bylaw is facially valid where it is (1) authorized by the DGCL, (2) is consistent with the corporation’s certificate of incorporation, and (3) its enactment is not otherwise prohibited. As to the first requirement, the court found that no provision of the DGCL (or any other Delaware statute) would forbid a fee-shifting bylaw, and would appear to satisfy the DGCL Sec. 109(b)’s command that bylaws “relat[e] to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.” It also held that while Delaware follows the “American Rule” that litigants typically bear their own fees and costs, because the bylaws of a corporation are considered to be “contracts among a corporation’s shareholders,” a fee-shifting bylaw would fall within the contractual exception to the American Rule. The court also found that the fee-shifting bylaw at issue was neither permitted nor prohibited in the relevant corporate charters.

The court cautioned, however, that while such fee-shifting bylaws might be facially valid, the venerable equitable holding that “inequitable action does not become permissible simply because it is legally possible” might serve to invalidate such a bylaw based on “the manner in which it was adopted and the circumstances under which it was invoked.”

Another important aspect of the court’s opinion in answering the certified questions was its confirmation that a validly adopted fee-shifting bylaw would be enforceable against all stockholders—even those that became stockholders before the adoption of the bylaw.

A Few Post-Opinion Thoughts

Before the boards of Delaware corporations rush to enact fee-shifting bylaws, there are several practical considerations that should be carefully considered:

1. Does it make a difference that the fee-shifting bylaw at issue was for a non-stock corporation? It does not appear that such a distinction makes a difference as the court, in a footnote, reminded readers: “Under 8 Del. C. Sec. 114, the provisions of the [DGCL], including Sec. 109(b), apply to non-stock corporations, and all references to the stockholders of a corporation are deemed to apply to the members of a non-stock corporation.” The Supreme Court did not appear to highlight a material distinction between stock and non-stock corporations in this regard.

2. Because stockholders are given the power to amend a corporation’s charter, and in most cases may also amend the corporate bylaws, will stockholders take action to prohibit a board from unilaterally adopting such bylaws? Could this be the “issue du jour” during the next proxy season?

3. Given the court’s caveat that even facially valid fee-shifting bylaws are reviewable for fair and equitable application, there is some uncertainty as to the limits of their adoption and use. The court was specific, however, that simply adopting such a bylaw with “the intent to deter litigation” is not necessarily an invalidating circumstance, as such provisions, “by their nature, deter litigation.”

This decision will likely be widely discussed in the coming months, and it will be interesting to see whether fee-shifting bylaws are adopted at a rate similar to that witnessed with forum selection bylaws.

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The opinions expressed on this blog are those of the author and are not to be construed as legal advice.

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