Fee-Shifting Corporate Bylaws–The Judicial Challenges Begin

As discussed in a previous post, the Delaware General Assembly has tabled its consideration of a bill that would ban fee-shifting bylaws for traditional corporations until the next legislative session. This legislative push followed the Delaware Supreme Court’s holding, in responding to certified questions of law, that “fee shifting provisions in a non-stock corporation’s bylaws can be valid and enforceable under Delaware law”. See ATP Tour, Inc., et al. v. Deutscher Tennis Bund (German Tennis Federation), et al., No. 534, 2013 (Del. Supr. May 8, 2014). The fee-shifting bylaws being considered are designed to shift the company’s costs (including attorneys’ fees) of successfully defending against litigation prosecuted by a company’s stockholders to the stockholder plaintiff. As one might imagine, such a scenario might be seen as a “game changer” with regard to shareholder representative litigation.

While things might be quiet on this front in Legislative Hall in Dover, DE, both the adoption of, and the resulting judicial challenges to, these fee-shifting bylaws are moving swiftly. Since the ATP decision was announced in May, at least five Delaware corporations (at least of which we are aware) have adopted fee-shifting bylaws. Just as quickly, those new bylaws are being challenged in Delaware’s Court of Chancery in proceedings initiated this summer.

On July 21st, a director and shareholder of Biolase, Inc., which manufactures dental laser and imaging equipment, filed a plenary action challenging the Biolase board’s adoption of a fee shifting bylaw. While this is primarily a battle for corporate control (pending before Vice Chancellor Noble), the plaintiff seeks, among other relief, a declaration that the Biolase board’s adoption of a fee-shifting bylaw that was directed solely at directors or current directors (rather than shareholders) who prosecuted litigation against the company or the other directors was invalid and solely designed to deter him from bringing suit to challenge the company’s actions in the contest for control of Biolase. The plaintiff has sought expedited treatment of this matter in advance of the company’s annual meeting.

The same day, two shareholders (and their counsel) of Hemispherx Biopharma, Inc. filed a Motion to Invalidate Retroactive Fee-Shifting and Surety Bylaw or, In The Alternative, To Dismiss and Withdraw Counsel. The shareholders had been prosecuting a derivative action on behalf of Hemispherx, and against the board, challenging certain bonuses paid to Hemispherx executives for approximately one year. On July 10, 2014, the board adopted a fee-shifting bylaw that would apply not only to the shareholders that bring the suit, but also “any other person who . . .offers substantial assistance to the Claimant, or has a direct interest in any Claim . . . .” The plaintiff stockholders filed their motion challenging the propriety of the bylaw amendments and contend that if the court does not invalidate the fee-shifting bylaw, then they seek to dismiss the action and their counsel seek to withdraw given their belief that it “would be economically irrational to continue this litigation.” This matter is pending before Chancellor Bouchard.

Readers should stay alert for future updates on this issue as the Delaware courts begin to consider the propriety of specific fee-shifting bylaws. Both of the fee-shifting bylaws being challenged in the two cases noted appear to involve allegations that the fee-shifting bylaws were enacted as a reaction to a specific situation, and it will be interesting to see if the resolution of these disputes turns on those facts or whether the Court of Chancery will make a more widely-applicable pronouncement on the propriety of fee-shifting bylaws.

Stay tuned!

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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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