Tag Archives: derivative action

Fee-Shifting Bylaws–Remain In A State of Flux

As we previously reported on this page, the topic of fee-shifting bylaws being adopted to shift the costs of shareholder litigation to shareholder plaintiffs and those who assist them has been the subject of activity in both Delaware’s courts and its General Assembly.  While the General Assembly is poised to take up the issue of fee-shifting bylaws in the new legislative session (the subject of an upcoming blog post), we wanted to report on the issuance of the first written decision from the Court of Chancery addressing a challenge to a fee-shifting bylaw that had been adopted by a stock corporation.

On March 16, 2015, Chancellor Bouchard issued his decision in Strougo v. Hollander, et al., C.A. No. 9770-CB (Del. Ch. March 16, 2015), in which he granted plaintiff’s motion for judgment on the pleadings, and which challenged the efficacy of a fee-shifting bylaw adopted by the board of directors of First Aviation Services, Inc.  It is important to note that the facial validity of fee-shifting bylaws was not before the court on this motion.  Rather, the plaintiff moved on a much narrower issue, that is, whether a fee-shifting bylaw adopted after he was no longer a stockholder–but before he filed litigation challenging conduct that occurred while a stockholder–was valid for that litigation.

The board of directors of First Aviation, at the behest of its controlling stockholder, adopted a reverse stock split that had the purpose and effect of freezing out the minority shareholders and taking the company private.  Plaintiff Strougo’s interest in First Aviation was eliminated via the transaction.  Shortly after the reverse stock split, First Aviation adopted the following bylaw:

Section VII.8.  Expenses for Certain Actions.  In the event that (i) any current or prior stockholder or anyone on their behalf (collectively a “Claiming Party”) initiates or asserts [any] claim or counterclaim (collectively a “Claim”), or joins, offers substantial assistance to or has a direct financial interest in any Claim against the Corporation or any director, officer, assistant officer or other employee of the Corporation, and (ii) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Claim the Claiming Party has a direct financial interest) does not obtain a judgment on the merits that substantially achieves, in substance or amount, the full remedy sought, then each Claiming Party shall be obligated jointly and severally to reimburse the Corporation and any such director, officer, assistant officer or employee for all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses) that the parties may incur in connection with such Claim.

First Aviation did not disclose to its former stockholders that it had adopted this new bylaw provision.  After the adoption of the bylaw, and unaware of its existence, former-stockholder Strougo filed suit in the Court of Chancery alleging that the reverse stock spit was unfair to the minority stockholders.  When the company informed Mr. Strougo and his counsel of the bylaw, plaintiff amended his pleading to also challenge the fee-shifting bylaw.

Chancellor Bouchard rejected the application of the fee-shifting bylaw to Mr. Strougo and this litigation.  Because the courts of Delaware have consistently construed bylaws as a contract between the company and its stockholders, he held the new bylaw could not apply to Mr. Strougo and his suit because it was adopted after he was no longer a stockholder, and thus, not a party to that “contract.”  Moreover, the litigation challenged conduct that occurred prior to the adoption of the fee-shifting bylaw.

While acknowledging the “serious policy questions implicated by fee-shifting bylaws in general” and the fact that the total value of the reverse stock split was less than $100,000, the Chancellor noted the reality that “applying the bylaw in this case would have the effect of immunizing the Reverse Stock Split from judicial review because, in [his] view, no rational stockholder–and no rational plaintiff’s lawyer–would risk having to pay the Defendants’ uncapped attorneys’ fees to vindicate the rights of the Company’s minority stockholders, even though the Reverse Stock Split appears to be precisely the type of transaction that should be subject to Delaware’s most exacting standard of review to protect against fiduciary misconduct.”

With this decision–and pending legislation on this front–the topic of how Delaware corporate entities might use bylaw provisions to control shareholder litigation continues to be a hot topic in Delaware corporate law.

 

Representative Litigation: “Mootness” Fee Awards

It is a nearly universal truth that counsel representing stockholder-plaintiffs in class or derivative litigation against (or on behalf of) Delaware entities will seek an award of fees and costs where their efforts have produced a benefit on behalf of the company or the class they represent.  This might occur via settlement or upon a successful conclusion of the litigation.  In most instances where a benefit is achieved, that benefit takes the form of a “common fund” (where there has been a payment of money) or some type of “therapeutic benefit” (for instance, amended disclosures or revised governance procedures).  Counsel for stockholder-plaintiffs also have the ability to seek an award of fees and costs where the claims asserted in representative litigation are effectively mooted by the entity taking action in response to the claims.

In recent months, the Court of Chancery has issued two letter decisions in which it refused to enter stipulations by the plaintiffs and the companies to dismiss the purportedly mooted litigation or to award a negotiated fee award to plaintiffs’ counsel unless and until the parties provided notice to the class of the dismissal and proposed fee award.   See In re Zalicus, Inc. Stockholders Litig., Consol. C.A. # 9602-CB (Del. Ch. Jan. 16, 2015)(Chancellor Bouchard); and In re Astex Pharm., Inc. Stockholders Litig., Consol. C.A. # 8197-VCL (Del. Ch. Aug. 25, 2014)(Vice-Chancellor Laster).  In both of these letter decisions, the court noted the benefit to the class of stockholders–on whose behalf the litigation was being prosecuted–of having these types of mootness dismissals (with a fee award) exposed to the watchful eyes of the purported beneficiaries so that they may police any chance of an improper “buy-off” of plaintiffs’ counsel or to “object to the use of corporate funds” by “challeng[ing] the fee payment as waste in a separate litigation.”

These two letter decisions can be read as evidence of the Court of Chancery’s re-affirmation of its role in scrutinizing the interactions of fiduciaries who purport to act on behalf of a class of stockholders or the company on one hand and the officers and directors of the company on the other.  Whether these decisions also signal an intent by the court to more carefully circumscribe fee awards for mooted claims (which have not infrequently been in the neighborhood of $250,000-$500,000) remains to be seen.