Many readers will recall that just a short time ago companies were actively experimenting to try to incorporate litigation management measures into their corporate bylaws. These efforts led to decisions by Delaware courts upholding both forum selection bylaws (about which refer here) and fee-shifting bylaws (refer here). Delaware’s legislature ultimately addressed these bylaw experimentation efforts by adopting statutory provisions allowing forum selection bylaws but prohibiting fee-shifting bylaws.
Following the enactment of this legislation, the payroll software services firm Paylocity adopted a bylaw provision designating Delaware as the forum for any shareholder disputes and holding any shareholder who filed an action outside Delaware and who did not prevail on the merits liable for the company’s attorneys’ fees. A Paylocity shareholder filed an action in Delaware Chancery Court challenging the bylaw’s fee-shifting provision. In an interesting December 27, 2016 opinion (here), Chancellor Andre Bouchard held that the Paylocity bylaw’s penalty provisions violated the Delaware statutory fee-shifting bylaw prohibitions, but dismissed the claims that company’s board had violated its fiduciary duties in enacting the bylaw.
As discussed here, in 2015, the Delaware legislature added Section 115 to the Delaware General Corporation Law permitting companies to adopt bylaws designating Delaware’s courts as the exclusive forum for “internal corporate claims.” The legislature also amended DGCL Section 109(b) prohibiting the adoption of bylaws imposing fee-shifting on unsuccessful claimants filing internal corporate claims.
Six months after these statutory provisions went into effect, Paylocity adopted a bylaw provision designating Delaware as the preferred forum for shareholder disputes. The bylaw also provides, in relevant part, that “to the fullest extent permitted by law,” any stockholder who filed an “Action” outside of Delaware and who fails to “obtain a judgment on the merits that substantially achieves … the full remedy sought,” shall be obligated to” reimburse Paylocity for the attorneys’ fees and other expenses” it incurred in connection with the action. In other words, as Chancellor Bouchard wrote in his recent opinion, “to trigger the Fee-Shifting Bylaw, a stockholder must first violate the company’s exclusive forum by law.”
A Paylocity shareholder filed an action in Delaware Chancery Court seeking a judicial declaration that the fee-shifting bylaw is invalid under DGCL Sections 109(b) and 102 (b)(6) (which prohibits imposing “debts” of a corporation on its shareholders). The shareholder also claimed that Paylocity’s board members’ breached their fiduciary duty in adopting the bylaw. The defendants moved to dismiss the plaintiff’s complaint, arguing that the plaintiff’s action was not “ripe” for decision because no stockholder had filed an internal corporate action outside of Delaware. The defendants also moved to dismiss the complaint on the grounds that the plaintiff failed to state a claim for relief.
The December 27 Decision
In his December 27, 2016 Opinion, Chancellor Bouchard (1) held that the plaintiff’s claims were ripe for dispute; (2) held that the Paylocity bylaw was contrary to the Delaware statute’s prohibition on the adoption of fee-shifting bylaws; (3) found that the bylaw did not violate DCGL 102 prohibiting the imposition of corporate “debts” on shareholders; (4) granted the defendants’ motion to dismiss the breach of fiduciary duty claims.
In finding that the plaintiff’s claims are ripe for decision even though no shareholder has filed an action outside of Delaware, Chancellor Bouchard focused on the bylaw’s deterrent effects. If the bylaw were to remain in place and unchallenged, he said, “it is highly unlikely that any rational stockholder of Paylocity would filed an internal corporate claim outside of Delaware because of the significant risk of personal liability,” which, he said further, “would mean, as a practical matter, that its validity under the DGCL would never be subject to judicial review.” He added that declining to review the bylaw would also “encourage other corporate boards to adopt similar bylaws to take advantage of their potent deterrent effect.”
Turning to the merits of the plaintiff’s claims, Chancellor Bouchard held that the plaintiff had stated a claim that the fee-shifting bylaw is “facially invalid” under DCGL 109(b). Section 109(b) provides that “bylaws may not contain any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an internal corporate action.” Bouchard agreed with the plaintiff that the “plain text” of Section 109(b) “unambiguously prohibits the inclusion of ‘any provision’ in a corporations bylaws that would shift to a stockholder the fees or expenses incurred by the corporation in connection with an internal corporate claim.” Thus, Chancellor Bouchard held that even though the fee-shifting provision in the Paylocity bylaw would be triggered only when an internal corporate claim is filed outside Delaware, “it is invalid under the blanket prohibition of such bylaws contained in Section 109(b).”
In reaching this conclusion, Chancellor Bouchard rejected the defendants argument that Section 109(b) was not intended to prohibit fee-shifting for internal corporate claims filed outside Delaware when the company adopts a valid bylaw under Section 115 designating Delaware’s courts as the exclusive forum for such disputes. Chancellor Bouchard said even though the two provisions were indeed adopted at the same time, “there is nothing in the plain text of those provisions indicating that the legislature intended to create an exception to the prohibition on fee-shifting for actions filed in violation of a forum selection provision compliant with Section 115.”
Chancellor Bouchard did hold, however, that the plaintiff had failed to state a claim for relief on his claim that the bylaw violated DCGL Section 102(b)(6) (prohibiting the imposition of corporate “debts” on shareholders). The plaintiff had provided no authority, he said, interpreting the term “debts” as used in the statute encompassed the kinds of expenses addressed in Paylocity’s fee-shifting bylaw.
Finally, he granted the defendants’ motion to dismiss the plaintiff’s breach of fiduciary duty claims against the Paylocity board, holding that the plaintiff had failed to state a claim. In reaching this decision, Chancellor Bouchard took into account the fact that Paylocity’s certificate of incorporation contains a provision adopted under DCGL Section 102(b)(7) exculpating the company’s directors from liability for breaches of the duty of care. He also noted that the plaintiff’s complaint contains no factual allegations questioning the directors’ independence or suggesting that any of them had any personal or financial interest in adopting the bylaw. Accordingly, he held the plaintiff’s breach of fiduciary duty claim could proceed only if “it is reasonably conceivable from the allegations of the Complaint that they acted in bad faith.”
In attempting to show that allegations were sufficient to make it reasonably conceivable that the directors had acted in bad faith, the plaintiff relied on the complaint’s allegation that the board must have known it was adopting the bylaw in violations of the law, because they adopted the bylaw six months after the Delaware legislature adopted Section 109(b). Chancellor Bouchard found this insufficient to meet the bad faith standards.
He also noted that the complaint lacked any factual allegations about the board’s processes in adopting the bylaw or any allegation that the “directors harbored some nefarious purpose, that they did not deliberate diligently, or that they failed to receive (or ignored) legal advice.” He added that the plaintiff could have filed a books and records action to explore the board’s deliberations, but failed to do so.
The Paylocity board’s adoption of this bylaw shows that the era of experimentation with litigation management bylaws has not ended. Clearly, this company, at least, showed that it was willing to continue to try to manage its litigation exposure through the bylaw amendment. Chancellor Bouchard’s analysis of the ripeness issues put a finger on the reason for the board’s actions; the plaintiff’s claims were ripe for judicial consideration precisely because the self-evident purpose of the bylaw was to deter shareholders from filing claims outside of Delaware. Bouchard is also correct that if this bylaw were not subject to judicial review, other companies might well adopt similar bylaws.
While I am sure Paylocity will seek to argue to the contrary in any appeal they may file, there is a certain amount of straightforwardness to Chancellor Bouchard’s analysis that Section 109(b) prohibits “any provision” requiring fee-shifting in internal corporate disputes, and that there is no exception in Section 109(b) allowing fee-shifting in connection with internal corporate claims filed outside of Delaware in violation of a valid forum selection clause.
Notwithstanding this straightforward statutory analysis, there is a sense in which Chancellor Bouchard seems in his opinion to be questioning whether there is really anything wrong with Paylocity’s fee-shifting by law. “I do not intend to suggest,” he wrote, “that a stockholder who files an internal corporate claim outside of Delaware in blatant violation of a plainly-valid forum-selection bylaw would suffer a detriment from being compelled to litigate in the mandated forum, nor should such behavior be condoned.” He added that, “to the contrary, stockholders are expected to play by the rules of the company in which they chose to invest.” If stockholders don’t like the bylaws adopted by the company, he seems to be saying, then they can just invest in a different company. From the company’s perspective, all the fee-shifting portion of its bylaw does is deter — and impose a penalty for any instance that is not deterred — of conduct that Chancellor Bouchard himself said he could not “condone.”
Chancellor Bouchard’s ruling on the defendants’ motion to dismiss plaintiff’s breach of fiduciary duty claims, on the other hand, represents good news for Paylocity’s board and for boards generally. Among other things, his ruling highlighted how difficult it is for a claimant to sustain a claim for breach of fiduciary duty when the company has adopted an exculpatory provision. Bouchard also restated the kinds of things a plaintiff might have to allege in order to make the requisite bad faith showing, referring to a “nefarious purpose,” lack of deliberation diligence, or failure to obtain or follow legal advice. His opinion also underscored the importance for claimants seeking to challenge board decision making to conduct a books-and-records inquiry, in order to establish the requisite factual record sufficient to state a claim.
There may be more to be told on this tale if the company chooses to pursue an appeal to the Delaware Supreme Court. And, in any event, it seems that there may yet be more to be told on the tale of experimentation with litigation management bylaws. I suspect we will see more occasions in which companies have attempted to use their corporate bylaw provisions as tools to manage their litigation exposures.
UPDATE: On January 6, 2017, Paylocity filed with the Chancery Court an Application Certification of an Interlocutory Appeal (here).
Francis Pileggi has a January 6, 2017 post on his Delaware Corporate & Commerical Litigation Blog (here) publishing an article that his colleagues Gary Lipkin, Justin Forcier and Alexandra Rogin wrote about Chancellor Bouchard’s opinion in the Paylocity case.
Special thanks to a loyal reader for providing me with a copy of Chancellor Bouchard’s opinion.
Massive Damages Award Against Puda Coal and its Former Chairman: A lot of different stuff crosses my desk here at The D&O Diary’s world headquarters. One of the more interesting items to pass my way in recent days is the Magistrate Judge’s January 6, 2017 Report and Recommendation in the Puda Coal securities class action lawsuit. Plaintiff shareholders had sued the company, its former Chairman Ming Zhao, and certain other defendants in the Southern District of New York, claiming that the defendants had defrauded shareholders. The plaintiffs claimed that before the company obtained its U.S. listing by way of a reverse merger Ming had transferred Puda Coal’s assets to a different company that Ming owned, leaving Puda Coal as an empty shell. Defaults were entered against Puda Coal and Zhao (the last remaining defendants) in the shareholder action, and the matter was referred to Magistrate Judge Henry B. Pittman to calculate the default judgment damages.
In his January 6, 2017 Report and Recommendation sent to Southern District of New York Judge Denise Cote, the Magistrate Judge recommended that damages of $228 million be awarded jointly and severally against Puda Coal and Zhao. The Magistrate Judge’s report makes for some very interesting reading, particularly with respect to the maneuvers and moves that Zhao made to obtain control of Puda Coal’s assets, as well as with respect to the disclosure claims that Puda Coal made after Zhao’s moves had already taken place.
As very wise person once said to me, “The world is full of all kinds of stuff.”