In a development with significant implications for the economics of shareholder litigation, the Delaware Supremee Court has upheld the validity of a corporate bylaw provision shifting fees to an unsuccessful litigant. In a May 9, 2014 opinion (here), the Court held in ATP Tour, Inc. v. Deutscher Tennis Bund that a by-law provision shifting attorneys’ fees and costs to unsuccessful plaintiffs in intra-corporate litigation can be valid and enforceable under Delaware law. A May 9, 2014 memorandum from the Paul Weiss law firm said the decision may “dramatically change the landscape of stockholder litigation.”
ATP Tour, Inc. operates the global professional men’s tennis tour. In 2007, ATP revised the tour schedule in a way that affected the annual tennis tournament in Hamburg. Upset about the changes, Deutscher Tennis Bund, an ATP Tour member, sued ATP and its board members in federal district court in Delaware alleging violations of the federal antitrust laws and braches of fiduciary duties under Delaware law. ATP and the individual board members ultimately prevailed on all claims.
ATP then filed a motion to recover the fees, costs and expenses it incurred in defending the lawsuit, in reliance on Article 23.3 of ATP’s bylaws, which in pertinent part shifts all litigation expenses to a plaintiff in intra-corporate litigation who “does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.” The federal district court determined that the enforceability of this bylaw provision was a novel question of Delaware law that should be addressed in the first instance by the Delaware Supreme Court. The district court certified a series of questions about the bylaw to the Delaware Supreme Court.
The May 9 Opinion
In a May 9, 2014 opinion written by Justice Carolyn Berger for a unanimous en banc panel of the Delaware Supreme Court, the Court addressed the federal district court’s certified questions.
The Court first observed that there is no prohibition in Delaware’s statutes forbidding the enactment of a fee-shifting bylaw. The Court also noted that while Delaware generally follows the American Rule, pursuant to which each party to a lawsuit bears its own costs, Delaware also allow contracting parties to agree to modify the American Rule to obligate a losing party to pay a prevailing party’s fees. Because corporate by-laws are considered contracts among a corporation’s shareholders, a fee-shifting provision would fall within the contractual exception to the American Rule .Therefore, “a fee-shifting provision would not be prohibited under Delaware common law.”
Whether or not ATP’s fee-shifting by-law is enforceable, however, depends on the manner in which it was adopted and the circumstances under which it was invoked. Bylaws that are otherwise facially valid will not be enforced if adopted or used for inequitable purposes. The Supreme Court said that the record certified from the district court did not provide the stipulated facts necessary to determine whether the ATP bylaw was enacted for a proper purpose or properly applied. The Court said that it is “able to say only that a bylaw of the type at issue here is facially valid, in the sense that it is permissible under [Delaware’s statutes], and that it may be enforceable if adopted by the appropriate corporate procedures and for a proper corporate purpose.”
On the questions of what might constitute an “improper purpose,” the Supreme Court noted that “the intent to deter litigation, however, is not invariably an improper purpose.” Fee shifting provisions “by their nature, deter litigation.” An intent to deter litigation “would not necessarily render the bylaw unenforceable in equity.”
The Supreme Court concluded its opinion by noting that “fee-shifting bylaw is not invalid per se, and the fact that it was adopted after entities became members will not affect its enforceability.”
The Paul Weiss law firm memo linked above notes that the Supreme Court’s ruling was delivered in the context of non-stock corporation, but “the holding may be read to apply to all Delaware corporations.” The memo goes on to note that whether such a bylaw would be appropriate for a particular corporate “will, however, depend on a number of factors specific to such corporation.” The memo also highlighted the fact that though a fee-shifting bylaw may be facially valid, it may “nevertheless be invalid if adopted or used for an inequitable purpose.”
But while there are unquestionably reasons for companies to proceed cautiously, the Delaware Supreme Court’s ruling that fee-shifting by laws can be valid and enforceable under Delaware law potentially presents a significant opportunity for companies organized under Delaware’s laws to try to address the burdens and expense often associated with intra-corporate litigation. Significantly, the Delaware Supreme Court specifically said an intent to deter litigation alone would not be sufficient to render a fee-shifting bylaw unenforceable.
The Delaware Supreme Court’s holding in the ATP Tour case is just the latest instance in which Delaware’s courts have upheld companies’ efforts to try to use bylaw provisions to protect themselves from the burdens and costs associated with shareholder litigation. As discussed here, in June 2013, the Delaware Chancery Court upheld the enforceability of a forum selection provision in corporate bylaws designating Delaware court’s as the authorized forum for shareholder disputes. This ruling provided a way for companies to try to protect themselves from the increasingly common curse of multi-forum litigation, particularly in the M&A context.
As significant as the ruling the forum selection by-law case was, the Delaware Supreme Court’s upholding the validity of a fee-shifting bylaw could be even more significant. By in effect allowing companies to opt out of the standard American Rule model under which each party bears its own litigation costs, and to adopt the an approac with attributes of the “loser pays” model that prevails in the courts of most other countries, the ruling provides an opportunity for companies to adopt provisions that may protect them from litigation costs, and indeed deter litigation in the first place.
It remains to be seen, of course, whether many companies will embrace this opportunity and seek to adopt fee shifting bylaw provisions. Shareholder advocates may resist companies’ efforts to adopt these kinds of provisions. In addition, if it turns out that the adoption of these kinds of provisions affects company share price or creates shareholder relations problems, companies may be reluctant to adopt a fee shifting bylaw. But while it may be too early too tell whether companies will adopt these kinds of provisions, the possibility that companies could adopt these kinds of provisions has the potential to significantly alter the shareholder litigation environment.
I wonder whether a fee-shifting bylaw would require a securities class action plaintiff whose complaint is dismissed to reimburse the company for its defense expenses? If it did, this judicial development in Delaware could turn out to have an enormous significance for corporate and securities litigation.
Francis Pileggi’s May 10, 2014 post about the ATP Tour decision on his Delaware Corporate and Commercial Litigation blog can be found here.