The Delaware Supreme Court stirred up quite a bit of controversy earlier this year in the ATP Tours, Inc. v. Deutscher Tennis Bund case when it upheld the facial validity of a fee-shifting by law. The bylaw provided that an unsuccessful shareholder claimant in intracorporate litigation would have to pay his or her adversaries’ cost of litigation. The controversy seemed headed for a swift resolution when the Delaware General Assembly quickly moved to act on a measure that would have limited the Supreme Court’s ruling to non-stock corporations (meaning that it wouldn’t apply to Delaware stock corporations). However, as discussed here, the legislature tabled the measure and now it will not be acted upon until at least January 2015.
In light of the uncertain state and indefinite future of fee-shifting bylaws under Delaware law, many lawyers have been counseling caution. For example, a July 11, 2014 memo from the Wilson Soninsi firm (here) states that in light of the “uncertain fate of fee-shifting bylaws” companies should adopt a “wait and see attitude.” Going to the heart of the matter, the memo further states that “we do not believe that directors of most Delaware corporations should adopt any specific fee-shifting bylaw at this time,” as companies adopting a fee-shifting bylaw now could “face the possibility of later statutory amendments intended to undercut those provisions, potential investor opposition, and possible litigation risks.”
But while the prudent course for companies considering these bylaws arguably is to await further action by the Delaware General Assembly next year, at least a few companies have gone ahead and adopted some version of a fee shifting bylaw. As detailed in Tom Hals’s July 7, 2014 Reuters article entitled “U.S. Companies Adopt Bylaws That Could Quash Some Investor Lawsuits” (here), at least six companies have adopted fee-shifting bylaws. Interestingly, among these companies are two — Biolase, Inc. and Hemispherix Biopharma, Inc. — that adopted bylaws with the obvious intent of seeking to address specific ongoing doing disputes in which each of the companies is involved.
Because of the targeted nature of these bylaws and because of the ongoing disputes, it is possible that Delaware’s courts will be called upon to consider the validity of each of the company’s respective bylaws even before the Delaware legislature acts on the pending legislation next year.
Hemispherx
As discussed in a July 22, 2014 Law 360 article (here, subscription required) Hemispherx adopted its fee-shifting bylaw in response to an ongoing shareholder derivative lawsuit. The plaintiffs filed the lawsuit in June 2013, seeking to invalidate $2.5 million in bonuses paid to board members in November 2012. The plaintiffs contend that the bonuses were not permissible under the board members’ employment agreements.
On July 10, 2014, Hemispherx’s board adopted a fee shifting bylaw attempting to impose a retroactive requirement holding shareholder plaintiffs liable for all the defendants’ costs in the event that the plaintiffs are not successful on all of their claims. The bylaw, which is detailed here, applies to any securityholder who after July 3, 2014 “initiates, asserts, maintains or continues” a derivative action or breach of fiduciary action against any current or past director, officer or securityholder and who is not successful on the merits. The bylaw also provides that the company can require a shareholder claimant to “post a surety” for the expenses incurred in defending the action.
According to a July 22, 2014 Wall Street Journal Law Blog post (here), the shareholder plaintiffs in the Hemispherx derivative suit have asked the court to invalidate the bylaw, arguing that it unfairly saddles them with financial risk. The plaintiffs argue that the company has “changed the rules in the middle of the game to place the plaintiffs and their counsel at risk not only for their own litigation costs, but for all litigation costs of the defendants back to the beginning of the case.”
The blog post quotes the company’s general counsel as saying that the bylaw was adopted to protect the money-losing developmental stage biotech company’s “scarce resources,” noting that the bonuses at issue were intended to “encourage and reward hard work” and came after an 18-month period in which no bonuses were paid. The company’s outside counsel added that whatever the debated merits of fee-shifting bylaws, the right to adopt such a bylaw now exists and companies can use the bylaw “as a sword against cases that corporations themselves deem to be empty and frivolous.”
Biolase
Biolase also adopted its bylaw in response to an ongoing dispute, but its bylaw is even more specifically targeted to address the dispute than the one adopted by Hemispherx. As discussed in a detailed July 8, 2014 post on Alison Frankel’s On the Case blog (here), Biolase adopted its fee-shifting bylaw as the latest step in an ongoing dispute with its former Chairman and CEO, Frederico Pignatelli, whom the company’s board ousted in June after months of legal wrangling over the composition of the company’s board.
At the same meeting at which the board ousted Pignatelli, it adopted a fee-shifting bylaw. But the bylaw Biolase adopted involves an interesting variant. Instead of applying to any shareholder claimant, the Biolase bylaw applies only to current or former directors (or anyone acting at their behest) who assert unauthorized claims against the board. In her blog post, Frankel quotes a company spokesman as saying that the bylaw was narrowly tailored in the hope of avoiding additional litigation expenses after the bitter fight to oust Pignatelli.
Pignatelli has already made it clear he is ready to continue the fight. As reflected here, Pignatelli has sent a books and records request to the company “relating to suspected wrongdoing, mismanagement and corporate governance failures by the company’s board of directors.” From the statements of Pignatelli’s counsel that Frankel quotes in her blog post, it appears that Pignatelli is primed to challenge the Biolase fee-shifting bylaw, which Pignatelli’s counsel says is “clearly designed to chill actions taken to protect all shareholders and hold the board accountable for misconduct.”
Discussion
There would seem to be a pretty good chance that between the Hemispherix case and the Biolase case that at least one and possibly two Delaware courts will have to address the question of a validity of a fee-shifting bylaw for Delaware stock corporations, perhaps before the Delaware legislature acts on the pending legislation next year.
The question the courts will be called upon to address with respect to these companies’ bylaws is whether or not the Delaware Supreme Court’s decision in the ATP Tour case compels a conclusion that the companies’ respective fee-shifting bylaws are valid and enforceable. A threshold issue the courts will have to address is whether the Delaware Supreme Court’s decision, which involved a non-stock corporation, also applies to stock corporations. Although many commentators have assumed that the decision is equally applicable to stock corporations, no court has yet made that determination.
Another issue that the courts will have to address is whether the bylaws, even if valid, are enforceable. As discussed here, the Delaware Supreme Court said in the ATP Tour case that whether a fee-shifting bylaw is enforceable 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. Specifically, the Court said a fee-shifting bylaw “may be enforceable if adopted by the appropriate corporate procedures and for a proper corporate purpose.”
The claimants in the disputes with Hemispheryx and Biolase may try to argue that the respective bylaws were not adopted for proper corporate purposes but rather were merely means to try to deprive the claimants of their rights to seek legal redress through the courts. On this point, it is interesting to note that the Delaware Supreme Court specifically said that on the question of what might constitute an “improper purpose” that “the intent to deter litigation … is not invariably an improper purpose.” Fee shifting provisions “by their nature, deter litigation.” The intent to deter litigation “would not necessarily render the bylaw unenforceable in equity.”
The developments in these cases will be closely watched. As Alison Frankel said in her post about the Biolase bylaw, if Pignatelli, the former Biolase CEO, is unsuccessful in challenging the validity or enforceability of the bylaw, “more public corporations will be emboldened to enact loser pays provisions.” Either way, the outcome of the courts’ considerations of these issues could affect the Delaware legislature’s consideration of the pending legislation next year, as regardless of the outcome one side or the other is likely to pick up ammo to use in the debates surrounding the merits of the legislation – and of fee-shifting bylaws.
When the Delaware legislature tabled the proposed legislation, it seems as if the topic of fee-shifting bylaws would lie dormant until next year. For better or worse, that will not be the case. Instead, there could possibly be some significant developments before the legislature takes up the issue again.
The Halliburton Decision and D&O Insurance: One of the many questions being asked in the wake of the U.S. Supreme Court’s decision last month in the Halliburton case is what the decision’s implications are for D&O insurance. Readers interested in thinking about this issue will want to read the July 25, 2014 Law 360 article by Roberta Anderson of the K&L Gates law firm entitled “Your D&O Insurance Policy Post-Halliburton” (here, subscription required).
After summarizing and reviewing the Court’s holding, Anderson considers that decision’s D&O insurance coverage implications. Anderson also analyzes the likely insurance issues associated with the Court’s holding that defendants may present absence of price impact evidence to try to defeat class certification. She specifically reviews current insurer initiatives to address the costs for event studies that defendants will use to show the absence of price impact. Anderson’s interesting article provides a good summary of the relevant issues.