One of the most interesting recent developments has been the onset of innovative litigation reform efforts in the form of bylaw revisions. Among the most intriguing of these efforts involves fee shifting bylaws, whereby an unsuccessful claimant in intracorporate litigation must pay the other party’s costs. As discussed here, earlier this year, the Delaware Supreme Court upheld the validity of a fee shifting bylaw, a judicial decision that immediately triggered a legislative initiative to limit the effect of the decision to non-stock companies. As discussed here, the Delaware legislative initiative has now been tabled until early next year.
But while the Delaware legislative initiative is on hold, at least one legislature has gone forward to provide for the awarding of fees against unsuccessful derivative lawsuit claimants. As discussed by University of Denver Law Professor J. Robert Brown in a September 24, 2014 post on the Race to the Bottom blog (here), the Oklahoma legislature has adopted a bill providing that in a shareholder initiated derivative action against a domestic or foreign corporation, the court “shall require the nonprevailing party or parties to pay the prevailing party or parties the reasonable expenses including attorneys’ fees, taxable as costs, incurred as a result of such action.” A copy of the Oklahoma legislation can be found here.
Professor Brown notes that the Oklahoma arrangements are, in a sense, narrower than what the Delaware Supreme Court approved, as the Oklahoma legislation only applies to derivative suits, and it is more balanced, as it provides for the awarding of attorneys fees for successful derivative plaintiffs.
Nevertheless the “loser pays’ model that the Oklahoma legislation adopts is extraordinary — It represents a significant departure from what is general known as the American Rule, under which each party typically bears its own cost. And unlike the fee-shifting bylaws being debated in Delaware –which would in any event require each company to decide whether it was going to adopt the bylaw (and might therefore be subject to shareholder scrutiny) — the Oklahoma legislation applies to any derivative action in the state, even if the company involved is not an Oklahoma corporation.
As Professor Brown points out in his blog post, derivative actions are often dismissed on procedural grounds (for example, based upon the failure to make a demand on the board, without a judicial determination that demand would be futile), meaning that derivative lawsuit plaintiffs often do not prevail. Under this statute, a shareholder plaintiff that does not prevail “will be forced to pay the other side’s fees, something that can result in dollar amount s that stretch into six and seven figures.”
The risk of this possibility, according to Professor Brown “provides a significant disincentive to file a suit against the board for breach of fiduciary duties” – which, it seems to me, was the Oklahoma legislature’s intent. I don’t have a good sense of how many derivative lawsuits are actually filed in Oklahoma’s courts, but whatever the number is, now with this legislation in place, there are certainly going to be fewer derivative lawsuits filed in the Sooner State than there were in the past.
I know there are some who might say that is a good thing. For his part, Professor Brown says the effect of these fee shifting provisions is “to insulate challenges to boards for breach of the duty of loyalty, for bad faith, or for wasting corporate assets. In other words, it has the potential to render boards unaccountable for their actions as directors.”
Professor Brown says that Oklahoma is the “first state to intervene in the debate” about fee shifting in derivative litigation. His use of the word “first” is telling – he did not say “only.” For starters, we know that Delaware is going to get into the mix on these issues sometime in 2015. In addition, as things stand, there is a Delaware Supreme Court decision holding that fee shifting bylaws are valid. If the Delaware legislature fails to act, or winds up taking a different action than originally proposed, fee shifting bylaws might well become a regular bylaw provision for Delaware corporations. And while we will have to wait to see what Delaware’s legislature will do, perhaps other states will, like Oklahoma, adopt a “loser pays” rule, or permit companies incorporated in their jurisdiction to adopt fee shifting by laws.
I don’t expect that every state’s legislature would be willing to adopt a bill like the one Oklahoma’s legislature passed, but there are some other states that might. If this kind of legislation becomes widespread, the environment for litigating derivative lawsuits in this country could be substantially altered. In any event, there will be many more developments ahead as this particular story unfolds.
Break in the Action: Due to Travel Requirements, the D&O Diary will not be published for the next few days. Regular publication will resume once I am back in the office toward the end of next week.