One of the more interesting recent developments in the D&O liability arena has been the emergence of issues surrounding fee-shifting bylaws. As readers will recall, in May 2014, the Delaware Supreme Court in the ATP Tours case upheld the validity of a non-stock corporation’s bylaw imposing attorneys’ fees on an unsuccessful claimant in an intra-corporate lawsuit. Legislation to limit the Court’s decision’s effect to non-stock corporations was quickly introduced in the Delaware legislature, but the proposed legislation has been tabled until the legislative session resumes in 2015. While the question of the validity of these kinds of bylaws under Delaware remains on hold, some companies have continued to press ahead. Among the companies adopting fee shifting bylaws is none other than Alibaba, the IPO superstory of 2014.
As discussed in a September 30, 2014 post by Denver Law School Professor J.Robert Brown on the Race to the Bottom blog (here), Alibaba’s Amended and Restated Memorandum and Articles of Association (which can be found here) provide in Article 173:
Unless otherwise determined by a majority of the Board, in the event that (i) any Shareholder (the “Claiming Party”) initiates or asserts any claim or counterclaim (“Claim”) or joins, offers substantial assistance to or has a direct financial interest in any Claim against the Company and (ii) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Claim the Claiming Party had a direct financial interest) does not obtain a judgment on the merits in which the Claiming Party prevails, then each Claiming Party shall, to the fullest extent permissible by law, be obligated jointly and severally to reimburse the Company for all fees, costs and expenses (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses) that the Company may incur in connection with such Claim.
As Professor Brown points out, Alibaba is a Grand Cayman corporation, so the pending legislative developments in Delaware are irrelevant to the validity of Alibaba’s fee-shifting bylaw. In addition, as a Grand Cayman corporation, the company and its directors and officers are not subject to the same kind of state court litigation as domestic U.S. companies and their directors and officers. So it would seem that this bylaw is targeted at securities lawsuits. However, it should also be noted that the bylaw applies by its terms to claims against the company itself (as opposed to its directors and officers) and that it requires only reimbursement of fees to the company by unsuccessful litigants.
Shareholders of Alibaba might well have reason to be concerned about this bylaw provision, because of the practical barriers it creates for any shareholder who might want to allege that the company misled investors and thereby violated the federal securities laws. However, for the shareholders to be concerned about the bylaw, they would have to know about it. As Professor Brown notes, the company’s IPO prospectus apparently neglected to mention the existence of this bylaw provision.
Nor is Alibaba the only recent IPO company to include a fee-shifting provision in its bylaw. As Alison Frankel discusses in her October 9, 2014 post on her On the Case blog (here), Smart & Final, a grocery store chain that went public last month, and ATD Corp, a tire distributor that in August filed to go public, have also adopted charter provisions that “shift the cost of defending shareholders’ claims to investors who sue and lose.” Interestingly, both Smart & Final and ATD Corp. are Delaware corporations, so the validity of their bylaw provisions will depend on the outcome of the pending legislative processes in Delaware. These companies join a number of other smaller public companies that have amended their bylaws to include fee-shifting provisions (as discussed here).
According to a Professor Brown’s September 28, 2014 post on the Race to the Bottom blog (here), the Smart & Final fee-shifting provision appears in the company’s articles of incorporation and expressly refers to actions against the company’s officers, directors and employees, so presumably it would apply to shareholders’ derivative lawsuits as well as other state court shareholder litigation.
As Frankel points out, the questions of the validity of these kinds of bylaw provisions may be different for IPO companies than for other publicly traded companies that amend their bylaws to include these kinds of provisions. For the publicly traded companies, shareholders may try to object that the bylaws were amended without their consent. For IPO companies, the defendants “will argue that their founding corporate documents told shareholders what to expect.” (Although that argument may carry less sway if, as seems to be the case with Alibaba, shareholders were not in fact informed about the existence of the provisions).
The more interesting question in all of this may be where the SEC was on these issues. In the past, the SEC seemingly at least, had been quite attentive to these kinds of initiatives. For example, as discussed here, when The Carlyle Group sought to go public in 2012 with, as was disclosed in its preliminary registration statement, a bylaw requiring the arbitration of shareholder disputes, the company ultimately was forced to revise its bylaw to remove the provision under pressure from the SEC. These prior events raise the question of how the various companies recently were able to complete their public offerings with fee-shifting bylaws, which in Alibaba’s case apparently were not even disclosed in the Prospectus
As Frankel notes in her blog post, even if the SEC has been quiet on these issues in the past, that may be about to change. The SEC’s Investor Advisory Committee apparently is taking up these issues. Among other things it may be expected that at least the agency will require companies to do a better job disclosing the existence of these kinds of bylaws.
In any event, it seems clear that these issues are going to continue to percolate, regardless of what the Delaware legislature ultimately does on the pending legislation. For starters, regardless of what the Delaware legislature does, these issues will continue to arise in connection with other companies – like Alibaba for example — to which Delaware’s laws do not apply. In addition, legislative and judicial developments in other jurisdictions could have their own impact; as I noted in a recent post, Oklahoma’s legislature recently adopted a provision authorizing Oklahoma corporations to extend loser-pays to all shareholder suits involving board members.
It remains to be seen where all of this well lead. I suspect that going forward there will be increased scrutiny on these issues for IPO companies and that companies with fee-shifting bylaws that are attempting to go public will likely be called out on the issue, assuming that is that the SEC continues to allow the IPOs of companies that have these kinds of bylaws to proceed.
The larger issue is whether or not the developments portend a significant revision of what is known as the American Rule, whereby it has been the practice in this country that each litigation party will bear its own costs. As companies increasingly seek to introduce their own form of litigation reform through revision of their own bylaws, and as courts and legislatures evolve their response to these kinds of bylaw provisions, there is a possibility that these developments could work a major change to the traditional American Rule on attorneys’ fees. Which in turn could have a significant impact on the corporate litigation environment.