Earlier this year, after the Delaware Supreme Court upheld the facial validity of fee-shifting bylaws in the case of ATP Tour, Inc. v. Deutscher Tennis Bund (as discussed here), a legislative initiative quickly emerged to restrict the case’s holding to Delaware non-stock companies. However, the initiative proved to be controversial, and the legislative proposal was tabled until early 2015. It appears that now, while the proposed legislation remains pending, institutional investors are mounting a concerted effort in support of legislative action “to curtail the spread of so-called ‘fee-shifting’ bylaws.”
As detailed in Alison Frankel’s November 26, 2014 post on her On the Case Blog entitled “Big Pension Funds Mobilize Against Delaware Fee-Shifting Clauses” (here), the Council of Institutional Investors and a coalition of public pension funds have launched a letter writing campaign to Delaware politicians and other key players. For example, on November 24, 2014, the groups sent a letter to Delaware Governor Jack Markell, in support of the legislative efforts to restrict the use of fee-shifting by law. The letter notes that over 30 companies have already adopted such bylaws, and contends that the bylaws “effectively make corporate directors and officers unaccountable for serious wrongdoing.”
The letter urges that the Delaware General Assembly must “act promptly to restore confidence in Delaware’s credibility in developing a balanced corporate law, preserve shareholders’ access to the court system, and make clear that directors and officers cannot insulate themselves from accountability under the guise of unilateral bylaw provisions.”
As reflected on the Council of Institutional Investors website (here), the groups also sent letters to a number of legal groups and to investment advisory firms. As Frankel summarized in her blog post, the letters contend that fee-shifting bylaws are bad corporate governance that, in the long run, will discourage investment in Delaware corporations and undermine the legitimacy of Delaware’s courts.
Arrayed against the efforts of these institutional investors are the advocacy exertions of the U.S. Chamber of Commerce’s Institute for Legal Reform, which had argued that the use of proposed legislation would “only protect frivolous lawsuits” and that the use of fee-shifting bylaws “gives corporations a way to protect shareholders against these costs of abusive litigation.” A November 14, 2014 Wall Street Journal op-ed piece by the Institute’s President and presenting the Institute’s position can be found here.
In their letter to the governor, the institutional investor groups contend that these arguments in support of fee-shifting bylaws are “directly contrary to the interests of investors in publicly traded Delaware corporations.” Far from protecting against frivolous litigation, the fee-shifting provisions would “effectively bar any judicial oversight of misconduct of corporate directors.” The provisions “undermine the most fundamental premise of the corporate form – that stockholders, simply by virtue of their investment, cannot be responsible for corporate debts.”
In conjunction with the campaign, the Kessler Topaz law firm has put together a list of the more than three dozen companies that have already adopted some form of the corporate bylaws. The list underscores the fact that while many companies are holding back awaiting the outcome of the pending Delaware legislative action, other companies have pressed ahead with bylaw changes. Frankel’s blog post quotes an attorney from the Kessler Topaz firm as saying that if the Delaware legislature or judiciary say explicitly that fee-shifting bylaws are legal for companies with public shareholders, “you’ll see a flood of these bylaws.”
The institutional investors are not the only ones critical of the advent of fee-shifting bylaws. In a November 24, 2014 post on the CLS Blue Sky Blog (here), Columbia Law School Professor John Coffee expresses a number of concerns about the efforts to advance the adoption of fee-shifting bylaws. First, he notes that many of the bylaws that have been adopted have been drafted “very aggressively” so as to “chill any prospect of litigation of any kind.” Coffee argues that these kinds of bylaws go “beyond a proper purpose” by “intentionally seek[ing] to discourage meritorious litigation,” which “may prove too much for Delaware, which … has little desire to ensure the extinction of intracorporate litigation.”
Coffee also argues that the “new theory of shareholder consent” on which the validity of the both fee-shifting and forum selection bylaws has been upheld “could lead to extreme possibilities.” Coffee argues that if the theory is valid, then company boards could adopt all sorts of provisions; Coffee invokes a parade of horribles by suggesting that if the theory is valid, boards could adopt, for example, by law provisions requiring shareholders to subscribe for additional shares or to pay the company’s costs associated with a proxy fight. In the end, Coffee contends, the theory of shareholder consent is fundamentally inconsistent with the basic notion of shareholders’ limited liability because they impose financial liability on shareholders.
Coffee suggests that Delaware has a number of alternatives. The state could, he suggests, provide that a “loser pays” provision could only be adopted by shareholder vote. Alternatively, he suggests, the state could place some form of ceiling on fee-shifting, or moderate the bit of the “loser pays” rule by limiting the fee-shifting to costs incurred up to the decision on the motion to dismiss. Coffee concludes by noting that the absence of any action on this issue by the SEC is telling; Coffee notes that “the SEC”s continuing passivity adds to the growing sense that it is not the agency that it once was.” UPDATE: For a presentation of a view that the SEC should not get involved in the fee-shifting bylaw issue, pleease see the October 16, 2014 post of Keith Paul Biship on his California Corporate & Securities Law blog, here.
There is definitely as sense in which, in the absence of any action from SEC, the action of the Delaware General Assembly alone will not put an end to this ongoing debate, regardless of what happens there. As I noted in a post discussing the adoption of a fee-shifting bylaw by recent IPO company Alibaba (here), Alibaba is a Grand Cayman company, to whom developments under Delaware law are irrelevant. 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 is entirely possible that these kinds of developments could simply overtake legal developments in Delaware, as companies could seek to form or reconstitute themselves in jurisdictions that allow fee-shifting bylaw.
As I have noted in prior posts on this topic, the larger issue is whether or not these 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.