One of the more significant recent developments in the corporate and securities litigation arena has been the emergence of the debate over fee-shifting bylaws following the Delaware Supreme Court’s May 2014 decision in ATP Tour, Inc. v. Deutscher Tennis Bund. Draft proposed legislation is now being considered by the Delaware legislature that would address fee-shifting bylaws, among other issues.
As part of this debate, Mark Lebovitch and Jeroen Van Kwawegen of the Bernstein, Litowitz, Berger & Grossmann law firm wrote a March 16, 2015 paper entitled “Of Babies and Bathwater: Deterring Frivolous Stockholder Suits Without Closing the Courthouse Doors to Legitimate Claims” (here) in which they contributed their views as plaintiffs’ attorneys on the fee-shifting bylaw controversy. A summary version of their longer article appears in an April 8, 2015 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation (here).
After reviewing their paper, I approached Mark to see if he would be willing to participate in a Q&A for this website, discussing his views on the topic. Mark agreed to participate, and our exchange is reproduced below. My questions are in boldface, Mark’s responses are in plain text.
By way of background, Mark is a partner at the Bernstein, Litowitz, Berger & Grossmann law firm. He heads the firm’s corporate governance litigation practice, focusing on derivative suits and transactional litigation. Since becoming a shareholder-side lawyer after leaving Skadden Arps as a senior associate, Mark has served as lead plaintiffs’ counsel in several of the highest profile and most successful shareholder lawsuits. I would like to thank Mark for his willingness to participate in this Q&A, which follows below.
I know your recent article opposes the Delaware Supreme Court’s opinion in the ATP Tour case for a wide range of policy and legal reasons. What was your immediate reaction to the opinion? At what point did you see the case as a threat to the viability of shareholder litigation itself?
When I first read the opinion, I was stunned. The Court justified bylaws adopted by the board of a member corporation that forced plaintiff-members to fund the board’s defense costs unless the plaintiff-members obtained substantially all the relief sought in their complaint. I kept waiting for the “but here’s the limitation” moment when the ruling would be cabined in some way so it would not apply to public companies. That moment never came. Instead, the opinion affirmatively said that “deterring litigation” was itself a proper purpose for a bylaw, without even including the word “frivolous.” As a result, the opinion seemed to invite boards to limit their accountability to the shareholders whose assets they manage by adopting fee-shifting bylaws. This outcome seemed totally inconsistent with everything I had believed about Delaware law. (I will note that the Chief Justice recently stated, publicly, that the Court did not contemplate that public companies would seize upon the ruling.)
Fee shifting provisions at public companies is just impossible to justify. They eliminate the ability of stockholders to pursue meritorious claims because you are letting corporations make an individual plaintiff seeking to achieve a benefit for a class of plaintiffs bear unknown and massive personal liability risk. Nobody would file suit knowing that the longer the case goes on, the larger the black hole of personal liability the stockholder will face if the case fails to get a complete and total victory. The deck is just stacked so fully against you that it would never make sense to begin the fight.
To me, it was just a matter of time before corporate CEOs, even those who generally mean well and try to do right by their shareholders, would be telling their executives and boards that by unilaterally passing a simple bylaw, they could now manage massive amounts of other people’s money without any fear of accountability to those investors. And sure enough, within days, certain corporate firms started recommending these bylaws to their clients, albeit nicely dressed up in some Orwellian terms that made the bylaws seem like a modest step.
Since the Delaware Supreme Court issued its ATP Tour opinion, the question of whether or not corporate boards should be able to unilaterally adopt fee-shifting bylaws has been actively debated. What is your core disagreement with the reasoning of the Delaware Supreme Court in the ATP Tour case? If fee-shifting bylaws should not be allowed, are fee-shifting provisions in a company’s articles of incorporation OK?
My core problem is that ATP seemed to ignore the inherent conflict of interest in allowing a board of directors to pass a resolution and, voila, become effectively immune to shareholder enforcement of fiduciary and related duties. That conflict is very real.
To take a slightly theoretical perspective, giving directors broad power to use bylaws to affect core stockholder rights conflicts with former U.S. Supreme Court Chief Justice Oliver Wendell Holmes’ “Bad Man” theory of how you set up the law. I may be oversimplifying, but Holmes wrote that when you craft laws that regulate conduct, you do so with a bad actor in mind, not the moral person of high integrity, who will naturally behave in a socially acceptable way with or without the lines drawn by law.
The business judgment rule conforms to Holmes’ theory. Courts will not generally intervene or second-guess director decisions. But that presumption of normalcy goes away, and courts expose decisions to various degrees of judicial scrutiny, when there is some misaligned incentive or other logical basis to fear the directors may not act solely for the best interests of the shareholders whose assets they oversee. In other words, the law typically presumes directors are good people. Yet, when there’s a basis to fear self-interested conduct or signs of a misalignment of interests, the corporate law is realistic about the situation, and provides judicial protection against abuse by the “bad man.”
The ATP opinion was troubling because it applied the business judgment presumption to a context where the conflict of interest just seems so obvious. If directors can benefit themselves at the expense of stockholders by simply writing a bylaw insulating themselves from accountability, then you not only empower the “bad man” directors and officers that we all know exist, but you may even push good actors, the vast majority of directors who have integrity and truly want to do the “right thing,” towards harmful and conflicted conduct.
That gets us to your question about charter provisions. I think Professor Larry Hamermesh got it right in a recent article that considers the issue of consent from the perspective of reasonable investor expectations. Public company investors are entitled to have some basic expectations about how their companies operate, and the ability to enforce fiduciary duties sure seems to me to be at the very heart of the corporate structure itself. People simply cannot invest their savings and retirement money with public company boards if those boards are immune from accountability, whether or not the charter creates that circumstance. The idea that shareholders implicitly consent to fee-shifting provisions by buying securities rests on a misconception as to why investors buy securities in the first place. Nobody buys stock with a future lawsuit in mind; they buy because they believe the securities will increase in value. So while I don’t think it is conceivable that disinterested shareholders would ever agree to consciously impose fee-shifting on themselves, I also think that the economic proposition that is the public corporation just doesn’t work without enforceable fiduciary duties.
Do you also think that forum selection bylaws are inappropriate? If you are OK with forum selection bylaws, what is the difference?
I don’t have a fundamental problem with the end goal of getting shareholders to bring identical lawsuits in a single competent jurisdiction. But I question the means the corporations have used to achieve that end.
Traditionally, bylaws were like the “Robert’s Rules of Order” aspect of the corporate structure – they told you how to call a meeting, who could vote, how many make a quorum, and so on. Bylaws truly addressed the internal functioning of corporate affairs. Letting directors amend bylaws did not typically raise conflict of interest concerns. Using bylaws to dictate where stockholders could bring a lawsuit, which is the essence of the forum selection issue, still relates to an internal affairs issue, but it comes closer to affecting shareholders’ personal rights.
To be clear, I’m not saying you reject that use of bylaws. Frankly, a forum selection provision does not impair any shareholder’s right to hold his or her agents on the board accountable. And in the post-Chevron world, any debate on the issue is beside the point anyway. But once the Delaware courts allowed the use of bylaws to dictate where a lawsuit is filed, you have to ask where the line is drawn and worry about unintended consequences. If judicial forum selection is within the proper function of a bylaw, would discovery limits also qualify? How about forcing arbitration? Holding requirements to sue? Each of these potential consequences would impair shareholder rights to hold boards accountable. So I had no problem with the end achieved through the Chevron ruling, but I did worry about the means used to achieve that end because it opened the foor for boards to push the envelope on this.
What is your view of the proposed amendment that has been submitted to the Delaware legislature, which would bar public companies from adopting fee-shifting provisions in their bylaws or charters?
I think the proposed amendment is a helpful clarification that the ATP ruling approving fee-shifting bylaws does not apply to stockholder corporations, and should be approved without delay. That said, the proposal is clearly limited only to fee shifting and does not otherwise limit what can be achieved through bylaws. So while it fixes the fee shifting problem, I’m concerned that we’ve opened a Pandora’s Box and not fully gone back to the status quo. Overly aggressive directors and corporate advisors are now actively exploring creative ways to use bylaws to impair core stockholder rights.
Just consider how aggressive directors have become in using bylaws as a weapon against their shareholders to impede proxy contests. The once routine stockholder notice and nomination process has been transformed, via the latest generation of advance notice and nomination bylaws, into a complex labyrinth that requires hundreds of pages of disclosures and provides all sorts of pretexts for a board to reject a stockholder nominee. So I think that the fighting over the proper use of and role for bylaws is going to continue.
Delaware is not the only state where developments involving fee-shifting bylaws are underway. For example, Oklahoma’s legislature has enacted a statute authorizing companies organized under that state’s laws to adopt fee-shifting bylaws. Isn’t it inevitable that there will have to be some type of federal action on the topic of fee-shifting bylaws?
It seems to me that the Oklahoma fee shifting statute was a political outcome driven by people who really do want to eliminate board accountability altogether. Oklahoma’s statute appears to have been adopted in direct response to a ruling by an Oklahoma court sustaining a derivative breach of fiduciary duty claim. Denying a pleadings motion should not cause a legislative overhaul, but it seems the defendants may have had some influence with the Oklahoma legislature and used it to escape accountability for their alleged misconduct.
Anyway, I think that if the Delaware legislature approves the proposed legislation, it can send a powerful message and forestall calls for federal intervention. A failure to pass the statute, on the other hand, will increases pressure on the SEC, which was largely silent on the issue until its Chairwoman recently discussed fee shifting bylaws and suggested that state laws allowing fee shifting provisions would be subject to preemption in the federal securities context. Getting back to your comment about Oklahoma, I think that the Delaware legislature can make it harder for other states to engage in a destructive “race to the bottom.” The legislature could make clear that it rejects corporate fee shifting because you can’t have a credible and balanced legal regime that leaves investors at the complete mercy of their fiduciaries, without any real ability to take action in response to serious wrongdoing.
The context for all of these developments is that that many observers feel there has been an upsurge in frivolous litigation (or if frivolous is too strong a word, then unmeritorious litigation). Do you have any suggestions for ways that frivolous litigation can be deterred or discouraged while allowing meritorious lawsuits to go forward?
I’ve said and written for years that there are, in fact, problems in the field of stockholder litigation. It makes no sense that so many public company deals trigger a lawsuit. But that does not mean that you do away with shareholder litigation altogether. Look, just because there’s some mold in the basement, you don’t burn down the whole house. Or, to use a medical analogy, a good doctor observes the symptoms, diagnoses the disease, and then selects the treatment. It seems to me that because of the overblown hyperbole about the symptom – too much litigation – the corporate world skipped the diagnosis stage and proposed treatments that just kill the patient.
So I think you need to address frivolous litigation without preventing meaningful litigation. As we write in the article, quoting professor Coffee, don’t throw out the baby with the bathwater. By allowing supposed cures that do not differentiate between frivolous cases and cases that may have merit, you lose the benefit of meaningful stockholder litigation. I truly believe that the cases in which I invest my and my partners’ time and resources arise from real misconduct that genuinely warrants a meaningful remedy, and/or raise important policy issues that broadly affect the interests of stockholders in public corporations.
My partner and co-author, Jeroen van Kwawegen, and I, propose some changes to the litigation practice that could deter a majority of the M&A litigation that is filed today. We suggest ways to make the disclosure-only settlement far less attractive for plaintiffs and defendants alike. Our proposal, which has support in Delaware law, requires that disclosures providing the consideration for a settlement actually be material as a matter of law, and that the release be limited, absent good cause, to the nature of the disclosures provided. If you don’t have material disclosures, you don’t have consideration. And if you link the scope of the release to the disclosures, you have a fair quid pro quo. I think the demanding scrutiny on the materiality of disclosures and narrowed scope of releases, combined, would deter the filing of the weakest 50-65% of merger lawsuits going forward.
I’m sure others may have better ideas. But the key is to be targeted. Fix problems. Don’t use problems as cover to fundamentally change the relationship between shareholders and their boards, and thus make bigger problems.
In the last few years there has been an increase in the number of shareholder derivative settlements involving the payment of substantial cash amounts. Is there a reason we have been seeing more of these derivative suit settlements involving large cash payments? What are the factors that you think lead to a derivative suit settlement involving a large cash component?
There are a couple of factors, but I think the growth in derivative settlements finds a parallel in the securities class action field. You have been writing about the declining numbers, in volume and dollar value, of securities class actions. Plenty stock drops don’t even trigger lawsuits. That is because the pleading standards keep getting tighter, and people don’t really want to invest their own time in cases that are extremely likely to die on the vine. From the PSLRA, to Dura, Tellabs, Stoneridge, and more recent cases, the ability of investors to bring lawsuits, even some that appear to be meritorious, has consistently been narrowed. The result, which I think reflects an improved quality in the lawsuits that are actually filed and prosecuted, is an increase in the relative recovery per settlement, notwithstanding fewer settlements. It’s harder to bring a suit, but if a case gets past the pleading stage, it more likely than not does have some merit.
I think the same dynamic exists in the derivative litigation practice. It’s tougher to get a case past the motion to dismiss stage. In fact, it feels like the courts have been tightening the standards and showing a willingness to dismiss cases that I think might have survived in prior years. This also means that cases that are sustained are more likely to have merit. Also, the Chancery Court has shown that it recognizes when plaintiff’s lawyers are willing to assume real risk and litigate aggressively. So when lawyers have a good case, they know they will be rewarded for fighting for the last dollar.
The other reason for increased settlements may be better advice on the defense side. I’m sure there are plenty of defense lawyers who lose a motion to dismiss in a derivative case and tell their clients that the judge got it wrong or the law is too permissive. I’m sure some of those lawyers even believe what they say. But I think it’s a credit to the D&O counsel and better defense advisors that beneath their posturing, they recognize that some cases have merit and should rationally be settled (even at significant levels) to avoid devastating adverse legal rulings.