In a late night session on June 11, 2015, the Delaware House of Representatives overwhelmingly passed S.B. 75, which prohibits Delaware stock corporations from adopting “loser pays” fee-shifting bylaws and which confirms that Delaware corporations may adopt bylaws designating Delaware courts as the exclusive forum for shareholder litigation. The bill, which previously passed the state’s Senate, now goes to Delaware Governor Jack Markel for his signature. The bill provides that the changes will be effective August 1, 2015. A copy of the bill can be found here.
The dust-up in Delaware over fee-shifting bylaws got started in May 2014, when the Delaware Supreme Court in the ATP Tours, Inc. v. Deutscher Tennis Bund case upheld the facial validity of a bylaw provision shifting attorneys’ fees and costs to unsuccessful plaintiffs in intra-corporate litigation. This development quickly caught the eye of litigation reform advocates, as the adoption of fee-shifting bylaws seemed to offer a way for companies to reduce the costs of and possibly curb burdensome litigation. At the same time, however, shareholder advocates became concerned that these types of bylaws could deter even meritorious litigation.
The controversy that followed over fee-shifting bylaws seemed headed for a swift resolution when the Delaware General Assembly quickly moved to enact 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 until the 2015 session.
While the proposed legislation was pending, institutional investors mounted a concerted effort in support of legislative action in Delaware “to curtail the spread of so-called ‘fee-shifting’ bylaws,” while business groups conducted a campaign opposing the legislation.
During the period while the legislation remained pending, a number of companies went ahead and adopted some version of a fee-shifting bylaw. Alibaba, one of 2014’s highest profile IPOs, was among several companies that completed offerings during the year and that adopted fee-shifting bylaws.
When the legislation recently was taken up again by the Delaware legislature, it quickly sailed through both houses – there was only one vote in opposition to the legislation when submitted to the Delaware House of Representatives.
The legislation itself does a number of things, but it does two basic things with respect to corporate bylaws.
First, the legislation invalidates a provision of either a certificate of incorporation or of a bylaw of a Delaware stock corporation that purports to impose liability upon a stockholder for the attorneys’ fees or expenses of the corporation or any other party for an “intracorporate claim” (These new restrictions do not apply to nonstock corporations.)
Second, the legislation confirms that the certificate of incorporation and bylaws of the corporation may specify that intracorporate claims must be brought only in the Delaware courts (including the federal court in Delaware). The provision also invalidates a provision that “may prohibit bringing such claims in the courts of this State”
For purposes of both of these provisions, the term “intracorporate claims” is defined to mean claims arising under Delaware’s statutory laws, including claims of breach of fiduciary duty by current or former directors or officers or controlling shareholders of the corporation, or persons who aid or abet such a breach.
While the legislation addresses the question of whether or not Delaware stock corporations validly may adopt fee shifting bylaws, other questions remain.
First, as detailed by Professor John C. Coffee, Jr. in a recent post on the CLS Blue Sky Blog, the Delaware legislation prohibits bylaws only to the extent they apply to “intracorporate disputes.” According to Coffee, as the term “intracorporate disputes” is defined in the legislation, it “does not clearly cover securities class actions (which need not and generally do not allege any fiduciary breach).” The result, according to Coffee, is “an unnecessary ambiguity and likely underinclusion, as federal antitrust, securities and related fraud actions (e.g., RICO) are not seemingly reached. Thus, fee-shifting bylaws could apply to these types of actions, unimpeded by the new statute.” So, at least according to Coffee, “this story has another chapter or two to go, and eventually the SEC will need to take a stand.”
Second, the legislation does not expressly address other types of litigation reform bylaws. For example, the legislation does not appear to address so-called minimum-stake-to-sue bylaws. As discussed here, these types of provisions require, for example, shareholders to deliver written consents representing at least three percent of the company’s outstanding shares in order to bring a class action or derivative suit. Others may also try to argue that the legislation does not address mandatory arbitration bylaws, requiring shareholders to arbitrate intracorporate disputes – however, those opposing the adoption or imposition of an arbitration bylaw may cite to the forum selection bylaw portions of the new statute, which invalidate bylaws that prohibit bringing intracorporate claims in Delaware’s courts. The argument would be that an arbitration bylaw runs afoul of this provision because it prohibits bringing claims in the Delaware courts.
Third, the Delaware legislation obviously applies only to corporations organized under the laws of Delaware. It has no effect upon corporations domiciled elsewhere. Alibaba, mentioned above, is organized under the laws of the Cayman Islands, and so the new Delaware legislation has no effect on Alibaba’s fee-shifting bylaw. The laws of other jurisdictions may vary from those of Delaware. Indeed, the Oklahoma legislature has adopted a provision mandating the shifting of fees in derivative suits. The Oklahoma provision specifically applies to derivative suits “instituted by a shareholder” where there is a “final judgment.” In those circumstances, the court “shall require the non-prevailing party or parties to pay the prevailing party or parties the reasonable expenses, including attorney fees . . . incurred as a result of such action.”
Finally, at least one commentator has asked whether Delaware’s adoption of this legislation, which eliminates the availability of fee-shifting bylaws as a way for the state’s corporations to deter expensive intracorporate litigation, will cost Delaware in its competition with other states as the preferred location for company incorporation. In a June 11, 2015 post on the Real Clear Markets blog (here) former SEC Commissioner Paul Atkins suggests that Delaware’s adoption of the legislation, together with aggressive moves by other states to attract incorporations, “could be the straw that breaks Delaware’s position as the destination of choice.”
The Delaware legislation clearly takes much of the wind out of the sails for the effort in support of fee-shifting bylaws. But there still may be more of the story about litigation reform bylaws to be told. The question of whether or not fee-shifting bylaws can be applied to litigation other than Delaware “intracorporate litigation” will have to be sorted out, and there undoubtedly will be efforts to advance other types of litigation reform bylaws, such as the minimum-stake-to-sue bylaws. And there could be contrary development in other states. I strongly suspect we will all be hearing more about litigation reform bylaws, including perhaps even more about fee-shifting bylaws.
Break in the Action: Due to my travel schedule over the next several days, there will be interruptions in The D&O Diary’s publication schedule through next week. The D&O Diary’s regular publication schedule should resume by the end of next week.