Shareholder litigation is on the rise, increasing the cost of doing business; and companies often face litigation on multiple fronts, further increasing litigation exposure. In 2013, 94 percent of M&A deals were challenged by shareholders. M&A deals that year attracted an average of more than five lawsuits each, and more than 60 percent of them resulted in multi-jurisdictional litigation. And M&A deals are not the only business transactions subject to shareholder litigation—“down-round” financings and related party transactions, for example, also run that risk.
However, as a result of positive developments in corporate law over the last year, companies may be able to reduce the cost of shareholder litigation and, in turn, the cost of doing deals by adopting carefully drafted amendments to their bylaws or charters, including fee-shifting (or “loser-pays”) provisions and exclusive forum provisions.
Earlier this spring, in ATP Tour, Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court held that fee-shifting provisions in a non-stock corporation’s bylaws can be valid and enforceable. At issue was a provision in the company’s bylaws that shifted attorneys’ fees and costs to unsuccessful plaintiffs in intra-corporate litigation. Delaware’s high court ruled that fee-shifting bylaws are permissible under Delaware law, reasoning that such bylaws are not forbidden by Delaware General Corporation Law or other statutory or common law.
The court further explained that because corporate bylaws are contracts among a corporation’s shareholders, a fee-shifting provision contained in a non-stock corporation’s validly-enacted bylaw would fall within the contractual exception to the American Rule, under which litigants generally must pay their own attorneys’ fees and costs. The court cautioned that to be enforceable, the fee-shifting bylaw must have been enacted for a proper—not inequitable—purpose. But according to the court, “[t]he intent to deter litigation, however, is not invariably an improper purpose” and, therefore, “an intent to deter litigation would not necessarily render the bylaw unenforceable in equity.”
Although ATP Tour was decided in the context of a non-stock corporation, the court’s analysis focused more broadly on the DGCL and principles of common law, which should apply to stock corporations, including public companies. In an attempt to limit the reach of the high court’s holding, the Delaware State Bar Association proposed legislation, including amendments to the DGCL, which would limit ATP Tour’s endorsement of fee-shifting bylaws to non-stock corporations. However, in June of this year, the Delaware Senate withdrew the bill, with a resolution urging the Delaware State Bar Association to continue examining the issue and to consider whether proposed legislation might be appropriate in 2015. Thus, for now, the current state of the law in light of ATP Tour remains undisturbed.
Even if the future of fee-shifting bylaws is uncertain, companies should consider whether to amend their bylaws to include such a provision. Any fee-shifting amendments, however, should be carefully drafted and tailored according to the parameters set by the Delaware Supreme Court.
Other less controversial measures are also available to reduce shareholder litigation costs and exposure. Last year, the Delaware Court of Chancery ruled that corporate boards of directors may validly adopt exclusive forum bylaws, providing that claims regarding the internal affairs of the corporation—such as derivative suits, fiduciary duty suits and other common shareholder and M&A litigation claims—must be brought in the corporation’s state of incorporation. An exclusive forum (or forum selection) bylaw can limit a company’s exposure to multi-jurisdictional litigation and, therefore, reduce the cost of defending shareholder lawsuits.
Companies should consider whether amending their bylaws or charters with a view to reducing litigation costs makes sense in light of these recent developments in corporate law.