Delaware Court Enforces “Loser Pays” Bylaw, Opens the Door for D&O Insurers to Better Assess and Control Shareholder Litigation Costs

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The Delaware Supreme Court held that a corporation’s fee-shifting bylaw is enforceable as long as the bylaw is not adopted for an inequitable purpose. A first of its kind, this ruling seems poised to change dramatically the landscape of shareholder litigation and paves the way for more “loser pays” bylaws. This decision could serve as a tool for insurers of director and officer (D&O) risks to better assess and control the risk of shareholder litigation costs.

In its May 8, 2014 opinion in ATP Tour, Inc. v. Deutscher Tennis Bund et al., the Delaware high court held that nothing in Delaware law prohibits the use of a contractual agreement to modify the “American Rule” (where each litigant pays its own attorneys’ fees and costs). ATP Tour, a professional tennis league incorporated in Delaware, was sued by a member alleging breaches of fiduciary duty and antitrust violations. After ATP won at trial, it moved to recover attorneys’ fees and litigation expenses, citing a 2006 bylaw. The bylaw provided that any member who sues and “does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought” must pay ATP’s litigation costs and attorneys’ fees.

The court ruled that because bylaws are a contract between the corporation and its shareholders, a bylaw which requires an unsuccessful shareholder to pay the corporation’s fees is facially valid, so long as it is not enacted for an improper purpose. The court also recognized that fee-shifting provisions are meant to deter litigation and said deterring litigation “is not invariably an improper purpose” for adopting a “loser pays” bylaw.

The volume of shareholder actions filed – especially in the context of merger or acquisition deals and activist investor contests – has skyrocketed in recent years. Press reports following the ATP Tour decision suggest that the plaintiffs’ and defense bars agree this decision could be a game-changer in shareholder litigation and will probably quell the number of lawsuits shareholders bring in Delaware which, according to The Wall Street Journal, is home to two-thirds of Fortune 500 companies and over half of all public companies in the U.S.

Apart from the likely reduction in shareholder litigation claim frequency, it seems ATP Tour gives D&O underwriters an impactful tool in assessing and managing the ever-growing risk of shareholder litigation costs. D&O applications might ask whether the corporation has a “loser pays” bylaw, and D&O underwriters could even suggest the corporation consider simply amending them to require the shareholder pay the company’s cost of litigation if the shareholder loses.

The ATP Tour ruling also presents a chance to broaden the market for “contract litigation insurance,” something that’s widely available in England, yet relatively new in the U.S. This type of insurance covers the risk of a litigant being required to pay the adversary’s attorneys’ fees under a prevailing party agreement or “loser pays” rule.

Time will tell, of course, but ATP Tour might shift more than just the attorneys’ fees in that case – it might shift the tide of shareholder lawsuits overall.

 


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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