Delaware Supreme Court Approves Fee-Shifting Bylaw for Non-Stock Corporations - The Court’s Reasoning Suggests These Provisions Would Apply To Other Private Or Public Delaware Corporations

by Reed Smith
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In its May 8, 2014 decision in ATP Tour, Inc. v. Deutscher Tennis Bund, No. 534, 2013, --- A.3d ----, 2014 WL 1847446 (Del. May 8, 2014), the Delaware Supreme Court may have opened the door to the adoption by Delaware corporations of a bylaw provision that shifts litigation expenses to shareholders when they bring, and lose, intra-corporate litigation claims against the corporation and its directors and officers.

The adoption of such a bylaw provision should now be carefully considered by the Boards of Directors of Delaware corporations as a way to manage litigation risks.

What Does A Fee-Shifting Bylaw Provide?

In 2006, the Board of ATP Tour, Inc. (“ATP”), a Delaware non-stock membership corporation that operates a global professional men's tennis tour (“the Tour”), adopted the fee-shifting bylaw provision. ATP’s Bylaw Article 23.3(a) provides, in relevant part as follows:

In the event that (i) any [current or prior member or Owner or anyone on their behalf (“Claiming Party”)] initiates or asserts any [claim or counterclaim (“Claim”)] or joins, offers substantial assistance to or has a direct financial interest in any Claim against the League or any member or Owner (including any Claim purportedly filed on behalf of the League or any member), and (ii) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Claim the Claiming Party had a direct financial interest) does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then each Claiming Party shall be obligated jointly and severally to reimburse the League and any such member or Owner for all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys' fees and other litigation expenses) (collectively, “Litigation Costs”) that the parties may incur in connection with such Claim.

The fee-shifting provision was challenged in a lawsuit brought in the United States District Court for the District of Delaware by two Federation members of ATP, who sued ATP and six of its board members. The underlying lawsuit asserted federal antitrust claims and Delaware breach of fiduciary duty claims arising out of changes made by the ATP Board in 2007 to the Tour schedule and format.

After a 10-day jury trial, plaintiffs failed to prevail on any of their claims. ATP then moved for recovery of its attorneys’ fees under Bylaw Article 23.3(a). Because the permissibility and enforceability of a fee-shifting bylaw was a novel question of Delaware law, the federal court certified those questions directly to the Delaware Supreme Court. The Delaware Supreme Court’s recent decision unequivocally affirms that such fee-shifting bylaws are valid under Delaware law.

The Court’s Reasoning is Grounded in Broad Corporate Law Principles

Because ATP is a non-stock, membership corporation, some might suggest the reach of the court’s decision should be limited to only non-stock corporations or to other membership organization such as LLCs. Indeed, it is entirely possible that subsequent Delaware decisions will take exactly that approach.

However, the court’s decision in ATP relies on and refers to other provisions in the Delaware General Corporation Law (“DGCL”) and cases involving bylaws adopted by “regular” stock corporations. In upholding ATP’s fee-shifting provision, the court held:

A fee-shifting bylaw, like the one described in the first certified question, is facially valid. Neither the DGCL nor any other Delaware statute forbids the enactment of fee-shifting bylaws. . . . Moreover, no principle of common law prohibits directors from enacting fee-shifting bylaws.

2014 WL 1847446, at *3. While acknowledging that Delaware follows the “American Rule,” under which parties to litigation generally pay their own costs, the court further held that, under settled law, contracting parties may agree to modify the American Rule, and corporate bylaws are “contracts among a corporation’s shareholders.” Id. at *3 fn. 19 (citing Airgas, Inc. v. Air Prods. & Chems., 8 A.3d 1182, 1188 (Del. 2010)).

The court’s decision also cites cases upholding the adoption of restrictive bylaw provisions by stock corporations. For example, the court cited Frantz Manufacturing Co. v. EAC Industries, 501 A.2d 401 (Del., 1985), in which the court upheld a majority stockholder’s act of amending the corporation's bylaws by written consent in order to limit the board's anti-takeover maneuvering after the stockholder had gained control of the corporation. The court also referred to Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), which recently upheld the adoption of a bylaw setting Delaware’s Chancery Court as the forum for shareholder lawsuits.

The court qualified its approval of the ATP fee-shifting bylaw by noting that the question of whether a fee-shifting bylaw is enforceable will depend on whether it was adopted for a proper purpose and the circumstances under which it was invoked. Those issues were outside the scope of the Supreme Court’s decision because the District Court’s certification did not provide the necessary stipulated facts to determine whether the bylaw was enacted for a proper purpose and whether it was properly applied.

However, in discussing “proper purpose,” the court observed that fee-shifting provisions, by their nature, deter litigation. Thus, “the intent to deter litigation [] is not invariably an improper purpose . . . Because fee-shifting provisions are not per se invalid, an intent to deter litigation would not necessarily render the bylaw unenforceable in equity.” Id. at *4.

Guidance and Practice Suggestions

Adoption of a fee-shifting bylaw amendment could have the effect of chilling the assertion of meritless claims against Delaware corporations. For that reason alone, Boards should consider whether to adopt such a bylaw amendment. Of course, some corporations may have charter provisions which restrict the authority of the Board to amend bylaws, so before undertaking a bylaw amendment, the Board should first confirm whether shareholder approval is required. Even if shareholder approval is not required, such approval could help persuade a future court, deciding whether to enforce a fee-shifting bylaw, that enforcement is appropriate. Additionally, the Board should carefully consider and articulate the proper purpose for adopting a fee-shifting bylaw, as well as consider the appropriate scope of a fee-shifting provision.

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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