The Delaware Supreme Court, sitting en banc, has held that a Delaware corporate bylaw that requires a losing claimant to pay the legal fees and expenses of the defendants is not invalid per se, and if otherwise enforceable can be enforced against losing claimants whether or not they were already stockholders when the relevant bylaw provision was adopted.
The court’s ruling in ATP Tour, Inc. et al. v. Deutscher Tennis Bund et al. was in response to four certified questions from the US District Court in Delaware, which had been considering whether to enforce the bylaw provisions in question in a dispute between ATP Tour, Inc. and some of its members.
In 2006, the board of directors of ATP Tour, Inc. a Delaware non-stock (also known as a membership) corporation, adopted a bylaw providing that if any member or members brought or supported a claim against the corporation or any other member, the claimant would then be obligated (and if more than one claimant, jointly and severally obligated) to pay the legal fees and expenses of those against whom the claim was brought if the claimant “does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought…” Members of ATP Tour, Inc. filed claims against the corporation and the board as a result of certain changes to the importance and timing of their tournaments, and the district court, having found for the defendants on all counts, certified the question of the fee-shifting provision to the Delaware Supreme Court.
Citing Section 109(b) of the Delaware General Corporation Law (DGCL) for the baseline rule that the bylaws may contain any provision not inconsistent with law or the corporation’s certificate of incorporation, the Court noted that bylaws are presumptively valid and that a bylaw that “allocated risk among parties in intra-corporate litigation would appear to satisfy the DGCL’s requirement that bylaws ‘must relat[e] to the business of the corporation, the conduct of its affairs, and its rights and powers or the rights and powers of its stockholders, directors, officers or employees.’” Although the corporation in this case was a non-stock corporation, the analysis is applicable to stock corporations and non-stock corporations alike, with the members of non-stock corporations being analogous to stockholders.
The Court noted that no principle of common law prohibits directors from enacting fee-shifting bylaws and that because contracting parties may modify the “American rule” under which litigants pay their owns costs to provide that “loser pays,” a fee-shifting bylaw (bylaws being “contracts among a corporation’s shareholders”) would be a permissible contractual exception to the American rule. The Court noted further that an intent to deter litigation (as a fee-shifting provision inherently does) was not invariably an improper purpose.
Declining to rule (or even comment in dicta) on the specific bylaw provision in question, the Court did note that the enforceability of such a bylaw provision would depend on the manner in which it was adopted and the circumstances under which it was envoked, and that “[b]ylaws that may otherwise be facially valid will not be enforced if adopted or used for an inequitable purpose.”
Finally, citing generally the propositions described above, the court affirmed the other questions presented for certification, that:
(i) this particular bylaw, if valid and enforceable, could shift fees if the plaintiff obtained no relief in the litigation
(ii) the bylaw would be unenforceable if adopted for an improper purpose and
(iii) a bylaw amendment is enforceable against members who join the corporation before its enactment.
Because the Court did not rule on the enforceability of the specific fee-shifting provision in question, practitioners will still need to rely on existing Delaware rulings on the enforceability of bylaw provisions for guidance on particular provisions to be adopted and enforced under particular circumstances.
Certainly, the adoption of a fee-shifting bylaw well before the possibility of any litigation would seem to improve its chances of enforcement. It is also notable that despite the Court’s analysis of the fee-shifting mechanics in light of “the American rule” versus “loser pays,” the bylaw provision in question only shifted the expense to a losing claimant, and is arguably asymmetric in its effect to the benefit of the corporation (not to mention the directors) in its (and their) more likely position as defendants.
While this distinction does not appear to be materially relevant to the Court’s overall analysis in ATP Tour, practitioners should take note of this and other issues in determining how best to craft fee-shifting bylaws that will be subject to additional scrutiny as these types of provision gain in popularity.