A topic of considerable controversy within the corporate community over the past two months has been the possibility of adopting a "fee-shifting" provision in the bylaws of Delaware corporations. Depending on how it is drafted, a fee-shifting bylaw may provide a corporation with the opportunity to recover expenses incurred by the defending corporation as well as its officers, directors, and/or their affiliates (including but not limited to legal fees) against a stockholder pursuing intra-corporate litigation if the stockholder is unsuccessful in the litigation.
The feasibility of this type of bylaw gained prominence following a decision by the Delaware Supreme Court concluding that a fee-shifting bylaw adopted by a non-stock corporation was facially valid.1 Shortly thereafter, however, the Council of the Corporation Law Section of the Delaware State Bar Association proposed legislation that broadly sought to prohibit traditional stock corporations from adopting such provisions. While Delaware's governor and General Assembly typically implement the recommendations of the Council on matters of corporate law, in this case, they decided to put the proposed legislation on hold in light of the objections of various parties claiming that additional time for deliberation and consideration would be prudent.
Although directors of Delaware corporations should carefully and seriously consider the potential impacts of any important changes in corporate law, given the uncertain fate of fee-shifting bylaws in the Delaware legislature and the fact that a court has not reviewed such a bylaw in the context of a stock corporation or the fiduciary bases pursuant to which a board may adopt this type of bylaw, we believe that there are good reasons for most corporations to take a "wait-and-see" approach while the Delaware courts, legislature, and investor community further debate the issue.
The debate over fee-shifting bylaws shifted into high gear on May 8, 2014, when the Delaware Supreme Court provided an en banc answer to a certified question of law in ATP Tour, Inc. v. Deutscher Tennis Bundupholding the facial validity of the fee-shifting bylaw of a non-stock Delaware corporation. That opinion did not delve into the particular facts underlying the parties' dispute because it was addressing a certified question of law, and the opinion strictly spoke to the bylaw of a non-stock corporation. Many commentators and practitioners, however, identified the opinion's potential applicability to traditional stock corporations given its broad reliance on general corporate law principles and the potential for such bylaws to deter wasteful or harmful litigation.
Fourteen days after the ATP decision, the Delaware Corporate Law Council proposed statutory amendments that were intended to nullify ATP's holding with respect to traditional stock corporations. Eventually known as Senate Bill 236 of the 147th General Assembly, the proposed legislation would have created a new Section 331 of the Delaware General Corporation Law broadly written to prohibit charter or bylaw provisions of Delaware stock corporations from imposing monetary liability or the responsibility for corporate debts on any stockholder, except as permitted by certain other statutory provisions related to (1) stock transfer restrictions and (2) charter provisions imposing liability on stockholders based solely on their stock ownership to a specified extent and upon specified conditions (e.g., if a company wanted to set up a structure whereby stockholders could be required to fund additional capital expenditures when the company expands). This bill, which was written to go into effect on August 1, 2014, progressed on a fast track to the Delaware General Assembly, whose legislative session was scheduled to end on June 30, 2014.
However, as SB 236 was under consideration, questions arose from several sources. Some expressed concerns related to the scope of the prohibition and others to the perceived haste with which the amendments were apparently drafted. Ultimately, the bill was never put to a vote. Instead, on June 18, 2014, Delaware's State Senate approved Senate Joint Resolution #12, which was passed by the House of Representatives and signed by Governor Jack Markell on June 30, 2014, the last day of the legislative session. Among other things, Joint Resolution #12 calls for continued examination of the proposed anti-fee-shifting amendment before the next legislative session begins in January 2015, the earliest expected point at which legislation similar to SB 236 could be reconsidered.
The Current Situation
To date, we are aware of two Delaware corporations that have adopted fee-shifting bylaws applicable to stockholders. One (The LGL Group, Inc.) adopted its bylaw a week before the Delaware State Senate passed Joint Resolution #12, and another (Echo Therapeutics, Inc.) did so a few days after the Senate acted. In addition, another company (Townsquare Media, LLC) has filed a preliminary registration statement with the Securities and Exchange Commission, indicating that it is considering including a fee-shifting provision in the certificate of incorporation it plans to adopt when it converts into a Delaware corporation in connection with its pending initial public offering. Early-adopted fee-shifting provisions will almost certainly spur further debate over this issue across numerous interested groups, including the corporate community, institutional investors, proxy advisory firms, and the Delaware bench, bar, and legislature.
In light of the current uncertainty over the validity of, and potential responses to, fee-shifting bylaws, we recommend that boards of directors of Delaware corporations continue to be mindful of this issue and observe the ongoing debate. However, we do not believe that directors of most Delaware corporations should adopt any specific fee-shifting bylaws at this time. Directors considering the adoption of some version of a fee-shifting provision in this environment may face the possibility of later statutory amendments intended to undercut those provisions, potential investor opposition, and possible litigation risks.
1 ATP Tour, Inc. v. Deutscher Tennis Bund, No. 534, 2013, 2014 Del. LEXIS 209 (Del. May 8, 2014). A WSGR Alert discussing that case in further detail is available at http://www.wsgr.com/WSGR/Display.aspx?SectionName=publications/PDFSearch/wsgralert-fee-shifting.htm.