The Fluid State of Delaware Fee-Shifting Bylaws

by Stinson Leonard Street
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On May 8, 2014, the Delaware Supreme Court held in ATP Tour, Inc. v. Deutscher Tennis Bund that a bylaw provision that shifts "all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys' fees and other litigation expenses)" to the losing party in litigation was facially valid. Days later, the Corporation Law Council of the Delaware State Bar Association proposed legislation limiting the decision to non-stock corporations and clarifying that the decision did not apply to stockholders of stock corporations.

ATP Tour, Inc. v. Deutscher Tennis Bund

ATP Tour, Inc.'s bylaws contained a provision that shifted "all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys' fees and other litigation expenses)" to the claiming party that did not obtain a judgment on the merits (in substance and amount of the full remedy). This fee-shifting provision was adopted by the board of the non-stock corporation without member approval.

The court examined four issues and determined the following:

  1. Can a Delaware non-stock corporation lawfully adopt a fee-shifting provision that shifts all litigation expenses to a plaintiff in intra-corporate litigation if the plaintiff does not substantially achieve the full remedy sought?
    Presently, no Delaware statute prohibits fee-shifting bylaws; therefore, the bylaw is facially valid. The enforceability of such a provision is a factual question that depends on the "circumstances surrounding its adoption and use," and the bylaw will be enforced if it is not adopted or used for an inequitable purpose. 
  2. Can a provision shifting fees to a member who obtains no relief at all on its claims against the corporation be lawfully enforced (i.e., could a watered down version of the provision in ATP be lawfully adopted)?
    Subject to certain limitations, the court answered that such a provision could be lawfully enforced. 
  3. Is a fee-shifting bylaw unenforceable if one or more board members subjectively intended for the provision to deter legal challenges by members for actions that were then under consideration?
    The provision's enforceability depends on whether it was adopted for an improper purpose. "The intent to deter litigation, however, is not invariably an improper purpose."
  4. Is a fee-shifting bylaw enforceable against a member if it was adopted by the board after the member had joined the corporation?
    Yes, assuming the provision is otherwise valid and enforceable and that the bylaws confer to the directors the power to adopt, amend or repeal bylaws.

Response to Decision and Legislative Proposal

Response to the decision in ATP has been varied. By some, the decision is viewed as having the potential to slow or even stop the potentially frivolous class-action suits that are routinely brought after public M&A transactions. For example, the Wall Street Journal recently cited a Cornerstone Research report that estimates that 94 percent of all U.S. public company mergers in 2013 were challenged by shareholders. Others are concerned about the significant deterrence effect for legitimate claims and possibility that shareholders' rights will be greatly diminished.

In response, the Corporation Law Council of the Delaware State Bar Association proposed legislation to clarify that the ATP decision only applies to non-stock corporations and that debts of a stock corporation cannot be imposed on a stockholder of such corporation through a charter provision and based on an action or omission of such stockholder.

If adopted by the Delaware legislature, the amendment would become effective August 1, 2014.

If the proposal is not adopted by the Delaware legislature, Delaware public companies may wish to consider whether to adopt a fee-shifting bylaw provision. Careful consideration should be paid to potential institutional investor response, whether the proposal would be beneficial to the company and to the timing of any decision to adopt a fee-shifting bylaw.

 

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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