Fee Shifting Bylaw Facially Valid Under Delaware Law

by Snell & Wilmer

On May 8, 2014, Delaware Supreme Court, en banc, answered four questions of law certified to it by the U.S. District Court for the District of Delaware and upheld the facial validity of a fee shifting provision in a Delaware corporation’s bylaws adopted for the purposes of deterring litigation. The decision was issued with respect to a non-stock corporation; however, the Court’s analysis is applicable to stock corporations as well. The decision should prompt boards of directors of Delaware public and private corporations to consider adopting fee shifting bylaws. To the extent that the decision does not conflict with the corporation laws of other states, boards of directors in other jurisdictions will likely do the same. The case, ATP Tour, Inc. v. Deutscher Tennis Bund, et al., can be read here.

ATP Tour (ATP or the Company) is a Delaware membership (non-stock) corporation that operates a professional men’s tennis tour (the Tour). The Company’s members include individuals and entities. Deutscher Tennis Bund (DTB) is a member of the Company. In the early 1990s, DTB joined ATP and agreed to be bound by ATP’s bylaws, as amended from time to time. In 2006, ATP’s board amended the bylaws to include Article 23.3(a) a fee shifting provision applicable to intra-corporate disputes. Article 23.3(a) provides that, where a current or former member brings a claim or counterclaim against the Company and “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 [the Company] . . . for all fees, costs and expenses of every kind . . . in connection with such Claim.”

In 2007, ATP’s board voted to make changes to the Tour which downgraded a tennis tournament operated, in part, by DTP from the highest tier of tournaments to the second highest tier. ATP’s board also changed the scheduling of several tournaments in the Tour. Unhappy with the board’s decisions, DTB and another member of the Company filed suit in the U.S. District Court, Delaware, alleging federal antitrust claims and Delaware breach of fiduciary duty claims. After a ten-day trial, ATP won on all claims brought against it. ATP then moved pursuant to Federal Rule of Civil Procedure 54 to recover its attorneys’ fees and costs pursuant to Article 23.3(a) of its bylaws.

The District Court denied ATP’s motion and found Article 23.3(a) to be contrary to the public policy underlying federal antitrust laws (“federal law preempts the enforcement of fee-shifting agreements when antitrust claims are involved”). ATP appealed to the Third Circuit Court of Appeals which vacated the District Court’s order and found that the District Court should have first decided whether Article 23.3(a) was enforceable under Delaware law before deciding the federal preemption question.

On remand the District Court found that whether Article 23.3(a) was enforceable was a novel question under Delaware law and certified four questions of law to the Delaware Supreme Court. The Delaware Supreme Court responded as follows:

  1. Fee shifting bylaws are facially valid under Delaware law. Corporate bylaws are “contracts among a corporation’s shareholders” and contracting parties may agree to modify the American Rule, under which parties to litigation each generally pay their own fees and costs. Whether Article 23.3(a) is enforceable, however, “depends on the manner in which it was adopted and the circumstances under which it was invoked.” The Court quoted from one of its earlier decisions that “inequitable action does not become permissible simply because it is legally possible.” Nonetheless, the Court stated that it has upheld similarly restrictive bylaws enacted for proper purposes, such as amended bylaws that increase board quorum requirements and mandate unanimous board actions for anti-takeover purposes.
  2. A fee shifting bylaw, if valid and enforceable under the circumstances in the underlying case, is facially valid under Delaware law whether a claimant fails to “substantially achieve” [the language contained in Article 23.3(a)] the full remedy sought or completely fails to achieve any relief against the company.
  3. “Legally permissible bylaws adopted for an improper purpose are unenforceable in equity. The intent to deter litigation, however, is not invariably, an improper purpose.”
  4. Fee shifting bylaws are enforceable against members who agree to be bound by rules adopted by the company’s board, even where the bylaw was enacted after a member joined the company.

The decision will be undoubtedly welcome news to the boards of Delaware companies, and where not in conflict with other states’ corporation laws, companies incorporated outside Delaware. Nonetheless, as with any other restrictive corporate bylaw, the circumstances surrounding its enactment and invocation will be closely scrutinized by courts to insure that it was not enacted or invoked for an improper or inequitable purpose.

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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