Supreme Court of Delaware Finds Fee-Shifting Bylaws Permissible and the Potential Delaware Legislative Response

by Foley & Lardner LLP
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On May 8, 2014, the Supreme Court of Delaware held that fee-shifting provisions in a non-stock corporation’s bylaws can be valid and enforceable if not enacted for an improper purpose or improperly applied, under Delaware law. ATP Tour, Inc. v. Deutscher Tennis Bund, No. 534, 2013 (Del. May 8, 2014).

Background

ATP Tour, Inc. (“ATP”) is a Delaware non-stock corporation that operates a global men’s professional tennis tour (the “Tour”). Members of the Tour include entities that own and operate tournaments; two of the members are Deutscher Tennis Bund (“DTB”) and Qatar Tennis Federation (“QTF” collectively with DTB, the “Federations”).

Upon joining ATP in the early 1990s, the Federations agreed to be “bound by ATP’s Bylaws, as amended from time to time.” In 2006, the seven-member board of directors of ATP amended its bylaws to include a fee-shifting provision. In relevant part, the bylaws provided that when any member initiated or asserted any claim against ATP or any member and the claiming party “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 [ATP] . . . for all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses)” that are incurred in connection with the claim.

Subsequently, in 2007, ATP’s board of directors voted to change the Tour format and schedule by placing the Federations’ owned and operated tournaments in lower tiers and delaying the relative tournaments from the spring until the summer. The Federations sued ATP and six of its board members alleging violation of federal antitrust laws and breach of fiduciary duty under Delaware law. Prevailing on all claims, ATP moved to recover its legal fees, costs and expenses from the Federations, pursuant to its bylaws.

Originally, the United States District Court for the District of Delaware (the “District Court”) denied ATP’s motion, holding that the fee-shifting provisions in its bylaws were contrary to public policy underlying the federal antitrust laws. On appeal, the United States Court of Appeals for the Third Circuit vacated the District Court’s order and remanded, stating that the District Court should first determine whether the fee-shifting bylaw provision is enforceable as a matter of Delaware law before reaching the federal preemption question. As the enforceability of a fee-shifting bylaw provision was a novel question, the District Court certified four questions of law to the Supreme Court of Delaware.

The Certified Questions of Law

  1. Paraphrased, the Supreme Court of Delaware (the “Court”) addressed four certified questions of law:
    Is a fee-shifting bylaw provision permissible under Delaware law?;
  2. If valid and enforceable, could a bylaw provision shift fees if a plaintiff obtained no relief in the litigation?;
  3. Would the fee-shifting bylaw provision be enforceable if adopted for an improper purpose?; and
  4. Is a fee-shifting bylaw amendment enforceable against members who join the corporation before the fee-shifting bylaw provision is enacted?

The Supreme Court of Delaware’s Holding

The Supreme Court of Delaware found that a fee-shifting bylaw provision is not invalid per se, under Delaware law. Yet, a fee-shifting bylaw provision must still be for a proper purpose and because certified questions only address matters of law and not facts, the Court cautioned that, as a matter of law, they could not hold whether the ATP fee-shifting bylaw provision was adopted for a proper purpose or is enforceable in the circumstances presented.

In determining that a fee-shifting bylaw provision is not invalid per se, the Supreme Court of Delaware stated that, for a corporation’s bylaws to be facially valid, a bylaw must be (i) authorized by the Delaware General Corporation Law (“DGCL”), (ii) consistent with the corporation’s certificate of incorporation, and (iii) its enactment must not be otherwise prohibited.

The Court noted that neither the DGCL nor any other Delaware statute forbids the enactment of a fee-shifting bylaw provision and although Delaware follows the American Rule, which requires each party to pay their own costs and attorney’s fees, contracting parties may agree to modify the American Rule. Because bylaws are contracts among shareholders, a fee-shifting provision contained in a non-stock corporation’s bylaws would fall within the contractual exception to the American Rule. However, despite being facially valid, a fee-shifting bylaw provision will not be enforced if “adopted or used for an inequitable purpose.” The Court explicitly stated that “[t]he intent to deter litigation, however, is not invariably an improper purpose. Fee-shifting provisions, by their nature, deter litigation.” In sum, the enforceability of a facially valid fee-shifting bylaw provision may turn on the circumstances surrounding its adoption and use.

Finally, assuming that the fee-shifting bylaw provision is otherwise valid and enforceable, the bylaw amendment is enforceable against members who join the corporation before its enactment. The DGCL permits a corporation to confer the power to “amend or repeal bylaws upon the directors.” Therefore, if the directors are so authorized, they may unilaterally amend the corporation’s bylaws.

Applications

What at first glance appears to be a substantial victory for Delaware corporations in an attempt to deter frivolous shareholder suits, this case still presents several possible limitations:

  • Would a similar fee-shifting bylaw provision in a stock corporation be upheld as facially valid? (see “Potential Delaware Legislative Response” below)
  • Although permissible, would a fee-shifting bylaw provision, unilaterally adopted by the board of directors, be generally looked upon favorably by stockholders, advisors and other interested persons of a corporation?
  • If shareholder litigation is threatened or pending, at what point would the inclusion of a fee-shifting bylaw provision be deemed too proximate to litigation to be considered an “equitable purpose”?

Potential Delaware Legislative Response

In response to the ATP Tour decision, the Delaware Corporate Law Council of the Delaware State Bar Association proposed an amendment to the DGCL that, if adopted by the Delaware legislature, would limit the applicability of the decision to non-stock corporations. If the DGCL is amended to include the proposed response, the effect would be to deny ordinary stock corporations the ability to adopt the fee-shifting bylaw provision.

Lawmakers in Delaware are expected to decide on the proposed change before their current session ends on June 30, 2014. If approved, the revised legislation would take effect on August 1, 2014.

Conclusion

As such, despite a promising start, a non-stock corporation and its board of directors should always consider the facts and circumstances surrounding a decision to include a fee-shifting bylaw provision and should always consider consulting with counsel and others as to whether adopting such a provision would be appropriate in light of its inevitably unique circumstances.

If and how the ATP Tour decision applies to stock corporations will be determined by the Delaware legislature shortly, but as the result of the application of ATP Tour to Delaware stock corporations would drastically change the litigation landscape, it is unlikely the legislature would allow stock corporations to effectively adopt fee-shifting bylaws.

Finally, while not binding precedent in other states, the ATP Tour court’s rationale should apply to jurisdictions other than Delaware. If determined to be facially valid based upon the corporation’s governing statutes and enacted for a proper purpose, a similar bylaw provision may be enforceable by a corporation incorporated outside of Delaware. A corporation considering such a provision should discuss with counsel the provision and any related laws of the corporation’s state.

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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