Overview
In early May of this year, the Delaware Supreme Court responded to several certified questions of law regarding whether a fee-shifting provision in a non-stock corporation's bylaws can be valid and enforceable under Delaware law. Answering in the affirmative, the court opened the door for non-stock, and potentially traditional stock, corporations to adopt bylaws that shift the costs (including attorneys' fees) of successfully defending against litigation prosecuted by a company's shareholders to the shareholder plaintiff. Since this decision, several Delaware corporations have adopted fee-shifting bylaws.
In response, however, the Delaware legislature proposed Senate Bill 236. Effective August 1, 2014, the bill would have banned such a bylaw. That bill has been withdrawn pending further investigation and will not be voted upon until the next legislative session. Still, the validity and enforceability of such a bylaw could change litigation in Delaware.
This article will examine the ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014) decision and the pending legislation in Delaware that prohibits such a bylaw. Next, it will discuss some considerations that Delaware corporations should remember when choosing whether to take the risk in adopting such an amendment to their company bylaws. Finally, this article provides a recommended approach to the fee-shifting bylaw dilemma.
The ATP Tour Decision
In ATP Tour, Inc v. Deutscher Tennis Bund, the Delaware Supreme Court responded to four certified questions of law from the United States District Court for the District of Delaware regarding the validity of fee-shifting bylaws. The court answered as follows: (1) Fee-shifting bylaws are permissible under Delaware Law; (2) If the bylaw is otherwise valid and enforceable, the bylaw could shift fees if a plaintiff obtained no relief in the litigation; (3) The bylaw would be unenforceable if adopted for an improper purpose; (4) A bylaw amendment is usually enforceable against members who join the corporation before its enactment.
ATP Tour, Inc. (ATP) is a Delaware non-stock corporation that operates a global professional men's tennis tour. Among its members were two entities: Deutscher Tennis Bund (DTB) and Qatar Tennis Federation (QTF). In 2006, the board of directors of ATP added a provision to its bylaws that states, in relevant part, that any member of ATP who initiates a claim against ATP and:
does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought,… shall be obligated jointly and severally to reimburse the League and any such members or Owners for all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys' fees and other litigation expenses).
After DTB and QTF unsuccessfully challenged the board of directors' decision to change the Tour schedule and format, ATP sought legal fees pursuant to its bylaws. Since the fee-shifting provision was a novel question of Delaware law, the District Court certified questions to the Delaware Supreme Court.
The Delaware Supreme Court first addressed the validity of fee-shifting bylaws under Delaware law. To be facially valid, the court explained that "a bylaw must be authorized by the Delaware General Corporation Law (DGCL), consistent with the corporation's certificate of incorporation, and its enactment must not be otherwise prohibited." The court found that the DGCL did not forbid such a bylaw, and that a "bylaw that allocates risk among parties in intra-corporate litigation would appear to satisfy the DGCL's requirement that bylaws must 'relate to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, office or employees.'"
According to the court, no other Delaware statute or common law prohibited such a bylaw. Still, the court explained that whether the specific ATP fee-shifting bylaw is enforceable "depends on the manner in which it was adopted and the circumstance under which it was invoked." A fee-shifting bylaw may be enforceable if adopted by appropriate corporate procedures as well as for a proper corporate purpose, but the court did not opine on the enforceability of ATP's fee-shifting bylaw since it did not have sufficient facts and was only asked to answer certified questions. The court did note, however, that deterring litigation is not invariably an improper purpose, and therefore the justification of deterrence would not necessarily render the bylaw unenforceable in equity. Finally, the court held that the fee-shifting bylaw applies not only to members who join the corporation after the adoption of the bylaw, but also to members who join the corporation before the bylaw's adoption.
The Delaware Legislature's Response
Fourteen days after the ATP decision, the Delaware Corporate Law Council responded by proposing statutory amendments that prohibited fee-shifting bylaws for stock corporations. Senate Bill 236 of the 147th General Assembly would create DGCL Section 331. The new section would prohibit any certificate of incorporation or bylaw provision of Delaware stock corporations from "impos[ing] monetary liability, or responsibility for any debts of the corporation, on any stockholder of the corporation, except to the extent permitted by Sections 102(b)(6) and 202" of the DGCL.
After various parties expressed concern, including the U.S. Chamber Institute for Legal Reform (affiliated with the U.S. Chamber of Commerce), the Delaware Senate withdrew SB 236 and adopted the Senate Joint Resolution No. 12 (Joint Resolution). The Joint Resolution requests that the "Delaware State Bar Association, its Corporation Law Section, and the Council of that Section" review the scope of the proposed bill. The Joint Resolution also asks that the examination consider whether this type of legislation would be appropriate, and for the three reviewing bodies to submit their results to the 148th General Assembly (2015 legislative session). Finally, it allows interested parties to voice their concerns since the Senate recognized the need to maintain "balance, efficiency, fairness and predictability" in business entity law. With this review in process, any legislation to address the fee-shifting bylaw issue will not occur until after January 1, 2015.
Considerations When Deciding to Implement a Fee-Shifting Bylaw
Since the Joint Resolution, whether fee-shifting bylaws of Delaware stock corporations are enforceable remains unanswered. Accordingly, when a company is weighing the option to adopt a fee-shifting provision, the corporate decision makers should take into account the following considerations:
- Fee-Shifting Bylaws May Reduce Shareholder Litigation and Negative Press: As the ATP Tour court noted, one of the primary benefits of the fee-shifting bylaw is that it will likely reduce the amount of shareholder litigation. More specifically, since losers pay, these bylaws will likely reduce frivolous lawsuits that seek to extract "settlement value." Less intercompany litigation also means less negative press, which most would agree is good for business. Fee-Shifting Bylaws Reduce Costs to the Company: Another obvious consideration that a company will need to weigh is the reduction of costs to the company. Less litigation will mean less money spent on outside counsel and settlements. Plaintiffs who do decide to sue and lose will have to pay for attorneys' fees. Corporate Bylaws are Difficult to Amend: Most bylaws do not allow a board of directors to amend its bylaws without shareholder approval. For stock corporations, a vote by shareholders, who always retain the right to amend corporate bylaws under Delaware law, may be the only way to amend current bylaws. The likelihood that a shareholder would agree to assume those costs is small. Implementing a Fee-Shifting Bylaws Could Result in an Adverse Reaction by Proxy Advisory Firms, Institutional Investors, and Stockholders: Even for a corporation whose board of directors has the ability to amend its bylaws without approval by shareholders, a decision to implement such a bylaw could result in a negative response by investors and decrease overall stock value. How the Delaware Legislature and Judiciary will Respond is Uncertain: There are many questions surrounding fee-shifting bylaws. Does ATP Tour extend to stock corporations? How will the Court of Chancery respond? Will the Delaware legislature act and prohibit stock corporations from implementing fee-shifting bylaws? How will investors react? While SB 236 has been withdrawn, the Delaware State Bar Association could very well recommend prohibiting such a bylaw. Legal challenges to this type of provision have just begun. Especially considering the fact that the DGCL has afforded non-stock corporations greater flexibility than stock corporations, stock corporations should be warned and expect prohibition. The Financial Cost to Implement a Fee-Shifting Provision is High: While a fee-shifting bylaw would ultimately reduce costs to the corporation, implementing such a change will be costly and time consuming. Like most large changes made by corporate leaders, the fee-shifting bylaw will likely face legal challenges. Companies will need to hire outside counsel since such a provision is not guaranteed to be a viable option for stock corporations. The Enforceability of Fee-Shifting Bylaws in Cases Involving Non-Delaware Corporations or Cases Brought in a Forum Outside of Delaware is Ambiguous: States may apply their own rules regarding shareholder litigation. Thus, even though a company may choose to put a fee-shifting provision in its corporate bylaws, other states may find that it violates their state constitutions or public policy. Moreover, it is not clear whether corporations incorporated outside of Delaware will benefit from the ATP decision. Not All Fee-shifting Bylaws Will Survive Judicial Scrutiny: As discussed above, the court declined to decide whether the ATP bylaw was equitable under the law. The Delaware Supreme Court specifically stated that the enforceability of the bylaw will "turn on the circumstances surroundings its adoption and use." While deterring litigation in general was a permissible purpose, seeking to deter specific shareholder litigation could be considered inequitable conduct. Therefore, judicial intervention will almost inevitably be required in order to find whether the given circumstance surrounding the adoption of the bylaw is permissible. Accordingly, it is only when there is no shareholder litigation that a bylaw such as this should be implemented. Even with no shareholder litigation, it is difficult to say how a court would rule on the equitability of a fee-shifting bylaw.
Recommended Approach: Wait and See…
Although no decisions have come up just yet, legal challenges are bound to begin soon. Moreover, the Delaware legislative session starts again on January 1, 2015. A decision to amend corporate bylaws would be premature and is guaranteed to raise issues. Until then, corporate counsel should stay apprised of the pending legislation and litigation. In an effort to streamline the process once a decision has been made, counsel should discuss the potential issues with business leaders regarding implementation of this new structure prior to the start of the 2015 legislative session. This type of provision is not for every corporation, and business leaders must weigh how investors might react.
Conclusion
Considerations other than deterring litigation must be examined before choosing to amend corporate bylaws to provide for a fee-shifting provision; given the potential for the Delaware legislature to invalidate any fee-shifting provision, Delaware corporations would be wise to wait until the dust settles. Nevertheless, such a provision could very drastically change intra-corporate litigation for Delaware corporations. Therefore, corporate counsel should closely monitor the Delaware General Assembly come January 2015.