These bylaws rely on two recent Delaware court decisions (Boilermakers2 and ATP3) that find board-adopted bylaws presumptively valid, even when they regulate matters outside the boardroom and were never explicitly consented to by stockholders. Proponents of these bylaws say they deter frivolous and duplicative litigation, and thus save companies money. But these bylaws do far more than deter frivolous litigation; if upheld by courts, they will make it economically irrational for serious investors to pursue even the most meritorious claims.
Historically, bylaws have only regulated internal corporate processes, such as director elections. While bylaws were sometimes susceptible to abuse by corporate directors seeking to ward off dissidents or thwart proxy proposals, they were never explicitly used to set the rules for shareholder litigation. That has all changed in the wake of Boilermakers and ATP. Boilermakers upheld the validity of a “forum selection” bylaw, which mandated that shareholder litigation concerning the fiduciary duties of directors of a Delaware corporation be filed in Delaware. While perhaps non-controversial in effect, the Boilermakers court’s reasoning, which required the shareholder opposing the bylaw to demonstrate that it could never operate lawfully under any scenario, set an impossible standard that shareholders will never be able to meet. Boilermakers also extended the permissible use of board-adopted bylaws: by allowing corporate directors to write litigation rules governing where they could be sued, Boilermakers paved the way for other, more aggressive bylaws governing how they could be sued.
ATP followed this spring, surprisingly holding that a board-adopted “fee shifting” bylaw at a non-stock corporation was valid. The Delaware Supreme Court’s reasoning would appear to extend to all manner of bylaws, even at public corporations. ATP is now being touted by public corporations when they adopt new bylaws setting rules for how and where they can be sued. The clear purpose of these new bylaws is to seek to insulate directors and officers from the legal scrutiny imposed by shareholder actions. New bylaws are being adopted every week, limited only by the aggressiveness and creativity of the corporate bar. In just two months during the summer of 2014, at least eleven public companies adopted bylaws shifting attorneys’ fees in shareholder litigation,4 and another half dozen have been adopted as of this writing. Several of these bylaws were adopted just after disclosure of negative events that the directors would assume might spawn shareholder litigation.5 One was adopted in the middle of ongoing shareholder litigation, with company counsel explicitly trumpeting the company’s adoption of
the bylaw as a “sword” to pressure plaintiffs to drop their lawsuit.6
The new bylaws being adopted are also not limited to forum selection and fee shifting. One company included a “surety” bylaw allowing the company to require shareholders to post a bond for the company’s litigation expenses.7 Another company, while adopting a fee shifting bylaw that requires a non-prevailing shareholder to pay the company’s fees, simultaneously absolved the company from ever owing fees to a successful shareholder plaintiff, even if the litigation led to “the creation of any common fund, or . . . a corporate benefit.”8 More and more aggressive provisions are likely to be included in these anti-litigation bylaws, especially since many of the bylaws have “severability” provisions, which state that even if one provision is struck down, the remaining terms still survive.9
Clearly, the slope is getting slippery. If the slide continues, corporate directors will be set free to draft and enforce the rules of representative litigation that is supposed to police directors’ own conduct. Advocates for these new bylaws, and for the hurdles they place before shareholder litigants, say they curb meritless litigation that distracts corporate actors from faithfully serving the shareholders.10 But these bylaws cast such a wide net that they will also foreclose even the most well-meaning stockholders from ever pursuing even the most meritorious claims.
Proponents call these bylaws “fee shifting” or “loser pays” bylaws, but this description ignores the text of the bylaws,11
The author thanks Michael Hanrahan of the firm Prickett Jones & Elliott, P.A., and specifically recommends Mr. Hanrahan’s article “The Parade of Horribles Has Begun,” (PLI 2014) for a fuller exposition of many of the legal issues discussed herein.
2Boilermakers Local 154 Retirement Fund, et. al. v. Chevron Corp., et. al., 73 A.3d 934 (Del. Ch. 2013).
3ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014).
4Viper Energy Partners, LP (“Viper”) (May 29, 2014); LGL Group (June 11, 2014) (“LGL”); Townsquare Media, LLC (“Townsquare”) (June 24, 2014); Echo Therapeutics, Inc. (“Echo”) (June 25, 2014); Biolase, Inc. (“Biolase”) (June 30, 2014); Westlake Chemical Partners LP (“Westlake”) (June 30, 2014); Hemispherx BioPharma, Inc. (“Hemispherx”) (July 10, 2014); Antero Resources Midstream LLC (“Antero”) (July 11, 2014); Lannett Company, Inc. (“Lannett”) (July 17, 2014); American Spectrum Realty, Inc. (“American Spectrum”) (July 25, 2014); and Portfolio Recovery Associates, Inc. (“Portfolio Recovery”) (July 28, 2014).
5See, e.g., Echo (adopted following proxy contest by 20% shareholder); Biolase (adopted in connection with dispute with former CEO/Chairman); Lannett (adopted one day after disclosing receipt of interrogatories and subpoena from Connecticut AG related to price fixing investigation); American Spectrum (adopted amidst allegations that CEO engaged in self-dealing and fraud); LGL (adopted following earnings miss, resignation of CEO, termination of Controller); Portfolio Recovery (adopted following negative blog posts and just prior to earnings miss).
6Liz Hoffman, “Shareholder Suit Involving Loser-Pays Provision Heats Up in Delaware,” The Wall Street Journal (July 22, 2014) (concerning Hemispherx
BioPharma’s adoption of a fee shifting bylaw in the middle of litigation).
9See, e.g., Viper, LGL, Biolase, Westlake.
10Avrohom J. Kess & Yafit Cohn, “‘Loser Pays’ Rules Make a Comeback,” The Wall Street Journal (Aug. 27, 2014).