After a sustained and unanimous outcry from institutional investors, the Delaware legislature now considers proposed legislation banning fee shifting in stockholder litigation.
The Delaware Supreme Court’s May 2014 ATP decision1 upheld the facial validity of a corporate bylaw that shifts fees to a non-prevailing stockholder plaintiff. This decision led dozens of public companies to adopt fee-shifting bylaws. As we reported here in our Winter 2015 newsletter,2 however, fee shifting bylaws deter meritorious litigation by making stockholder litigation economically irrational for stockholders.
Specifically, such bylaws impose potentially crippling financial risk on stockholder plaintiffs who will receive only a small proportion of the financial reward of a victory. They also typically define “prevailing” in stockholder litigation extremely narrowly, requiring the plaintiff to achieve a full victory on the merits, or else be liable for all of the defendants’ fees. In ATP, defendants’ attorneys’ fees were more than $17 million.
Corporate practitioners, both for plaintiffs and defendants, quickly understood that ATP could spell the end of meritorious stockholder litigation under state law. (Most commentators assumed that federal law would preempt such bylaws.) So within a month of ATP, in June 2014, the Delaware Corporate Law Section proposed legislation banning fee shifting at Delaware public corporations. This legislation met with stiff opposition from the Chamber of Commerce, which encouraged the legislature to delay consideration of the bill until 2015.
The Delaware legislature delayed consideration of the initial legislation until the January 2015 session. Over next nine months, corporate lobbyists, led by the U.S. Chamber of Commerce, met with legislators and published numerous editorials supporting fee shifting. KTMC helped lead an effort to coordinate institutional investor opposition to fee shifting. More than 50 institutional investors, controlling more than $2.5 trillion in assets, wrote letters to the Delaware legislature asking it to ban fee shifting.
In early 2015, after significant deliberation, the Corporate Law Section came out with its new proposed legislation banning fee shifting. The legislation was passed by the Delaware Senate on May 12, 2015, by a vote of 16-5, with all 12 Democrats voting in favor, and 5 out of 9 Republicans voting against. The legislation now moves to the Delaware House of Representatives, which is currently considering it.
While banning fee shifting, the proposed legislation also specifically authorizes Delaware corporations to adopt “forum selection” bylaws, which require stockholder litigation to be brought in one forum, specifically Delaware Chancery Court. KTMC had unsuccessfully challenged forum selection bylaws by bringing suit in Chancery Court in 2013,3 where we argued that boards of directors should not be allowed to pass bylaws restricting litigation against the board members.
The new proposed legislation also explicitly leaves for another day the validity of other kinds of bylaws that limit stockholder litigation. For example, one company has adopted a “surety” bylaw, allowing the company to require stockholders to post a bond for the company’s litigation expenses while the litigation proceeded. Four companies passed bylaws decreeing that only stockholders owning or controlling more than 3% of the company’s stock are allowed to sue. Other companies have passed bylaws that prevent plaintiffs’ counsel from being paid for creating a “common fund” or “common benefit” shared by all stockholders.
So while fee shifting bylaws appear to be dead, corporate boards have been empowered to pass other bylaws restricting stockholder litigation, each of which will be evaluated on a case-by-case basis. Each of these bylaws presents unique challenges and disincentives for stockholders to exercise their rights. Institutional investors will need to be vigilant in protecting the rights of stockholders against each of these new threats.
1ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014).
2Lee Rudy, “Investors Opposing Fee-Shifting Bylaws,” KTMC Bulletin (Winter 2015), available at www.ktmc.com/pdf/KTMC_2015_WINTER_NEWSLETTER.pdf.
3 Boilermakers Local 154 Retirement Fund, et. al. v. Chevron Corp., et. al., 73 A.3d 934 (Del. Ch. 2013).