Curbing stockholder litigation: exclusive forum and fee-shifting provisions.
The significance of this problem becomes shockingly clear when one considers the statistics on M&A litigation. While the 2014 information is still being compiled, they are not expected to be materially different from 2013. A study prepared by Matthew D. Cain (University of Notre Dame, Department of Finance) and Steve M. Davidoff (Ohio State University, Michael E. Moritz College of Law) on M&A deals in 2013 showed:
* 97,5 percent of all transactions resulted in litigation
* Each transaction resulted in an average of 7 lawsuits (an all time high)
* 41.6 percent of all transactions experienced multi-jurisdictional litigation (down from 51.8 percent in 2012)
* Median attorneys' fee awards per settlement were US$485,000
EXCLUSIVE FORUM PROVISIONS
In 2013, the Court of Chancery, in Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), held that boards of directors of Delaware corporations may adopt exclusive forum bylaws that are binding on stockholders. The court addressed the validity of the bylaws under the DGCL as well as the question of whether bylaws enacted by a board of directors without stockholder involvement can be enforced, as a contractual matter, against stockholder plaintiffs.
The court made two primary holdings. First, Section 109(b) of the DGCL permits an exclusive forum selection bylaw because it allows a corporation's bylaws to "contain any provision, not inconsistent with law or with the certificate of incorporation, relating 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, officers, or employees." The court held that forum selection bylaws "easily meet these requirements." Second, forum selection provisions are enforceable against stockholder plaintiffs, even though the bylaws were board-enacted, because bylaws are part of a flexible contractual relationship between stockholders and a corporation. Based on the certificate of incorporation, stockholders understand whether a particular board of directors has the power to enact bylaws.
If the certificate of incorporation grants a board the power to unilaterally amend the corporation's bylaws, as permitted by Section 109(a), then the board may enact bylaws and thereby unilaterally alter the flexible contract.
The Chevron case provided for exclusive jurisdiction in Delaware, but in a 2014 case involving a Delaware corporation--City of Providence v. First Citizens Bancshares, Inc., et al., 2014 WL 4409816 (Del. Ch. Sept. 8, 2014)--the company's bylaw provided for exclusive jurisdiction in the United States District Court for the Eastern District of North Carolina or, if that court lacks jurisdiction, any North Carolina state court with jurisdiction. Delaware's new Chancellor, Andre C. Bouchard, upheld the bylaw based on the same rationale in Chevron and dismissed the case.
1. The Delaware case law is important, but it is when the company and management are facing lawsuits in other states that they really need the exclusive forum provisions to be enforced--and that requires non-Delaware courts to accept their validity and enforce them. To enhance enforcement, such provisions should be adopted by stockholder-approved charter amendment (if possible) rather than by management-approved bylaw. For example, in Roberts v. TriQuint Semiconductor, 2014 WL 4147465 (Cir. Ct. Or. Aug. 14, 2014), an Oregon court refused to enforce a forum selection bylaw adopted at the same time as the merger agreement being challenged by stockholders because of "the closeness of the timing of the bylaw amendment to the board's alleged wrongdoing, coupled with the fact that the board enacted the bylaw in anticipation of this exact lawsuit."
2. Mandatory arbitration for corporate governance disputes will be the next challenge. One could argue that certain actions expressly permitted by the DGCL should be excluded--e.g,,
211 (annual meetings), 220 (books and records), 225 (votes and elections) and 262 (appraisal) actions--because the DGCL authorizes them without condition, but the rationale for exempting even these actions from a validly adopted charter or bylaw provision is not clear (other than a court making a public policy judgment call).
In ATP Tour, Inc. et at. v. Deutscher Tennis Bund et al., --A.3d--, 2014 WL 1847446 (Del. May 8, 2014), the Delaware Supreme Court, sitting en banc, held that a Delaware corporate bylaw that requires a losing claimant to pay the legal fees and expenses of the defendants is not invalid per se, and if otherwise enforceable can be enforced against losing claimants whether or not they were already stockholders when the relevant bylaw provision was adopted.
In 2006, the board of directors of ATP Tour, Inc. a Delaware non-stock (also known as a membership) corporation adopted a bylaw providing that if any member or members brought or supported a claim against the corporation or any other member, the claimant would then be obligated (and if more than one claimant, jointly and severally obligated) to pay the legal fees and expenses of those against whom the claim was brought if the claimant "does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought ..." Members of ATP Tour, Inc. filed claims against the corporation and the board, A federal district court, having found for the defendants on all counts, certified the question of the fee-shifting provision to the Delaware Supreme Court.
Citing Section 109(b) of the DGCL for the baseline rule that the bylaws may contain any provision not inconsistent with law or the corporation's certificate of incorporation, the court noted that bylaws are presumptively valid and that a bylaw that "allocated risk among parties in intra-corporate litigation would appear to satisfy the DGCL's requirement that bylaws 'must re I at [e] to the business of the corporation, the conduct of its affairs, and its rights and powers or the rights and powers of its stockholders, directors, officers or employees.'" Although the corporation in this case was a non-stock corporation, the analysis is applicable to stock corporations and non-stock corporations alike, with the members of non-stock corporations being analogous to stockholders.
The court held that no principle of common law prohibits directors from enacting fee-shifting bylaws and that because contracting parties may modify the "American Rule" under which litigants pay their owns costs to provide that "loser pays," a fee-shifting bylaw (bylaws being "contracts among a corporation's shareholders") would be a permissible contractual exception to the American Rule. The court noted further that an intent to deter litigation, as a fee-shifting provision inherently does, was not invariably an improper purpose.
The court did note, however, that the enforceability of such a bylaw provision would depend on the manner in which it was adopted and the circumstances under which it was envoked, and that "[b]ylaws that may otherwise be facially valid will not be enforced if adopted or used for an inequitable purpose."
1. Because this is the first case touching on this issue, the reaction of ISS, proxy advisory firms and others to the extension of the ATP rationale to general corporations is yet to be fully known. The court was careful to point out that such a bylaw may be facially valid but could be rendered unenforceable if used for an inequitable purpose.
2. If ATP could be extended to general corporations, the logistics are easy. If a company has an exclusive forum provision, it could make the fee-shifting provision apply to any and all claims covered by the exclusive forum provision, which would cover class actions, derivative claims and claims involving the internal affairs doctrine. Also, the adoption of a fee-shifting bylaw well before the possibility of any litigation would improve its chances of enforcement.
3. It is notable that despite the court's analysis of the fee-shifting mechanics in light of the "American Rule" versus "loser pays," the bylaw provision in question only shifted the expense to a losing claimant, and is arguably asymmetric in its effect. However, for class actions and derivative actions, a court has to approve of any fee to plaintiff's counsel, so a provision that says corporate-loser pays plaintiff-winner may not be enforceable.
All of the above considerations may become irrelevant, After wrangling behind closed doors, on May 29, 2014, the Corporation Law Section of the Delaware State Bar Association voted to recommend to the Delaware Legislature a statutory amendment that would quash the adoption of ATP-type bylaw provisions for general corporations--essentially making a legislative end-run around the Supreme Court's decision. Proposed changes to the DGCL are often given great deference: the Delaware State Bar Association recommends a change and the Delaware Legislature gives great weight to the advice of Delaware legal experts, which has worked quite well and has created the most widely-respected corporate legal framework in the world. Statutory changes generally occur on an annual cycle where new changes take effect on August I. However, in an unusual turn of events, the proposed legislation was opposed by several corporations and tabled for later discussion. In early March of 2015, the Corporation Law Section again proposed legislation barring management's ability to shift fees in stockholder litigation, even if the prevision is contained in a stockholder-approved charter amendment. It remains to be seen whether the Delaware Legislature will accept the recommendation this time. In the interim, rather than rushing to have their boards adopt fee-shifting bylaw provisions, corporations will do well to step back and coolly observe the Delaware process at work. That said, some corporations have adopted fee-shifting bylaws and the issue is surely going to be well-litigated in the near future.
While a "loser pays" system remains uncertain in Delaware, in 2014, Oklahoma became the first state to adopt a law mandating fee shifting in stockholder derivative suits.
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|Publication:||Directors & Boards|
|Date:||Jan 1, 2015|
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