Delaware Chancery Court may consider validity of fee-shifting bylaw

by Cydney Posner

As discussed in this Cooley Alert, “Delaware Supreme Court Holds Fee-Shifting Bylaw Facially Valid,” in May of this year, in ATP Tour, Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court held that a “fee-shifting” bylaw adopted by a board was “facially valid” under Delaware law. (Generally, under Delaware law, parties to litigation must pay their own attorneys’ fees and costs.  However, a fee-shifting bylaw obligates a plaintiff in intra-corporate litigation to pay the company’s legal fees and costs if the plaintiff is not successful.)  Although, under ATP, a fee-shifting bylaw was held to be legally permissible under Delaware law, whether a bylaw is valid and enforceable in any  individual case turns “on the circumstances surrounding its adoption and use,” in particular, whether the bylaw was “adopted or used for an inequitable purpose.” Notably, according to the ATP court, “[t]he intent to deter litigation… is not invariably an improper purpose.” We may soon see how this ruling plays out in practice. 

As discussed in this article from Law360, “Shareholders Fight Hemispherx’s Fee-Shifting In Del. Chancery,” Hemispherx was sued derivatively to invalidate as improper large “bonus” amounts paid to board members in 2012. The litigation was commenced in June 2013. In July 2014, the company’s board  adopted a fee-shifting bylaw that operated retroactively to require plaintiffs in derivative actions who do  “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 the Company … for all fees, costs, and expenses.” A “claiming party” includes the plaintiff and “any other person who joins with the Claimant, offers substantial assistance to the Claimant, or has a direct financial interest in any Claim.”  This week, counsel for the plaintiffs, apparently preferring to avoid the risk of being on the hook for legal fees and costs, asked the court either to invalidate the company’s fee-shifting bylaw or to remove them as counsel from the suit: counsel maintained that the effect of the bylaw was to change “the rules in the middle of the game,” making it “’economically irrational’ to continue the litigation.” The article, quoting from the motion, observes that the “’plain terms of the bylaw and the company’s July 18, 2014 letter demonstrate an intent to force plaintiffs and their counsel to discontinue this litigation by threatening financial liability under the bylaw….The bylaw has had its effect.’”

Given the circumstances under which the bylaw was adopted and the breadth of its application, a decision by the court invalidating the bylaw here would not necessarily be indicative of how a court would view a more narrowly tailored fee-shifting bylaw adopted on a “clear day.” If the court did not invalidate the bylaw, however, the outcome would certainly reinvigorate the ongoing debate in Delaware regarding proposed legislation to preclude adoption of fee-shifting bylaws in Delaware. As you may recall, soon after the opinion in ATP was issued, the Delaware legislature, out of concern that the bylaw would “chill even meritorious claims,” proposed the ban, but the proposal ran headlong into stiff opposition from corporations, the Chamber of Commerce and other corporate organizations (which are, after all, bread and butter to Delaware), and the legislature agreed to put the prohibition on hold until January.

We’ll try to keep you posted on the outcome.

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