by Cydney Posner

Those expecting that the Delaware court, in a case involving Hemispherx, would soon address the as-applied validity of a fee-shifting bylaw may be disappointed. (As discussed in this post and this Cooley Alert, the Delaware Supreme has already ruled in another case that a “fee-shifting” bylaw adopted by the board of a non-profit was “facially valid” under Delaware law.)  In this case, Kastis v. Carter, plaintiffs filed a derivative suit challenging certain bonus amounts awarded to Hemispherx board members. After the complaint was filed, the company adopted a fee-shifting bylaw that purported to apply retroactively to the plaintiffs and potentially even to plaintiffs’ counsel. in July, plaintiffs’ counsel asked the Delaware Chancery Court either to invalidate the company’s fee-shifting bylaw or to remove them as counsel from the suit.  At the request of plaintiffs, in August, the court held a scheduling conference to determine how to proceed with the case. The company wanted to proceed with a motion to dismiss that had been filed on behalf of the Hemispherx Special Litigation Committee. The plaintiffs, however, wanted the bylaw first declared invalid, arguing that they were reluctant to make any move forward in the case because of the potential for “crippling financial liability” if they were not completely successful. The Court said that it did not see how it could address the bylaw issues until plaintiffs amended their complaint to include a challenge to the bylaw. Plaintiffs’ counsel responded that anything they did to “continue or maintain the litigation,” could result in liability for their clients. (As noted during the conference, Hemispherx has previously expressly confirmed that, despite the broad language of the bylaw, it was not intended to impose liability on plaintiffs’ counsel.)

The conference transcript reveals that the Court was “not sympathetic to the notion … of barreling ahead either simultaneously or solely” with the SLC’s motion to dismiss  “without sorting out this bylaw issue because [the Court] view[ed] the bylaw issue to have been a creation of the defendants in the middle of this case to change the rules.”  As a result, the transcript indicates, during the conference, the Court essentially negotiated a limited waiver of the application of the bylaw to plaintiffs in connection with fees related to the SLC’s  motion to dismiss as well as for fees arising out of a challenge to the facial validity of the bylaw; however, to the extent plaintiffs wanted to challenge the bylaw on an as-applied basis, the commitment was, as the court characterized it, “a little squishier,” with a limitation added that, beyond a reasonable and limited amount of discovery, the company’s counsel was unable to commit to a waiver without consultation with the company.

During the conference, the Court identified a number of “very interesting issues” with respect to the fee-shifting bylaw:  its proposed retroactive application to underlying conduct, not just to the universe of shareholders to whom it would apply; the bylaw’s bond requirement; and the policy implications regarding liability of stockholders in a for-profit corporation as compared with a non-profit.  The last point could be especially interesting (or humiliating, depending on the outcome), because many of us had assumed that the validity of the bylaw would not depend on the for-profit or non-profit status of the corporation.

After the conference, plaintiffs’ counsel moved for leave to file an amended complaint which, as the court had indicated, included a challenge to the fee-shifting bylaw, arguing that the bylaw made the litigation “economically irrational,” and that it was contrary to Delaware law and policy on a number of grounds. The company then asked the Court to reconsider its conference ruling to instead require that the motion to dismiss be heard prior to addressing any challenge to the bylaw, arguing that the outcome could make the bylaw issue moot. As part of that filing, the company confirmed the limited waivers described above, but with respect to a bylaw challenge on an as-applied basis, the company reserved the right to pursue from the plaintiffs under the bylaw the amount of fees they might incur above $30,000 (a liability threshold that is unlikely to provide much comfort to the plaintiffs).

If the Court concludes that the motion to dismiss should proceed first, it is entirely possible that the bylaw challenge will not be heard before the Delaware legislature takes up the issue of fee-shifting bylaws, as expected, in 2015 or, depending on the outcome, that the Court may not reach the issue at all. We hope to keep you posted on new developments.

Posted by Cydney Posner