by Cydney Posner
The Delaware Bar’s Corporation Law Council is proposing amendments to the Delaware General Corporation Law that would address forum selection provisions, and, more significantly, the debate roiling the Delaware bar regarding the validity and advisability of fee-shifting charter and bylaw provisions. No real surprises in the directions these proposed amendments take: generally, the proposed amendments expressly authorize, in Delaware charters and bylaws, forum selection provisions that choose Delaware as the selected forum and invalidate fee-shifting provisions. It is anticipated that the proposals would be considered first by the Corporation Law Section and the Bar’s Executive Committee and then, if approved, introduced in the Delaware General Assembly.
(Note that the proposed legislation also addresses concerns regarding abuse of the Delaware “appraisal” statute, not discussed in this post.)
Fee-shifting Provisions. As discussed in this Cooley Alert and these PubCo posts, generally, under the so-called “American rule,” parties to litigation must pay their own attorneys’ fees and costs. A fee-shifting bylaw or charter provision, however, obligates a stockholder-plaintiff in intracorporate litigation to pay the company’s (and perhaps its directors’) legal fees and costs if the plaintiff is not “successful.” In May 2014, in ATP Tour, Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court held that a “fee-shifting” bylaw adopted by a private non-stock corporation was legally permissible under Delaware law, although whether a particular bylaw would be valid and enforceable in any individual case would still turn “on the circumstances surrounding its adoption and use,” in particular, whether the bylaw was “adopted or used for an inequitable purpose.” In addition, as noted in this PubCo post, it is possible that the ATP court never intended the holding of ATP to be extended to the public company context.
Following ATP, the Delaware corporate bar, concerned about the potential impact of ATP, advocated that the Delaware legislature adopt legislation to prohibit the adoption by stock corporations of fee-shifting provisions that would impose monetary obligations in the absence of individual consent. The legislature, faced with strong opposition from the Chamber of Commerce and others expressing concern about the high proportion of merger transactions subject to stockholder challenges (see this post), determined to postpone consideration of this legislation until 2015. As discussed in this post, the Council of Institutional Investors, along with a number of individual pension funds and other institutional investors, chimed in on the debate over fee-shifting bylaws, sending letters to the governor of Delaware, the chair of the state bar’s corporation law section, as well as ISS and Glass Lewis, in support of a legislative prohibition on these bylaws.(Both of those proxy advisory firms disfavor unilaterally adopted bylaw provisions that can have a material adverse effect on shareholders, such as fee-shifting bylaws.)
However, as the Council Explanatory Paper accompanying the proposed legislation indicates, companies that “believe that stockholder litigation is excessive and undesirable perceive ATP-type provisions in corporate charters and bylaws as a means to constrain or eliminate it. Since June, 2014, approximately 39 corporations, of which 30 are Delaware entities, have adopted bylaw or charter provisions that purport to shift counsel fees to less than fully successful stockholder litigants, and related provisions that purport to affect how stockholder claims are litigated.”
Generally, the Council’s proposals preclude adoption of fee-shifting provisions in charters and bylaws for stock corporations (i.e., the holding in ATP regarding non-stock corporations would not be disturbed). More specifically, they would prohibit “any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an intracorporate claim….” “Intracorporate claims” are defined as claims, including “claims in the right of the corporation, that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity,” or as to which the corporation law confers jurisdiction on the Court of Chancery. For example, these would include “claims arising under the DGCL, including claims of breach of fiduciary duty by current or former directors or officers or controlling stockholders of the corporation, or persons who aid and abet such a breach.” The synopsis indicates that the amendments are not intended to preclude enforcement of fee-shifting provisions in agreements where the stockholder has agreed in writing.
Why did the Council recommend against fee-shifting provisions? The synopsis cryptically indicates that the purpose was to “preserve the efficacy of the enforcement of fiduciary duties in stock corporations.” The accompanying paper elaborates extensively on that contention, arguing that, in essence, while some believe that the volume of stockholder litigation involving public companies is excessive and should be curbed, stockholders initiate “most litigation testing the propriety of conduct under either the DGCL or the common law of fiduciary duty…. [While] corporate managers seldom, if ever, believe that their conduct warrants legal action, class and derivative actions are widely recognized as important protections for stockholders, and critical to reducing investment risk and the cost of capital.” Accordingly, much of this litigation serves a useful function, and allowing widespread adoption of fee-shifting bylaws would be too draconian a remedy.
According to the Paper, fee-shifting bylaws would effectively preclude stockholder litigation that is critical to stockholder protections and the development of Delaware corporate law:
“The Council believes that absent legislation, many Delaware corporations will eventually adopt ATP-type provisions….. If such adoption became widespread, the effects on stockholder litigation would be severe. Every lawsuit is a risk; no one can confidently predict the outcome at the start. Moreover, virtually no lawsuits of any type substantially achieve in substance and amount the full remedy sought as the ATP bylaw contemplates. If fee shifting on such a broad basis is possible, even successful litigations could result in plaintiffs having to reimburse opponents’ attorneys’ fees. Because the consequences of any corporate decision affect investors only commensurately with the scope of their investments, few stockholders will rationally be able to accept the risk of exposure to millions of dollars in attorneys’ fees to attempt to rectify a perceived corporate wrong, no matter how egregious. Nor is it clear that this is a problem that can be solved through the courts. The in terrorem effect of fee shifting bylaws is self-enforcing: to even challenge the bylaw itself, a stockholder must risk paying uncapped legal fees of the corporation. In fact, at least one stockholder plaintiff has sought to dismiss its claim in the wake of a corporation’s adoption of a fee-shifting bylaw.”
As a result, the Council maintains, fee-shifting provisions would have the effect of curtailing the development of corporate common law, particularly the body of case law regarding fiduciary duties, which is most highly developed in Delaware by the Delaware courts. In the absence of stockholder-initiated litigation, “there would be essentially no effective enforcement mechanism for statutory or fiduciary obligations… Permitting fee shifting as a limitation on stockholder litigation would be functionally equivalent to permitting corporate charter or bylaw provisions limiting or eliminating fiduciary duties of officers and directors. If investors were to perceive over time that statutory rights and fiduciary obligation had become hollow concepts, investors’ confidence could diminish, and capital formation could be adversely affected.” If the goal is channeling “stockholder litigation constructively towards meritorious claims,” the Council concluded, fee-shifting bylaws are not the appropriate means. The Council encouraged experimentation with other types of litigation-regulating provisions that might not have as dramatic an effect: “the proposed legislation does not deprive corporations of the ability to adopt other provisions that address unproductive stockholder litigation by means other than fee-shifting. The DGCL is broadly enabling and gives wide authority to boards – and stockholders – to adopt binding bylaws and charter provisions.”
Forum Selection Provisions. Instead of taking a sledgehammer approach such as fee-shifting bylaws, the Council implies, how about using a scalpel? Along with the many other tools available to the Delaware courts, perhaps forum selection provisions might be the ticket, especially if the forum selected is Delaware. These provisions enable “courts to more effectively address abusive litigation because plaintiffs cannot ‘shop’ for favorable forums.”
Forum selection bylaws (bylaw provisions that require certain types of intracorporate litigation – typically claims by stockholders for breaches of fiduciary duty, in derivative suits or for other corporate governance-related claims against the company or its management — to be brought in a single or particular forum, usually the company’s state of incorporation) have not raised nearly the same level of concern as fee-shifting provisions. Delaware courts have a record (albeit a brief one) of recognizing forum selection provisions. In 2013, a Delaware Chancery Court upheld a forum selection bylaw provision that selected Delaware as the exclusive forum for intracorporate litigation. Notably, in 2014, the Delaware Chancery Court even enforced, in part as a matter of judicial comity, bylaws of a Delaware corporation that selected North Carolina (the state of the company’s headquarters) as the exclusive forum. In December 2014, the Delaware Supreme Court, in overturning a lower court determination not to limit the use of information gathered in the course of a “books and records” inspection only to litigation conducted in Delaware, instructed the Chancery Court on remand to take into consideration the company’s forum selection bylaw, even though it had been adopted subsequent to the plaintiff’s filing of his claim. The Supreme Court viewed the bylaw to represent “a non-case-specific determination by its board of directors that internal affairs litigation involving the company should proceed in a single forum.” Courts in several other states, including California, Illinois, New York and Texas, have also enforced the provision, with the result that the litigation proceeded only in the selected forum; however, a federal court in California and an Oregon state court have refused to enforce these bylaw provisions.
The Council’s proposed amendments expressly authorize the adoption of exclusive forum provisions, as long as the exclusive forum is in Delaware. More specifically, the charter or bylaws “may require, consistent with applicable jurisdictional requirements, that any or all intracorporate claims shall be brought solely and exclusively in any or all of the courts in this State, and no provision of the certificate of incorporation or the bylaws may prohibit bringing such claims in the courts of this State.” Although the proposed amendment does not address the validity of a provision that selects, as an additional forum, a forum other than Delaware, the synopsis indicates that “it invalidates such a provision selecting the courts in a different State, or an arbitral forum, if it would preclude litigating such claims in the Delaware courts.” Accordingly, the legislation would not allow Delaware corporations to select another state as the exclusive forum. The effect of that clause would be, in essence, to curtail the impact of the Delaware Chancery Court decision that enforced the bylaw adopted by a Delaware corporation selecting North Carolina as the exclusive forum. The FAQs issued by the Council explain that “the legislation does not permit charter or bylaw provisions that preclude stockholders from bringing their claims in Delaware courts. The Council believes that stockholders of Delaware corporations should not be denied access to the protection of the Delaware courts. Thus, the broadly enabling nature of the DGCL would be trimmed back to address this issue. In particular, the Council believes that the value of Delaware as a favored jurisdiction of incorporation is dependent on a consistent development of a balance of corporate law, and that the Delaware courts are best situated to continue to oversee that development.”
The synopsis indicates that the amendments are not intended to preclude enforcement of forum selection provisions in agreements where the stockholder has agreed in writing or to foreclose evaluation of whether there are fiduciary or reasonableness issues in connection with the specific terms or manner of adoption or operation (such as lack of Delaware jurisdiction “over indispensable parties or core elements of the subject matter of the litigation.” The legislation is also not intended to foreclose federal jurisdiction or to limit or expand the jurisdiction of the Delaware Courts.
In the accompanying Paper, the Council explained that, while the Delaware courts have already validated forum selection provisions, “statutory endorsement is intended to give other state and federal courts additional reason to honor such exclusive venue provisions.” These provisions may also help curb the costs and other problems associated with multi-forum litigation. The Council argued that, “if a Delaware corporation wants to specify a venue for intracorporate actions, the choice of Delaware incorporation and resulting implicit choice of Delaware corporation law should result in a preference for Delaware courts to resolve disputes. To the extent the prevalence of multi-forum litigation has made Delaware courts reluctant to police stockholder litigation, this proposal’s enhanced means to end the multi-forum litigation problem should increase judicial confidence to use the tools available to supervise stockholder litigation more effectively.”