Fee shifting bylaws moved to back burner
Photo by Sharon Drummond

In a case of first impression, the Delaware Supreme Court held that provisions contained in a nonstock corporation’s bylaws, requiring a plaintiff stockholder to reimburse the corporation’s legal expenses if the plaintiff loses on a claim it has brought against the corporation, are facially valid if adopted properly and for a proper purpose (i.e., not for the purpose of deterring meritorious litigation). The court reached its conclusion in its May 8, 2014 decision based on the following factors and analysis: 

  • the Delaware General Corporation Law (“DGCL”) and other Delaware statutes did not forbid the enactment of fee-shifting bylaws;
  • the fee-shifting bylaw related 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 because it related to the allocation of risk in connection with intra-corporation litigation (DGCL § 109(b)); 
  • a provision for fee-shifting was not required to be included in the charter and could therefore be adopted in the bylaws (DGCL § 102(a)); and 
  • because the Delaware Supreme Court has held that bylaws are treated as contracts among a corporation’s stockholders, it was permissible to modify the American attorney’s fees rule (i.e., that each party in litigation bears its own costs and expenses) by adopting a fee-shifting bylaw. 

Because of the statutory basis of the court’s decision, the holding was presumed to also apply to ordinary stock corporations. Thus, a fee-shifting bylaw would likely allow Delaware corporations to require the loser of an intra-corporate lawsuit to pay the corporation’s attorney expenses. 

In response to the Delaware Supreme Court’s ruling, the Delaware State Bar Association (with significant plaintiff’s attorney membership) was considering a proposed amendment to the DGCL would amend Section 102(b)(6) and add a new Section 331 to clarify that these costs cannot be borne by stockholders of stock corporations. The proposed legislation was expected to be presented to the Delaware General Assembly before the end of the current session and, if passed, would have become effective on August 1, 2014. 

However, in a recent development, the Delaware legislature passed, with the approval of the Governor, Senate Joint Resolution No. 12, which directs the Delaware State Bar Association to further evaluate the proposed amendments to the DGCL regarding fee-shifting bylaws and other aspects of corporate litigation. Although the resolution seems to support for the proposed legislation, the Delaware legislature seems to want further analysis so as not to disenfranchise publicly traded companies that have come to Delaware because of the state’s business-centric approach. The Delaware legislature will likely ultimately insist on a balanced approach after giving full consideration of the interests of all potential parties. Some commentators have speculated that this balancing could be achieved, for example, by permitting fee-shifting bylaws if approved by a stockholder vote or by limiting fee-shifting to lawsuits wrongly filed outside of Delaware in contravention of a valid forum-selection bylaw. To achieve the appropriate balance, the legislature in Delaware will need to weigh the contracts theory of bylaws and deterring meritless strike suits against a public policy argument that would favor access to courts for meritorious lawsuits. In any case, no action will likely be taken on this front until 2015. Until such time, companies should consider to potential utility of adopting fee-shifting bylaws in light of the Delaware Supreme Court’s recent decision.