Oklahoma Adopts Mandatory Fee-Shifting Law; Academics Say Will ‘Chill’ Derivative Lawsuits

Bloomberg BNA’s Corporate Law & Accountability Report is available on the Corporate Law Resource Center. This news service keeps corporate practitioners informed of legal developments of...

By Michael Greene

Oct. 23 — While the applicability of “loser pays” corporate bylaws remains uncertain in Delaware, Oklahoma has become the first state to adopt a law mandating the shifting of fees in derivative lawsuits.

According to the bill adopted by the Oklahoma legislature, in derivative actions the court “shall require the nonprevailing party or parties to pay the prevailing parties the reasonable expenses, including attorney fees, taxable as costs, incurred as a result of such action.” The law goes into effect Nov. 1.

In Delaware, State Sen. Bryan Townsend (D) sponsored a bill that would prohibit Delaware companies from adopting fee-shifting bylaws. However, Townsend in June tabled debate on the matter to hear from business interests. Accordingly, the Delaware General Assembly will not decide until 2015 whether to amend the state's General Corporation Law to restrict these bylaws.

Chilling Effect?

Both plaintiffs' firms and academics have raised concerns over the potential impact of fee-shifting provisions that allow corporations to recover litigation costs from unsuccessful plaintiffs.

In a statement e-mailed to Bloomberg BNA, J. Robert Brown, Jr., a professor at the University of Denver Sturm College of Law, said he believes that “bylaw shifting will reduce litigation, particularly against boards of directors.” He added that “[t]o the extent that these bylaws remain valid, derivative suits in Oklahoma will largely dry up.”

Brown's concerns have been echoed by other academics.

In theory, the Oklahoma law “will chill bad derivative lawsuits and encourage good ones,” said Celia Taylor, also a professor at the University of Denver Sturm College of Law.

Taylor, however, noted that she thinks the Oklahoma law will have a chilling effect on both frivolous and non-frivolous derivative lawsuits because of the risks of extremely large fee-shifting. “I think more realistically it will chill all of them because you never know whether you are going to win a lawsuit when you go into it.”

Other States

While the Oklahoma statute is drafted to apply only to derivative lawsuits brought in that state, other states may be considering adopting similar provisions.

States are trying to find ways to attract corporations, and “[t]his is one way to do it,” according to Brown.

Fee-shifting provisions are “popular among boards of public companies,” according to Taylor. “The step taken by the Oklahoma legislature is likely to be positively received by issuers in the state.”

John C. Coffee, Jr., a professor at Columbia Law School and director of the school's Center on Corporate Governance, told the SEC Investor Advisory Committee Oct. 9 that since May, “24 public corporations have adopted one-way loser pays bylaws”.

Status in Delaware

Responding to a certified question in May in ATP Tour Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court found that fee-shifting provisions in the bylaws of a Delaware non-stock corporation can be enforceable.

Because the ATP Tour court was merely answering a certified question, uncertainty remains as to the scope and applicability of these bylaws in Delaware. A legal challenge to one such bylaw is ongoing in the Delaware Chancery Court.

Brown noted, “[i]f Delaware upholds these bylaws, other states will feel pressure to adopt provisions validating these bylaws in order to prevent their corporations from moving to Delaware.”

Once one state makes a move, others are likely to follow; but the real question is whether “Delaware will take that route or not,” said Taylor.

According to Taylor, Delaware is likely to react in some way to maintain its “prominence in the corporate world.”

Potential Challenges

The scope of the Oklahoma law appears to be different from that of the bylaws adopted by many corporations and may have an affect on what types of challenges can be brought in the state.

The language in some Delaware fee-shifting bylaws makes it appear that plaintiffs need to have a “resounding victory,” whereas the Oklahoma statute only requires the plaintiff to “prevail,” Taylor noted.

The issue over how successful a plaintiff must be in order to avoid the fee-shifting provision is currently under dispute in the ongoing Delaware action. According to Taylor, this could have an impact on how “effective the bylaws are going to be.”

When asked about what type of challenges could be made to state laws that mandate fee-shifting, Brown stated that “the Oklahoma statute is drafted to apply only to derivative suits. As a result, the provision does not shift fees in federal cases such as securities cases. This takes away one basis for challenging the provision.”

“Under state law, courts may strike down these provisions because they effectively insulate directors from liability, eliminating their fiduciary obligations,” Brown added.

To contact the reporter on this story: Michael Greene in Washington at mgreene@bna.com

To contact the editor responsible for this story: Kristyn Hyland at khyland@bna.com

A link to the Oklahoma bill is available at https://www.sos.ok.gov/documents/legislation/54th/2014/2R/SB/1799.pdf.