Companies Should Remove Fee-Shifting Bylaws, Attorneys Warn

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

June 20 — Delaware stock corporations that still have fee-shifting bylaws on their books should rescind them, attorneys say.

Such provisions allow companies to recoup litigation expenses when they prevail in shareholder lawsuits. The clauses were largely invalidated by the Delaware Legislature last year, but some companies haven't removed them from their charters and bylaws (13 CARE 1431, 6/26/15).

Within the last two months, shareholders have sued four companies— StemCells Inc., Paylocity Holding Corp., Echo Therapeutics Inc. and IDI Inc.—over the provisions. Attorneys told Bloomberg BNA that more companies may face lawsuits unless they repeal the clauses.

Cleaning Up Bylaws

In August 2015, Delaware banned bylaw and charter language that allowed stock corporations to shift fees “in connection with an intracorporate claim”—a claim that involves the company's internal affairs, such as directors' fiduciary duties (13 CARE 1431, 6/26/15).

Before the amendment went into effect, many companies, including Lannett Co., PRA Group Inc. and Net Element Inc., removed such “loser pays” bylaws from their books.

While the legislation doesn't mandate that stock corporations rescind their fee-shifting bylaws, it makes sense from a “corporate housekeeping perspective” to do so, Irwin Kishner, a New York-based partner at Herrick Feinstein LLP, told Bloomberg BNA.

Companies that don't repeal the clause run the risk of shareholder litigation in which they may end up paying the plaintiffs' attorneys' fees, attorneys warned.

Attorneys' Fees

It's been almost a year since the Delaware fee-shifting ban went into effect, said Lawrence Hamermesh, a professor at Widener University Delaware Law School who teaches corporate governance. “The longer a company waits to remove an invalidated bylaw the more likely” it is that there will be attorneys' fees awarded should a shareholder sue over the provision.

At least two of the companies that were sued—StemCells and Echo Therapeutics—removed their fee-shifting provisions within a week of an investor filing an action.

StemCells was the first company that was sued in Delaware this year over the bylaw. The action was filed April 27, and the company removed the bylaw May 2 (86 CARE, 5/4/16). The Delaware Chancery Court dismissed the StemCells lawsuit as moot but retained jurisdiction to hear the plaintiffs' application for an award of attorneys' fees.

The Echo Therapeutics lawsuit was filed June 1 and the company removed its provision that same day.

Wiggle Room?

Because the legislation only invalidated fee-shifting provisions with respect to “intracorporate claims,” attorneys said companies may keep “loser pays” bylaws that apply outside of such actions.

What is less clear is whether bylaws that allow fee-shifting “to the fullest extent permitted by law” should be repealed. The case involving Paylocity, whose bylaw is phrased in that manner, may be a test case. The company has asked the chancery court to dismiss the shareholder lawsuit for lack of subject-matter jurisdiction and for failure to state a claim.

Unlike the other companies in litigation, Paylocity's bylaw was adopted six months after Delaware banned fee-shifting provisions.

Companies also have to take into account how these clauses may impact shareholder relations, Jason Halper, a New York-based partner at Orrick, Herrington & Sutcliffe LLP, told Bloomberg BNA.

Corporations with these provisions are in the significant minority, said Halper, who co-chairs his firm’s financial institutions litigation practice. Companies that keep these bylaws face the possibility that their shareholder constituency might not react favorably, he said.

Valuable Tool?

Kishner said that fee-shifting provisions can prove to be a valuable tool in the right situation.

The attorney noted that Delaware has not banned fee-shifting provisions in non-stock corporations. He added that he is seeing more and more privately-held companies adopt such measures.

Moreover, other jurisdictions haven't invalidated fee-shifting provisions, Kishner continued. Companies outside of Delaware that are going public should consider adopting fee-shifting clauses, he said. “They are very good provisions to have from a legal vantage point.”

However, he warned that such bylaws may make an IPO less attractive to some institutional investors. Companies that are going public must weigh whether the clause may impact their offering price, he said.

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

To contact the editor responsible for this story: Yin Wilczek at ywilczek@bna.com

Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.