Company Repeals No-Pay Bylaw, Mooting Investor Lawsuit

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By Michael Greene

May 3 — Biopharmaceutical company StemCells Inc. May 2 removed its “fee-shifting” and “no-pay” bylaw provisions, less than a week after an investor asked the Delaware Chancery Court to invalidate the clauses.

The fee-shifting bylaw would have allowed the Delaware company to recoup litigation expenses where it substantially prevails in a shareholder action. The no-pay provision would have required a shareholder suing the company to bear its own fees and costs unless bad faith was involved or the court characterized the lawsuit as a derivative action.

StemCells's case is one of the first legal challenges of no-pay provisions. Attorneys have suggested that such clauses could become the next battleground over bylaws that restrict shareholder litigation rights.

In her complaint, shareholder Sydelle Guardino claimed that StemCells should have rescinded its fee-shifting bylaws when the Delaware Legislature declared such provisions void and unenforceable. She also alleged that after the fee-shifting ban went into effect, StemCells “double-downed” by further amending its bylaws to provide that if its fee-shifting provisions were found to be unenforceable, then a no-pay provision would go into effect.

Paul Fioravanti Jr., a director at Prickett, Jones & Elliott PA who is representing the plaintiff shareholder, told Bloomberg BNA in a May 3 e-mail that in light of the company's repeal of the bylaws, “we believe the claims in the action are now moot.”

StemCells representatives did not respond to a request for comment.

Delaware Fee-Shifting Ban

Last year, Delaware passed legislation that barred stock corporations from adopting fee-shifting bylaw and charter provisions (30 CCW 199, 7/1/15).

The push to invalidate “loser pays” bylaws was due in large part to the Delaware Supreme Court's May 2014 decision in ATP Tour Inc. v. Deutscher Tennis Bund, which found that fee-shifting provisions in the bylaws of a Delaware non-stock corporation can be enforceable (29 CCW 161, 5/21/14).

J. Robert Brown Jr., a University of Denver Sturm College of Law professor, told Bloomberg BNA in an e-mail that StemCells's no-pay bylaw probably was “a direct by-product” of the ATP ruling. Although fee-shifting bylaws are now prohibited under Delaware law, the underlying reasoning in ATP was not overturned, he said.

“As a result, there is still plenty of room for companies to try to adopt bylaws that affect a shareholder’s ability to bring an action against the company so long as they don’t violate the ban on fee-shifting,” Brown said.

Exclusive Forum Provisions

Claudia H. Allen, a Chicago-based partner and co-chair of the corporate governance practice at Katten Muchin Rosenman LLP, observed that StemCells's repealed provisions were aggressive. They would have effectively closed the courthouse doors to shareholder litigation, she told Bloomberg BNA. “When you stand back and look at it, you have to ask why somebody would have put in a fee-shifting provision and no-pay provision in light of what the Delaware Legislature did.”

Allen suggested that companies may be better served by adopting exclusive forum provisions in response to concerns over shareholder litigation. These clauses, which designate a jurisdiction in which to bring shareholder lawsuits against the company, have been upheld by state and federal courts, she said.

In the same bill that restricted fee-shifting, the Delaware Legislature endorsed Delaware exclusive forum selection clauses.

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

For More Information

The 8-K filing in which the company disclosed the removal of its bylaws is available at http://src.bna.com/eMY.

The investor's complaint is available at http://src.bna.com/eM0.