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By Michael Greene
March 16 — In a closely watched case, the Delaware Chancery Court March 16 held that a fee-shifting bylaw was unenforceable because it was adopted after the challenging shareholders' ownership interests were eliminated.
Chancellor Andre G. Bouchard found that the plaintiff and the putative class could not be bound by the fee-shifting bylaw because they were cashed out of the company before the bylaw was adopted.
“In sum, the Bylaw does not apply here because the Bylaw was adopted after Plaintiff’s equity interest in the Company was eliminated,” Bouchard wrote, basing his decision on contract law and § 109(b) of the Delaware General Corporation Law.
Bouchard did not address the more controversial issue presented by the case: the validity of the fee-shifting bylaw in light of the Delaware Supreme Court's divisive ATP Tour Inc. v. Deutscher Tennis Bund decision because the plaintiff's motion only focused on the timing of the bylaw’s adoption.
In a statement e-mailed to Bloomberg BNA, the defendant's attorney, Francis G.X. Pileggi, Eckert Seamans Cherin & Mellott, LLC, Wilmington, Del., pointed out that “the court did not rule on the underlying merits of the case and only decided the very narrow issue of the applicability of a bylaw amendment adopted after the date the plaintiff's stock was sold.”
The plaintiff minority stockholder filed a lawsuit against First Aviation Services Inc. and its board of directors alleging a breach of fiduciary duty in connection with a reverse stock split.
The plaintiff's amended complaint also included a challenge to a fee-shifting bylaw that would allow the corporation to recoup litigation expenses from unsuccessful plaintiffs.
Late last year, Chancellor Bouchard agreed to a proposed trifurcation that would resolve the more-nuanced issue regarding the timing of the defendant's “loser-pays” bylaw before any other issues in the case.
Chancellor Bouchard found that the bylaw did not apply to the plaintiff for two related reasons: “the Board adopted the Bylaw after Plaintiff’s interest in the Company was eliminated in the Reverse Stock Split; and (ii) Delaware law does not authorize a bylaw that regulates the rights or powers of former stockholders who were no longer stockholders when the bylaw was adopted.”
Although Chancellor Bouchard declined to address whether the bylaw was facially valid under Delaware law, he noted that because of the dollar value of the plaintiffs' claims, this case addressed some of the serious policy concerns over whether the bylaw deprived stockholders of the right to sue.
“As a practical matter, therefore, applying the Bylaw in this case would have the effect of immunizing the Reverse Stock Split from judicial review because, in my view, no rational stockholder—and no rational plaintiff’s lawyer—would risk having to pay the Defendants’ uncapped attorneys’ fees to vindicate the rights of the Company’s minority stockholders, even though the Reverse Stock Split appears to be precisely the type of transaction that should be subject to Delaware’s most exacting standard of review to protect against fiduciary misconduct.”
“This reality demonstrates the serious policy questions implicated by fee-shifting bylaws in general, including whether it would be statutorily permissible and/or equitable to adopt bylaws that functionally deprive stockholders of an important right: the right to sue to vindicate their interests as stockholders,” Bouchard opined.
Critics of fee-shifting bylaws argue that they may excessively chill shareholder litigation (13 CARE 262, 2/6/15).
The plaintiff’s counsel, Gustavo F. Bruckner, Pomerantz LLP, New York, in a statement e-mailed to BBNA said: “It is baffling that Defendants even attempted to enforce the bylaw against Plaintiff who was no longer a stockholder when the bylaw was adopted, but it just goes to show you the tremendous pressure being exerted to limit shareholder rights. Had Defendants succeeded in their quest to bind former stockholders to bylaws adopted after their interests were extinguished, the ramifications would have been far-reaching and disastrous.”
Responding to a certified question in May 2014, the Delaware Supreme Court in ATP Tour found that fee-shifting provisions in the bylaws of a Delaware non-stock corporation can be enforceable.
Since the decision, fee-shifting bylaws have proven to be a lightning rod for controversy in the corporate community as almost 40 companies have enacted them, according to research by Claudia H. Allen, a partner and co-chair of the Corporate Governance practice at Katten Muchin Rosenman LLP.
Earlier this month, the Delaware State Bar's Corporation Law Council proposed long-expected legislation to restrict the ability of stock corporations to adopt fee-shifting bylaws.
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The opinion is available at http://www.bloomberglaw.com/public/document/CONF_ORD_ON_DISC_Strougo_Robert_vs_Aaron_P_Hollander_Docket_No_97/9.
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