Delaware Courts Take Hard-Line Position Against Fee-Shifting Bylaws

Delaware Court of Chancery

Delaware corporations: beware. A recent ruling suggests that state courts will take a hard-line stance against fee-shifting provisions, no matter how creatively crafted.

In Solak v. Sarowitz, the Delaware Chancery Court Dec. 27 found cloud-based payroll-services provider Paylocity Holding Corp.'s fee-shifting bylaw facially invalid under state law.

The decision is the first to interpret amendments to the Delaware General Corporation Law—effective in August 2015—that prohibit bylaw and charter language allowing stock corporations to shift litigation expenses to shareholders that bring unsuccessful “intracorporate” claims, i.e., actions relating to a company’s internal affairs, such as board fiduciary duties.

Paylocity’s bylaw, adopted six months after the amendments went into effect, clothed itself as a forum-selection clause. It provided that Paylocity can recoup litigation expenses when shareholders file certain claims outside Delaware.

Chancellor Andre G. Bouchard concluded that Paylocity’s bylaw clearly violates the state statute by shifting litigation expenses to the shareholder, regardless of where the claim is filed.

Bouchard also cleared up some open questions. He ruled that:

  • Paylocity’s bylaw was unlawful despite a savings clause that made it enforceable to “the fullest extent permitted by law”; and
  • the action challenging the bylaw was ripe for review even though no stockholder had triggered Paylocity’s fee-shifting provision by bringing a case outside Delaware.

However, the court did find that Paylocity’s board didn’t breach its fiduciary duty by approving the bylaw.

What the ruling suggests is that stock corporations should remove such bylaws from their books. In the wake of the state prohibition, shareholders have sued over such clauses, and it seems that the Delaware courts are likely to come down on their side.