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By Michael Greene
March 24 — Last month, the Delaware State Bar's Corporation Law Council proposed several potentially significant amendments to the Delaware General Corporation Law, seeking to strike a balance between curbing abusive litigation tactics and protecting the fundamental right of stockholders to file lawsuits.
The most controversial proposal included in the March 6 package was an amendment that would invalidate fee-shifting bylaws and charters that allow stock corporations to recoup litigation expenses from unsuccessful plaintiffs. Like the Delaware Supreme Court case that provoked it, ATP Tour Inc. v. Deutscher Tennis Bund, the proposal has drawn both strong praise and criticism.
According to practitioners and academics interviewed by Bloomberg BNA, the debate about whether fee-shifting provisions should be enforceable turns upon many issues, including what is a permissible method for companies to address abusive litigation, what do stockholders implicitly agree to when they purchase their shares and whether attorneys are inherently biased in seeking to ban these types of provisions.
Fee-shifting bylaws have been a topic of controversy since the Delaware Supreme Court's May 2014 ATP Tour opinion.
In that decision, responding to a certified question, the state's high court found that a fee-shifting provision in the bylaws of a Delaware non-stock corporation could be enforceable.
Since ATP Tour, both plaintiffs' firms and academics have raised concerns over whether such provisions would effectively deter all stockholder litigation. That debate has been fueled by almost 40 companies enacting provisions by early 2015, according to research by Claudia H. Allen, a partner and co-chair of the Corporate Governance practice at Katten Muchin Rosenman LLP.
However, the facial validity of a fee-shifting provision has not yet been tested by a Delaware court. In March, in Strougo v. Hollander, the chancery court sidestepped the general validity issue and found a fee-shifting bylaw unenforceable based on the timing of its enactment.
According to Allen, part of the reason the ATP Tour decision has received such intense attention is the general view that all fee-shifting provisions are as aggressive as the bylaw in that case.
Allen noted that even though fee-shifting provisions can take milder forms, in the wake of ATP, some corporations began adopting similar one-way provisions that require a plaintiff to be substantially successful on all of its claims to avoid fee-shifting.
These type of aggressive fee-shifting provisions can create an unachievable standard for plaintiffs to meet, said Allen, echoing the primary concern of many critics.
The council addressed this criticism in its legislative proposal. According to an explanation accompanying the proposal, the council states that “virtually no lawsuits of any type substantially achieve in substance and amount the full remedy sought as the ATP bylaw contemplates. If fee shifting on such a broad basis is possible, even successful litigations could result in plaintiffs having to reimburse opponents’ attorneys’ fees.”
These types of fee-shifting provisions do more than just eliminate frivolous litigation, said Allen, adding that in this most aggressive form, “the solution is worse” than what the bylaws are designed to address because they effectively “close the courthouse doors to many plaintiffs.”
Although the council's proposal would strip many Delaware corporations of the ability to adopt “loser pay” provisions, the proposed legislation also included other amendments aimed at providing relief to corporations that believe they have been victimized by abusive litigation, such as amendments that would validate Delaware exclusive forum selection provisions and address concerns that the state's appraisal statute is being abused.
There are many potential ways for corporations to deal with frivolous litigation, Allen said, adding that even though the proposed endorsement of exclusive forum bylaws may not have been necessary because courts have consistently upheld these provisions, its inclusion in the proposed legislation may been part of a compromise.
It appears that the bar may have struggled with the issues of how far a board-adopted bylaw can go and the limits of stockholder implied consent in bylaw contracts, Allen said.
Members of the council, as well as corporate practitioners, acknowledged and discussed these concerns during a recent Fordham University event.
Given these concerns, Allen said the council's proposal is a good start. She added that empirical research is emerging that shows a correlation between a decline in multi-forum litigation and the advent of exclusive forum provisions, so the preliminary conclusion is that these provisions are going to be effective.
There never is going to be a perfect solution to deterring frivolous litigation, but exclusive forum bylaws are a more measured response, she said. “They don't close the courthouse doors, they don't affect whether you can sue or the remedies you can seek. They only say where you can sue and their enforceability can be tested by a foreign court.”
Nonetheless, the council's proposals are already facing strong criticism from the business community.
“[The] proposal does precious little to solve the broadly-recognized problem of abusive mergers and acquisitions litigation, while taking away the fee-shifting approach some companies have used to combat it,” Lisa A. Rickard, president of the U.S. Chamber Institute for Legal Reform, said in a statement e-mailed to BBNA.
Stephen M. Bainbridge, a professor at the University of California at Los Angeles School of Law, has also questioned whether “loser pays” provisions have the effect of immunizing executives and directors from shareholder lawsuits.
“Fee shifting bylaws and charters are not intended to prevent meritorious litigation,” he said in statement e-mailed to BBNA. “They are intended to deter meritless litigation that serves only to enrich plaintiff lawyers.”
According to a Feb. 25 report by Cornerstone Research, stockholders challenged 93 percent of M&A deals valued at more than $100 million in 2014.
“There simply is no possibility that fraud or breaches of fiduciary duty are present in 90% of M&A deals,” said Bainbridge, adding that the prevalence of meritless litigation has had an indisputable negative impact on the U.S. economy.
In addition to concerns about the proposed bill's effectiveness, critics have also questioned the Delaware Bar's motivation for seeking the proposal.
“The Bar proposal is an incredibly pro-litigation bill. Fee shifting is a powerful tool that could potentially deter a substantial number of meritless lawsuits,” Bainbridge said.
However, the council's explanation accompanying the proposal claims that this argument “does not address the substance or merits of the issues; it is simply an assertion that whatever the Council does or does not recommend in relation to stockholder litigation is inherently tainted.”
According to Bainbridge the other proposed amendments also do little to deter meritless litigation.
“Meanwhile, the bill merely slaps a band-aid on the plague of appraisal arbitrage litigation. If the Bar had been serious about dealing with the rash of appraisal lawsuits, they would have proposed banning appraisal claims by anyone who bought shares after public announcement of the transaction.”
Moreover, he said that the bill is not only favorable to plaintiffs' attorneys.
“It is a pro-lawyer bill. After all, fewer lawsuits mean less work for defense litigators too. Both sides of the litigation bar thus have a strong interest in banning fee shifting bylaws. Widespread adoption of fee shifting bylaws could also adversely affect transactional lawyers. Litigation risk is a major driver in the level of advisory work. All corporate lawyers—litigators and transactional—have a strong incentive to oppose fee shifting bylaws,” he said.
“And that's why this bill will do nothing—nada, zip, zilch—to deter frivolous litigation.”
The Delaware Bar is expected to consider the fee-shifting and forum selection proposals at a section meeting to be scheduled early this month.
Questions also have been raised concerning the effect the council's proposal could have on federal securities litigation.
“I don't think anybody really knows where this piece of legislation will come out because it is rather unique and it is not on a glide path to enactment,” said Allen.
John C. “Jack” Coffee, Jr., a professor at Columbia Law School and director of the school's Center on Corporate Governance, in a recent article posited that the new legislation may not preclude boards from unilaterally adopting fee-shifting bylaws in some contexts.
According to Coffee, because the proposal only bars fee-shifting bylaws and charters “in connection with an intracorporate claim,” the new legislation could be read not to apply to certain types of federal securities class actions.
Given these concerns, Coffee's article also addressed whether federal securities law could play a role in preempting fee-shifting—a concern he's raised before.
During a March 19 speech, Securities and Exchange Commission Chair Mary Jo White March warned companies not to take measures that could stifle investors' ability to hold management accountable, commenting on fee-shifting bylaws in particular.
“If the Commission comes to believe that these provisions improperly hinder shareholders' exercise of their rights, it may need to weigh in more directly,” White said in prepared remarks at Tulane University Law School.
If the SEC decides to act, it could consider declining to accelerate registration statements for companies that have fee-shifting bylaws, which is an option that Coffee has proposed, among others.
SEC action in this area would add to the perennial tension about who is best positioned to enforce the corporate/securities laws in Delaware—the federal government or Delaware—and how much each side should influence, or intersect with, the other.
During the University of Delaware's Corporate Governance Symposium last month, Jon Lukomnik, executive director of the Investor Responsibility Research Center Institute, noted that this tension is often created because federal securities laws, which are designed to regulate the trading markets, are being used for stewardship issues that fall under state law.
To contact the reporter on this story: Michael Greene in Washington at firstname.lastname@example.org
To contact the editor responsible for this story: Ryan Tuck at email@example.com
The fee-shifting and forum selection proposal is available at http://op.bna.com/car.nsf/r?Open=mgre-9ufsfe.
The proposed appraisal amendments are available at http://op.bna.com/car.nsf/r?Open=mgre-9ufsbs.
The council's explanation of its fee-shifting and forum selection proposal is available at http://op.bna.com/car.nsf/r?Open=mgre-9ufsdb.
A summary of the proposed appraisal amendment is available at http://op.bna.com/car.nsf/r?Open=mgre-9ufseh.
The FAQs are available at http://op.bna.com/car.nsf/r?Open=mgre-9ufs9w.
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