In Fee-Shifting Test Case, Defendants Say Loss Would ‘Wreak Havoc'

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By Michael Greene

Feb. 2 — The defendants in an ongoing Delaware Chancery Court lawsuit argue that a unilaterally adopted fee-shifting bylaw is applicable to stockholders such as the plaintiff, who had their ownership extinguished before the bylaw was enacted.

“A contrary result would wreak havoc in mixed derivative and direct suits,” the defendants wrote in their Jan. 30 response brief in support of upholding the challenged bylaw.

In what could be the first test case of the Delaware Supreme Court's conceptual endorsement of fee-shifting bylaws, Chancellor Andre G. Bouchard agreed late last year to trifurcate the case in a manner that would first resolve the plaintiff's more-nuanced arguments regarding the timing of the “loser-pays” bylaw. 

Dec. 24, the plaintiff filed an opening brief claiming that because his ownership in the company was extinguished before the bylaw was adopted, it would be inconsistent with Delaware law and public policy to enforce the provision against him and the putative class.

The defendants, however, assert that Delaware law does not support this position, further arguing that if the court accepts the plaintiff's argument, it could result in a scenario where one version of a company's bylaws applies to direct claims and another version applies to derivative claims.

Extinguished Ownership

In the underlying case, the plaintiff minority stockholder filed a Sept. 24 amended complaint against First Aviation Services, Inc. and its board of directors alleging a breach of fiduciary duty in connection with a reverse stock split.

The amended complaint included a challenge to a bylaw that would allow First Aviation to recoup litigation expenses from the plaintiff if he is unsuccessful in his lawsuit. 

The plaintiff claims that the bylaw is not applicable to him because the reverse stock split caused he and the putative class to lose their stock ownership four days before the bylaw was adopted.

‘Vested Rights Doctrine.'

The defendants argue in their Jan. 30 brief that the plaintiff is attempting to “resurrect the long-rejected ‘vested rights doctrine.'”

They claim that Delaware courts have repeatedly rejected the plaintiff's position.

Moreover, they argue that plaintiff is attempting to have it both ways: “On the one hand, he is attempting to assert rights as a stockholder, yet, on the other hand, he does not want to be bound by the bylaws the same way all other stockholders are bound,” their brief states.

The brief further claims that several recent Delaware decisions, including United Technologies. Corp. v. Treppel and City of Providence v. First Citizens BancShares Inc., have affirmed a company's right to amend its bylaws and apply them to stockholders even where doing so may impact pre-amendment conduct

‘ATP Tour.'

Responding to a certified question in May in ATP Tour Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court found that fee-shifting provisions in the bylaws of a Delaware non-stock corporation, which would allow the company to recoup litigation expenses from unsuccessful plaintiffs, can be enforceable. 

Fee-shifting bylaws have proven to be a lightning rod for controversy in the corporate community, and since ATP Tour, 39 domestic corporations, have adopted similar types of bylaws.

Among those that have raised concerns about the impact of such bylaws include plaintiffs' firms, academics, labor unions, the Council of Institutional Investors, proxy advisory firms and Sen. Richard Blumenthal (D-Conn.).

After a bill stalled last year, the Delaware General Assembly is expected to act in May or June to possibly restrict the use of such bylaws.

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

To contact the editor responsible for this story: Ryan Tuck at rtuck@bna.com

The defendant's brief is available at http://www.bloomberglaw.com/public/document/CONF_ORD_ON_DISC_Strougo_Robert_vs_Aaron_P_Hollander_Docket_No_97/7.