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By Yin Wilczek
March 27 — The March proposal by the Delaware State Bar's Corporation Law Council to restrict companies' ability to adopt fee-shifting bylaws strikes the “right balance,” an attorney argued March 26.
Motivated by the desire to “keep charters in Delaware,” the council sought to restore a system that works for both shareholders and corporations, according to Frederick Alexander, counsel at Morris, Nichols, Arsht & Tunnell LLP in Wilmington, Del., and author of Bloomberg BNA's portfolio on Delaware corporation law.
Alexander was one of three council members who defended the proposal at a lively panel held at Fordham University. He also suggested that shareholder litigation is the “only real regulator” in the director/management/stockholder relationship, and were the Delaware Legislature not act on fee-shifting provisions, some other regulator may step in.
While the system is “certainly imperfect” and improvements may be made, “it may be better than the alternative,” Alexander said.
The council members said they expressed their own views and did not speak for the council.
At a Council of Institutional Investors event March 30, Delaware Supreme Court Chief Justice Leo E. Strine Jr. shared his views on, and endorsed, the proposal.
Fee-shifting bylaws—which shift litigation expenses to the losing party—were thrust into the spotlight by the Delaware Supreme Court in ATP Tour Inc. v. Deutscher Tennis Bund. In the May 2014 ruling, the state high court found that fee-shifting provisions in the bylaws of a Delaware non-stock corporation can be enforceable.
Since the decision, about 40 companies have enacted fee-shifting bylaws, according to research by Claudia H. Allen, a partner and co-chair of the Corporate Governance practice at Katten Muchin Rosenman LLP.
Shareholders have criticized such provisions, arguing that they would significantly curtail investors' rights to enforce the nation's securities laws and hold corporations accountable for their actions.
In a recent speech, Securities and Exchange Commission Chairman Mary Jo White warned that the agency “may need to weigh in more directly” should it discover that such bylaws are hindering shareholder rights.
The council's proposal, if passed, would invalidate fee-shifting provisions in stock corporations only. It also would not prevent application of “losers pay” provisions included in stockholder agreements.
Among other criticisms of the proposal, panel moderator Sean Griffith, a Fordham law professor, argued that the council failed to cite any of the “dense literature” issued by academics on the effects of fee-shifting bylaws on settlement, filing and litigation practices. “It's deflating to academics who hope to have some effect on public policy,” Griffith quipped.
Andrew Pincus, a Washington-based Mayer Brown LLP partner who represents corporations, also charged that the proposal would eliminate a tool for addressing frivolous litigation. He argued that the current system under which shareholders file lawsuits challenging more than 90 percent of merger and acquisitions activity is “sick.”
“The council’s proposal takes away an instrument for dealing with that, but does nothing to provide an alternative way to deal with this very serious problem,” Pincus said. “It seems to me that this is something that Delaware should look at, and I don’t think with a bazooka, but it seems to me there is a pretty strong argument that some additional controls are needed to deal with these targeted abuses.”
In defending the proposal, council member Kurt Heyman, founding partner of Proctor Heyman Enerio LLP, Wilmington, Del., who represents investors, argued that ATP was wrongly decided based on Delaware precedent. Contrary to the Delaware Supreme Court's holding, bylaws are “not a contractual issue at all,” he said. Instead, Delaware “needs to be able to regulate its corporations” and such bylaws “are part of the regulatory scheme of the corporate law.”
For his part, council member Norman Monhait, a shareholder at Rosenthal, Monhait & Goddess PA in Wilmington, Del. who represents shareholders, asserted that the council sought to restore the status quo in the wake of the “earthquake” that was ATP.
“What is significant about fee-shifting as distinguished from every other mechanism that may be suggested to suppress shareholder litigation is that it precludes a method of private enforcement that really has been the only method of private enforcement of statutory fiduciary law for years,” Monhait said.
To Pincus' point about frivolous lawsuits, Monhait observed that the Delaware courts increasingly are balking at rubber stamping settlements—including disclosure-based deals in M&A litigation. “If the message comes” from the chancery court over time that if you bring frivolous cases “you’re going to get an investment of time and expense without any return,” that will discourage the filing of lawsuits that have no merit, he said.
Moreover, Mark Lebovitch, a partner at plaintiffs' firm Bernstein Litowitz Berger & Grossmann LLP in New York, warned that bylaws are a “dangerous weapon to give to directors.” He noted, for example, that hedge fund activist investors fear that bylaws will be used to target proxy fights.
Alexander noted that the council's report also alluded to the fact that if fee-shifting bylaws are restricted, companies may still be able to enact other types of bylaws to limit shareholder litigation. As an example, he cited a bylaw that would require shareholders to hold a certain amount of stock before they can bring a claim against the company. Should the legislation pass, “I think we will see some developments” on that front, he said.
Unlike fee-shifting bylaws, which could result in the virtual elimination of shareholder litigation, these other provisions can be challenged without the threat of having to pay the company's legal expenses, Alexander continued. So “the court can look at it,” Institutional Shareholder Services Inc. “can look at it, decide whether it’s reasonable, and as we are with proxy access, we may well get to an equilibrium that works well.”
ISS Managing Director Chris Cernich observed that while it may be satisfying to “stick it to the people that are abusing the system,” determining who is a loser with respect to a “loser pays” bylaw is “not nearly as easy as it should be.” He noted that from the provisions he has seen, a party—to escape that characterization—would have to substantially prevail on the merits or substantially obtain the damages sought.
According to a research note ISS recently sent to its clients, securities class action settlements over the past decade reached $83 billion, Cernich continued. In reviewing the 12 securities class action settlements during that time that were greater than $1 billion, ISS found that none of the actions would have satisfied both of those tests, not even the $7.2 billion Enron deal, he said.
“Frankly, not allowing fee-shifting is a lot better than [shareholders] putting at risk that $83 billion over the past decade and” what may come in the future, Cernich said.
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