Plaintiff Files Opening Brief In Delaware Fee-Shifting Bylaw Test Case

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By Michael Greene

Dec. 26 — The plaintiff in the closely watched first test case of Delaware's conceptual endorsement of fee-shifting bylaws filed his initial brief Dec. 24, seeking to render the fee-shifting bylaw at issue inapplicable to him and the putative class involved in the underlying lawsuit.

During a Nov. 25 teleconference, Chancellor Andre G. Bouchard agreed to a proposed trifurcation that would resolve the more-nuanced issue regarding the timing of the defendant's “loser-pays” bylaw—enacted after the Delaware Supreme Court's controversial ATP Tour opinion—before any other issues in the case.

The plaintiff claims that because his ownership in the defendant was extinguished before the bylaw was unilaterally adopted, it would be inconsistent with Delaware corporate and contract law, as well as public policy, to enforce such a provision against him and the putative class.

The defendant's brief is due Jan. 30.

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 derivative lawsuit.

As a result of the reverse stock split at issue, the plaintiff and every other member of the putative class had their stock ownership in First Aviation extinguished four days before the fee-shifting bylaw was adopted.

The plaintiff claims this fact is dispositive in determining whether the bylaw is applicable to him because “Delaware Courts have interpreted bylaws to operate as contracts between a corporation and its stockholders.” Accordingly, “a party cannot unilaterally amend a contract and affect the rights of an individual who is no longer a party to that contract,” the plaintiff argues in his brief.

He adds: “While on its face the Bylaw purports to apply retroactively to former stockholders, Delaware contract law clearly controverts the validity of such a provision.”

Stockholder Protections

The plaintiff additionally claims in his brief that there are public policy concerns with applying a fee-shifting bylaw to former stockholders because it “effectively divests those stockholders of their power to amend or repeal the bylaw,” adding that “[u]nilaterally amended bylaws that purport to bind former stockholders rob stockholders of all the protections ordinarily enjoyed by stockholders in connection with board-adopted bylaws.”

Gustavo F. Bruckner, Pomerantz LLP, New York, who is representing the plaintiff, said in a Nov. 29 statement e-mailed to Bloomberg BNA that “it would be unconscionable to bind a former stockholder to a fee shifting bylaw adopted after the stockholder no longer held any equity interest. That cannot be the law in Delaware or anywhere in the United States.”

He added, “[t]o do otherwise would wreak havoc on the capital markets as it would require stockholders to escrow in perpetuity the proceeds of any stock sale should they be held liable at some unknown date in the future.”

‘ATP Tour.'

Fee-shifting bylaws have proven a lightning rod for controversy in the corporate community, as dozens of companies have enacted similar bylaws to First Aviation's after the Delaware Supreme Court in May, in ATP Tour Inc. v. Deutscher Tennis Bund, found that fee-shifting provisions in the bylaws of a Delaware non-stock corporation can be enforceable.

Since the Delaware Supreme Court's decision, both plaintiffs' firms and academics have raised concerns regarding the impact of such bylaws, and Sen. Richard Blumenthal (D-Conn.) has asked the Securities and Exchange Commission to take action.

Recently, proxy adviser Institutional Shareholder Services, Inc. updated its benchmark voting policies to include a general policy to “vote against bylaws that mandate fee-shifting whenever plaintiffs are not completely successful on the merits (i.e., in cases where the plaintiffs are partially successful)” 

In a Dec. 3 letter to Delaware Gov. Jack Markell (D,) the National Conference of Public Employees Retirement Systems (NCPERS) and eight labor unions expressed their opposition to these types of bylaws. That request came just a week after the Council of Institutional Investors sent a letter asking the Delaware State Bar to formulate and recommend a proposal to the Delaware General Assembly that would either overturn or narrow ATP Tour .

After a bill last session stalled in response to business concerns, the Delaware General Assembly is scheduled to take up a bill in January that would prohibit all “loser pays” bylaws. 

Meanwhile, the Oklahoma legislature adopted a bill, which went into effect Nov. 1, that mandates fee-shifting in derivative lawsuits.

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 plaintiff's brief is available at http://www.bloomberglaw.com/public/document/CONF_ORD_ON_DISC_Strougo_Robert_vs_Aaron_P_Hollander_Docket_No_97/6.