Delaware Supreme Court Endorses "Fee-Shifting" Bylaw in Certified Question of Law
May 12, 2014
On May 8, 2014, the Delaware Supreme Court provided an en banc answer to a certified question of law from the U.S. District Court for the District of Delaware captioned ATP Tour, Inc. v. Deutscher Tennis Bund, concluding that fee-shifting provisions in the bylaws of a Delaware corporation are facially valid under Delaware law and enforceable even against parties who joined the corporation before the bylaw was adopted.1 Although this opinion arose in the context of a non-stock corporation, as discussed below, the opinion is relevant to traditional stock corporations as well. Further, the court acknowledged that the bylaw would not necessarily be rendered unenforceable as an equitable matter if adopted with the "intent to deter litigation."
In the 1990s, entities operating professional men's tennis tournaments became members of ATP Tour, Inc. (ATP), a non-stock, Delaware membership corporation. In 2006, the board of directors of ATP amended the company's bylaws to adopt a fee-shifting provision applicable to intra-corporate disputes. The bylaw generally provided that if a current or former member initiated or asserted any claim or counterclaim against ATP, fellow members, or certain of their affiliates, and the member asserting the claim "does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought," then the member asserting the claim would be obligated to reimburse the fees, costs, and expenses incurred by ATP or other such parties defending against the claim.
Shortly thereafter, two members challenged a decision made by ATP, naming the company and six of its directors as defendants in the U.S. District Court for the District of Delaware. After the members lost their claims on the merits, ATP moved to recover its fees, costs, and expenses pursuant to the Federal Rules of Civil Procedure and the fee-shifting bylaw. After the U.S. Court of Appeals for the Third Circuit vacated the district court's initial order that had sidestepped Delaware corporate law issues, the district court certified questions of law to the Delaware Supreme Court regarding the validity and enforceability of a fee-shifting bylaw like ATP's.
The Delaware Supreme Court's Answers to Certified Questions
The en banc Delaware Supreme Court answered the certified questions as follows:
- The board of directors of a non-stock corporation may lawfully adopt a bylaw providing that, in intra-corporate disputes, plaintiffs who are not wholly successful will bear the litigation expenses of the corporation and related defendants. Such a bylaw is facially valid, as it is consistent with the provisions of the Delaware General Corporation Law (the DGCL).
- A fee-shifting bylaw could be drafted to require the plaintiff to bear the defendants' expenses (a) only if the plaintiff is wholly unsuccessful or (b) as in the ATP case, even if the plaintiff is partly successful. Either version of a fee-shifting bylaw would be facially valid under Delaware statute.
- However, the "enforceability of a facially valid bylaw may turn on the circumstances surrounding its adoption and use."2 If a fee-shifting bylaw was adopted for "an improper purpose," it would be unenforceable in equity, even if it is permissible by law.
- Fee-shifting bylaws can be adopted "midstream" and be enforced against pre-existing members of the corporation.3
The opinion arose in the context of a non-stock corporation. However, by focusing on the DGCL, case law addressing Delaware stock corporations, and the well-established theory that bylaws are a contract between a company and its investors, the analysis appears equally applicable to traditional Delaware stock corporations. Accordingly, it is certainly fair to assume that the court's answers would have come out similarly if the questions had been posed with a stock corporation in mind.
Because the procedural posture of this opinion was an answer to a certified question, the Delaware Supreme Court was not able to review the factual background in the same way that it would have if deciding an appeal of a state court decision.4 As a result, the decision does not contain much guidance as to what factors might prompt a Delaware court to conclude that a board of directors acted disloyally or for an "improper purpose" when adopting a fee-shifting bylaw. However, such issues are often decided on a case-by-case basis depending on the particular facts involved, and the court expressly noted that "[t]he intent to deter litigation . . . is not invariably an improper purpose."5
The practical effect of this decision, along with the Court of Chancery's earlier decision in Chevron (written by then-Chancellor and now Chief Justice Strine), is that many boards of directors of private and public Delaware corporations should seriously consider adopting fee-shifting bylaws of their own. There are a few gating issues to keep in mind:
First, by default, boards of directors do not have the power to amend corporate bylaws. That right must be granted to the board in the certificate of incorporation. However, stockholders always retain the power to amend the bylaws of a Delaware corporation, so companies must also consider the possibility that stockholders (with the support of proxy advisory firms) may try and adopt opposing bylaws.
Second, a board of directors considering adopting a fee-shifting bylaw should consider its intentions carefully. While the Delaware Supreme Court recognized that an "intent to deter litigation" might in certain cases be a proper purpose for the adoption of a fee-shifting bylaw, Delaware judges and plaintiffs' firms are often focused on directors' potential duty of loyalty breaches. This sort of bylaw will be less susceptible to successful challenge if adopted on a "clear day," when a board is not facing threatened or pending derivative litigation.6
Third, we strongly recommend that a board of directors considering adopting such a provision seek the advice of outside experts. Particularly because the ATP fee-shifting bylaw was written to operate in the context of a non-stock corporation and accordingly may not serve as a perfect model for stock corporations, outside legal counsel can assist in tailoring appropriate language. In addition, given the substantial risk that such a bylaw will be subject to challenge, at least initially, a board will want to have it carefully reviewed with counsel at the time it is being adopted. A board may also consult with underwriters, proxy advisory firms, investors, and experts familiar with agencies under which the company is regulated in order to gauge reactions before adopting this sort of provision. After Chevron and now ATP, a board of directors might view itself as having significant legal latitude to specify the rules of the game for intra-corporate litigation, but it should remember that these other interests may create practical limitations.
Fourth, directors should anticipate the possibility that even if adopted, a fee-shifting bylaw may not be honored in every circumstance. According to the factual history of the ATP case, the district court initially rejected ATP's fee-shifting motion after holding that "federal law preempts the enforcement of fee-shifting agreements when antitrust claims are involved."7 On appeal, the Third Circuit found that the district court first should have determined whether the bylaw was permissible under Delaware law before addressing federal law preemption issues.8 This does not mean, however, that the district court will necessarily change its ruling on federal preemption after receiving this answer from the Delaware Supreme Court.
Finally, and consistent with the district court's first opinion, there may be other states that have different rules regarding fee shifting. In the event that a court might apply non-Delaware law in interpreting or enforcing a fee-shifting bylaw,9 it would be important to fully understand the other potential legal and practical ramifications implicated by a decision to adopt the bylaw, including, for example, the possibility that non-Delaware law might include rules requiring that any fee-shifting provision be interpreted as bilateral even if written to apply to one party.
For more information about this certified question or any related matter, please contact William Chandler, David Berger, Katherine Henderson, Steven Guggenheim, Amy Simmerman, Tamika Montgomery-Reeves, or any member of Wilson Sonsini Goodrich & Rosati's corporate law and governance practice.