Delaware Supreme Court Holds Fee-Shifting Provisions in Bylaws Facially Valid

06/16/2014

Many entities choose to incorporate in Delaware as a result of the abundance of case law on corporate matters and the willingness and ability of the Delaware legislature to adapt to changing times. The ATP decision is a recent example of the Delaware courts and legislature in considering corporate governance changes in response to stockholder litigation.

ATP Decision

In ATP Tour, Inc. v. Deutscher Tennis Bund, No. 534, 2013 (Del. May 9, 2014), the Delaware Supreme Court held that fee-shifting provisions contained in a non-stock corporation’s bylaws that required the losing party of intra-corporate litigation to pay both parties’ legal fees, were facially valid. The decision allows a Delaware non-stock corporation to draft around the traditional “American Rule,” which is the prevailing policy throughout the United States for determining whether a losing party is responsible for another party’s court costs and attorneys’ fees. The “American Rule” requires each party to a lawsuit, regardless of whether winner or loser, plaintiff or defendant, to pay its respective court costs and attorneys’ fees. Fee-shifting provisions similar to the one at issue in the litigation have historically not garnered widespread adoption in corporate bylaws.

ATP Tour, Inc. (“ATP”) is a Delaware non-stock membership corporation that operates professional men’s tennis tournaments. Deutscher Tennis Bund, a German tennis federation, is the host of an ATP tournament that filed a lawsuit alleging antitrust violations and breach of fiduciary duty that challenged ATP’s decision to change the date and the significance of the tennis tournament that Deutscher hosted. Following a ruling by the federal court in favor of ATP, ATP pointed to its bylaws to seek recovery of its court costs and attorneys’ fees incurred in defending itself in the litigation. Specifically, ATP cited Article 23 of their bylaws, which stated in part that “[i]n the event … the Claiming Party does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then each Claiming Party shall be obligated jointly and severally to reimburse the League and any such member or Owner for all fees, costs, and expenses of every kind and description.” The federal court certified the question for the Delaware Supreme Court’s consideration of whether the board of a Delaware non-stock corporation can lawfully adopt such a provision.

After examining relevant statutes and previous court precedent, the Delaware Supreme Court determined that a fee-shifting bylaw, like the one at issue in the litigation, is facially valid under Delaware law when authorized by the Delaware General Corporation Law (the “DGCL”) and consistent with a corporation’s certificate of incorporation and the enactment is not otherwise prohibited. The court spent significant time discussing the importance of the circumstances surrounding the adoption of such a provision when examining the legality of corporate bylaws. Specifically, the court noted that “[b]ylaws that may otherwise be facially valid will not be enforced if adopted or used for an inequitable purpose.” Depending upon whether proposed amendments to the DGCL are adopted, the ATP decision might lay the foundation for the future adoption and enforcement of similar fee-shifting provisions.

Related Case

The ATP decision is even more informative when considered within the context of additional recent Delaware court rulings. In a decision by the Chancery Court of Delaware, Boilermakers Local 154 Retirement Fund v. Chevron, 72 A.3d 934 (Del. Ch. 2013), the Chancery Court addressed the question of whether or not forum selection provisions contained in corporate bylaws are legally valid. The litigation in Boilermakers centered around Section 109(b) of the DGCL which reads, in relevant part, that the bylaws of a corporation “may contain any provision … relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.” The question for the Chancery Court was whether or not forum selection clauses contained in corporate bylaws relate to the “business of the corporation, the conduct of its affairs, or rights of the stockholders.” The court held that forum selection provisions indeed relate to the “rights” of shareholders and therefore do not fall outside the scope of Section 109(b). When taken together ATP and Boilermakers send a message of caution to shareholders seeking to file suit against a Delaware corporation.

Response of the Delaware Legislature

In response to the ATP decision, proposed amendments to the DGCL have been introduced in the Delaware legislature to prohibit the adoption of a fee-shifting provision in a Delaware stock corporation’s charter or bylaws. Under the proposed amendments, Section 102(b)(6) would be amended to only allow personal liability to be imposed on stockholders for the debts of a corporation based solely on their stock ownership (and not based on any other status or action of the stockholder). In addition, a new Section 331 is being proposed to expressly state that provisions in a Delaware corporation’s charter or bylaws may not impose monetary liability on any stockholder of a corporation, except in the limited circumstances already provided for in the DGCL. The effect of the proposed amendments would be to limit the applicability of the ATP decision to only non-stock corporations and to clarify that, subject to limited exceptions in the DGCL, charter and bylaw provisions may not be used to impose monetary liability on stockholders of Delaware stock corporations.

Effects Going Forward

If the proposed amendments to the DGCL are not adopted, there is thought that the ATP decision, in conjunction with the Boilermakers decision, will have an effect beyond just non-stock corporations. This sentiment comes from taking a deeper dive into the court’s analysis and support for the decision in ATP. Most significantly, the unanimous opinion by the court cites sections of the DGCL that apply equally to both stock and non-stock corporations alike. Further, the Delaware Supreme Court also considered common law, stating that “no principle of common law prohibits directors from enacting fee-shifting bylaws.” With such broad language that applies beyond non-stock corporations, this ruling may soon influence decisions with respect to stock corporations.

The ATP decision also addressed the enforceability of fee-shifting provisions against all members or only members that joined non-stock corporations after the adoption of such fee-shifting provisions. The court stated that if the provision is otherwise valid and enforceable, as a statutory matter the answer is that such provisions can also be enforced against all members that joined prior to their adoption. Lastly, as mentioned above, the court spent significant time discussing the importance of the nature and manner in which bylaws were adopted and the impetus behind the adoption of new bylaws when the court is deciding the validity of new bylaws.

Because the DGCL might be amended in the near future to limit the applicability of the ATP decision to only non-stock corporations, Delaware corporations might want to consider waiting to adopt a fee-shifting bylaw, instead of adopting a provision that could subsequently be rendered invalid. In addition, future rulings should provide additional guidance on the enforceability of similar fee-shifting provisions to all Delaware corporations. If the proposed amendments are not ultimately enacted into law, Delaware corporations and directors and executive officers of such corporations should carefully consider adopting fee-shifting and forum selection bylaws.

Beyond the specific impact of the ATP decision on fee-shifting bylaws, the case may result in the adoption of additional types of bylaws to deter stockholder litigation and other issues faced by Delaware corporations. Any of these bylaws would be subject to review by the Delaware courts and may lead to future changes in Delaware law.

For additional information regarding the ATP decision, please contact one of the attorneys listed below:

Brian D. Barnard
817.347.6605
brian.barnard@haynesboone.com

William R. Hays, III
214.651.5561
bill.hays@haynesboone.co

William B. Nelson
713.547.2084
bill.nelson@haynesboone.com

Janice V. Sharry
214.651.5562
janice.sharry@haynesboone.com

W. Scott Wallace
214.651.5587
scott.wallace@haynesboone.com

Jennifer T. Wisinski
214.651.5330
jennifer.wisinski@haynesboone.com

Gregory R. Samuel
214.651.5645
greg.samuel@haynesboone.com

Ricardo Garcia-Moreno
713.547.2208
ricardo.garcia-moreno@haynesboone.com

Michael E. Dill
214.651.5210
michael.dill@haynesboone.com

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