Pierce Atwood Business Counselor Q3 2014

Delaware Supreme Court Upholds Fee-Shifting By-Laws - Law Remains in Flux

By: Jamie Baker

Earlier this year, the Delaware Supreme Court held that a facially valid fee-shifting by-law may be enforceable if adopted by the appropriate corporate procedures and for a proper corporate purpose.  If this ruling is not effectively overruled by legislation, it provides a meaningful way for companies to reduce the cost of shareholder litigation, as a fee-shifting by-law may provide a corporation with the opportunity to recover expenses incurred in defending itself.

The dispute arose between the premiere professional men’s tennis tour, ATP Tour, Inc., a Delaware non-stock corporation, and two of its members, Deutscher Tennis Bund and Qatar Tennis Foundation, which own and operate a professional men’s tennis tournament.  Upon joining the ATP Tour in the early 1990s, the members agreed to be bound by the ATP Tour’s by-laws, as amended from time to time.  In 2006, the board of the ATP Tour amended the by-laws to provide that any member making a claim against the ATP Tour that does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought would be obligated to reimburse the ATP Tour for its litigation costs (also known as a “loser pays” provision). 

In 2007, the board of the ATP Tour voted to downgrade the tournaments owned and operated by the Deutscher Tennis Bund and the Qatar Tennis Foundation from the highest tier of tournaments to the second highest tier.  Those members subsequently filed suit in the United States District Court for the District of Delaware alleging both federal antitrust claims and Delaware fiduciary duty claims.  The members did not prevail on any of their claims and the ATP Tour, pursuant to the by-law provision enacted in 2006, moved to recover its legal fees, costs and expenses.  To resolve the matter, the District Court ultimately certified to the Delaware Supreme Court whether the board of a non-stock corporation could lawfully adopt a by-law provision shifting litigation costs to the losing party in disputes between the corporation and its members.

The Delaware Supreme Court concluded that properly enacted fee-shifting by-laws are facially valid and they are not prohibited by the Delaware General Corporation Law (the “DGCL”), any other Delaware statute or any common law principle.  However, the Delaware Supreme Court did not find that the specific fee-shifting by-law in question was enforceable, as such enforceability would depend on the manner in which it was adopted and the circumstances under which it was invoked.  The Court went on to discuss examples of impermissible by-laws intended to “obstruct legitimate efforts of dissident stockholders” and “clearly adopted for an inequitable purpose,” and permissible by-laws used to “avoid…disenfranchisement as a majority shareholder.”  Ultimately, the determination of whether, and to what extent, facially valid by-laws may be enforceable turns on the circumstances surrounding their adoption and use.  According to the Court, “[t]he intent to deter litigation, however, is not invariably an improper purpose.”

Almost immediately, the Delaware State Bar Association drafted an amendment to the DGCL precluding fee-shifting by-laws in the context of stock corporations.  The rationale behind the amendment is that despite claims of an excess of shareholder litigation, fee-shifting by-laws could effectively eliminate the ability of stockholders to bring even meritorious claims.  However, in June of this year, the Delaware Senate withdrew the bill, with a resolution urging the Delaware State Bar Association to continue examining the issue and to consider whether proposed legislation might be appropriate in 2015.  Thus, the principles outlined in ATP Tour remain in place, for now.

In light of the uncertainty regarding the ATP Tour decision, many practitioners have taken a “wait and see” approach.  While this may be a prudent course of action, we urge all boards of directors to consider whether amending their by-laws to include a fee-shifting provision may be appropriate as different considerations apply depending upon a company’s shareholder base and litigation risk profile.