Delaware Enacts Legislation to Ban Fee Shifting and Enforce Delaware Forum Selection

7/2/2015 - In a major win for investors in public companies incorporated in Delaware, the Delaware General Assembly recently enacted a bill to ban fee-shifting provisions in Delaware corporation bylaws and charters.   The legislation, signed into law on June 24, 2015 by Governor Jack Markell and effective August 1, 2015, amends the Delaware General Corporation Law (the “DGCL”) and prohibits a Delaware corporation’s bylaws or certificate of incorporation from shifting legal fees to unsuccessful stockholders who sue a corporation or its directors or officers.  As a result of the legislation, neither boards of public companies nor company stockholders may vote to adopt such provisions in charters or bylaws and the threat of fee-shifting provisions will no longer deter stockholders from bringing stockholder litigation against Delaware corporations involving mergers, acquisitions and corporate governance.  Institutional investors interested in corporate governance issues who often serve as corporate watchdogs will benefit from this legislation because it allows concerned investors to ensure that board members and executives fulfill their fiduciary duties to the companies they are managing and to their shareholders without the threat of a loser-pays system.

Specifically, the new DGCL provision, 8 Del. Ch. § 102(f), invalidates any language in a Delaware corporation’s certificate of incorporation that purports to impose liability upon a stockholder for the corporation’s attorneys’ fees or expenses in connection with an “internal corporate claim.”  Also, 8 Del. Ch. § 102(b) was amended to invalidate the same provisions in a corporation’s bylaws.  Delaware law now defines “internal corporate claims” as including:

claims in the right of the corporation [that is, derivative claims], (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery. 

These claims are “claims arising under the DGCL, including claims of breach of fiduciary duty by current or former directors or officers or controlling stockholders of the corporation, or persons who aid and abet such a breach.”  8 Del. C. § 115.  The amendments further provide that corporate charters and bylaws cannot prevent shareholders and others from asserting “internal corporate claims” in Delaware courts (including federal courts), although Delaware corporations are permitted to limit where such “internal corporate claims” may be asserted. 

The amendments to the DGCL were initially proposed in response to the Delaware Supreme Court’s 2014 ruling in ATP Tour, Inc. v. Deutscher Tennis Bund, where the Court upheld the facial validity of a non-stock corporation’s bylaw provision shifting attorneys’ fees and costs to unsuccessful plaintiffs.  Nothing in the ATP Tour holding limited its application to non-stock corporations, and the ruling appeared to allow all Delaware corporations (stock and non-stock) to adopt fee-shifting bylaws.  Indeed, in the 12 months following the ATP Tour decision, over 75 stock corporations adopted fee-shifting provisions. 

At the same time, numerous so-called “litigation reform” advocates encouraged the adoption of fee-shifting bylaws as a way for corporations to ward off stockholder litigation. Shareholder advocates, including many institutional investors, were concerned that these new bylaw provisions would chill stockholder litigation and deter meritorious lawsuits.  On May 22, 2014, the Delaware Corporate Law Council proposed an amendment to the DGCL, which was presented to the Delaware General Assembly in late June 2014, to limit the Supreme Court’s ATP Tour ruling to non-stock corporations. Institutional investors launched an effort to support such legislation to prevent fee-shifting bylaws, while certain business groups opposed the proposed bill.  After hearings on the proposed legislation and a delay of nearly a year, the legislation passed in both houses and was signed into law by Governor Markell.  

While the amendments do not address specifically whether the fee-shifting prohibition applies retroactively, most commentators have argued in favor of retroactive application.  Commentators have noted that many of the companies that amended their bylaws to include fee shifting provisions likely will again amend their bylaws to avoid potential challenges to their bylaws.

Another issue commentators have raised is whether the fee-shifting prohibition also applies to securities fraud claims, as the new legislation’s explicit focus is on corporate governance matters such as derivative suits and proxy contests.  Lawrence A. Hamermesh, a professor of corporate and business law, and Norman M. Monhait, a Delaware practitioner, members of the Council of the Corporation Law Section of the Delaware State Bar Association, which was responsible for drafting the legislation, concluded, in an article titled “Fee-Shifting Bylaws: A Study in Federalism,” that the new amendments do not address the validity of a fee-shifting bylaw or charter provision for federal securities claims.  They argue such claims are not covered by the fee-shifting ban in the amendments to the DGCL because the DGCL does not “confer[] jurisdiction upon the Court of Chancery” to hear such claims and such claims do not fall within the definition of “internal corporate claims.”  However, they argue that nothing in Delaware law would authorize a corporation to include fee-shifting provisions for claims under the federal securities laws in its charter or bylaws.  The issue will likely be resolved through litigation. 

Despite these uncertainties, the new amendments are beneficial to stockholders of Delaware corporations.  Without the new legislation, fee-shifting provisions in corporate charters and bylaws would have created a significant impediment to meritorious stockholder actions and would have substantially curtailed Delaware stockholder litigation. Thus, the recent legislation will further the interests of stockholders of public companies by allowing those stockholders to continue protecting their interests and challenging apparent corporate mismanagement or breaches of fiduciary duties by officers and directors of public companies.