As Kevin LaCroix notes, the Delaware Supreme Court recently ruled in favor of fee shifting bylaws:
In a May 9, 2014 opinion (here), the Court held in ATP Tour, Inc. v. Deutscher Tennis Bund that a by-law provision shifting attorneys’ fees and costs to unsuccessful plaintiffs in intra-corporate litigation can be valid and enforceable under Delaware law. A May 9, 2014 memorandum from the Paul Weiss law firm said the decision may “dramatically change the landscape of stockholder litigation.” ...
The Court first observed that there is no prohibition in Delaware’s statutes forbidding the enactment of a fee-shifting bylaw. The Court also noted that while Delaware generally follows the American Rule, pursuant to which each party to a lawsuit bears its own costs, Delaware also allow contracting parties to agree to modify the American Rule to obligate a losing party to pay a prevailing party’s fees. Because corporate by-laws are considered contracts among a corporation’s shareholders, a fee-shifting provision would fall within the contractual exception to the American Rule .Therefore, “a fee-shifting provision would not be prohibited under Delaware common law.”
Whether or not ATP’s fee-shifting by-law is enforceable, however, depends on the manner in which it was adopted and the circumstances under which it was invoked. Bylaws that are otherwise facially valid will not be enforced if adopted or used for inequitable purposes. ...
LaCroix goes on to explain in detail why the court concluded that the bylaw was not adopted for an inequitable purpose, even if that purpose was putting plaintiff lawyers out of business deterring frivolous litigation.
Naturally this seriously pissed off the sharks trial bar (both plaintiff and defendant trial lawyers, both of whose business would be adversely affected), so the bar ran to the Delaware legislature seeking to have the decision overturned by statute. Their flunkies faithful representatives in the Delaware Senate responded with SB 236, which would do so. Yesterday, the U.S. Chamber Institute for Legal Reform sent an open letter to the members of the Delaware legislature, urging them to oppose SB 236:
Abusive intra-corporate litigation has become an extremely serious problem that imposes very substantial and wholly unjustified costs upon shareholders in Delaware companies. For example, in the merger and acquisition context:
Just about every merger or acquisition involving a significant public company becomes a litigation target soon after the deal’s announcement – 94% of all deals valued at over $100 million were targets of lawsuits; compared to 44% in 2007.1 No one can seriously believe that every one of these transactions was legally flawed.
Multiple lawsuits filed by different law firms challenge each deal, an average of five in 2013.2 Lawsuits typically are filed in different States – 62% of the time in 2013. This multiplies the defense costs and increases the leverage to force settlements regardless of the merits.
The overwhelming majority of cases (more than 80%) settle, typically with a fig leaf of some additional, practically meaningless disclosure for shareholders accompanied by large fee awards for plaintiffs’ counsel.
Indeed, members of the Court of Chancery have commented on the abusive nature of some of these lawsuits.
A company’s shareholders suffer when one or both parties to a merger transaction are forced to expend millions of dollars defending suits in multiple courts and paying multiple attorneys’ fee awards in connection with settlements necessary to eliminate legal uncertainty and allow the transaction. Those expenditures reduce the funds available to integrate the two companies effectively, expand the business, or create new products, imposing a “merger tax” that benefits lawyers and hurts shareholders.
The Delaware Supreme Court’s ATP decision gives corporations a way to protect their shareholders against these costs of abusive litigation. The possibility of fee shifting will deter the filing of abusive, duplicative lawsuits.
I agree. Indeed, I recently argued that rational shareholders would support these sort of fee-shifting bylaws.
Why would the Legislature so quickly deprive shareholders of the opportunity to obtain that protection – overturning the decision of a Court that is widely respected as the leader in corporate law? Furthermore, why would it do so without providing an alternative deterrent to the abusive litigation that is a well-recognized problem?
Why indeed? The only plausible answer is so as to pay off lawyers. Which calls to mind Jonathan Macey and Geoffrey Miller's classic paper, Toward An Interest Group Theory of Delaware Corporate Law, which argues that "the rules that Delaware supplies often can be viewed as attempts to maximize revenues to the bar, and more particularly to an elite cadre of Wilmington lawyers who practice corporate law in the state."
Fortunately, most of the time, the Delaware bar's interests are consistent with efficient outcomes, which is why Delaware's dominance and the bar's influence is usually a good thing. But SB 236 is one of those exceptions that proves the rule.
So the Delaware legislature for once should bite the hands that feed it and nix SB 236. Let's let the market decide. After all, if the perspicacious Steven Davidoff is right, few public corporations will adopt these bylaws.