As part of the annual update cycle for Delaware’s General Corporations Law (DGCL), the Delaware Bar has returned to last year’s controversy on fee-shifting provisions in bylaws and certificates of incorporation to propose, yet again, destroying the ability of Delaware corporations to, in their organizing documents, have the losing party in an intra-company (i.e. fiduciary duty) lawsuit pay the prevailing party’s legal fees.
The proposal is among several 2015 legislative changes to the DGCL proposed by the Council of the Corporation Law Section of the Delaware State Bar Association, which is the working-level body that, historically through consensus, creates changes to the DGCL.
In addition the Council has proposed:
- that the right to seek appraisal rights be limited to stockholders who own at least $1 million of stock or 1 percent of the disputed company
- that exclusive forum provisions be officially sanctioned, so long as the exclusive forum is the State of Delaware and
- a revised approach to having the Chancery Court supervise arbitration proceedings, in an attempt to work within the federal judiciary’s quashing of direct Chancery Court private adjudication of disputes in secret.
While one can question whether Delaware should allow another state’s courts to become the exclusive forum of a corporation for disputes centered on the DGCL, it is the renewed recommendation of outright proscription of the hotly debated fee-shifting bylaws that is the most controversial. Accordingly, while the other provisions are slated to be voted upon by the Delaware State Bar Association’s Corporation Law Section on March 13, the fee-shifting prohibition vote has been slated for a vote at an unspecified point in April.
In an unusual move, for the fee-shifting prohibition the Council not only released the actual proposed legislative language, but also has circulated both an “Explanatory Note” and an “FAQ” with respect to the proposed changes.
The Council argues that:
- “Because the consequences of any corporate decision affect investors only commensurately with the scope of their investments, few stockholders will rationally be able to accept the risk of exposure to millions of dollars in attorneys’ fees to attempt to rectify a perceived corporate wrong, no matter how egregious.”
- “Without stockholder-initiated litigation, there would be essentially no effective enforcement mechanism for statutory or fiduciary obligations.”
- Other avenues exist for penalizing potentially frivolous stockholder litigation, including Rule 11 sanctions from the bench for abusive claims, motions to dismiss early in the case, determining an accurate/representative plaintiff, scrutiny and potential rejection of proposed settlements, and limiting plaintiff’s lawyers fees.
- For those who would posit that the Council is self-interested as loser-pays bylaws would potentially decimate the total addressable market for the Delaware plaintiffs’ bar, “that criticism, of course, does not address the substance or merits of the issues; it is simply an assertion that whatever the Council does or does not recommend in relation to stockholder litigation is inherently tainted. In any event, we reject that criticism.
- “Those who argue that the legislation is protectionist will also note that the DGCL is often praised for its flexibility, and that the inflexibility of the proposed legislation is counter to that tradition. This argument fails to recognize that while the DGCL and fiduciary law do provide remarkable flexibility, they also contain certain ‘bottom line’ provisions that cannot be changed, such as information rights and the fiduciary duty of loyalty."
However, the Council failed to adequately address the following:
- The legislative amendment would abolish, wholesale, loser-pays provisions: there is no room for a middle ground of proportionate fee allocation, or a measured cap system – so that the deterrent effect is material but not overwhelming for a particular plaintiff class. While the plaintiff’s bar may argue that the mere cost of filing and pursuing a claim is a sufficient lower level deterrent, it is substantially less than what a modest cap amount could be. The Council did not address that, presumably, an insurance marketplace could emerge if loser-pays provisions were implemented that could be purchase by plaintiffs and, in candor, plaintiffs’ law firms which stoke the embers on many of these types of lawsuits. Claims with clear merit could be expected to receive insurance at a reasonable premium.
- There is no explanation of the philosophical standard by which loser-pays bylaws are against the bottom-line,wholly subjective scaffolding of Delaware’s sense of fairness, whereas other corporate governance devices (in particular, dual-class corporations where a select number of stockholders dwarf the voting power of the other stockholders) are perfectly acceptable. Of course, dual-class stock structures, while many stipulate stifle the democratic process at annual meetings, conversely do not threaten the workload of the Delaware plaintiff’s bar.
- The Council’s proposal abolishes the ability for fee-shifting provisions in both the bylaws and the certificate of incorporation. The current practical bifurcation of the bylaws versus the certificate of incorporation is that bylaws provisions may be adopted by a board of directors whereas the certificate of incorporation requires stockholder approval. That said, proxy advisory firms take a dim view of a board’s unfettered discretion to revise bylaws and voice these concerns at annual meetings when such directors are up for re-election. Nonetheless, one could see Delaware objecting to a bylaws inclusion (without stockholder approval), but allowing for inclusion in the certificate of incorporation (requiring stockholder approval) and preserving the state’s history of respecting and allowing the right of contract to prevail.
- The ringfencing of exclusive jurisdiction provisions to Delaware alone, whether based on valid substantive grounds or not, when taken together with the ban on fee-shifting bylaws, creates forced bundling and lends the appearance of a litigation land grab. Delaware has long prided itself on its many corporate-friendly features, including a responsive Secretary of State’s office, an evolved and thoughtful body of law in both the DGCL and decades of case law and a dedicated judiciary. Limiting exclusive forum provisions to Delaware forces a corporation to take those features as a “bundle.” There may be a good reason to do so, specifically that one presumes Delaware does not want a proliferation of other courts trying to interpret its laws without parties having recourse to Delaware’s courts. However, the likely outcome is that corporations will almost certainly want exclusive forum provisions, which eliminate multi-forum stockholder suits, but will now shift that litigation entirely and exclusively to Delaware, again much to the benefit of the Delaware plaintiff’s bar.
When taken as a whole, Delaware’s approach as a practical matter incents corporations to concentrate an enormous amount of discretion and latitude, and thus power, in a hitherto unprecedented amount, with the Delaware bench, while protecting, and in fact greatly increasing, the market for the Delaware plaintiffs’ bar.
The delay in the voting on the fee-shifting provisions demonstrates the ongoing friction in Delaware regarding the Council’s decision. While the most recently released changes were done in due course following the annual cycle for DGCL amendments, following the standard process has not changed in any way what appears to be the expected result – which is the further of the initial visceral reaction in the aftermath of the ATP decision. Indeed, the Council noted that ATP created room for counsel to posit that fee-shifting bylaws were now acceptable in Delaware. Lest that misconception pervade, the proposed changes will once and for all end the debate, albeit using the dullness of a butter knife instead of the precision of a scalpel.