On June 24, 2015, the governor of Delaware signed into law legislation that amends the Delaware General Corporation Law (Title 8 of the Delaware Code) (“DGCL”) to effectively prohibit fee-shifting bylaw provisions in the context of most stockholder litigation related to corporate governance and M&A transactions, and to allow Delaware corporations to adopt forum selection (or exclusive forum) bylaw provisions. The changes to the DGCL will become effective August 1, 2015.
In the typical shareholder lawsuit, each party bears its own legal fees and expenses regardless of the outcome of the litigation. A fee-shifting clause, typically found in a corporation’s charter or bylaws, requires a shareholder who brings a direct or derivative action against a corporation and/or its directors, officers, or employees to reimburse the defendants’ litigation costs if the plaintiff does not obtain a judgment on the merits or does not obtain the remedy sought. A fee-shifting bylaw thus makes it much more riskier for plaintiffs to bring a lawsuit against a corporation, knowing that if they lose, they will have to bear the defendant’s litigation costs. This “shifting of fees” reduces the number of lawsuits filed against corporations, since only plaintiffs with strong cases are likely to proceed and risk an expensive loss.
The Delaware Supreme Court had recently upheld a fee-shifting bylaw, holding that such bylaws are facially valid, and that enforceability of a specific bylaw would depend on the manner of adoption and the circumstances in which it was invoked. See ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 555 (Del. 2014).
In response to the ATP Tour, Inc. decision, the newly-enacted legislation will add a new Section 102(f) and amend current Section 109(b) of the DGCL to invalidate any provision in the certificate of incorporation or bylaws of a stock corporation that shifts the corporation’s or any other party's attorneys’ fees or expenses to the stockholder in an “internal corporate claim.” As defined in new Section 115 of the DGCL, internal corporate claims are “claims, including claims in the right of the corporation, (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.”
A forum selection clause, typically found in a corporation’s charter or bylaws, limits the jurisdiction in which a corporation can sue or be sued in certain types of actions, primarily involving (i) derivative actions or proceedings brought on behalf of the corporation, (ii) actions asserting a claim of breach of fiduciary duty owed by a director, officer or other employee of the corporation to the corporation or its shareholders, (iii) actions asserting a claim arising pursuant to the corporation law of the state of incorporation, or (iv) actions asserting a claim governed by the internal affairs doctrine.
In 2013, the Delaware Chancery Court found that forum selection provisions are facially valid and may be adopted unilaterally by a board of directors as long as they are reasonable and fair. Enforceability should be assessed on a case-by-case basis under a reasonableness standard. Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch., 2013).
The newly enacted legislation will allow Delaware corporations to include a Delaware choice of law provision in their certificates of incorporation and bylaws. However, a Delaware corporation cannot designate a state other than Delaware as the exclusive forum for an internal corporate claim. New section 115 of the DGCL states that “the certificate of incorporation or the bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State, and no provision of the certificate of incorporation or the bylaws may prohibit bringing such claims in the courts of this State.”
Although forum selection clauses are now permitted as a legal matter under Delaware law, the statute does not prevent a court from assessing enforcement of a specific forum selection clause if, under the particular facts and circumstances, such clause was adopted or operates in an unreasonable or unlawful manner.
Proxy Advisory Firms on Fee-Shifting and Forum Selection Clauses
Each of Institutional Shareholder Services, Inc. (“ISS”) and Glass Lewis & Co., LLC (“Glass Lewis”) has published guidelines for the 2015 proxy season that include its recommendations as to voting by shareholders in the case of (i) the unilateral adoption of fee-shifting or forum selection bylaws by boards of directors of public companies, and (ii) proposals seeking the approval of shareholders for the adoption of fee-shifting or forum selection bylaws.
Unilaterally Adopted Bylaws: When fee-shifting bylaws or forum selection bylaws are adopted unilaterally by a board of directors, ISS and Glass Lewis recommend a vote against boards of directors or committees that supported the unilateral adoption.
Proposals for Shareholder Approval: While in practice ISS has always recommended that shareholders vote against proposals seeking the adoption of fee-shifting bylaws or forum selection bylaws, the published ISS approach to these proposals is a case-by-case analysis, taking into account factors such as:
- The company’s stated rationale for adopting such a provision;
- Disclosure of past harm from shareholder lawsuits in which plaintiffs were unsuccessful or shareholder lawsuits outside the jurisdiction of incorporation;
- The breadth of application of the bylaw, including the types of lawsuits to which it would apply and the definition of key terms; and
- Governance features such as shareholders’ ability to repeal the provision at a later date (including the vote standard applied when shareholders attempt to amend the bylaws) and their ability to hold directors accountable through annual director elections and a majority vote standard in uncontested elections.
Glass Lewis recommends that shareholders vote against proposals seeking the adoption of forum selection bylaws unless the company:
- Provides a compelling argument on why the provision would directly benefit shareholders;
- Provides evidence of abuse of legal process in other, non-favored jurisdictions;
- Narrowly tailors the bylaws to the risks involved; and
- Maintains a strong record of good corporate governance practices.
With respect to proposals seeking the adoption of fee-shifting clauses, Glass Lewis recommends that shareholders vote against such proposals.
Securities and Exchange Commission
Fee-shifting bylaws also appear to be disfavored by the Securities and Exchange Commission (“SEC”). The SEC’s Investor Advisory Committee discussed these types of clauses at its meeting on October 9, 2014. At the meeting, Professor John Coffee advocated that the SEC: (i) assert in amicus curiae briefs that federal securities laws preempt the enforcement of fee-shifting provisions, (ii) refuse to accelerate registration statements when the registrant has fee-shifting provisions in its charter or bylaws, and/or (iii) require registrants to state in their registration statements that they understand that the SEC believes that the fee-shifting bylaws are inconsistent with federal securities laws.