The “American Rule” provides that each side generally pays its own legal fees during litigation. However, a recent Delaware Supreme Court decision seemingly allows for the American Rule to be set aside when a “loser pays” provision is included in a Delaware corporation’s bylaws. In light of this decision, new legislation has been proposed in Delaware to limit the breadth of the Court’s ruling. Depending on the stance the Delaware legislature ultimately takes, the amount of certain corporate litigation – and who pays the fees when this litigation is over – may be significantly affected.

The Delaware Supreme Court Allows for Fee-Shifting

On May 8, 2014, the Delaware Supreme Court decided en banc that fee-shifting provisions in a non-stock corporation’s bylaws are enforceable under Delaware law, so long as they were not enacted for an improper purpose. See ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014). This holding does not appear to be limited to non-stock corporations. Thus, the Court’s decision ultimately may allow for all Delaware corporations to shift fees and costs to unsuccessful plaintiffs in corporate litigation, a result some trumpet as a means to protect corporations from abusive and frivolous lawsuits.

ATP Tour, Inc. (“ATP”) is a Delaware membership corporation made up of professional men’s tennis players and entities that own and operate professional tennis tournaments. When members join ATP, they agree to be bound by ATP’s Bylaws. In 2006, ATP’s board amended ATP’s Bylaws to add Article 23, which included a provision regarding fee-shifting.1

This provision went untested until an issue arose regarding a 2007 decision to change the well-known tennis tour’s schedule. Two members of ATP, Deutscher Tennis Bund and Qatar Tennis Federation (the “Federations”), sued ATP and six board members in the United States District Court for the District of Delaware, alleging both federal antitrust and Delaware fiduciary duty claims. After a ten-day jury trial in which the Federations did not prevail on any claims, ATP sought to recover its legal fees, costs, and expenses under Rule 54 of the Federal Rules of Civil Procedure and Article 23.3 of ATP’s Bylaws. The District Court, however, denied ATP’s motion, finding that when antitrust claims are involved, federal law preempts the enforcement of fee-shifting agreements. ATP appealed, and the United States Court of Appeals for the Third Circuit vacated the District Court’s order, holding that the District Court’s first step should have been to determine whether the fee-shifting provision in ATP’s Bylaws was enforceable underDelaware law before reaching the federal preemption question.

On remand, the District Court decided that the fee-shifting provision’s enforceability was a novel question of law to be answered by the Delaware Supreme Court. The District Court therefore certified four questions of law to the Delaware Supreme Court. Ultimately, the Delaware Supreme Court concluded in response to each of the four certified questions that:

  1. Fee-shifting bylaws are permissible under Delaware law;
  2. The bylaw, if valid and enforceable, could shift fees if the plaintiff obtained no relief in the underlying litigation;
  3. The bylaw is unenforceable if adopted for an improper purpose; and
  4. Generally, a bylaw amendment is enforceable against members who join the corporation before its enactment.

See ATP Tour, 91 A.3d at 557-60.

A Possible Legislative Response

Opponents to fee-shifting provisions reacted quickly after the Delaware Supreme Court’s ruling. Just weeks after the ruling, they proposed an amendment to Delaware’s corporate law that would prohibit publicly traded corporations from shifting fees to unsuccessful shareholders in corporate lawsuits. The proposed legislation stirred up significant debate, causing the legislature to delay any vote on the measure until 2015. In delaying the vote, legislators cited a need for more time to consider the proposal amid the strong opinions both for and against.

Not surprisingly, corporations generally favor fee shifting provisions. They see these provisions as a device to curtail meritless lawsuits from being brought by an overly-aggressive plaintiffs’ bar and generally to limit costly corporate litigation. Since the May 2014 ruling in ATP Tour, dozens of companies have amended their bylaws to include fee-shifting provisions. If the Court’s ruling is not overturned through legislation, more and more corporations undoubtedly will incorporate fee-shifting provisions into their bylaws.

On the other hand, shareholder advocates and lawyers who represent shareholders argue against fee-shifting provisions. They claim that such provisions give corporations too powerful a weapon to stave off meritorious claims by shareholders unwilling to risk potentially large losses at the hands of multi-billion dollar corporations. They point out that many litigants are smaller investors or institutional investors that will fear huge legal fees and, accordingly, suits that otherwise would have been brought to remedy corporate wrongdoing will not be pursued.

Conclusion

ATP Tour did not involve a stock corporation. However, barring legislation limiting its application, it seems likely that ATP Tour’s reasoning will apply to stock corporations, including publicly traded corporations. Indeed, there is nothing in ATP Tour suggesting that the enforceability of fee-shifting bylaws depends upon the type of corporation at issue.

Should stock corporations be able to insert fee shifting provisions into their bylaws, it is likely that most companies will do so. Such an outcome would have a significant impact on corporate litigation. Currently, significant corporate transactions, such as larger mergers and acquisitions, nearly uniformly face challenges from investors. While some of these challenges may have merit, many do not. However, corporations routinely settle such nuisance suits simply to avoid the cost and distraction of litigation, with plaintiffs’ counsel usually negotiating and obtaining an attorneys’ fees award. If Delaware law allows for fee-shifting by public companies, it is likely that the number of cases brought will decrease. It is, however, also likely that the lawsuits that are brought will have more merit and will be more expensive to litigate and settle. Indeed, it is likely that shareholders and their counsel will focus on cases in which they face less risk of ultimately having to pay the corporation’s fees, i.e., cases that are stronger on the merits. Plaintiffs may also demand higher settlements to compensate for the additional risk that they faced in bringing the case.