On June 24, 2015, Delaware Governor Jack Markell signed into law new legislation addressing two separate corporate governance measures that have provoked heated debate in recent years. 

  • First, the bill authorizes Delaware stock corporations to adopt forum-selection provisions requiring any “internal corporate claim” to be filed in state or federal court in Delaware.
  • Second, the new legislation prohibits Delaware stock corporations from adopting fee-shifting provisions that require a stockholder to pay the corporation’s legal fees in connection with a claim alleging breach of duty by a director or officer (referred to as “internal corporate claims” in the new legislation).

The new legislation will be effective on August 1, 2015 and raises important questions for those charged with the governance of Delaware corporations.

Approval of Forum-Selection Provisions that Limit Multi-Forum Stockholder Litigation

The new legislation removes any remaining uncertainty over the facial validity of forum-selection clauses, expressly permitting a Delaware corporation to adopt a provision in its certificate of incorporation or bylaws requiring that “any or all internal corporate claims [] be brought solely and exclusively in any or all of the courts in [Delaware].”1
  
As has been well-documented, most public-company M&A transactions valued at over US$100 million result in stockholder litigation. In such lawsuits, stockholders of the target company typically allege that its directors breached their fiduciary duties in considering, negotiating, and/or approving the transaction. According to a report published by Cornerstone Research, 93% of M&A transactions valued over US$100 million in 2014 were the subject of stockholder litigation, and each transaction was the subject of, on average, 4.5 separately filed lawsuits. Moreover, for the years 2009-2013, more than half of those M&A transactions subject to stockholder litigation involved lawsuits filed in multiple jurisdictions, a development that increases both the cost and complexity of stockholder litigation.2

To address the inefficiency and costs of multi-forum litigation, many Delaware corporations have adopted forum-selection provisions that require stockholders to bring litigation in a single selected forum (typically Delaware). In 2013, the Delaware Court of Chancery upheld the facial validity of a forum-selection bylaw inBoilermakers Local 154 Retirement Fund v. Chevron Corporation, a ruling that accelerated the adoption of such provisions.3 More than 300 companies (though not all of them incorporated in Delaware) adopted forum-selection provisions in 2013 and 2014.4 And these provisions appear to have achieved their intended effect – less than half of challenged M&A transactions in 2014 were the subject of multi-forum litigation.5

At the same time, the new legislation prohibits a Delaware corporation from adopting a forum-selection provision that selects an exclusive forum other than Delaware, thereby effectively overruling a decision by the Delaware Court of Chancery upholding the bylaw of one Delaware corporation that selected North Carolina as the exclusive forum for stockholder litigation.6

Nevertheless, the new legislation does not close the book on all questions concerning forum-selection clauses. For example, the legislation does not preclude a court from scrutinizing whether the specific terms and manner of adoption of a particular forum-selection provision comport with the fiduciary duties of the corporation’s directors. Nor does the new legislation specifically address the validity of a provision allowing stockholder litigation in Delaware and another forum – such as a corporation’s principal place of business. The new law also does not expressly address charter or bylaw provisions permitting or mandating the arbitration of stockholder litigation, although presumably the latter provisions, mandating arbitration to the exclusion of Delaware courts, would be prohibited. And it still remains to be seen how these statutorily authorized forum-selection provisions, which purport to require courts in other jurisdictions to dismiss stockholder litigation so it can be re-filed in Delaware, will be viewed or enforced by courts in those jurisdictions. In short, future litigation regarding forum-selection provisions appears inevitable even after this legislation.

Prohibition on Fee-Shifting Provisions

Debate over fee-shifting provisions was sparked by the Delaware Supreme Court’s 2014 decision in ATP Tour, Inc. v. Deutscher Tennis Bund.7 In that case, the Delaware Supreme Court found facially valid a bylaw provision that obligated members of a non-stock corporation who asserted an unsuccessful internal corporate claim to reimburse the corporation “for all fees, costs and expenses of every kind and description...incur[red] in connection with such [c]laim.” The ATP decision prompted some to recommend that Delaware stock corporations similarly adopt fee-shifting provisions as a means of deterring so-called “strike-suits” by plaintiffs’ attorneys. And it has been reported that 30 Delaware stock corporations adopted fee-shifting provisions after the Delaware Supreme Court’s ATP decision.

On April 13, 2015, in response to ATP, the Delaware Corporation Law Council of the Delaware State Bar Association (the Council) proposed legislation that would have prohibited Delaware stock corporations from adopting fee-shifting provisions in their certificates of incorporation or bylaws. The Council argued that allowing fee-shifting bylaws of general applicability would virtually eliminate stockholder litigation, which it described as the only effective mechanism to enforce corporate statutory and fiduciary responsibilities. In the words of the Council: “[b]ecause the consequences of any corporate decision affect investors only commensurately with the scope of their investment, few stockholders will rationally be able to accept the risk of exposure to millions of dollars in [the company’s] attorney’s fees to attempt to rectify a perceived corporate wrong, no matter how egregious.”8 The Council also claimed that existing mechanisms – Rule 11 sanctions, motions to dismiss, judicial doctrines that allow for fee-shifting, and scrutiny of plaintiffs as appropriate stockholder representatives – already allow courts to deter meritless stockholder litigation.

Although many corporate defendants would vigorously dispute the Council’s statements on both the purported benefits of stockholder litigation and on the effectiveness of existing devices to address meritless suits, the new Delaware law largely mirror’s the Council’s proposal. Under the new law, neither a stock corporation’s certificate of incorporation nor its bylaws may “contain any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with [] internal corporate claim[s],” which are defined as “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 the [Delaware General Corporation Law] confers jurisdiction upon the Court of Chancery.”9

Again, however, the new legislation leaves important questions unresolved. For example, although the new law prohibits provisions that “impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party,” it does not address the enforceability of a potential charter or bylaw provision that would require a stockholder to pay his or her own attorneys’ fees and expenses (or prohibit the corporation from paying them) in certain cases. This matters because most stockholder governance litigation brought under state law, e.g., lawsuits alleging that directors or officers breached a fiduciary duty under state law, typically results in little or no monetary recovery to the company or the stockholders, and the economic incentive behind the litigation is the attorneys’ fees awarded by courts for the successful prosecution or (more frequently) settlement of the stockholder class or derivative action. An enforceable provision that prohibited a corporation from paying (and by extension a court from awarding) attorneys’ fees in such litigation therefore could have a very significant deterrent effect on the plaintiffs’ bar.

Take-Aways

The new Delaware legislation provides welcome clarity on two key disputed matters of corporate governance. It now is settled that: (1) forum-selection provisions that select Delaware as the exclusive forum for stockholder litigation are facially valid under Delaware law; and (2) at least for ordinary stock corporations, fee-shifting provisions that impose the corporation’s litigation costs directly on a stockholder-plaintiff are impermissible. At the same time, key questions remain for Delaware corporations. 

With respect to forum selection provisions, these questions include:

  • Does an existing forum-selection provision in the corporation’s certificate of incorporation or bylaws comply with the new Delaware legislation?
  • If the corporation currently has no forum-selection provision, should it: (1) adopt a Delaware-only forum selection bylaw; (2) adopt a bylaw allowing litigation to be brought either in Delaware or another forum; or (3) continue with no forum-selection clause at all?
  • If the corporation has or adopts a forum-selection provision, will courts in other jurisdictions uniformly enforce the provision and dismiss cases pending before them in favor of Delaware?
  • If the corporation was considering adopting a mandatory arbitration provision for stockholder litigation, can it do so under the new legislation, or is its only option to reincorporate in a more arbitration-friendly venue?10

With respect to fee-shifting provisions, Delaware corporations may want to consider whether to adopt a provision that precludes an award of fees to plaintiffs’ counsel in state-law governance litigation, but that does not impermissibly impose another party’s fees on the plaintiffs.