In 2015, the Delaware General Corporation Law (“DGCL”) was amended to prohibit Delaware corporations from adopting bylaws that imposed liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an internal corporate claim. Simultaneously, the DGCL was amended to permit Delaware corporations to adopt bylaws requiring that internal corporate claims be filed exclusively in Delaware. A recent case from the Delaware Court of Chancery addresses a scenario where a Delaware corporation adopted a bylaw imposing liability on stockholders who filed an internal corporate claim outside of Delaware, in violation of an exclusive forum bylaw.

In Solak v. Sarowitz, C.A. No. 12299-CB (Del. Ch. Dec. 27, 2016), the board of Paylocity Holding Corporation adopted two new bylaws: (1) an exclusive forum bylaw that, absent the company’s consent, required internal corporate claims to be filed in a state or federal court located in Delaware, and (2) a fee-shifting bylaw that shifts the attorneys’ fees and other expenses to a stockholder who files an internal corporate claim outside of Delaware and that stockholder does not obtain a judgment on the merits (“Fee-Shifting Bylaw”).

In Solak, a stockholder of Paylocity sought a declaration that the Fee-Shifting Bylaw was invalid under Sections 109(b) and 102(b)(6) of the DGCL, and asserted that the members of Paylocity’s board should be liable for breaching their fiduciary duties by adopting the Fee-Shifting Bylaw and by failing to disclose certain information when the company publicly announced its adoption. Section 102(b)(6) of the DGCL permits a corporation to adopt in its charter “a provision imposing personal liability for the debts of the corporation on its stockholders to a specified extent and upon specified conditions; otherwise, the stockholders of a corporation shall not be personally liable for the payment of the corporation’s debts except as they may be liable by reason of their own conduct or acts.” Section 109(b) of the DGCL provides that “the bylaws may not 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 an internal corporate claim.”

In addressing Count I of Plaintiff’s three-count complaint, the court agreed with the plaintiff that the plain text of the Fee-Shifting Bylaw violated Section 109(b) of the DGCL because the statute unambiguously prohibits the inclusion of “any provision” in a corporation’s bylaws that would shift to a stockholder the attorneys’ fees or expenses incurred by the corporation “in connection with an internal corporation claim,” irrespective of where such a claim is filed. The defendants argued that the simultaneous adoption of Section 109(b) and Section 115 (forum selection provisions) of the DGCL “must be read in tandem” to mean that Section 109(b) was not intended to prohibit fee-shifting for internal corporate claims filed outside of Delaware when a corporation adopts an exclusive forum bylaw requiring that such claims be filed in Delaware, as Section 115 allows. In rejecting defendants’ arguments, the court pointed that Section 109(b) prohibits “any provision” that would shift fees “in connection with an internal corporate claim” without regard to where such a claim is filed. The defendants also argued that the Delaware Supreme Court in the past has awarded damages for breach of forum selection clauses. However, the court distinguishes that case in question by the fact that the damages were awarded pursuant to the breach of a private contract, not a bylaw. In summarizing its holding on this count, the court explained that the Fee-Shifting Bylaw cannot operate lawfully under any circumstances given the blanket prohibition on fee-shifting bylaws in Section 109(b).

In Count II of Plaintiff’s complaint, Plaintiff sought a declaration that the Fee-Shifting Bylaw was invalid because it violated Section 102(b)(6) of the DGCL. Section 102(b)(6) authorizes a corporation to include in its certificate of incorporation “[a] provision imposing personal liability for the debts of the corporation on its stockholders to a specified extent and upon specified conditions,” and further states that “otherwise, the stockholders of a corporation shall not be personally liable for the payment of the corporation’s debts except as they may be liable by reason of their own conduct or acts.” Plaintiff asserted that, because Paylocity’s certificate of incorporation “does not contain any provision imposing on its stockholders personal liability for the debts of the corporation,” the Fee-Shifting Bylaw cannot lawfully require a stockholder to pay the company’s litigation expenses. In dismissing this count for failure to state a claim, the court raised the question of whether the expenses highlighted in the Fee-Shifting Bylaw would fall within the meaning of the term “debts” as used in Section 102(b)(6). Another question raised by the court is whether fee-shifting under the Fee-Shifting Bylaw would satisfy the exception to the prohibition against personal liability for the corporation’s debts when stockholders are “liable by reason of their own conduct or acts,” which in this case is triggered by a stockholder’s “own conduct or act” in filing a claim outside of Delaware. The court further stated that “it is plausible that the term ‘debts’ as used in Section 102(b)(6) could encompass the type of expenses enumerated in the Fee-Shifting Bylaw, but that conclusion is not self-evident or free from doubt.” It is worth noting that, in connection with the amendment of the DGCL to prohibit fee-shifting bylaws, a simultaneous amendment was made to 102(f) to clarify that a Delaware corporation’s certificate of incorporation may not 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 an internal corporate claim.

Last, in addressing Count III of Plaintiff’s complaint, the court did not find that the board of Paylocity breached its fiduciary duties. Plaintiff had previously questioned the company’s failure to disclose the adoption of the amendment to Section 109(b) and the board’s “rationale for why the Fee-Shifting Bylaw was permissible in light of Section 109(b).” More specifically, the failure to disclose the well-known public fact that Section 109(b) had been amended and the board’s rationale for the validity of the Fee-Shifting Bylaw, the full text of which was attached as an exhibit to the Form 8-K, did not amount to such “an extreme set of facts” to warrant the inference that Paylocity’s concededly disinterested directors intentionally disregarded their duties, or that they acted in a manner that is “inexplicable on any ground other than bad faith.” In doing so, the court noted that Paylocity’s charter contained a Section 102(b)(7) provision exculpating its directors from breaches of the duty of care, and Plaintiff did not plead any facts from which one could reasonably infer that the Paylocity directors acted in bad faith or otherwise knew they were violating the law.

This opinion confirms that corporate bylaws that attempt to shift litigation expenses, including attorneys’ fees, to stockholders would be held to be invalid under Delaware law.