ATP Tour, Inc. – Fee-Shifting Corporate Bylaws. The Delaware Supreme Court issued a decision holding that a non-stock corporation could adopt a fee-shifting bylaw provision, in effect implementing a “loser pays” arrangement for intra-corporate litigation.1 Not long after the decision was issued, legislation was introduced in the Delaware General Assembly that would have limited the decision’s impact to non-stock entities. However, that legislation has not been passed and instead the Delaware General Assembly passed a resolution calling for further study of the potential impact of fee-shifting bylaw provisions, and recommending potential legislation to address the balance between discouraging meritless litigation without unduly restricting stockholder attempts to vindicate legitimate interests in court. While awaiting consideration by the Delaware legislature, corporations and their counsel will assess whether and how fee-shifting bylaws might be implemented with respect to stock corporations.
ATP Tour Inc., a Delaware membership corporation that operates a global men’s tennis tour, adopted a bylaw requiring a member who brings suit against ATP or other members to pay the attorneys’ fees and litigation costs of defendants unless the suing member obtains a judgment for substantially all of whatever the suing member initially demanded. After certain members brought suit challenging changes to ATP’s tennis tour schedule and lost their suit in federal court, ATP attempted to enforce the fee-shifting provisions of the bylaws, seeking attorneys’ fees and other costs from the plaintiffs.
The federal court issued certified questions to the Delaware Supreme Court related to the enforceability of the fee-shifting bylaw. The Delaware Supreme Court held that a fee-shifting bylaw is permissible as a matter of Delaware law and the bylaw before the court was “facially valid” in that it complied with the Delaware General Corporation Law and was not otherwise prohibited. The court added that the enforceability of any specific bylaw, including ATP’s bylaw, would depend in part on the manner in which the bylaw was adopted and invoked. Even where it is within a corporation’s power to adopt a bylaw, it may be invalid if adopted or applied for an inequitable purpose. The court did not reach that issue with respect to the specific bylaw before it and left the issue to be decided by the federal district court.
The ATP decision was widely discussed and many commentators considered the issue of whether fee-shifting bylaw provisions might be broadly adopted by stock corporations, including public companies attempting to curtail stockholder litigation. On June 3, 2014, a bill to limit the application of the ATP decision to non-stock entities was introduced in the Delaware General Assembly. Senate Bill No. 236 would prohibit a corporation from adopting a charter or bylaw provision that imposed liabilities on stockholders for bringing litigation against the corporation or other corporate constituents. Supporters of the legislation argue that the ATP decision is overbroad in its application, discouraging even meritorious litigation, and that it cuts against the usual norm of limited liability for corporate stockholders. Opponents of the legislation argue that the result in ATP is consistent with Delaware law’s long-held respect for private ordering, and that stock corporations should have the option of implementing a bylaw to curtail unproductive and costly stockholder litigation, subject to the constraints recognized by the ATP court. Senate Bill 236 was not passed before the General Assembly’s adjournment on June 30, 2014. Rather, Senate Joint Resolution No. 12, which was introduced and unanimously passed in the Delaware State Senate on June 18, 2014 and passed by the Delaware House of Representatives on June 30, 2014, directs that the Corporation Law Council of the Delaware Bar further study the issue of bylaw provisions and similar restrictions on the conduct and forum for litigation involving corporations or other business entities. That examination may lead to new legislation addressing fee-shifting bylaws in 2015. In the absence of legislative restrictions on the adoption of fee-shifting bylaws, at least some Delaware corporations will consider and adopt fee-shifting bylaw mechanisms. Additional court cases will be needed to develop a more detailed analysis of the effectiveness of such a provision as applied in particular circumstances.
Sotheby’s – Adoption of Poison Pill to Address Activist Investors’ Stock Acquisition. In a recent decision, the Delaware Court of Chancery clarified key issues of Delaware law concerning the use of a stockholder rights plan – commonly referred to as a “poison pill” – in circumstances in which activist investors are trading in a company’s stock.2
The case involved renowned auction house Sotheby’s, a Delaware corporation whose shares are widely traded on the New York Stock Exchange. In 2013, several “activist” hedge funds, including Third Point LLC, a fund controlled by Daniel Loeb, began purchasing significant amounts of Sotheby’s stock on the open market. By early October 2013, Third Point alone controlled approximately 9.4% of the company’s outstanding stock, which made Third Point the company’s largest single stockholder, and Loeb issued a letter critical of incumbent management suggesting the company needed a new board and CEO.
In response to this activist trading activity, the Sotheby’s board adopted a rights plan. A rights plan customarily provides for the issuance of additional stock (actually, rights to purchase stock) when one investor reaches a certain threshold of ownership (or “trigger” for the pill). Historically, companies have employed rights plans as defensive tactics in the face of a hostile acquisition proposal. Prior to the Sotheby’s decision, the use of a rights plan to restrict “activist” investors’ purchasing activities had not been the subject of significant judicial scrutiny.
The Sotheby’s rights plan provided for a “two-tier” trigger. For an investor filing a Form 13D with the Securities and Exchange Commission, the pill would be triggered when the investor reached a 10% threshold. However, for investors filing a Form 13G (which can only be filed by an investor disclaiming any interest in changing the control of the issuer), the threshold to trigger the pill was 20%.
In February 2014, Third Point filed a Form 13D disclosing that it owned 9.53% of Sotheby’s stock and was nominating three directors to the board at the company’s upcoming annual meeting. Third Point requested that Sotheby’s waive the 10% trigger and permit Third Point to purchase up to 20% of the company’s shares. The board denied Third Point’s request. Thereafter, Third Point brought suit in the Court of Chancery seeking a preliminary injunction invalidating the application of the rights plan and delaying Sotheby’s annual meeting.
After expedited discovery and a hearing, the court denied Third Point’s request for a preliminary injunction on the ground that the plaintiffs did not show that they would prevail on the merits with respect to their challenge to the rights plan. The court invoked the long recognized standards of Unocal, which provide that a defensive measure will be upheld where (i) it is in response to a board’s good faith assessment of a legally cognizable threat to corporate policy, and (ii) the response is reasonably proportionate to that threat.
The court found that the board’s concern with respect to “creeping control” – the possibility that Third Point and other activist investors trading in the company’s stock might band together to obtain effective control of the company’s management, without paying any control premium to other Sotheby’s stockholders – constituted a legally cognizable and reasonable threat for the board to consider. The court emphasized that Sotheby’s board was independent and reviewed the circumstances related to activist investors with competent and qualified legal and financial advisors before adopting the pill. The court also found that the rights plan was proportionate to the threat presented. In particular it was not “coercive” or “preclusive.” The plan was not coercive in that it did not dictate a particular way that stockholders should vote in the pending proxy contest. The plan was not preclusive because it would not render Third Point’s proxy contest unviable. In fact, the court noted that the ongoing proxy contest was considered a “toss-up” at the time it rendered its opinion.
The court expressed concern about the pill’s “two-tier” nature. The plan was concededly discriminatory against activist investors (i.e., those that file Form 13D) as compared to “passive” investors (i.e., those that file Form 13G). The court found that distinction insignificant to the case before it. With holdings of 9.6% of the company’s outstanding stock, Third Point was the largest company stockholder. There were no “passive” investors who owned more than Third Point and therefore the distinction, in the court’s words, was a “complete non-issue.”
The court separately considered whether the board’s refusal to waive the 10% limit for Third Point violated the Unocal standards. By March 2014, management of Sotheby’s was in the midst of a hotly contested proxy contest with Third Point and Third Point’s inability to acquire and vote more shares in that contest might have affected the outcome of the stockholder vote. Ultimately, the court determined that the board’s refusal to waive the 10% trigger was within the range of reasonableness, in that allowing Third Point – already Sotheby’s largest stockholder – to go to 20% might provide it with a blocking position (termed “negative control” by the court).
Based upon its limited consideration of the merits, the court declined to issue a preliminary injunction invalidating the rights plan or delaying Sotheby’s annual meeting. Within days of the court’s decision, Sotheby’s and Third Point announced a settlement in which Loeb and his two nominees were seated on Sotheby’s board, and the threshold under the pill was raised to 15% for Third Point.
The Sotheby’s case clarifies key issues of Delaware law with respect to the use of a poison pill to constrain activities of activist stockholders. It confirms that a board can adopt and employ a poison pill with respect to more tenuous threats to control than the direct and imminent threat of a hostile acquisition offer, including as a defensive measure in light of opportunistic activist investor activity in the company’s stock. The Delaware courts will consider the board’s actions in adopting or refusing to waive defensive measures. Boards are well-advised to consult legal and financial advisors with respect to any rights plan, and to ensure that the minutes of the board meetings during which the adoption of the rights plan is considered reflect the reasons for the board’s decision, including the perceived threat. In addition, it is notable that the court did not endorse “two-tier” rights plans, i.e., those that discriminate between activist and passive investors, so it is not clear that such an approach would pass judicial muster in future cases.