In an abrupt reversal, Delaware says “Ummm… Wait!” to fee shifting bylaws

It has been a dizzying couple of weeks for the Delaware Bar. Previously, the disaffected German tennis federation of the professional ATP tennis tour had sour grapes over the downgrading of the Hamburg tennis tournament and the tournament’s concurrent move from spring to summer. (One cannot invent such colorful facts.) The German federation sued but lost in court, prompting the ATP tour to request reimbursement of its legal fees and other costs and expenses (“of every kind and description”) in accordance with the bylaws of the ATP tour. The federal District Court of Delaware held that the enforceability of such a provision was an open question under Delaware law and sent limited related questions over to the Delaware state courts for a decision.

On May 8, Delaware’s Supreme Court released an opinion in ATP Tours, Inc. v. Deutscher Tennis Bund in which fee shifting bylaws were upheld for a non-stock corporation. But in a “dude, not so fast” moment, after wrangling behind closed doors, on May 22, the Corporation Law Section of the Delaware State Bar Association served notice that a special meeting would be held on May 29.

This is high drama in the buttoned-down halls and quiet streets of Wilmington.  The purpose of the meeting will be to halt the forecasted consequences of ATP by voting on recommending to the Delaware Legislature a statutory amendment that would quash such bylaw provisions – essentially making a legislative end-run around the Supreme Court’s decision.

Fee shifting bylaws, also known as loser-pays bylaws, have been the new-age favorite child of many in the corporate defense bar. These are simply provisions by which a losing party in litigation must pay the fees and costs of the prevailing party. In an era where at least 80 percent of mergers result in lawsuits against the company’s board of directors for various breaches of disclosure duties or purported conflicts of interest, such provisions would likely make plaintiffs’ firm reflect long and hard before filing suit. While in the past, plaintiffs’ firms needed only invest a relatively small amount of their own capital in bringing an action to get past a motion to dismiss and into discovery, the advent of loser-pay bylaws would have introduced the specter of paying a potentially unlimited (or perhaps limited only by a vague “reasonableness” standard) amount to the other side’s pricey AmLaw 100 lawyers and e-discovery experts, plus, assumedly, in-house expenses as well, in the event the plaintiffs were to lose.

Proponents of such loser-pays bylaws argue that such bylaws would deter frivolous suits, but that truly legitimate suits would still be brought, since plaintiffs would be doubly sure before filing that they believe their case would prevail. Detractors argue that such provisions are an over-correction and the mere chance, no matter how small, of losing even a strong case would scare off plaintiffs and stamp out otherwise meritorious claims before they were even filed in court.

Following the ATP decision, many law firms immediately (and justifiably) inferred the analysis used in the arcane realm of a non-stock corporation could be easily applied to the much more common domain of the stock-issued corporation. This sent the Delaware plaintiffs’ bar into a frenzy. A cynic could argue that an entrenched Delaware plaintiffs’ bar (and, even more cynically, perhaps secretly one or two litigators from the Delaware defense bar) sensed the end of the lucrative gravy train of legal fishing expeditions that often result in settlements with modest substantive results as well as individually relatively modest, but in the aggregate stunningly large, amounts of attorneys’ fees.

Frequently, such so-called “disclosure only” settlements result merely in changing often subtle language in a merger SEC disclosure document. At the end of the day, let’s not kid ourselves into believing that stockholders actually read the fine print of such tombs in any event.  Because of the fees (and timing problems) with fighting such suits, it often makes sense for a company to simply tinker with some requested legalese, pay the legal fees of the plaintiffs’ firm and move on, rather than litigate the issue and rack up expensive outside counsel fees – from both their primary corporate law firm and often a second Delaware litigation firm – which would not be reimbursed even if the company were to win the case.  However, with fee shifting bylaws provisions, suddenly those costs transform from eternally sunk to potentially recoverable, such that increasing numbers of companies may choose to fight lawsuits rather than rolling over and reluctantly but quickly resigning themselves to settling.

Changes to the Delaware General Corporation Law (DGCL) are normally a rather rubber-stamp affair – the Delaware State Bar Association recommends a change and the Delaware legislature dutifully tends to follow the advice of its experts, lest it monkey around with a pristine legal framework that generates millions of fees each year for the state. These statutory changes generally occur on an annual cycle in which new changes take effect on August 1, as with routine changes for 2014 on contractual statutes of limitations and other matters.

It will be interesting to gauge over the course of the coming weeks whether the recommendation of the Corporate Law Section in this instance is first embraced by the wider bar and then enacted by the legislature. Both these outcomes seem highly probable – but less so than with prior changes. In addition, one wonders whether Chief Justice Strine – whose ascendancy was widely heralded and whose wit and writing style are prone to bold rhetorical flourish and have been equally admired – will quietly acquiesce. Instead, he may pluckily note that he only interprets law but does not make it. Given his history, he seems unlikely to merely quietly note that the ATP decision technically only applied to non-stock rather than stock corporations. But such a point would be, while a bit hyper-technical, both convenient and face saving.

The irony is that Delaware is considered the most corporation-friendly jurisdiction among the favorite organizational homes of companies, and thus the least likely to witness a homegrown insurgency against fee shifting bylaws. Pretenders to the Delaware throne, such as Nevada and North Dakota, are universally perceived as more stockholder/founder friendly. Accordingly, it seems almost certain that this issue will remain isolated to Delaware. It will not likely spread elsewhere.

In the interim, rather than rushing to have their boards adopt fee shifting bylaws provisions, corporations will do well to step back and coolly observe as the gladiators of the Delaware Bar fight it out among themselves.