Retirement insights from a Colorado PERA perspective

Legislation & Governance

Fee-Shifting in Litigation: Concerning Decision in Delaware (Update)

UPDATE: On June 24, 2015, Delaware Governor Jack Markell signed into law Delaware Senate Bill 75. This is certainly a step in the right direction to limit the impact of the ATP Tour decision. But there is still likely some question as to whether the new law as approved covers fee-shifting in securities litigation cases. The way that Delaware SB 75 reads, it provides protection to stock corporations (but not nonstock corporations) by invalidating a provision in the certificate of incorporation that purports to impose liability upon a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an “internal corporate claim.”

“Internal corporate claims” means 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 Delaware law confers jurisdiction upon the Court of Chancery. It is likely that “internal corporate claim” is written broadly enough to encompass securities fraud claims based on a corporate officer’s breach of a common law duty of loyalty. Although this is helpful to shareholder rights, it is still not a settled area of the law.

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As conscientious investors already know, committing to own a piece of a company often requires just a bit more than throwing a dart at a list of ticker symbols and writing a check. Company policies are important! So when companies begin making changes to bylaws that could restrict their shareholders’ rights to bring a lawsuit, and the courts say that the company can do that legally, it’s time to sit up and take notice.

In 2014, the Delaware Supreme Court held in ATP Tour v. Deutscher Tennis Bund that a board of directors could unilaterally adopt bylaws (that is, without member or shareholder approval) to shift the payment of litigation costs to shareholders who bring a lawsuit against a company and do not obtain relief.

And that is not all — the bylaws can apply to anyone who is already a member or a shareholder, as well as those potential future members or shareholders. As long as the company’s Certificate of Incorporation provides that the board may unilaterally amend bylaws, everyone will be subject to the new bylaws.

This court holding represents a significant departure from how shareholder rights are typically set. Often, shareholder rights are established by the terms in place on the day a shareholder purchases a share in a company. However, if a board may adopt bylaws unilaterally that apply to existing members or shareholders, those existing shareholders are bound to the new bylaws to which they did not explicitly agree or agree to change. The unilateral shift of responsibility for the payment of litigation costs is clearly a significant use of that authority.

The Court created a couple of caveats to the decision. First, the bylaws have to be adopted and used for an equitable purpose (in other words, the reason for the bylaw must be fair)—and avoiding litigation may be an equitable purpose. Second, the Court’s ruling applies only to a bylaw that requires the plaintiff shareholder to pay if the plaintiff shareholder obtains no relief at all. This leaves open the question of whether a bylaw would be valid if it permits fee-shifting on a less-than-total recovery.

Caveats notwithstanding, the ATP Tour decision is concerning because of the erosion of shareholder rights that it represents. Shareholders need to have the ability to hold the company and its directors responsible for their actions, whether it is concerning a bad act or poor, unsupportable decision making. This is such an important part of investing that PERA has adopted a Securities Litigation Policy to guide PERA in decision making. (An earlier PERA on the Issues article addresses that policy.) And although the ATP Tour decision currently is limited to state actions, specifically Delaware, and does not include actions brought under federal securities laws, investors are apprehensive that fee-shifting may become a trend.

Immediately following the ATP Tour decision, legislative efforts began in the hopes of undoing the potential damage caused by that decision. PERA, as well as other institutional investors with collective assets of almost $2 trillion, has made a point to join advocacy efforts to support legislative changes in Delaware that would prohibit this erosion of shareholder rights.

One of the primary efforts has been a letter from 21 different institutional investors, including Colorado PERA, to the Chair of the Delaware State Bar Association’s Corporation Law Council, an actively involved advocate to the Delaware legislature. In March 2015, the Delaware State Bar Association’s Corporation Law Council issued the most recent proposed legislation which, among other things, prohibits fee-shifting provisions in charters and bylaws of stock corporations. A bill accomplishing these goals was introduced into the Delaware Senate as Senate Bill 75 in April and passed on May 12, 2015. The bill has now been assigned to the House Judiciary Committee.

This world of fee-shifting bylaws is a new one. And PERA, along with its peer funds, is hopeful for a solution that will restore the balance of shareholder rights to where they belong – with the shareholders who are, after all, part owners of the company. Stay tuned!

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  • Jeffrey Sprole

Comments

  1. Peter Hansen says:

    Dear Sirs; Who made the decision to deduct from our annual increase of 3% per year when we retired and then changed it to 2%. Someone somewhere invested our hard earned money to make more money. and lost it in the trade.

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