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Delaware Court of Chancery Restricts Board’s Ability to Subject Former Shareholders to New Bylaws

The Delaware Court of Chancery recently held, in a case of first impression, that a non-reciprocal fee-shifting bylaw cannot be applied to a claim brought by a former shareholder who had been cashed out of the company before the bylaw was adopted.

 

 

In May 2014, First Aviation Services, Inc. completed a 10,000 – 1 reverse stock split at the instigation of the CEO and controlling stockholder. As a result of this transaction, Plaintiff Robert Strougo and other shareholders/putative class members were involuntarily cashed out, thereby making First Aviation a privately owned company. Four days later, First Aviation’s Board of Directors adopted a bylaw that applied to current and former shareholders and shifted attorney’s fees and litigation expenses to unsuccessful plaintiff-shareholders, but did not impose a parallel obligation on First Aviation or its officers or directors. Strougo filed suit in June 2014 alleging the reverse stock split was a breach of fiduciary duty and challenging the fee-shifting bylaw.

Before addressing the enforceability of the bylaw to the plaintiff, the court observed that the practical effect of the one-way fee-shifting bylaw was to immunize the reverse stock split from review because the risk of an attorney’s fee award would deter most rational stockholders (and their counsel) from suing. The court, however, did not need to reach the “serious policy” issues raised by the fee-shifting bylaw because the court held that the bylaw could not apply to Strougo as he was not a shareholder at the time the bylaw was adopted. Starting with the premise that bylaws are contracts among the shareholders, once the reverse stock split terminated Strougo’s status as a shareholder, he was no longer a party to the corporate contract. The court, therefore, reasoned that Strougo could no longer be bound by future amendments to the contract, i.e., First Aviation’s charter or bylaws. The court distinguished the case from the recent Delaware Supreme Court decision in ATP Tour, Inc. v. Deutscher Tennis Bund., 91 A.3d 554 (Del. 2014), because the non-reciprocal fee shifting bylaw upheld there was not adopted after the plaintiff’s stockholder interest terminated.

Strougo v. Hollander, C.A. No. 9770-CB (Del. Ch. Mar. 16, 2015).

 

©2020 Katten Muchin Rosenman LLPNational Law Review, Volume V, Number 79

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About this Author

Zachary D Denver, Litigation Attorney, Katten Muchin Rosenman
Associate

Zachary Denver concentrates his practice in litigation and dispute resolution matters.

While attending law school, Zachary was an editor of the NYU Journal of Law and Liberty, and was a board member for the Suspension Representation Project.

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