Delaware Supreme Court Upholds Fee-Shifting Bylaw
On May 8, in ATP Tour v. Deutscher Tennis Bund, the Delaware Supreme Court held that a board-adopted bylaw shifting attorneys’ fees and costs in intra-corporate litigation to unsuccessful plaintiffs is facially valid. Due to the deterrent effect of “loser pays” provisions, the decision could have a significant impact on the dynamics of stockholder litigation.
Under Delaware law, corporate bylaws are presumed to be valid, and the Court stated that a bylaw allocating risk among parties to intra-corporate litigation is permissible under the Delaware General Corporation Law (DGCL). The Court noted that there is no requirement that a fee-shifting provision be included in the charter and that there is no principle of common law that prohibits directors from adopting such a bylaw. While Delaware follows the American Rule, under which each party to litigation generally pays its own legal costs, the Court stated that it is settled law that parties to litigation may agree to modify that rule by contract. Because bylaws are contracts under Delaware Supreme Court precedent, a fee-shifting provision would fall within the contractual exception.
Since the opinion responded to certified questions of law from the US District Court for the District of Delaware, the Court was not addressing a specific fact pattern. Accordingly, the Court cautioned that a facially valid bylaw will not be enforced if it is adopted or used for inequitable purposes: “inequitable action does not become permissible simply because it is legally possible.” Notably, the Court went on to state: “[t]he intent to deter litigation, however, is not invariably an improper purpose.”
ATP Tour arose in connection with a dispute involving a Delaware non-stock, membership corporation, but it has broader implications since most provisions of the DGCL, including those concerning bylaws, apply to both traditional and non-stock corporations. The opinion extensively cites Delaware case law involving traditional corporations.
A public company considering a fee-shifting bylaw should factor in the potential reaction of its stockholders, stockholder rights advocates and proxy advisory services. Additionally, adopting such a bylaw in response to actual or threatened litigation, rather than on a “clear day,” could negatively affect its enforceability.