In an exception to the “American Rule”—under which which each litigant, whether successful or not, pays only her own legal fees—courts have developed the long-standing “common corporate benefit” (or, “corporate benefit”) doctrine, to order corporations to reimburse the attorneys’ fees and expenses of shareholder plaintiffs whose litigation benefited at least one class of shareholders.
As the United States Supreme Court explained in the context of a securities action, although the statute at issue did not explicitly provide for such fee-shifting, “private stockholders’ actions of this sort ‘involve corporate therapeutics,’ and furnish a benefit to all shareholders by providing an important means of enforcement of the proxy statute. To award attorneys’ fees in such a suit to a plaintiff who has succeeded in establishing a cause of action is not to saddle the unsuccessful party with the expenses but to impose them on the class that has benefited from them and that would have had to pay them had it brought the suit.” Mills v. Electro Auto-Lite Company, 90 S.Ct. 616, 628 (1970).
The Delaware Court of Chancery has indicated that such reimbursement is justified in the event of “(1) the presentation of a meritorious corporate claim by a shareholder, (2) the expenditure of funds or credit by the shareholder in investigating such claim, (3) action by the board that confers a quantifiable financial benefit on the corporation, (4) which action is ‘causally related to the making of the shareholder demand.’” Bird v. Lida, Inc., 681 A.2d 399, 405 (Del. Ch. 1996).
Yet until recent years, the reverse of this proposition has been much less clear: if a shareholder’s action against the corporation and/or one or more of its agents is not substantially successful, can the defendants recover their legal fees and expenses from the shareholder?
Allowing this form of fee-shifting might reduce unjustified litigation, but it could also discourage shareholders from asserting legitimate claims that could benefit the corporation and its other shareholders, if potential plaintiffs fear personal liability for the charges of a company’s and/or its executives’ top-flight (and top-billing) counsel.
In ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 556 (Del. 2014), the Delaware Supreme Court confronted such a policy in the bylaws of a membership corporation, under which any player or owner whose action against the sports league or any of its constituents (including any claim purportedly filed on behalf of the league or any of its constituents) “does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought” would be required to reimburse the defendants’ responsive “fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses).”
The Court observed that fee-shifting bylaws (or such provisions in a certificate of incorporation) did not violate any section of the Delaware General Corporation Law (DGCL) or any other Delaware statute, and that “no principle of common law prohibits directors from enacting” such policies unilaterally, without a shareholder vote. Id. at 558. In fact, as an attempt to “allocate[ ] risk among parties in intra-corporate litigation” such provisions fall within DGCL Section 109(b)’s broad requirement that bylaws “relat[e] to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.” Id. at 558.
The following year, the Delaware Legislature effectively overruled the ATP Tour decision by adding to the DGCL’s Section 109(b)—and creating as Section 102(f), part of the Section concerning the content of certificates of incorporation—a sentence prohibiting either of these documents from including “any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an internal corporate claim, as defined in §115 of this title.”
Section 115, added to the DGCL that same year to authorize forum selection bylaws, defined “internal corporate claims” as those, “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 this title confers jurisdiction upon the Court of Chancery.”
In Solak v. Sarowitz, 153 A.3d 729 (Del. Ch. 2016), the Court of Chancery addressed the validity of a fee-shifting provision that directors of the Paylocity Holding Corporation had added to the company’s bylaws at the same time as they had inserted an exclusive forum bylaw requiring internal corporate claims to be brought in a state or federal court in Delaware.
In the Court’s summary, the provision “shifts the company’s litigation expenses (including attorneys’ fees) to any stockholder who brings, substantially assists, or has a direct financial interest in any ‘Action’ in a forum not located in Delaware, unless the stockholder obtains a judgment on the merits that substantially achieves the full remedy sought.” Id. at 735.
Despite the bylaw’s applicability only to internal corporate claims filed in a non-Delaware forum, the Court agreed with the shareholder plaintiff that it violated the newly-revised Section 109(b), which “unambigously prohibits the inclusion of ‘any provision’ in a corporation’s bylaws that would shift to a stockholder the attorneys’ fees or expenses incurred by the corporation ‘in connection with an internal corporate claim,’ irrespective of where such a claim is filed.” Id. at 741.
However in Manti Holdings, LLC v. Authentix Acquisition Co., Inc., 2020 WL 4596838 (Del. Ch.) at *2, the Court upheld the following “loser-pays” provision, which appeared not in bylaws but in a stockholder agreement: “In the event of any litigation or other legal proceeding involving the interpretation of this [Stockholders] Agreement or enforcement of the rights or obligations of the Parties, the prevailing Party or Parties shall be entitled to recover reasonable attorneys’ fees and expenses in addition to any other available remedy.”
“Here, the fee shifting mechanism was adopted by sophisticated parties—including the Petitioners—in a negotiated transaction. Because. . . . stockholder agreements are of a different character than charters and bylaws, the prohibition is inapplicable, and there is no subversion of the hierarchy,” id. at *8, in which, as Delaware caselaw has recognized, “the DGCL comes first, then the charter, then the bylaws, then contracts [, and p]rovisions in lower-order documents cannot trump those in higher-order documents.” Id. at *7.
Parties considering installing fee-shifting arrangements in documents related to a corporation could consider:
First, if the company is not incorporated in Delaware, does its state have statutory provisions and/or caselaw that follow those of Delaware in this context?
Second, if the company is not incorporated in Delaware, does a choice of law provision in a contract, license, or other arrangement invoke the Delaware rules discussed above?
Third, could a fee-shifting arrangement be enforceable if it is included in a shareholder agreement that does not apply the same way to all of the agreeing shareholders?
Fourth, in a situation governed by Delaware law, could a fee-shifting arrangement be included in the terms of specific classes of stock, or would the required discussion of those terms in the company’s certificate of incorporation, under DCGL Section 102(a)(4), thereby violate Section 102(f)?
Fifth, under Delaware statutory provisions and caselaw, in what documents besides shareholder agreements, as in the Manti Holdings decision, could enforceable fee-shifting provisions (even if they govern “internal corporate claims”) be included?
Sixth, is there any ambiguity in DCGL Section 115’s definition of “internal corporate claims”? If so, how could it be clarified by a bylaw or certificate provision, or in a corporate agreement?
Seventh, could the bylaws or certificate of incorporation provision validly recharacterize as “internal corporate claims,” and thus as not subject to fee-shifting, specific types of claims that do not fall within Section 115’s definition, thereby effectively protecting potential plaintiffs to a greater degree than Sections 109(b) and 102(f) already do? If so, what types of claims should be considered for such treatment?
Eighth, if an otherwise enforceable fee-shifting provision is triggered only, as in the provision at issue in the Solak decision, upon a party’s obtaining “a judgment on the merits that substantially achieves the full remedy sought,” is there any way to clarify, in the bylaws and/or the certificate of incorporation, the level of “substantially achievement” necessary?
Ninth, would there be any reason for a corporation to install in its bylaws or certificate of incorporation a provision reflecting any existing caselaw and procedural rules that entitle a corporate and/or executive defendant to reimbursement of its legal fees and expenses if a shareholder’s complaint is found by a court to be frivolous?
Tenth, although this situation is not directly addressed by the amendments to the DGCL, would there be any reason for a board to attempt to clarify in the company’s bylaws and/or certificate of incorporation the application of the “corporate benefit rule” to reimburse a shareholder’s legal fees and expenses? Would such a provision be enforceable, particularly if it attempted to restrict the circumstances under which relevant caselaw would support such reimbursement?