United States: Is The Free Lunch Ending For Stockholders Who Sue Corporations? Fee-Shifting Introduced In Intra-Corporate Litigation

Last Updated: May 23 2014
Article by Daniel J. Dunne

ATP Tour: The Little Case That Could

On May 8, 2014 the Delaware Supreme Court upheld a "loser pays" fee-shifting bylaw for a Delaware non-stock corporation in ATP Tour, Inc. v. Deutscher Tennis Bund. While the decision was released with little heralding, if ATP Tour's "loser pays" provisions are widely adopted by public corporations and held also to be valid, the decisionmay create a significant impediment to the ubiquitous lawsuits alleging that directors have breached their fiduciary duties of loyalty and care to the corporation.

The board of ATP Tour, a membership organization that operates men's professional tennis competitions, enacted a fee-shifting bylaw which provides that a "Claiming Party," i.e. a member organization, would be liable for the corporation's attorneys' fees and other litigation expenses if it loses in an intra-corporation claim against the company. The fee-shifting bylaw obligates any Claiming Party to reimburse the League and any member or owner of ATP Tour that the Claiming Party also sued.

In responding to certified questions from a Delaware federal court where the ATP Tour civil action is pending, Delaware's Supreme Court held that a "loser pays" provision in corporate bylaws can be valid and enforceable. The court recognized that Delaware generally follows the "American Rule," wherein each party to the litigation pays its own costs, but held that there is no provision under the Delaware General Corporation Law, or under any principal of the common law, that would prohibit "contracting parties . . .to . . . obligate the losing party to pay the prevailing party's fees [in a dispute]." Because corporate bylaws are a form of contract between the corporation and its shareholders, the court found no basis to impose a different rule in the corporate context. To be effective, a "loser pays" bylaw need only be validly enacted for a proper cause following proper procedure. Of particular significance, the court recognized that deterring litigation—a principal goal of "loser pays" provisions—is not an improper purpose.

Here, the Delaware Supreme Court was not presented with the question whether the particular fee-shifting provision before it was validly enacted, and left that factual determination to the District Court. The Supreme Court only offered its guidance that the determination is highly fact-specific, and that the key to a valid fee-shifting bylaw is the factual determination whether the bylaw was properly enacted, accounting for the all circumstances of when and how the board decided to adopt the bylaw

Notably, although ATP Tour is a non-stock organization, there is nothing in the language of this decision or the in legal principals cited by the court which appears to limit the outcome of ATP Tour to non-stock corporations. Indeed, the language of the decision itself (and in the cases cited by the court) characterizes bylaws as a contract between a corporation and shareholders, suggesting that the Delaware Supreme Court foresees the broader implications of the ATP Tour decision for stock corporations.

The Court also was not called on to determine whether the extension to "any member or owner" was enforceable. An important question will be whether ATP Tour can be applied to lawsuits in which the corporation is only a nominal party. Even more important, will Delaware courts balk at enforcing stock corporation bylaws that shift fees for the benefit of officers or directors who are sued by virtue of their corporate roles? If ATP tour is given its broadest possible effect and is extended to directors and officers, it will certainly change the landscape of Delaware stockholder litigation.

What Happens If It Does?

In future shareholder derivative lawsuits, broad application of the ATP Tour holding may place small shareholders and union pension funds, which populate the plaintiff's pool, at direct risk for litigation fees that may easily run to millions of dollars. For most, the risk is likely to far outweigh the small possibility of a potential substantial reward from derivative litigation. Given the magnitude of attorneys' fees that can be in play, the "loser pays" provision could potentially alter the calculus in proxy battles between corporate management and activist investors.

As for certain public and union pension funds which have been conspicuous in their willingness to act as repeat plaintiffs in Delaware shareholder cases, the officers of those funds may face their own personal financial liability if they breach their fiduciary duties by exposing their funds to "loser pays" liability for no direct financial benefit to the fund, especially if fund beneficiaries obtain discovery about perks and benefits the officers received from the lawyers. One conceivable response would be for repeat institutional plaintiffs to create shell entities to hold stock subject to litigation and to transfer and assign all rights to the entity, including all legal claims, and in doing so, also make remote the risks from fee-shifting provisions. Although conceivable in theory, this would be hard to effect in reality, even if permitted by pension rules. Such schemes may not thread the needle of Delaware's strict stockholder standing rules which require continuous ownership of the stock throughout the events at issue in the lawsuit.

When lawsuits are brought subject to "loser pays" bylaws, corporations will have substantially greater leverage to settle favorably, or to demand simply that plaintiff dismiss its complaint voluntarily or risk crippling financial liability. On the other hand, these provisions may incentivize corporations to overplay their hand and improvidently reject settlements that they would be better accepting.

By far, the largest potential impact could come in the context of the ubiquitous challenges to mergers and acquisitions. According to the Wall Street Journal, shareholders challenged 94% of all corporate mergers in 2013, up from 44% in 2007. Together with Delaware-specific forum and venue provisions, wide-spread adoption and application "loser pays" provisions by Delaware-chartered corporations could chill these suits. Challenges to cash-out mergers are typically filed as class actions. If the ATP Tour holding is held to apply to shareholder class actions, in which the corporation is not a party but is on the hook for expenses by virtue of its obligations to indemnify directors and officers, knee-jerk M&A litigation may virtually disappear.

In the wake of ATP Tour, the shape of stockholder lawsuits in Delaware will be determined by three developments—the number of corporations that adopt loser pay provisions, the breadth of the provisions, and whether Delaware courts substantially confine ATP Tour to its particular facts. Pending future developments, many corporations should consider adding a "loser pays" bylaw to their arsenal of defensive measures against meritless shareholder litigation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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