United States: Adoption Of Fee-Shifting Bylaws By Pennsylvania Corporations

Recently, there has  been some unusual excitement in the corporate bar in Delaware after the Supreme Court of Delaware held that a nonstock corporation could adopt a bylaw requiring a losing plaintiff in a lawsuit involving the governance of the corporation to pay the corporation's legal fees (although the court left open the possibility that the bylaw could be invalid depending on the circumstances surrounding its adoption and use).1  Interest in the subject significantly increased when the Delaware Bar Association quickly moved to propose legislation invalidating that type of bylaw.  The U.S. Chamber of Commerce weighed in on the other side from the bar association and the Delaware Legislature then pushed off consideration of the issue until next year.2

We believe that the reasons cited by the Supreme Court of Delaware that validate a fee-shifting bylaw adopted by a Delaware corporation will also validate a fee-shifting bylaw adopted by a Pennsylvania corporation.  But we also believe that Pennsylvania corporations should seriously consider the same issues that are being debated in Delaware before acting.

Background on the Delaware Decision

In its decision in ATP Tour, Inc. v. Deutscher Tennis Bund, the Supreme Court of Delaware held that a nonstock corporation's bylaws may contain a fee-shifting provision and that such a provision could be enforceable against members who joined the corporation before as well as after the adoption of the bylaw.

ATP Tour Inc. ("ATP") was formed in the 1990s, and its membership consisted of various entities operating professional tennis tournaments.  In 2006, the board of directors of ATP adopted a fee-shifting bylaw applicable to intra-corporate disputes that required a plaintiff member to reimburse the corporation for its legal fees if the plaintiff "[did] not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought."  After successfully defending litigation brought against the company by some of its members, ATP sought to recover its legal fees under this bylaw provision.  The federal district court handling the litigation between ATP and the losing members certified several questions of law to the Delaware Supreme Court relating to the validity and enforceability of the bylaw.

The Supreme Court of Delaware concluded that it did not have enough of a factual basis to determine whether the ATP bylaw was valid as adopted and applied in the pending lawsuit.  However, the court answered the question in the abstract, holding that a fee-shifting bylaw was facially valid under Section 109(b) of the Delaware General Corporation Law (the "DGCL") and that the bylaw would be enforceable against members who joined before the adoption of the bylaw so long as the bylaw was not adopted or used for an improper purpose.

Delaware law presumes that a corporation's bylaws are valid and the courts will seek to uphold the bylaws in a manner consistent with law rather than strike them down.  DGCL § 109(b) provides that a bylaw may contain any provision that is "not inconsistent with law or with the certificate of incorporation, relating 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."  Applying the first part of that provision, the Delaware Supreme Court found that there is no statute or principle of common law forbidding the enactment of a fee-shifting bylaw.  The court further found that a bylaw that allocates the risk among parties in intra-corporate litigation relates to the business of the corporation and thus satisfies the second part of the requirement of Section 109(b).

Delaware law considers corporate bylaws to be a contract between the corporation and its stockholders.  Additionally, Delaware follows the "American Rule," which allows parties to agree by contract to allocate the cost of litigation.  Combining the two principles of law, the court found that a fee-shifting bylaw would not be prohibited under Delaware common law so long as the bylaw was not adopted or used for an inequitable purpose.

Lastly, the court held that because Section 109(a) provides that a corporation "may, in its certificate of incorporation, confer the power to adopt, amend or repeal bylaws upon the directors," the stockholders will be bound by bylaws adopted unilaterally by the board.3

An important aspect of the ATP case is the fact that it involved a nonstock corporation – what most other states call a nonprofit corporation.  Most states other than Delaware have a separate statute applicable to nonprofit corporations, but Delaware follows the unusual approach of having its General Corporation Law apply to both business corporations and nonprofit corporations.  Although the ATP decision does not involve a fee-shifting bylaw adopted by a Delaware business corporation, the logic of the court is equally applicable to business corporations because DGCL § 109 applies to both stock (business) corporations and nonstock (nonprofit) corporations.  The court, in fact, says nothing in its opinion to suggest that the result would be different if the bylaw had been adopted by a stock corporation instead of a nonstock corporation.

Applying the Delaware Rationale in Pennsylvania

Permissible contents of bylaws.  As in Delaware, the Pennsylvania Business Corporation Law (the "BCL") in Section 1504(a) permits a corporation to include in its bylaws "any provision for managing the business and regulating the affairs of the corporation not inconsistent with the law or the articles."  Thus, Pennsylvania and Delaware essentially look at the same two issues when evaluating the validity of a bylaw:

  1. Is the bylaw inconsistent with law and the corporate charter?
  2. Does the bylaw relate to the business and affairs of the corporation?

Given the close similarity between DGCL § 109 and BCL § 1504, we believe that a Pennsylvania court would likely conclude that a fee-shifting bylaw is facially valid based on the same principles as in Delaware.

Assuming that a fee-shifting bylaw would be valid under Pennsylvania law, the next question is whether a fee-shifting bylaw would apply to persons who are already shareholders at the time of the bylaw's adoption.

Which shareholders are bound by a bylaw amendment.  Perhaps the most influential Pennsylvania case on the enforceability of a bylaw against the shareholders of a Pennsylvania corporation is Bechtold v. Coleman Realty Co., which addressed the validity of a provision in corporate bylaws that imposed transfer restrictions on the corporation's shareholders.4

Bechtold affirmed that under Pennsylvania law certain types of bylaws are a contract between the corporation and its shareholders.  The Bechtold court also created a doctrine in Pennsylvania that distinguished between two kinds of bylaw provisions in Pennsylvania: (i) those that govern the conduct of the internal affairs of the corporation; and (ii) those that are designed to vest property rights among shareholders.5 Bechtold held that bylaws adopted in the first category may be amended under the usually applicable rules for amending the bylaws, but an amendment of a bylaw in the second category will not bind a shareholder that has not agreed to the amendment. 

We believe that a fee-shifting bylaw does not impact a property right vested in the shareholders and, therefore, would not fall under the second Bechtold bylaw category.  Rather, a fee-shifting bylaw seeks to govern the relationship between a corporation and its shareholders, and how to allocate the financial risk associated with an internal dispute regarding the affairs of the corporation.  Applying the Bechtold framework, we believe that a Pennsylvania court would likely agree with the conclusion of the Delaware Supreme Court that a properly adopted fee-shifting bylaw of a Pennsylvania corporation can apply to all of its shareholders.

Giving the board authority to amend the bylaws.  In order for the board of directors of a Delaware corporation to have the power to amend the bylaws, the board must be given that authority in the certificate of incorporation.  The Delaware Supreme Court in ATP noted that if the members have agreed to give authority to the board to amend the bylaws, then bylaws adopted by the board must be binding on the members.  Under BCL § 1504(a), the board of directors of a Pennsylvania corporation must also be given the authority to amend the bylaws, although the BCL permits the grant of authority to be contained in either the articles of incorporation or the bylaws.  The similarity between Delaware and Pennsylvania law on this issue is another reason why we believe that a Pennsylvania court would likely conclude that a fee-shifting bylaw will be binding on all of the shareholders of the corporation. 

Application of the American Rule in Pennsylvania.  Pennsylvania follows the American Rule on fee-shifting,6 which permits attorneys' fees in litigation to be shifted by statutory authorization, a clear agreement of the parties or some other established exception to the general rule that fees will be borne by the parties that originally incurred them.7  Pennsylvania courts interpret the phrase "clear agreement" to mean the language relied on to shift fees must be clear, and they analyze whether the fee-shifting provision clearly describes the agreement of the parties.8  If the bylaw clearly describes the agreement between the parties as to how the fee-shifting would occur, Pennsylvania courts would likely find the bylaw to be valid.

Final Considerations

While we believe there is clear support for the validity of fee-shifting bylaws under Pennsylvania law, we also believe there are practical considerations that should be evaluated by a Pennsylvania corporation before adopting a fee-shifting bylaw.  Those considerations include the following:

  • The potential reactions of shareholders and proxy advisory firms to the adoption of a fee-shifting bylaw.  Initial speculation by commentators is that these groups will be opposed to fee shifting bylaws in light of their opposition to bylaws that fix the exclusive forum for litigation regarding the internal governance of corporations.  If the opposition of proxy advisory firms becomes significant, adoption of a fee-shifting bylaw will need to be evaluated in the context of any other governance issues those firms have raised with respect to the corporation.
  • Related to the preceding consideration is the shareholder profile of the corporation and past issues the corporation may have faced with proxy advisory firms.
  • Whether other Pennsylvania corporations are adopting fee-shifting bylaws.
  • The timing of the adoption of the fee-shifting bylaw and whether the corporation is facing any issues that may lead to a question of improper purpose.  For example, if the bylaw is adopted shortly before or during a sale of the corporation, the bylaw may be challenged on the basis that the purpose of the bylaw is to forestall challenges to the sale transaction.
  • Continued discussion of the issue under Delaware law and what happens with respect to the delayed legislative action to amend the DGCL.  The Delaware Bar Association and the U.S. Chamber of Commerce are continuing to debate whether these types of provisions properly balance the interests of corporations in protecting themselves against meritless litigation and the interests of stockholders in enforcing the fiduciary duties of the board.  The lawyers argue that fee shifting bylaws are a dangerous compromise of the fundamental principle of corporate law that stockholders are not liable for debts of their corporation, while business interests see the lawyers motivated simply by their self-interested desire that litigation not be discouraged.

Footnotes

ATP Tour, Inc. v. Deutscher Tennis Bund, No. 534, 2013 (Del. May 8, 2014).

2  Liz Hoffman, Delaware to Weigh Who Pays Legal Fees in Corporate Litigation, The Wall Street Journal (June 10, 2014). The proposed Delaware amendment would explicitly limit the liability of stockholders to their investment and bar any bylaw or article of incorporation from expanding their potential liability. The text of the proposed legislative amendment can be found here.

3 No. 534, 2013 at 14 (citing Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934, 956 (Del. Ch. 2013)).

4 Bechtold v. Coleman Realty Co., 367 Pa. 208 (1951) (recently abrogated in part by an amendment to BCL § 1529 on the issue of transfer restrictions).

5 Id. at 213.

See McMullen v. Kutz, 985 A.2d 769, 775 (Pa. 2007) (affirming that under the American Rule "each side is responsible for the payment of its own costs and counsel fees absent bad faith or vexatious conduct" (quoting Lucchino v. Commonwealth, 809 A.2d 264, 267 (Pa. 2002))).

7 "This Court has consistently followed the general, American rule that there can be no recovery of attorneys' fees from an adverse party, absent an express statutory authorization, a clear agreement by the parties or some other established exception." Merlino v. Del. Cnty, 728 A.2d 949, 951 (Pa. 1999).

8 See Trizechahn Gateway LLC v. Titus, 976 A.2d 474, 482 (Pa. 2008) (in which an agreement by which a tenant agreed "to pay a reasonable attorney's fee if legal action is required to enforce performance by Tenant of any condition, obligation or requirement" was enforceable in an action to recover on a lease default).

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
William H. Clark, Jr.
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions