Delaware Supreme Court Upholds Facial Validity of Fee-Shifting Provisions in Bylaws of Delaware Non-Stock Corporation

On May 8, 2014, the Delaware Supreme Court sitting en banc unanimously decided ATP Tour, Inc. v. Deutscher Tennis Bund (German Tennis Federation), No. 534 (2013) (Del. May 8, 2014). The court held that fee-shifting provisions in the bylaws of a Delaware non-stock corporation are on their face valid and are enforceable against members who joined before their adoption. The Court further stated that adopting fee-shifting provisions with an intent to deter litigation would not necessarily render such bylaws unenforceable. The Court's conclusion logically extends to Delaware stock corporations, as its analysis draws upon case law concerning Delaware stock corporations and the Delaware General Corporation Law (DGCL) and describes bylaws as a contract between a company and its investors (under which the typical American Rule that each party bear its own attorneys' fees and costs could be modified).


ATP Tour, Inc. (ATP), a Delaware membership corporation, operates a global professional men's tennis tour. ATP's members include entities which own and operate tennis tournaments, and tennis players. Two entities, Deutscher Tennis Bund (DTB) and Qatar Tennis Federation (QTF) joined ATP in the early 1990s and agreed to be bound by its bylaws, as amended from time to time. In 2006, ATP's board of directors amended ATP's bylaws to add a provision stating that if a current or former member initiates litigation against ATP, and "does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought," then the member initiating litigation would be obligated to reimburse ATP for any fees, costs and expenses incurred by ATP in connection with such litigation. In 2007, these entities challenged a decision made by ATP, suing the company and six of its seven directors in the U.S. District Court for the District of Delaware. The plaintiffs lost their claims on the merits, and ATP moved to recover its fees, costs and expenses pursuant to the new fee-shifting provision. The District Court certified questions concerning the validity and enforceability of fee-shifting bylaws to the Delaware Supreme Court, which found such bylaws to be facially valid.

Key Takeaways

Shifting Litigation CostsShifting the cost of defending litigation to unsuccessful plaintiffs could decrease the frequency of shareholder litigation against Delaware corporations and mitigate the significant costs, monetary or otherwise, of shareholder litigation. However, such measures may also have the unintended effect of discouraging meritorious litigation.

Potential Delaware Legislative ResponseIn response to the Court's decision, the Delaware State Bar Association proposed an amendment to the DGCL that would effectively overrule the Delaware Supreme Court's ruling. The amendment aimed to limit the applicability of the holding to only non-stock corporations and limit the imposition of monetary liability by Delaware corporations on stockholders through charter or bylaw provisions. As a result of lobbying efforts by several Delaware headquartered corporations, the Delaware legislature has tabled until early 2015 discussion of the proposed amendment.

Amending BylawsIn the interim, boards of directors of both public and private Delaware corporations may seek to amend their bylaws to adopt fee-shifting provisions, either in the form permitted by the ATP Tour decision or an alternative that seeks to take into account the potential legislative response to the decision. Given the current uncertainty at the legislature, such provisions run the risk of being rendered invalid by future legislative action. Delaware corporations must also consider the possibility that activist stockholders may try and adopt provisions that oppose or restrict any fee-shifting construct. Boards should consider the corporate environment in which such provisions are adopted and how stockholders and proxy advisory firms may react and whether it may be seen as an anti-corporate governance maneuver.

Applicability of Fee-Shifting ProvisionsEven if valid on their face under Delaware law, fee-shifting bylaws may not be viable in every circumstance. Federal law could preempt Delaware law with regard to the enforcement of fee-shifting provisions in connection with federal law based claims (e.g. in the context of antitrust actions), other states may have different rules regarding fee-shifting, and other courts may apply non-Delaware law in interpreting or enforcing a fee-shifting bylaw leading to unintended results. Finally, the circumstances at the time of adoption of a fee-shifting bylaw may affect the enforceability thereof, for example, if adopted in the face of an active claim the bylaw may be seen as an impermissible attempt at entrenchment.


Court of Chancery Analyzes Allegations of Divided Loyalties Among Target Company's Directors and Officers

In Chen v. Howard-Anderson (C.A. No. 5878-VCL (Del. Ch. Apr. 8, 2014)), Vice Chancellor Laster of the Delaware Court of Chancery evaluated allegations that a target company's directors and officers breached their fiduciary duties in connection with a change-in-control transaction by favoring the winning bidder, which favoritism caused other bidders (who may have been willing to pay a higher price) to avoid the sale process.

This action arose in connection with Calix, Inc.'s 2010 acquisition of Occam Networks, Inc. The plaintiffs alleged that director-affiliated investment funds holding approximately 25% of Occam's stock had conflicting loyalties and that Occam's senior officers showed favoritism to a bidder that confirmed its willingness to honor management's change in control agreements and monetize their equity awards. In evaluating at the summary judgment phase whether Occam's directors breached their fiduciary duty of loyalty, the Court held that the plaintiffs needed not only to establish that the affiliation with the investment funds presented a potential conflict but also to provide evidence supporting an inference that the directors "made decisions that fell outside the range of reasonableness for reasons other than pursuit of the best value reasonably available." In doing so, the Court rejected the defendants' attempt to invoke the standard set forth in the Delaware Supreme Court's Lyondell decision, namely that to subject independent directors to liability under the good faith aspect of the duty of loyalty a plaintiff must show that such directors "utterly failed" to satisfy known duties. The Court held that the "utterly failed" standard for bad faith applies only to claims that directors had consciously disregarded known duties, not to claims (as in this case) that directors acted with a purpose other than advancing the best interests of the corporation.

However, in applying the relevant standard, the Court concluded that the directors did not breach their duty of loyalty in connection with the sale process. Vice Chancellor Laster concluded that even if there is the potential for a director to have divided loyalties, there is no conflict if the interests of the director's affiliates are aligned with those of the common stockholders.

Occam's senior officers fared less well on summary judgment, even though the alleged conflict only related to fairly standard change of control benefits the officers would receive in a potential acquisition transaction. The Court rejected the officers' motion for summary judgment, noting that the record showed that the bidder to whom the officers showed alleged favoritism was "willing to confirm that it would honor management's change in control agreements and monetize equity awards."

Stockholder Plaintiffs Must Allege "Extreme" Facts to Sustain Revlon Process Claims Against Disinterested Directors

A recent decision from the Delaware Court of Chancery (Houseman v. Sagerman, C.A. 8897-VCG (Del. Ch. Apr. 16, 2014)) dismissing stockholder plaintiffs' claims concerning an allegedly defective sales process illustrates the high bar that the Court will apply to Revlon process claims against a disinterested board. In Houseman, the Court rejected the plaintiffs' claims that the directors of Universata, Inc. breached their fiduciary duties by administering an inadequate sale process in connection with the sale of Universata to HealthPort Technologies, LLC, during which the Universata board did not obtain a fairness opinion in support of the transaction.

In 2010, HealthPort and at least one other potential acquirer approached Universata regarding a potential transaction. The Universata board retained KeyBanc Capital Markets, Inc. to advise the board in connection with the deal. Concerned with costs, Universata's board limited the scope of KeyBanc's engagement and did not request a fairness opinion from KeyBanc. Nevertheless, Universata's board approved the transaction in which HealthPort acquired all of Universata's outstanding stock.

Vice Chancellor Glasscock rejected the plaintiff's claims of a defective sales process, stating that while the board "did not conduct a perfect sales process," the board did not "utterly fail to undertake any action to obtain the best price for stockholders." Indeed, the Court held that the board had fulfilled its duty of loyalty by consulting with legal and financial advisors, considering offers from various bidders, and negotiating with HealthPort. That deferential standard shows that stockholder plaintiffs need to allege sufficiently "extreme" facts in order to discredit a sale process conducted by a board consisting of a majority of independent directors.

The plaintiffs also brought aiding and abetting claims against KeyBanc, asserting that KeyBanc was liable for the defective sale process because it failed to issue a fairness opinion or otherwise administer an appropriate process. In evaluating that claim, the Court confirmed Vice Chancellor Laster's holding from In re Rural Metro Corp. that a corporation's exculpation provision will not immunize financial advisors or acquirors from aiding and abetting liability. However, the Court concluded that the plaintiffs had failed to allege that KeyBanc "knowingly participated" in any wrongdoing by the Universata board, rejecting the claim that KeyBanc's limited engagement was improper or constituted knowing participation in any purported breach of fiduciary duties by the Universata board.

Despite Favorable Ruling, Sotheby's Settles With Activist Investor

The Delaware Court of Chancery declined to invalidate Sotheby's adoption of a two-tiered stockholder rights plan (poison pill) with a lower trigger for activist investors. The Sotheby's board subsequently settled with the activist investor the poison pill was meant to deter.

On May 2, 2014, Vice Chancellor Parsons declined to overturn a poison pill that would limit activist investors to holding no more than 10 percent of Sotheby's shares, while permitting passive investors to hold as much as 20 percent. The Sotheby's board adopted this plan in October 2013 after learning that activist investor Third Point Capital LLC had accumulated just under 10 percent of Sotheby's stock. As noted in the Q1 2014 edition of the Recap, Third Point subsequently filed suit against Sotheby's seeking to invalidate Sotheby's poison pill. Third Point also launched a proxy contest to name three of its designees to Sotheby's board and sought a preliminary injunction to delay Sotheby's annual stockholder meeting.

Applying the Court's heightened standard of review from Unocal Corp. v. Mesa Petroleum Co. with respect to defensive tactics, Vice Chancellor Parsons declined to enjoin Sotheby's annual meeting and determined that the rationale behind Sotheby's stockholders rights plan was both reasonable and proportionate to the threat posed by activist investors. As part of its analysis, the Court accepted the notion that a "wolfpack" of activist investors who form together for the purpose of jointly acquiring large blocks of a target company's stock could pose a legally cognizable threat to stockholders.

Vice Chancellor Parsons also noted that there was a substantial possibility that Third Point would win its proxy contest, making any preliminary intervention by the Court unnecessary. At the time of the Court's decision, Third Point had already won the support of Sotheby's third-largest stockholder, another activist investor, as well as support for two of its three nominees from ISS.

Notwithstanding Vice Chancellor Parson's decision, Sotheby's announced on May 5, 2014 an agreement to appoint Third Point's three designees to the board and to allow Third Point to increase its equity stake in Sotheby's to 15 percent. The settlement is one in a growing trend of recent settlements with activist investors. (Third Point LLC v. Ruprecht, C.A. 9469-VCP (Del Ch. May 2, 2014)).

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