Investors and their advocates are speaking up against a Delaware Supreme Court decision that has inspired dozens of companies to adopt provisions that force plaintiffs to bear all costs of shareholder litigation, a maneuver that left unchecked could kill even the most meritorious private lawsuits.
Unilaterally adopted as changes to corporate bylaws or buried in IPO offering documents, these so-called “fee shifting” provisions go far beyond the “loser pays” rules in some non-U.S. jurisdictions. They are in fact one-sided measures that shift all litigation costs to plaintiffs even if the lawsuits they bring are wildly successful.
Worse still, some experts believe the Delaware Supreme Court’s May 8 ruling in Deutscher Tennis Bund v. ATP Tour, Inc. could open the door to similar conditions on other shareowner initiatives, such as proxy contests to replace directors.
In its ATP Tour, the court said fee-shifting provisions can be enforceable under Delaware law as long as they weren’t adopted for “improper” purposes. (By the way, the court said that trying to deter litigation against the board, even after it is filed, is not necessarily an improper purpose.) Though the ATP Tour case involved a private non-stock corporation, publicly traded companies have seized on its main holding to enact their own plaintiffs-pay provisions. In one notable example, the Chinese e-commerce company Alibaba Group Holding Limited included a fee-shifting provision on the last page of a document accompanying its record-setting September IPO, something the company didn’t bother to tell would-be investors.
The bylaws could expose not only plaintiffs, but also those who assist them or have a direct financial interest in their claims, to legal fees and expenses that dwarf their biggest potential recovery in a case. Moreover, the fee-shifting provisions kick in unless plaintiffs win substantially all of what the lawsuit sought. In other words, a plaintiff can get a judgment for 90% of damages or settle out of court for the same amount and still be forced to reimburse the corporation for legal costs.
The trend, which appears to be accelerating, has stirred investors and their allies to call on Delaware lawmakers and the Securities and Exchange Commission to act before shareowners are disenfranchised.
Investors Fight Back
This week, 20 institutional investors with nearly $2 trillion in assets under management wrote Delaware Gov. Jack Markell a letter urging “swift legislative action to curtail the spread of so-called ‘fee-shifting’ bylaws” to more than 30 companies since the ATP Tour decision.
The investors took issue with claims that raising the bar for shareholders contemplating lawsuits against corporate directors will deter frivolous litigation without harming shareowners’ rights.
“While lobbyists hired by corporate interests are trying to portray these bylaws as protecting shareholders, the exact opposite is true,” the letter stated. “These bylaws effectively make corporate directors and officers unaccountable for serious wrongdoing.”
Signatories to the letter included the state pension funds of California, Colorado, Connecticut, Florida, Massachusetts, New York, North Carolina and Oregon, city pension funds in Houston, New York and San Diego, the Middlesex County Retirement System and three Dutch asset managers.
The same group of investors also sent letters to proxy advisory services ISS and Glass Lewis to adopt policies “to oppose any effort by corporate directors to insulate themselves from accountability under the guise of bylaw or charter provisions that expose stockholders to personal liability for corporate expenses.”
Finally, the coalition sent letters to the Delaware state senator who sponsored a June bill to ban fee-shifting provisions in publicly traded corporations – and to the Delaware State Bar Association section chair drafting a successor to the bill, which was withdrawn in reaction to vigorous lobbying by the U.S. Chamber of Commerce. Draft language could be made available for public comment in the next few weeks, with a new bill potentially presented to the legislature in early 2015.
The Council of Institutional Investors, whose members represent more than $3 trillion in assets, has led the effort to counter the effects of the ATP Tour ruling. This week, CII General Counsel Jeff Mahoney wrote his own letter to the chair of the Corporate Law Section of the Delaware State Bar Association, one which appealed to the state bar’s own interests as well as those of shareholders.
Mahoney said allowing corporations “to unilaterally adopt fee-shifting provisions under the authority of the ATP Tour decision” would insulate corporate officials, reducing accountability to shareholders and eventually diminishing Delaware courts’ status as leading arbiters of U.S. business disputes.
“Simply put, the ATP Tour decision is bad for Delaware and bad for long-term investors,” he wrote.
Strange Bedfellows
In fact, the Delaware Supreme Court ruling has created some strange bedfellows, as lawyers who represent corporate defendants in litigation face the prospect of their lucrative hourly work drying up along with lawsuits.
Columbia University Law School Professor John C. Coffee, Jr. noted the “uniquely conflicted” position of Delaware corporate lawyers who could watch their workload decline as their clients face a significantly reduced exposure to shareholder litigation. “Never before have the interests of the Delaware bar and its clients clashed so directly,” he wrote in an article for the law school’s Blue Sky Blog.
A Solution from The SEC?
Coffee believes that the problem uncapped by the ATP Tour decision requires a solution that goes beyond Delaware. Even if the state legislature enacts a law limiting the spread of fee-shifting provisions, other pro-business states may seek to attract corporations by enabling loser-pays themselves. Oklahoma has already enacted a law approving fee-shifting in derivative actions in its state courts.
For that reason, Coffee and others have turned to the SEC to stanch what he calls “the first trickle of water through a leak in a dam,” the dam being private enforcement of state and federal securities laws.
In testimony before an Oct. 9 meeting of the SEC’s Investor Advisory Committee, Coffee urged the SEC to side “selectively” with investors to argue that federal law can preempt fee shifting unless it is warranted by violations of Federal Rule of Civil Procedures 11. He also asked the SEC to refuse to “accelerate” registration statements in public offerings of companies that put fee-shifting provisions in their charters or bylaws, a practice that has successfully convinced companies going public to abandon mandatory arbitration provisions. In addition, Coffee wants the SEC “to require registrants to state in their registration statements that they understand that the SEC believes that the federal securities laws are inconsistent with fee-shifting bylaws.”
Two weeks after Coffee testified, U.S. Sen. Richard Blumenthal, a Connecticut Democrat, wrote SEC Chair Mary Joe White to investigate Alibaba because it “failed to disclose to investors the existence of provisions limiting private citizen suits.” In his Oct. 29 letter, Sen. Blumenthal said that the ATP Tour decision represented “a serious and imminent threat” to U.S. capital markets because it allows Delaware corporations “to unilaterally amend their bylaws and effectively immunize themselves from the possibility of shareholder lawsuits.”
Sen. Blumenthal correctly noted that the potential financial risk to shareholders who bring a lawsuit, no matter how meritorious, against corporations could turn soon turn private litigation into “an empty threat.”
“No rational investor, even with significant financial interests at stake and when presented with clear evidence of corporate misconduct, will brave litigation when the corporate defendant can force the investor to face financial ruin unless he substantially wins on every point,” Sen. Blumenthal wrote.
The SEC, thus far, has remained silent.