Update on “Loser Pays” Fee Shifting

The Delaware State Senate passed legislation on May 12th that will preclude “loser pays” fee shifting by bylaw or charter provision—sometimes. The Delaware House is expected to act sometime in June. But the pending legislation only bars such fee-shifting “in connection with an internal corporate claim.” Internal corporate claims are narrowly defined in a new Section 115 of the DGCL to mean claims “(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.” This definition does not clearly cover securities class actions (which need not and generally do not allege any fiduciary breach). The result is an unnecessary ambiguity and likely underinclusion, as federal antitrust, securities and related fraud actions (e.g., RICO) are not seemingly reached. Thus, fee-shifting bylaws could apply to these types of actions, unimpeded by the new statute.

Nonetheless, some believe the Delaware courts will still read the new legislation to fill this apparent gap or, alternatively, will rule that bylaws under DGCL § 109 cannot shift fees incurred with respect to the litigation of a shareholder’s “personal” claims.[1] But that may require some tortured reasoning, because the Delaware Supreme Court ruled just last year in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A. 3d 554 (Del. 2014), that fee-shifting by bylaw could apply with respect to antitrust claims.[2] Both antitrust and securities actions are third party actions brought against the corporation for its misconduct, and not “internal corporate claims” based on fiduciary duties. If fee shifting is possible in an antitrust case, it logically seems equally possible in a securities case, and nothing in the pending legislation broadly overrules ATP Tour.

Still, Delaware judges may wish to resolve this issue and close the gap before any federal court rules on whether federal law preempts efforts to shift fees in a securities or antitrust action. Thus, what should happen next procedurally? A potential lead plaintiff in a securities class action could sensibly bring a declaratory action, either in federal court or in Delaware Chancery Court, arguing that its ability to sue has been foreclosed by a fee-shifting bylaw that is invalid under the new Delaware statute. If brought in federal court, that court might stay this action and certify the issue of the proper construction of the Delaware statute to the Delaware Supreme Court (which is exactly what happened in ATP Tour). If the Delaware Supreme Court reads the new statute to bar fee shifting in securities class actions, the matter is at an end. If not, the federal court can now proceed to the federal preemption issue, and the plaintiff should request the SEC to appear as an amicus curiae. This approach is quicker, but leaves open the possibility of some fee-shifting if the suit is lost on all theories.

Alternatively, the plaintiff could sue in the Chancery Court, again seeking a declaratory judgment that fee-shifting would violate the new Delaware statute. This will take longer (because the issue cannot be resolved authoritatively until the Delaware Supreme Court speaks), but an action in the Delaware Chancery Court will be more clearly exempt from fee-shifting under the statute. The tradeoff here is speed versus safety.

Eventually, however, the SEC will be asked to take a position—either because (1) the Delaware courts may read the new statute, consistent with ATP Tour, not to apply to federal securities claims, or (2) corporations in other jurisdictions (most notably Nevada and some foreign jurisdictions) have already adopted very broad fee-shifting bylaws to which the Delaware legislation does not apply.

This story has another chapter or two to go, and eventually the SEC will need to take a stand.

[1] Very recently, in In re Activision Blizzard, Inc. Stockholder Litigation, C.A. No. 8885-VCL (May 20, 2015), Vice Chancellor J. Travis Laster suggested that a Rule 10b-5 claim “is a personal claim akin to a tort claim for fraud” and “not a property right associated with shares.” Id at p. 50. This could be a hint that such “personal” claims cannot be regulated by bylaws adopted pursuant to DGCL § 109. Time will tell.

[2] ATP Tour specifically upheld fee shifting in a case where the underlying costs were largely incurred defending a federal antitrust action. The case only found the bylaw to be “facially valid” and did not inquire into the circumstances surrounding its adoption. Also, the case involved a non-stock corporation, and fiduciary duty claims were litigated and rejected in addition to the antitrust claims. Distinctions thus can be drawn, but the decision was written in the broadest possible language and specifically noted that the goal of seeking to deter litigation could be legitimate.

The preceding post comes to us from John C. Coffee, Jr., the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance.