Delaware Supreme Court Upholds Fee-Shifting Provision in Corporate Bylaws

In ATP Tour, Inc. v. Deutscher Tennis Bund,[1] the Delaware Supreme Court addressed certified questions of law from the United States District Court for the District of Delaware.[2]  The case involved a Delaware nonstock corporation whose amended bylaws contained the following provision:

(a) In the event that (i) any [current or prior member or Owner or anyone on their behalf (“Claiming Party”)] initiates or asserts any [claim or counterclaim (“Claim”)] or joins, offers substantial assistance to or has a direct financial interest in any Claim against the League or any member or Owner (including any Claim purportedly filed on behalf of the League or any member), and (ii) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Claim the Claiming Party had a direct financial interest) does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then each Claiming Party shall be obligated jointly and severally to reimburse the League and any such member or Owners for all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses) (collectively, “Litigation Costs”) that the parties may incur in connection with such Claim.

A subsequent claim raised by several members of the corporation against the corporation and six of its directors for both breach of fiduciary duty and violation of antitrust law led to a ten-day trial, after which the court granted judgment as a matter of law on the bulk of the claims.  Subsequently, the parties engaged in a dispute in both District Court and the U.S. Court of Appeals for the Third Circuit regarding the enforceability of the fee-shifting provision.

Fee-shifting provisions in LLC operating agreements are routinely enforced under Delaware law.[3] However, the enforceability of fee-shifting provisions in corporate bylaws is an issue not previously dealt with by Delaware courts. Accordingly, the District Court certified four questions of law to the Delaware Supreme Court:

1. May the Board of a Delaware non-stock corporation lawfully adopt a bylaw (i) that applies in the event that a member brings a claim against another member, a member sues the corporation, or the corporation sues a member (ii) pursuant to which the claimant is obligated to pay for “all fees, costs, and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses)” of the party against which the claim is made in the event that the  claimant “does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought”?
2. May such a bylaw be lawfully enforced against a member that obtains no relief at all on its claims against the corporation, even if the bylaw might be unenforceable in a different situation where the member obtains some relief?
3. Is such a bylaw rendered unenforceable as a matter of law if one or more Board members subjectively intended the adoption of the bylaw to deter legal challenges by members to other potential corporate action then under consideration?
4. Is such a bylaw enforceable against a member if it was adopted after the member had joined the corporation, but where the member had agreed to be bound by the corporation’s rules “that may be adopted and/or amended from time to time” by the corporation’s Board, and where the member was a member at the time that it commenced the lawsuit against the corporation?

On the novel issue of the general enforceability of the provision, the Supreme Court held that fee-shifting provisions may lawfully be included in corporate bylaws:

A fee-shifting bylaw, like the one described in the first certified question, is facially valid. Neither the DGCL nor any other Delaware statute forbids the enactment of fee-shifting bylaws. A bylaw that allocates risk among parties in intra-corporate litigation would also appear to satisfy the DGCL’s requirement that bylaws must “relat[e] 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.” The corporate charter could permit fee-shifting provisions, either explicitly or implicitly by silence. Moreover, no principle of common law prohibits directors from enacting fee-shifting bylaws.[4]

Contrary to some of the commentary circulating regarding this case, the Court's analysis is consistent with the American Rule, which generally requires parties to litigation to bear their own costs and fees.  The American Rule incorporates several exceptions, one of which is allowance for contractual fee-shifting.[5]

The Court found, however, that it had insufficient facts to answer the other certified questions as applied to the parties.  However, it ruled as a general matter that the bylaw would be unenforceable if it was adopted in a manner contrary to law or for an improper purpose, and that the provision could be applied to members joining the corporation before its enactment.

This case is noteworthy for a number of reasons.  Fee-shifting provisions in corporate bylaws are relatively rare, and many practitioners long assumed that they would be unenforceable per se.  The Supreme Court, however, has made clear that it would treat such provisions no differently than similar provisions in any other contract.  Moreover, nothing in the opinion suggests that this rule will not apply to traditional stock corporations.  The implications are significant, particularly in the realm of shareholder class-action lawsuits.  Consider, for example, the following from Reuters:

[Shareholder litigation attorney Stuart] Grant said a shareholder with 1 percent of a company's stock - a large holding for a typical plaintiff - would never sue if they stood to get 1 percent of the benefit but risked bearing 100 percent of the cost if they lost. Investor lawsuits can cost millions of dollars to litigate.
The ruling could blunt critics of Delaware courts, who say judges there are not doing enough to stem a tide in recent years of certain class action lawsuits that are filed against every merger deal, sometimes by shareholders with only a few shares.
The lawsuits accuse board members of breaching their duties to shareholders under Delaware law by agreeing to sell the company too cheaply.
The weakest cases typically settle quickly, with directors being released from liability in return for giving shareholders a bit more information about the deal, but no more money. The companies also agree to pay the shareholder's attorneys, who get around $400,000 for a typical "disclosure only" settlement.
The U.S. Chamber of Commerce has called the practice "extortion through litigation."

However, any potential prejudice to the rights of shareholders may be offset by the risk to directors' positions if they adopt a similar bylaw provision:

Claudia Allen, a specialist in corporate governance at Katten Muchin Rosenman in Chicago, said directors adopting such bylaws could risk a backlash from investors unhappy about a board restricting their rights.


[1] ATP Tour, Inc. v. Deutscher Tennis Bund, No. 534,2013 (Del. May 8, 2014).
[2] C.A. No. 07-178 (GMS).
[3] Mahani v. Edix Media Group, Inc., 935 A.2d 242 (Del. 2007).
[4] ATP Tour, Inc. v. Deutscher Tennis Bund, Op. at 9.
[5] See Sternberg v. Nanticoke Mem’l Hosp., Inc., 62 A.3d 1212, 1218 (Del. 2013) (“‘An exception to [the American R]ule is found in contract litigation that involves a fee shifting provision’”).