Unmeritorious shareholder litigation is a persistent problem for U.S.-listed public companies. Delaware, where so many public companies are incorporated, has taken this issue seriously. A recent Delaware Supreme Court ruling provides a potential new option for corporations (and their directors and officers) to avoid frivolous litigation. The new protection involves corporations adopting the English Rule when it comes to attorneys’ fees.
In the United States, we normally follow the “American Rule” when it comes to the cost of litigation: absent extraordinary circumstances, the winners and the losers in any adjudicated matter each pay their own legal bills, regardless of the litigation's outcome. Even if a defendant wins a total victory in court, the defendant will still bear the cost of paying his or her lawyers. The public policy purpose of the American Rule is to enhance plaintiff access to the court system.
By contrast, the English Rule, also known as a fee-shifting rule or the “Loser Pays” rule, is this: the loser of the litigation will pay all of the victor's legal bills.
Consider the impact of this rule on the dynamics of corporate shareholder litigation. Plaintiffs are less likely to bring weak cases because they will have to pay the defendant's legal bills if the defendant wins. Moreover, defendants are less likely to settle frivolous cases. Instead, any defendant being sued for frivolous reasons will spend more in legal fees, win the case and have the plaintiff pay the defendant's legal bills. This is a superior outcome for the defendants compared to settling the claim for some amount and also having to pay their lawyers.
In May, the Delaware Supreme Court opened the door for corporations to move to the English Rule. In ATP Tour, Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court held that Delaware law does not prevent a non-stock corporation from adopting fee-shifting bylaws. Most commentators have noted that the court's reasoning is directly applicable to regular stock corporations as well.
Of course, not everyone wants to see all stock corporations move to the English Rule. The immediate reaction of Delaware State Bar Association's Corporation Law Council was to introduce legislation banning stock corporations from adopting fee-shifting rules in their bylaws. The Council wanted to pass this legislation before the end of the June 30, 2014 legislative session. However, as of the writing of this column, the Delaware Senate has elected instead to study the issue further.
What should you do if your corporation wants to adopt fee-shifting bylaws? Assuming your bylaws give your board the ability to modify the corporation's bylaws without shareholder approval, it's still a good idea both to study the issue and understand what your particular shareholders’ reactions are likely to be. While this is generally an easier exercise for private companies, it is still worthwhile for public companies since the issue squarely confronts the question of to what extent and in what manner shareholders should be able to express themselves outside of the annual director election process.
While some shareholders will not want any restraints placed on their ability to sue directors and officers, others are likely to be more sympathetic to the need for fee-shifting bylaws. After all, when a group of shareholders sues a corporation, in almost all cases it is the corporation—which is to say the shareholders as a whole—that pays the legal bills to defend the corporation and its directors and officers. To the extent that a few plaintiffs and their attorneys are bringing frivolous suits merely to obtain settlement payments and plaintiff attorneys’ fees, adopting fee-shifting bylaws may be a prudent way to defend the corporate treasury.