Company Response to ATP Tour
With more than half of all Fortune 500 companies incorporated under the laws of Delaware, the ATP Tour decision hardly went unnoticed. Because the Delaware Code does not have separate provisions for stock and member corporations, corporate law firms quickly began alerting their clients to the decision. This ignited a new “race to the bottom,” as some of those clients commenced adopting burdensome fee-shifting provisions.
At present, more than 70 companies have adopted fee-shifting provisions restricting shareowners’ ability to bring meritorious claims against or on behalf of the companies in which they invest. While there is some variation among the recently adopted provisions, the following bylaw of Delaware public corporation Insys Therapeutics, Inc. is typical:
Section 50. Litigation Costs. To the fullest extent permitted by law, in the event that (i) any current or prior stockholder or anyone on their behalf (“Claiming Party”) initiates or asserts any claim or counterclaim, including any derivative action brought by or in the right of the corporation (“Claim”) or joins, offers substantial assistance to, or has a direct financial interest in any Claim against the corporation and/or any director, officer, employee or Affiliate of the corporation, and (ii) the party bringing the Claim does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then each Claiming Party that initiated or asserted the Claim or joined, offered substantial assistance to, or had a direct financial interest in the Claim shall be obligated jointly and severally to reimburse the corporation and any such director, officer, employee or Affiliate of the corporation, the greatest amount permitted by law of all fees, costs and expenses of every kind and description (including but not limited to, all reasonable attorney's fees and other litigation expenses) (collectively, “Litigation Costs”) that the corporation and/or any director, officer, employee or Affiliate of the corporation may incur in connection with such Claim. . . .
Notably, some companies have adopted even more onerous fee-shifting provisions than INSY. For example, another Delaware public corporation, Hemispherx Biopharma, Inc., adopted a fee-shifting provision that applies retroactively to pending litigation and requires shareowners to post a bond to cover the defendant corporation’s costs.
The most troubling aspect of the ATP Tour bylaw and its progeny, as illustrated in the INSY provision, is the requirement that a shareowner “substantially achieve, in substance and amount, the full remedy sought” to avoid paying the defendant corporation’s costs and fees. Under that provision a shareowner could assert a potentially meritorious claim for $100 million, obtain a favorable judgment for $60 million, and nonetheless be required to “pay fees, costs and expenses of every kind and description (including but not limited to, all reasonable attorney’s fees and other litigation expenses)” to the defendant corporation.
From the investor’s perspective, if broad fee-shifting bylaws like those adopted post-ATP Tour become more widespread in corporate America, the ability of shareowners to pursue litigation of meritorious claims against companies would be severely limited. Virtually no lawsuits of any type substantially achieve in substance and amount the full remedy sought, as the bylaws appear to contemplate. In addition, settlements would likely be discouraged because, absent a consent judgment, fee-shifting provisions might still apply, providing corporate defendants with additional leverage in settlement negotiations despite the merits of the shareowner’s claim.
When faced with such provisions, few rational investors would bring meritorious claims given the potential exposure to which they, and in the case of institutional investors, their beneficiaries, would be subject. This is particularly true when the probable monetary recovery may be small in comparison to the defendant corporation’s potential expenses.
Moreover, fee-shifting provisions may not be limited to state statutory or fiduciary duty claims. Meritorious federal law claims, including securities law claims, might also be impacted as a result of the broad language of these provisions. The scope of fee-shifting provisions under federal law ultimately is an issue which will have to await determination by the courts. In the meantime, additional oversight and disclosure of fee-shifting provisions by the U.S. Securities and Exchange Commission may be appropriate.
The Council of Institutional Investors (CII) represents the interests of public, corporate, and union employee benefit plans, foundations, and endowments, and strives to promote effective corporate governance and strong shareowner rights. CII’s corporate governance best practices provide that companies should establish structures that protect and enhance a company’s accountability to its shareowners. CII believes the adoption of broad fee-shifting provisions conflicts with that policy.
Fee-shifting provisions reduce accountability to shareowners by essentially sweeping away an essential mechanism for policing misconduct by officers and boards. If investors perceive over time that the statutory rights of shareowners and the fiduciary obligations of corporate officers and boards are unenforceable, their confidence would likely diminish, and capital formation could be adversely affected.
Proposed Delaware Legislation
Delaware’s legislature, however, may have the opportunity to restore accountability to shareowners by reversing some of the damage engendered by ATP Tour. This past March, the Delaware State Bar Association approved draft recommendations for amendments to the Delaware Code, directly implicating the issues raised by ATP Tour. Those recommendations are expected to be considered during the current session of the Delaware General Assembly.
If enacted, the draft legislation would invalidate provisions in the articles of incorporation or bylaws of stock corporations that impose liability upon a shareowner for the corporation’s attorney fees or expenses in connection with certain claims. More specifically, the draft legislation includes the following two parallel provisions:
Section 2. Amend § 102, Title 8 of the Delaware Code, by adding a new section, § 102(f), shown by underline as follows:
(f) The certificate of incorporation may not contain any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an intracorporate claim, as defined in § 115 of this title.
Section 3. Amend § 109(b), Title 8 of the Delaware Code, by making insertions as shown by underline as follows:
(b) . . . The bylaws may not contain any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an intracorporate claim, as defined in § 115 of this title.
A legislative proposal containing similar language was tabled by the Delaware General Assembly last June pending more input from corporate interests. This year, the General Assembly may pass some form of the draft legislation after consideration of input from a broader mix of market interests. All interested members of the American Bar Association are encouraged to share their views with the General Assembly on this issue of great consequence to investors and corporate governance generally.
Keywords: securities litigation, ATP Tour, investing, fiduciary duty, Delaware General Assembly
Jeff Mahoney is a CPA and general counsel at the Council of Institutional Investors in Washington, D.C. Andrew Droste is a legal policy intern with the Council of Institutional Investors and a third-year law student at Northeastern University School of Law.